Recent sluggish broad money growth in the US and UK is unlikely to signal economic weakness since investors are voluntarily shifting out of cash in response to low interest rates and perceived opportunities in markets. Reduced money demand releases additional liquidity to support economic expansion.
In further evidence of this shift, UK retail buying of mutual funds (unit trusts and OEICs) was again solid at £2.4 billion in October, according to Investment Management Association figures. Inflows are on course to exceed £25 billion for the year as a whole, well above the previous annual record of £17.7 billion in 2000.
The chart shows six-month growth in "M4 excluding other financial corporations" – i.e. money holdings of households and non-financial firms – together with a six-month running total of retail mutual fund flows, expressed as a percentage of the M4 measure. Fund buying has been on a similar scale to the rise in the money supply recently.
In the current context, the sum of money growth and mutual fund flows is probably a better guide to liquidity support for the economy than M4 itself. This indicator – the green line in the chart – bottomed in late 2008 and recovered significantly during the first half, with faster expansion maintained recently. This supports hopes of an imminent economic pick-up. (See previous post for a similar US analysis.)