30 Years of U.S. Money Supply and Interest Rates
Money supply and interest rates are important macroeconomic factors that can change the direction of entire economies.
In the United States, the Federal Reserve, also known as the Fed, uses open market operations to influence these factors and fulfill its “dual mandate” of maximum employment and stable prices.
But how is money supply associated with interest rates?
How Money Supply Affects Interest Rates
Interest rates determine the cost of borrowing money in an economy. The higher the interest rate, the more expensive it is to borrow money, and vice versa.
By the law of supply, when there is less money in the economy, the cost of borrowing money tends to be higher. All else being equal, a decrease in money supply corresponds to higher interest rates, and by contrast, an increase in money supply tends to put downward pressure on interest rates.
Central banks use monetary policy—the macroeconomic policy that manages interest rates and money supply—to improve economic health. However, the nature of the monetary policy differs based on the state of the economy:
- Expansionary Monetary Policy
Expansionary monetary policies aim to stimulate economic growth by increasing the money supply, lowering interest rates, and increasing demand, spending, and investment in the economy.
- Contractionary Monetary Policy
Contractionary policies aim to slow down unsustainable economic growth and inflation by decreasing the money supply, increasing interest rates, and reducing spending while facilitating saving.
Today, the U.S. Fed is employing expansionary monetary policy, with near-zero interest rates and some of the fastest growth rates for M3 money supply ever seen.
But how has the Fed’s monetary policy changed over recent decades?
Economic Booms and Busts in the U.S.
Between 1990 and 2020, the U.S. money supply (M3) increased from around $3 trillion to $19 trillion, a rate that far exceeds that of economic growth.
During this time, the U.S. economy went through major shocks that affected its monetary policy.
The 2001 Recession
Internet and tech-based companies came to dominate the U.S. economy by the end of the 1990s.
During the same period, the Fed eased its monetary policy, with the goal of reducing interest rates and increasing liquidity in the economy. Excess money supply also went into the stock market, propelling the NASDAQ index to new highs at the time.
To curtail rising inflationary pressures and an overheating stock market, the Fed raised its Fed funds rate target six times between June 1999 and May 2000, reducing money supply growth. This, in turn, slowed down the flow of capital into the stock market in the lead-up to the dot-com crash and the recession that followed.
The 2008 Financial Crisis
The 2008 recession was the most severe economic downturn in the U.S. since World War II.
In an effort to spur the economy out of recession, the Fed dropped its rate target from 3.5% in January of 2008 to near-zero rates by the end of the year. Additionally, it also started a series of large-scale asset purchase programs (also known as quantitative easing), accelerating money supply in the economy.
From the end of 2008 to 2015, the Federal Open Market Committee (FOMC) established near-zero targets for the Fed funds rate in order to support economic activity and job creation.
The 2020 Recession
The pandemic-induced recession of 2020 called for policymakers and central banks around the world to take action.
In response to the financial turmoil, the FOMC dropped its Fed funds rate target by 1.5 percentage points to a range of 0% to 0.25%. It expects these near-zero interest rates to stay until 2023. Furthermore, at the end of 2020, M3 money supply was up by almost 25% year-over-year, the largest yearly increase since 1961.
The Fed’s response to economic turmoil involves large changes in money supply and the Fed funds rate, which affects not only the short term but also the long-term direction of the economy.
The Future of U.S. Money and Interest Rates
An economy’s money supply has a strong association with the currency’s purchasing power and inflation, although there are other factors at play. As the number of dollars in the economy increases, the amount of goods and services that can be bought with one dollar falls as price levels rise.
Due to the policy response during the pandemic, inflation has become a growing concern for investors and consumers alike. With money supply at unprecedented highs and interest rates near all-time lows, it’ll be interesting to see how long it takes for the U.S. economy to recover and rates to rise again.
Charting the Gold-to-Silver Ratio Over 200 Years
The gold-to-silver ratio used to define the value of currencies and still remains an important metric for metals investors today.
Charting 200 Years of the Gold-to-Silver Ratio
Gold and silver have been precious and monetary metals for millennia, with the gold-to-silver ratio having been measured since the days of Ancient Rome.
Historically, the ratio between gold and silver played an important role in ensuring coins had their appropriate value, and it remains an important technical metric for metals investors today.
This graphic charts 200 years of the gold-to-silver ratio, plotting the pivotal historical events that have shaped its peaks and valleys.
What is the Gold-to-Silver Ratio?
The gold-to-silver ratio represents the amount of silver ounces equivalent to a single ounce of gold, enabling us to see if one of the two precious metals is particularly under or overvalued.
Currently, the ratio sits at about 80 ounces of silver equivalent to one ounce of gold. This is after the ratio spiked to new highs of 123.3 during the COVID-19 pandemic.
While gold is primarily viewed as an inflation and recession hedge, silver is also an industrial metal and asset. The ratio between the two can reveal whether industrial metals demand is on the rise or if an economic slowdown or recession may be looming.
The History of the Gold-to-Silver Ratio
Long before the gold-to-silver ratio was allowed to float freely, the ratio between these two metals was fixed by empires and governments to control the value of their currency and coinage.
The earliest recorded instance of the gold-to-silver ratio dates back to 3200 BCE, when Menes, the first king of Ancient Egypt set a ratio of 2.5:1. Since then, the ratio has only seen gold’s value rise as empires and governments became more familiar with the scarcity and difficulty of production for the two metals.
Gold and Silver’s Ancient Beginnings
Ancient Rome was one of the earliest ancient civilizations to set a gold-to-silver ratio, starting as low as 8:1 in 210 BCE. Over the decades, varying gold and silver inflows from Rome’s conquests caused the ratio to fluctuate between 8-12 ounces of silver for every ounce of gold.
By 46 BCE, Julius Caesar had established a standard gold-to-silver ratio of 11.5:1, shortly before it was bumped to 11.75:1 under emperor Augustus.
As centuries progressed, ratios around the world fluctuated between 6-12 ounces of silver for every ounce of gold, with many Middle Eastern and Asian empires and nations often valuing silver more highly than Western counterparts, thus having a lower ratio.
The Rise of the Fixed Ratio
By the 18th century, the gold-to-silver ratio was being redefined by the U.S. government’s Coinage Act of 1792 which set the ratio at 15:1. This act was the basis for U.S. coinage, defining coins’ values by their metallic compositions and weights.
Around the same time period, France had enacted a ratio of 15.5:1, however, neither of these fixed ratios lasted long. The growth of the industrial revolution and the volatility of two world wars resulted in massive fluctuations in currencies, gold, and silver. By the 20th century, the ratio had already reached highs of around 40:1, with the start of World War II further pushing the ratio to a high of nearly 100:1.
Recently in 2020, the ratio set new highs of more than 123:1, as pandemic fears saw investors pile into gold as a safe-haven asset. While the gold-to-silver ratio has since fallen to roughly 80:1, runaway inflation and a potential recession has put gold in the spotlight again, likely bringing further volatility to this historic ratio.
2022’s Stores of Value: Gold, Oil and Grains
The start of 2022 has seen commodities surge with crude oil, gold, and grains acting as the new stores of value.
Gold, Oil and Grains Emerge as 2022’s Stores of Value
2022 started off with a slump for equity and cryptocurrency prices, but real assets like gold, crude oil, and agricultural commodities have more than held their dollar value.
Even before Russia’s invasion of Ukraine resulted in extreme uncertainty over energy and raw material exports from both nations, commodities had already started to outperform other assets.
This graphic looks at how five key assets have performed in 2022 thus far, comparing the prices of WTI crude oil, the Invesco DB Agriculture Fund, gold, the S&P 500, and bitcoin.
Commodities Surge to Start off 2022
Just a few months into 2022 and commodities have already surged by double digits while nearly every other asset class has struggled to hold its value. Equity indices have continued to slide downwards from their all-time highs set in January of this year, with the S&P 500 down 13.4% from its all-time high.
Although the Energy sector of the S&P 500 is up 33.4% and the Information Technology sector is down 18.9% YTD, tech makes up more than a quarter of the index at 28.1% while Energy only makes up 3.7%. Other speculative tech assets like bitcoin and other cryptocurrencies have also significantly drawn down in 2022, with bitcoin down 16.3% and the total crypto sector’s market cap down by 22.4%.
|Asset||2021 Performance||2022 Performance YTD|
|WTI Crude Oil||+56.4%||+34.4%|
|Invesco DB Agriculture Fund||+22.4%||+10.4%|
Prices as of March 14, 2022
In the meantime, commodity investors have seen record-breaking rallies and volatility, especially in the energy and agricultural sectors. Crude oil is already up 34.4% in 2022 after WTI Crude reached highs of $129 a barrel, and the Invesco DB Agriculture fund which tracks wheat, corn, soybeans, and other agricultural commodities is up 10.4% YTD.
Gold Recovers 2021’s Losses as Rate Hike Looms
While 2021 saw metals and energy prices surge, precious metals like gold and silver lagged behind the pack with negative returns. However, the Fed’s suggestion of raising interest rates has seen investors move out of speculative growth assets and into gold which has historically outperformed other assets in tightening cycles.
Russia’s invasion of Ukraine has also spurred investors towards gold in a flight to safety, with the yellow metal’s price rallying by more than six percent in February, the month of the invasion.
As Russia is cut off and cuts itself off from trade with the U.S. and other Western countries, a new trade system with China that primarily uses gold-backed settlement akin to the petroyuan could push gold prices even higher.
Sanctions and Supply Shocks Fuel Crude Oil and Wheat Rallies
Not long after the U.S. announced sanctions against Russia alongside the European Union and G7 nations, Russia immediately responded with comprehensive export bans against 48 different countries including the U.S. and the EU.
Agriculture and specifically wheat prices have also surged as the invasion began, as both Russia and Ukraine are two of the world’s biggest wheat exporters. As a result of the uncertainty around these vital agricultural exports, wheat prices have skyrocketed nearly 40% over the past two months, and Russia has added fuel to the fire with a temporary grain export ban against ex-Soviet nations.
While the start of 2022 has seen a sizable shift in value towards commodities, we’ll see if these prices stabilize while stocks and crypto recover, or if this year is the beginning of a new commodity supercycle.
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