In a recent article, Ambrose Evans opined that a rising narrow money supply (M1 to be exact) presaged a rise in economic activity.
Usually this might be the case as an increase in shorter duration/easier access narrow money might imply a) an increase in bank lending that creates deposits via the money multiplier (implying higher current and/or future economic expenditure), and/or b) a shift from longer duration money with the intent of spending (which implies a reallocation of money from future consumption to current consumption). It may also very well mean just an increase in money supply occasioned by quantitative easing.
An increase in narrow money supply, via QE or reallocation of money balances, will only lead to an increase in GDP if consumers start to spend more, and they can only spend more if earnings and employment are increasing, or if they believe economic conditions are expected to improve and hence to reduce saving and increase expenditure and/or borrowing. Likewise, companies will only increase borrowing to invest if they expect an improvement in demand or an opportunity to raise productivity and efficiency. In the current economic environment the typical relationship between money supply growth on the liability side may well differ from lending growth on the asset side.
So let us look at money supply data, and let us start with the UK:
In the UK narrow money supply growth has risen in the year to June, but at a rate which is historically weak. Likewise the broader retail M4 data is rising but at a low level:
But what of broader money supply growth (M4):
That has been declining, as has M4 less M1, which has been declining at a faster rate – overall money supply is not growing.
This is backed up by M4 lending data (the key asset side component of money supply growth):
Between May 2008 and June 2012 UK Central bank assets have increased by 267,338 (millions), Central Bank reserve balances by 212,839 (millions), M1 by 95,526 (millions) and M4 by 314,525 (millions), but M4 lending by 174,096 (millions). Clearly, the monetary mechanism is not working as it would under more normal conditions and hence normal expectations should be qualified.