One of the most important concepts in economic theory is the quantity of money. However, when going from theory to practical application, things get messy. FULL ARTICLE by Robert P. Murphy
Source link: http://archive.mises.org/15679/lost-in-a-maze-of-money-aggregates/
Lost in a Maze of Money Aggregates?
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Nothing to do with the article, but something is wrong with the logarithmic TMS chart:
http://mises.org/content/nofed/makegraph.php?tms=true&mzm=true&unit=log&range=max&bars=true&size=large
Logarithmic MZM looks correct, considering the linear data:
http://mises.org/content/nofed/makegraph.php?tms=true&mzm=true&unit=lin&range=max&bars=true&size=large
I’m a bit confused: what’s the difference between the currency held in the bank vaults (included in M0) and the excess reserves that are held at the bank (the $30 million in the MB section of the article)?
If the quantity of money is to be a useful economic variable, then it seems only logical that changes in the quantity of money must have some kind of economic effect. Furthermore, if the quantity of money is to be formed by the simple addition of various sub-components, then it is hard to understand how a change in one sub-component can have a substantially different economic effect than the same change in any other sub-component, or in the aggregate as a whole.
While it is certain that a daily increase in my checking account balance of $1000 will eventually produce an economic effect, it is hard to see what economic effect an increment in a federal government bank balance of $1B per day would bring about. With the ability of the government to manufacture an effectively unlimited amount of new money at will, what possible government action, and economic effect, is limited by the size of the balance of a government bank balance?
Regards, Don
Of course the Austrian theory of money gets messy when applied to the real world. That’s because it’s a bad theory. But the backing theory is not messy at all. Is a grocer’s gift certificate part of the money supply? The backing theory doesn’t even ask this question. It only asks whether the gift certificate is adequately backed by the grocer’s assets. If the answer is yes, the certificate will hold its value. If not, it will lose value.
Asking “Is it money?” is asking the wrong question. The right question is “What backs this money?”
Mike, you didn’t actually read the article, did you? Just skimmed the first paragraph for a key word, hey? Either you did not read it, or you did not understand it. Either way, really, your comment on it is superfluous.
And what happens when many different things back the money. Suppose I print up some “eric” notes and say that these are backed by all my possessions. Obviously, this would be dumb, because I’d never let you redeem the notes for just anything in my possession you choose.
Unless the backing is all the same thing, like gold, then backing means nothing. This is why saying fed notes are backed by the holdings of the fed is a worthless statement since you can’t go to the fed with some fed notes and demand to redeem them in anything – except other fed notes.
And if you could redeem them, you’d have to determine the market value of each item (like the toxic loans they bought up) before redemption could take place. Then you’d find there’s probably not nearly enough backing up fed notes for all the notes that exist.
Eric:
If you’ve issued 10 eric dollars, each redeemable for 1 oz of silver, and if your net worth is 1000 oz., then you have plenty of assets to redeem those dollars in silver, even if you don’t always have 10 oz. in your possession. Your dollars will trade in the market for 1 oz. If your net worth was only 9 oz., your dollars would trade for .9 oz.
The Fed’s dollars are redeemable at the fed for the same bonds for which most of those dollars were issued in the first place. Those dollars are also acceptable for, and backed by, taxes.
Wow, your second paragraph is a marvelous example of circular reasoning.
Just as you likely didn’t read the article, you apparently didn’t even read my post. The fed notes are NOT backed by a homogeneous asset today. Maybe in the beginning they were, but no longer. They are backed by a load of crappy loans and other assets, since the fed can now create fed notes and buy anything it wants with them. What it buys is the backing. If it buy a bunch of lottery tickets and they all lose, then the fed notes are backed by useless losing tickets.
If you want to redeem your fed notes, you can’t pick and choose what fed items you get in return. All you can get for a $100 fed note is, five $20 fed notes or some other combination.
So, changing my example to eric dollars being redeemable for 1 oz of silver completely changed the point of my post. If fed notes were actually redeemable for an amount of gold or silver (like the old silver certificates) then they wouldn’t be the same animal that we have today.
Salerno’s article is dated.
I don’t mean his arguments, but rather his listing as what is included in the various measures.
Repurchase agreements and eurodollars are gone.
Mike
You don’t make any sense.
The notional objections you are prone to repeating over and over again have already been refuted (in previous threads) several times. Seems you just don’t understand what you’ve been taught (or don’t want to).
Sione
Bob,I usually enjoy your articles but this one was a real disappointment. I was hoping that you would drive a stake in the monetarist/Keynesian idea of monetary aggregates and instead you attempted to justify the Austrian monetary theory of Joe Salerno and even repeated the monetarist fallacy about money aggregates.
You lost me at the first sentence quoted above. Money is only an important economic concept in a demand side world. In a world on the gold standard money becomes no more than a footnote to economics. Under a gold standard changes in the money supply may change the flow of gold between nations but the value of the currency and general economic principles simply are not impacted by the supply of money.
It is a fallacy to even focus on money. A currency backed by gold will take care of itself.
Joe Salerno is not a bad economist when he gets away from his monetarist roots. Since you come out of the supply side tradition, I am surprised that you embrace the demand side ideas of monetarism.
Also note Don Lloyd’s post above along these same lines.
From a general catallitic viewpoint, a money isn’t privileged. However, money is different from eggs, just as eggs are different from fish. As most everyone deals with money, how the “money market” is doing is pretty impacting on the whole economy. For this reason, I think money aggregates do have a place in economic understanding, and it’s not necessarily a demand-side fallacy to deal with them.
I dont understand why it is necessary to bother dealing with monetary aggregates at all. Supply of money is endogenous and from the development of trends in different components of money supply cannot be said anything.
Central banks tried once to deal directly with monetary aggregates and thought that it could be possible to control inflation rate and expectations by it but it did not work out. It seemed that you lost control as quickly as you put these aggregates as a instruments of policy.
In the realm of economic statistics you are always tied to different definitions and I dont know any good reason that some particular definition is the correct one.
Robert Murphy wrote: “The basic problem is that some of the components in various mainstream aggregates (such as money-market mutual funds) don’t really satisfy the requirements of a money substitute, and so these components do not belong in the ‘true money supply.’”‘
But some of these items (especially money market mutual funds (MMMFs)) should be included in the total money stock on the theoretical grounds that Ludwig von Mises advanced. It must be stressed here that in Austrian theory a claim on money should be counted if (1) each unit of the claim is viewed by the market as being redeemable at par on demand; and (2) each unit is as transferable among market actors as the money commodity itself, serving as a final means of payment with the legal obligations of the claim being unchanged in the hands of third parties (what the lawyers in the Anglo-American tradition would call “negotiability”). These qualities of at-par redemption on demand and negotiability mean that each unit of the claim can function just as effectively as a media of indirect exchange as a unit of the money commodity itself.
Some Austrians have challenged MMMFs on the grounds that they might be redeemed at less than par, and others on the grounds that they really represent ownership of a share in a pool of credit instruments, not a claim on money. The first argument is wrong because it confuses the de jure legalities of the accounts with the de facto treatment by the market. Interestingly enough, Rothbard embraced this distinction with respect to savings accounts–he agreed that savings deposits should be counted even though the account issuer has a legal right to delay redemption, which violates the requirement that the redemption be made on demand. In this case, Rothbard correctly noted that any financial institution that exercised such a legal right would be subjected to a prompt and devastating run by its clients. Notwithstanding the legalities of savings accounts, no solvent financial institution would dare fail to redeem on demand.
Clearly, a MMMF “breaking the buck” and redeeming at less than par falls into the same category–the market regards such behavior as a default of the claim and a failure of the issuing institution. Maybe this wasn’t so obvious to Rothbard many decades ago, but there’s no excuse for contemporary Austrians to keep repeating this error. In the present depression, it is also telling that the Fed stepped in to guarantee MMMF redemptions at par, undertaking the same role that the FDIC plays with respect to banks. If the Fed makes sure that a MMMF share is worth a buck, and I can write negotiable checks to spend a MMMF share just like buck, then how is it not equivalent to a buck?
The second argument is also wrong. The fact that a MMMF share represents fractional ownership of a pool of credit instruments is no different in principle than owning deposit shares in a credit union or in a mutual savings and loan. The crucial point is that such shares have a guaranteed at-par redemption value, and therefore represent claims to definite sums of money. Moreover, a transfer of such shares serves as a final means of payment, notwithstanding the likely subsequent redemption of the shares by the payee. This in principle is no different than any other fractional reserve institution having to liquidate assets when claims are transferred to non-clients. If these transfers are off-set by incoming deposits, or if the transfers take place among clients, or if the MMMF draws down its cash reserve, then the MMMF doesn’t have to sell any of its credit portfolio. Again, how is this any different than how an ordinary bank (or more analogously, a credit union or mutual savings and loan) operates?
Given the basic Austrian insights into the nature of money, the mainstream MZM is actually a pretty good proxy for the Austrian total money stock. The main thing that is missing from MZM are the non-reserve deposits held at the Federal Reserve Banks, mainly by the US Treasury. These were formerly quite insignificant, but have lately become more important (with the TARP bailout, etc.), currently around $300 billion.
According to my calculations, as of December 2010 the total money stock is $10,119 billion. This figure was hovering below $10 trillion since the big bailouts of 2008, and only resumed its upward climb again last summer. This is in sharp contrast to the prolonged upward spike that Murphy’s graph of his version of the Austrian TMS shows. What this means is that instead of a rapid inflation of the money stock (as Murphy would have it), we have experienced a large shift from MMMFs to more traditional bank accounts, coupled with a propensity of the banks to build up excess reserves instead of lending them out (which is the main reason why the dollar hasn’t hyperinflated to nothingness yet). The rates of price increases likewise had moderated a bit but are now accelerating again, consistent with what has been happening with the total money stock.
An MMMF will not be accepted as money by any vendor that I am aware of. To be money, it must be immediately accepted by such a large proportion of unknown future exchange partners that you can confidently hold your entire cash balance in it, without worry.
Just being exchangeable for money is something that can effectively be said about almost any asset.
Regards, Don
Don, I don’t believe this is correct. Almost all MMMFs come with check-writing and/or electronic transfer privileges of some kind, and are generally more flexible in this respect than savings deposits, at least for large transactions. I’m not sure what kind of vendors you are dealing with, but obviously MMMFs are acceptable with enough vendors (especially stock brokerages) that they can serve a monetary purpose.
Even with ordinary bank demand deposit accounts, there are many vendors who won’t accept checks or at least out-of-state checks. However, this doesn’t alter the status of such accounts as money substitutes. Every kind of money substitute has limitations in certain contexts, just as Federal Reserve Notes are are useless in certain contexts and deposits at the Federal Reserve are useless in certain contexts and token coins minted by the US Treasury are useless in certain contexts. However, since all these different components of the money stock are freely convertible at par with one another in a relatively brief amount of time, each component can serve its role as money within its own sphere without decoupling its value from the other components. As the exchange demand for different components changes, the reservation demand and hence the relative quantities of each component can change right along with it.
It should be noted that Rothbard argued for components of the money stock that are far more exotic than MMMFs, which makes his exclusion of MMMFs from the total money stock rather puzzling. Some of us can remember the days when savings accounts only existed as hand-written notations in a passbook, which had to be presented to the teller at a Savings & Loan if you wanted a negotiable instrument (in this case, a cashier’s check) for transferring a money claim. Yet, according to Rothbard’s analysis of the Great Depression, even with this highly restricted transferability S&L shares counted as legitimate money substitutes. As he explained, whether you can write a check yourself or have to get a teller to do it for you is just a matter of banking technique, not a difference in economic function. Perhaps restricting transfers to cashier’s checks made savings deposits much less convenient as a media of indirect exchange in those days, but nevertheless they were still transferable as a final means of payment as well as being redeemable in gold.
Rothbard also argued for the monetary status of the surrender value of life insurance policies, where he seemed to ignore the need for transferability altogether in favor of at-par redemption on demand. If such redemption is all that matters, then surely MMMF shares qualify. If transferability matters also (as I think is implied by Mises’s theory), then the fact that MMMF checks and transfers are widely used as a final means of payment would also argue for MMMFs’ monetary status.
Vincent,
From my POV, the important context is not stock brokerages, but convenience stores and cafeteria trucks. According to Mises, it is uncertainty that makes money necessary. If you expect to pay a tow truck driver out in the sticks with a MMMF check, be my guest and keep all of your money holdings in MMMFs. Today, most purchase transactions (and even more purchase amounts) do not require a continuous holding of an actual medium of exchange. Credit cards and anything that can easily be converted into money as necessary together reduce the demand for holding money, but they are not money.
Regards, Don
Don,
From the viewpoint of economic theory, I don’t think we can say that convenience stores, cafeteria trucks, or tow trucks occupy a more special status as vendors than the people who peddle stocks and mutual funds. Besides, many of these vendors won’t take checks drawn on ordinary bank accounts either. Does that mean that they aren’t money substitutes either?
Also, I can think of at least one MMMF, namely Paypal’s, that is a whole lot more useful for certain kinds of small-scale transactions (those involving many on-line vendors) than are Federal Reserve Notes. Does that mean that the Paypal MMMF is real money, but that FRNs are not?
I understand your point about credit cards reducing the need for cash holdings, but MMMFs are not used like credit cards; they are used more like bank accounts. You write checks or make electronic transfers against your MMMF balances, and those checks/transfers serve as a final means of payment. With MMMF transactions, you aren’t left with any balances to settle later, as is the case with transactions involving lines of credit or clearing systems.
Best regards,
Vince
Bob, a question:
You state: “shares of corporate stock are not money by any stretch; they don’t appear in any of the standard monetary aggregates. . . The reason is that the price of a share of stock is constantly changing.”
Is fluctuating price the reason stocks aren’t money? It seems to me that they don’t fit Mises’s base definition of “generally accepted medium of exchange.” Even when stocks are traded directly or for other goods they would be priced in dollar terms before the exchange.
The other problem I’m having is the idea that constant price fluctuations is relevant to the “non-moniness” of stocks. The price of fiat dollars is constantly changing, too, with targeted inflation intentionally reducing the value of dollars. Price fluctuations appear to me to relate to the secondary purpose of money as a store of value, not the core definition.
Am I thinking about this too hard?
My thoughts:
If stock values didn’t change so rapidly maybe they would be a generally accepted medium of exchange.
The value of fiat dollars may change over time, but not nearly so rapidly as a stock. If they did then there would be no listed prices at stores. They would just have signs saying “market price” like you often see for lobster at a seafood restaurant.
What about Paul van Eeden’s “Actual Money Supply”?
http://www.paulvaneeden.com/The.Actual.Money.Supply
THE CONTRARIAN TAKE publishes monthly money supply metrics and commentary under the TMS formulations (Shostak and Salerno-Rothbard) for US, Euro and Japan currency blocks, including comparisons against mainstream Ms here….
http://blogs.forbes.com/michaelpollaro/austrian-money-supply/
Also found here is component analyses – currency + covered substitutes+ uncovered money substitutes. explanatory definitions, notes and sources
If the legal reserve ratio is 10 percent, the checking deposits $980 millions, and cash reserves $80 millions, than the banks will need to call in only $18 millions of their loan portfolio to restore the 10 percent reserve ratio, if the $18 millions is paid in cash.
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