Sectoral monetary details in the Fed’s Q2 financial accounts, released yesterday, strengthen the case for economic optimism.
The additional information in the quarterly financial accounts allows calculation of the M3 broad money measure, which the Fed discontinued in 2006. Annual M3 growth was 25.3% at end-Q2, a record in the 70+ year history of the financial accounts and above growth of the published M2 measure, of 22.9% in June – see first chart. (M3 additionally includes large time deposits, institutional money funds and security repos).
The encouraging new information in the report is that the monetary surge was distributed across sectors. As expected, money holdings of non-financial business grew most strongly as firms took advantage of the Paycheck Protection Program (PPP) and raised a record amount in bond markets. Annual household growth, however, was also a record, while growth of financial* holdings remained high – second chart.
Household M3 holdings are three times larger than those of non-financial business. Faster household growth has been the key driver of the M3 surge, accounting for two-thirds of aggregate M3 growth of 25.3% in the year to end-Q2. Household money holdings are likely to be in excess of underlying demand, suggesting a flow into consumer spending, housing investment and financial markets.
Correspondents claim that corporations have increased borrowing temporarily to boost precautionary money holdings and will repay debt as economic conditions normalise, causing M3 to contract. The significant household contribution to the M3 surge argues against a reversal scenario, as does the concentration of corporate borrowing in bond markets, suggesting semi-permanence. The rise in bank borrowing, moreover, was entirely due to PPP loans, most of which will be forgiven (with no negative impact on M3).
Another hopeful piece of news from the accounts is that the net financial position of nonfinancial corporations (i.e. outstanding liabilities net of assets) was little changed between end-Q4 and end-Q2, with the profits hit from the covid shock fully offset by cuts to fixed investment and inventories. The corporate “financing gap” – capital spending minus retained earnings – was slightly negative in Q2. A broader measure of financing requirements including borrowing for share retirement has fallen significantly below its long-run average as a share of GDP, suggesting a rebound in corporate spending – third chart.
*Insurance companies, pension funds and GSEs.