According to the British newspaper the Telegraph from 26 of May US money supply M3 (the Fed doesn’t publish this data any longer) displays a visible decline. The yearly rate of growth of this measure of money stood in April at minus 5.3% against minus 4.3% in March and plus 5.2% in April last year.
Economists that follow M3 are alarmed with the sharp fall in this measure of money. They are of the view that this large decline might be pointing to a nasty recession ahead. Most economists that have expressed concern to the Telegraph about the large fall in M3 belong to the monetarist camp, which was formed by the late professor Milton Friedman. Some of them hold that the plunge in M3 is on account of regulators forcing the banks to raise capital asset ratios. It is held that this forces banks to shrink their assets, which is blamed for the shaky economic recovery.
Monetarists, or Friedmanites, are of the view that the Fed is running the risk of repeating the errors that plunged the US economy and the rest of the World into the Great Depression of 1930′s. According to monetarists the Fed then allowed the money supply rate of growth to fall sharply. By July 1932 the yearly rate of growth of M3 stood at minus 14.7% (see chart). From this it follows that the Fed should aim at reversing the current fall in M3 as soon as possible to prevent an economic disaster.
It is quite possible that monetarists are reaching valid conclusions with respect to the economy in the months ahead. We are of the view however, that money M3 is not a valid measure of money.
In order to account correctly for money, one must make a distinction between money that is deposited and money that is loaned out.
When an individual exchanges goods for money he in fact increases his demand for money and when he lends his money he is lowering his demand for money. Individuals can exercise their demand for money in a variety of ways. For example, they can keep money in a jar, or under the mattress, or in their wallets, or place the money in a bank warehouse. From this it follows that the overall amount of money in individual holdings should be the sum of money they hold in bank warehouses also known as demand deposits plus the money they hold outside banks warehouses.
This, in turn, means that the inclusion of various term deposits such as large time deposits and money market mutual funds deposits into the definition of money such as M3 produces an erroneous account of the amount of money in the economy.
For instance, Tom places $1,000 into a long-term saving account with Bank 1. The bank in turn lends this $1,000 to Mike. This type of transaction temporarily transfers the ownership of the $1,000 from Tom to Mike. Consequently, to add $1,000 in Tom’s long term saving deposit into the definition of money will lead to double counting since this money resides either in Mike’s pocket or in Mike’s demand deposit.
Following this line of thinking, one could easily note that, notwithstanding popular practice, money invested with money market mutual funds (MMMFs), which is part of M3 definition must be also excluded from the money supply definition. Investment in a money market mutual fund is, in fact, an investment in various money-market instruments. The quantity of money is not altered as a result of this investment; only the ownership of money has temporarily changed. Including investments in MMMFs in the money definition will only lead to a double counting again.
If one wants to use money supply as a predictor of future economic events one must ascertain what money is all about. This of course means that various credit transactions must be excluded from the definition of money. Once one adjusts for credit transactions one will get a clean monetary measure, which we have labeled AMS (the Austrian School of Economics money supply).
Now contrary to M3 the growth momentum of AMS currently shows a visible bounce. The yearly rate of growth stood at 4.7% so far in May against 3.5% in April. We suggest that a major threat to economic activity, or to be more precise to bubble activities, is the fall in the yearly rate of growth of AMS from 32.9% in November 2008 to minus 10% by November last year. Also note that the yearly rate of growth stood at negative figure during October to December last year.
Contrary to monetarists more pumping by the Fed can make things much worse. It will only weaken the process of real wealth generation further and undermine the pool of real savings — the key for economic growth. Also note that if the pool of real savings is in trouble then banks are likely to encounter difficulties in finding good quality borrowers i.e. wealth generators. In the framework of a declining pool of real savings a lowering of banks capital asset ratios is not going to make banks to expand their lending. Obviously one could try forcing banks to expand lending. This type of lending, given that the pool of real savings is in trouble, would amount to the creation of credit out of “thin air”. So even if this type of credit were to revive the rate of growth of money M3 it will not be able to revive the economy if the pool of real savings is in trouble.
On the contrary such type of lending, which is not backed up by real savings, will only further dilute the pool of real savings. (Also this type of lending will erode further banks quality of assets).
We suggest that it is on account of previously loose monetary policies that the pool of real savings is currently in trouble. It is the fall in the real savings that causes banks to shrink their lending, which is mirrored by the fall in M3. This however, doesn’t imply that the Fed should start pushing more money to reverse the rate of growth of M3. Pushing more money will only make things much worse.
Contrary to monetarists we suggest that in order to lay the foundation for a meaningful economic recovery the Fed should stop the money printing machinery as soon as possible. Printing more money only weakens the pool of real savings and weakens prospects for economic recovery.
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From the perspective of Austrian Business Cycle Theory, M3 is not as important as money supply, but as for effects on current prices, M3 as well as larger credit aggregates play a large role.
In this case at least, M3 seems to be signalling important information. No wonder the Fed doesn’t track it any more.
does ABCT (was it really developed many decades ago by someone named mises…from the ukraine) use prices to determine if there is a bubble taking place as claimed here??
“Contrary to monetarists we suggest that in order to lay the foundation for a meaningful economic recovery the Fed should stop the money printing machinery as soon as possible. Printing more money only weakens the pool of real savings and weakens prospects for economic recovery.”
But this would go against the interests of those who work in the Fed. Look at what has happened in the last 2 years (or 96+ years if you look at the Big Picture). The economy, which gets better or worse for the average person in response to the amount of real savings, has been kicked hard in the stomach and is now flat on its back. The Fed on the other hand has become more powerful and those who control it have become far more wealthy than they would have otherwise. As long as they can convince Congress to keep renewing their appointments, prevent any real audit, and prevent any large segment of the population from demanding their abolition, the Fed has no real prospect of any downturn in the immediate future.
The people involved with the Fed would be harmed by the policies advocated by Prof. Shostak, and they will benefit enormously by ignoring him and continuing the same policies, and even to ratchet them up. Look at Bono Whatsizname, the Zimbabwean central banker. He still has his palace, his servants, his cars, his private irrigation system, and so on. Does he want to go back to being a minor functionary as in the old pre-inflation days?
Likewise Congress has benefited from not serving the public. There may be a slight backlash that takes down one or two incumbents, but other than that pretty much every seat is a safe one. And I would bet that there are many, many more lobbyists throwing around many, many more lunches, campaign donations and outright bribes as the business world becomes more and more desperate to find a government shelter from the Fed-created catastrophe.
Saying that the Fed or Congress should do this or that in the public interest is therefore a waste of time. They are not the public. To ask them to work against their own interests is like asking an owl to stop eating mice as a gesture of kindness to the rodent population.The most that the Fed or Congress will ever do is take its boot off the throat of the public slightly, for a little while, in order to keep their slaves alive so they can be plundered again another day.
This analysis is excellent but it is ignoring the fundamentals of human action which have brought us to this situation. We can’t just educate the public on the problems with printing money, but we must also tell them why government banks print money and why they will never stop as long as they are constituted in their current form – centralized planners working as the tools of a coercive monopoly.
i have seen others here say that m3 didnt correlae with govt price information as well as lesser measures.
if m2 and m3 are measures that show how the current banking system is kept afloat via the govt…then perhaps they are better measures. i dont know.
but if there is a decline in the amount of currency how what is happening to deposit accounts???
less in the bank but more cash in hand????
does it mean less loans but perhps more direct investment????
economagic.com shows currency in circulation going from 750 billion in 2005 to 950 billion at present.
m1 for the same period was 1.35 trillion in 2005 and and 1.75 trillion at present.
if you subtract currency in circulation from m1 for the same period in 2005 there was 600 billion of non-currency dollars and at present there are 800 billion of non-currency dollars.
if this info is true…i dont know.
is 200 billion increase over five years a level that would cause economic woes???
throughout an economy that has how many dollar trades per day???? billions????
did any of this money go into sustainable endeavors…of the non-bubble type described at these sites??? doas anyone know how much??
when in vegas recently citi-center seemed to be booming (though it could have been fake) and the strip was packed with people.
if you subtract currency in circulation from m1 for the same period in 2005 there was 600 billion of non-currency dollars and at present there are 800 billion of non-currency dollars.
i meant non-cash dollars. or whatever the dollar type is called that is the difference between what economagic calls currency in circulation and m1.
When are the shadow stat’s guys now predicting hyper-inflation.
They were predicting sometime between 2010-2015. But if M3 is down this far, it’s possible this might be prolonged more. Because it’s not until Austrian Money is all in circulation (or AMS=M3) that we really have to worry about this problem right?
Tracy
if m2 and m3 are primarily made of m1 and a lots of cd type accounts is it only the insured part (250k???) or an estimate of what coulo likely be withdrawn with penalty that is counted in those measures???
Printing more money only weakens the pool of real savings and weakens prospects for economic recovery.”
is there a pool of real savings money measure???
are the savings you mention dollars in a savings account???
do dollars in a savings account get lent like a checking account yet are also availble to withdraw and spend ant the same time??
the weakend pool that you mention…is it often temporary or unnoticable??? if printing dollars means more dollars could that also mean just more in the pool??
if the printing of dollars went into better crop yield techniques, or cheaper municipal lighting, could that bring the prices of constant and necessary goods down more than the weakend pool???
I decided I will repeat this in every money supply related post, as I can.
You can not measure the money supply so stop trying.
This futile effort only undermines the understanding of what money is and serves no purpose.
M1 doesnt work, M2 doesnt work, M3 doesnt work, MZM doesnt work and surely TMS doesnt really work.
“Most economists that have expressed concern to the Telegraph about the large fall in M3 belong to the monetarist camp, which was formed by the late professor Milton Friedman. Some of them hold that the plunge in M3 is on account of regulators forcing the banks to raise capital asset ratios. It is held that this forces banks to shrink their assets, which is blamed for the shaky economic recovery.”
It only makes good sense to insist that banks keep adequate capital reserves on hand. That’s what creates stability in the system, preventing the future need for more bailouts. Whenever banks get too far out on that limb, putting every penny in the coffers out on the street, some depositor wants his money back. And the whole Empire of Air collapses.
2. “In order to account correctly for money, one must make a distinction between money that is deposited and money that is loaned out.”
But that’s a mistake. The money on deposit is PRECISELY the money being lent out. How could it be otherwise?
This kind of argument seems to be advocating legerdemain. As is this other fallacious statement:
“For instance, Tom places $1,000 into a long-term saving account with Bank 1. The bank in turn lends this $1,000 to Mike. This type of transaction temporarily transfers the ownership of the $1,000 from Tom to Mike.”
No, Mike doesn’t “own” that money. He has borrowed it. The $1,000 temporarily placed among his assets is balanced by the $1,000 that has been added to his debt. In truth, he owns zippo. What he’s now doing is managing the money, for the bank and for Tom.
If we don’t keep our terms straight, someone’s going to get dizzy and start making mistakes.
In the service of rebuilding the banking system so that it acts more responsibly, I think a trend toward rebuilding capital reserves is a very healthy development. I hope they put this requirement back into law and start enforcing it.
“But that’s a mistake. The money on deposit is PRECISELY the money being lent out. How could it be otherwise?”
It’s called fractional reserve banking. It is not only possible… it happens every day.
Frank
Thanks for this terrific essay
Can you help us out? Can you provide the components of your AMS metric. For the life of me, I can not figure it out
Here is my attempt at AMS, fully documented, including your formulation…
http://trueslant.com/michaelpollaro/2010/04/19/money-supply-metrics-the-austrian-take/
“For instance, Tom places $1,000 into a long-term saving account with Bank 1. The bank in turn lends this $1,000 to Mike.”
Under fractional reserve system doesn’t the bank also lend out $1000 each to George, Joe, Bill, Sam, Greg, Victor, Barney, Richard, and mayby even Larry, Curly and Moe? When they start paying down or defaulting on their loans, wouldn’t this reduce the money supply by what ever name you call it? I am trying to figure this out myself.
The best way to understand this would be to incorporate yourself as a bank. It’s not as hard as you would think.
Then take in $1,000 in deposits and lend out a thousand each to a half dozen different people. See what happens next.
Put that way, it sounds like a bizarre business model for sure. But isn’t the comment really a just a simplification (and maybe slight exaggeration) of the ideas expressed here under the headings of Money creation and deposit mulitplication? Is this an accurate article? Is this currently in practice? If so, what happens to the money supply in the case of default? If not, what does current banking practice look like?
Sorry-messed up the link in above post: http://en.wikipedia.org/wiki/Fractional-reserve_banking
Economists that follow M3 are alarmed with the sharp fall in this measure of money.
unleess they arent being genuine.
Of course, the government has to make money to support the printing of money since they have to have the bullion etc to balance the books so to speak.
I’ve always been somewhat curious about the way this works.
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