As we navigate through changing economic times, it’s essential to understand some key financial concepts that impact both individual and global economic conditions. You may have heard of the concept, “Cash on the Sidelines,” which often comes up in discussions about stock markets and worries over high risk investments and keeping money in either cash or lower risk, lower-yield investments.
Let’s delve into this and other related terms to make sense of the current financial scenario:
1. The Era of Easy Everything is Ending
The “Era of Easy Everything” refers to a period characterized by low interest rates and abundant liquidity, making borrowing easier and stimulating economic growth. This era is now concluding as central banks, like the Federal Reserve, aim to bring inflation back to their target levels, typically around 2.0%. This shift is part of a broader strategy to stabilize the economy after the impacts of COVID-19. Click here to link to a PDF from First Trust for more information.
2. Understanding the M2 Money Supply
The M2 money supply is a crucial measure of the money circulating in an economy. It includes cash, checking deposits, and easily convertible near money, like savings deposits. Since 2008, the M2 money supply has nearly tripled, reflecting the vast amount of money the Federal Reserve has introduced into the economy. This increase in money supply can lead to higher inflation if not managed carefully.
3. The Consumer Price Index (CPI)
The Consumer Price Index measures the average change over time in the prices paid by consumers for goods and services. According to First Trust’s information, the CPI is currently 13% higher than it would have been if it had followed the pre-COVID trend of about 1.8% per year. This rise in the CPI indicates a “new normal” for prices, influenced by factors like money supply growth and supply chain disruptions.
4. Cash on the Sidelines
The term “Cash on the Sidelines” often suggests that there is a pool of money waiting to be invested in the stock market, potentially driving prices up. However, the reality is not as straightforward. When an investor uses their cash to buy stocks, the seller of those stocks ends up with the cash, meaning the net amount of “cash on the sidelines” remains unchanged. While this may initially lift prices, the impact becomes less once the cash is “in the system.”
5. Inflation and Asset Prices
Inflation not only affects the general cost of goods and services but also the price of assets like stocks, gold, and real estate. An increase in money supply can raise these prices, but it doesn’t necessarily make us wealthier because the value of money decreases.
As we navigate these changing times with the economy, being educated and researching financial concepts is important.
You may be interested in our blog, Planning for Market Uncertainty: 5 Things to Consider If the Market Is Shaky and Annuities: A Financial Anchor in Times of Economic Instability
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