The US M2 money measure contracted over the summer, leading some commentators to expect the economic recovery to falter in late 2009, with attendant deflationary risks. Prior posts argued against this view on the grounds that the M2 decline was modest and followed strong growth, while the velocity of circulation was likely to be rising in response to miniscule interest rates and reviving risk appetite.

M2 now seems to be picking up again. It rose by 0.3% in both September and October and weekly numbers suggest a similar rise in November. Implied three-month annualised growth of about 4% is likely to be sufficient to support further solid economic expansion and could even be too strong if velocity rises by 4-5% over the next year, as an earlier post argued was possible.

Another approach to measuring monetary backing for economic growth is to add together broad money changes and mutual fund flows – the idea here is that fund flows are likely to be inversely related to the demand to hold money so provide an indirect measure of changes in velocity. As the chart shows, this indicator – the green line – has continued to expand robustly recently. (A post last week presented a similar chart for the UK.)

The concern for markets in early 2010 is not that monetary growth will be insufficient to support a sustained economic recovery but that stronger expansion and higher inflation will fully absorb the available supply, implying an absence of "excess" liquidity to push asset prices higher – in marked contrast to this year.