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Source link: http://archive.mises.org/7730/on-the-money-supply-definition-issue/

On the Money Supply definition Issue

February 1, 2008 by

I tried to post this as a reply to the criticism of my criticism of Frank Shostak’s money supply definition that the person calling himself Newson posted under Frank’s most recent article. It strangely disappeared so that’s why it’s posted under a new post (slightly reformulated since it is a new post rather than a comment under a post):

First of all, I am not the only Austrian economist who thinks that Shostak’s definition of the supply of money is too narrow. None other than Murray Rothbard argued for a broader definition, and argued against Shostak’s view that for example savings deposits shouldn’t be considered money.

http://mises.org/rothbard/austrianmoneysupply.pdf

As for Mark Humphrey’s argument (“For example, shares in a money market mutual fund are an investment acquired by the owner in exchange for money.”) about how setting Money Market accounts involve giving up cash, I find that argument to be very strange. Any bank account holding means giving up cash, so that argument would leave us with a ultra-narrow money supply definition where only cash (as in notes and coins) would be money. And the argument about potential losses is also strange considering that 1) such losses virtually never occurs 2) There’s no guarantee that holders of notes and coins won’t lose their money due to physical destruction 3) Even if there was such a distinction it wouldn’t be relevant as there’s nothing about the essentialist definition of money that mentions this issue.

The key factor to consider regarding what is and what isn’t money is whether or not it can be used as a means of payment in a similar manner as cash. If it can-it is money, if it can’t isn’t. That is why MZM is the best definition of money.

As for Eric Lansing’s argument. that claim Shostak’s unspecified definition correlate in some unspecified way better with some unspecified economic indicator without explaining why this unspecified correlation is relevant. Even setting aside the very un-Austrian nature of this argument ( While Shostak and Rothbard (and I) disagrees about how money should be defined, all agree that correlation to some economic aggregate isn’t a valid way to settle the issue), any inductive empirical claim must meet some minimum quality standards that his argument certainly didn’t meet. Including 1) How the variables are defined 2) Why the alleged relationship if real is relevant 3) In what way they correlate and with what timelag 4) Which source back up that claim. If and when Eric or some one else is able to answer that, please return to this debate.

{ 18 comments }

Bill aka NO DooDahs! February 1, 2008 at 4:32 pm

All forms of credit should be included in money – because it can be used as a means of payment in a similar manner to cash. Credit itself is inflationary and drives increased prices for goods and services, as anyone who has ever bid cash in the marketplace, against someone using credit, can readily attest.

Does MZM capture all forms of credit? If not, I would suggest that it is not broad enough.

John February 1, 2008 at 4:50 pm

One thing I have found helpful is to put the monetary base in real terms. Just saying there are 10000000 more dollars doesn’t mean anything when comparing periods unless you also adjust for inflation. Whether it is MZM, monetary base, or the Ms, you can add things up different ways, but as long as you’re looking at it (and its % changes) in real terms, you’ll get a lot out of looking at it. I did some research into the correct monetary statistic, but it seems a little absurd. If we were on a sound monetary system in the first place, it might be relevant. Until then, I’ll stick with real monetary base due to its predictive ability in the past. It’s not THE MONETARY AGGREGATE, but it is a useful addition to my forecasting. As long as I don’t construe it as having more predictive power than it does (hubris), I don’t see anything wrong with this aproach.

Bill aka NO DooDahs! February 1, 2008 at 7:55 pm

John, most Austrians would maintain that an increase in the amount of money (measured in dollars) IS inflation. So there’s no way to adjust the amount of money for the amount of money!

An increase in money supply will lead to an increase in the average price level over time, but the initial increase won’t necessarily be uniform, as the process of creating the money increases prices in some areas before other areas. Think of the credit bubble inflating home prices …

Now, I have in the past used M3 as my inflation adjustment for other things, and found it useful for that purpose.

Vincent Cook February 1, 2008 at 8:31 pm

Shostak’s take on this has bothered me a lot also. The fundamental characteristic of money is that it serves as the media of indirect exchange. For a claim on a unit of money to serve as a strict equivalent to the unit of money itself, the claim must be viewed by the market as being redeemable at par on demand (so each unit of the claim can satisfy one’s reservation demand in the same way as a unit of money), and must be able to serve as a final means of payment (so each unit of the claim can satisfy one’s exchange demand in the same way as a unit of money).

Credit instruments won’t work, even if they commonly serve as a final means of payment. Mises classifies them as a different kind of money, namely a credit money. However, a claim to a portfolio of credit instruments can be more problematic–if the issuer promises to redeem on demand at par and the claims can be transferred as a final means of payment, then the issuer is in fact functioning like a bank notwithstanding the legal form of the claim.

Rothbard also made an important observation of about legal restrictions on claims–if the market perceives the claim as being a dead letter, then they are irrelevant to this analysis. I would argue that while money market funds, for example, can theoretically be redeemed below par, no one in fact would invest in a fund that “breaks the buck.” In this respect, fluctuations in MMF portfolio values are as irrelevant as the delayed redemption privileges attached to savings accounts. Lately, MMF issuers have even been bailing out their funds when they get in trouble–another sure sign of bank-like character of MMF claims.

With a few caveats, I would endorse MZM as being the most accurate measure of money supply that is currently available. MZM does fail to count certain government and foreign government bank accounts. There are some components of MZM, like savings accounts and MMFs, where a small fraction of the claims are effectively converted to credit claims for a few days because of restrictions on the number of transactions in a month (savings accounts) or on spending freshly deposited sums (MMFs). Finally, MZM doesn’t necessarily accurately reflect what is going on in foreign banking systems vis-a-vis the dollar–undoubtedly there must be dollar claims overseas that are in fact genuine demand accounts and not just overnight credit instruments, etc. that are not being reported to the Fed.

Vincent Cook February 1, 2008 at 8:34 pm

Shostak’s take on this has bothered me a lot also. The fundamental characteristic of money is that it serves as the media of indirect exchange. For a claim on a unit of money to serve as a strict equivalent to the unit of money itself, the claim must be viewed by the market as being redeemable at par on demand (so each unit of the claim can satisfy one’s reservation demand in the same way as a unit of money), and must be able to serve as a final means of payment (so each unit of the claim can satisfy one’s exchange demand in the same way as a unit of money).

Credit instruments won’t work, even if they commonly serve as a final means of payment. Mises classifies them as a different kind of money, namely a credit money. However, a claim to a portfolio of credit instruments can be more problematic–if the issuer promises to redeem on demand at par and the claims can be transferred as a final means of payment, then the issuer is in fact functioning like a bank notwithstanding the legal form of the claim.

Rothbard also made an important observation of about legal restrictions on claims–if the market perceives the claim as being a dead letter, then they are irrelevant to this analysis. I would argue that while money market funds, for example, can theoretically be redeemed below par, no one in fact would invest in a fund that “breaks the buck.” In this respect, fluctuations in MMF portfolio values are as irrelevant as the delayed redemption privileges attached to savings accounts. Lately, MMF issuers have even been bailing out their funds when they get in trouble–another sure sign of bank-like character of MMF claims.

With a few caveats, I would endorse MZM as being the most accurate measure of money supply that is currently available. MZM does fail to count certain government and foreign government bank accounts. There are some components of MZM, like savings accounts and MMFs, where a small fraction of the claims are effectively converted to credit claims for a few days because of restrictions on the number of transactions in a month (savings accounts) or on spending freshly deposited sums (MMFs). Finally, MZM doesn’t necessarily accurately reflect what is going on in foreign banking systems vis-a-vis the dollar–undoubtedly there must be dollar claims overseas that are in fact genuine demand accounts and not just overnight credit instruments, etc. that are not being reported to the Fed.

Bill aka NO DooDahs! February 1, 2008 at 8:54 pm

While Mises may have classified credit as a different kind of money, I don’t. For what that’s worth! LOL

Credit spends like money.

In the market bidding process, an increase in credit drives prices higher. An individual with credit can bid more than an individual with cash.

The Cantillon effect is very much present in the credit creation process. Not only are hard consumer goods driven up in price, but so are investable assets and financial instruments.

Nowadays, much credit is created outside of the traditional banking process.

For my money (pun intended), I think M3 UNDERstated the true amount of money in the system.

Pete Canning February 1, 2008 at 9:31 pm

Many people hold all of their cash in money market accounts. If money market accounts are not part of a money supply definition it becomes quite meaningless.

newson February 1, 2008 at 9:59 pm

i cited the karlsson/shostak monetary definition divergence to shed more light on this important debate.

shostak’s “ams” appears a proprietary measure. as karlsson says, without knowing it’s composition, it’s hard to judge its worth.

i found karlsson’s sept 15 and 26 discussions (and the “comments” section) more convincing than the shostak view.

my criticism of karlsson was the trenchancy of his language. that is:

“But this is just another case of Shostak being completely clueless.”
“Two famous Austrian-leaning economists who have fallen for Shostak’s nonsense are Mike Shedlock and Gary North.”

Inquisitor February 1, 2008 at 10:22 pm

North is famous? I don’t think he is as well known as Block or Hulsmann or Boettke, for instance, but I might be wrong.

anon February 2, 2008 at 8:49 am

Credit is truely money in a full reserve system.

Otherwise, debt and money intermingle.

DonL February 2, 2008 at 10:04 am

I posted my opinion some time ago as to what I use for a monetary aggregate in my studies. I am curious as to what other’s opinion is of this version. I took it from Shostak and Rothbard (of which I cannot totally agree with either) along with what is available from the Fed’s reportage.

It consists of adding together CURRNS (Currency component of the money stock), DDDFCBNS (Demand deposits by foreign banks), DDDFOINS (Demand deposits due to foreign institutions), USGDBC (Government demand deposits at corner banks), and DEMDEPNS (Demand deposits at corner banks).

I have been keeping this aggregate for about 10 years now and find it as good as anything else. I also watch MZM and M2, but not as closely.

Is it totally necessary toknow what the real number is? In my studies, I look at the trend rather than a level anyway, and if the trend of the various measures track, is this not what is really important? Don’t we look for variations in the trend to detect possible effects on the economy? Just for thought.

Mike Sproul February 2, 2008 at 11:16 am

What is money? What a classic case of asking the wrong question! Silver is money. A piece of paper promising current (or future) delivery of silver is money. A checking account promising delivery of one of those pieces of paper is money. A credit card promising delivery of one of those units of checking account currency is money. Same for gift certificates, Disney dollars, overdrafts, etc.
The main reason people care about the definition of money is that they think that the quantity of money influences prices. But every kind of money mentioned above (except silver) is a call option on some other kind of money. Any financial economist will tell you that the value of the base security is not affected by the issue of call options on that security. Thus the value of base money is not affected by the quantity of various derivative moneys.
For what it’s worth, the right question to ask is “What backs the money?” The answer to that is that all money is backed by the assets of the institution that issued it. This is the fundamental idea of the real bills doctrine, and it is the starting point for anyone who wants to understand money.

Dennis February 2, 2008 at 2:02 pm

Regarding the issue of whether money market mutual funds (MMMF) are money (i.e., the generally accepted medium of exchange), these funds are comprised of extremely short-term, highly liquid debt instruments. When a check drawn on a MMMF is used as a means of payment, these short-term debt instruments must first be sold by the fund for cash, and the cash is then transferred to the bank account of the recipient of the check drawn on the MMMF.

This process is in contrast to what occurs when a check drawn on a demand deposit at a bank (i.e., checking account) is accepted as payment. In this case, cash already existing in the bank account of the individual drawing the check is transferred to the account of the recipient of the check. No sale of securities for cash is involved in the process.

For further elaboration of this issue see the article by Professor Joseph Salerno,
http://mises.org/journals/scholar/TMS.pdf

Pete Canning February 2, 2008 at 8:44 pm

So it is FDIC insurance that makes something part of the money supply? It seems that is what Salerno is stating in that paper. Money market deposit accounts are part of the money supply, but money market mutual funds are not? What of deposits not covered by FDIC insurance?

The “True Money Supply” seems to be arbitrary, and does not serve the purpose that a money supply figure ought serve.

DonL February 4, 2008 at 9:59 am

A point of picky definition: “money” is a noun without substance; a 3rd class thing. Technically, there is no such ‘thing’ as money. Things are used “as” money, that being whatever facilitates indirect exchange. If paper coupons printed by the government are accepted in exchange or goods and services, then they are being used ‘as money’ and fit the definition, regardless what the Constitution says or what we prefer to be “Money”. Denial does not alter the fact. Sorry.

Dennis February 4, 2008 at 2:59 pm

As to the inclusion of money market mutual funds in the money supply, I do not believe this issues centers around whether or not there is FDIC insurance. What matters, to quote from the above-referenced Professor Salerno article is:

“Unlike a check drawn on a demand deposit
or MMDA, therefore, an MMMF draft does not
simply represent a direct transfer of current claims to currency, but a dual order to the fund’s manager to sell a specified portion of the shareowner’s asset holdings and
then to transfer the monetary proceeds to a third party named on the check. Note that the payment process is not finally completed until the payee receives money, typically
in the form of a credit to his demand deposit.”

Robert November 18, 2008 at 11:27 am

I could put all my cash into canned goods, stocks, or credit assets, yet I cannot casually exchange these things to acquire virtually any good on the market. Thus, they are not money.

MMDA’s and MMMF’s are not money because they are not commonly accepted in trade. Rather, the accounts/funds would convert themselves into money, which is then used in trade.

Plus, they are not truly a money substitute, because they always add to the money supply, as this would effectively say that certain securities, stocks, and bonds can simply be monetized by effective brokerage management. Then again, if money markets can de facto create a form of credit redeemable for cash on demand without any fee, and more people use it over other savings, perhaps it is not so difficult to believe these things ARE being monetized.

Compare a demand deposit – the bank can withhold the cash given to them from circulation in their vault, thus neither adding or subtracting from the money supply…of course, they’re not used like that…

so, who knows – look at ALL the figures and compare them to price inflation

Dan P November 16, 2011 at 10:22 am

Take Bank Lending stats from the BIS, Regress agains inflation, oil prices, home prices etc. You will find some shocking correlations….

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