What Is the Money Supply? Are Record Highs Even Real?

What the money supply is

The money supply is exactly what it sounds like — the total amount of money circulating in an economy. Crucially, it isn’t fixed. It grows, sometimes slowly and sometimes very fast.

Here’s the insight that makes it matter for your portfolio. A stock index is a number of dollars. The money supply is the number of dollars in existence. If the second one grows, the first can grow right alongside it without any company earning more or being worth more. That’s the denominator effect: you’re not measuring a bigger thing, you’re measuring with a smaller unit.

How it’s measured: M1, M2, M3

Economists slice the money supply into definitions labeled M1, M2, and M3. M1 is the narrowest — the most liquid money, physical cash plus checking balances, the stuff you can spend right now. M2 is broader: M1 plus savings accounts, small time deposits, and retail money market funds — money that’s spendable now or can become spendable very easily. M3 was broader still, but the Fed stopped publishing it back in 2006, so you can mostly ignore it.

When a headline mentions the money supply, it’s almost always talking about M2. That’s the standard, and it’s the one to know.

The part most takes get wrong

Knowing the money supply grows isn’t enough. You have to know how fast — and that rate swings dramatically with what the Fed and the government are doing.

During the pandemic, M2 grew more than 26 percent in a single year, a historically extreme expansion. When money grows that fast, a big chunk of any market gain really is just the denominator — the ruler genuinely was shrinking, quickly. But that’s not the normal state of things. For most of modern history M2 has run closer to 4 to 5 percent a year, a few percent above a roughly $20-trillion-plus base. That’s modest, close to the historical norm.

And here’s the critical point: a money supply growing at 4 percent cannot explain a market up 20 or 30 percent. The math doesn’t work. So when records pile up during a period of normal money growth, most of that gain isn’t the denominator — it’s earnings, productivity, or simply investors willing to pay more for the same thing.