Q. What has demonstrated a compounded annual growth rate (CAGR) of 10% per year for the past 13 years? What puts on a growth spurt each and every time an economic crisis presents itself? What typically results in inflation when too much is produced, yet receives unequivocal approval by governments, consumers and businesses alike during times of woe?
A. M2 money supply in the United States.
Investors talk up secular trends. One of the most powerful trends, perhaps THE most powerful and persistent trend of them all has been staring investors squarely in the face for more than a decade. M2 money supply increased from $7 trillion in 2007 to over $18.3 trillion USD as of July 2020. By the time that 2020 ends, given the further stimulus packages contemplated at the US federal level, American M2 may easily exceed $19 trillion. That represents an annual growth rate of greater than 10% per year for roughly 14 years.
There has been no year in the past 13 where M2 declined. Money supply is set by policy and during times of crisis, is equalized among multiple global central banks. In fact, money supply, arguably, is the only form of collusion protected by legislation, in the world today. When corporations manage output with peers, it is deemed to be illegal racketeering, but when central banks engage in supply management, it isn’t considered to be “bad” collusion, but rather “good” coordination.
Reported US M2 at the end of July, 2020 was up by by a whopping 19.6% vs the end of 2019. That is not the annualized rate; that’s the ACTUAL increase for the first 7 months of 2020. Such growth certainly suggests that someone, somewhere, might be able to make a buck off of this trend. The logical question that follows is; “How does one profit from the secular increase in money supply”?
Many money managers will make a great leap of faith and suggest financial service companies, after all, aren’t finance and money the same thing, more or less? If that was a given, taking into account the M2 increases reported since 2007, why have so many financial service investments, which would be considered beneficiaries of M2 growth, produced disappointing returns over that comparable period? Investors might wade into the fray and suggest commercial banks. Their business model isn’t primarily centered on the persistent moving of money; rather, banks earn the bulk of their profits from the warehousing of money for interest spreads. Maybe the obvious rationalizations aren’t so obvious after all.
A sector that has benefitted greatly, arguably more than any other, in the past decade, resultant from the abnormal growth in global money supplies, are the payment processors. Firms such as Visa and Mastercard in the United States are, simplistically, included in this sector. Oddly, that broad description doesn’t fully reflect the business model of Visa and Mastercard. The aforementioned giants and a handful of other companies on the planet represent toll highways for money. These toll roads are called interchange networks. Each and every time that money enters that toll road, to be moved somewhere else on the planet, the interchange operators receive a toll. The amount of toll paid to the processors is based upon a number of variables, just as a traditional toll road receives different fees based upon whether the vehicle utilizing the road is a passenger vehicle or a commercial highway tractor.
Only two truly global toll highways exist on the planet; the market really IS that concentrated. One major toll firm is Chinese (China Unionpay) and while it portrays itself as the largest in the world, based upon the number of transactions processed, it is truly just a regional business. In order to more fully capture the global trend in money supply growth, the larger the toll road system, the more money that may ultimately be processed; that’s what is important here, scale and size. Most companies in the payment processing or money movement space do NOT own their own toll highways, but are, in point of fact, customers of the major interchange networks that belong to others. PayPal, for example, a giant in its own right, utilizes the services of Visa and Mastercard for interchange.
Analysts couch their discussions and analysis of Visa and Mastercard almost exclusively based upon retail sales trends. This begs the question, how is overall retail sales growth achieved? Well, it certainly doesn’t come about with good wishes, it results from money being placed into the pockets of consumers or, alternatively, credit supplied to them. In the past 13 years, money supply, as reported in M2, has more than doubled and might fully triple, by the end of 2021, when compared to 2007. That potential tripling of the money supply, more than any other factor, is the reason for such a massive growth rate in payment processing. The US economy isn’t 3 times larger than it was in 2007. Incomes haven’t tripled in the past 13 years. Even prior to the Covid crisis, the economy was good, but not THAT good. No, the increase in consumption is overwhelmingly driven by the expansion of the money supply; that much is clear to me.
The current pandemic response, through the concerted global flooding of money into the system, has a very short lag from the time that money is placed into the hands of consumers, to the time that multiplier effects are reported. That lag is usually just one quarter. For the first month of the pandemic shut-downs, shocked consumers, lacking a place to spend and having limited current resources, they utilized government payments to reduce short term debts and build up a store of liquidity. Now, with sufficient liquidity in the system, there are reports of massive retail surges among key large retailers. Those upticks are to be expected; the amount of fiscal stimulus, overall, exceeds the income shortfalls experienced by the pandemic shutdowns and loss of jobs. More specifically, those lower and middle income earners that spend almost 100% of their disposable incomes have experienced, overall, a significant short term income bump from the stimulus payments. This money is quickly pouring into the system.
As for investment opportunities, when it comes to such a meaningful increase in M2, I COULD choose to own a retailer that must compete with many other retailers, in a freely competitive market. I COULD select some commercial banks to participate that simply just store money and that also pay interchanges for the movement of money. I COULD own any number of ancillary payment processors that need to utilize interchange networks. All of this may have some potential according to analysts. Realistically, to more fully own the trend, why would I bother with any of these categories, when I may readily participate through investment in the interchange systems, so as to capture the lions share of this money supply volume flow, without the hassles of external competition? On a toll highway, the owner of that highway benefits from volumes as costs of operating the highway are primarily fixed. Who wouldn’t want to own a toll-road when the number of vehicles that may potentially use that road has increased by 300% in just 14 years?
Central bankers worldwide have determined that it is not in the public interest to reduce the supply of money globally, so the growth trend in money clearly looks to have secular legs for a while yet. They utilize a variety of schemes and some outright machinations to mask inflation in investments, but most specifically, they deflect from asset and investment inflation by cramming consumer price indexes (CPI) reports down the throats of consumers via the mass media. This deliberate obfuscation of the entirety of the economy disregards important information required by the public to make sensible investment decisions. CPI sheds a bit of light on the cost of buying a, more or less, transitory basket of items to be consumed and little else.
Those doomsayers who fret about the money supply increase are looking at the growth rate as a problem. Gold bugs and resource bugs call out M2 growth and conclude, as they always do, that the world is coming to an end, so “gitchyer guns, gold, seeds and a fallout shelter”. Well, I’m not buying what they are selling. The 13 year increase in M2, globally, exceeds the combined market caps of Apple, Microsoft, Google, Amazon, Netflix, Tesla, Facebook and a WHOLE bunch of other “must-have” investments, by a very wide margin. Bears see M2 growth as risk, I perceive M2 growth as an opportunity for profit. So long as money supply continues to increase at a multiple of 6x-7x the reported rate of consumer price inflation, then I will want to continue to own businesses that move money through interchange networks.
All this money supply growth IS leading to a type of inflation, again, right before our very eyes, but since the type of inflation I allude to doesn’t typically reflect in CPI reports, the public, by and large, isn’t worried about it, for now. Governments are more paternalistic than ever in the 21st century and the investigative media is hollowed out and hobbled by a lack of revenue. Inflation hides in plain site from the public but revealing the extent of the inflation doesn’t comport with the current narrative. I’ll write upon it in a future column.