M is for Money Supply!

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• published: 27 Aug 2015
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Welcome back to the A-Z of investing. Today we’ve reached the letter M which stands for one of the least understood aspects of our economy, Money Supply We all take it for granted that there’s enough money for the things we need. If we need more money, we go to the bank or the hole in the wall. Unless, of course, we live in Greece or Cyprus. But control of the money supply by central banks has been at the heart of monetary policy for years. If you don’t take the time to understand it, you won’t be able to make informed investment decisions. Let’s start with the definitions. Money supply is the entire stock of currency and other liquid instruments in a country's economy at a particular time. The money supply includes cash, coins and balances held in bank and savings accounts. There are a number of different definitions depending on what you include in the total number. For example M1 is the sum of coins and notes held by the public and the banks. M2 is M1 plus the balances in current accounts and instantly accessible savings and money market accounts. M3 includes all of M2 plus larger and less liquid deposits in banks, savings organisations and other institutional money market funds. The theory is that, if you want to stimulate growth in the economy, you increase money supply. If you want to put the brakes on growth, you decrease the money supply. There’s a whole generation of politicians and central bankers who dream about the day when they have to apply the brakes because there’s too much growth occurring. Today, we’ve taken this theory to a whole new level. Trillions of pounds, dollars, euros and yen have been printed in an attempt to kick start growth in tepid global economy. At best you could say it might have avoided a nineteen thirties style depression. When they first started counting American money supply back in nineteen fifty nine, M2 stood at two hundred and eighty six billion dollars. In June twenty fifteen it reached an all time high of eleven thousand nine hundred and eighty two billion. That’s an increase of forty two times. In the last decade alone M2 money supply has doubled. Now let me ask those of you in gainful employment a question. Has your salary doubled in the last ten years? I thought not. Official inflation figures show a rise in prices of just eleven per cent since the financial crisis of two thousand and eight. So where has all that extra money gone? The answer is, into asset bubbles. Like stock markets. Like property. Like art and classic cars. Into speculative investments like the Chinese stock market. Into trophy assets like Mayfair and Manhattan real estate. So the question is, what happens next? History tells us that these asset bubbles will burst. It’s just not very good at telling us precisely when. It likes to creep up on us in the night when we least expect it. A good question to ask yourself is, which asset bubbles am I currently exposed to? How would my portfolio look if there was a sudden thirty to fifty per cent correction? Harry Dent, my keynote speaker at the 2015 Wealth Summit, suggests that now is the time to sit on the sidelines in cash and wait for the bargains to appear after the inevitable crash. That may seem like an extreme position, but I’d argue strongly that keeping your head in the sand and doing nothing is an even riskier strategy. The massive and artificial ramping up of global money supply has selectively distorted many markets to the point where fundamental valuation approaches have become meaningless. Don’t use that as an excuse to just ride the trend. Make sure every investment you own has been reviewed for its bubble worthiness and make a conscious decision on what to keep and what to let go as we head into these turbulent waters.