What Is the Money Supply and What Does it Mean For You?

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Another day, another lesson on financial terminology. This time, we're tacking the money supply.

Put simply, the money supply is the total number of dollars of highly liquid assets in a country's economy at any given point in time.

Let's define 'highly liquid' first: assets that are either 100% cash or cash-like, which means they're so close to cash that they can be considered cash. 

There's M1, which is all cash, like dollar bills, coins and total amounts held in checking accounts. Then there's M2, which is M1 plus cash in savings accounts and assets held in money market mutual funds, which own highly liquid and short-term government bonds or commercial paper. 

Recently, the money supply has expanded at an unprecedented pace as the Federal Reserve and Congress fight to put out the fire of the coronavirus-induced recession. 

The Federal Reserve expands the money supply by buying bonds to keep interest rates low (rates fall when prices rise, which is caused by the overwhelming demand from the Fed's cash injection). Sellers of bonds — short term and long-term governments bonds and even corporate bonds — receive cash from the Fed. 

You can imagine one of the biggest sellers here is the banking industry, which is transacting with the Fed. 

Now, the banking system is strapped with cash to lend into the economy, which borrowers will accept, as rates have plummeted. This can't cure the pandemic -- a vaccine can. But it enables businesses, households and corporations to remain liquid until lockdowns end, employment rises and a vaccine hits the market, bridging the gap between this desperate time and a more healthy economic environment. 

Research from Morgan Stanley investment strategists show that M2 has increased 22% in the few months since the beginning of the Fed's quantitative easing program (QE), in which it buys long-dated government bonds. In the same time frame after QE after the financial crisis in 2009, M2 increased just 5%. 

Furthermore, Morgan Stanley says about $800 billion of that new money is now sitting in bank deposits, one piece of evidence that banks are lending out this money to willing borrowers. 

To see how this impacts your investments and your wallet, see the quick video above.

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