The concept of the money supply is central to understanding events and prospects in modern, mixed economies. What the money supply is doing, and what the manipulators of the money supply are doing, are key indicators of immediate and intermediate economic events. In my blog, I refer to the money supply often. Analysts and writers who are influenced by the Austrian school of economics, and here, as always, I am referring to von Mises and his predecessors, will refer to the money supply in understanding business cycles in modern, mixed economies. So, how do we know what is happening with the money supply?
From the U.S. government we have several measurements of the money supply, called M1, M2, and M3 (no longer published). There is also MZM, my preference generally. There are also indicators such as the balance of payments, for indications of the outflow of money. Another important tool to keep in mind is the changing level of bank loans. The past two asset price inflation events have both been created by bank loans. Finally, there are some private measurements available at various websites.
As with any measurement, it is absolutely necessary to clearly understand what is being measured, how, and how those measured elements relate to your conceptual framework. You must also know how the measurement in question performed in the past, i.e., what the results meant and how the economy performed.
All too often, what I see when reading other authors is that they have chosen tools that reinforce their own expectations. They ignore other tools that currently are pointing in other directions. That is especially true of the people who are expecting hyperinflation in today’s world. I certainly sympathize with the hyperinflationists. There is reason to be concerned, from what I can see. But I do not accept their knee jerk approach.
My approach is to look at all of the indicators that I have identified and try to make sense of them and what is happening in the economy.
One indicator can also be the interest rate set by the Federal Reserve Board. One influential online group recently used the argument that since the Fed had set the Reserve rate at zero, there had been billions of dollars created. In other words, it was automatic. If the interest rate is set well below a market rate, then money will be created. This same reasoning occurs when the Fed creates reserves. For example, in 2008, the Fed created nearly $1T in member bank reserves. People immediately said that the Fed had created billions of dollars in the economy. But, there is a difference here. Lowering the interest rate and creating reserves are not the same as actually printing money. Printing money and shoving it into people’s hands through government handouts or expenditures or payrolls put money into circulation immediately. That money is in play.
But the actions of the Fed are different. The Fed can create reserves and lower interest rates, but the Fed depends upon the banks and businesses to actually put the money into play. If the banks do not lend (which requires a borrower) then nothing happens. That is what we have seen over the last two years. The Fed has tried to put more money into play, but the banks have not cooperated. The Fed’s influence is not automatic. The claim that low interest rates have created massive amounts of money is not substantiated by the level of bank loans and other indicators, e.g., MZM. It is important to objectively understand how this stuff works.
I saw an argument that claimed that it is wrong to argue if the money supply has expanded or not. According to this person, looking at the facts was not thinking in principles. Instead, he said that we should state that the Fed is, “The reality is that money has been created out of nothing and it therefore will alter behavior (otherwise why do it?). … that this money has created price increases in several sectors, commodities and oil among them, despite the ‘we haven't really increased the money supply’ theory.” Somehow, for this person, thinking in principles does not include relating one’s ideas to the real world nor having a sound, fact based argument for our position. We merely sate that the government has made money that raised prices without being able to even demonstrate it, not to mention, prove it. It does not include looking at the present, specific situation and making sense of it or presenting your position in the context of the crisis we actually face. I do not know how this person thinks that we can be convincing or persuasive.
Some will then point out that the Fed has recently been buying Treasuries from the Government directly, thus putting newly made money directly into the economy. That is true. That step leads directly to expanding the money supply and to affects in the economy, generally, to increases in consumer prices. However, given the size of the economy vs. the amount of purchases the Fed has made, the effect is not particularly significant. We would have to see closer to $1T of Fed direct purchases from the Treasury for the Fed to trigger consumer price rises.
Potentially more significant would be the return of sizable amounts of the dollars held overseas via Treasury Bond purchases. With a $1.7T deficit, if $1T was financed from overseas, we would see a mammoth flooding of dollars flooding our markets. This returning money, often as much as $500B in the past few years, has been a source of some of our price inflation. Higher amounts would put more pressure on prices.
Yet another recent argument that I have seen implies that in today’s world, real market forces (as opposed to governmental influences) have no impact on prices. The field of play, this person held, is controlled completely by governments. Again, there was no attempt to demonstrate how this is so. The position was presented as necessarily following from the fact that governments act and have bad influences, there were bad events happening (the raising of oil prices), therefore, it was completely because of government intervention. No facts about the current situation were necessary.
Thus, it is important to look at the various moving parts of the make up of the money supply and their impact. Then, it is imperative that your understanding relates these different measuring tools to the real world in an objective manner. For example, look at M2 http://research.stlouisfed.org/fred2/series/M2?cid=29 , the simple view would be that inflation is rampant and that prices should be going through the roof. But have they? I just saw an observer on PJTV who kept track of his expenditures of a few items over the last year. His personal stats did show across the board significant price increases. What is your experience? Mine has been that there has been little change for some time, with some bigger increases just recently. Even if prices are going up, does that mean that the hyperinflationists are correct in saying that general, average price increases of 20% or more (hyperinflation) are beginning soon? That is a big jump.
Some argue that because certain prices went up, there is inflation. Most recently, these are the prices of gold, oil, and food commodities. But prices go up and down for various reasons. That is especially true in a “mixed economy”, where government actions have hidden, unforeseen, and often weird, effects. You have to be careful when attributing reasons for price movements, which means actually finding a cause and effect. For example, the decades old efforts by governments around the world to control oil discovery and production in many different ways means that there are restrictions on production and supply. The result is an artificial shortage of oil. Supply shortages would mean higher prices, given level demand. In our situation today, and for the last several years, demand is actually growing. So you have three different factors pushing the price of oil upward, including whatever inflationary pressure there might be. But the price would be going up anyway. When discussing the price of oil, you cannot objectively leave out the supply restrictions and all of the reasons for increases in demand.
Turning back to the analysis of the money supply, my overall point is that many things are happening within an economy that will affect whatever actions governments take to manipulate the money supply. How it plays out and what the ultimate effect will be depends upon those factors. To accurately explain events, you need to have identified the actual causal connections and explained other details that may seem to be contrary to your conclusion. A site or writer who ignores those contrary elements only means that they are pushing their pet theory without actually relating it fully to reality. Economics is a difficult science, but it is a science. Economics is about the real world, and one’s standard of truth must be consistency with reality.
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