Expansion of the Money Supply

[Toro]

I recall someone sometime back question the assertion that the money supply had expanded at an extraordinary pace. As I find further posts, I will put them here.

Earlier this week, my pal Larry Kudlow showed a chart of M1. His purpose was to demonstrate that the growth of the money supply was modest, therefore future inflation expectations would/should subside. Hence, this would leave the Fed free to slash rates much further.

The unspoken subtext was this was needed to bail out a weakening economy and an increasingly volatile stock market.

If you want to prove that the Fed has been stingy, M1 is the wrong data point to use -- it paints a misleading portrait of money supply, as the nearby chart reveals. The Fed, as we have seen, has been doing their work not via the printing press, but rather through the Repo Credit market. The near daily repos, along with a little help from their Euro-buddies (who just injected half a trillion dollars of short term notes into their system.

M1 is merely physical currency, plus demand accounts. What you really need to see is M3, which includes eurodollars and repurchase agreements. (Hey, what do you know! The Fed no longer reports M3. What an astounding coincidence!). ...

Deep down inside, I suspect Larry realizes that much of the "boom" from 2002 til '07 was driven by the absurdly cheap money -- and not tax cuts, as has been argued by many on his show. Just about everything from share buybacks to M&A to private equity bids to the Housing boom and MEW driven consumer spending to weak dollar led export boom were functions of ultra-low rates. Now, that cycle has ended, and we are seeing the repercussions of the irresponsible policies of Alan Greenspan.

http://bigpicture.typepad.com/photos/uncategorized/2007/12/21/sgsm3.gif

 

[BaronVonBigmeat]

16% growth in the money supply minus a (supposed) 2% growth in GDP should yield some pretty serious inflation. Which is what we've seen in just about everything--commodities, education, housing, health care. Ok, except maybe trinkets from China. They've held steady, although without the monetary inflation we'd probably be paying $10 for a pair of Nikes right now.

My question is, do mainstream economists even have a clue what's going on? I argue these points with a guy on another forum, he is a graduate student who teaches an undergrad course on economics, specifically money and banking and so forth. According to him, M3 is meaningless, leaving out price hikes in gasoline, housing, etc. from inflation numbers is completely sensible because they are "volatile", there's nothing wrong with the way we calculate GDP, etc. It's like he hasn't even been trained in economics 101, he's been trained to be a good government bureaucrat who will collect cooked statistics and shill for whatever the official explanation is.

Also I understand that M1 is just cash basically, but what is M2, MZM, and M3? And why would someone say that M3 growth is meaningless?

 

[Warner]

16% growth in the money supply minus a (supposed) 2% growth in GDP should yield some pretty serious inflation. Which is what we've seen in just about everything--commodities, education, housing, health care. Ok, except maybe trinkets from China. They've held steady, although without the monetary inflation we'd probably be paying $10 for a pair of Nikes right now.

My question is, do mainstream economists even have a clue what's going on? I argue these points with a guy on another forum, he is a graduate student who teaches an undergrad course on economics, specifically money and banking and so forth. According to him, M3 is meaningless, leaving out price hikes in gasoline, housing, etc. from inflation numbers is completely sensible because they are "volatile", there's nothing wrong with the way we calculate GDP, etc. It's like he hasn't even been trained in economics 101, he's been trained to be a good government bureaucrat who will collect cooked statistics and shill for whatever the official explanation is.

Also I understand that M1 is just cash basically, but what is M2, MZM, and M3? And why would someone say that M3 growth is meaningless?

s

They say the M3 is meaningless because they don't like what it reveals.

http://en.wikipedia.org/wiki/Money_supply

United States
Components of US money supply (M1, M2, and M3) since 1959
Components of US money supply (M1, M2, and M3) since 1959

The most common measures are named M0 (narrowest), M1, M2, and M3. In the United States they are defined by the Federal Reserve as follows:

* M0: The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency.
* M1: M0 + those portions of M0 held as reserves or vault cash + the amount in demand accounts ("checking" or "current" accounts).
* M2: M1 + most savings accounts, money market accounts, and small denomination time deposits (certificates of deposit of under $100,000).
* M3: M2 + all other CDs, deposits of eurodollars and repurchase agreements.

The Federal Reserve ceased publishing M3 statistics in March 2006, explaining that it costs a lot to collect the data but doesn't provide significantly useful information.[1] The other three money supply measures continue to be provided in detail.

[edit] United Kingdom
It has been suggested that M4 money supply be merged into this article or section. (Discuss)

There are just two official UK measures. M0 is referred to as the "wide monetary base" or "narrow money" and M4 is referred to as "broad money" or simply "the money supply".

* M0: Cash outside Bank of England + Banks' operational deposits with Bank of England.
* M4: Cash outside banks (ie. in circulation with the public and non-bank firms) + private-sector retail bank and building society deposits + Private-sector wholesale bank and building society deposits and Certificate of Deposit. [2]

[edit] Link with inflation

[edit] Monetary exchange equation

Money supply is important because it is linked to inflation by the "monetary exchange equation":

\textrm{velocity} \times \textrm{money\ supply} = \textrm{real\ GDP} \times \textrm{GDP\ deflator}

U.S. M3 money supply as a proportion of gross domestic product.
U.S. M3 money supply as a proportion of gross domestic product.

where:

* velocity = the number of times per year that money turns over in transactions for goods and services(if it is a number it is always simply nominal GDP / money supply)
* nominal GDP = real Gross Domestic Product × GDP deflator
* GDP deflator = measure of inflation. Money supply may be less than or greater than the demand of money in the economy

In other words, if the money supply grows faster than real GDP growth (described as "unproductive debt expansion"), inflation is likely to follow ("inflation is always and everywhere a monetary phenomenon"). This statement must be qualified slightly, due to changes in velocity. While the monetarists presume that velocity is relatively stable, in fact velocity exhibits variability at business-cycle frequencies, so that the velocity equation is not particularly useful as a short run tool. Moreover, in the US, velocity has grown at an average of slightly more than 1% a year between 1959 and 2005 (which is to be expected due to the increase in population, unless money supply grows very rapidly).

[edit] Percentage

In terms of percentage changes (to a small approximation, the percentage change in a product, say XY is equal to the sum of the percentage changes %X + %Y). So:

%P + %Y = %M + %V

That equation rearranged gives the "basic inflation identity":

%P = %M + %V - %Y

Inflation (%P) is equal to the rate of money growth (%M), plus the change in velocity (%V), minus the rate of output growth (%Y).[3]

Look at the graph on the lined page showing M1+M2+M3 money supply growth! (or look at the one in Toro's post - how do you get images into your posts?)

Between 1945 and 1971 the US money supply grew 8 fold. In 1971 Nixon took the USA off the "Gold Standard". The Government no longer needed to back dollars with gold reserves. Between 1971 and 2004 the US Money supply grew over 8000 fold!

 

[BaronVonBigmeat]

They say the M3 is meaningless because they don't like what it reveals.

Well yes, of course, that's the bottom line; I was just wondering what the Official Party Line on the issue was. I remember someone explaining it, eurodollars don't matter, blah blah blah, but I didn't understand it to be quite honest.

I've also read somewhere about how the huge amount of money expansion is directly related to the hollowing out of america's industrial base, although I didn't quite follow their explanation either. Both phenomena take off in earnest in the early 70's. Not to mention the statistics we've all heard a million times--ever since the early 70's, it takes two incomes to provide what one once did, real wages for average workers have been stagnant since the early 70's, etc. It begs the rather obvious question (which never seems to be asked in the MSM), "Well...what policy or law changed in the early 70's?"

 

[Toro]

16% growth in the money supply minus a (supposed) 2% growth in GDP should yield some pretty serious inflation. Which is what we've seen in just about everything--commodities, education, housing, health care. Ok, except maybe trinkets from China. They've held steady, although without the monetary inflation we'd probably be paying $10 for a pair of Nikes right now.

My question is, do mainstream economists even have a clue what's going on? I argue these points with a guy on another forum, he is a graduate student who teaches an undergrad course on economics, specifically money and banking and so forth. According to him, M3 is meaningless, leaving out price hikes in gasoline, housing, etc. from inflation numbers is completely sensible because they are "volatile", there's nothing wrong with the way we calculate GDP, etc. It's like he hasn't even been trained in economics 101, he's been trained to be a good government bureaucrat who will collect cooked statistics and shill for whatever the official explanation is.

The idea of excluding volatile items makes sense when the long-term trend is flat. The problem with mainstream economists is that they haven't recognized the trend has changed. Or at least most of them had not until recently. That is because for most of their entire lives, commodity prices have been falling. In theory, commodity prices should equal the marginal cost of production. Thus, because the marginal cost for producing commodities had not risen until the last couple of years, and had fallen for three decades, economists have fallen into the trap of forecasting via the rear-view mirror.

The other reason for excluding volatile items is if they do not filter into the broader economy. If prices continue to rise for food and energy and not for everything else in general, then economists view inflationary pressures are relatively benign.

A very, very big problem with conventional economics is that they view "inflation" as changes in prices paid for goods and services. An Austrian view is that inflation is an overexpansion of the money supply. Thus, inflation may or may not show up in prices paid for goods and services. It may, as it has for the past 10 years, show up in asset prices. Thus, you have a stock market bubble. Then you have a housing bubble. Then you have a commodities bubble. And so on.

It is a failure of conventional economics.