The Cantillon Effect

On measuring value with a shrinking measuring stick

The unprecedented amount of US Dollars being created and injected into the system to offset the effects of COVID-19 is rapidly shrinking the measuring stick we use to determine the value of things in real time.

Here’s a chart of the M2 Money Supply. 

(Note: M1 money supply includes those monies that are very liquid such as cash, checkable (demand) deposits, and traveler’s checks. M2 money supply is less liquid in nature and includes M1 plus savings and time deposits, certificates of deposits, and money market funds — aka the total amount of US Dollars in the system.)

Notice how the stimulus-related jumps in ’08 and ’11 are dwarfed in comparison to the scale of the current stimulus.

Pricing things accurately is difficult in the best of times, it’s almost impossible in unprecedented times like we’re experiencing now.

The Cantillon Effect — the change in relative prices resulting from a change in money supply — is a very real dynamic right now. Max pandemic uncertainty combined with a rapidly expanding money supply is causing extreme price distortions across the entire global economy, particularly at stimulus injection points like the stock market. The result of which is what we’re seeing in the markets now: A wild decoupling of prices and reality, as market participants struggle to measure what something is worth.

In order to dampen the distortion, I’ve started dividing asset prices by M2 Money Supply when I chart them. I’ve been finding the /M2 counterparts particularly helpful, as they give a slightly more sober lens to look through while the dollar priced equivalents drunkenly thrash around(Tip:Trading View is my favorite charting tool. You should check it out.)

The S&P 500 and Gold are good examples of where I’ve been using /M2 versions quite a bit: 


You’ll notice that price in dollar terms has been setting all time highs, but in /M2 terms the current cycle topped at the same level as 2008 (a long way short of the 2000 cycle top). You’ll also notice that the /M2 chart has remained below major resistance levels, despite the raw S&P moving up the past couple weeks. This makes sense because the stock market indexes are the scoreboard leadership uses to measure economic success and thus much of the stimulus has been designed to bolster equity prices. My current theory is that stock market prices will become less warped over time as the stimulus flows into other areas. 


S&P/M2 (SPX/M2)


You’ll notice that price in dollar terms is near all time highs, but in /M2 terms has been in a major down trend since 2011 (though the trend is currently trying to reverse).

Gold (GC1!)

Gold/M2 (GC1!/M2)

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