The advice “Don’t fight the Fed” makes sense. If the Fed is flooding the financial markets with cash, then buy and follow along as the Fed makes money available to drive up asset prices. If the Fed is tightening, reducing the available supply of cash, then sell and move to the sidelines. It will be hard for the price of financial assets to climb if the Fed is pulling money out of the financial markets.
Right now it sure looks like the Fed is expanding the money supply.
In the three months though May, M1, the narrowest measure of the money supply (since it includes checking accounts and other highly liquid “kinds” of money but not savings accounts or money market accounts (those are part of M2) climbed at an annualized rate of 105%. (M2 climbed at an annualized rate of just 65.3%. From March 30 when M1 stood at $4.525.9 trillion, M1 climbed to $5.078.4 trillion on May 11, and then to $5,225.6 trillion on June 15.
That’s a flood of $700 billion in cash added to the M1 money supply.
Enough to power big gains in the prices of financial assets and to jump start the economy.
If people bought stocks and bonds with that money or went out to purchase things in the economy.
But there’s some question what they’re going to do with that cash.
The advocates of a V-shaped economic recovery say that consumers will spend the part of that increase in cash that went into their pockets. We’ll see a rebound in the economy as demand recovers. There were signs of that in May when consumer spending grew by 8.2% as many states re-opened their economies.
But the numbers also say that consumers saved a good part of the cash that came their way from those $1,200 stimulus checks and the $600 a week in expanded employment benefits.
The personal savings rate increased to a record 33% in April (from the previous record of 17.3%.)
Saving some of that temporary windfall would be a reasonable response to the continued uncertainty of the coronavirus pandemic. In May the economy dded 2.5 million jobs when economists expected the economy to lose another 8.33 million jobs.
But average hourly wages fell 6.7% as a job number of these jobs came with fewer hours or lower hourly compensation than before the virus outbreak.
We know from recent experience with central banks in the United States and the European Union that cutting interest rates and making more cash available for purchases doesn’t have to result in higher levels of demand. We’re witnessing the corporate equivalent of that in the bon market right now where companies are selling a lot of debt but not spending it to expand production by hiring more workers or buying more machinery. They’re putting money aside “just in case.”
Which is a reasonable response to the high levels of uncertainty in the economy.
Consumers could decide to do the same and stash their “extra” cash in checking and savings accounts. (M2 totals have also soared.)
It would be a useful moment to remind ourselves that recessions have a huge psychological element. Consumers pull back on spending and stash more money into mattresses for a rainy day because they feel uncertain about the future and decide that spending less is prudent. (Congress might have removed some of this uncertainty by acting on another coronavirus rescue bill. But it didn’t. That inaction problem increased the degree of uncertainty and made the earlier rounds of fiscal spending less effective.)
We don’t know how much of that explosion in cash engineered by the Federal Reserve will get spent or when.
We might have a slightly better idea from the June jobs report due on July 2.
But I’d be surprise in the degree of clarity went way up.