It is said that asset prices reflect the current status of money supply. Is the global money supply increasing or decreasing?
The balance sheet of central banks serves as the monetary base. Through the banking system, the monetary base gives rise to M2, which is typically multiple times the monetary base.
This so-called multiplier effect hinges on the level of confidence of the people with regard to achieving economic growth. If people are confident, they spend more and invest more, and so banks lend out more money, thus resulting in a bigger multiplier effect.
As such, M2 is partly determined by the central bank and partly contingent on the banking sector and the public.
US economic growth has been accelerating since last year, and hit 4.2 percent in the second quarter. We are in the so-called Goldilocks era of high growth and low inflation. This is why even though the Federal Reserve has been shrinking its balance sheet since the fourth quarter of last year, M2 has continued to increase.
In China, M2 has also been increasing. The balance sheet of the People’s Bank of China has risen by US$70 billion to US$5.3 trillion year to date, while M2 increased by US$380 billion to US$26 trillion.
Does that mean asset prices are set to rally further since there are more money in the system?
In the US, the Fed would cut the debt purchase amount by US$50 billion per month from October, and that means a full-year reduction of US$600 billion next year.
As long as the economy stays firm, the Fed is likely to keep shrinking the balance sheet.
The Fed’s balance sheet is expected to drop to US$2.8 trillion by the end of 2020, which means nearly half of new money supply over the last decade will be taken back.
It would take some time for the effect to surface, but a slower pace of M2 growth should take place as the monetary base continues to contract.
Meanwhile, China realizes it cannot keep printing money to prop up the economy.
It has kicked off a financial deleveraging campaign this year. And we’ve yet to hear any massive relaxation in its monetary policy despite the weaker stock market, indicating that Beijing has a strong resolve to pursue the deleveraging effort.
Hong Kong’s housing price is also closely tied to the local M2 growth. The city’s M2 growth rate eased to 5 percent in August from 13.6 percent in April, and the housing market has shown signs of cooling off.
To assess the outlook of housing prices, one should keep a close watch on M2 changes.
This article appeared in the Hong Kong Economic Journal on Oct 3
Translation by Julie Zhu
[Chinese version 中文版]
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