Money Supply Has Grown Like a Weed

For investors seeking clear signals about the direction of the economy, this has been an especially difficult period. Perhaps a closer look at an alternative indicator can shed some light.

I have been tracking the progress of M1, the broadest gauge of money supply. An increase in money in circulation is often a harbinger of expanding economic activity. I last looked at M1 back in June.

The most recent preliminary data for July from the Federal Reserve show that M1 figures have risen sharply in June and July after falling in May. M1 stood at $1.36 trillion in May but rose to $1.38 trillion in July before another uptick to $1.4 trillion in July. That's a $34 billion increase in three months. M1 does not typically rise 2.5% in just three months.

Generally speaking, M1 can be viewed as a measure of transaction demand. This includes items such as checking accounts that are used by businesses and individuals to pay for day-to-day expenses. If businesses are conducting more transactions, then they need to maintain higher balances in these types of accounts.

This could also mean that higher gas prices and rising inflation are causing people to keep higher checking balances to cover these increased costs. But for now, let's assume that M1 increased as a result of increased economic activity in line with the second quarter revisions to gross domestic product (GDP). Government economists now believe that GDP rose 3.3%, which is adjusted for inflation, and thus a reflection of true economic growth.

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