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Falling money supply points to recession, and maybe severe


Professor Tim Congdon is Chair of the Institute of International Monetary Research at the University of Buckingham. Firstlinks has featured his work several times, starting at the height of the pandemic on 15 April 2020 in Magic money printing and the reality of inflation, when he said:

"What is wrong with the supposed ‘magic money tree’? The trouble is this. When new money is fabricated ‘out of thin air’ by money printing or the electronic addition of balance sheet entries, the value of that money is not necessarily given for all time. The laws of economics are just as unforgiving as the laws of physics. If too much money is created, the real value of a unit of money goes down ... The Federal Reserve’s preparedness to finance the coronavirus-related spending may prove suicidal to its long-term reputation as an inflation fighter ... If too much money is manufactured on banks’ balance sheets, a big rise in inflation should be expected."

He was correct about inflation but most people, including central bankers,  ignored him. We revisited his opinions, most recently here, at the beginning of 2023. This is an edited extract from a video update in march 2023.


In developments in the global monetary scene. I want to focus today only on the three Western economies, the United States, the Eurozone and the UK. I'll say one or two things about China, India and Japan.

The message will be short and sweet, although perhaps not as sweet as it might be, because in fact, the news is rather worrying.

You will remember that back in early 2020 I pointed out the explosion in money growth that was then occurring in these economies, in the United States, the Eurozone and the UK, a bit elsewhere, but particularly really in those three economies. And we warned about a coming inflationary boom and rising inflation as economies return to normal after the COVID pandemic.

Money growth boom has collapsed

Today, the situation is radically different. We have had the inflation that was correctly forecast. Now, we have a collapse in money growth. And in the last few months, the quantity of money has actually been falling in all three of those places, the US, the Eurozone and the U.K. And even in the US, the change in money is not just a fall of a few months, it's fallen the whole year.

(This extract will not include the sections on the UK).

The coming recession in the US

First, let's look at the United States since just after the GFC around 2009.

Back in 2009-2010, we had contractions in money in the US, followed by a period of stability. And then there was an explosion in 2020. On the 12-month measure, that's the brown line, the high money growth rolled through into 2021. It then comes down, and in the last few months, money has been actually contracting with the brown line finally going negative in the opening month of 2023. This chart finishes in January. 

We do have numbers for bank deposits in February and two weeks in March. That's the quantity of money, which includes bank deposits and notes and coins. The detailed data on deposits is more frequent than M3.

What these figures show is that the quantity of money has continued falling, as  deposits dominate money (M3). So, this is a continuing trend. Roughly speaking, money is going down at around about 0.25% to 0.5% a month. In the US Great Depression of the early 1930s, money was falling by about 1% a month. It's not that disastrous at the moment because there is still this cushion, an overhang from 2020 and 2021.

But the way things are going signals a recession and potentially quite a bad one.

These numbers are, of course, very different from what I was talking about three years ago, the boom/bust cycle, but it shows total incompetence on the part of the US Federal Reserve. But inflation coming down and probably, in 2024, coming down towards the 2% figure, which is the target that central banks have in mind these days.

Eurozone also negative over next few months

The Eurozone for much of last year was very different. In fact, rather high money growth carried on until the final months of last year, then collapsed. Quite why this happened, I'm not sure, but that's what the data show. The 12-month change is still positive, with the blue line at about 3% or so, but well down from the figures over 10% in 2021. And the way things are going, this will probably go negative in the next three to six months.

This chart goes back to 2005 and the rapid growth of money in 2006-2007. There was a boom in the Eurozone then, particularly in the so-called Club Med countries – Spain, Portugal, Italy and so on. Then came a plunge, and a long period of rather weak money growth down at about 1% or 2% a year when in fact, the Eurozone, unlike the USA or the U.K. had a second recession.

Then 5% a year in the late 2010s, stable growth, low inflation, followed by a rapid growth of money in the COVID period, and now a collapse.

So you can see the connection between what's happening to money and what's happening to the economy, and this again is telling us that a recession is in prospect in the Eurozone. Some countries, in fact, have that negative quarters or even two quarters, but not as yet for the entire Eurozone.

A simple and obvious warning

This is a relatively simple, relatively obvious warning. What happened in 2007 to 2008 was that the banks got the blame. In autumn 2008, the powers at the G20 governments, their finance ministers, the central banks, the Bank of International Settlements and the International Monetary Fund decided that the banks must have more capital relative to their risk assets. There was a big rise for around about 60%-70% in the banks' capital requirements per unit of risk assets, per unit of loans to the private sector.

As far as whether you think that's desirable, the effect on economies was catastrophic because the banks started to pull in loans, to sell securities, to reduce their risk assets because they were required hold much more capital relative to those assets. And the result of that was to aggravate, to intensify the falls in the quantity of money, the falls in bank deposits.

To avert another Great Depression, the central banks then organised quantitative easing (QE) programmes where they bought assets from non-banks which increased the deposits held by non-banks and that did deal with the problem.

However, with the failure of SVB Bank, the absorption of Credit Suisse into UBS and so on, talk is of another round of increases in capital asset ratios for the banks, not just the banks that are delinquent. That will make any coming recession even worse.

That's my sombre message this time

I'm sorry it's a bit gloomy. One has to be direct about these things. I haven't dealt with the non-monetary theories of inflation that have been going around, but they are wrong. I have outlined here the move to contractions in the quantity of money and the risks that these will get worse if the regulators blunder as they did in 2008. 


Professor Tim Congdon, CBE, is Chairman of the Institute of International Monetary Research at the University of Buckingham, England. Professor Congdon is often regarded as the UK’s leading exponent of the quantity theory of money (or ‘monetarism’). He served as an adviser to the Conservative Government between 1992 and 1997 as a member of the Treasury Panel of Independent Forecasters. He has also authored many books and academic articles on monetarism.

This article is general information and does not consider the circumstances of any investor.

Former Treasury policy maker
April 17, 2023

Actual economic analysis, rather than the populist 'supply side' argument, shows that it was excess demand that caused inflation to rise. The only way that supply issues in one market - even oil - can cause a general rise in the level of inflation (prices rising across the board, which is what's happened in 2022 and into 2023) is if demand overall is strong enough that those costs aren't absorbed by other industries. (That's what's happened a few times in the last couple of decades when oil prices have risen.) Or that other prices don't fall to offset those that rise. Demand was strong enough, because easy monetary policy was turned into credit creation by highly supportive fiscal policy. This was true in other countries, though even more so in Australia. Had central banks, including the RBA, been paying attention to folk like Prof Congdon - and their own money supply data - they could have seen that this was turning into something much greater than just GDP hanging in there better than expected. They could have started to raise rates and cut their QE programs during 2021 instead of waiting another year. It is now a much more painful process to get inflation back under control than it needed to be.

April 17, 2023

you mean RAISING rates in 2021 of course.

To help those less economically literate:
btw agree with your assessment of Oil supplies and demand analysis i.e. if there was poor overall demand then the oil price rise will dampen demand for oil keeping its price down. However due to strong overall demand, oil consumption did not drop but caused overall prices to rise.

Also note that Oil was not cut off but in reality diverted to China and India(cheaper for them) from Russia thereby keeping total world oil production relatively stable. Oil/Energy was of course more expensive for the West

Former Treasury policy maker
April 18, 2023

While on the topic of oil, the key indicator price of WTI crude rose sharply in 2022, but from about it's lowest level in 2 decades to a price still somewhat below where it was trading from 2011-2014, and it's fallen back since. There is just no real evidence to support the idea that the oil market caused this global inflation surge. It's been the excuse for slow monetary response, to everyone's detriment.

April 17, 2023

J. Abernethy's explanation and T. Congdon's monetary supply theory and MV=PT all still holding true. Just different ways of looking at the issue of inflation, Money supply etc : Currently M down and decreasing due to central bank action. Currently V likely to be dropping with banks being more cautious Therefore P likely to drop slowly as T(GDP as proxy) is falling from the rebound level i.e. slowly too and not negative. Japan : High M but low V after the crash 20 yr ago. So P did not rise. T did not rise either. Note recent M acceleration with COVID and now P beginning to rise a little. The current rise in risk free interest rates ( 10 yr USD bonds ) explains the drop in Asset prices - bonds and equity. No denying that Energy and grain prices rose substantially with Ukraine War ( cost pull inflation) however note that oil markets did not suffer a shortage just redirection of flows ( Russian oil to China and India). Total energy production did not drop significantly. Usage went up due to excess monetary supply and economic rebound activity. What now ? MV=PT P,T will drop with M,V dropping. How fast and how much ? ??

John Abernethy
April 14, 2023

It seems extraordinary that Mr.Congdon downplays a 50% increase in oil and LNG prices, as well as coal and grain prices that flowed from the Ukraine War, and infers that these did not substantially add to inflation that had been caused by the reopening of the world economy after Covid.

There was “reopening” inflation as supply lines across the world struggled to be get back to 2019 levels. Ask any Australian importer of goods that originated from China, Asia and Europe and they will confirm the immediate price hikes and supply shortages that were encountered. By the way I am on the Board of an importer and saw it occur.

So maybe Mr.Congdon got his inflation call correct - but for the wrong reasons.

In any case the money supply theory of inflation has been debased by near 25 years of QE in Japan, without any inflation outbreak - until the Ukraine War.

However, to offer some support to Mr.Congdon I can suggest the real debasement of currency from QE, was seen in asset price inflation that was not captured in the CPI. Notably bonds and negative cashflow companies.

The 2022 collapse in the bloated prices of bonds, directly flowed from QE stalling, QT commencing and the cost pull inflation flowing from Covid/Ukraine War.

The 20% decline in US bonds and equities in 2022 was an asset price reaction to the upward change in the risk free return ( 5 and 10 year bond yields ). At this point those declines have not ( as in the past) correctly forecast an economic decline in the US.

Further, long dated US bond yields are today trading well below recorded inflation - as if inflation does not exist.

Negative real yields and what these mean for economies and asset prices, is not covered by Mr.Congdon and that is an oversight in his opinion piece.

April 13, 2023

"Banks lend first, then find reserves later.": First households form, earn, save a bit, then, if small interest rates make saving uneconomic, mortgage their future incomes to borrow to buy a home for the household. Then the mortgagee (bank) seeks additional funds to lend to the mortgagor (household). The home seller offers the money from the home sale to one or more banks. One turn of the cashflow cycle - An smaller un-mortgaged portion of an home owned by the seller becomes a larger mortgaged portion of an home owned by the buyer. Money supply increased. As buyer uses income to pay off mortgage principal, money supply decreases.

Russell (a veteran adviser)
April 13, 2023

I'm sorry, you are confusing "money" as commodity, as opposed to being "credit". Current inflation has not been caused by "too much money" it has been caused by supply-side issues. Higher interest rates will inevitably cause recession, at the expense of those thrown on the unemployment heap and those for whom the cost of living will remain too high. The quantity theory of money has been disproven. CBs don't control the rate of growth of the money supply. There is no such thing as the banking multiplier. Banks don't lend out their deposits. QE doesn't lead to increased credit creation. Banks lend first, then find reserves later.

Former Treasury policy maker
April 13, 2023

Russell, I think it's you who is getting confused here. Money and credit are, to an economist like Prof Congdon, almost the same thing. Money is created by banks making loans - ie creating credit. Every monetarist knows this so I'm not sure what the nature of your criticism actually is.

You say that QE doesn't lead to increased credit creation. Um, that's simply not true. Typically people who argue that have in mind the immediate years after the GFC when the so-called 'money printing' didn't result in an outbreak of inflation. However, you have to counter the argument that broad money growth was in the process of collapsing, which was going to cause a massive recession, and QE was part of the mix that prevented that happening. Credit didn't get created, but it was prevented from going disastrously backwards.

Turn to 2020 and the resumption of QE policies came at a time when broad money wasn't on the brink of collapsing apart from concerns about the pandemic shutting things down. Governments provided a lot of targeted fiscal stimulus at the time which prevented that so that the low interest rates across the maturity spectrum resulted in a massive increase in borrowing (i.e. bank lending or credit creation). This was because of easy monetary policy including some elements of QE.

So in what sense is the quantity theory of money 'disproven'?

As for banks lending first and finding reserves later, yep. Every monetary economist, including Prof Congdon knows that. But when you're talking about monetary trends you use data for both as evidence of what's happening.

Finally, as for supply-side issues causing inflation, that's the great furphy. Supply side issues can only become a general inflation of the overall price level if the price rises in those markets aren't offset by price declines elsewhere. We've had many cases over the last 20 years of, say, rising oil prices that haven't produced a sustained rise in the CPI or other measures of inflation because monetary policy was operating in an environment where it kept an appropriate macro restraint on a fairly steady state situation in which lots of other prices (eg of telecommunications devices) were falling rapidly. 2022 was different because those supply issues in oil and some other sectors were not being offset by rapid falls elsewhere because easy monetary policy had enabled broad-based growth in demand. MV = PT and the 2020-21 bout of low interest rates and other QE measures resulted in rapid growth in M so that PT was able to rise rapidly. T held up remarkably well (IE the economy kept growing for the most part, contrary to almost everyone's expectations including folk like Phil Lowe) and thus P was able to take off.

MV = PT is not a theory, it's an identity. How the elements within it play out is the stuff of macroeconomic theories and debate, but to me the approach that makes the most sense is that the rapid rise in M in 2020 pushed PT beyond the capacity of T to absorb it all, resulting in P rising. Congdon warned of this and he's now warning of the same thing you are in your comment - that continued high interest rates and tight monetary policies are causing a collapse in M that will bring P down, but also T with it - i.e. recesssion.

You are right that CB's don't control the money supply. But they sure as anything do influence it through their interest rate and balance sheet policies, if they wish to pay attention to it.

Hence, I detect a schizophrenic element in your comment which is criticising Congdon for saying the same thing that you're saying!

April 22, 2023

Russell - supply issues cause relative prices to change but dies not explain inflation. Some prices go up, others go down.

At the moment we gave seen relative price increases in food and energy which have caused issues


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