Trader Tip: Money Supply In recent testimony from Janet Yellen, the current Fed chair, she spoke of what keeps her up at night. If it keeps her up at night, perhaps we should take note. She went on to say that the $20 trillion US national debt ‘should keep people awake at night.’ Though some would dispute, the recent Trump tax plan that is about to be approved, is set to add $1.5 trillion on top of this. Yippes! For us traders we should take a look at this and understand more of the fundamentals that affect the markets we trade. As we have discussed in the past the value of fiat currencies has a lot to do with the monetary base. Remembering that all fiat money is a function of credit, we want to go into more understanding of the denominator of our fiat money value equation, the money supply.

GDP (Gross Domestic Product)/Monetary Base = Fiat Currency Value

First off how do we define money supply? I reprint here from Wikipedia the broad categories that most economist see this money supply:

Type of money M0 MB M1 M2 M3 MZM
Notes and coins in circulation (outside Federal Reserve Banks and the vaults of depository institutions) (currency)
Notes and coins in bank vaults (Vault Cash)
Federal Reserve Bank credit (required reserves and excess reserves not physically present in banks)
Traveler’s checks of non-bank issuers
Demand deposits
Other checkable deposits (OCDs), which consist primarily of Negotiable Order of Withdrawal (NOW) accounts at depository institutions and credit union share draft accounts.
Savings deposits
Time deposits less than $100,000 and money-market deposit accounts for individuals
Large time deposits, institutional money market funds, short-term repurchase and other larger liquid assets
All money market funds

Today total US money supply is near $70 trillion. It is growing at near a rate of 5% a year. Let’s see how this works with an example, using today’s economic numbers (though US centric, the same issues applies to other countries and each currency does need to be juxtapose against the other). Strictly from a monetarist view point (see again the fiat money value formula from above), with GDP growing at around 3%, this means the net (money growth – GDP growth) would a 2% inflation rate. So you can see how this puzzle begins to fit together.

You might say that this is fine and dandy but how can I use this to trade? Nearly each day there are scheduled events, reports and statements that come out that can effect the money supply. Knowing the fundamentals behind this can help guide the trade. Here are some basic things to watch for and their effect on money supply and hence currency price:

  • Central bank statements – indicating hawkish or dovish (money supply expansive) tendencies on rates. The latter being negative for the currency.
  • Business or consumer credit reports – large increases (money supply expansive), without GDP growth are negative for the currency.
  • Government spending or taxation – where the policy is more austerity focused (money supply reduction) tends to be positive for the currency.
  • Sudden unexpected change – (strong or weak) in expectations on these reports can jolt the markets.

Note that the economy is a bit of a Rubik’s cube. Everything is related, some are effects and others are causes. Of course one could debate which is which. In this article, though somewhat high level and with a broader view, we focused on the money supply part.

We hope this will spur you on to do more research on this and develop your own thinking on how best to use this as a “Filter” in your Trade Plans, or background information to guide you in general trends in the markets. It just might save from a trade, that could go very wrong. Click here, or watch below a video presentation of this Trader Tip.

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Trader Tip: Money Supply

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