M2 growth has slipped to single-digit since May, while market has become concerned about the potential ramification of anemic money supply growth – slower growth and disinflation. In this note, we share our analysis on the implication of slower M2 growth in today’s context. We conclude that the representativeness and relevancy of M2 growth has deteriorated in the past decade, while we provide our readers with an alternative measure of money supply, the “M2 Proxy”, in order to gauge the underlying shift in monetary expansion growth.

The representativeness and relevancy of reported M2 growth have declined in the past decade, both as a gauge of underlying monetary expansion and as a leading indicator of growth and inflation.

The notable divergence between M2 growth and the underlying monetary expansion was driven by the diversification of savings away from the traditional bank saving deposits to savings in the forms of non-bank financial institution deposits, wealth management products, and money market funds.

We provide our readers with an alternative gauge for underlying monetary expansion – the “M2 proxy”. Since the data on the banks’ liability side is scattered and the data classification is convoluted, we use the conceptual equivalence of M2 on the asset side of the banks’ balance sheet to construct a “M2 proxy”. The “M2 Proxy” is largely equivalent to “adjusted TSF + commercial bank FX positions – fiscal deposits”.

The slowdown in the “M2 Proxy” growth is far more moderate than that of the reported M2 and adjusted TSF, indicating robust growth and continued reflation in the near term. Furthermore, “M2 Proxy” provides us with a new tool for forecasting growth and inflation next year. We expect the M2 proxy growth to pick up on both sequential and YoY terms in July. The adjusted TSF growth and M2 proxy growth both point to strong cyclical momentum in 3Q.