Gold advocates often argue that an expanding supply of dollars automatically weakens the currency: more money in circulation means each dollar buys less, prices rise, and gold serves as the ultimate hedge against this erosion of purchasing power. From this perspective, growth in the money supply is treated as inherently inflationary.
However, this view is overly simplistic for two main reasons. First, it strips away important context around how and why money supply expands. Second, it ignores a crucial driver of inflation that is just as important as supply itself: the velocity of money.
A recent commentary by Michael Oliver of Momentum Structural Analysis prompted a closer look at this debate. He points out that M2 has increased by roughly 45% since 2020, implying a steady erosion in the real value of cash “year by bloody year,” while reinforcing gold’s role as a preferred alternative store of value. While this is a persuasive narrative, the link between money supply expansion and inflation is not as direct or mechanical as often implied, and requires a more nuanced interpretation of M2 dynamics.
It is also worth noting that Oliver’s bullish stance on gold is not based solely on M2 growth. He also cites several additional factors, including the long-term debasement of fiat currencies by central banks, supportive technical structures, declining confidence in central bank credibility, geopolitical tensions increasing safe-haven demand, and persistent fiscal deficits that necessitate continued monetary accommodation.
Context Matters
Simply pointing to M2 growth in isolation is not meaningful without proper context. To clarify this point, we can refer back to a recent Commentary.
If inflation is the key reason for buying or selling gold, then what truly matters is how money supply growth compares to economic growth. On that basis, the picture changes significantly. During 2020 and 2021, M2 expanded far more rapidly than the real economy. However, in the years since, money supply growth has slowed considerably. Over the broader six-year period referenced by Oliver, GDP growth has actually modestly outpaced M2 expansion.
Assuming, for simplicity, that monetary velocity remains stable (a topic we address separately below), the implication is clear: M2 growth was strongly inflationary during 2020–2021, but in the current environment it is, at best, neutral—and may even be disinflationary or deflationary.
The intuition is straightforward. If an economy produces 10% more goods and services, but the money supply only expands by 5%, there is relatively more supply of goods than purchasing power. That imbalance forces either price reductions or rising unsold inventories. In both cases, the pressure on prices is downward rather than upward.
In that sense, if gold is being held primarily as a hedge against inflation, then relying on M2 growth alone may have been a reasonable argument during the pandemic-era monetary surge. But under current conditions, that same rationale is far less convincing without additional supporting factors.
Monetary Velocity Also Matters
Consider a simple thought experiment.
What if the government secretly printed an enormous amount of money, locked it away in a vault, and permanently lost the key? Would that sudden increase in the money supply drive prices of goods and services higher?
The answer is no—it would have virtually no impact.
Now imagine a different scenario: rumors of that hidden stockpile begin to circulate. Even though the money still isn’t being spent, expectations shift. People start to anticipate future spending, and that change in behavior alone could begin to influence prices.
The distinction here is important. Inflation is not determined solely by how much money exists “on paper.” It also depends on how actively that money is used—how quickly it circulates through the economy. This is what economists refer to as monetary velocity.
In other words, price levels are shaped not just by the supply of money, but by the willingness and ability of households, businesses, and institutions to spend it. When velocity is high, money changes hands quickly and exerts more upward pressure on prices. When velocity is low, even a large money supply may have limited inflationary impact.
This is why analyzing inflation through M2 alone can be misleading: without considering velocity, the picture is incomplete.
What Is Monetary Velocity
According to the Federal Reserve Bank of St. Louis, the velocity of money refers to the rate at which a single unit of currency is used to purchase domestically produced goods and services over a given period of time. In simpler terms, it measures how often each dollar is spent within the economy.
Put differently, it reflects how many times one dollar changes hands to facilitate transactions during a specific timeframe. When monetary velocity rises, it indicates that more economic transactions are taking place between individuals and businesses, signaling a more active flow of spending.
Velocity is therefore influenced by both economic activity and the money supply. A shrinking money supply does not necessarily imply lower prices if economic activity is strong and money is circulating rapidly—velocity can rise and still exert upward pressure on prices. Conversely, even if the money supply expands significantly, inflation may remain muted if that money is not actively being spent, meaning demand for goods and services stays weak and price pressures remain limited.
In short, monetary velocity helps explain why the relationship between money supply and inflation is not mechanical: it is the interaction between how much money exists and how quickly it is used that ultimately matters for price dynamics.
What Impacts Velocity?
Monetary velocity doesn’t move randomly—it reflects how people, businesses, and financial systems behave. A range of economic and psychological factors can either accelerate or slow the rate at which money changes hands.
Factors typically associated with higher velocity
These conditions encourage spending, investing, and faster circulation of money:
- Lower interest rates — reduce the incentive to hold cash, encouraging spending and investment instead
- Strong consumer and business confidence — optimism about the future leads to higher spending activity
- Rising inflation expectations — if people expect prices to increase, they tend to spend sooner rather than later
- Easy credit conditions — abundant lending increases effective purchasing power and transaction volume
- Technological innovation — new products, services, and platforms create additional channels for spending
- Income and wage growth — higher earnings support more frequent and larger transactions
- Economic expansion — growing output naturally leads to more economic exchanges per unit of money
Factors typically associated with lower velocity
These conditions encourage saving, caution, or reduced spending:
- Recessions or economic uncertainty — fear leads households and firms to defer spending
- Expectations of falling prices (deflation) — consumers delay purchases in anticipation of cheaper goods later
- Rising interest rates — saving becomes more attractive, slowing money circulation
- Debt reduction (deleveraging) — paying down loans removes credit-driven money from active circulation
- Aging populations — older demographics generally spend less and save more
- Financial or banking stress — tighter credit conditions reduce lending and the “multiplier” effect of money
The key takeaway
Velocity is ultimately a behavioral and structural variable. It reflects confidence, incentives, credit conditions, and demographics—not just monetary policy or money supply figures. This is why two economies with similar M2 growth can experience very different inflation outcomes depending on how actively money is being used.
M2 and Core CPI
With a clearer understanding of monetary velocity, we can re-examine the common claim among gold advocates that M2 growth and inflation move closely together.
To test this more rigorously, a regression analysis is conducted using quarterly data on M2 and monetary velocity against Core CPI since 2010.
In this context, Core CPI is used instead of headline CPI because it excludes volatile food and energy components. These categories are often influenced by short-term shocks such as geopolitical events or weather conditions, which can obscure underlying inflation trends. By focusing on Core CPI, the analysis aims to capture a more stable and statistically meaningful relationship.
The first step of the analysis examines how M2 alone relates to Core CPI, allowing us to quantify the direct association between money supply growth and underlying inflation over time.
The results suggest that M2 growth, in isolation, has a very weak and statistically insignificant relationship with Core CPI. The R-squared value of 5.13% implies that changes in M2 explain only a small fraction of the variation in Core CPI over the sample period. In practical terms, most inflation dynamics are driven by other factors outside the money supply variable alone.
The negative t-statistic (-1.771) further indicates that the estimated relationship is not only weak but also inversely signed in this model specification—meaning that, within this dataset, higher M2 growth is associated with slightly lower Core CPI. However, this relationship is not statistically robust and should not be interpreted as causal.
Using the regression equation to forecast Core CPI from M2 alone therefore produces unreliable results. As expected from the low explanatory power of the model, the output has little predictive value and is effectively not useful for practical forecasting.
Overall, the takeaway is that M2 by itself is a poor standalone indicator of inflation dynamics, reinforcing the importance of incorporating additional variables—such as velocity, credit conditions, and broader economic activity—when analyzing price pressures.
M2, Velocity, and CPI
Next, we extend the analysis by incorporating monetary velocity into the multiple regression framework alongside M2.
The R-squared value indicates that the relationship becomes substantially stronger when both M2 and monetary velocity are included in the model, with the combined variables explaining more than half of the variation in Core CPI.
In addition, the F-statistic’s near-zero p-value suggests that the overall model is highly statistically significant, meaning there is a very low probability that these results are due to chance.
Finally, when the model’s implied Core CPI is plotted against actual Core CPI, the comparison shows that the combination of money supply and velocity tracks inflation much more closely than M2 alone. This supports the view that inflation dynamics are better understood as a function of both liquidity (M2) and its rate of circulation (velocity), rather than money supply in isolation.
Summary
There are valid reasons to buy and hold gold, but for short-term traders, it is important to understand the narratives that often drive gold price action.
The idea that rising money supply alone explains inflation—and therefore supports higher gold prices—can be misleading. As discussed, this relationship needs to be placed in proper context relative to economic growth. Equally important is not just the quantity of money in circulation, but the rate at which it circulates through the economy, or monetary velocity.
Many widely accepted macro narratives appear intuitive at first glance, but lose explanatory power once examined more closely. It is in these gaps between narrative and reality that investors can better understand the true drivers of asset prices—and reduce the risk of being caught offside when simplified stories fail to hold up in practice.
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