The US M2 returns to peak levels, is the second wave of inflation on the way?

The M2 money supply in the United States has returned to the peak levels seen during the pandemic, while multiple inflation indicators show that price pressures are re-accumulating, raising market concerns about a "second wave" of inflation. Economists warn that further easing policies in the current monetary environment could repeat the historical tragedy of the three rounds of inflation waves in the 1970s.

Latest data shows that the Producer Price Index (PPI) in the U.S. has risen to a high of 3.3%, while the growth rate of the M2 money supply is approaching a dangerous level of 5%. This combination evokes memories of the inflation cycle of the 1970s, when central banks prematurely eased policies after initial inflation subsided, ultimately triggering more severe second and third rounds of inflation shocks.

Analysts point out that although the Consumer Price Index (CPI) remains relatively stable for now, rising wholesale prices typically transmit to the retail level, and the rapid growth of the money supply provides ample "fuel" for future inflation. In the current situation, Federal Reserve Chairman Jerome Powell's delay in interest rate cuts may be a wise move.

Economists are concerned that if policymakers repeat the mistakes of the 1970s—rushing to stimulate the economy before inflation has been fully eradicated—America could face price shocks more severe than those of the past five years.

Money Supply Returns to High Levels, Sounding the Inflation Alarm

In the current assessment of inflation risks, a key variable is the M2 money supply. Data shows that during the COVID-19 pandemic in 2020, the Federal Reserve implemented zero interest rates and significantly expanded the money supply, leading to a historic increase in M2. Subsequently, the Federal Reserve withdrew some of the excess liquidity from the system through tightening policies such as interest rate hikes.

However, analysis indicates that these tightening efforts have essentially ceased before the 2024 elections. As a result, the total M2 has now rebounded to the previously established peak levels. Even more concerning is that its annual growth rate is approaching 5%, a level historically associated with inflation risks. Analysts point out that if the Federal Reserve succumbs to pressure to cut interest rates, the growth trend of M2 will only accelerate further.

In addition to the money supply, recent price data also provides evidence for inflation concerns. The latest CPI data has been described by the market as "quite hot."

The year-on-year increase of 3.3% in the PPI directly reflects cost pressures at the wholesale level. The PPI is often seen as a leading indicator of the CPI, and its rise suggests that consumers will face new price increases in the future

There is evidence that the recent rise in upstream prices is more attributed to monetary factors rather than tariffs. Analysis indicates that many importers are absorbing tariff costs by compressing their profit margins and have not yet significantly passed these costs onto consumers. Analyst David Stockman pointed out that the core PPI, excluding food and energy, has risen by 33.3% since January 2017, equivalent to an average annual increase of 3.4% over the past eight and a half years. Another closely watched Truflation index also shows that prices of consumer goods and services are on an upward trend.

Historical Warning: Repeating the "Three Waves of Inflation" of the 1970s?

The biggest concern among economists currently is that the U.S. may be replaying the script of the 1970s. At that time, the U.S. experienced three waves of consecutive inflation: inflation returned with greater momentum after a brief retreat, and the central bank's repeated misjudgments ultimately led to disastrous economic consequences.

After the first wave of inflation, there was a retreat, and the central bank mistakenly believed it had conquered inflation, prematurely cutting interest rates and loosening policies. This resulted in a higher second wave of inflation. After authorities made the same mistake again, the third wave of inflation reached double digits, destroying the U.S. capital stock and forcing millions of young mothers into the workforce to maintain household finances.

The lesson from that period is that the complacency of central bank officials—believing they had defeated inflation—was key to subsequent policy errors. They failed to accurately control the monetary machine at that time, and loose policies only exacerbated the situation. Currently, the market fears that history may repeat itself.

The Political and Economic Risks Behind Calls for Interest Rate Cuts

The current inflation backdrop has highlighted the policy divergence between the White House and the Federal Reserve. The Trump administration has openly called for interest rate cuts, with clear motives: lowering interest rates can make mortgage loans more affordable, reduce the government's interest burden on national debt, and stimulate business investment. Almost every new president tends to favor a low-interest-rate environment because it can create the appearance of economic growth in the short term and provide more room for government spending.

However, on the other side are significant risks. A renewed wave of inflation could damage the credibility of Trump's second term and may be attributed to his tariff policies. In this context, Powell's stance against pressure to cut interest rates is seen by some observers as a demonstration of "responsible central banking." The real concern in the market is that once Powell's position is replaced, his successor may face the sole task of lowering interest rates.