Money Supply: Recent Episodes
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Mises.org economist and senior editor Ryan McMaken joins Jeff and Bob for a hard look at the economic reality Americans face today.
Shostak on the true definition of a recession: Mises.org/HAP349-Shostak Bob's article in the QJAE: Mises.org/HAP349-Murphy
Paul Krugman recently wrote that the reason we see high inflation is that people mistakenly believe inflation is in our future and act accordingly. This reasoning is false.
Original Article: "Do "Inflationary Expectations" Cause Inflation? Contra Krugman, the Answer Is No"
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The usual "experts" claim inflation is a general increase in the price level. Wrong. Prices rise because of inflation, which is a government-caused increase in the amount of money in circulation.
Original Article: "Inflation Isn't What the "Experts" Say It Is. The Confusion in Terms Is Deliberate"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Abstract: This article reviews the analytical justification, the theoretical content, and the practical experience of inflation targeting, which has become the standard framework for monetary policy. It shows that due to the inflation-targeting literature’s neglect for the money demand as part of the monetary relation that drives price determination, it provides a distorted theoretical account of the most basic relations in a monetary economy and an illusionary vision of what a modern central bank could achieve. The last section of the article uses the recent monetary history of Ukraine to illustrate the pitfalls and illusions of inflation targeting.
JEL Classification: E02, E14, E31, E42, E58, N10, Y10
Nikolay Gertchev (ngertchev@gmail.com) holds a PhD in economics from the University of Paris II Panthéon-Assas and is currently based in Brussels, Belgium, where he works for an international organization. The author is grateful to an anonymous referee for his very useful comments.
INTRODUCTION Three renowned economists have declared recently that “inflation-forecast targeting can be considered the state of the art for monetary policy” (Adrian, Laxton, and Obstfeld 2018, 14). Others have seen in inflation targeting (IT) a consistent and durable standalone international monetary system in which the key players, i.e., the central banks, “are now more independent, accountable and transparent than under Bretton Woods” (Rose 2007, 671). One of its chief theoretical advocates has concluded that IT is just the best manner which humanity has discovered so far to conduct monetary policy: “I believe it fair to say that never before in monetary history has an incentive system been set up with such strong incentives for optimal monetary policy decisions” (Svensson 1999, 633).
After the central bank of New Zealand adopted IT in early 1990, six other central banks in developed countries switched to this policy framework in the next four years. In the aftermath of a first academic conference that reviewed the experience with IT in 1994 and thanks to increased interest and research in IT by the International Monetary Fund (IMF) since 1997, thirteen central banks had moved to IT by the year 2000. Without including the euro area, which can be seen as a de facto case of IT, the IMF counted forty-one independent countries with an inflation-targeting framework in 2018 (IMF 2019, 7). Although twenty years ago it was indeed “too early to offer a final judgment on whether inflation targeting will prove to be a fad or a trend,” the evidence nowadays undoubtedly shows that IT has gained overwhelming dominance (Bernanke and Mishkin 1997, 114). The success of this type of monetary policy, in terms of persistent and growing attractiveness for modern central banks, calls for an explanation. What are the specific goals and means of IT that account for its distinctiveness? Is its success due to a fundamental and innovative breakthrough in monetary theory? This article purports to provide answers to such questions.
The first section presents the standard definition, justification, and performance assessment of inflation targeting. The review of the various strands of literature distills the theoretical underpinnings of IT. The second section assesses the analytical foundation of IT from the angle of the Misesian theory of money, with special emphasis on the demand for money and the modern-day multiplicity of currencies. It concludes that the advocacy for IT is fundamentally flawed because of its neglect for the theoretical relevance of the pivotal concept of money demand. Because of this serious theoretical failure, IT can hardly be considered as an outgrowth of monetary theory at all. At best, it should be perceived as alleged guidance, clothed in the pretense of scientific knowledge, for the bureaucratic management of a central bank. The third and final section reviews, from that standpoint, the recent experience with IT in Ukraine.
THE PRACTICE AND THEORY OF INFLATION TARGETING Inflation targeting is canonically defined as a framework or strategy for the conduct of monetary policy that comprises five elements (Mishkin 2004, 1). First, monetary policy is committed to the overarching, if not exclusive, goal of price stability, understood as a constant positive inflation rate, measured by historical changes in the consumer price index (commitment).This is also the sense in which this article uses the word inflation, in striking opposition to the admitted Austrian definition of inflation as any increase in the money supply beyond what it would have been in the free market, i.e., “the process of issuing money beyond any increase in the stock of specie” (Rothbard 2009, 990). Second, the monetary authority publicly announces a medium-term numerical target, with or without bands, for the inflation rate (target). Third, to achieve this target, the central bank regularly determines its policy interest rate based on a large information set primarily focused on, but not limited to, a formal inflation rate forecast model (instrument). Fourth, the central bank communicates transparently and periodically on its objectives and informed decisions (transparency). Fifth, the monetary authority is held accountable, either formally or with a public stake in its reputation, for the effective outcome of the inflation rate (accountability). There is an intimate link between the last two elements, as gains in accountability critically depend on the effectiveness of transparency. The second and third elements operationalize the conduct of monetary policy and in relation to the first one determine the institutional credibility of the central bank.
Conceptually, IT provides a structured approach to what a central bank should do in the post–Bretton Woods world of multiple money producers. It is a response to the failure of many central banks to produce money with a relatively stable purchasing power. Recurrent currency devaluations in the case of fixed exchange rates and continuous depreciations in the case of floating exchanges have been alerting the public at least since the early 1970s about the poor performance of the domestic central bank. Thus, IT emerged in the 1990s as a practical solution for central banks in search of existential revival.
The Intellectual Roots of Inflation Targeting
Developments in economic theory in the 1970s and 1980s seriously challenged the conventional Phillips curve view according to which monetary policy can achieve higher growth and lower unemployment through a tradeoff against higher inflation. The challenge came out of macroeconomists’ interest in individual actions, notably as informed by their judgment about the future state of the economy. Thus, the formal integration in the analysis of inflation expectations concluded that money is neutral in the long run, in the sense that increases in the money supply have a lasting impact on prices and nominal variables only, with no effect on real output and employment (Friedman 1968). The power of this conclusion, which derives exclusively from the focus on expectations, led to stronger attention to expectations themselves. Economists from the entire intellectual spectrum quickly admitted that the assumption of choice rationality, i.e., of individuals’ optimizing behavior, necessarily implied rationality of the formation of their views and opinions about the future. Thus, the assumption of rational expectations (Muth 1961)—that economic actors form their beliefs about the future based on all relevant information with respect to the causal relations in the economy, to the policies pursued by the authorities, and to the economic models and theories that underpin these policies—became the new norm. This so-called rational expectations revolution (Begg 1982) radicalized the revised view of the expectations-augmented Phillips curve, in particular, and of the potency of economic policy in general.
One of the most relevant pieces of the economic agents’ information set for forming their expectations is the very model used by the economist to describe the functioning of the economy. This congruence between the assumed causal relationships between economic variables and the individual belief in these relationships leads to the self-validation of the assumed hypothetical model. Hence, rational expectations became a modeling tool that serves the purpose of proving the formal validity of the model’s conclusions (Gertchev 2007, 326). As a result, economic science further disintegrated into separate schools, each defined by its own set of auxiliary assumptions. The New Classics, who emphasize the lack of any friction and therefore the permanent and instantaneous clearing of all markets, conclude what is already implied by these assumptions—that monetary policy is inefficient at any moment, hence including in the short run (Lucas 1972; Sargent and Wallace 1975). The broader implication is that if discretion does not work, then monetary policy should follow a rule (Kydland and Prescott 1977). The New Keynesians, who assume a noncompetitive, sticky, or monopolistic price-setting mechanism, allow for a lag in the adjustment between economic variables, thereby creating room and scope for a well-designed policy. Moreover, the temporal lag in the New Keynesian version of the Phillips curve triggers an interpretation of current inflation as causally determined by future inflation expectations. Therefore, if a central bank aims to control inflation, it must first control inflation expectations, for which a credible commitment to a simple rule is most appropriate.
Essentially, inflation targeting is rooted in this theory-informed belief in the virtues of a rule-based monetary policy. It is in this context that the five aforementioned framework elements are best understood. Before proceeding to a presentation of the targeting rule itself, it is expedient to make two additional points on the choice of the target and of the instrument. First, without ever discussing details about the principles that should guide the numerical determination of the inflation target, advocates of IT simply admit that a low positive inflation rate should be pursued: “It seems clear that an inflation target of zero or near zero is not desirable for several reasons” (Bernanke and Mishkin 1997, 110; our emphasis). Following a very succinct discussion according to which i) inflation figures are overstating actual inflation, ii) too low inflation worsens the allocative efficiency of resources if nominal wages are rigid, and iii) deflation is bad, the IT advocates openly acknowledge that “Indeed, a potentially important advantage of inflation targeting is that it provides not only a ceiling for the inflation rate, but also a floor” (ibid., 110). Thus, what seems clear, indeed, is that IT is premised on a strong proinflation bias.Only Frömmel (2019) has raised the question of the most consistent rationalization of the inflation target value itself. Within a Hayekian intellectual framework, he argues convincingly that monetary policy should target a negative inflation rate, equal to the opposite of the growth rate.
Second, with respect to the choice of the monetary policy instrument, proponents of IT consider the deregulation of the financial sector to have compromised the stability of the relation between the supply of and demand for money (Debelle 1997, 6). Due to the resulting volatility of “money velocity,” there is no longer an empirically exploitable link between changes in the supply of money and the inflation rate (Mishkin 2004, 28). Hence, the choice of the money supply and of monetary aggregates as the operational intermediate target by the central bank appears impractical and unfit (Svensson 1997, 8). Rather, the central bank should strive to control the interest rate, in such a way that “inflation targeting provides a nominal anchor for policy and the economy” (Bernanke and Mishkin 1997, 108; our emphasis).
The Theoretical Optimality of Inflation Targeting
The rationalization of IT as the most optimal conduct of monetary policy relies on two building blocks: the so-called transmission mechanism and the minimization of an objective loss function.
The transmission mechanism is a depiction of the relevant causal relationships that describe the functioning of a monetary economy. The advocates of IT borrow this description from an alleged “conventional wisdom [which] appears to grow increasingly dominant” (Svensson 1999, 609). De facto, the economy is depicted in line with the tenets of a standard macroeconomic aggregate supply and aggregate demand model in the New Keynesian fashion. In such a model of the closed economy, monetary policy affects aggregate demand via its impact on the interest rate “and possibly on the availability of credit” (ibid., 609). Then, the effect on inflation stems from the aggregate supply, which is an expectations-augmented Phillips curve. This expectations channel is critical, as “[it] allows monetary policy to affect inflation expectations which, in turn, affect inflation, with a lag, via wage- and price-setting behaviour” (ibid., 609). In the open economy, expected and induced changes in the exchange rate are additional channels of transmission for monetary policy, as they either contribute to aggregate demand or directly impact the prices of goods (Svensson 2000, 158).
This standard macroeconomic model has two remarkable implications. First, it manages to abstract from a detailed analysis of the monetary equilibrium. In particular, it ignores the role of the supply of and demand for money in the determination of monetary prices. Thus, it is questionable whether the very foundation of IT belongs to monetary theory at all. The most vocal theoretician of IT has actually acknowledged this peculiar feature: “In this view of the transmission mechanism, it is apparent that, perhaps somehow paradoxically and heretically, money only plays a minor role” (Svensson 1999, 610). Second, as an explanation of the factors that drive general changes in monetary prices is needed nevertheless, this explanation is provided by the modern infatuation with expectations. Hence, inflation expectations become the cornerstone of both theorizing about inflation and monetary policy.
The second building block of IT exemplifies this last point. In opposition to an instrument rule, such as the Taylor rule, which links the policy interest rate to some economic factors according to a deterministic reaction function, a targeting rule links the policy instrument to the minimization of a loss function. The loss function grows when inflation deviates from the target, and it can integrate deviations from other policy goals too, such as of output from its potential or of the exchange rate from its target or its volatility, etc. Strict IT includes only inflation deviations in the loss function. Flexible IT accounts for other potential goals of monetary policy. One way or another, the loss function is minimized when the actual inflation rate is at or very close to the targeted inflation rate. Now, faced with this tautology already implied in the very notion of inflation targeting, what should a central bank do in practice, especially given that according to the transmission mechanism it has no direct control over inflation?
The proposed solution consists of the central bank setting its policy rate at such a level that its own inflation forecast, conditioned by the formal macroeconomic models developed by its research department and based on any other relevant information, moves closer to the inflation target: “As emphasized in Section 2, using conditional forecasts as intermediate target variables is arguably the most efficient way of implementing monetary policy, since it can be interpreted as implementing first-order conditions for a minimum of the loss function, using all relevant information” (Svensson 1999, 627). Therefore, inflation-forecast targeting becomes the operationalized real-world version of the theoretical IT. Since, allegedly, what matters for actual inflation are the inflation expectations of money users, the central bank must then engage in an intense communication campaign to engineer a congruence between modeled expectations, i.e., its own forecasts and projections, and real-world expectations, i.e., the public’s actual beliefs. This includes the regular publication of inflation reports, of the central bank’s updated forecasts and of the reasons that underpin its effective policy decisions.
Hence, IT boils down to the regular and yet nonmechanical setting of the policy interest rate, based on a large set of data and informed justifications. In recognition of the simplicity of this evident fact, some economists prefer to consider IT as a case of “constrained discretion” rather than a firm monetary rule (Bernanke and Mishkin 1997, 106; Kim 2011). What this view implies is that IT epitomizes the notion of an independent central bank in search of reputation and credibility, in the sense of covering its interest rate policy decisions with the mantle of scientism. The very fact that the optimizing approach takes the inflation target for grantedThe restatement of the 2 percent inflation target as a goal “over the longer run” by the Fed as of August 27, 2020, illustrates the arbitrariness of the target. best reveals the fictitiousness of the entire approach. The true issue with respect to optimality is the optimality of inflation itself. This, however, is a question that the supposedly optimal IT never raises. The unavoidable conclusion is that the true contribution of IT has been to rationalize the operational independence of modern central banks in terms of controlling the policy interest rate. In short, IT has become so popular, because it provides both a raison d’être and a modus operandi to central bankers.
Performance Assessment of Inflation Targeting
Central banks could not have embarked on IT so overwhelmingly had it failed to deliver on the promised results. Naturally, economists focused their attention on assessing its performance and the possible link to institutional prerequisites or other conditions. Interestingly, even though the reviews of IT experiences do not reach consensus on the materiality of macroeconomic benefits, they manage nevertheless to issue a rather favorable overall assessment.
As a starting point, all performance reviews recognize that IT has been successful in reducing the inflation rate. However, this temporal correlation only begs the question of whether a systematic underlying causality is at work. The IT literature has proved especially inventive in the variety of its responses. A very early review concluded that IT “is useful for those countries which may lack anti-inflation credibility” and that subsequently IT “is not necessarily appropriate for all countries” (Debelle 1997, 21 and 29). This is an open recognition that IT is just a tool to set up a fully fledged central bank in control of an independent monetary policy. IT becomes instrumental in producing “a convergence of central bank behaviour to that of the Bundesbank,” which itself needs no IT to gain its independence and credibility (Neumann and Hagen 2002, 136). Thus, even though the “evidence does not support the claim that IT is superior to strategies that focus on monetary aggregates,” it matters because it helps low-credibility central banks gain in reputation (ibid., 144).
Various econometric techniques, correcting for the resulting self-selection bias, helped reassess the evidence on macroeconomic performance in terms of reduced inflation rates, lowered inflation volatility, potential output gap, or even interest rate stability. The results are rather unanimous in concluding that IT in itself does not improve the economic performance of a country (Ball and Sheridan 2003, 17; Lee 2011, 396). Yet, in line with the relativism of methodological positivism, no firm conclusion is drawn. First, it is pointed out that the lack of a clear positive link between IT and macroeconomic performance implies in no way that IT is harmful. Second, if the available data has not yet confirmed a positive causal relationship, this would only mean that the test has not been conclusive and that a firm conclusion would require more data: “Thus a paper that replicates this study in 25 or 50 years may find ample evidence that targeting improves performance” (Ball and Sheridan 2003, 17). The authors admit, however, that if IT central banks do not bring about better macroeconomic results than non-IT central banks, this might suggest that both groups are pursing the same interest rate policy, despite their formally different policy frameworks. This in fact reinforces the view that IT is but a device for weak central banks to acquire independent political stance.
From that perspective, the macroeconomic success of IT is necessarily related to the broader institutional and policy setup in a country. The International Monetary Fund (IMF), in particular, has devoted great attention to the question of the required institutions and practical details to make IT a suitable strategy, especially for less developed and emerging economies (Masson, Savastano, and Sharma 1997; Schaechter, Stone, and Zelmer 2000; Clinton et al. 2015). The importance of stable fiscal, monetary, and financial institutions for smoothing the impact of currency depreciation on banks’ and companies’ balance sheets and for preventing a sudden stop in foreign capital inflows has become a highlight of the debate on whether the exchange rate regime matters at all (Calvo and Mishkin 2003). The inclusion of such considerations in the debate has resulted in a very positive overall attitude towards IT. Although the literature recognizes controlled government spending and banks’ sound risk exposures as prerequisites for independent monetary policy, it also admits that, because of its strong commitment to achieving the price stability goal, IT effectively brings about these very same necessary conditions (Amato and Gerlage 2002; Mishkin 2004, 11). Again, economists have turned the argument in such a way that neither in theory nor in practice could one find an obstacle to the widespread adoption of IT by central banks.
The discussion of the broader institutional setup surrounding IT has widened to include the exchange rate regime itself. The conventional view that IT necessarily implies the central bank’s neglect for the exchange rate has been challenged, notably thanks to the prevalence of the so-called financial transmission channel. Often the distinctive feature of small open emerging economies is their high degree of currency and bank liability dollarization, which amplifies the effect of exchange rate volatility on real output and macrofinancial stability. Since central banks in emerging economies consider this liability dollarization as a serious source of vulnerability, they more often than not, and upon advice from economic theory, intervene in the foreign exchange markets in order to contain sharp movements in the exchange rate. This raises the question of the potential incompatibility of IT with the necessary reality of more or less frequent foreign exchange interventions.
The latest research has concluded that far from being incompatible with IT, foreign exchange interventions can enhance its efficacy. In the context of dollarization, in order to mitigate the currency risks, “exchange-rate-anchored IT produces much better results” (Buffie, Airaudo, and Zanna 2018, 182). Fundamentally, in that specific context the central bank is bound to pursue two objectives and must therefore have recourse to two policy instruments (ibid., 161). Although foreign exchange interventions might amplify inflation volatility, the more credible a central bank is, the narrower the tradeoff between reduced output and increased inflation volatility (Adler, Lama, and Medina 2019, 1). Finally, research from the IMF concludes that there might be plenty of good reasons for an IT central bank to intervene on the forex market: manage risks from currency mismatches, contain an exchange rate shock, support a weak interest rate transmission channel, build up official reserves, and buffer foreign capital flows to contain the credit cycle (Hofman et al. 2020). In spite of two potential costs, namely moral hazard due to the implicit public guarantee on private risky behavior and possibly confusing and deanchoring inflation expectations, the compatibility of IT with any exchange rate regime has been established de facto (ibid., 18).
The literature on the macroeconomic effects of IT skillfully explores different aspects of monetary policy and its impact on the economy. This literature review leads to two conclusions. First, most of the discussion has not focused on IT itself as a standalone policy, but rather on its broader effect in terms of observed changes in macroeconomic variables. From that perspective, it belongs more to the area of economic history than to the field of monetary theory.A large part of the literature on the performance of IT belongs to the field of public policies evaluation and consists in the application of evaluation-specific econometric techniques to the outcomes of IT in a given economy during a given period. Evaluation has become extremely popular within public policy agencies at all levels, both ex ante, to justify, and ex post, to assess the impact of concrete policy interventions. Public authorities have developed evaluation from a mere accountability exercise into a crucial foundation of so-called evidence-based policymaking. It should be obvious that in its constant search to invalidate or confirm an assumed policy impact, policy evaluation denies that economic and social theory has something meaningful to say about the design and assessment of public policy. Evaluation is methodol by public agencies in search of existential justification. Second, whenever the findings reveal inconclusive data, they are depicted in a context of benevolent doubt. As a result, the studies of IT exhibit a clear pro-IT bias that gives the perception that the dissimulated goal of IT literature is to legitimize and popularize the adoption of that strategy by central banks.
Analytical Foundation of Inflation Targeting
The intellectual roots and biases of IT have been highlighted above. IT builds upon the New Keynesian version of an aggregate supply and aggregate demand macroeconomic model. It admits that high inflation disturbs economic choices. Yet it considers virtuous a positive inflation rate and sees deflation as a danger. Since these conjectures have received their fair share of rational critique elsewhere, and as they do not form the core of IT, they will not be analyzed further. Here, the focus will be the question of what the analytical core of IT is. Two elements in particular make the essence of IT.
First, IT relies on a presumably stable relation between nominal interest rates and inflation. This same link between interest and inflation underpins the claim by its proponents that IT offers central banks a solution for exerting control over inflation. At the same time, the relation between monetary aggregates, i.e., money supply, and inflation is de facto denied due to the instability of money demand or of the so-called velocity of circulation. In other words, the nominal interest rate is presented as the single most important economic variable that brings a monetary economy into equilibrium and consequently provides a policy tool by which to change that equilibrium.
Although IT proponents avoid the notion of monetary equilibrium, this is precisely what they mean by the very frequently used concept of a “monetary anchor.” Practically any publication on IT refers to it but without defining it clearly. The IT-controlled interest rate is sometimes meant to anchor inflation expectations: “One role for inflation targets is to provide an anchor or coordinating device for inflation expectations” (Debelle 1997, 17). At other times, the anchor refers to monetary policy only: “to bind its [the central bank’s] policy to an intermediate target that serves as the monetary anchor for monetary policy” (Neumann and Hagen 2002, 145). Others consider IT to anchor the economy itself: “inflation targeting can confer some important advantages. It provides a nominal anchor for policy and the economy” (Bernanke and Mishkin 1997, 108). One explicit discussion on the “need for a nominal anchor” explores IT as a monetary system for the economy (Freedman and Laxton 2009, 8–11). It appears, therefore, that this “monetary anchor” function of IT is a crucial analytical foundation, which also represents a specific view of the monetary equilibrium of an economy.
The second essential element of IT is the conjecture that in a world of multiple currencies this “monetary anchor” is independent from the relative quality of the domestic money. The monetary equilibrium of the national economy and the influence that the domestic central bank can exert upon it relate exclusively to the interest rate. This assumption underlies all claims about the very possibility of an independent monetary policy, i.e., a policy that is capable of controlling domestic inflation. As noted above, researchers have noted lately that more often than not central banks in emerging economies pursue (sterilized) exchange rate interventions while following IT. These interventions have been presented as a matter of choosing to employ a second tool that actually enhances the impact of the independent monetary policy. The implication is that all central banks operate on an equal footing, irrespective of the relative quality of their products as perceived by money users. This very egalitarian approach to paper money and central banking allows IT proponents to advocate its adoption by any central bank.
The foundations of IT are at odds with the essential contribution to monetary theory of the Austrian school of economics. The next section focuses on two crucial analytical weaknesses of IT that seriously question both its theoretical justification and its fitness to the real world.
THE ANALYTICAL PITFALLS OF INFLATION TARGETING The Austrian theory of money uniquely integrates monetary, or macroeconomic, and individual, or microeconomic, phenomena through the pathbreaking application of the concept of marginal utility to the monetary good itself. The resulting successful analytical apparatus is naturally the most fit to approach contemporary issues arising from the coexistence of multiples monies.
The Monetary Relation as the True Anchor of the Economy
Money, as the most commonly used medium of exchange, derives its utility from its capacity to exchange against other goods in the future. The monetary good does not embed these specific services of intermediation technologically, in the way a piano, a book, or a hammer physically contain and determine their own specific services. Rather, the services of a given unit of money depend on the quantity of goods it could sell for, i.e., on its expected purchasing power at the moment of exchange.This point is crucial for establishing the social and individual optimality of any amount of money in the economy: “The services money renders are conditioned by the height of its purchasing power. Nobody wants to have in his cash holding a definite number of pieces of money or a definite weight of money; he wants to keep a cash holding of a definite amount of purchasing power. As the operation of the market tends to determine the final state of money’s purchasing power at a height at which the supply of and the demand for money coincide, there can never be an excess or a deficiency of money” (Mises [1949] 1998, 418). This conclusion implies that monetary theory itself cannot provide a rationale for monetary policy, which is therefore necessarily rooted in nonmonetary considerations. Consequently, individuals’ demand to hold money is effectively a demand for “real” money balances. At higher monetary prices, a larger money balance provides the same monetary services as a smaller money balance at lower prices. Individuals value the “real” monetary services of a given stock of money based on the marginal utility of the relevant unit, as in the case of any other good. These individual valuations bring about society’s aggregate demand to hold money, which contributes to the determination of all monetary prices: “It is demand, a subjective element whose intensity is entirely determined by value judgments, and not any objective fact, any power to bring about a certain effect, that plays a role in the formation of the market’s exchange ratios” (Mises [1949] 1998, 397).
The supply of money is the other factor that plays a role in the determination of prices: “The purchasing power of money is determined by demand and supply, as is the case with the prices of all vendible goods and services” (ibid., 407). Supply of and demand for money interact through the so-called money relation that encompasses all markets. Indeed, as a universal medium of exchange, money exchanges against all other goods. Hence, the purchasing power of money is determined by the very same process that is behind all goods’ price formation. The valuation of consumer goods and the appraisement of producer goods occur concomitantly and through the same market exchanges that explain how the purchasing power of money forms and evolves. From that perspective, the monetary relation is the foundation of that general coordination process between individual actions that ensures the all-time clearing and equilibration of all markets (Salerno 2011, 181–97).Mises called this the driving force of money: “While money can be thought of only in a changing economy, it is in itself an element of further changes. Every change in the economic data sets it in motion and makes it the driving force of new changes. Every shift in the mutual relation of the exchange ratios between the various nonmonetary goods not only brings about changes in production and in what is popularly called distribution, but also provokes changes in the money relation and thus further changes. Nothing can happen in the orbit of vendible goods without affecting the orbit of money, and all that happens in the orbit of money affects the orbit of commodities” (Mises [1949] 1998, 415).
This true anchor of all catallactic phenomena operates through continuous market exchanges based on Mises’s crucial observation that “Nobody ever keeps more money than he wants to have as cash holding” (Mises [1949] 1998, 401). Whenever individuals find themselves in possession of excess cash holdings, as in the hypothetical case of a general increase in the money supply, they divert the surplus monetary units toward additional exchanges that bring about a tendency toward higher-than-otherwise prices. Should individuals feel a deficit in their cash balances, they will dump other goods and services on the market in an attempt to increase their monetary reserves, which puts in motion a tendency toward lower-than-otherwise prices. These price movements are actuated by concrete market exchanges that bring about a new distribution, and hence a different employment, of the resources in the economy. They come to an equilibrating halt when, at the updated price and ownership structure, the acting individuals consider their effective monetary holdings adequate to their respective demands and therefore take no further action to add to or subtract from their cash holdings.
The crucial point is that the money relation truly anchors the economy through actual individual actions of buying and selling. Given a stock of money or changes therein, individuals’ demand for money relative to other goods is the determining factor of prices. From the point of view of the acting individual, the stock of money in his possession is merely an economic datum among others. The conscious effort, by means of market exchanges, to bring his stock of money in correspondence with his valuation-driven demand for monetary services drives the price formation mechanism, which is also a resource allocation mechanism. The description of money price formation as relying on the actuality and necessity of individuals’ market actions produces a praxeological quantity theory of money, fully integrated with the marginal value theory.
Hence, it is the demand for money and individuals’ purposeful buying and selling of goods and services, analytically referred to as the “real” cash balances doctrine, that bring about the nominal anchoring of the economy, to borrow the vocabulary of the inflation-targeting literature. In this framework, there can be no direct causal link between interest rates and inflation. If a relationship exists between these two variables, it is the money relation itself that brings it about. Knut Wicksell’s attempt to relate interest rates to prices exemplifies this point amply.Beyond the specific contribution of Wicksell to this problem, the reference to him in this context is unavoidable because of Michael Woodford’s explicit tribute to Wicksell in the very title of his modern, now authoritative, textbook on monetary theory, in advocacy of rule-based monetary policy (Woodford 2011). Wicksell was a convinced proponent of the classical version of the quantity theory of money: “Absolute prices on the other hand—money prices—are a matter in the last analysis of pure convention, depending on the choice of a standard of price which it lies within our own power to make” (Wicksell [1898] 1962, 4).Consider also this more analytical passage on the dichotomy between relative and money prices: “It is then obvious that the fundamental conditions of exchange are not affected by the intervention of money…. So the function of money is here purely that of an intermediary; it comes to an end as soon as the exchange has been effected. Hence we arrive at an important, if self-evident, fact the neglect of which has constantly resulted in false conclusions. The exchange of commodities in itself, and the conditions of production and consumption on which it depends, affect only exchange values or relative prices: they can exert no direct influence whatever on the absolute level of money prices” (Wicksell [1898] 1962, 23; original emphasis). Yet, when it comes to providing an account of actual price changes, the reference to individual actions becomes unavoidable:
Now let us suppose that for some reason or other commodity prices rise while the stock of money remains unchanged, or that the stock of money is diminished while prices remain temporarily unchanged. The cash balances will gradually appear to be too small in relation to the new level of prices.… I therefore seek to enlarge my balance.… The same is true of all other owners and consumers of commodities. But in fact nobody will succeed in realising the object at which each is aiming—to increase his cash balance; for the sum of individual cash balances is limited by the amount of the available stock of money, or rather is identical with it. On the other hand, the universal reduction in demand and increase in supply of commodities will necessarily bring about a continuous fall in all prices. This can only cease when prices have fallen to the level at which the cash balances are regarded as adequate. (ibid., 39–40)
In his dynamic explanation of the cumulative price changes triggered by discrepancies between the market and the normal interest rates, Wicksell refers to this same analytical device. Price changes, and hence inflation, are rooted in individuals’ endeavors to equilibrate their demand for money to the supply thereof. In short, human action as regards the money relation brings about and regulates the social phenomenon of inflation.
This conclusion exposes four major deficiencies with the analytical foundation of the inflation-targeting framework. First, the explicit neglect of the demand for money and of monetary aggregates, on the ground that they are empirically unstable, is a fatal theoretical flaw. Fundamentally, it is a reflection of the classical dichotomized classification of economic phenomena into real and monetary areas. It is in this context only that one can think in conceptual categories such as aggregate demand for money or average velocity of circulation. Conscious of the related lack of realism, the proponents of inflation targeting propose to break the dichotomy through the integration of so-called microeconomic foundations into a formal aggregate model. However, this proposed alternative to the praxeological approach based on individuals’ concrete actions is bound to fail precisely because it ignores the critical importance of the demand for money and relies instead on conceptual categories that cannot be identified in the real world. In other words, the replacement of the money relation by the inflation target as an alleged monetary anchor for the economy, and hence for policy, is intellectually bankrupt and illusionary.
Second, this analytical neglect for the money relation results in a mechanical, and even distorted, view of the relation between interest rates and inflation. Lower interest rates lead to inflation only to the extent that they trigger an increase in the money supply. By implication, a central bank can influence inflation through its control over the interbank refinancing rate only to the extent that it is effectively influencing bank credit policy. This point, which was evident for Wicksell and has become a hallmark of Austrian monetary theory, is either silenced or outright ignored by the proponents of inflation targeting: “With the aggregate demand channel, monetary policy affects aggregate demand, with a lag, via its effects on the short interest rate (and possibly on the availability of credit)” (Svensson 2000, 158; our emphasis). In fact, in modern economies bank credit expansion is the primary means to bring additional means of exchange into existence. At any level of nominal interest rates and irrespective of central bank-engineered changes, many other factors—e.g., minimum cofinancing by borrowers’ own funds, minimum revenue requirements for borrowers, creditors’ collateral evaluation, or return expectations—determine banks’ willingness to extend and borrowers’ readiness to take extra credit. Consequently, no direct mechanical relationship exists between interest rate changes and inflation.
Third, the money relation shows that inflation expectations influence actual inflation only through their effect on the demand for money. The anticipation of future price increases is tantamount to an expected decline in the marginal utility of money holders’ balances relative to other goods. The subsequent tendency to lower the demand to hold money balances, through increased purchases of other goods, brings about the actual tendency for prices to increase. The sequence, speed and magnitude of the price increases are engendered by and depend on the additional exchanges made possible by the lowered demand for money. This realistic and theoretically consistent view contrasts patently with the mechanistic approach followed by IT proponents who ground the role of inflation expectations in the self-validating properties of rational expectations rather than in the causal relations produced by human action.
Fourth, the fact that money permeates all markets suggests that the policy emphasis on exclusively targeting consumer prices lacks theoretical foundation. Producer and asset prices, as well as the exchange rate of a money relative to other currencies, are equally important aspects of the general price structure in the economy. Depending on individuals’ concrete preferences and market choices, a decline in the purchasing power of money may translate initially into higher producer prices, while consumer prices first remain broadly stable. The resulting differences in sectoral price spreads trigger a resource reallocation, which is an integral part of explaining the dynamics of business cycles. IT’s narrow focus on consumer prices as the single meaningful manifestation of inflation conveys a very incomplete and therefore distorted view of the market process itself.Yet although lacking theoretical justification, this focus can be understood from the point of view of the self-interest of a monopolist money producer. Although many assets provide store-of-value services, there are few alternatives to the medium-of-exchange function of money. In fact, most such alternatives are other, foreign monies. This implies that changes in the money relation are most visible in asset price changes and in exchange rate movements, which appear more volatile than changes in consumer prices. Thus, a money producer who wants to convince people of the quality of his money would naturally insist upon measuring its purchasing power in terms of consumer prices.
Relations between Multiple Money Producers
An important aspect of the contemporary monetary order is the coexistence of multiple fiat money producers, each of them enjoying a monopoly protected by legal tender laws upon territories that commonly, though not always, coincide with the national boundaries. This multitude of monies goes together with a diversity in their relative quality. This observation has important bearing on each central bank’s capacity to conduct monetary policy on its own.
The monetary relation, again, best reveals the quality differences between fiat monies. In the absence of an international commodity money, such as gold, there arises the problem of financing trade between nations using different monies. One solution is to use one or a few of the national fiat monies for intermediating international exchanges. The international use of these originally national monies implies a substantial expansion beyond their national boundaries in the demand to hold them. This is reflected, for instance, in so-called international currencies being held in reserve by all central banks and by commercial banks worldwide. Thanks to this foreign demand, which grows with the expansion of international division of labor and cooperation, the international currencies’ purchasing power is strengthened, which in turn confirms their outstanding position. Hence, international monies are necessarily of better quality than the simply national fiat monies.
It appears, hence, that an international monetary order based on multiple fiat monies puts in place a particular dynamic of rivalry between central banks. The producers of international reserve currencies enjoy special privilege due to their significantly enlarged territory of use. Hence, the inflationary impact of any round of monetary expansion on the strictly national economy is diluted significantly. This allows the central banks that issue these currencies to be comparatively more expansionary, to follow a relatively more inflationary policy, and to benefit from practicing seigniorage abroad.Given that the production of fiat money is the political means of exploitation par excellence, this system of double-tier exploitation has aptly been called “monetary imperialism” (Hoppe 1990). The resulting rivalry between producers of international monies creates a tendency toward further centralization and domination with the view of expanding each money’s territory of use. Fixed exchange rates, currency boards, and outright dollarization are effective means for achieving this goal and represent forms of de facto monetary imperialism.
In this system, which describes the present-day monetary order, the producers of strictly national monies appear effectively dominated. To the extent that the international transactions in goods and capital are free, they influence the domestic monetary conditions. In addition to having to hold the international currencies for their cross-border transactions, and despite legal tender laws, individuals enjoy some degree of freedom to allocate part or all of their money holdings toward the foreign currency at the expense of the domestic money. Thus, the unavoidable international currency holdings domestically and abroad imply that these national central banks do not have full control of the domestic money supply. In particular, the choice of currency composition in individuals’ money holdings implies that the demand to hold the national money is influenced by its perceived relative quality. On one hand, a spontaneous tendency toward further dollarization triggers higher prices in domestic currency and a relative depreciation. On the other hand, a stronger demand for domestic money at the expense of foreign currency holdings induces the money producer to acquire the extra units of international reserve money in exchange for additional units of its own exclusively domestic money. Thus, the producers of strictly national monies have to intervene in the foreign exchange market depending on individual preferences with respect to the currency composition of money holdings.The money holders need not be national residents only. Nonresident foreigners, especially if animated by speculative motives, play a crucial role. Thus, even though a strictly national money might have a geographically limited scope, it is still part of the global international money relation and in necessary economic competition with other national and international monies. In all circumstances, the national-money central banks lose their autonomy and hence cannot exercise an independent monetary policy.
What sense, then, could one make of the advocacy of IT for emerging and developing economies, where the national money producers are in a dominated position? The striking fact of the current system of dominant international currencies and dominated national monies is its inherent instability. The very multiplicity of monies puts in motion a rivalrous environment between all central banks aiming to ensure that their product, whether strictly domestic or international, remains relatively attractive. To achieve this, the gradual loss in a money’s purchasing power due to the regular expansion of its supply should not be greater than that of other monies. Otherwise, this could trigger a decline in the demand to hold that money, which would de facto reduce the extent of its use and could even compromise its particular standing as an international currency. Thus, it is in the common interest of all money producers to coordinate their monetary expansion with the view of avoiding disruptive changes in the relative quality of their products. The popularization of IT for all central banks, with its emphasis on a similar inflation rate for all economies, i.e., a similar loss of purchasing power for all monies, is best understood as such a coordination device.
INFLATION TARGETING IN UKRAINE After communism in the East collapsed in 1989 and Ukraine gained independence from the Soviet Union in 1991, the ruling political elite, not without favorable public opinion sick with nostalgia, procrastinated in transitioning away from central planning. Ukrainian politicians refused to submit the allocation of resources to the discipline of international market competition. Instead, they tried to shelter and privilege the nascent cooperatives, allowed since 1987 and often politically connected, and to avoid socially painful reforms by maintaining the status quo of controlled prices and government subsidies (Havrylyshyn 2017, 63–64). This also included keeping a network of bilateral trade treaties at nonmarket exchange rates with the former Soviet republics at a time when the latter were already opening their economies to international competition. Thus, the misallocation of resources in Ukraine persisted and deepened until late 1994, when eventually price liberalization started (ibid., 90).Gas and electricity prices for households were not liberalized until 2019. Because of a corrupt and insider-biased privatization process that gave birth to a large number of oligarchs with monopolistic stakes in practically all sectors,Andrusiv et al. (2018) contains the clearest presentation of oligarchic interests by sector. the economy of Ukraine continued to lag behind its regional peers even during the reformist period of 1994–2000. Ten years after 1994, the gross domestic product (GDP) in dollars per capita was only 35 percent higher. During the same decade, the per capita GDP had increased by 54 percent in Russia, from an initial level two and a half times higher, and by 132 percent in Poland.World Bank National Accounts Data (GDP per capita current US$, NY.GDP.PCAP.CD); accessed Feb. 8, 2021), https://databank.worldbank.org/reports.aspx-?source=2&series=NY.GDP.PCAP.CD&country=#. Recently, after two years of stagnation in 2011 and 2012, the real GDP contracted by a cumulative 15.7 percent in 2014 and 2015. After returning to modest though accelerating real growth that reached 3.2 percent in 2019,Ukrstat (The Change of Gross Domestic Product, Volume, Archives; accessed Feb. 8,2021), http://www.ukrstat.gov.ua/operativ/operativ2004/vvp/ind_vvp/ind_vvp_e/arh_indvvp_e.html. the nominal per capita GDP in Ukraine barely amounted to USD 3,660, i.e., slightly above one-fifth of the average for Central Europe and the Baltics.
Oligarchic monopolies, systematic encroachment on property rights, and delayed market reforms have contributed to an exceptionally low level of investment in Ukraine. Gross fixed capital formation averaged only 16.6 percent of GDP between 2009 and 2019, respectively 2.8 and 4.8 percentage points behind the economies of Poland and Russia.World Bank National Accounts Data (Gross fixed capital formation, % of GDP, NE.GDI.FTOT.ZS; accessed Feb. 8, 2021), https://databank.worldbank.org/reports.aspx?source=2&series=NE.GDI.FTOT.ZS&country. The difference of 8 percentage points to Romania is even more striking. Investors from abroad have also shown little interest in Ukraine. The stock of foreign direct investment amounted to USD 1,186 per inhabitant in 2019, while it reached USD 7,373 and 4,024 in Poland and Russia, respectively.IMF International Financial Statistics (International Investment Position, Liabilities, Direct investment [BPM6], US Dollar; accessed on Feb. 8, 2021), https://data. imf.org/?sk=78748667-480d-45ce-9768-e3541d7b3932&hide_uv=1. International official statistics estimate the 2019 population of Ukraine at 44.0 million, with the last fully-fledged census from 2001 showing 48.4 million inhabitants. A refined methodology from end-2019, also correcting for the regions outside government control (1.9 million in Crimea, 4.4 million in Donetsk, and 2.2 million in Luhansk), suggests that a more correct population figure would be 35.5 million. This would put foreign direct investment per head at USD 1,470, which does not alter the country comparison materially. Although low levels of investment, along with high likelihood of misallocation, are the major cause of the delayed development of Ukraine, monetary factors have also contributed to the economic backwardness.
Monetary Developments in Ukraine
Initially a member of the rouble zone, the National Bank of Ukraine (NBU) introduced the karbovanets in January 1992. Presented as a “coupon” currency, the real function of the karbovanets was to withdraw the rouble from domestic transactions. The NBU succeeded in centralizing Ukrainians’ rouble holdings, which provided the government with the reserves necessary for centrally planned international transactions. Later in that same year, the Central Bank of Russia refused to supply more roubles to the Ukrainian government, which would have used them to finance dubious subsidies and the general deficit of an unreformed state.Although the Russian government indeed started the policy of price liberalization about two years before Ukraine, the conflict was due ultimately to the choice of who the first beneficiary of any newly created money should be. Already in October 1992, the Russian central bank had stopped honoring some of the payments that the NBU had authorized and financed with its own credits. The split of the rouble zone into independent money producers (Ukraine left on November 12, 1992) provided the final solution to this conflict. Johnson and Ustenko (1993) provide very interesting details on the early post-1989 monetary history of Ukraine. Once the karbovanets had replaced the rouble completely, the Ukrainian government removed the domestic legal tender privilege of the rouble. The NBU discontinued converting the karbovanets into the rouble and started producing the karbovanets independently in the autumn of 1992. Naturally, this resulted in a very strong hyperinflationary episode that started later that same year and lasted through 1993. Because of the loss of purchasing power, the exchange rate of the karbovanets to the dollar depreciated from 120 in January 1992 to 17,000 in September 1993 (Harvylyshin, Miller, and Perraudin 1994, 391).
The regular and relatively high inflation during the following years, due to the continued monetary financing of unreformed and inefficient state-owned companies, was depleting the official international reserves. It is in this context that, eventually, the Ukrainian authorities recognized the need for a monetary reform and the NBU replaced the karbovanets with the modern hryvnia (UAH) in September 1996. The authorities attempted to gain the confidence of the money users with a peg to the US dollar at UAH 1.85. However, the NBU continued to inflate and revised the peg down to UAH 5.5 in 2000, which implied an external devaluation by 66 percent. Since then, the monetary history of Ukraine has been marked by the uninterrupted depreciation of the hryvnia’s purchasing power, exerting continuous pressure on the sustainability of the peg (see chart 1).“Official hryvnia exchange rate against foreign currencies,” National Bank of Ukraine, accessed on Feb. 8, 2021, https://bank.gov.ua/files/Exchange_r.xls and “Consumer Price Indices,” National Bank of Ukraine, accessed on Feb. 8, 2021, https://bank.gov.ua/files/macro/CPI_y.xlsx.
Chart 1. Cumulative internal and external depreciation of the hryvnia relative to the US dollar, 2000–19
The devaluation of 2009 relative to the US dollar continued to lag behind the internal depreciation, despite the stability of consumer prices during the economic stagnation of 2011 and 2012. The NBU increased its holdings of government securities by 50 percent in 2013, triggering a 20 percent increase in the monetary base. The peg to the dollar was abandoned in early 2014, and after a further doubling of central bank credit to the government, official international reserves were almost depleted by end-2014 (see chart 2).“International Investment Position of Ukraine,” National Bank of Ukraine, accessed on Feb. 8, 2021, https://bank.gov.ua/files/ES/IIP_y_en.xlsx. By that time, the sizable external depreciation of the hryvnia had caught up with the cumulative loss of domestic purchasing power by 80 percent since 2000. The floating exchange rate to the dollar has remained broadly stable around UAH 27 for the last five years.
Chart 2. Official Ukrainian international reserves, 2000–19
The Ukrainian Experience with Inflation Targeting
The National Bank of Ukraine decided and publicly announced in September 2015 that by end-2016 it would have a fully functioning inflation-targeting framework implemented. It set its inflation targets at 12 ± 3% for end-2016, 8 ± 2% for end-2017, 6 ± 2% for end-2018, and 5 ± 1% for end-2019 and as medium-term objective beyond. Although the NBU had no difficulty in meeting the 2016 target, due to its largeness, it missed the targets for the next two years. Annual inflation remained close to 9 percent until the summer of 2019, when it started a steady decline to 1.7 percent in May 2020 before rebounding slowly to 2.5 percent in last August (see chart 3).“Consumer price indices (to corresponding month of the previous year, %),” National Bank of Ukraine, accessed on Feb. 8, 2021, https://bank.gov.ua/files/ macro/CPI_m.xlsx and “NBU Key Policy Rate,” National Bank of Ukraine, accessed on Feb. 8, 2021, https://bank.gov.ua/en/monetary/stages/archive-rish. Meanwhile, after cutting its policy interest rate by 350 basis points in the second half of 2019, the NBU embarked upon an even more aggressive policy and lowered its policy rate from 13.5 percent in December 2019 to 6 percent as of June 2020. Arguably, although inflation targeting in Ukraine failed during its first three years, eventually it delivered on its medium-term target for a few months, before consistently missing the lower band of this target range. This raises the question of how much NBU policy contributed to that achievement and which factors ultimately kept inflation in, and below, the target zone.
Let us first examine the NBU’s inflation forecasting and its relation to the policy interest rate.Data on the inflation forecasts by the NBU is extracted from the NBU quarterly “Inflation Reports,” accessed on Feb. 8, 2021, https://bank.gov.ua/en/publications?page=1&perPage=5&search=&document=&pubCategory=2&keywords=& created_from=&created_to=. For end-2016, the NBU inflation forecast of 12 percent was very close to the actual rate of consumer price change of 12.4 percent. The NBU kept its end-2017 inflation forecast at 9.1 percent until July 2017. In line with this expected decline in inflation, the central bank cut its policy rate gradually from 22 percent in January 2016 to 12.5 percent in mid-2017. Contradicting the forecast, actual inflation started to accelerate in 2017. Faced with this reality, the NBU revised its end-of-year inflation forecast up to 12.2 percent, which eventually turned out to be 1.5 percentage points below the effective figure. It also initiated a cycle of rate hikes that lasted until April 2019. In October 2018, reality forced the NBU to again revise its initial inflation forecast of 8.9 percent to 10.1 percent, which turned out to be broadly correct, though outside the target range. Given its two-year record of undershooting forecasts, and the relative stability of actual inflation around 9 percent until August 2019, the NBU put its inflation forecast at 6.3 percent, i.e., slightly above the upper bound of the end-2019 target. The NBU started lowering its policy interest rate cautiously in April 2019 and accelerated the cuts beginning in September, when inflation began its decline. By August 2020, the inflation rate had been more than halved and sat below the lower band of the target, surprising all analysts.The consumer price index hit the middle of the target range in December 2020. However, this appears to be an accidental development that is unlikely to remain a permanent achievement. The NBU inflation forecasts for end-2020 remained somewhat volatile, though anchored within the target range.
Chart 3. Inflation and NBU policy interest rate, January 2015–December 2020
These developments invite two conclusions. First, the NBU is using a formal model that has failed to anticipate actual inflation within reasonable margins of error for the last three years. The only reason why the central bank did not adjust its forecast in October 2019 is that, at the time, the forecast looked correct as nobody foresaw that the decline in inflation would accelerate toward the end of the year. Second, there is no identifiable causal link between the inflation forecasts and the changes in the policy interest rate. Except for the October upward revisions, the NBU inflation forecasts have been on a systematic downward slope. The NBU lowered its policy rate until September 2017, increased it for the next twelve months, kept it constant between September 2018 and April 2019, and then decreased it afterward. Moves in the policy instrument do not appear motivated or even informed by the inflation forecasts. Rather, the NBU policy actions resemble more of a trial-and-error approach based on actual inflation developments.The erratic nature of the NBU policy persists even with an assumed standard lag of four to six quarters between the policy interest and inflation.
If we look now at the inflation expectations of market participants (see chart 4),“Inflation expectations,” National Bank of Ukraine, accessed on Feb. 8, 2021, https://bank.gov.ua/files/macro/Surveys_price.xlsx. they have been at odds with both actual inflation and the NBU forecast. Although financial analysts’ expectations were somewhat closer to the NBU forecast, they had been undershooting actual inflation from 2016 until the summer of 2017 and failed to anticipate the disinflation from the second half of 2019. Households, i.e., money users themselves, were much more pessimistic than both financial experts and the reality itself for most of the period.This overshooting is probably due to Ukraine’s long inflationary history and to households’ having a different perception of the right measure of inflation. Strikingly, households’ inflation expectations, even though declining from above 20 percent to around 9 percent in mid-2019 and 7 percent in mid-2020, fell outside the NBU inflation forecast and even its inflation target. Thus, households deliberately ignored, or disagreed with, the central bank’s policy announcements. Yet they did revise their expectations downward in line with realized inflation and possibly other factors. This is a sign that households had been increasing their confidence in the domestic money slowly yet gradually.
Chart 4. Inflation expectations for the next twelve months, July 2015–December 2019
Though still short lived, the Ukrainian experience with IT offers enough insights to seriously question all of the framework’s assumptions. First, there is no clear correlation between interest rate policy moves, inflation forecasts, and actual inflation. Second, money users’ inflation expectations seem little influenced by official inflation forecasts. Third, the Ukrainian case does not confirm the presumed direct causal relationship between inflation expectations and inflation. Finally, the standard theory behind IT fails to account for the strong disinflation in the second half of 2019.
In fact, developments in the supply of money and the demand for money much better explain the changes in inflation since the formal introduction of IT in Ukraine. The growth rates of both base and broad money, as measured by the aggregate M3, declined steadily from 2016 to 2018 before rebounding in late 2019 (see table 1).“Surveys of Financial Corporations,” National Bank of Ukraine, accessed on Feb. 8, 2021, https://bank.gov.ua/files/3.1-Monetary_Statistics_e.xlsx. Interestingly enough, the expansion of base money, which is under stricter control by the central bank, had already accelerated in 2018, when the NBU increased its policy interest rate. This calls into question the very foundations of IT. Credit expansion, by both the central bank and the commercial banks, has abated even more strongly. More specifically, domestic credit, including in hryvnias, contracted in 2019, which is consistent with the rapid disinflation toward the end of that year and the low inflation in 2020.Note that that the annual money supply growth rates have tripled by November 2020, which has contributed to the increase in consumer prices inflation as from December that year.
Table 1. Changes in money supply and in bank credit, 2016–19 (all figures are percentages)
Changes in the demand for money, which are not directly observable, are more difficult to fathom. Nevertheless, the very high degree of dollarization of the Ukrainian economy allows for a relative analysis of the residents’ demand for the hryvnia, as opposed to their demand for foreign currency. From that perspective, a number of factors suggest that the demand for the hryvnia had been strengthening even prior to IT adoption and especially in late 2019. First, investments in currency and deposits abroad have been mostly stable since 2012, which suggests that dollarization has come to a halt.According to NBU data on the international investment position of Ukraine (see footnote 22), investments in currency and deposits abroad reached USD 109.6 billion in 2012 (63 percent of GDP), then declined to USD 100.7 billion in 2016, and stabilized at USD 100.4 billion in 2019 (67 percent of GDP). Of these assets, the estimated holdings of foreign currency cash only were, respectively, USD 83.6 billion, USD 83.1 billion, and USD 88.6 billion. The ratio between estimated foreign currency cash held by residents and the monetary aggregate M3 has been declining steadily from 2.1 in 2015 to 1.5 in 2019. Second, over this same four-year period, the degree of dollarization of households’ deposits diminished from 52.7 percent to 42.0 percent.“Deposits held with deposit-taking corporations (excluding National Bank of Ukraine),” National Bank of Ukraine, accessed on Feb. 8, 2021, https://bank.gov. ua/files/3.2-Deposits_e.xlsx. The abating dollarization of the Ukrainian economy is a sign that demand for the domestic currency has been strengthening, thereby creating a tendency toward its relative appreciation in terms of both other goods and other monies.
The relative strengthening in the demand for the domestic currency accelerated in the second half of 2019 and resulted in the significant appreciation of the hryvnia compared to the dollar. Capital inflows from abroad, including into government debt, accelerated, causing the net foreign assets held by commercial banks to increase in the single year 2019 by more than in the previous four years. This substantial net inflow of foreign currency liquidity nourished a sustained demand for the hryvnia, which ultimately could be provided only by its monopolistic producer. Consequently, the NBU had to intervene more intensely in 2019 and made net foreign currency purchases in exchange for additional hryvnia in the amount of about USD 8 billion, which was five and a half times more than in 2018 and eight times more than in 2017.“NBU currency interventions,” National Bank of Ukraine, accessed on Feb. 8, 2021, https://bank.gov.ua/files/Finmarket/InterventionsResults_eng.xlsx.
This brings us to the last piece of evidence related to the Ukrainian experience with IT: the central bank’s open market interventions. One feature of the supplying of base money by the NBU is particularly striking—the vast majority of open market interventions are foreign exchange based (see table 2).“Current Data on Banking System Liquidity and Factors Affecting Liquidity,” National Bank of Ukraine, accessed on Feb. 8, 2021, https://bank.gov.ua/files/ Arhiv_liquidity_eng.xlsx. The original file by the NBU presents the daily change in banks’ reserves as the balancing item between open-market operations (interest- rate based and others) and the so-called autonomous absorbing factors (cash in circulation, the Single Treasury Account and others). The table rearranges these items from the economic perspective of changes in base money supply and demand, on an annual basis. For instance, in 2017 and 2018 interest rate–based operations accounted for 22.1 percent and 5.8 percent of all hryvnia liquidity supplied to commercial banks. In 2019, the central bank used its interest rate–based interventions to absorb liquidity by issuing more certificates of deposits while it lowered the policy interest rate.In 2020, the first year in which most of the open market operations are interest based, the main driving factor is the spectacular increase in the demand for cash, most likely driven by a robust precautionary attitude toward the uncertainty related to the COVID-19 lockdowns and other policies. This data reveals that since the implementation of IT in Ukraine, the NBU’s increased supplying of base money has been in response to banks’ net aggregate supply of foreign currency, which turns out to be the main component of their demand for hryvnia, given the extent of dollarization and openness of the economy. The 2019 surge in the interbank demand for hryvnias in exchange for dollars corroborates the relative increase in the broad demand for the domestic currency discussed above and explains the sharp disinflation. Together, these factors lead to one conclusion—the NBU has been reacting and adapting its policy to the improved liquidity situation of banks as determined by their customers’ transactions and the resulting enhanced demand for the domestic currency. This illustrates the analytical point that in a world of multiple rival currencies, individuals’ demand to hold the domestic money effectively limits the capacity of the domestic central bank to conduct independent monetary policy.
Table 2. Open market interventions by the National Bank of Ukraine and changes in the demand for base money, 2017–20
This review of Ukraine’s recent experience with inflation targeting shows that monetary demand and supply factors have been the main drivers of inflation developments. Moreover, the changes in the supply of base money have not been autonomous; rather, they have accommodated respective and underlying changes in the domestic economy’s demand for hryvnias relative to the US dollar. The central bank’s open market operations, presumably directed by interest rate moves and geared toward the goals and targets of monetary policy, do not appear to be determined independently. Rather, they respond to changes in the demand for the domestic currency, in particular relative to foreign currencies. In short, the Ukrainian experience illustrates that the primary function of IT is to create the illusion of scientific control over money production and hence to legitimize modern central banking.
CONCLUSION Over the last three decades, inflation targeting has evolved from a new tentative approach to setting monetary policy into an established authoritative wisdom, acclaimed by both academia and policymakers. This article has documented economists’ endeavors to justify IT and disentangled its main principles and assumptions from the realistic and individualistic standpoint of monetary theory in the Austrian tradition. Although helpful for understanding IT in its specific historical context, this approach also allows for more general insights into contemporary developments in monetary analysis. In particular, IT can hardly be considered as belonging to monetary theory at all. Its excessive emphasis on formal optimizing models offers no new knowledge about the monetary relations in an economy. More specifically, IT commits two analytical blunders—excessively formalistic emphasis on the role of inflation expectations and total neglect for individuals’ demand for money. In fact, the only meaningful way to integrate inflation expectations into the analysis of inflation would be through the demand for money, i.e., through individuals’ revealed actions to hold more or less money. From that point of view, IT is definitely a failed intellectual attempt. Moreover, it supports a simplistic, mechanistic view of complex volitional social phenomena and hence contributes to veiling modern central banking with the mantle of expert scientism. Put briefly, it distorts impartial theory, subordinating it to interested policy. It builds up analytical illusions, because it aims at upholding the practical illusion of independent central banking.
The hollow content of IT naturally makes it unfit to properly explain real-world monetary developments. The recent experience of Ukraine provides an illustration. The empirical evidence does not support some of the main tenets of IT, such as a direct link between inflation expectations and inflation, congruence between official forecasts and the public’s expectations, or even a perceptible directional link between official inflation forecasts and policy interest rate changes. Moreover, IT gives no useful insights into two striking features of the Ukrainian reality that a valid monetary theory should be able to account for. First, despite formally sticking to strict IT, the central bank in Ukraine has been intervening much more prominently in the foreign currency market, through exchange rate interventions, than in the domestic interbank market through interest rate operations. Second, rapid disinflation, which surprised all analysts and for which the central bank itself has claimed no merit, occurred in the last two quarters of 2019. Two essential elements of Austrian monetary theory, namely its emphasis on the demand to hold money as part of the all-permeating monetary relation and its insight into the nature of fiat monies and modern central banking, offer a compelling explanation for these two outcomes. This is evidence of the superiority of economic theory based on a realistic approach to human action in understanding inflation.
Download the slides from this lecture at Mises.org/MU21_PPT_33. Recorded at the Mises Institute in Auburn, Alabama, on 22 July 2021.
Dr. Mark Thornton joins the show to discuss what might just be Murray Rothbard's best book on money and banking: The Case Against the Fed. Written not long before his untimely death, this work is nothing less than a master class on the history of money: the sordid players and interests behind the creation of the Federal Reserve bank; the workings of demand deposits and fractional reserve, inflationism, and the monetary mechanics behind it all. The final pages of the short and penetrating book are especially fascinating, as Rothbard lays out a process for unwinding the Fed and paying off its liabilities using the federal government physical gold holding. End the Fed starts with understanding the Fed, and this book is vital for any lay reader.
Find the online version of the book at Mises.org/RothbardFed
Guido Hülsmann's The Ethics of Money Production is a masterclass both on the fundamentals of money and the disastrous moral consequences of monetary "policy." Inflation is not only an economic problem which impoverishes us materially, but a deeply corrosive force in society for individuals. There is no better work to explain the broader implications of central banking which go almost totally unremarked in the financial press.
Podcaster Stephan Livera is a big fan of the book and joins the show to explain why you need to read it.
Guido Hülsmann's The Ethics of Money Production: Mises.org/Ethics
Listen to Stephan's podcast at StephanLivera.com
Do we fund government or does government fund us? Can sovereign states issue currency at will without risk of default? Are government deficits actually a form of public wealth? And can newly issued currency (rather than taxes or bonds) be used to pay for public works, health care, college, entitlements, and guaranteed jobs? These are the arguments made by Professor Stephanie Kelton in The Deficit Myth, the latest addition to the "Modern Monetary Theory" concept. If it sounds too good to be true, it is—and Dr. Murphy joins the show to explain why.
Read Dr. Murphy's review of The Deficit Myth at mises.org/DeficitMyth
Bob explains some of the highlights of his newly released chapter for the Mises Institute book on “Understanding Money Mechanics.” He explains the operation of the classical gold standard, as well as some of the issues of US bimetallism during the 1800s.
Mentioned in the Episode and Other Links of Interest: Bob’s new essay on the gold standardBob’s book on capitalism #CommissionsEarned (as an Amazon Associate I earn from qualifying purchases)Bob on the 1920–21 Depression For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
The value of a paper dollar originates from its historical link to commodity money—which happens to be gold—and not government decree or social convention.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "The Origins of the Dollar's Value".
Download the slides from this lecture at Mises.org/MU20_PPT_18.
Recorded at the Mises Institute in Auburn, Alabama, on 19 July 2020.
Download the slides from this lecture at Mises.org/MU20_PPT_21.
Recorded at the Mises Institute in Auburn, Alabama, on 15 July 2020.
The heart of economic growth is the expansion of real savings. Monetary pumping only destroys wealth and savings.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Savings Are Critical to a Prosperous Economy".
Thanks to past interventions, the economy is now rife with malinvestments and prices that don't reflect real demand. The solution is to allow deflation and other types of painful readjustment. Otherwise true growth will elude us.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "How Government Intervention Triggers Depressions"
During March 2020, year-over-year (YOY) growth in the money supply was at 11.37 percent. We're now seeing a trend similar to what we saw during late 2008 and early 2009.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Money Supply Growth Surges to 92-Month High"
Central bankers dismiss gold as a relic, even as they buy up more of it. Politicians dismiss gold as money they don't control and can't expand. Holders dismiss gold as outdated tech. And investors dismiss gold as a static metal paying no yields.
So why does gold still matter? Why does it hold value over millennia? Why does it threaten inflationist governments? Why does it seem to be flowing West to East? Why does an ounce of it still trade for more than $1,000, if the critics are right? This is the comprehensive show on gold and its enduring role in today's economy, with Keith Weiner of Monetary Metals.
Bob Murphy explains some of the most important points in his new QJAE article on the fractional reserve banking debate. Bob shows why Mises thought any issuance of fiduciary media caused the boom-bust cycle, and he points out a major flaw in George Selgin’s defense of fractional reserve banking.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
A private graduate seminar, recorded at the Mises Institute in Auburn, Alabama, on 16 July 2019.
Growth in the supply of US dollars fell again in May, this time to a 105-month low of 5.4 percent. The last time the money supply grew at a smaller rate was during September 2008 — at a rate of 5.2 percent.
The money-supply metric used here — an "Austrian money supply" measure — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure than M2. The Mises Institute now offers regular updates on this metric and its growth.
The "Austrian" measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short time deposits, traveler's checks, and retail money funds).
M2 growth also slowed in May, falling to 5.6 percent, a 20-month low.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
Thanks to the intervention of central banks, of course, money supply growth in recent decades has never gone into negative territory.
Nevertheless, as we can see in the graph, significant dips in growth rates show up in years prior to a economic bust or financial crisis.
For insights into what's affecting money supply growth, we can look at loan activity, such as the Federal Reserve's measure of industrial and commercial loans.
In this case, we find that the growth rate in loans has fallen to a 74-month low, dropping to 1.9 percent. Loan growth has not been this weak since April of 2011, in the wake of the last financial crisis.
We find similar trends in real estate loans and in consumer loans, although not to the same extent.
The current subdued rates of growth in the money supply suggests an economy in which lenders are holding back somewhat on making new loans, which itself suggests a lack of reliable borrowers due to a lackluster overall economy. This assessment, of course, is reinforced by the Federal Reserve's clear reluctance to wind down it's huge portfolio, and to end its ongoing policy of low-interest rates — concerned that any additional tightening might lead to a recession.
The supply of US dollars has slowed during early 2017 with March's year-over-year percentage increase hitting a 103-month low of 5.9 percent. The last time the year-over-year growth rate was lower was during September of 2008, when the growth rate was 5.2 percent. Monthly year-over-year growth rates in the money supply have been falling each month since October. (All the numbers used here were posted in mid-April 2017.)
Over the past eight months or so, money supply growth rates have become somewhat volatile with the growth rate surging from 6.7 percent in late 2015 up to 11.3 percent by late 2016, and down again to March's multi-year low.
The M2 measure also showed a downward turn in recent months, although not to the same extent as the "Austrian" measure. The year-over-year change in M2 during March was 6.3 percent which put M2 growth near a 12-month low. M2 movements were otherwise unremarkable, however.
In fact, the measure has now dropped below that of M2, which has not happened since the period of 2005 to 2008. A similar phenomenon occurred from 2000 to 2001. In both cases, sizable declines in the Austrian measure below M2 signaled brewing economic troubles.
Two factors that may be contributing to a decline in money supply are the drop in Treasury Deposits at the Fed, and a relative lack of new loans being made in the banking sector.
In March, growth in commercial and industrial loans began to fall to multi-year lows, with April's totals showing the smallest amount of growth in loan activity since 2009. As Frank Shostak explains here, the money stock tends to shrink when banks cut back on loans:
Another factor at work may be the ongoing decline in treasury deposits at the Fed, which in March dropped to a nearly 18-month low.
March's large decline in money supply growth partially reflects a collapse in treasury deposits at the Fed. Indeed, March's year-over-year decline in treasury deposits was the largest decline recorded in 29 years, with treasury-deposit totals dropping by 72 percent.
The "Austrian" money supply measure (also known as the "true money supply") used here is a measure of the money supply pioneered by Murray Rothbard and Joseph Salerno and is designed to provide a better measure than M2. The Mises Institute now offers regular updates on this metric and its growth.
The "Austrian" measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short time deposits, traveler's checks, and retail money funds).
Nota Bene: Given a large number of confused comments by readers to these money-supply articles in the past, it may be necessary to clearly state that a measure of the money supply is not a measure of price inflation, and movement in money supply growth should not be interpreted as an index of index of price changes in the general economy. As Frank Shostak explained in a recent article:
[I]ncreases in the money supply need not always to be followed by general increases in prices. Prices are determined by both real and monetary factors. Consequently, it can occur that if the real factors are pulling things in an opposite direction to monetary factors, no visible change in prices might take place. In other words, while money growth is buoyant, prices might display low increases.
... If the growth rate of money is 5% and the growth rate of goods is also 5% then there will not be any increase in the prices of goods. If one were to follow that inflation is the increase in the CPI then one will conclude that despite the increase in money supply by 5% inflation is 0%.
[Excerpted from Defending the Undefendable]
The miser has never recovered from Charles Dickens's attack on him in A Christmas Carol. Although the miser had been sternly criticized before Dickens, the depiction of Ebenezer Scrooge has become definitive and has passed into the folklore of our time. Indeed, the attitude pervades even in freshman economics textbooks. There the miser is roundly condemned and blamed for unemployment, changes in the business cycle, and economic depressions and recessions.
In the famous — or rather infamous — "paradox of savings," young students of economics are taught that, although saving may be sensible for an individual or a family, it may be folly for the economy as a whole. The prevalent Keynesian doctrine holds that the more saving in an economy, the less spending for consumption, and the less spending, the fewer jobs.
It is time that an end be put to all these misconceptions. Many and various benefits are derived from saving. Ever since the first caveman saved seed corn for future planting, the human race has owed a debt of gratitude to the hoarders, misers, and savers. It is to those people who refused to use up at once their entire store of wealth and chose rather to save it for a needy time that we owe the capital equipment that enables us to aspire to a civilized standard of living.
It is true, of course, that such people became richer than their fellows, and perhaps thereby earned their enmity. Perhaps the whole process of saving and accumulating was cast into disrepute along with the saver. But the enmity is not deserved. For the wages earned by the masses are intimately dependent upon the rate at which the saver can accumulate money.
There are, for example, many reasons contributing to the fact that the American worker earns more than, say, his Bolivian counterpart. The American worker's education, health, and motivation play important roles. But a major contribution to the wage differential is the greater amount of capital stored up by American employers than by Bolivians. And this is not an exceptional case. The saver has been instrumental throughout history in lifting the pack above the level of the savage.
Perhaps it will be objected that there is a difference between saving (acknowledged to be productive in the process of capital accumulation) and hoarding (withholding money from consumption spending), and that while the saver channels his money into capital goods industries where it can do some good, hoarded money is completely barren. The hoarder, it will be claimed, reduces the money received by retailers, forcing them to fire employees and reduce orders from jobbers. Jobbers in turn are forced to reduce their staff and to cut back on orders from wholesalers. The whole process, under the influence of hoarders, will be repeated throughout the entire structure of production. As employees are fired, they will have less to spend on consumption goods, thus compounding the process. Hoarding is thus seen as completely sterile and destructive.
The argument is plausible except for a crucial point that this Keynesian-inspired argument fails to take into account — the possibility of changes in prices. Before a retailer begins to lay off employees and cut back on orders because of unsold goods, he will usually try lowering his prices. He will hold a sale or use some other technique that will be equivalent to a decrease in price. Unless his troubles are due to the unsalability of his wares, this will suffice to end the vicious circle of unemployment and depression.
How so? In withholding money from the consumer's market, and not making it available for the purchase of capital equipment, the hoarder causes a decrease in the amount of money in circulation. The amount of available goods and services remains the same. Since one of the most important determinants of price in any economy is the relationship between the amount of money and the amount of goods and services, the hoarder succeeds in lowering the level of prices.
Consider a simplistic but not wholly inaccurate model in which all the dollars in the economy are bid against all its goods and services. Thus the fewer the dollars, the greater the purchasing power of each. Since hoarding can be defined as reducing the amount of money in circulation, and other things equal, less money means lower prices, it can readily be seen that hoarding leads to lower prices.
There is no harm in lowering the level of prices. Quite the contrary: one of the great benefits is that all other people, the nonmisers, benefit from cheaper goods and services.
Nor will lower prices cause depressions. Indeed, the course of the prices of some of our most successful machinery has followed a strong downward curve. When cars, televisions, and computers were first produced, they were priced far beyond the reach of the average consumer. But technical efficiency succeeded in lowering prices until they were within the reach of the mass of consumers. Needless to say, neither a depression nor recession was caused by these falling prices. In fact, the only businessmen who suffer in the face of such a trend are those who follow the Keynesian analysis and do not lower their prices in the face of falling demand.
But far from causing an ever-widening depression, as the Keynesians contend, such businessmen only succeed in driving themselves into bankruptcy. For the rest, business continues as satisfactorily as before, but with a lower price level. The cause of depressions, therefore, exists elsewhere.See Murray N. Rothbard, America's Great Depression (New Rochelle, NY: Van Nostrand, 1963).
There is likewise no substance in the objection to hoarding on the ground that it is disruptive, and continually forces the economy to adjust. Even if true, it would not constitute an indictment of hoarding, for the free market is preeminently an institution of adjustment and reconciliation of divergent and ever-changing tastes. To criticize hoarding on this ground, one would also have to criticize changing clothing styles, for they continually call on the market for "fine tuning" adjustment.
Hoarding is not even a very disruptive process, because for every miser stuffing money into his mattress, there are numerous misers' heirs ferreting it out. This has always been the case, and it is not likely to change drastically.
Claims that the miser's hoard of cash is sterile because it does not draw interest as it would if it were banked are also without merit. Could the money held by individuals in their wallets be characterized as sterile since it does not draw interest either? If people voluntarily forbear to earn interest on their money and instead hold it in cash balances, the money may appear useless from our point of view, but it undoubtedly is not useless from theirs.
The miser may want his money not for later spending, not to bridge the gap between expenditures and payments, but rather for the pure joy of holding cash balances. How can the economist, educated in the utility maximization tradition, characterize joy as sterile? Art lovers who hoard rare paintings and sculpture are not characterized as engaging in a sterile enterprise. People who own dogs and cats, solely for the purpose of enjoyment and not investment, are not described as engaging in sterile activity. Tastes differ among people, and what is sterile for one person may be far from sterile for another.
The miser's hoarding of large cash balances can only be considered heroic. We benefit from lowered price levels, which result from it. The money that we have and are willing to spend becomes more valuable, enabling the purchaser to buy more with the same amount of money. Far from being harmful to society, the miser is a benefactor, increasing our buying power each time he engages in hoarding.
[From New Directions in Austrian Economics, edited with an introduction by Louis M. Spadaro (Kansas City: Sheed Andrews and McMeel [1978]), pp. 143–56) and The Logic of Action I: Method, Money, the the Austrian School (Cheltenham, UK: Edward Elgar and Auburn, Ala.: Mises Institute, 1997), chap. 16, pp. 337–49.]
I. The Definition of the Supply of Money The concept of the supply of money plays a vitally important role, in differing ways, in both the Austrian and the Chicago schools of economics. Yet, neither school has defined the concept in a full or satisfactory manner; as a result, we are never sure to which of the numerous alternative definitions of the money supply either school is referring.
The Chicago school definition is hopeless from the start. For, in a question-begging attempt to reach the conclusion that the money supply is the major determinant of national income, and to reach it by statistical rather than theoretical means, the Chicago school defines the money supply as that entity which correlates most closely with national income. This is one of the most flagrant examples of the Chicagoite desire to avoid essentialist concepts, and to "test" theory by statistical correlation; with the result that the supply of money is not really defined at all. Furthermore, the approach overlooks the fact that statistical correlation cannot establish causal connections; this can only be done by a genuine theory that works with definable and defined concepts.In a critique of the Chicago approach, Leland Yeager writes: "But it would be awkward if the definition of money accordingly had to change from time to time and country to country. Furthermore, even if money defined to include certain near-moneys does correlate somewhat more closely with income than money narrowly defined, that fact does not necessarily impose the broad definition. Perhaps the amount of these near-moneys depends on the level of money-income and in turn on the amount of medium of exchange. … More generally, it is not obvious why the magnitude with which some other magnitude correlates most closely deserves overriding attention. … The number of bathers at a beach may correlate more closely with the number of cars parked there than with either the temperature or the price of admission, yet the former correlation may be less interesting or useful than either of the latter" (Leland B. Yeager, "Essential Properties of the Medium of Exchange," Kyklos [1968], reprinted in Monetary Theory, ed. R. W. Glower [London: Penguin Books, 1969], p. 38). Also see, Murray N. Rothbard, "The Austrian Theory of Money," in E. Dolan, ed., The Foundations of Modern Austrian Economics (Kansas City, Kansas: Sheed & Ward, 1976), pp. 179–82.
In Austrian economics, Ludwig von Mises set forth the essentials of the concept of the money supply in his Theory of Money and Credit, but no Austrian has developed the concept since then, and unsettled questions remain (e.g., are savings deposits properly to be included in the money supply?).Ludwig von Mises, The Theory of Money and Credit, 3rd ed. (New Haven: Yale University Press, 1953). And since the concept of the supply of money is vital both for the theory and for applied historical analysis of such consequences as inflation and business cycles, it becomes vitally important to try to settle these questions, and to demarcate the supply of money in the modern world. In The Theory of Money and Credit, Mises set down the correct guidelines: money is the general medium of exchange, the thing that all other goods and services are traded for, the final payment for such goods on the market.
In contemporary economics, definitions of the money supply range widely from cash + demand deposits (M1) up to the inclusion of virtually all liquid assets (a stratospherically high M). No contemporary economist excludes demand deposits from his definition of money. But it is useful to consider exactly why this should be so. When Mises wrote The Theory of Money and Credit in 1912, the inclusion of demand deposits in the money supply was not yet a settled question in economic thought. Indeed, a controversy over the precise role of demand deposits had raged throughout the nineteenth century. And when Irving Fisher wrote his Purchasing Power of Money in 1913, he still felt it necessary to distinguish between M (the supply of standard cash) and M1, the total of demand deposits.Irving Fisher, The Purchasing Power of Money (New York: Macmillan, 1913). Why then did Mises, the developer of the Austrian theory of money, argue for including demand deposits as part of the money supply "in the broader sense"? Because, as he pointed out, bank demand deposits were not other goods and services, other assets exchangeable for cash; they were, instead, redeemable for cash at par on demand. Since they were so redeemable, they functioned, not as a good or service exchanging for cash, but rather as a warehouse receipt for cash, redeemable on demand at par as in the case of any other warehouse. Demand deposits were therefore "money-substitutes" and functioned as equivalent to money in the market. Instead of exchanging cash for a good, the owner of a demand deposit and the seller of the good would both treat the deposit as if it were cash, a surrogate for money. Hence, receipt of the demand deposit was accepted by the seller as final payment for his product. And so long as demand deposits are accepted as equivalent to standard money, they will function as part of the money supply.
It is important to recognize that demand deposits are not automatically part of the money supply by virtue of their very existence; they continue as equivalent to money only so long as the subjective estimates of the sellers of goods on the market think that they are so equivalent and accept them as such in exchange. Let us hark back, for example, to the good old days before federal deposit insurance, when banks were liable to bank runs at any time. Suppose that the Jonesville Bank has outstanding demand deposits of $1 million; that million dollars is then its contribution to the aggregate money supply of the country. But suppose that suddenly the soundness of the Jonesville Bank is severely called into question; and Jonesville demand deposits are accepted only at a discount, or even not at all. In that case, as a run on the bank develops, its demand deposits no longer function as part of the money supply, certainly not at par. So that a bank's demand deposit only functions as part of the money supply so long as it is treated as an equivalent substitute for cash.Even now, in the golden days of federal deposit insurance, a demand deposit is not always equivalent to cash, as anyone who is told that it will take 15 banking days to clear a check from California to New York can attest.
It might well be objected that since, in the era of fractional reserve banking, demand deposits are not really redeemable at par on demand, that then only standard cash (whether gold or fiat paper, depending upon the standard) can be considered part of the money supply. This contrasts with 100 percent reserve banking, when demand deposits are genuinely redeemable in cash, and function as genuine, rather than pseudo, warehouse receipts to money. Such an objection would be plausible, but would overlook the Austrian emphasis on the central importance in the market of subjective estimates of importance and value. Deposits are not in fact all redeemable in cash in a system of fractional reserve banking; but so long as individuals on the market think that they are so redeemable, they continue to function as part of the money supply. Indeed, it is precisely the expansion of bank demand deposits beyond their reserves that accounts for the phenomena of inflation and business cycles. As noted above, demand deposits must be included in the concept of the money supply so long as the market treats them as equivalent; that is, so long as individuals think that they are redeemable in cash. In the current era of federal deposit insurance, added to the existence of a central bank that prints standard money and functions as a lender of last resort, it is doubtful that this confidence in redeemability can ever be shaken.
All economists, of course, include standard money in their concept of the money supply. The justification for including demand deposits, as we have seen, is that people believe that these deposits are redeemable in standard money on demand, and therefore treat them as equivalent, accepting the payment of demand deposits as a surrogate for the payment of cash. But if demand deposits are to be included in the money supply for this reason, then it follows that any other entities that follow the same rules must also be included in the supply of money.
Let us consider the case of savings deposits. There are several common arguments for not including savings deposits in the money supply: (1) they are not redeemable on demand, the bank being legally able to force the depositors to wait a certain amount of time (usually thirty days) before paying cash; (2) they cannot be used directly for payment. Checks can be drawn on demand deposits, but savings deposits must first be redeemed in cash upon presentation of a passbook; (3) demand deposits are pyramided upon a base of total reserves as a multiple of reserves, whereas savings deposits (at least in savings banks and savings and loan associations) can only pyramid on a one-to-one basis on top of demand deposits (since such deposits will rapidly "leak out" of savings and into demand deposits).
Objection (1), however, fails from focusing on the legalities rather than on the economic realities of the situation; in particular, the objection fails to focus on the subjective estimates of the situation on the part of the depositors. In reality, the power to enforce a thirty-day notice on savings depositors is never enforced; hence, the depositor invariably thinks of his savings account as redeemable in cash on demand. Indeed, when, in the 1929 depression, banks tried to enforce this forgotten provision in their savings deposits, bank runs promptly ensued.On the equivalence of demand and savings deposits during the Great Depression, and on the bank runs resulting from attempts to enforce the thirty-day wait for redemption, see Murray N. Rothbard, America’s Great Depression, 3rd ed. (Kansas City, Kansas: Sheed & Ward, 1975), pp. 84, 316. Also see Lin Lin, "Are Time Deposits Money?" American Economic Review (March 1937), pp. 76–86.
Objection (2) fails as well, when we consider that, even within the stock of standard money, some part of one's cash will be traded more actively or directly than others. Thus, suppose someone holds part of his supply of cash in his wallet, and another part buried under the floorboards. The cash in the wallet will be exchanged and turned over rapidly; the floorboard money might not be used for decades. But surely no one would deny that the person's floorboard hoard is just as much part of his money stock as the cash in his wallet. So that mere lack of activity of part of the money stock in no way negates its inclusion as part of his supply of money. Similarly, the fact that passbooks must be presented before a savings deposit can be used in exchange should not negate its inclusion in the money supply. As I have written elsewhere, suppose that for some cultural quirk — say widespread revulsion against the number "5" — no seller will accept a five-dollar bill in exchange, but only ones or tens. In order to use five-dollar bills, then, their owner would first have to go to a bank to exchange them for ones or tens, and then use those ones or tens in exchange. But surely, such a necessity would not mean that someone's stock of five-dollar bills was not part of his money supply.Rothbard, "The Austrian Theory of Money," p. 181.
Neither is Objection (3) persuasive. For while it is true that demand deposits are a multiple pyramid on reserves, whereas savings bank deposits are only a one-to-one pyramid on demand deposits, this distinguishes the sources or volatility of different forms of money, but should not exclude savings deposits from the supply of money. For demand deposits, in turn, pyramid on top of cash, and yet, while each of these forms of money is generated quite differently, so long as they exist each forms part of the total supply of money in the country. The same should then be true of savings deposits, whether they be deposits in commercial or in savings banks.
A fourth objection, based on the third, holds that savings deposits should not be considered as part of the money supply because they are efficiently if indirectly controllable by the Federal Reserve through its control of commercial bank total reserves and reserve requirements for demand deposits. Such control is indeed a fact, but the argument proves far too much; for, after all, demand deposits are themselves and in turn indirectly but efficiently controllable by the Fed through its control of total reserves and reserve requirements. In fact, control of savings deposits is not nearly as efficient as of demand deposits; if, for example, savings depositors would keep their money and active payments in the savings banks, instead of invariably "leaking" back to checking accounts, savings banks would be able to pyramid new savings deposits on top of commercial bank demand deposits by a large multiple.In the United States, the latter is beginning to be the case, as savings banks are increasingly being allowed to issue checks on their savings deposits. If that became the rule, moreover, Objection (2) would then fall on this ground alone.
Not only, then, should savings deposits be included as part of the money supply, but our argument leads to the conclusion that no valid distinction can be made between savings deposits in commercial banks (included in M2) and in savings banks or savings and loan associations (also included in M3).Regardless of the legal form, the "shares" of formal ownership in savings and loan associations are economically precisely equivalent to the new deposits in savings banks, an equivalence that is universally acknowledged by economists. Once savings deposits are conceded to be part of the money supply, there is no sound reason for balking at the inclusion of deposits of the latter banks.
On the other hand, a genuine time deposit — a bank deposit that would indeed only be redeemable at a certain point of time in the future, would merit very different treatment. Such a time deposit, not being redeemable on demand, would instead be a credit instrument rather than a form of warehouse receipt. It would be the result of a credit transaction rather than a warehouse claim on cash; it would therefore not function in the market as a surrogate for cash.
Ludwig von Mises distinguished carefully between a credit and a claim transaction: a credit transaction is an exchange of a present good (e.g., money which can be used in exchange at any present moment) for a future good (e.g., an IOU for money that will only be available in the future). In this sense, a demand deposit, while legally designated as credit, is actually a present good — a warehouse claim to a present good that is similar to a bailment transaction, in which the warehouse pledges to redeem the ticket at any time on demand.
Thus, Mises wrote:
It is usual to reckon the acceptance of a deposit which can be drawn upon at any time by means of notes or cheques as a type of credit transaction and juristically this view is, of course, justified; but economically, the case is not one of a credit transaction. If credit in the economic sense means the exchange of a present good or a present service against a future good or a future service, then it is hardly possible to include the transactions in question under the conception of credit. A depositor of a sum of money who acquires in exchange for it a claim convertible into money at any time which will perform exactly the same service for him as the sum it refers to has exchanged no present good for a future good. The claim that he has acquired by his deposit is also a present good for him. The depositing of the money in no way means that he has renounced immediate disposal over the utility it commands.Mises, Theory of Money and Credit, p. 268.
It might be, and has been, objected that credit instruments, such as bills of exchange or Treasury bills, can often be sold easily on credit markets — either by the rediscounting of bills or in selling old bonds on the bond market, and that therefore they should be considered as money. But many assets are "liquid," i.e., can easily be sold for money. Blue-chip stocks, for example, can be easily sold for money, yet no one would include such stocks as part of "the money supply." The operative difference, then, is not whether an asset is liquid or not (since stocks are no more part of the money supply than, say, real estate) but whether the asset is redeemable at a fixed rate, at par, in money. Credit instruments, similarly to the case of shares of stock, are sold for money on the market at fluctuating rates. The current tendency of some economists to include assets as money purely because of their liquidity must be rejected; after all, in some cases, inventories of retail goods might be as liquid as stocks or bonds, and yet surely no one would list these inventories as part of the money supply. They are other goods sold for money on the market.For Mises's critique of the view that endorsed bills of exchange in early nineteenth-century Europe were really part of the money supply, see ibid., pp. 284–86.
One of the most noninflationary developments in recent American banking has been the emergence of certificates of deposit (CDs), which are genuine time and credit transactions. The purchaser of the CD, or at least the large-demonination [sic] CD, knows that he has loaned money to the bank which the bank is only bound to repay at a specific date in the future; hence, large-scale CDs are properly not included in the M2 and M3 definitions of the supply of money. The same might be said to be true of various programs of time deposits which savings banks and commercial banks have been developing in recent years: in which the depositor agrees to retain his money in the bank for a specified period of years in exchange for a higher interest return.
There are worrisome problems, however, that are attached to the latter programs, as well as to small-denomination CDs; for in these cases, the deposits are redeemable before the date of redemption at fixed rates, but at penalty discounts rather than at par. Let us assume a hypothetical time deposit, due in five years' time at $10,000, but redeemable at present at a penalty discount of $9,000. We have seen that such a time deposit should certainly not be included in the money supply in the amount of $10,000. But should it be included at the fixed though penalty rate of $9,000, or not be included at all? Unfortunately, there is no guidance on this problem in the Austrian literature. Our inclination is to include these instruments in the money supply at the penalty level (e.g., $9,000), since the operative distinction, in our view, is not so much the par redemption as the ever-ready possibility of redemption at some fixed rate. If this is true, then we must also include in the concept of the money supply federal savings bonds, which are redeemable at fixed, though penalty rates, until the date of official maturation.
Another entity which should be included in the total money supply on our definition is cash surrender values of life insurance policies; these values represent the investment rather than the insurance part of life insurance and are redeemable in cash (or rather in bank demand deposits) at any time on demand. (There are, of course, no possibilities of cash surrender in other forms of insurance, such as term life, fire, accident, or medical.) Statistically, cash surrender values may be gauged by the total of policy reserves less policy loans outstanding, since policies on which money has been borrowed from the insurance company by the policyholder are not subject to immediate withdrawal. Again, the objection that policyholders are reluctant to cash in their Austrian definitions of the surrender values does not negate their inclusion in the supply of money; such reluctance simply means that this part of an individual's money stock is relatively inactive.For hints on the possible inclusion of life insurance cash surrender values in the supply of money, see Gordon W. McKinley, "Effects of Federal Reserve Policy on Nonmonetary Financial Institutions," in Herbert V. Prochnow, ed. The Federal Reserve System (New York: Harper & Bros., 1960), p. 217n; and Arthur F. Burns, Prosperity without Inflation (Buffalo: Economica Books, 1958), p. 50.
One caveat on the inclusion of noncommercial bank deposits and other fixed liabilities into the money supply: just as the cash and other reserves of the commercial banks are not included in the money supply, since that would be double counting once demand deposits are included; in the same way, the demand deposits owned by these noncommercial bank creators of the money supply (savings banks, savings and loan companies, life insurance companies, etc.) should be deducted from the total demand deposits that are included in the supply of money. In short, if a commercial bank has demand deposit liabilities of $1 million, of which $100,000 are owned by a savings bank as a reserve for its outstanding savings deposits of $2 million, then the total money supply to be attributed to these two banks would be $2.9 million, deducting the savings bank reserve that is the base for its own liabilities.
One anomaly in American monetary statistics should also be cleared up: for a reason that remains obscure, demand deposits in commercial banks or in the Federal Reserve Banks owned by the Treasury are excluded from the total money supply. If, for example, the Treasury taxes citizens by $1 billion, and their demand deposits are shifted from public accounts to the Treasury account, the total supply of money is considered to have fallen by $1 billion, when what has really happened is that $1 billion worth of money has (temporarily) shifted from private to governmental hands. Clearly, Treasury deposits should be included in the national total of the money supply.
Thus, we propose that the money supply should be defined as all entities which are redeemable on demand in standard cash at a fixed rate, and that, in the United States at the present time, this criterion translates into: Ma (a = Austrian) = total supply of cash – cash held in the banks + total demand deposits + total savings deposits in commercial and savings banks + total shares in savings and loan associations + time deposits and small CDs at current redemption rates + total policy reserves of life insurance companies – policy loans outstanding – demand deposits owned by savings banks, saving and loan associations, and life insurance companies + savings bonds, at current rates of redemption. Ma hews to the Austrian theory of money, and, in so doing, broadens the definition of the money supply far beyond the narrow M1, and yet avoids the path of those who would broaden the definition to the virtual inclusion of all liquid assets, and who thus would obliterate the uniqueness of the money phenomenon as the final means of payment for all other goods and services.
II. The Money Supply and Credit Expansion to Business In contrast to the Chicago school, the Austrian economist cannot rest content with arriving at the proper concept of the supply of money. For while the supply of money (Ma) is the vitally important supply side of the "money relation" (the supply of and demand for money) that determines the array of prices, and is therefore the relevant concept for analyzing price inflation, different parts of the money supply play very different roles in affecting the business cycle. For the Austrian theory of the trade cycle reveals that only the inflationary bank credit expansion that enters the market through new business loans (or through purchase of business bonds) generates the overinvestment in higher-order capital goods that leads to the boom-bust cycle. Inflationary bank credit that enters the market through financing government deficits does not generate the business cycle; for, instead of causing overinvestment in higher-order capital goods, it simply reallocates resources from the private to the public sector, and also tends to drive up prices. Thus, Mises distinguished between "simple inflation," in which the banks create more deposits through purchase of government bonds, and genuine "credit expansion," which enters the business loan market and generates the business cycle. As Mises writes:
In dealing with the [business cycle] we assumed that the total amount of additional fiduciary media enters the market system via the loan market as advances to business …
There are, however, instances in which the legal and technical methods of credit expansion are used for a procedure catallactically utterly different from genuine credit expansion. Political and institutional convenience sometimes makes it expedient for a government to take advantage of the facilities of banking as a substitute for issuing government fiat money. The treasury borrows from the bank, and the bank provides the funds needed by issuing additional banknotes or crediting the government on a deposit account. Legally the bank becomes the treasury's creditor. In fact the whole transaction amounts to fiat money inflation. The additional fiduciary media enter the market by way of the treasury as payment for various items of government expenditure. … They affect the loan market and the gross market rate of interest, apart from the emergence of a positive price premium, only if a part of them reaches the loan market at a time at which their effects upon commodity prices and wage rates have not yet been consummated.Ludwig von Mises, Human Action, 3rd rev. ed. (Chicago: Henry Regnery, 1966), p. 570.
Mises did not deal with the relatively new post–World War II phenomenon of large-scale bank loans to consumers, but these too cannot be said to generate a business cycle. Inflationary bank loans to consumers will artificially deflect social resources to consumption rather than investment, as compared to the unhampered desires and preferences of the consumers. But they will not generate a boom-bust cycle, because they will not result in "over" investment, which must be liquidated in a recession. Not enough investments will be made, but at least there will be no flood of investments which will later have to be liquidated. Hence, the effects of diverting consumption investment proportions away from consumer time preferences will be asymmetrical, with the overinvestment-business cycle effects only resulting from inflationary bank loans to business. Indeed, the reason why bank financing of government deficits may be called simple rather than cyclical inflation is because government demands are "consumption" uses as decided by the preferences of the ruling government officials.
In addition to Ma, then, Austrian economists should be interested in how much of a new supply of bank money enters the market through new loans to business. We might call the portion of new Ma that is created in the course of business lending Mb (standing for either business loans or business cycle). If, for example, a bank creates $1 million of deposits in a given time period, and $400,000 goes into consumer loans and government bonds, while $600,000 goes into business loans and investments, then Mb will have increased by $600,000 in that period. In examining Mb on the American financial scene, we can ignore savings banks and savings and loan associations, whose assets are almost exclusively invested in residential mortgages. Savings bonds, of course, simply help finance government activity. We are left, then, with commercial banks (as well as life insurance investments). Commercial bank assets are comprised of reserves, government bonds, consumer loans, and business loans and investments (corporate bonds). Their liabilities consist of demand deposits, time deposits (omitting large CDs), large CDs, and capital. In trying to discover movements of Mb, with any precision, we founder on the difficulty that it is impossible in practice to decide to what extent any increases of business loans and investments have been financed by an increase of deposits, thus increasing Mb, and how much they have been financed by increases of capital and large CDs. Looking at the problem another way, it is impossible to determine how much of an increase in deposits (increase in Ma) went to finance business loans and investments, and how much went into reserves or consumer loans. In trying to determine increases in Mb for any given period, then, it is impossible to be scientifically precise, and the economic historian must act as an "artist" rather than as an apodictic scientist. In practice, since bank capital is relatively small, as are bank investments in corporate bonds, the figure for commercial bank loans to business can provide a rough estimate of movements in Mb. With the development of the concepts of Ma (total supply of money) and Mb (total new money supply going into business credit), we have attempted to give more precision to the Austrian theory of money, and to the theoretical as well as historical Austrian analysis of monetary and business cycle phenomena.
In June, for the third month in a row, money supply growth surged to an all-time high, following new all-time highs in both April and May that came in the wake of unprecedented quantitative easing, central bank asset purchases, and various stimulus packages.
The growth rate has never been higher, with the 1970s the only period that comes close. It was expected that money supply growth would surge in recent months. This usually happens in the wake of the early months of a recession or financial crisis. The magnitude of the growth rate, however, was unexpected.
During June 2020, year-over-year (YOY) growth in the money supply was at 34.5 percent. That's up from May's rate of 29.5 percent, and up from June 2019's rate of 2.04 percent. Historically, this is a very large surge in growth, both month over month and year over year. It is also quite a reversal from the trend that only just ended in August of last year, when growth rates were nearly bottoming out around 2 percent. In August, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007.
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The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased to historic highs in June, growing 22.9 percent compared to May's growth rate of 21.9 percent. M2 grew 4.7 percent during June of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months. As of March, it is following the same trend as TMS.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. February 2020 was the first month since late 2008 that the TMS growth rate climbed higher than the M2 growth rate. The TMS growth rate again exceeded M2 in March and April 2020. As of mid-June 2020, it does appear that the decline in money supply growth has again preceded a recession. Although some observers will likely claim that the current economic crisis is a result solely of the COVID-19 panic and resulting government-forced shutdowns, several indicators do suggest that the economy was primed for a recession. The decline in TMS is one of these indicators, as is the late 2019 liquidity crisis in the repo markets. The Fed's moves to drop interest rates and to once again grow its balance sheet speak to the weakness of the economy leading up to April 2020.
After initial balance-sheet growth in late 2019, total Fed assets surged to over $7 trillion in June, setting a new all-time high and propelling the Fed balance sheet far beyond anything seen during the Great Recession's stimulus packages. The Fed's assets are now up more than 600 percent from the period immediately preceding the 2008 financial crisis.
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While Fed asset purchases are not solely responsible for the surge in new money creation, they are certainly a sizable factor. Bank loan activity has surged as well, also driving new money creation.
Dollar volume for M2 and TMS:
[[{"fid":"91643","view_mode":"default","fields":{"format":"default","alignment":"","field_file_image_alt_text[und][0][value]":"tota","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"format":"default","alignment":"","field_file_image_alt_text[und][0][value]":"tota","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tota","class":"media-element file-default","data-delta":"3"}}]] In terms of total dollar amounts now extant, the overall M2 total money supply in June was $18.1 trillion and the TMS total was $18.09 trillion. Since January, this is an increase of $2.7 trillion in M2 and $3.8 trillion in the TMS.
Monetary inflation is highly desired by the state. This has been the case thought history and still is the case today. That is because inflation facilitates government spending beyond revenue it takes through taxation. Government spending gives rulers, politicians and bureaucrats greater centralised control and commanding power over people's lives (i.e., the economy and society). Without inflation, the state finds itself shackled within the confines of what it can take via taxes. Therefore, governments will not miss a change to gain control of the monetary system. Once the state does have control of money, inflation becomes inevitable and institutionalised. This is why, in recorded history, nearly all cases of great inflation and hyperinflationary socioeconomic collapse (e.g., Weimar Germany, Zimbabwe and more recently Venezuela) have been a result of government (and/or its central bank) deliberate policy. It is because of the insatiable appetite to spend more than they take through taxes that governments, through political deception and coercion, tend to undermine a sound money system and repress monetary freedom in favor of one that facilitates currency debasement (i.e., money printing). That is to say a fiat currency regime monopolised by the state and forced on the people by legal tender laws. As such, from the statist economics standpoint, the definition of inflation had to be distorted and the public miseducated about it —so that the process of currency debasement (i.e., monetary inflation) may go unnoticed and accepted by those whom it hurts the most, the general pupation.
Definition of inflation The popular and textbook definition of inflation is a generalized rise in the prices of goods and services. Commonly measured by the Consumer Price Index (CPI). This definition is not wrong per se but it is inaccurate and grossly misleading. Deliberately so. The original and more accurate definition of inflation is the artificial increase in the supply of money (and credit). By artificial it is meant that the expansion of the supply of money is not determined by the market (i.e., the people) but rather by the government, usually through a central bank.
So, this confusion in terms is not coincidental, it is deliberate. Given the rise of Keynesian economics and the inherently inflationary fiat dollar standard we, humanity, live under for fifty years now. Deliberate distortion The original definition of inflation has been distorted for two principal reasons. First, the government and its monetary agency—the central bank—shield themselves from any future blame for the continuing rise in prices and the currency loss of purchasing power that inevitably happens as a result of inflationist monetary policy. This enables the government and mass media outlets to divert the blame to something or someone else. The usual scapegoats being “greedy businessmen” or “corporations.”
Second, the official and distorted definition of inflation—a generalised increase in prices of goods and services—conceals the truth, the true source of inflation, thus preventing the public from knowing that inflation and the currency’s loss of purchasing power is a deliberate policy of government/central bank. Not knowing this, the public will not protest against it. For example, this report claims that most Americans believe “corporate greed, profiteering and price gouging” is the cause of the current inflation crisis in the United States, where price inflation hit a 40 year record high. What’s more unsettling is the same report found that the majority of those polled also believe that the government should step in and resolve the problem. In other words, the public wants the causer of the problem to solve the problem.Such is the depth of economic misinformation and miseducation we face. Perhaps, if the public knew that since the establishment of the current US central bank in 1913, the dollar lost more than 95 percent of its purchasing power relative to gold (the commodity that gave the dollar its initial value, stability and global acceptability), they wouldn't blame the inflation crisis on “corporate greed”. Economist and social philosopher Murray Rothbard wrote: "Government is inherently inflationary because it has, over the centuries, acquired control over the monetary system. Having the power to print money (including the "printing" of bank deposits) gives it the power to tap a ready source of revenue. Inflation is a form of taxation, since the government can create new money out of thin air and use it to bid away resources from private individuals, who are barred by heavy penalty from similar "counterfeiting." Inflation therefore makes a pleasant substitute for taxation for the government officials and their favored groups, and it is a subtle substitute which the general public can easily—and can be encouraged to—overlook." The government’s monetary agency and the current fiat money system are the cause for today’s increasingly inflationary and chaotic monetary situation. Not corporate greed, speculators, free-market capitalism, Vladimir Putin, or the weather. Under a fiat currency regime, the central bank can easily, artificially and systematically increase the money supply, almost like a magic trick, which makes inflation (mild or severe) the norm. And this inflationary process gradually destroys the purchasing power of the currency resulting in higher prices. This policy, while benefiting the government and associates, defrauds the people and impoverishes society, economically and morally. Economist Hans F. Sennholz noted:It is not money, as is sometimes said, but the depreciation of money—the cruel and crafty destruction of money—that is the root of many evils. For it destroys individual thrift and self-reliance as it gradually erodes personal savings. It benefits debtors at the expense of creditors as it silently transfers wealth and income from the latter to the former. It generates the business cycles, the stop-and-go boom-and-bust movements of business that inflict incalculable harm on millions of people. Professor Sennholz further noted:Monetary destruction breeds not only poverty and chaos, but also government tyranny. Few policies are more calculated to destroy the existing basis of a free society than the debauching of its currency. And few tools, if any, are more important to the champion of freedom than a sound monetary system. Conclusion
A generalised rise in the prices of goods and services, is a consequence of inflation, not inflation itself. Inflation was classically (pre-Keynesian economics) defined as an artificial increase in the supply of money and credit. Nowadays it makes sense to use the terms monetary inflation to specify the artificial increase of the money supply, on one hand. And use price inflation to refer to a generalised rise in prices of goods and services on the other. Irrespective of the confusion in definition, inflation stealthily distorts and debilitates the economy, steals the people's purchasing power and impoverishes society while benefiting the ruling political and business elites. History (and common sense too) makes it clear that fiat currency regimes are unsustainable arrangements that always and inevitably fail. As such, there is no reason to believe today’s cruel and oppressive fiat currency regime will defy Natural law to stand the test of time. Evidence suggests it is more sensible to believe the fiat dollar standard too will crumble. And when it does, we hope economic miseducation and misinformation will crumble along with it.
A monetary system that allows the creation of money out of thin air is vulnerable to the fits of credit expansion and credit contraction. Periods of credit expansion typically occur over many years and even decades while the phases of credit contraction happen like sudden implosions. The monetary policy makers tend to promote the prolongation of credit expansion because they fear deflation.
By doing this, however, the central banks prevent monetary moderate deflation as it would happen as the natural consequence of rising productivity. This way, an antideflationary monetary policy lays the groundwork for an upsurge of price inflation along with augmenting the risk of an abrupt contraction of the financial markets.
Credit Cycles Financial cycles can extend over long periods of time. In the past decades, there has been a massive global credit expansion, each of which has received new waves of boosts as it happened since the 1980s and as the result of such events like the 2008 financial crisis, the 2020 pandemic policy, and the current policy of sanctions in response to the war in Ukraine.
Figure 1: Global debt since 1970 as a percentage of World GDP
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The chart (fig. 1) shows total global debt, public debt, household debt, and non-financial corporate debt as a percentage of the global gross domestic product. Calculated in absolute terms, total global debt is rapidly approaching $300 trillion.
With the end of the US dollar's link to gold in the 1970s, the international monetary system lost its anchor. Global debt in relation to the world’s gross domestic product has risen from one hundred percent to over two hundred and fifty percent. The attenuation of this credit cycle is long overdue. However, again and again, the major central banks have been fighting any sign of a credit contraction for several decades.
In Japan, the battle against credit consolidation began as early as the 1990s. In the United States, the fight against a perceived threat of deflation began around the turn of the millennium. Since the European debt crisis in 2010, the European Central Bank has also joined the monetary orgy. Obviously, the monetary policy makers ignore the risk that by not letting moderate deflationary contraction happen, they produce a monetary overhang. This in turn, poses the twin risk of higher price inflation along with an uncontrolled collapse of the credit markets.
Central banks are waging a relentless fight against deflation. Being traumatized by the Great Depression, the modern monetary policy makers suffer from the psycho-pathological condition of “apoplithorismosphobia”—the fear of deflation. The battle of the central banks against deflation has created so much liquidity that the earlier deflationary tendency begins now to manifest itself as an upsurge of price inflation that even the official statistics cannot hide anymore.
Having internalized the monetarist lesson about the origin of the Great Depression, central bankers have a deep-seated fear of price deflation, assuming that a fall in the general price level would provoke an economic contraction. However, had central banks left the system alone, deflation would have happened gradually without much turmoil. The economic actors would have had enough room and time to adapt. As such, deflation would not only be harmless but also beneficial. Trapped by their obsession with “stabilization,” central banks have not permitted the economy to move on its natural path. Instead of allowing the self-correcting economic fluctuations, monetary policy has fabricated one artificial expansion after the other.
The conventional monetary theory claims that a growing economy would need an expanding money supply. Even monetarist economists like Milton Friedman supported this idea. Yet Murray Rothbard has shown that there is no need of expanding the money supply to provide more liquidity even when the economy grows. If the money supply remains constant and productivity increases, prices would fall accordingly. This would be a beneficial deflation. Why complain when the goods are getting cheaper for consumers and the real wages rise? The crucial point is whether the price deflation happens due to productivity gains in the economy or abruptly as a sharp decline of the liquidity due to a financial market crisis.
When central banks intervene and expand the money supply, as it happened in the form of the "zero interest rate policy" (ZIRP) or in some cases of a "negative interest rate policy" (NIRP), tensions will arise between the natural tendency of the interest rate to rise and the monetary interest rate that is kept low through the interventions of the central bank. Because of this discrepancy, there will be an additional demand for money. Over time, this monetary overhang promotes financial fragility and lays the foundation for future price inflation.
The massive expansion of the Federal Reserve’s money supply in the form of its monetary base did not immediately lead to price inflation because the velocity of money experienced a sharp fall since 2008. The trend of a falling velocity began to stop in the third quarter of 2020—well before the outbreak of the war in Ukraine. Given that the monetary overhang had persisted, prices began to rise right away, and the official consumer price inflation has accelerated to its highest rate in the past four decades.
Changes in Relative Prices Do Not Cause Price Inflation The increase in individual prices—for example, crude oil—manifests itself as the change in the relative price. One specific good becomes more expensive in relation to other products. Only if there is a monetary overhang as the result of a previous or ongoing credit expansion, such individual price increases would show up in the so-called price level as an increase of general price inflation.
When the policy makers manipulate the interest rate, they create a discrepancy between human time preference and the monetary interest rate. Stimulus policies push down artificially the monetary rate below the natural interest rate, which would emerge in the unhampered market if there were no central bank intervention. Disproportions occur in the financial markets the same way as they do when the state intervenes in the market for goods. Relative prices then no longer reflect consumer preferences and the marginal cost of production. The consequences are economic disruptions in the supply and demand of these goods.
The monetary system possesses a natural degree of elasticity. Even if the money supply were tied to a fixed supply of central bank money or in a gold standard, there would be expansions and contractions in macroeconomic spending and the nominal national income. With an anchor of the money supply, these variations of economic activity would happen mainly as fluctuations and short-term swings and not as prolonged phases. The whole idea of stabilization stands in contrast to the need for a system in motion to fluctuate.
Money does have loose joints to do its job, yet it should have an anchor to prevent extreme cycles. Under a gold standard, for example, there is an elasticity of money, even if the gold stock is constant. In this respect, the current monetary system is dysfunctional.
The use of money will oscillate naturally also with a fixed quantitative amount of its base. It is wrong to claim that only the artificially created so-called fiat money would offer financial flexibility. Rather, the decisive point is that with an anchored monetary system, the degree of deviation is limited, while under the current fiat money regime, there is no restriction.
Conclusion A state-sponsored fiat currency system with only a partial reserves coverage of the money in circulation allows the commercial banks to put more money into circulation than they hold in cash. By persistently pursuing an antideflationary policy, the central banks have fueled an ongoing credit expansion. They artificially prolonged the cycle of credit expansion. This means that a natural contraction has been prevented. Along with an upsurge of price inflation, this policy has also increased the risk of an uncontrolled implosion of the credit markets. The current outbreak of price inflation does not come by accident or because of external shocks. The foundation for rising prices was laid over a long period of time. As a consequence, another severe financial crisis looms now again on the horizon.
Whenever the signs of an economic weakness emerge, most economic and political commentators declare that the government should increase spending in order to prevent the economy falling into a recession. Economic activity, in this view, consists of a circular flow of money, with one individual’s spending becoming part of the income of another individual. Spending equals income, hence more spending will mean higher incomes.
If some individuals decide to reduce their spending, their actions weaken the circular flow of money. If an individual spends less, the incomes of others are lessened and they, in turn, reduce their purchases of goods from other individuals. As a result, overall spending on goods and services declines and, thus, overall income falls, too.
Following this logic, in order to prevent a downward spiral, mainstream economists claim the government should step in and increase its outlays, thereby filling the shortfall in private sector spending. Thus, government spending is a vital agent of economic growth.
The Magic of the Keynesian Multiplier John Maynard Keynes popularized the view that an increase in government outlays causes the economy’s income to increase by a multiple of the initial government increase. The following example illustrates the essence of this way of thinking.
Assume that in order to strengthen the pace of economic activity, the government decides to increase its expenditure by $100 million. Assume also that out of each additional dollar received, individuals spend ninety cents and save ten cents.
Once the government increases its outlays, the amount of money in individuals’ possession increases by $100 million. Given that individuals spend ninety cents of an additional dollar received, this means that they are going to spend 90 percent of the $100 million, so they will increase expenditure on goods and services by $90 million.
The recipients of this $90 million in turn spend 90 percent of the $90 million, which is $81 million. Then, the recipients of the $81 million spend 90 percent of this sum, which is $72.9 million, and so on. Note that the key in this way of thinking is the belief that the expenditure of one person becomes the income of another person.
At each stage in the spending chain, individuals spend 90 percent of the additional income they receive. This process eventually ends, with total income higher by $1 billion than it was before government increased its expenditure by $100 million, with the multiplier being 10 ($100 million x 10 = $1 billion). Observe that the more of the additional income is spent, the greater the multiplier is going to be and, therefore, larger the impact of the initial spending on the overall income.
For instance, if individuals change their habits and spend 95 percent of each dollar, the multiplier is going to become 20. Conversely, if they decide to spend only 80 percent and save 20 percent, then the multiplier is going to decline to 5. This means that the less individuals save, the larger the impact of a demand increase on overall income is going to be. According to John Maynard Keynes,
If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course by tendering for leases of the note-bearing territory), there need be no more unemployment and with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.John Maynard Keynes, The General Theory of Employment, Interest and Money (London: Macmillan, 1964), p. 129.
Fiscal Stimulus and Economic Growth If government spending does not generate new wealth, how can an increase in government outlays revive the economy? First, people employed by the government are compensated for their work; then, these workers spend the proceeds and supposedly expand the economy.
However, note that the government pays these individuals by taxing entrepreneurs and private business workers who are actually generating wealth. By doing this, the government weakens the wealth-generating process and undermine prospects for economic growth. The following example clarifies this point further.
In an economy that is comprised of a baker, a shoemaker, and a tomato grower, another individual enters the scene, an enforcer exercising his demand for goods by means of force. The baker, the shoemaker, and the farmer are forced to part with their products in an exchange for nothing. As a result, all other things being equal, their ability and willingness to produce goods weakens. This in turn undermines the production flow of final consumer goods. According to Ludwig von Mises,
There is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens' spending and investment to the full extent of its quantity.Ludwig von Mises, Human Action: A Treatise on Economics, 3rd rev. ed. (Chicago: Contemporary Books, 1966), p. 744.
Fiscal stimulus can “work” as long as the flow of savings is expanding, since the expanding savings fund government activities while still permitting an increase in the activities of wealth generators. However, if the flow of savings declines, then overall economic activity cannot be revived. In this case, the more the government spends, the more it takes from wealth generators and the more it weakens prospects for economic growth.
Thus, when the government by means of taxes diverts bread to its own activities, the baker is going to have less bread at his disposal. Consequently, the baker is not going to be able to secure the services of the oven maker to build a new oven. As a result, it is not going to be possible to increase the production of bread, all other things being equal.
As the pace of government spending increases, a situation could emerge in which the baker is left with too little bread to hire a technician to maintain the existing oven. Consequently, the baker’s production of bread is going to decline, all other things being equal.
Similarly, because of the increase in government outlays, other wealth generators are going to end up having less funding at their disposal. This in turn is going to hamper their production of and retard rather than promote overall economic growth.
We can thus conclude that an increase in government outlays is not going to raise the economy’s income by a multiple of the initial increase. On the contrary, the increase in government outlays will weaken the overall income, all other things being equal.
What Causes Recessions? Central bank policy makers (such as those at the Federal Reserve) regard the central bank as the responsible entity authorized to bring the economy onto the path of stable growth and prices. These policy makers decide what the “right” growth rate should be.
Consequently, any deviation from the predetermined stable growth path determines the central bank’s response, whether it employs a tighter or a looser stance. This response in turn affects the fluctuations in the money supply’s growth rate.
Observe that loose central bank monetary policy, which results in an expansion of money supply out of “thin air,” sets in motion an exchange of nothing for something, which amounts to a diversion of savings from wealth-generating activities to non-wealth-generating activities.
Loose monetary policy produces the same outcome as the counterfeiter does. Its diversion of savings weakens wealth generators and thus their ability to grow the overall pool of wealth.
The various activities that emerge on the back of a loose monetary policy are labeled bubble activities. An increase in bubble activities, which generates the impression of an expanding economic growth, is labeled an economic boom.
Bubble activities cannot stand on their “own feet.” These activities are supported by the expansion of the money supply, which diverts wealth generators’ savings to them.
Also, note that once the central bank increases the pace of monetary expansion, the pace of the diversion of savings toward bubble activities also increases. Once, however, the central bank tightens its monetary stance, this slows the diversion of savings.
Because bubble activities cannot stand on their own feet, these activities require ongoing increases in the growth rate of money supply in order to survive. (Again, the increase in money supply diverts to them consumer goods. These consumer goods are the savings of wealth generators.)
When the central bank takes tighter monetary stance, bubble activities that sprang up on the back of the previous loose monetary policy get less support. They are in trouble—an economic bust emerges. Recessions, then, are not about the weakening of economic activity but rather about the liquidation of the various bubble activities that sprang up on the back of increases in the money supply out of “thin air.”
Aggressive monetary policy, which creates bubbles, weakens wealth generators, thereby diminishing economic recovery. Once the economy falls into a recession, the central bank should restrain itself and do nothing to counter the economic downturns. Recessions are in fact good news for wealth generators, since recessions demolish bubble activities that weaken wealth producers.
Conclusion During an economic crisis, what is required is for the government and the central bank to do as little as possible. With less tampering, more wealth remains with wealth generators, allowing them to expand the pool of savings.
With a larger pool of savings, it is easier to absorb various unemployed resources. Aggressive monetary and fiscal policies that undermine the process of wealth generation make things much worse.
As long as the pool of savings is still expanding, the government and the central bank can pass off the illusion that they can grow the economy. However, once savings begin to stagnate or decline, the illusion is shattered.
In the New York Times article “How High Inflation Will Come Down,” Paul Krugman suggests that the key for future inflation is inflation expectations. Krugman does not think that currently inflation expectations are comparable to the 1980s. According to him:
Forty years ago, as many economists will tell you, inflation was “entrenched” in the economy. That is, businesses, workers and consumers were making decisions based on the belief that high inflation would continue for many years to come. One way to see this entrenchment is to look at the wage contracts—typically for three years—that unions were negotiating with employers. Even then, most workers weren’t unionized, but these deals are a useful indicator of what was probably happening to wage- and price-setting more generally.
Furthermore:
So, what did those wage deals look like? In 1979, union settlements with large companies that didn’t include a cost-of-living adjustment specified an average wage increase of 10.2 percent in the first year and an annual average of 8.2 percent over the life of the contract. As late as 1981, the United Mine Workers negotiated a contract that would raise wages 11 percent annually over the next several years…. Why were workers demanding, and employers willing to grant, such big pay hikes? Because everyone expected high inflation to persist for a long time. In 1980 the Blue Chip Survey of professional forecasters predicted 8 percent annual inflation over the next decade. Consumers surveyed by the University of Michigan expected prices to rise by about 9 percent annually over the next five to 10 years. With everyone expecting inflation to continue, workers wanted raises that would keep up with rising prices, and employers were willing to grant those raises because they expected their competitors’ costs to be rising as fast as their own. What this did, in turn, was make inflation self-perpetuating: Everyone was raising prices in anticipation of everyone else raising prices. Ending this cycle required a huge shock—an economy so depressed both that inflation fell and that workers were compelled to accept major concessions.
This time around, Krugman holds, things are different:
Back then almost everyone expected persistent high inflation; now few people do.Bond markets expect inflation eventually to return to pre-pandemic levels. While consumers expect high inflation over the next year, their longer-term expectations remain “anchored” at fairly moderate levels. Professional forecasters expect inflation to moderate next year. This means that we almost surely aren’t experiencing the kind of self-perpetuating inflation that was so hard to end in the 1980s. A lot of recent inflation will subside when oil and food prices stop rising, when the prices of used cars, which rose 41 percent (!) over the past year during the shortage of new cars, come down, and so on. The big surge in rents also appears to be largely behind us, although the slowdown won’t show up in official numbers for a while. So it probably won ‘t be necessary to put the economy through an ’80s-style wringer to get inflation down.
Given all this, Krugman holds, history tells us that we are not moving to rampant inflation as we did in the 1970s:
So, my message for those intoning dire warnings about the return of ’70s-type stagflation—which some of them have been itching to do for years—is that they should look at their history more carefully. The inflation of 2021–22 looks very different, and much easier to solve, from the inflation of 1979–80.
Inflation Expectations and General Price Increases For most economic commentators the underlying driving force of general price increases, which they label as inflation, is inflationary expectations.Ben S. Bernanke, “Inflation Expectations and Inflation Forecasting” (speech given at the Monetary Economics Workshop of the National Bureau of Economic Research Summer Institute, Cambridge, Massachusetts, July 10, 2007). For instance, if there is a sharp increase in the price of oil, individuals may form higher inflationary expectations that could set in motion increases in the prices of goods and services, or so it is held.
These same commentators believe that if expectations can be made less responsive to various price shocks, then over time this would mitigate the effect of price shocks on the momentum of prices of goods and services. That also believe that suitable central bank policies can bring individuals inflationary expectations to a state of equilibrium in which expectations are perfectly anchored or not sensitive to changes in various economic data.
Once inflationary expectations are anchored, they believe, various price shocks such as sharp increases in oil or food prices are likely to have a short-lived effect on general increases in prices. This means that over time sudden large price increases are unlikely to have much effect on the rate of inflation. Note that what matters in this way of thinking is the underlying inflation.
Federal Reserve policy makers and many economists believe that in order to track underlying inflation one must pay attention to core inflation—percentage changes in the consumer price index minus food and energy. To make inflation expectations well-anchored, individuals must be clear about the monetary policy of central bank policy makers, and as long as individuals are unclear about the rate of inflation that policy makers want to target, it is going to be difficult to bring inflationary expectations to a state of equilibrium.
Can General Increases in Prices Be Induced without Increasing Money Supply? Without a preceding increase in money supply, there cannot be general increase in prices, a price of a good being amount of dollars paid per unit of a good. All other things being equal, if prior to the increase in money supply, the price of a loaf of bread that formerly stood at $1 now is $2 after an increase in the supply of dollars. For a given amount of goods, if the stock of money remains unchanged the amount of dollars spent per unit of a good will stay unchanged, as long as nothing else has occurred.
However, suppose that a sudden increase in the price of oil leads people to form higher inflation expectations. If the money stock remains unchanged, then no general increase in the prices of goods and services is going to take place, all other things being equal. In this situation, the prices of oil and energy related goods will go up while the prices of other goods and services will go down. (If more money spent on oil and energy related products, obviously then less money will be left for other goods and services—note again a price is the amount of money per unit of a good).
We can conclude that changes in the money supply underpin the rises in prices, and not inflationary expectations. Without the support from money supply, all other things being equal, no general increase in prices can take place notwithstanding inflation expectations.
Instead of inflation being the increase in prices, we measure inflation by increases in money supply. Note that we do not say that inflation is caused by increases in money supply; instead, we hold that inflation is about increases in money supply.
According to Ludwig von Mises,
Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term ‘inflation’ to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation.Ludwig von Mises, Economic Freedom and Interventionism: An Anthology of Articles and Essays, ed. Bettina Bien Greaves (Indianapolis, Ind.: Liberty Fund, 1990), p. 115.
The larger problem with inflation is not so much how it causes price increases (although price increases do cause problems) but the damage it inflicts to the wealth generation process. This is because increases in money supply set in motion an exchange of nothing for something, which generates a similar outcome to what the counterfeit money does. It weakens wealth generators thereby weakening their ability to generate wealth and, in turn, undermines individuals’ living standards.
What Is the Present Status of Inflation? So what is the present status of inflation? The official version is that the yearly growth rate of the US Consumer Price Index (CPI) stood at 7.9 percent in February against 7.5 percent in January and 1.7 percent in February 2021. However, in terms of money supply, inflation stood at 7.9 percent in February 2021 against 4 percent in January 2019. Given such massive increases in money supply and given the long time lags from changes in money and changes in prices one should not be surprised that the yearly growth rate of the CPI displays a visible increase.
Summary and Conclusion We suggest that a decline in the yearly growth rate of the AMS from 79 percent in February 2021 to 8 percent by February this year has likely set in motion a possible decline in the momentum of the CPI towards year end or early next year.
Contrary to what Krugman claims, we hold that inflation is not about increases in consumer prices but about increases in money supply. Also contrary to various commentators, what Krugman describes as inflationary expectations in the absence of increases in money supply cannot cause general increase in the prices of goods and services.
For most experts, deflation is bad news since it generates expectations for a continued decline in prices, leading consumers to postpone the purchases of present goods, since they expect to purchase them at lower prices in the future. Consequently, this weakens the overall flow of current spending and this, in turn, weakens the economy. Economic activity, believe the experts, is a circular flow of money. Spending by one individual becomes the earnings of another individual, and spending by another individual becomes a part of the previous individual's earnings.
If people have become less confident about the future decide to reduce their spending, this weakens the circular flow of money. Once an individual spends less, this worsens the situation of some other individual, who in turn also cuts his spending.
According to the former Federal Reserve chairman Ben Bernanke,
Deflation is in almost all cases a side effect of a collapse of aggregate demand—a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending—namely, recession, rising unemployment, and financial stress.
Murray Rothbard, however, held that in a free market the rising purchasing power of money (shown by declining prices) makes goods more accessible to people. He wrote:
Improved standards of living come to the public from the fruits of capital investment. Increased productivity tends to lower prices (and costs) and thereby distribute the fruits of free enterprise to all the public, raising the standard of living of all consumers. Forcible propping up of the price level prevents this spread of higher living standards.
Economist Joseph Salerno adds:
Historically, the natural tendency in the industrial market economy under a commodity money such as gold has been for general prices to persistently decline as ongoing capital accumulation and advances in industrial techniques led to a continual expansion in the supplies of goods. Thus throughout the nineteenth century and up until the First World War, a mild deflationary trend prevailed in the industrialized nations as rapid growth in the supplies of goods outpaced the gradual growth in the money supply that occurred under the classical gold standard. For example, in the US from 1880 to 1896, the wholesale price level fell by about 30 percent, or by 1.75% per year, while real income rose by about 85 percent, or around 5 percent per year.Joseph T. Salerno, "An Austrian Taxonomy of Deflation" (paper presented at Boom, Bust, and the Future, January 19, 2002, Mises Institute, Auburn, Alabama).
Money and Money out of “Thin Air” Money emerged because it could support the market economy more efficiently than barter. The distinguishing characteristic of money is its role as general medium of exchange, evolving from the most marketable commodity. On this Ludwig von Mises wrote:
There would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.
All goods and services are traded for money. This fundamental characteristic of money must be contrasted with other goods. For instance, food supplies the necessary energy to human beings. Capital goods permit the expansion of the infrastructure that in turn permits the production of a larger quantity of goods and services. Through the ongoing selection process over thousands of years, individuals settled on gold as the standard for money.
In a market economy, money’s key function is to be the medium of the exchange. By means of money, a product of one specialist is exchanged for the product of another specialist.
Alternatively, we can say that something is exchanged for money, and then money is exchanged for something else, which means that something is exchanged for something else with the help of money.
This process is disrupted once an increase in the money supply out of “thin air” emerges. When money is generated out of “thin air,” no wealth has been exchanged for it, but the holder of newly generated money now can exchange it for wealth. Therefore, we have an exchange of nothing for something. An exchange of nothing for something amounts to a diversion of wealth from people that have produced wealth to the holders of the generated money. We emphasize that the act of wealth diversion is made possible because of the increase in money supply, or the inflation of money.
The Essence of Deflation In order to establish the essence of deflation, we first must understand the essence of inflation. Contrary to popular thinking, inflation is not about general increases in the prices of goods and services. Inflation is not set in motion by increases in wages, nor is it set in motion by a decline in unemployment or an increase in economic activity (the “overheating” economy), as popular thinking goes.
Another popular viewpoint is that a growing economy creates a growing demand for money that must be accommodated in order to prevent economic disruptions. As long as the increase in money supply is in line with the increase in the demand for money, there are no negative economic effects. Now, irrespective of the state of the demand for money, an increase in the money supply out of “thin air” leads to an exchange of nothing for something, which diverts wealth.
Because any given amount of money can perform the job of a medium of the exchange, there are no requirements to increase the supply of money in order to accommodate an increase in the demand for money. According to Mises:
The services which money renders can be neither improved nor repaired by changing the supply of money. . . . The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.
We can conclude that the subject matter of inflation is the diversion of wealth from wealth generators towards the holders of newly created money. The increase in the money supply out of “thin air” sets in motion this diversion. The increase in the money supply out of “thin air” is what inflation is all about.
Note that deflation emerges once the process of wealth diversion comes to a halt. This occurs once the money supply begins to decline. A decline in money supply, or deflation, is good news for the economy, since the diversion of wealth is coming to a halt. We also hold that a major factor behind the expansion of money out is bank lending not backed up by savings.
Nonproductive Activities Come from Lending Fake Money When loaned money is fully backed by savings on the day of the loan’s maturity, it is returned to the original lender. For instance, Bob borrows $5 and will pay back on the maturity date the borrowed sum and interest to the bank. The bank in turn will pass to Joe the lender his $5 plus interest adjusted for bank fees. The money makes a full circle and goes back to the original lender. Note that the bank here is just a facilitator; it is not a lender, so the borrowed money is returned to the original lender.
In contrast, when lending originates out of "thin air" and the borrowed money is returned on the maturity date to the bank, this leads to a withdrawal of money from the economy and the money supply declines. The reason is that we never had a saver/lender, since this lending emerged out of nothing. Note that savings do not support the newly formed demand deposits here, so when Bob repays the $5, the money leaves the economy since there is no original lender to whom the loaned money should be returned.
Observe that the $5 loan out of “thin air” is a catalyst for an exchange of something for nothing, and it provides a platform for various nonproductive activities that prior to that generation of lending would not have emerged. As long as banks continue to expand credit in that manner, various nonproductive activities continue to prosper. At some point, however, the relentless expansion of the money supply diverts wealth, and a structure of production emerges that ties up more consumer goods than it releases. (The consumption of final consumer goods exceeds the production of these goods). The positive flow of savings is arrested and a decline in the pool of wealth is set in motion.
Consequently, the performance of various activities starts to deteriorate and bad loans start to pile up. In response to this, banks curtail their lending and this in turn triggers a decline in the money supply. A decline in the money supply begins to undermine various nonproductive activities, so an economic recession emerges. Some economists such as Milton Friedman believe that once the money supply starts to decline the central bank should embark on the monetary pumping to prevent an economic slump. An economic slump is not caused by the decline in the money supply as such, but comes in response to the shrinking pool of wealth because of the previous easy monetary policies. The shrinking pool of wealth leads to the decline in economic activity and, in turn, to the decline in the lending out of “thin air,” which results in the decline of the money supply.
Even if the central bank could prevent a decline in the money supply, such as reverting to something like dropping money from helicopters, it still cannot prevent an economic slump if the pool of wealth is declining. The more the central bank attempts to lift the economy by fixing the symptoms such as the fall in prices and rising unemployment, the worse things become.
Once various nonproductive activities are allowed to go bankrupt, and the sources of money supply out of “thin air” are sealed off, one can expect a genuine wealth expansion to ensue. With the expansion of wealth and for a given supply of money, we will have a fall in prices. Observe that when prices decline because of the liquidation of nonproductive activities and because of wealth expansion, it is always good news. This indicates that more savings is now available for wealth generation, and secondly that more wealth is generated.
The fall in the money supply, which precedes price deflation and an economic slump, is triggered by the previous loose monetary policies of the central bank, which provide support to the generation of unbacked credit. Without this support, banks would have difficulty offering an unbacked by savings credit, since some of them will not be able to clear their checks because they will not have enough cash. By means of open market operations, the central bank makes sure that there is enough cash in the banking system to prevent banks from bankrupting each other. Again, note that price deflation and the fall in the economy are due to the decline in the pool of wealth brought about by previous loose monetary policies.
Because deflation works toward reducing the wealth diversion from wealth generators toward non–wealth generators, the central bank should conduct tight monetary policies rather than loose policies. Policies that tamper with financial markets are always have bad outcomes, since such policies misallocate resources. Hence, the best policies is to have a genuine free market without the central bank tampering with financial markets.
Summary and Conclusion Deflation is not about a general decline in prices, but rather emerges in response to the decline of the pool of wealth, which is caused by increases in the money supply. The emergence of deflation is always good news, since it is in response to the liquidation of various activities that lead to the erosion of the wealth generation process.
An economic slump is not caused by the decline in the money supply, but rather because of the shrinking pool of wealth due to previous easy monetary policies. This shrinking pool of wealth leads to the decline in economic activity and, in turn, leads to the decline in the lending out of nothing, which then results in the decline in the money supply. While inflation weakens the generation of wealth, deflation ultimately strengthens wealth creation.
Growth in the supply of US dollars remained near a multi-year low in December, growing 2.9 percent, year over year.
In November, year-over-year growth in the money supply fell to a 129-month low, growing 2.7 percent. The last time the money supply grew at a smaller rate than November 2017's rate was during March 2007 — at a rate of 2.1 percent.
The money-supply metric used here — an "Austrian money supply" measure — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure than M2. The Mises Institute now offers regular updates on this metric and its growth.
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The "Austrian" measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short time deposits, traveler's checks, and retail money funds).
M2 growth also slowed in October 2017, falling to 3.0 percent.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
One factor behind slowing money-supply growth is likely a slowing in new loans being made by commercial banks. As we can see in the latest data from the Fed, commercial and industrial loans were up only 0.9 percent in November 2017, compared to November 2016. That's the smallest growth rate recorded since April 2011. The overall trend in loans growth is similar to what we saw in 2009, during the last recession.
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(Thanks to the intervention of central banks, of course, money supply growth in recent decades has never gone into negative territory.)
Nevertheless, as we can see in the graph of money supply growth above, significant dips in growth rates show up in years prior to a economic bust or financial crisis. The current trend is an unusual one in which growth in AMS is smaller than it is in M2. In the past this situation has often pointed toward a recession.
Money supply growth slowed in January, falling to the second-lowest rate recorded since February of last year. Overall, money-supply growth remains well below the growth rates experienced from 2009 to 2016, and has fluctuated little since March of last year
In January, year-over-year growth in the money supply was at 3.3 percent. That was down from December's growth rate of 3.8 percent, but was up from January 2018's rate of 2.8 percent.
[[{"fid":"80183","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"1"}}]] The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth.
This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
M2 growth rose in January, rising 4.3 percent, compared to December's growth rate of 3.8 percent. M2 grew 4.4 percent in January of last year. Like the TMS measure, the M2 growth rate has fallen considerably since late 2016, but has varied little in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
[[{"fid":"80184","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"2"}}]] Many factors contribute to these trends. In recent months, money supply growth — in both M2 and TMS — has likely been impacted by falling growth rates in real estate loans at commercial banks. In January, real estate loans grew 2.9 percent, year over year, which was a 49-month low. The demand for mortgage loans has softened as mortgage rates have risen. In January, the 30-year, fixed average mortgage rate reached 4.46 percent, which was down from November's recent high of 4.87. Janaury 2018's average mortgage rate was much lower, however, coming in at 4.03 percent.
Money supply growth inched up in May, rising slightly above March's and April's growth levels. But overall growth levels remain quite low compared to growth rates experienced from 2009 to 2016. March's growth rate, for examples, was at a 12-year (145-month) low.
In May, year-over-year growth in the money supply was at 2.21 percent. That was up from April's growth rate of 2.00 percent. May 2019's growth rate was well down from May 2018's rate of 4.19 percent.
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The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth.
This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
M2 growth rose in May, growing 4.14 percent, compared to April's growth rate of 3.86 percent. M2 grew 3.83 percent during May of last year. The M2 growth rate has fallen considerably since late 2016, but has varied little in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slow-downs in rates of money-supply growth.
Moreover, periods preceding recessions often show a growing gap between M2 growth and TMS growth. We saw this in 2006-7 and in 2000-1. The gap between M2 and TMS narrowed considerably from 2011 through 2015, but has grown in recent years.
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Money supply growth inched up in April, rising slightly above the March growth level, which was at a 12-year (145-month) low.
In April, year-over-year growth in the money supply was at 1.99 percent. That was up slightly from March's growth rate of 1.92 percent, but was well down from April 2018's rate of 4.32 percent.
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The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth.
This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
M2 growth rose slightly April, growing 3.84 percent, compared to March's growth rate of 3.77 percent. M2 grew 3.72 percent in April of last year. The M2 growth rate has fallen considerably since late 2016, but has varied little in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slow-downs in rates of money-supply growth.
Moreover, periods preceding recessions often show a growing gap between M2 growth and TMS growth. We saw this in 2006-7 and in 2000-1. The gap between M2 and TMS narrowed considerably from 2011 through 2015, but has grown in recent years.
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The overall M2 total money supply in April was $14.6 trillion, and the TMS total was $13.4 trillion.
The money supply growth rate fell in August, dropping to a 150-month low. To find a lower growth rate, we need to go back to August 2007, when the rate was 1.59 percent.
During August, year-over-year growth in the money supply was at 1.87 percent. That down from July's rate of 2.19 percent, and was well down from August 2018's rate of 4.48 percent.
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The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased in August, growing 5.37 percent, compared to July's growth rate of 5.12 percent. M2 grew 3.83 percent during August of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slow-downs in rates of money-supply growth.
Moreover, periods preceding recessions often show a growing gap between M2 growth and TMS growth. We saw this in 2006-7 and in 2000-1. The gap between M2 and TMS narrowed considerably from 2011 through 2015, but has grown in recent years.
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The overall M2 total money supply in August was $14.9 trillion, and the TMS total was $13.5 trillion.
The lack of money supply growth also points to growing weaking in economic activity since the Fed has turned to increasingly accommodative monetary policy in recent months — but has not managed to return money supply growth to levels we'd expect in an expansion. Today, the FOMC announced another cut to the Federal Funds Rate — the second cut in three months. The Fed is also looking toward further incrasing its balance sheet as it readies another "blast of cash" for the repo market.
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Money supply growth slowed in October, falling to the lowest rate recorded since February of this year. Overall, money-supply growth remains well below the growth rates experienced from 2009 to 2016, and has fluctuated very little since March.
In October, year-over-year growth in the money supply was at 3.7percent. That was down from September's growth rate of 4.5 percent, but was up from October 2017's rate of 3.0 percent.
[[{"fid":"78612","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"1"}}]] The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth.
This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
M2 growth rose in October 2018, rising 3.7 percent, compared to September's rate of 3.9 percent. M2 grew 5.0 percent in October of last year. Like the TMS measure, the M2 growth rate has fallen considerably since late 2016, but has varied little in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
[[{"fid":"78613","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"2"}}]] Many factors contribute to these trends. In recent months, money supply growth — in both M2 and TMS — has likely been impacted by falling growth rates in real estate loans at commercial banks. In October, real estate loans grew 3.2 percent, year over year, which was a 46-month low. The demand for mortgage loans has softened as mortgage rates have risen. In October, the 30-year, fixed average mortgage rate reached 4.8 percent, which was a 90-month high.
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Jeffrey Peshut at RealForecasts.com has composed several very illuminating graphs based on the Rothbard-Salerno True Money Supply (TMS). In one graph Peshut shows the collapse of the growth rate of TMS beginning at the end of 2016, which was caused by the Fed beginning to raise the fed funds target rate at the end of the preceding year. What is of great interest is that the recent deceleration of monetary growth (the second red arrow) almost exactly matches in extent and rapidity the monetary deceleration (the first red arrow) that immediately preceded the financial crisis of 2007-2008.
RELATED: "Money-Supply Growth Near a Ten-Year Low As Lending Slows" by Ryan McMaken
The Fed recently reaffirmed its commitment to increasing the fed funds rate three more times in 2018 and has just begun its program of shrinking its balance sheet by a cumulative total of $450 billion by the end of 2018. Given these circumstances, I am inclined to agree with Peshut’s conclusion:
“it’s easy to see that the growth of TMS could grind to a halt and even begin to contract later this year.”
With equity prices heading back toward historic highs after the January “correction” and housing prices bubbling to an all time high in major markets, the suppression of the TMS growth rate, if it is sustained for the rest of the year, portends another credit crisis and housing bust, followed by an economic recession for the U.S. economy. As Peshut’s graph below indicates the qualitative relationship between TMS growth, credit crisis, and recession has been remarkably clear since 1978. Of course, this empirical relationship should not surprise us, because it is nothing but an illustration of the Austrian theory of the business cycle.
In July, for the fourth month in a row, money supply growth surged to an all-time high, following new all-time highs in April, May, and June that came in the wake of unprecedented quantitative easing, central bank asset purchases, and various stimulus packages.
The growth rate has never been higher, with the 1970s being the only period that comes close. It was expected that money supply growth would surge in recent months. This usually happens in the wake of the early months of a recession or financial crisis. But it appears that now the United States is several months into an extended economic crisis, with around 1 million new jobless claims each week now the "norm" for the past two months. The central bank continues to engage in a wide variety of unprecedented efforts to "stimulate" the economy and provide income to the approximately 12 to 15 million unemployed workers. Moreover, as government revenues have fallen considerably, Congress has turned to unprecedented amounts of borrowing. But in order to keep interest rates low, the Fed has been buying up trillions in assets—including government debt. This has fueled new money creation.
During July 2020, year-over-year (YOY) growth in the money supply was at 36.9 percent. That's up from June's rate of 34.4 percent, and up from July 2019's rate of 2.21 percent. Historically this is a very large surge in growth, both month over month and year over year. It is also quite a reversal from the trend that only just ended in August of last year, when growth rates were nearly bottoming out around 2 percent. In August, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007.
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The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased to historic highs in July, growing 23.2 percent compared to June's growth rate of 22.8 percent. M2 grew 5 percent during July of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018 but has been growing again in recent months. As of March, it is following the same trend as TMS.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. February 2020 was the first month since late 2008 that the TMS growth rate climbed higher than the M2 growth rate. The TMS growth rate again exceeded M2 in March, April, and June 2020. As of mid-July 2020, it does appear that the decline in money supply growth has again preceded a recession, and a severe one at that. GDP fell 9.5 percent year over year during the second quarter of 2020. While a single quarter of decline would not meet the definition of "recession" now commonly used by economists, the US will have to stage an enormous economic comeback during the third quarter to avoid what most everyone will admit is a serious recession.
Although some observers will likely claim that the current economic crisis is a result solely of the covid-19 panic and resulting government-forced shutdowns, several indicators do suggest that the economy was primed for a recession. The preceding decline in TMS is one of these indicators, as is the late 2019 liquidity crisis in the repo markets. The Fed's moves to drop interest rates and to once again grow its balance sheet speak to the weakness of the economy leading up to April 2020.
After initial balance sheet growth in late 2019, total Fed assets surged to nearly $7.2 trillion in June and have rarely dipped below the $7 trillion mark since then. These new asset purchases have set a new all-time high and are propelling the Fed balance sheet far beyond anything seen during the Great Recession's stimulus packages. The Fed's assets are now up more than 600 percent from the period immediately preceding the 2008 financial crisis.
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While Fed asset purchases are not solely responsible for the surge in new money creation, they are certainly a sizable factor. Bank loan activity has surged as well, also driving new money creation.
Below is the dollar volume for M2 and TMS:
[[{"fid":"92149","view_mode":"default","fields":{"format":"default","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"default","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-default","data-delta":"2"}}]] In terms of total dollar amounts now extant, the overall M2 total money supply in July was $18.2 trillion and the TMS total was $18.4 trillion. Since January, this is an increase of $2.8 trillion in M2 and $4.2 trillion in the TMS.
Money supply growth rose in August, rising to the highest rate recorded since March of this year. Overall, money-supply growth remains well below the growth rates experienced from 2009 to 2016, and has fluctuated very little since March.
In August, year-over-year growth in the money supply was at 4.8 percent. That was up from July's growth rate of 4.1 percent, and was also up from August 2017's rate of 4.2 percent.
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The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth.
This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
M2 growth rose slightly in August 2018, rising 4.1 percent, compared to July's rate of 3.9 percent. M2 grew 5.3 percent in August of last year. Like Like the TMS measure, the M2 growth rate has fallen considerably since late 2016, but has varied little in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
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Many factors contribute to these trends. In recent months, money supply growth — in both M2 and TMS — has likely been impacted by falling growth rates in real estate loans at commercial banks. In August, real estate loans grew 3.3 percent, year over year, which was a 44-month low. The demand for mortgage loans has softened as mortgage rates have risen. In August, the 30-year, fixed average mortgage rate reached 3.55 percent, which was near a seven-year high:
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Growth in the supply of US dollars fell again in September, this time to a 116-month low of 3.4 percent. The last time the money supply grew at a smaller rate was during January 2008 — also at a rate of 3.4 percent.
The money-supply metric used here — an "Austrian money supply" measure — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure than M2. The Mises Institute now offers regular updates on this metric and its growth.
The "Austrian" measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short time deposits, traveler's checks, and retail money funds).
M2 growth also slowed in September, falling to 5.1 percent, a 76-month low.
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Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
Current trends in money supply growth suggest a slowing in loan activity due to a lack of good borrowers, among other possibilities. Given that savings rates have fallen to 10-year lows in recent months suggests that new borrowers may be increasingly hard to find for lenders.
Thanks to the intervention of central banks, of course, money supply growth in recent decades has never gone into negative territory.
Nevertheless, as we can see in the graph, significant dips in growth rates show up in years prior to a economic bust or financial crisis. The current trend is an unusual one in which growth in AMS is smaller than it is in M2. In the past this situation has often pointed toward a recession.
For more insights into what's affecting money supply growth, we can look at loan activity, such as the Federal Reserve's measure of industrial and commercial loans.
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In this case, we find that the growth rate in loans was at 2 percent in September. That's the second-lowest rate we've seen since 2004. Growth is down substantially from where it was in 2015.
We find similar trends in real estate loans, although not to the same extent. Real estate loan growth was at 4 percent in September, a 29-month low.
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Money supply growth inched upward again in June this year, but remains well below the growth rates experienced from 2009 to 2016. Overall, June's growth rate does not suggest a departure from the general downward slide in growth rates that's been in place since late 2016.
In June, year-over-year growth in the money supply was at 4.4 percent. That was up from May's growth rate of 4.2 percent, but down from June 2017's rate of 5.4 percent.
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The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure than M2. The Mises Institute now offers regular updates on this metric and its growth.
This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
M2 growth accelerated in June 2018, rising 4.2 percent, compared to May's rate of 3.8 percent. M2 grew 5.6 percent in June of last year. Overall, though, the M2 growth rate has fallen considerably since late 2016.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
Factors at work in differences between M2 and the Rothbard-Salerno measure include treasury deposits at the Fed, which have climbed again in recent months back to near all-time highs. Rothbard-Salerno calculates money supply including these deposits as money, although M2 does not. Thus, these recent increases in treasury deposits will result — all else being equal — in more money-supply growth in the Austrian measure of the money supply, than in M2.
The Rothbard-Salerno method also removes retail money funds and small-time deposits from the money supply. In recent months, both retail money funds and small-time deposits have been increasing. So these increases, which show up in M2, are not reflected in the Austrian measure.
The overall result has been slightly more moderation in the TMS measure of money supply over the past 18 months, than we see in the M2 measure. We can see that in the orange line here showing the total money supply in billions of dollars:
[[{"fid":"76763","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"2"}}]] Another contributing factor in slowing money-supply growth in recent months has been the overall slowdown in commercial loan activity. Commercial loan growth hit a 17-month high in June, but as the graph shows, we can see that activity remains below the levels we routinely saw during the recovery from 2011 to 2017. [[{"fid":"76764","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"3"}}]]
Money supply growth fell in July, dropping to the lowest rate recorded since February of this year. Overall, money-supply growth remains well below the growth rates experienced from 2009 to 2016.
In July, year-over-year growth in the money supply was at 4.1 percent. That was down from June's growth rate of 4.4 percent, and was also down from July 2017's rate of 4.9 percent.
[[{"fid":"77316","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"1"}}]]
The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure than M2. The Mises Institute now offers regular updates on this metric and its growth.
This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
M2 growth slowed in July 2018, rising 3.9 percent, compared to June's rate of 4.2 percent. M2 grew 5.6 percent in July of last year. July's growth rate has nearly fallen back to April 2018's growth rate of 3.7 percent, which was an 89-month low. Overall, the M2 growth rate has fallen considerably since late 2016.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
[[{"fid":"77317","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"2"}}]]
Graph source: Jeffrey Peshut.
Many factors contribute to these trends. Money supply growth, however — in both M2 and TMS — has been impacted by falling growth rates in real estate loans at commercial banks. In July, real estate loans grew 3.4 percent, year over year, which was a 42-month low. Not surprisingly, mortgage loan applications have stagnated as interest rates have risen.
[[{"fid":"77318","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"3"}}]]
Source.
Money supply growth slowed in November, falling to the lowest rate recorded since February of this year. Overall, money-supply growth remains well below the growth rates experienced from 2009 to 2016, and has fluctuated very little since March.
In November, year-over-year growth in the money supply was at 3.48 percent. That was down from October's growth rate of 3.7 percent, but was up from November 2017's rate of 2.6 percent.
[[{"fid":"79269","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"1"}}]] The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth.
This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
M2 growth rose in November 2018, rising 3.8 percent, compared to October's growth rate of 3.7 percent. M2 grew 4.6 percent in November of last year. Like the TMS measure, the M2 growth rate has fallen considerably since late 2016, but has varied little in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
[[{"fid":"79272","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"3"}}]] Many factors contribute to these trends. In recent months, money supply growth — in both M2 and TMS — has likely been impacted by falling growth rates in real estate loans at commercial banks. In November, real estate loans grew 2.9 percent, year over year, which was a 48-month low. The demand for mortgage loans has softened as mortgage rates have risen. In November, the 30-year, fixed average mortgage rate reached 4.87 percent, which was the highest rate since March of 2011.
[[{"fid":"79271","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"2"}}]]
Money supply growth slowed in February, falling to the lowest rate recorded since February of last year. Overall, money-supply growth remains well below the growth rates experienced from 2009 to 2016, and has fluctuated little since March of last year
In February, year-over-year growth in the money supply was at 3.1 percent. That was down from January's growth rate of 3.3 percent, but was up from February 2018's rate of 3.0 percent.
[[{"fid":"81035","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"1"}}]]
The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth.
This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
M2 growth fell in February, growing 4.2 percent, compared to January's growth rate of 4.3 percent. M2 grew 4.1 percent in February of last year. Like the TMS measure, the M2 growth rate has fallen considerably since late 2016, but has varied little in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
[[{"fid":"81036","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"2"}}]] Many factors contribute to these trends. In recent months, money supply growth — in both M2 and TMS — has likely been impacted by falling growth rates in real estate loans at commercial banks. In February, real estate loans grew 2.9 percent, year over year, which was a 51-month low. The demand for mortgage loans has softened as mortgage rates have risen. In February, the 30-year, fixed average mortgage rate reached 4.4 percent, which was down from November's recent high of 4.87. February 2018's average mortgage rate was much lower, however, coming in at 4.33 percent. However, the Fed has recently signaled it plans to half increases in the target rate, and this may lead to more real-estate loan activity.
The money supply growth rate rose in July, climbing to a six-month high, but remaining well below the growth rates typically seen during 2017 and 2018.
In July, year-over-year growth in the money supply was at 2.19 percent. That was up slightly from June's rate of 1.98 percent, but was well down from July 2018's rate of 4.07 percent.
[[{"fid":"85178","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"1"}}]]
The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased in July, growing 5.12 percent, compared to June's growth rate of 4.74 percent. M2 grew 3.94 percent in July of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slow-downs in rates of money-supply growth.
Moreover, periods preceding recessions often show a growing gap between M2 growth and TMS growth. We saw this in 2006-7 and in 2000-1. The gap between M2 and TMS narrowed considerably from 2011 through 2015, but has grown in recent years.
[[{"fid":"85180","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"2"}}]]
The overall M2 total money supply in July was $14.8 trillion, and the TMS total was $13.5 trillion.
Money supply growth fell in June, falling back near March's growth level, which was at a 12-year (145-month) low. June growth rate was higher than only two other months during this 12-year period: March 2019 and April 2019.
In June, year-over-year growth in the money supply was at 1.98 percent. That was up slightly from May's rate of 2.10 percent, but was well down from June 2018's rate of 4.30 percent.
[[{"fid":"84681","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"1"}}]]
The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth.
This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
M2 growth rose in June, growing 4.74 percent, compared to May's growth rate of 4.26 percent. M2 grew 4.17 percent in June of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slow-downs in rates of money-supply growth.
Moreover, periods preceding recessions often show a growing gap between M2 growth and TMS growth. We saw this in 2006-7 and in 2000-1. The gap between M2 and TMS narrowed considerably from 2011 through 2015, but has grown in recent years.
[[{"fid":"84682","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"2"}}]] The overall M2 total money supply in June was $14.7 trillion, and the TMS total was $13.4 trillion.
The money supply growth rate rose in October, climbing to a twenty-eight-month high. The last time the growth rate was higher was during July of 2017, when the growth rate was 5.07 percent.
During October 2019, year-over-year growth in the money supply was at 4.95 percent. That's up from September's rate of 3.10 percent, and was up from October 2018's rate of 3.49 percent. The increase in money-supply growth in October represents a sizable reversal of the trend we've seen for most of this year so far. In August, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007. Growth rates are still a long way from reaching the heights reached from 2009 to 2016, however.
[[{"fid":"86550","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"1"}}]] The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased in October, growing 6.65 percent, compared to September's growth rate of 5.61 percent. M2 grew 3.38 percent during October of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slow-downs in rates of money-supply growth.
Moreover, periods preceding recessions often show a growing gap between M2 growth and TMS growth. We saw this in 2006-7 and in 2000-1. The gap between M2 and TMS narrowed considerably from 2011 through 2015, but has widened since then. Even with October's jump in growth levels, M2 was still growing faster.
[[{"fid":"86551","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"2"}}]]
The overall M2 total money supply in October was $15.1 trillion, and the TMS total was $13.9 trillion.
The lack of money supply growth also points to growing weakening in economic activity since the Fed has turned to increasingly accommodative monetary policy in recent months — but has not managed to return money supply growth to levels we'd expect in an expansion. The FOMC has cut the target fed funds rate more than once this year, but the big change is in the Fed's recent moves to increase its balance sheet again. Since late August, the Fed has added more than 370 billion to its total assets in an effort to provide a "blast of cash" for the repo market. Another $103 billion was added Thursday.The Fed apparently has concluded the market requires additional liquidity and has acted accordingly. Fed assets are now headed back to four trillion dollars, in spite of numerous claims from the Fed that the economy is sound and strong.
Part (but by no means all) of what is driving the increase in the TMS is October's large increase in "treasury deposits at the Fed." Since August, this sum has grown from $133 billion to $349 billion.
Money supply growth surged to another all-time high in May, following April's all-time high that came in the wake of unprecedented quantitative easing, central bank asset purchases, and various stimulus packages.
The growth rate has never been higher, with the 1970s the only period that comes close. It was expected that money supply growth would surge in recent months. This usually happens in the wake of the early months of a recession or financial crisis. The magnitude of the growth rate, however, was unexpected.
During May 2020, year-over-year (YOY) growth in the money supply was at 29.8 percent. That's up from April's rate of 21.3 percent, and up from May 2019's rate of 2.15 percent. Historically, this is a very large surge in growth both month over month and year over year. It is also quite a reversal from the trend that only just ended in August of last year, when growth rates were nearly bottoming out around 2 percent. In August, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007.
[[{"fid":"90990","view_mode":"default","fields":{"format":"default","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"default","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-default","data-delta":"2"}}]] The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased to historic highs in May, growing 23.09 percent compared to April's growth rate of 18.01 percent. M2 grew 4.2 percent during May of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months. As of March, it is following the same trend as TMS.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. February 2020 was the first month since late 2008 that the TMS growth rate climbed higher than the M2 growth rate. The TMS growth rate again exceeded M2 in March and April 2020. As of mid-April 2020, it does appear that the decline in money supply growth has again preceded a recession. Although some observers will likely claim that the current economic crisis is a result solely of the COVID-19 panic and resulting government-forced shutdowns, several indicators do suggest that the economy was primed for a recession. The decline in TMS is one of these indicators, as is the late 2019 liquidity crisis in the repo markets. The Fed's moves to drop interest rates and to once again grow its balance sheet speak to the weakness of the economy leading up to April 2020.
After initial balance-sheet growth in late 2019, total Fed assets surged to over $7 trillion in June, setting a new all-time high and propelling the Fed balance sheet far beyond anything seen during the Great Recession's stimulus packages. The Fed's assets are now up more than 680 percent from the period immediately preceeding the 2008 financial crisis.
[[{"fid":"90991","view_mode":"default","fields":{"format":"default","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"format":"default","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-default","data-delta":"3"}}]]
While Fed asset purchases are not solely responsible for the surge in new money creation, they are certainly a sizable factor. Bank loan activity has surged as well, also driving new money creation.
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In terms of total dollar amounts now extant, the overall M2 total money supply in May was $17.9 trillion and the TMS total was $17.4 trillion. This is an increase of $4.0 trillion in M2, and $3.3 trillion in the TMS.
Fueled by unprecedented quantitative easing, central bank asset purchases, and various stimulus packages, the money supply growth rate ballooned in April to an all-time high. The growth rate has never been higher, with the 1970s as the only period that comes close. It was expected that money supply growth would surge in recent months. This usually happens in the wake of the early months of a recession or financial crisis. The magnitude of the growth rate, however, was unexpected.
During April 2020, year-over-year (YOY) growth in the money supply was at 21.30 percent. That's up from March's rate of 11.3 percent, and up from April 2019's rate of 1.94 percent. Historically, this is a very large surge in growth both month over month and year over year. It is also quite a reversal from the trend that only just ended in August of last year, when growth rates were nearly bottoming out around 2 percent. In August, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007.
[[{"fid":"89960","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"1"}}]] The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased to historic highs in April, growing 18.01 percent compared to March's growth rate of 10.95 percent. M2 grew 4.0 percent during April of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months. As of March, it is following the same trend as TMS.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. February 2020 was the first month since late 2008 that the TMS growth rate climbed higher than the M2 growth rate. The TMS growth rate again exceeded M2 in March and April 2020. As of mid-April 2020, it does appear that the decline in money supply growth has again preceded a recession. Although some observers will likely claim that the current economic crisis is a result solely of the COVID-19 panic and resulting government-forced shutdowns, several indicators do suggests that the economy was primed for a recession. The decline in TMS is one of these indicators, as is the late 2019 liquidity crisis in the repo markets. The Fed's moves to drop interest rates and to once again grow its balance sheet speak to the weakness of the economy leading up to April 2020.
The overall M2 total money supply in February was $17.2 trillion and the TMS total was $16.3 trillion.
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The growth in the money supply in recent months is in part tied to the fact that the Federal Reserve grew more accommodative in late 2019 and embraced unprecedented monetary stimulus in March and April. The Fed drove down the target key interest rate to 0.25 percent and began broad and unprecedented new "quantitative easing" programs. The Federal Open Market Committee (FOMC) cut the target fed funds rate more than once in the months preceding March 2020, but in response to government-forced shutdowns of several sectors of the economy, it cut the federal funds rate by 150 basis points in less than a month. The Fed has flooded markets with new money by purchasing a variety of assets from US government debt to securities. The Fed's balance sheet is now at an all-time high.
Another change partially driving the increase in the TMS is the large increase in Treasury deposits at the Fed that we've seen in recent months. In April 2020, this sum surged to a new all-time high of $783 billion. This is well in excess of the previous high of $423 billion reached during February of this year.
[[{"fid":"89962","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tm","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tm","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tm","class":"media-element file-image-no-caption","data-delta":"3"}}]]
The money supply growth rate rose again in February, climbing to a 37-month high. The last time the growth rate was higher was during February of 2017, when the growth rate was 7.9 percent.
During February 2020, year-over-year (YOY) growth in the money supply was at 7.49 percent. That's up from January's rate of 6.32 percent, and up from February 2019's rate of 3.20 percent. The increase in money supply growth in February represents a sizable reversal of the trend we saw during most of 2019. In August, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007. If the trend continues, growth rates will need only a few months to reach the heights reached from 2009 to 2016.
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The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased in February, growing 7.42 percent compared to January's growth rate of 6.98 percent. M2 grew 4.11 percent during February of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. February 2020 was the first month since late 2008 that the TMS growth rate climbed higher than the M2 growth rate. If recession does occur in 2020, the relationship between recessions and a preceding drop in money supply growth would appear to continue.
Periods preceding recessions also often show a growing gap between M2 growth and TMS growth. We saw this in 2006–7 and in 2000–1. The gap between M2 and TMS narrowed considerably from 2011 through 2015 but has widened since then.
[[{"fid":"88602","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"gap","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"gap","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"gap","class":"media-element file-image-no-caption","data-delta":"2"}}]]
The overall M2 total money supply in February was $15.4 trillion, and the TMS total was $14.3 trillion.
The growth in the money supply is in part tied to the fact that the Federal Reserve grew more accommodative in late 2019. The Federal Open Market Committee (FOMC) cut the target fed funds rate more than once in the months preceding February 2020, but the big change was in the Fed's late-2019 moves to increase its balance sheet again. Since late August, the Fed has added more than $400 billion to its total assets in an effort to provide a "blast of cash" for the repo market. These funds do not directly fuel money supply growth in the regular economy, but they do provide liquidity to financial institutions, which allows for greater loan volume. The Fed apparently has concluded that the market requires additional liquidity and has acted accordingly. Fed assets are now headed to new peak levels, although the Fed's renewed quantitative easing efforts do not show up yet in this data.
Another change partially driving the increase in the TMS is the large increase in Treasury deposits at the Fed that we've seen in recent months. In February 2020, this sum reached an all-time high of $423 billion.
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Listen to the Audio Mises Wire version of this article. The money supply growth rate rose again in March, climbing to a 92-month high. The last time the growth rate was higher was during July 2012, when the growth rate was 11.5 percent. At that time, however, money supply growth was on its way down. The current upward trend has more in common with the trend we saw during late 2008 and early 2009.
During March 2020, year-over-year (YOY) growth in the money supply was at 11.37 percent. That's up from February's rate of 7.33 percent, and up from March 2019's rate of 1.9 percent. The increase in money supply growth in March represents a sizable reversal of the trend we saw during most of 2019. In August, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007. The growth rate has now surged back to where it was in the wake of the 2008 financial crisis.
[[{"fid":"89423","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"1"}}]] The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased in March, growing 10.96 percent compared to February's growth rate of 7.25 percent. M2 grew 3.98 percent during March of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months. As of March, it is following the same trend as TMS.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. February 2020 was the first month since late 2008 that the TMS growth rate climbed higher than the M2 growth rate. The TMS growth rate again exceeded M2 in March 2020. As of mid-April 2020, it does appear that the decline in money supply growth has again preceded a recession. While some observers will likely claim that the current economic crisis is a result solely of the COVID-19 panic and resulting government-forced shutdowns, several indicators do suggests that the economy was primed for a recession. The decline in TMS is one, as is the late 2019 liquidity crisis in the repo markets. The Fed's moves to drop interest rates and to once again grow its balance sheet speaks to the weakness of the economy leading up to March 2020.
The overall M2 total money supply in February was $16.1 trillion, and the TMS total was $14.9 trillion.
The growth in the money supply is in part tied to the fact that the Federal Reserve grew more accommodative in late 2019, and embraced unprecedented monetary stimulus in March. The Fed drove down the target key interest rate to 0.25 percent and began broad and unprecedented new "quantitative easing" programs. The Federal Open Market Committee (FOMC) cut the target fed funds rate more than once in the months preceding March 2020, but in response to government-forced shutdowns of several sectors of the economy, the Fed responded by cutting the federal funds rate by 150 basis points in less than a month. The Fed has flooded markets with new money by purchasing a variety of assets from US government debt to securities. The Fed's balance sheet is now at an all-time high.
Another change partially driving the increase in the TMS is the large increase in Treasury deposits at the Fed that we've seen in recent months. In March 2020, this sum remains near an all-time high of $376 billion.
Weekly data suggests that money supply growth is likely to continue growing at highly elevated levels at least through April. Weekly data on commercial loans for recent weeks (not fully reflected in March data) shows that year-over-year growth in April is at historic highs.
[[{"fid":"89425","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"loans","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"loans","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"loans","class":"media-element file-image-no-caption","data-delta":"2"}}]]
The money supply growth rate rose again in January, climbing to a 36-month high. The last time the growth rate was higher was during February of 2017, when the growth rate was 7.9 percent.
During January 2020, year-over-year (YOY) growth in the money supply was at 6.32 percent. That's up from December's rate of 5.53 percent, and up from January 2019's rate of 3.38 percent. The increase in money supply growth in January represents a sizable reversal of the trend we saw during most of 2019. In August, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007. If the trend continues, growth rates will need only a few months to reach the heights reached from 2009 to 2016.
[[{"fid":"88281","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"1"}}]] The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased in January, growing 6.98 percent compared to December's growth rate of 6.76 percent. M2 grew 4.16 percent during January of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough before the onset of recession. If the US enters recession or a significant slowdown during the next two years, this dynamic would appear to still hold.
Moreover, periods preceding recessions often show a growing gap between M2 growth and TMS growth. We saw this in 2006–7 and in 2000–1. The gap between M2 and TMS narrowed considerably from 2011 through 2015, but has widened since then. Even with recent jumps in TMS growth levels, M2 is still consistently growing faster than the TMS.
[[{"fid":"88283","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"3"}}]]
The overall M2 total money supply in January was $15.4 trillion, and the TMS total was $14.2 trillion.
The growth in the money supply is at least in part tied to the fact the Federal Reserve grew more accommodative in late 2019. The Federal Open Market Committee (FOMC) has cut the target fed funds rate more than once in recent months, but the big change was in the Fed's late-2019 moves to increase its balance sheet again. Since late August, the Fed added more than $400 billion to its total assets in an effort to provide a "blast of cash" for the repo market. The Fed apparently has concluded that the market requires additional liquidity and has acted accordingly. Fed assets are now headed back to former peak levels, although totals have flattened since late January.
[[{"fid":"88285","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms4","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"5":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms4","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms4","class":"media-element file-image-no-caption","data-delta":"5"}}]] Another change partially driving the increase in the TMS is the large increase in "Treasury deposits at the Fed" that we've seen in recent months. In January, this sum reached a 39-month high of $387 billion. The last time Treasury deposits reached this level was during November 2016, when deposits hit $400 billion.
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The money supply growth rate rose in December slowed after a November surge of nearly six percent.
During December 2019, year-over-year growth in the money supply was at 5.53 percent. That's down from November's rate of 5.9 percent, but was up from December 2018's rate of 3.90 percent. The increase in money supply growth in December continues a sizable reversal of the trend we saw for most of 2019. In August, the growth rate had hit a 120-month low, falling to the lowest growth rates we'd seen since 2007. Growth rates are still a long way from reaching the heights reached from 2009 to 2016, however.
[[{"fid":"87498","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"1"}}]] The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also slowed in December, growing 6.75 percent compared to November's growth rate of 7.11 percent. M2 grew 3.73 percent during December of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth.
Moreover, periods preceding recessions often show a growing gap between M2 growth and TMS growth. We saw this in 2006–7 and in 2000–1. The gap between M2 and TMS narrowed considerably from 2011 through 2015, but has widened since then. Even with the jump in growth levels seen during late 2019, M2 was still growing faster than TMS.
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The overall M2 total money supply in October was $15.4 trillion, and the TMS total was $14.2 trillion.
The lack of money supply growth also points to a growing weakening in economic activity since the Fed has turned to increasingly accommodative monetary policy in recent months—but has not managed to return money supply growth to levels we'd expect in an expansion. The Federal Open Market Committee (FOMC) has cut the target fed funds rate more than once this year, but the big change is in the Fed's recent moves to increase its balance sheet again. Since late August, the Fed has added more than $385 billion to its total assets in an effort to provide a "blast of cash" for the repo market. In January, the Fed announced it was adding another $83 billion "in temporary liquidity to financial markets." The Fed also noted that it "may keep adding temporary money to markets for longer than policy makers had expected in September." The Fed apparently has concluded that the market requires additional liquidity and has acted accordingly. Fed assets are now headed back to four trillion dollars, in spite of numerous claims from the Fed that the economy is sound and strong.
[[{"fid":"87500","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"3"}}]]
Part (but by no means all) of what is driving the increase in the TMS is December's increase in "treasury deposits at the Fed," which are included in the TMS money supply (unlike in M2). Since August, this sum has grown from $133 billion to $382 billion This is near an all-time high. Treasury deposits at the Fed peaked during November 2016 at $400 billion.
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The money supply growth rate surged in November, climbing to a 33-month high. The last time the growth rate was higher was during February of 2017, when the growth rate was 7.06 percent.
During November 2019, year-over-year (YOY) growth in the money supply was at 6.22 percent. That's up from October's rate of 4.93 percent, and from November 2018's rate of 3.07 percent. The increase in money-supply growth in November represents a sizable reversal of the trend we saw during most of 2019. In August, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007. If the trend continues, growth rates will need only a few months to reach heights reached from 2009 to 2016.
[[{"fid":"87090","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"1"}}]] The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased in November, growing 7.40 percent compared to October's growth rate of 6.61 percent. M2 grew 3.25 percent during November of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdowns in rates of money-supply growth. However, money-supply growth tends to grow out of its low-growth trough before the onset of recession. If the US enters recession or a significant slowdown during the next two years, this dynamic would appear to still hold.
Moreover, periods preceding recessions often show a growing gap between M2 growth and TMS growth. We saw this in 2006–7 and in 2000–1. The gap between M2 and TMS narrowed considerably from 2011 through 2015, but has widened since then. Even with November's jump in growth levels, M2 is still growing faster than the TMS.
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The overall M2 total money supply in October was $15.3 trillion, and the TMS total was $14.1 trillion.
The growth in the money supply is at least in part tied to the fact the Federal Reserve has become increasingly accommodative in its monetary policy in recent months. The Federal Open Market Committee (FOMC) has cut the target fed funds rate more than once in recent months, but the big change is in the Fed's recent moves to increase its balance sheet again. Since late August, the Fed has added more than $413 billion to its total assets in an effort to provide a "blast of cash" for the repo market. The Fed apparently has concluded that the market requires additional liquidity and has acted accordingly. The Fed has essentially bailed out the repo market in a manner that can only be called "quanitative easing," although the Fed refuses to call it this. Fed assets are now headed back to former peak levels, in spite of numerous claims from the Fed that the economy is sound and strong.
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Another change partially driving the increase in the TMS is the large increase in "treasury deposits at the Fed" that we've seen in recent months. Since August, this sum has grown from $133 billion to $372 billion.
Money supply growth fell to a three-month low in May this year, continuing a general downward slide in growth rates that's been in place since late 2016.
In May, year-over-year growth in the money supply fell to a 3-month low, growing 4.2 percent. That was down from April 2018's rate of 4.3 percent, but remains up from November 2017's low of 2.6 percent:
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The money-supply metric used here — an Austrian or "true" money supply measure — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure than M2. The Mises Institute now offers regular updates on this metric and its growth.
The "Austrian" measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short time deposits, traveler's checks, and retail money funds).
M2 growth accelerated in May 2018, rising to 3.8 percent, compared to April's rate of 3.7 percent. Overall, though, the M2 growth rates has fallen considerably since late 2016.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
Factors at work in differences between M2 and the Rothbard-Salerno measure include treasury deposits at the Fed , which have climbed again in recent months back to near all-time highs. Rothbard-Salerno calculates money supply including these deposits as money, although M2 does not. Thus, these recent increases in treasury deposits will result — all else being equal — in more money-supply growth in the Austrian measure of the money supply, than in M2.
The Rothbard-Salerno method also removes retail money funds and small time deposits from the money supply. In recent months, both retail money funds and small time deposits have been increasing. So these increases, which show up in M2, are not reflected in the Austrian measure.
The overall result has been slightly more moderation in the Austrian measure of money supply over the past 18 months, than we see in the M2 measure. We can see that in the orange line here showing the total money supply in billions of dollars:
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What should we take away from this? Falling growth rates — not necessarily into negative territory — often precede economic crises. It nevertheless remains impossible to say with any precision as to how long after a sizable drop in money-supply growth a recession is likely.
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2017's declines in money supply, however, were the largest we've seen since 2007, and do point toward a worsening in economic activity.
We can see this partly, for example, in falling loan activity, since loan activity is a major factor in money creation:
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In February, money supply growth hit yet another all-time high. February's surge in money-supply growth makes February the eleventh month in a row of remarkably high growth, and came in the wake of unprecedented quantitative easing, central bank asset purchases, and various stimulus packages.
During February 2021, year-over-year (YOY) growth in the money supply was at 39.1 percent. That's up slightly from January's rate of 38.7 percent, and up from the February 2020 rate of 7.3 percent. Historically this is a very large surge in growth, year over year. It is also quite a reversal from the trend that only just ended in August of 2019 when growth rates were nearly bottoming out around 2 percent. In August 2019, the growth rate hit a 120-month low, falling to the lowest growth rates we've seen since 2007.
Historically, the growth rate has never been higher than what we've seen over the past ten months, with the 1970s being the only period that comes close.
It is likely that growth will continue for the time being as it appears that now the United States is nearly a year into an extended economic crisis, with around 1 million new jobless claims each week from March until mid-September. Claims have remained above 600,000 every week since. Moreover, more than 3.8 million unemployed workers are currently collecting standard unemployment benefits, and total unemployment claims have failed to fall back to non-recessionary levels, even a year after lockdowns began. More than seven million additional unemployed are collecting "Pandemic Emergency Unemployment Compensation" as of February 27.
The central bank continues to engage in a wide variety of unprecedented efforts to "stimulate" the economy and provide income to unemployed workers and to provide liquidity to financial institutions. Moreover, as government revenues have fallen, Congress has turned to unprecedented amounts of borrowing. But in order to keep interest rates low, the Fed has been buying up trillions of dollars in assets—including government debt. This has fueled new money creation.
[[{"fid":"123041","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"1"}}]] The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
Similar to the TMS measure, the M2 growth rate reached new historic highs in February 2021, growing 27.0 percent compared to January's growth rate of 25.9 percent. M2 grew 6.8 percent during February of last year.
Money supply growth can often be a helpful measure of economic activity, and an indicator of coming recessions. During periods of economic boom, money supply tends to grow quickly as commercial banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowing rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate typically climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. A similar pattern appeared before the 2020 recession, suggesting the US was headed for a recession even before the covid shutdowns.
The question now is how long the current recession will last. The second, third, and fourth quarters of 2020 all showed negative growth in real GDP. Real GDP was down 9 percent, year over year, during the second quarter, and real GDP was down 2.4 percent, year over year, during the fourth quarter.
[Read More: "The V-Shaped Recovery Never Happened" by Ryan McMaken]
One significant driver in money supply growth has been growth in the Fed's balance sheet. After initial balance sheet growth in late 2019, total Fed assets surged to nearly $7.2 trillion in June and have rarely dipped below the $7 trillion mark since then. As of February, total assets have hit a new all-time high of over $7.5 trillion. These new asset purchases are propelling the Fed balance sheet far beyond anything seen during the Great Recession's stimulus packages. The Fed's assets are now up more than 600 percent from the period immediately preceding the 2008 financial crisis.
While Fed asset purchases are not solely responsible for the surge in new money creation, they are certainly a sizable factor. Bank loan activity has surged as well, also driving new money creation. Total Fed assets, going back to 2007:
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Also of note is the continuing surge in the Treasury's deposits at the Fed, which also partly fuels money supply growth. There is some debate over why this amount has surged so much, and why the Treasury has decided to keep such a large amount of money at the Fed. The Fed certainly has contributed to this by buying bonds on the secondary market. In any case, these deposits are counted as part of the money supply under the Rothbard-Salerno money-supply calculation. These dollars are not money according to M2, but of course these deposits should be counted as money. This is because recent stimulus packages have made it clear that the Federal government could in fact spend hundreds of billions of dollars in a short period of time through various bailouts, stimulus checks and other measures. In other words, these deposits are very liquid.
Treasury may just be keeping dollars on hand for the next spending spree.
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In January, money supply growth hit a new all-time high, rising slightly above September 2020's previous high, and remaining well above growth levels that one year ago would have been considered unthinkable. January's surge in money-supply growth makes January the tenth month in a row of remarkably high growth, and came in the wake of unprecedented quantitative easing, central bank asset purchases, and various stimulus packages.
Historically, the growth rate has never been higher than what we've seen over the past ten months, with the 1970s being the only period that comes close.
It is likely that growth will continue for the time being as it appears that now the United States is several months into an extended economic crisis, with around 1 million new jobless claims each week from March until mid-September. Claims have remained above 700,000 every week since. Moreover, more than 4.8 million unemployed workers are currently collecting standard unemployment benefits, and total unemployment claims have failed to fall back to non-recessionary levels, even a year after lockdowns began. More than seven million additional unemployed are collecting "Pandemic Emergency Unemployment Compensation" as of March 4.
The central bank continues to engage in a wide variety of unprecedented efforts to "stimulate" the economy and provide income to unemployed workers and to provide liquidity to financial institutions. Moreover, as government revenues have fallen, Congress has turned to unprecedented amounts of borrowing. But in order to keep interest rates low, the Fed has been buying up trillions of dollars in assets—including government debt. This has fueled new money creation.
During January 2021, year-over-year (YOY) growth in the money supply was at 38.6 percent. That's up slightly from December's rate of 37.5 percent, and up from the January 2020 rate of 6.2 percent. Historically this is a very large surge in growth, year over year. It is also quite a reversal from the trend that only just ended in August of 2019 when growth rates were nearly bottoming out around 2 percent. In August 2019, the growth rate hit a 120-month low, falling to the lowest growth rates we've seen since 2007.
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The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
Similar to the TMS measure, the M2 growth rate reached new historic highs in January, growing 25.8 percent compared to December's growth rate of 24.9 percent. M2 grew 6.7 percent during January of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018 but has been growing again in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as commercial banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate typically climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. February 2020 was the first month since late 2008 that the TMS growth rate climbed higher than the M2 growth rate. The TMS growth rate exceeded M2 through most of 2020. As the year progresses, it does appear that the decline in money supply growth has again preceded a recession, and a severe one at that. The second, third, and fourth quarters of 2020 all showed negative growth in real GDP. Real GDP was down 9 percent, year over year, during the second quarter, and real GDP was down 2.4 percent, year over year, during the fourth quarter.
Government stimulus efforts have failed to turn economic growth positive.
After initial balance sheet growth in late 2019, total Fed assets surged to nearly $7.2 trillion in June and have rarely dipped below the $7 trillion mark since then. As of February, total assets have hit a new all-time high of over $7.5 trillion. These new asset purchases are propelling the Fed balance sheet far beyond anything seen during the Great Recession's stimulus packages. The Fed's assets are now up more than 600 percent from the period immediately preceding the 2008 financial crisis.
While Fed asset purchases are not solely responsible for the surge in new money creation, they are certainly a sizable factor. Bank loan activity has surged as well, also driving new money creation. Total Fed assets, going back to 2007:
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Also of note is the continuing surge in the Treasury's deposits at the Fed. There is some debate over why this amount has surged so much, and why the Treasury has decided to keep such a large amount of money at the Fed. The Fed certainly has contributed to this by buying bonds on the secondary market and keeping the US government very liquid. In any case, these deposits are counted as part of the money supply under the Rothbard-Salerno money-supply calculation. (It is not money according to M2.) But of course these deposits should be counted as money because recent stimulus packages have made it clear that the Federal government, could in fact spend hundreds of billions of dollars in a short period of time through various bailouts, stimulus checks and other measures. In other words, these deposits are very liquid. So, Treasury may just be keeping dollars on hand for the next spending spree.
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In October, money supply growth fell slightly from September's all-time high, although growth still remains at levels that would have been considered outlandish just eight months ago. October's easing in money-supply growth comes after eight months of record-breaking growth in the US which came in the wake of unprecedented quantitative easing, central bank asset purchases, and various stimulus packages.
Historically, the growth rate has never been higher than what we've seen this year, with the 1970s being the only period that comes close. It was expected that money supply growth would surge in recent months. This usually happens in the wake of the early months of a recession or financial crisis. But it appears that now the United States is several months into an extended economic crisis, with around 1 million new jobless claims each week from March until mid-September. More than 6 million unemployed workers are currently collecting standard unemployment benefits, with eight million more collecting "Pandemic Emergency Unemployment Compensation." Economic growth plummeted in the second quarter as GDP growth fell more than 9 percent.
The central bank continues to engage in a wide variety of unprecedented efforts to "stimulate" the economy and provide income to unemployed workers and to provide liquidity to financial institutions. Moreover, as government revenues have fallen considerably, Congress has turned to unprecedented amounts of borrowing. But in order to keep interest rates low, the Fed has been buying up trillions of dollars in assets—including government debt. This has fueled new money creation.
During October 2020, year-over-year (YOY) growth in the money supply was at 37.08 percent. That's down slightly from September's rate of 37.54 percent, and up from October 2019's rate of 4.8 percent. Historically this is a very large surge in growth, year over year. It is also quite a reversal from the trend that only just ended in August of last year, when growth rates were nearly bottoming out around 2 percent. In August 2019, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007.
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The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate reached new historic highs in October, growing 24.17 percent compared to September's growth rate of 24.04 percent. M2 grew 6.4 percent during October of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018 but has been growing again in recent months. As of March, it is following a trend similar to that of TMS, but to a lesser degree.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. February 2020 was the first month since late 2008 that the TMS growth rate climbed higher than the M2 growth rate. The TMS growth rate has exceeded M2 in most of this year. As the year progresses, it does appear that the decline in money supply growth has again preceded a recession, and a severe one at that. Both the second and third quarters showed negative growth in real GDP this year. The second quarter this year fell 9 percent, year over year, and the third quarter was down 2.9 percent, year over year.
Although some observers will likely claim that the current economic crisis is a result solely of the covid-19 panic and resulting government-forced shutdowns, several indicators do suggest that the economy was primed for a recession. The preceding decline in TMS is one of these indicators, as is the late 2019 liquidity crisis in the repo markets. The Fed's moves to drop interest rates and to once again grow its balance sheet speak to the weakness of the economy leading up to April 2020.
After initial balance sheet growth in late 2019, total Fed assets surged to nearly $7.2 trillion in June and have rarely dipped below the $7 trillion mark since then. As of late October, total assets are again pushing above $7.2 trillion. These new asset purchases have set a new all-time high and are propelling the Fed balance sheet far beyond anything seen during the Great Recession's stimulus packages. The Fed's assets are now up more than 600 percent from the period immediately preceding the 2008 financial crisis.
While Fed asset purchases are not solely responsible for the surge in new money creation, they are certainly a sizable factor. Bank loan activity has surged as well, also driving new money creation.
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Below is the dollar volume for M2 and TMS:
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tms2.png In terms of total dollar amounts now extant, the overall M2 total money supply in October was $18.7 trillion and the TMS total was $19.0 trillion. Since January, this is an increase of $3.3 trillion in M2 and $4.8 trillion in the TMS. Moreover, for the past two months, the TMS total has done something new: it has grown to become larger than the M2 total. This is largely being fueled by the immense growth in US Treasury deposits at the Fed, which are factored into TMS, but not M2. Treasury deposits ballooned from $375 billion in March to an unprecedented $1.7 trillion in July. In October, Treasury deposits fell slightly to $1.5 trillion, but remained near record-breaking levels.
In August, for the fifth month in a row, money supply growth surged to an all-time high, following new all-time highs in April, May, June, and July that came in the wake of unprecedented quantitative easing, central bank asset purchases, and various stimulus packages.
The growth rate has never been higher, with the 1970s being the only period that comes close. It was expected that money supply growth would surge in recent months. This usually happens in the wake of the early months of a recession or financial crisis. But it appears that now the United States is several months into an extended economic crisis, with around 1 million new jobless claims each week from March until mid-September, with more than 12 million unemployed workers currently collecting benefits. Economic growth plummeted in the second quarter as GDP growth fell more than 9 percent. At a September press conference, Federal Reserve chairman Jerome Powell predicted "millions of people…are going to struggle to find work [for] couple of years at least.”
The central bank continues to engage in a wide variety of unprecedented efforts to "stimulate" the economy and provide income to unemployed workers and to provide liquidity to financial institutions. Moreover, as government revenues have fallen considerably, Congress has turned to unprecedented amounts of borrowing. But in order to keep interest rates low, the Fed has been buying up trillions of dollars in assets—including government debt. This has fueled new money creation.
During August 2020, year-over-year (YOY) growth in the money supply was at 37.56 percent. That's up from July's rate of 36.92 percent, and up from August 2019's rate of 1.86 percent. Historically this is a very large surge in growth, both month over month and year over year. It is also quite a reversal from the trend that only just ended in August of last year, when growth rates were nearly bottoming out around 2 percent. In August 2019, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007.
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The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate retreated slightly from historic highs in August, growing 23.23 percent compared to July's growth rate of 23.29 percent. M2 grew 5.18 percent during August of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018 but has been growing again in recent months. As of March, it is following a trend similar to that of TMS.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. February 2020 was the first month since late 2008 that the TMS growth rate climbed higher than the M2 growth rate. The TMS growth rate again exceeded M2 in March, April, and June 2020. As the year progresses, it does appear that the decline in money supply growth has again preceded a recession, and a severe one at that. While a single quarter of decline would not meet the definition of "recession" now commonly used by economists, the US will have to stage an enormous economic comeback during the third quarter to avoid what most everyone will admit is a serious recession.
Although some observers will likely claim that the current economic crisis is a result solely of the covid-19 panic and resulting government-forced shutdowns, several indicators do suggest that the economy was primed for a recession. The preceding decline in TMS is one of these indicators, as is the late 2019 liquidity crisis in the repo markets. The Fed's moves to drop interest rates and to once again grow its balance sheet speak to the weakness of the economy leading up to April 2020.
After initial balance sheet growth in late 2019, total Fed assets surged to nearly $7.2 trillion in June and have rarely dipped below the $7 trillion mark since then. These new asset purchases have set a new all-time high and are propelling the Fed balance sheet far beyond anything seen during the Great Recession's stimulus packages. The Fed's assets are now up more than 600 percent from the period immediately preceding the 2008 financial crisis. Total assets had declined from the early-June peak during late June and much of July. Total assets have grown again, however, in recent weeks.
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While Fed asset purchases are not solely responsible for the surge in new money creation, they are certainly a sizable factor. Bank loan activity has surged as well, also driving new money creation.
Below is the dollar volume for M2 and TMS:
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In terms of total dollar amounts now extant, the overall M2 total money supply in August was $18.3 trillion and the TMS total was $18.5 trillion. Since January, this is an increase of $2.9 trillion in M2 and $4.3 trillion in the TMS. Moreover, for the past two months, the TMS total has done something new: it has grown to become larger than the M2 total. This is largely being fueled by the immense growth in US Treasury deposits at the Fed, which are factored into TMS, but not M2. Treasury deposits ballooned from $375 billion in March to an unprecedented $1.7 trillion in July. In August, Treasury deposits fell slightly to $1.6 trillion, but remained near record-breaking levels.
In consecutive issues of The Freeman, Richard Timberlake has contributed an interesting trilogy of articles advancing a monetarist critique of the conduct of U.S. monetary policy during the 1920s and 1930s.Richard H. Timberlake, “Money in the 1920s and 1930s,” The Freeman, April 1999, pp. 37–42; “Gold Policy in the 1930s,” The Freeman, May 1999, pp. 36–41; and “The Reserve Requirement Debacle of 1935–1938,” The Freeman, June 1999, pp. 23–29. In the first of these articles, Timberlake disputes the late Murray Rothbard’s “Austrian” account of the boom-bust cycle of the 1920s and 1930s. Timberlake contends that Rothbard proceeds on the basis of a “new and unacceptable meaning” for the term “inflation” and a contrived definition of the money supply to “invent” a Fed-orchestrated inflation of the 1920s that, in fact, never occurred. Moreover, Timberlake alleges, Rothbard’s account was marred by a “mismeasurement of the central bank’s monetary data” as well as by a misunderstanding of the nature and operation of the Fed-controlled pseudo-gold standard by which U.S. dollars were created during this period.
In the two subsequent articles, Timberlake also takes issue, respectively, with the U.S. Treasury’s policy of neutralizing gold inflows and the Fed’s policy of sharply raising reserve requirements in the mid-1930s, arguing that these complementary policies aborted an incipient economic recovery and brought on the recession of 1937–38. In what follows I will address the weighty charges brought against Rothbard and, in the process, offer an evaluation of the Federal Reserve System’s culpability for the economic events of these tragic years that diverges radically from Timberlake’s.
The Meaning of “Inflation” Let me begin with Timberlake’s contention that Rothbard imputes a meaning to the word “inflation” that is both new and unacceptable. In fact Rothbard’s definition of inflation as “the increase in money supply not consisting in, i.e., not covered by, an increase in gold,” is an old and venerable one. It was the definition that was forged in the theoretical debate between the hard-money British Currency School and the inflationist British Banking School in the mid-nineteenth century. According to the proto-Austrian Currency School, which triumphed in the debate, the gold standard was not sufficient to prevent the booms and busts of the business cycle, which had continued to plague Great Britain despite its restoration of the gold standard in 1821.For a review of this debate, see Murray N. Rothbard, Classical Economics: An Austrian Perspective on the History of Economic Thought, Volume II (Brookfield, Vt.: Edward Elgar Publishing Company, 1995), pp. 225–74.
Briefly, according to the Currency School, if commercial banks were permitted to issue bank notes via lending or investment operations in excess of the gold deposited with them this would increase the money supply and precipitate an inflationary boom. The resulting increase in domestic money prices and incomes would eventually cause a balance-of-payments deficit financed by an outflow of gold. This external drain of their gold reserves and the impending threat of internal drains due to domestic bank runs would then induce the banks to sharply restrict their loans and investments, resulting in a severe contraction of their uncovered notes or “fiduciary media” and a decline in the domestic money supply accompanied by economy-wide depression.
To avoid the recurrence of this cycle, the Currency School recommended that all further issues of fiduciary media be rigorously suppressed and that, henceforth, the money supply change strictly in accordance with the inflows and outflows of gold through the nation’s balance of payments. The latter provided a natural, noncycle-generating mechanism for distributing the world’s money supply strictly in accordance with the international pattern of monetary demands.
Following the triumph of the Currency School doctrine and the implementation of its policy prescription by the Bank of England, its definition of inflation became accepted in the English-speaking world, especially in the United States, where there existed a much more radical and analytically insightful American branch of the School. The term “inflation” was now used strictly to denote an increase in the supply of money that consisted in the creation of currency and bank deposits unbacked by gold. Thus for example, the American financial writer Charles Holt Carroll wrote in 1868 that “The source of inflation, and of the commercial crisis, is in the nature of the system which pretends to lend money, but creates currency by discounting such bills when there is no such money in existence.”Charles Holt Carroll, Organization of Debt into Currency and Other Papers, ed. Edward C. Simmons (Princeton: D. Van Nostrand Company, Inc., 1964), p. 333. Even earlier, in 1858, Carroll had written, “Instead of using gold and silver for currency they are merely used as the basis of the greatest possible inflation by the banks,” and that “we should prevent any artificial increase of currency to prevent a future … catastrophe.”Ibid., p. 91. So it was the “artificial increase of currency” only — through the creation of unbacked bank notes and deposits — that constituted inflation.
The leading monetary theorist in the United States in the last quarter of the nineteenth century was Francis A. Walker. According to Walker, writing in 1888, “A permanent excess of the circulating money of a country, over that country’s distributive share of the money of the commercial world is called inflation.”Francis A. Walker, Political Economy (New York: Henry Holt and Company, 1888), p. 151. While this version of the definition is applicable to inconvertible paper fiat currency, Walker also believed that inflation was an inherent feature of the issuance of convertible bank notes and deposits that lacked gold backing. In Walker’s words, “there resides in bank money, even under the most stringent provisions for convertibility, the capability of local and temporary inflation.”Ibid., p. 171.
Unfortunately, however, because the writers of the British Currency School, unlike their American cousins, neglected to consider bank deposits as part of the money supply, their policies as adopted in Great Britain failed to prevent inflation and the business cycle. Consequently, and tragically, the School’s doctrines and policies fell into profound disrepute by the late nineteenth century, and its definition of inflation was replaced by that of the opposing Banking School, which saw inflation as a state in which the money supply exceeds the needs of trade.
Early American quantity theorists following the proto-monetarist Irving Fisher, in particular, seized upon and adapted this definition to their peculiar analytical perspective. Thus, Edwin Kemmerer wrote in 1920 that, “Although the term inflation in current discussion is used in a variety of meanings, there is one idea common to most uses of the word, namely, the idea of a supply of circulating media in excess of trade needs.”Edwin Walter Kemmerer, High Prices and Deflation (Princeton: Princeton University Press, 1920), p. 3. Kemmerer went on to define inflation as a state in which, “at a given price level, a country’s circulating media — money and deposit currency — increase relatively to trade needs.” From here it was a short step to the currently prevailing definition of inflation as an increase in the price level.Ibid., p. 4.
So Rothbard’s theory is surely not new and to say that it is “unacceptable” is simply to express one’s agreement with the long-entrenched preference among orthodox quantity theorists, including contemporary monetarists, for the Banking School over the Currency School.
Defining Money Timberlake also challenges Rothbard’s statistical definition of the money supply for including savings and loan share capital and life insurance net policy reserves, alleging that Rothbard contrived this definition in order to make the rate of monetary growth appear larger than it actually was during the 1920s. Timberlake argues that the two items in question are not money because “they cannot be spent on ordinary goods and services. To spend them, one needs to cash them in for other money — currency or bank drafts.”Timberlake, “Money in the 1920s and 1930s,” p. 38. For Rothbard’s explanation and defense of his broader definition of the money supply, see Murray N. Rothbard, America’s Great Depression (Los Angeles: Nash Publishing Corporation, 1972 [1963]), pp. 83–86. Let us take these items one at time.
In the case of savings and loan share capital, there are two responses to Timberlake. First, the “share accounts” offered by savings and loan associations are and always have been economically indistinguishable from the savings deposits offered by commercial banks, included in the older (pre-1980) definition of M2 that Timberlake apparently upholds as the appropriate definition of the money supply.I say “apparently,” because he states that “No basis exists for a more inclusive money stock than M2” (ibid., p. 42, n. 3). It should be pointed out that, since February 1980, savings accounts of savings and loan associations and credit unions have been included, along with savings deposits of commercial and mutual savings banks in the new M2, an official Fed statistic that is today considered to be the most reliable indicator of movements in the money supply by many economists. In practice depositors could withdraw their savings deposits from commercial banks on demand, because the law that permitted the banks to insist on a waiting period was rarely if ever invoked. Similarly, while savings and loan associations were contractually obligated to “repurchase” their “shares” at par on request of the shareholder, they could legally delay such repurchase for shorter or longer periods depending on their individual bylaws. Nonetheless such delays rarely occurred and “for many years savings and loan associations have made the proud boast ‘every withdrawal paid upon demand’ or some similar statement.John G. Ranlett, Money and Banking: An Introduction to Analysis and Policy (New York: John Wiley & Sons, Inc., 1969), p. 251.
Moreover, while Timberlake is right that “shareholders” had to trade their share accounts in for currency or bank drafts (at par and on demand) before they could spend them on goods and services, this was equally true of savings depositors at commercial banks. Thus the public has always considered dollars held in savings and loan share accounts or savings accounts as readily spendable as dollars held in commercial bank savings deposits.
Second, Timberlake curiously does not object to Rothbard’s inclusion of the savings deposits of mutual savings banks in the money supply, although they also are not included in the M2 definition he favors.Paul A. Meyer, Monetary Economics and Financial Markets (Homewood, Ill.: Richard D. Irwin, Inc., 1982), pp. 31–32. What makes Timberlake’s position even more puzzling is that mutual savings banks were practically identical in economic function to savings and loan associations and were also technically “mutually” owned by their depositors.Walter A. Haines, Money, Prices, and Policy (New York: McGraw-Hill Book Company, Inc., 1961), pp. 249–50. So why, then, does Timberlake insist so vehemently on treating the liabilities of these two institutions differently?
A resolution of this mystery can perhaps be found in the work of Milton Friedman and Anna Schwartz, who excluded the share accounts of savings and loans (and of credit unions) from their definition of the money supply on the grounds that these institutions are technically not banks as defined “in accordance with the definition of banks agreed upon by federal bank supervisory agencies” since “holders of funds in these institutions are for the most part technically shareholders, not depositors.” Despite this legal technicality, however, even Friedman and Schwartz were forced to admit that those who place funds with these institutions “clearly … may regard such funds as close substitutes for bank deposits, as we define them.”Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: Princeton University Press, 1963), p. 4, fn. 4. The essential economic—as opposed to the technical legal—identity between commercial bank deposits and all kinds of instantaneously cashable savings accounts held at the various nondepository or thrift institutions was established many years before Friedman and Schwartz wrote, in 1937, in a brilliant but neglected article by Lin Lin (“Are Time Deposits Money?” American Economic Review, March 1937, pp. 76–86). This article was not cited by Friedman and Schwartz but greatly influenced Rothbard.
Life Insurance Reserves This brings us to the issue of the net policy reserves of life insurance companies. Rothbard claimed that the cash surrender values of life insurance companies, that is, the immediately cashable claims possessed by policyholders against life insurance companies, statistically approximated by the companies’ net policy reserves, represent a source of currently spendable dollars and should be included in the money supply. Once again the question is not whether insurance companies superficially resemble banks or can be technically classified as such according to some arbitrary regulatory definition. It is whether they essentially function like depository institutions, receiving funds from the public with which to make loans and investments, while contractually promising that such funds are available for withdrawal on demand by the policyholder. In Rothbard’s view, the policyholder is economically in precisely the same position as a bank depositor (and thrift institution shareholder) in holding an immediately cashable par-value claim to dollars.
Now admittedly, Rothbard’s inclusion of this item in the money supply is controversial, much more so than his inclusion of savings and loan share accounts. However, he was hardly alone in maintaining this position. A number of mainstream writers of money and banking textbooks in the 1960s and 1970s recognized that cashable life insurance reserves possessed some of the characteristics of money. For example, Walter W. Haines characterized insurance companies as “savings institutions” and noted that these savings “can be withdrawn at any time” simply by allowing the policy to lapse, a feature that marks them as a “near-money” on a par with savings accounts.Haines, pp. 253–54, 31–32. M.L. Burstein maintained that the cash value of a life insurance policy offered “ready convertibility” into cash, was “almost as liquid as a mattressful of currency,” and satisfied the “precautionary motive” for holding liquid assets no less than savings and loan accounts and savings bonds.M. L. Burstein, Money (Cambridge, Mass.: Schenkman Publishing Company, Inc., 1963), p. 111. Albert Hart and Peter Kenen included the “net cash values of life insurance” in the broadest class of financial assets possessing the attribute of “moneyness,” while Thomas F. Cargill ranked them on a liquidity spectrum immediately below large certificates of deposit, which are included in the current M3 definition of the money supply.Albert Gaylord Hart and Peter B. Kenen, Money, Debt, and Economic Activity (Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1961), pp. 4–6; Thomas F. Cargill, Money, the Financial System and Monetary Policy (Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1979), p. 11.
More important, however, even if we grant for the sake of argument that net life insurance reserves should be excluded from the money supply, we find that it makes very little difference to Rothbard’s characterization of the 1920s as an inflationary decade. With this item included, the increase in Rothbard’s M between mid-1921 and the end of 1928 totaled about 61 percent, yielding an annual rate of monetary inflation of 8.1 percent a year; with this item left out (but savings and loan share accounts included), the money supply increased by about 55 percent over the period or at an annual rate of 7.3 percent.I have based this calculation on Rothbard’s data. See Rothbard, America’s Great Depression, p. 88. Mirabile dictu, by using a definition of the money stock that arbitrarily excludes savings and loan share accounts while including mutual savings bank deposits on the basis of an inexplicable adherence to a legalistic regulatory definition of banks, it turns out that it is Timberlake (and Friedman and Schwartz) who have mismeasured money supply growth during the 1920s.
Flawed Institutions Timberlake also criticizes Rothbard for “ignorance of the flawed institutional framework within which the gold standard and the central bank generated money” and also of “mismeasurement of the central bank’s monetary data.”Timberlake, “Money in the 1920s and 1930s,” p. 38. But this is surely a curious charge to level against Rothbard, steeped as he was in Currency School doctrine. In fact, Rothbard was quite cognizant that the U.S. monetary regime of the 1920s and 1930s was not a genuine gold standard in which the supply of money was determined exclusively by market forces, that is, by the balance of payments and the mining of gold, but a hybrid system in which the Fed possessed substantial power to manipulate the money supply by pyramiding paper bank reserves atop its stock of gold reserves. Indeed, Rothbard went much further than Timberlake in rigorously and completely separating those factors affecting the money supply that were subject to Fed control from those that the Fed had no control over.Rothbard, America’s Great Depression, pp. 94–100.
In analyzing the central bank monetary data, Timberlake starts with the monetary base or “Total Fed,” which is equal to currency in circulation plus member bank reserves. From this aggregate he properly subtracts the Fed’s legal-tender reserves, mainly the gold stock, whose size depends on balance-of-payments flows and is not under the immediate control of the Fed. What remains is the “net monetary obligations” of the Fed or “Net Fed,” which, according to Timberlake, “faithfully indicates the intent of Fed policy.”Timberlake, “Money in the 1920s and 1930s,” p. 40. From 1921 to 1929, this aggregate declined by 8 percent per year, leading Timberlake to conclude that the intent of Fed policy was decidedly deflationary during this period. The motive for this deflationary policy bias was, Timberlake suggests, to aid Great Britain in re-establishing and maintaining gold convertibility for the pound sterling.
However, as important as it is, the gold stock is not the only factor that lay beyond the Fed’s control. For as Rothbard points out, currency in circulation, which improperly remains in Timberlake’s Net Fed aggregate, is not controlled by the Fed at all but by the banking public. Any time a depositor withdraws cash from a bank, currency in circulation increases and bank reserves decline, dollar for dollar. Under a fractional-reserve banking system, this loss of reserves causes a multiple contraction of bank deposits that far exceeds the original increase in currency in circulation that induced it and therefore results in a net deflation of the money supply. Conversely, a decline in the amount of currency held by the public causes an overall increase in bank reserves and an overall inflation of the money supply.
This is not all, however — Timberlake also ignores the fact that under the prevailing policy regime the banks themselves could autonomously reduce the amount of bank reserves and thus the quantity of money in existence by deliberately reducing their indebtedness to the Fed. During this period, it was the chosen policy of the Fed to lend liberally and continuously to all banks at an interest, or “discount,” rate below the market rate. While the Fed was legally authorized to make such loans to its member banks, it was not mandated to do so. Furthermore, it also retained complete power to set the “discount rate” it charged on these loans. Hence, if it had chosen to, the Fed could have restricted its lending to emergency situations and charged a penalty rate substantially above the market rate, so as to discourage all but the most seriously troubled banks from applying for loans. In short, it could have almost completely neutralized the inflationary impact of its discounting operations. This “emergency lending” policy had been urged by some prominent officials within the Fed establishment itself.On the Fed’s discount policy in the 1920s, see Rothbard, America’s Great Depression, pp. 111–16.
The fact that the Fed chose instead to pursue a “continuous lending” policy meant that the increase in bank reserves that resulted from the origination of new Fed loans to member banks via the rediscounting of business bills or advances on collateralized bank promissory notes was under the exclusive control of the Fed. But it also meant that the reduction in bank reserves entailed by the net repayment of discounted bills was uncontrolled by the Fed, because it depended solely on the decisions of the banks. Given the Fed’s indiscriminate, below-market rate discount policy, the banks were always in a position to maintain or augment their debts to the Fed if they so desired simply by discounting additional bills with the Fed. Thus, as Rothbard concluded, when “Bills Repaid” exceeded “New Bills Discounted,” banks were deliberately and autonomously diminishing their level of indebtedness to the Fed and this must be counted as an uncontrolled deflationary influence on bank reserves.
Real Fed Intent If we follow Rothbard, then, in identifying currency in circulation and the reduction of bank indebtedness to the Fed along with the gold stock as the main “uncontrolled” factors affecting bank reserves, we get a picture of the Fed’s intent during the 1920s and early 1930s that is poles apart from the one suggested by Timberlake. Indeed, we find that from the inception of the monetary inflation in mid-1921 to its termination at the end of 1928, “uncontrolled reserves” decreased by $1.430 billion while controlled reserves increased by $2.217 billion. Since member bank reserves totaled $1.604 billion at the beginning of this period, this means that controlled reserves shot up by 138 percent or 18.4 percent per year during this seven-and-one-half year period, while uncontrolled reserves fell by 89 percent or 11.9 percent per year. Thus Rothbard correctly concluded that the 1920s were an inflationary decade and that it was indeed the intention of the Federal Reserve System that it be so.For an analysis of the factors involved in the development of the monetary inflation of the 1920s, see ibid., pp. 101–25.
The Fed’s inflationary intent is perfectly consistent, moreover, with its motive of helping Great Britain re-establish and maintain the pre-war parity between gold and the British pound. While Timberlake properly recognizes this motive underlying Fed policy, he is incorrect in suggesting that it necessitates a deflationary policy on the part of the Fed. In fact, the precise opposite is required. The British pound in the mid-1920s was overvalued vis-à-vis gold and the U.S. dollar, causing British products to appear relatively overpriced in world markets. As a result, Great Britain experienced imports chronically in excess of exports accompanied by persistent balance-of-payments deficits and outflows of gold reserves. Had the Fed deflated the U.S. money supply, thus lowering U.S. prices even more relative to British prices as Timberlake claims was its intention, it would have exacerbated, and not resolved, Great Britain’s gold drain. Clearly, then, the Fed’s desire to aid Britain in reversing its balance-of-payments deficits and rebuilding its gold stocks called for an inflationary policy intended to pump up U.S. prices, thereby rendering British products relatively cheap and enhancing the demand for them on world markets.On the desire to help Great Britain restore the gold standard at an overvalued gold parity without having to endure the consequences of deflating its economy as an important motive driving the Fed’s inflationary monetary policy in the 1920s, see ibid., pp. 131–45.
This point about the motive for the Fed’s easy-money policy in the 1920s was not only advanced by Rothbard, but by other economists, including monetarists such as Kenneth Weiher. According to Weiher:
Great Britain was calling for help [in 1924] and Benjamin Strong [president of the New York Fed] heard the call. Expansionary monetary policy in the U. S. would drive prices up and interest rates down in this country, which would tend to send gold flowing toward Great Britain, where prices were lower and interest rates higher. These changes would help America’s ally build up its stock of gold. … [T]here can be no question that the Fed would not have moved when it did were it not for concern over the gold standard and the plight of Great Britain. … By 1927, the stagnant British economy needed help from the United States and the rest of Europe. … Just as had been the case in 1924, monetary policy was shifted to an expansionary program in an effort to aid Great Britain’s struggles to return to the gold standard.Kenneth Weiher, America’s Search for Economic Stability: Monetary and Fiscal Policy Since 1913 (New York: Twayne Publishers, 1992), pp. 48–49.
Rothbard’s reinterpretation of the monetary data also cuts against Timberlake’s claim that the Fed “monetarily starved the country into the worst economic crisis it has ever experienced.”Timberlake, “Gold Policy in the 1930s,” p. 36. On the contrary, the factors controlled by the Fed continued to exercise a highly inflationary impact on bank reserves and the money supply from late 1929 through 1932, as the Fed attempted desperately to ward off the depression precipitated by the termination of the bank credit inflation that it had orchestrated in the 1920s.
The deflation of the money supply, therefore, was caused wholly by factors beyond the control of the Fed. First, there was a loss of confidence in the Fed-dominated phony gold standard among the domestic public and foreign investors. As a result there occurred an increase in currency in circulation and a decline in the Fed’s gold stock, both of which caused bank reserves to decline. Second, U.S. banks prudently attempted to save themselves and their depositors by restricting their loans to overcapitalized and failing businesses and instead using these funds to pay down their indebtedness to the Fed, which gave further impetus to the “uncontrolled” reduction of bank reserves. Third, in the second quarter of 1932, the banks also began to increase their liquid reserves beyond the legal minimum. The accumulation of “excess reserves,” as they were called, constituted a separate uncontrolled factor that reinforced the deflationary influence of the uncontrolled decline in bank reserves on the money supply.
From the end of December 1929 to the end of December 1931, bank reserves fell from $2.36 billion to $1.96 billion causing RM (for Rothbard’s money supply) to drop from $73.52 billion to $68.25 billion or at an annual rate of 3.6 percent. But this monetary deflation was not caused by the Fed, which pumped up controlled reserves by $672 million or at an annual rate of 17 percent during the period, while uncontrolled reserves declined by $1,063 million or by 27 percent per year. During 1932, RM continued to decline, falling to $64.72 billion or by 5.2 percent. But bank reserves increased sharply during the year from $1.96 billion to $2.51 billion, as the Fed furiously inflated controlled reserves. In the last ten months of the year, controlled reserves rose by a staggering $1,165 million, or at an annual rate of 76 percent. Fortunately, this attempted massive inflation of the money supply was undone by the domestic public, foreign investors, and the banks as uncontrolled reserves dwindled by $495 million and banks began to accumulate substantial excess reserves.
The story was much the same in 1933 as a determined inflationary campaign conducted by the Fed in the early part of the year — controlled reserves rose by $785 million in February alone — was defeated by the public and the banks, and RM declined by over $3 billion, or by almost 5 percent.On the factors responsible for the monetary deflation of the early 1930s, see Rothbard, America’s Great Depression, pp. 186–295 passim.
So once the data have been properly arranged and interpreted, it becomes clear that the Fed does not deserve praise for the bank credit deflation of 1930–1933. This honor goes to private dollar-holders, domes-tic and foreign, who attempted to reclaim their rightful property from a central bank-manipulated and inflationary financial system masquerading as a gold standard that had repeatedly betrayed their trust.
“Sterilizing” Gold In two follow-up articles, Timberlake extends his attack on what he considers to be the “deflationary” monetary policies pursued by the Treasury and Fed in the mid-1930s. In particular, he criticizes the Treasury’s policy of “neutralizing,” or “sterilizing,” the effect of the inflow of gold on bank reserves from late 1936 to early 1938 and the Fed’s policy of increasing reserve requirements in 1936 and 1937. But neither of these policies caused a contraction of the money supply. They merely temporarily interrupted a massive monetary inflation caused by the abolition of the gold standard and subsequent devaluation of the dollar engineered by the Roosevelt administration.
It is important to recognize that this influx of gold was not a result of the “uncontrolled” operation of the gold standard, which had been abolished in 1933. Rather, it was the result of the deliberate and steady increase in the price at which gold was purchased by the U.S. Treasury and the Reconstruction Finance Corporation. By January 1934, the price of gold had risen from $20.67 to $35.00 per ounce, or by almost 70 percent, where it was officially pegged by the Gold Reserve Act of 1934. The Treasury was now legally mandated to maintain this devalued exchange rate between gold and the dollar by freely purchasing all the gold offered to it at this price. In effect, then, Treasury gold purchases were now economically identical to inflationary Fed open market purchases, substituting demonetized gold for government securities. Consequently, in response to this unilateral increase in the price of gold above its world price, there occurred a prodigious influx of gold into the United States — a “golden avalanche” it was called at the time — which vastly increased bank reserves. The result was an unprecedented inflation of the money supply (M2) during 1934, 1935, and 1936 at annual rates of 14 percent, 14.8 percent, and 11.4 percent, respectively.Weiher, pp. 75, 79–82.
With respect to its influence on the supplies of bank reserves and money, the demonetized gold stock thus had been transformed into a factor “controlled” by monetary — in this case Treasury — policy. Given that the use and ownership of gold money by the public had been legally suppressed, gold was effectively demonetized and its continued purchase by the Treasury was purely a matter of discretionary monetary policy. Accordingly — and contrary to Timberlake’s assertion — when during 1937 the Treasury began to finance its purchases of gold in a manner that neutralized their effect on bank reserves, it was not engaging in deflation. The simultaneous sales of government securities to finance these purchases were simply and properly eliminating any extraneous effects of a demonetized asset on the money supply.
Even if gold were permitted to continue in its monetary function, however, Timberlake would still be wrong in criticizing the policy of neutralizing its effect on bank reserves. For under a genuine, Currency School-type gold standard, a country’s money supply would increase by exactly the amount of the gold inflow from abroad. This is not inflationary and represents precisely the proper amount by which the money supply should expand, because it is the outcome of the deliberate actions of the country’s residents who are decreasing their purchases of foreign imports and increasing their sales of exports in order to satisfy their desires for greater money holdings. This balance-of-payments mechanism is a natural part of the market economy and works continually on all levels — including the region, state, town, and even household—to efficiently adapt money supply to relative changes in money demand.
A problem arises, however, when these benign, money demand-driven gold inflows are used, as they were in the 1920s and early 1930s, as bank reserves to create unbacked notes and deposits. In this case, as F. A. Hayek has so aptly described, international gold flows will regularly cause a serious distortion of the free-market interest rate and investment pattern in the affected countries, leading to a business cycle.F. A. Hayek, Monetary Nationalism and International Stability (New York: Augustus M. Kelley Publishers, 1971 [1937]), pp. 25–32. The reason is that the needed adjustment in national money supplies upward or downward now entails creating or destroying fiduciary media by expanding or contracting bank loans in defiance of the preferences of the economy’s consumers and savers. Thus, a policy of neutralizing the effect of gold flows on bank reserves in the context of a fractional-reserve banking system dominated by a central bank does not constitute a gross violation of the rules of the gold standard; to the contrary, it tends to facilitate the operation of the natural money-supply mechanism that prevails under a genuine gold standard.
Not surprisingly, in the third article of the trilogy, Timberlake also objects to the Fed’s policy of raising reserve requirements in 1936 and 1937, which was undertaken to mop up the massive amounts of excess reserves held by the banking system. Timberlake advances two criticisms against this policy. First, the policy was unnecessary because, even if all the excess reserves that existed on the eve of its implementation were subsequently fully loaned out by the banks, the inflationary potential was relatively minor. Appealing to the Banking School definition of inflation, Timberlake pronounces the 52 percent increase in the money supply that would have resulted as only mildly inflationary because the larger money supply would have exceeded the needs of trade of a fully employed economy by 5.6 percent at 1929 prices, which were about 25 percent higher than prices prevailing in June 1936.These figures are calculated from Timberlake’s data. See Timberlake, “The Reserve Requirement Debacle,” p. 27. In plain language, Timberlake is literally defining away a potential money and price inflation of gargantuan proportions because of its perceived expedience in expanding employment and output and extricating the economy from a depression. But as Timberlake himself admits in a footnote — and as Rothbard and other Austrians have never ceased to argue — what impeded the economy’s natural and noninflationary recovery from the depression was the existence of “government programs [that] had actively worked against money price declines for ten years.”Ibid., p. 29, n. 11.
Growing Money Supply In his second criticism, Timberlake contends that the increase in reserve requirements went beyond closing off a potential avenue of recovery for the economy and “turned what had been an ongoing recovery into another cyclical disaster.” But if we once again turn to Timberlake’s data we find that the money supply (M2) continued to grow, from $43.3 to $45.2 billion or by 4.4 percent, between June 30, 1936, and June 30, 1937, the year in which this policy was implemented. Even if we focus on the last six months of the period, there was hardly a wrenching deflation, as the money supply increased at an annual rate of 0.8 percent.Ibid., p. 27. Even from Timberlake’s monetarist standpoint, then, it is difficult to blame the “recession within a depression” of 1937–1938 on deflationary Fed policy.
Unfortunately Timberlake’s strained and narrow emphasis on Fed deflationism as the cause of all the woes of the 1930s causes him to ignore a plausible “Austrian” explanation of the relapse of 1937. As a result of a spurt of union activity due to the Supreme Court’s upholding of the National Labor Relations Act of 1935, money wages jumped 13.7 percent in the first three quarters of 1937. This sudden jump in the price of labor far outstripped the rise in output prices and, with labor productivity substantially unchanged, brought about a sharp decline in employment beginning in late 1937.Richard K. Vedder and Lowell E. Gallaway, Out of Work: Unemployment and Government in Twentieth-Century America (New York: Holmes and Meier, Publishers, Inc., 1993), pp. 129–36. For a similar explanation of the 1937 slump, see Benjamin M. Anderson, Economics and the Public Welfare: A Financial and Economic History of the United States, 1914–1946(Indianapolis: LibertyPress, 1979 [1949]), pp. 432–38. The large upward spurt in excess reserves and the accompanying decrease in the money supply that we observe in Timberlake’s data between June 30, 1937, and June 30, 1938, therefore, can be explained as the result, and not the cause, of the recession.Timberlake, “The Reserve Requirement Debacle,” p. 27. As business profits were squeezed by the run-up of labor costs and the economy slipped into recession, banks prudently began to contract their loans and pile up liquid reserves to protect themselves against prospective loan defaults and bank runs. To offset this uncontrolled decline of the money supply, beginning in mid-1938 the Fed (and the Treasury) once again resorted to an inflationary policy, reversing the reserve requirement increase and allowing gold inflows to once again pump up bank reserves. As a result, M2 increased by 5.9 percent, 10.1 percent, and 12.5 percent in 1938, 1939, and 1940, respectively.Weiher, pp. 75–86.
Our conclusion, then, is that the Fed’s monetary policy, except for very brief periods in 1929 and 1936–1937 when it turned mildly disinflationist, was consistently and unremittingly inflationist in the 1920s and 1930s. This inflationism was the cause of the Great Depression and one of the reasons why it was so protracted.
Originally published in The Freeman, October 1999
This interview was originally published in the March 2018 issue of the Lara-Murphy Report.
Lara-Murphy Report: We ultimately want to ask you about the latest readings on the “true money supply” calculation, but before we do that, can you first explain to our readers why there are different concepts about “the money supply” in the first place? We don’t even mean what the Austrians say. Right now, can you just explain why there are different measures, such as M1, M2, etc., and why there is even a debate as to what counts as “money”?
Joseph Salerno: The Fed calculates several monetary aggregates. M1 includes currency held by the (nonbank) public and checkable deposits, both standard checking accounts and “other checkable deposits” such as NOW accounts, which are checking deposits that pay interest. M1 is an attempt to quantify the total number of dollars that people hold for the purpose of making transactions. M2 includes M1 plus “non-transaction accounts,” which people hold mainly as liquid savings and which include: small time deposits, which are certificates of deposit (CDs) of $100,000 or less that cannot be withdrawn without penalty before their maturity date; savings deposits including money market deposit accounts that offer limited checking privileges; and money market mutual fund shares (MMMFs) issued by nonbank financial institutions and offering check writing privileges. M2 is the preferred aggregate of policymakers and mainstream economists because it has the most stable relationship with interest rates and total spending in the economy. The Fed also calculates MZM, for “money of zero maturity,” which is a relatively new aggregate and is an attempt to capture the supply of dollars that are immediately accessible at par value (that is, without penalty). It is basically equal to M2 minus small time deposits plus wholesale MMMFs available only to large institutions. In terms of its purpose and its components, MZM is much closer to the aggregate that Rothbard believed and some contemporary Austrians like me believe is most useful for applied work.
LMR: Now that you’ve given the readers a crash course in monetary aggregates, can you explain the development of the so-called Austrian true money supply (TMS)? You developed it with Rothbard, right?
JS: In his book, America’s Great Depression published in 1963, Rothbard developed a U.S. monetary aggregate based on the theoretical definition of money as the general medium of exchange. Rothbard elaborated on this definition in an article published in 1978 and in his book, Mystery of Banking, published in 1983. In creating this new monetary aggregate, Rothbard aimed at capturing the supply of dollars instantly accessible for spending by the public. Thus he included all currency outside bank vaults plus deposits at commercial banks and thrift institutions (savings banks, saving and loan associations, and credit unions) that could be withdrawn on demand at par value. These deposits naturally included all checkable deposits but also all savings deposits. Rothbard also added U.S. and foreign government deposits at banks and the Federal Reserve, which had been routinely included in the money supply by most economists before World War 2. More controversially, Rothbard included the cash surrender values of life insurance policies, that is, the savings component of life insurance policies that could be withdrawn on demand.
In 1987, I published an article in the Austrian Economics Newsletter entitled “The ‘True’ Money Supply: A Measure of the Supply of the Medium of Exchange in the U.S. Economy.” My article was an attempt to elaborate and defend Rothbard’s definition of the money supply, especially with respect to the items he chose to include or exclude from the money supply. I called Rothbard’s monetary aggregate the “‘true’ money supply” or TMS, with the word “true” in scare quotes to emphasize the fact that the proposed monetary aggregate was true in the limited sense of approximating the theoretical definition of money as the general medium of exchange. Thus for an asset to be included as a component of TMS, I argued that it must be either generally and routinely accepted in exchange as a final means of payment for goods and services, like dollar bills issued by the Federal Reserve or immediately redeemable for dollar bills at par on demand by the depositor. All of the items in TMS meet this criterion. Or, if we wish to put it in these terms, all components of TMS are “money of zero maturity,” dollars that are instantly accessible by their owners at par value.
Sometime after I published my article, Rothbard and I agreed that we should delete the savings component of life insurance policies, mainly for practical reasons. Besides being controversial, it was difficult to acquire the data on this series necessary to calculate TMS in a timely manner. Also, Professor Timberlake, a prominent monetarist, had claimed that by including this item in the money supply Rothbard had deliberately overstated the inflationary nature of the 1920s. However, in defending Rothbard, I recalculated the TMS series for the 1920s without the life insurance component and found that it made very little difference to the growth rate of the money supply. I also found that several authors of mainstream money and banking textbooks in the 1960s and 1970s routinely included this item in their broader definitions of the money supply or as near-moneys. Nonetheless, TMS no longer includes the net cash values of life insurance.
Here, I will digress a bit to distinguish between TMS and the Fed’s MZM aggregate. About a year after my article was published, Brian Motley, a senior economist at the San Francisco Fed, argued based on empirical factors that M2 should be redefined based on “the single distinction between deposits that have a specified term to maturity (term accounts) and those that have no fixed term and are, for practical purposes, withdrawable on demand (nonterm accounts).” He proposed a new monetary aggregate, which he called “nonterm M3”and which included all the components in TMS, except government deposits. However, he also included MMMFs, which are excluded from TMS. In 1991, William Poole, later president of the St. Louis Fed, referred to the importance of the aggregate in testimony before Congress and labeled it MZM. Shortly thereafter the Fed began to calculate MZM and added it to its menu of official aggregates. So Rothbard had anticipated the Fed by nearly 30 years in developing a monetary aggregate that emphasized instant redemption as the key criterion for determining which dollar deposits should be included in the statistical definition of the money supply.
In contrast to MZM, however, TMS excludes MMMFs. Despite the fact that they offer checking privileges, MMMFs are not instantly redeemable claims to a fixed quantity of dollars. Rather they are equity shares in a portfolio of short-term assets, like high grade commercial paper and treasury bills, whose value fluctuates proportionally to the gains and losses to the value of the underlying assets. Although the value of a share is fixed at $1.00, in the case of extreme losses on the fund’s portfolio, such as occurred during the financial crisis, the shares may “break the buck” and fall below the value of $1.00. As with a decline in the value of any investment, the shareholder would bear the burden of the capital loss. Furthermore, when a buyer writes a check on an MMMF to make a payment, say $10,000, the shares themselves are not actually transferred from the buyer to the seller. The check is actually drawn on a bank associated with the MMMF and $10,000 is transferred from the MMMF’s bank deposit to that of the payee named on the check. The bank then informs the MMMF of the transaction, which in turn liquidates $10,000 of assets, replenishes its checkable deposit at the bank, and debits that amount to the share account of the person who drew the check. MMMFs therefore do not meet the criteria to be included in TMS: they are not redeemable at par under all circumstances nor are they a final means of payment. In short, MMMFs are not fixed claims to immediately spendable dollars, but are shares of ownership in a portfolio of assets that must first be sold for dollars before spending can take place.
LMR: Now we are in a position to ask: What’s been happening lately with this particular measure, i.e. what’s happening with “the true money supply”?
JS: During the past year the growth rate of TMS has fallen sharply from over 10% per year to 4% per year. This parallels the behavior of TMS growth during 2005, the year leading up to the end of the housing bubble, when the growth rate declined precipitously from 9% to 2%. After a further decline of TMS growth rate to 1% and a leveling off of housing prices in 2006, the subprime and financial crises and the Great Recession struck in 2007-2008. In fact if we go back to 1978, we observe similar sharp falls in the growth rate of TMS preceding the recessions of 1980-82, 1990-91, and 2001. (See the TMS graphs constructed by Jeff Peshut.)
LMR: Of course Austrian economists know that we can’t predict the future. Even so, can you give our readers a sense of what you think is in store? Many financial pundits are becoming very alarmed about asset markets, now that the Fed is hiking rates. What do you think?
JS: We should be clear that the Fed does not directly control interest rates. When we say that the Fed is “raising or lowering rates,” what we really mean is that it is changing the quantity of money in the economy. For what the Fed controls directly and completely is the monetary base, which it creates out of thin air and which consists of currency (dollar bills) held by the public and bank reserves. By increasing the bank reserves component, the Fed increases the funds that banks have on hand to lend. The “reserves” are actually just digital entries in the banks’ reserve deposits in the Fed’s computer, which can be turned into currency on demand. In order to induce businesses and households to borrow these newly created funds, the banks reduce the interest rate and create new checking deposits for the borrowers, up to $10 for every dollar of reserves. If this is a one-shot deal and the Fed were then to stop creating reserves in exchange for government securities purchased from the banks via “open market operations,” then the interest rate would return to roughly its former level despite the increased supply of money in existence. In order to suppress the interest rate permanently below its market or “natural” level the Fed must continually inject new reserves into the banking system thus constantly expanding the money supply. And this was exactly what it did from the end of 2008 to the end of 2015 when it maintained the fed funds rate—the basic interest rate that banks charge each other on overnight loans—at roughly 0 percent. The Fed actually created more bank reserves than necessary to hold interest rates at zero under its policy of quantitative easing (QE). Since 2015 it has permitted the interest rate to rise very slowly to 1.5 percent. As a consequence of these monetary policies and its attempt to manage a super-slow unwinding of its zero interest rate policy (ZIRP) in the past two years, the Fed expanded the money supply (MZM) by 66% or $6 trillion, from $9.275 trillion at the end of 2008 to $15.365 trillion in March 2018.
The Fed’s “unconventional” monetary policies thus brought us a gigantic monetary expansion that fueled bubbles in the housing market, the student loan market, and equities markets. After reaching all time highs early this year, The Dow Jones Industrial Average lost about 8.5% of its value and the NASDAQ lost 7.8%. The Wilshire 5000, which approximates the total capitalization of the stocks issued by U.S.-based firms, shed 7.7% or over $2 trillion dollars of value. But there is still a long way down, because these indexes currently stand well above the highs reached immediately prior to the financial crisis of 2007-2008. In addition, the housing bubble continues to expand despite the uptick in mortgage rates as housing prices continue to accelerate well beyond their previous all-time high of early 2007. As a result the qulity of mortgage loans continues to deteriorate. For example, roughly 20% of the conventional mortgages that were approved last quarter went to borrowers who are spending 45% or more of their pretax monthly incomes on mortgage payments and other debts. This is the largest percentage of mortgage borrowers spending such a high proportion of their monthly income on debt service since the percentage spiked to 35% shortly before the subprime mortgage crisis.
Given these conditions, if the Fed adheres to its recently stated commitment to raise interest rates two more times and shrink its balance sheet by nearly one-half trillion dollars in 2018, it will further throttle back the growth rate of TMS, possibly turning it negative. This portends a spike in market interest rates, a collapse of the housing bubble, and a deep dive in equity prices. The ensuing financial crisis and recession will be made worse by the fact that large financial institutions and are still in a weakened state. While these events cannot be precisely timed and quantified, Austrian business cycle theory teaches us that they are the inevitable outcome of the Fed’s 10-year manipulation of money and interest rates.
After three months in a row of hitting new all-time highs, money supply growth slowed in March, dropping to a 10-month low. This slowdown, however, does not suggest any significant departure from the past year's high growth in money supply—which came in the wake of unprecedented quantitative easing, central bank asset purchases, and various stimulus packages.
During March 2021, year-over-year (YOY) growth in the money supply was at 34.1 percent. That's down slightly from February's rate of 39.1 percent, and up from the March 2020 rate of 11.3 percent. March's data confirms we're now twelve months in to the current trend of remarkably high money-supply growth.
Historically, the growth rate has never been higher than what we've seen over the past year, with the 1970s being the only period that comes close.
It is likely that historically large amounts of growth will continue for the time being as it appears that now the United States is a year into an extended economic crisis. For example, around 1 million new jobless claims were filed each week from March until mid-September, and claims only finally dropped below 500,000 in early May 2021. Moreover, more than 3.8 million unemployed workers are currently collecting standard unemployment benefits, and total unemployment claims have failed to fall back to non-recessionary levels, even a year after lockdowns began. More than six million additional unemployed are collecting "Pandemic Emergency Unemployment Compensation" as of late March. As of April 2021, total employment remained more than five million jobs down from March 2020.
The central bank continues to engage in a wide variety of unprecedented efforts to "stimulate" the economy and provide income to unemployed workers and to provide liquidity to financial institutions. Moreover, as government revenues have fallen, Congress has turned to unprecedented amounts of borrowing. But in order to keep interest rates low, the Fed has been buying up trillions of dollars in assets—including government debt. This has fueled new money creation.
[[{"fid":"124096","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"1"}}]] The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
Similar to the TMS measure, the M2 growth rate reached new historic highs in March 2021, growing 24.2 percent compared to February's growth rate of 26.9 percent. M2 grew 10.1 percent during March of last year.
Money supply growth can often be a helpful measure of economic activity, and an indicator of coming recessions. During periods of economic boom, money supply tends to grow quickly as commercial banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowing rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate typically climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. A similar pattern appeared before the 2020 recession, suggesting the US was headed for a recession even before the covid shutdowns.
Recession did become a reality in the Spring of 2020 with the the second, third, and fourth quarters of 2020 all showing negative growth in real GDP. Real GDP was down 9 percent, year over year, during the second quarter, and still down 1.1 percent for the fourth quarter of 2020. Although year-over-year GDP growth was positive during the first quarter of 2021 (at 2.3 percent) this represents very weak growth given the enormous amounts of monetary and fiscal stimulus that have poured into the larger economy. Considering the Fed's reluctance to scale back stimulus plans, it appears there is little confidence that the economy would stay in positive territory without ongoing stimulus.
Another factor in money supply growth has been growth in the Fed's balance sheet. After initial balance sheet growth in late 2019, total Fed assets surged to nearly $7.2 trillion in June and have rarely dipped below the $7 trillion mark since then. Assets are now headed toward a new all-time high of $8 trillion. These new asset purchases are propelling the Fed balance sheet far beyond anything seen during the Great Recession's stimulus packages. The Fed's assets are now up more than 600 percent from the period immediately preceding the 2008 financial crisis.
Total Fed assets, going back to 2007:
[[{"fid":"124097","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"assets","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"assets","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"assets","class":"media-element file-image-no-caption","data-delta":"2"}}]] Some factors are working to depress money creation, however. For example, commercial and industrial loans have been slowing, year over year, since February, with loan growth dropping from 10.1 percent in February to 3.9 percent in March. (By April, loan growth had turned negative.) If loan activity slows or declines, this will put downward pressure on money-supply growth.
Money supply growth slowed again in August, falling for the sixth month in a row, and to an eighteen-month low. That is, money supply growth in the US has come down from its unprecedented levels and has now returned to more "normal" levels. This comes after thirteen months of unprecedented YOY growth in the money supply, coming in at over 20 percent in each month between April 2020 and April 2021.
During August 2021, year-over-year (YOY) growth in the money supply was at 8.2 percent. That's down from July's rate of 8.9 percent, and down from the August 2020 rate of 37.5 percent. Growth peaked in February 2021 at 39.1 percent.
Historically, the growth rates during most of 2020, and through April of this year, were much higher than anything we'd seen during previous cycles, with the 1970s being the only period that comes close.
[[{"fid":"126462","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"1"}}]] The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
Unlike the TMS measure, the M2 growth rate began to increase again in August, following five months of decline. M2 in August rose slightly to 13.2 percent, up from July's growth rate of 12.5 percent. August's rate was nonetheless down from August 2020's rate of 23.0 percent. M2 growth peaked at a new high of 27.0 percent during February 2021 before declining from March through July.
Money supply growth can often be a helpful measure of economic activity, and an indicator of coming recessions. During periods of economic boom, money supply tends to grow quickly as commercial banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowing rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate typically climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. A similar pattern appeared before the 2020 recession, suggesting the US was headed for a recession even before the covid shutdowns.
Fed Stimulus and Declining Loan Growth The central bank continues to engage in a wide variety of unprecedented efforts to "stimulate" the economy, provide income to unemployed workers, and provide liquidity to financial institutions. For example, although the Fed has recently hinted at "tapering" its bond and mortgage-backed security purchases, the Fed's portfolio continues to grow. As of October 2021, the Fed has not pared back its monthly asset purchases totaling $120 billion. These asset purchases also indirectly enable fiscal policy by allowing the Treasury to continue to borrow trillions of dollars at very low interest rates. This feeds monetary growth.
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Yet the slowing rate of money-supply growth suggests weakness in the economy, and this can be seen in part in declining loan activity. For example, commercial real estate loans in August grew only 2.8 percent year over year, placing August's growth not far above May's eight-year low in loan activity. Meanwhile, year-over-year growth in commercial and industrial loans has been in negative territory since April of this year, dropping to the lowest levels seen since loans went into steep decline following the 2008 financial crisis.
Another factor in declining growth rates is declining totals in Treasury deposits at the Fed. These totals are factored into the TMS money supply measure, and this total has declined from $1.7 trillion in July 2020 to $391 billion in August of this year.
Overall, TMS growth dipping below M2 growth suggests a weakening in economic activity. Moreover, September's jobs totals suggests job growth is flattening out well below the precrisis totals. With only 194,000 new jobs added in September, the employment total remains more than 5 million jobs below the February 2020 peak. Hopes of a V-shaped jobs recovery have long since evaporated.
The money supply growth rate rose in September, rising to an eight-month high. The last time the growth rate was higher was during February of this year, when the growth rate was 3.19 percent.
During September 2019, year-over-year growth in the money supply was at 3.10 percent. That's up from August's rate of 1.85 percent, and was down from September 2018's rate of 4.38 percent. The increase in money-supply growth in September represents a small reversal of the trend we've seen for most of this year so far. In August, the growth rate hit a 120-month low, falling to the lowest growth rates we'd seen since 2007. Growth rates are still a long way from reaching the heights reached from 2009 to 2016, however.
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The money-supply metric used here — the "true" or Rothbard-Salerno money supply measure (TMS) — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
The M2 growth rate also increased in September, growing 5.62 percent, compared to August's growth rate of 5.22 percent. M2 grew 3.70 percent during September of last year. The M2 growth rate had fallen considerably from late 2016 to late 2018, but has been growing again in recent months.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slow-downs in rates of money-supply growth.
Moreover, periods preceding recessions often show a growing gap between M2 growth and TMS growth. We saw this in 2006-7 and in 2000-1. The gap between M2 and TMS narrowed considerably from 2011 through 2015, but has grown in recent years.
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The overall M2 total money supply in August was $15.0 trillion, and the TMS total was $13.7 trillion.
The lack of money supply growth also points to growing weakening in economic activity since the Fed has turned to increasingly accommodative monetary policy in recent months — but has not managed to return money supply growth to levels we'd expect in an expansion. The FOMC has cut the target fed funds rate more than once this year, but the big change is in the Fed's recent moves to increase its balance sheet again. Since late August, the Fed has added 208 billion to its total assets in an effort to provide a "blast of cash" for the repo market. The Fed apparently has concluded the market requires additional liquidity and has acted accordingly. Fed assets are now headed back to four trillion dollars, in spite of numerous claims from the Fed that the economy is sound and strong.
[[{"fid":"86188","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"class":"media-element file-image-no-caption","data-delta":"3"}}]]
Money supply growth rose slightly in November, rising above October's twenty-one-month low. Even with November's rise, though, money supply growth remains far below the unprecedented highs experienced during much of the past two years. During thirteen months between April 2020 and April 2021, money supply growth in the United States often climbed above 35 percent, well above even the "high" levels experienced from 2009 to 2013. As money supply growth returns to "normal," however, this may point to recessionary pressures in the near future.
During November 2021, year-over-year (YOY) growth in the money supply was at 7.0 percent. That's up from October's rate of 6.2 percent, and down from the November 2020 rate of 36.8 percent. Growth peaked in February 2021 at 39.1 percent.
Historically, the growth rates during most of 2020, and through April 2021, were much higher than anything we'd seen during previous cycles, with the 1970s being the only period that comes close.
[[{"fid":"130101","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"1"}}]] The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits and retail money funds).
M2 growth rates have been largely stable for the past six months, with the growth rate in November falling slightly, to 12.7 percent. That's down slightly from October's growth rate of 12.5 percent. November's rate was well down from November 2020's rate of 24.4 percent. M2 growth peaked at a new high of 27.0 percent during February 2021.
Money supply growth can often be a helpful measure of economic activity, and an indicator of coming recessions. During periods of economic boom, money supply tends to grow quickly as commercial banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowing rates of money supply growth. However, money supply growth tends to begin growing again before the onset of recession. As recession nears, the TMS growth rate typically climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. A similar pattern appeared before the 2020 recession. Money-supply growth fell throughout much of 2019, and the economy appeared headed toward recession. However, the "lockdowns" and stay-at-home orders of the covid panic accelerated this process and ensured a sizable drop in economic activity. Massive stimulus then pushed money-supply growth up to record levels.
Fed Stimulus and Declining Loan Growth Money supply growth was fueled in part by enormous amounts of deficit spending that occurred throughout 2020 and 2021. This led to the "need" for large amounts of monetization by the Federal Reserve. (This was needed to keep interest on the national debt low.) Indeed, as federal deficit spending grew throughout 2020, Fed purchases of government bonds increased substantially as well. Since June 2021, however, federal spending has fallen well below its earlier peaks. This has allowed the Fed to scale back its monthly asset purchases, and the growth in Federal Reserve assets has been slowing—although there are still no plans at the Fed to actually decrease total assets:
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Moreover, year-over-year growth in commercial loans has been negative since March 2021, further putting downward pressure on money-supply growth. Commercial and industrial loans in the US were down year over year, 7.9 percent in November, and have been in negative territory since April 2021.
Another factor in declining growth rates is declining totals in Treasury deposits at the Fed. These totals are factored into the TMS money supply measure—but not with M2—and this total has declined from $1.7 trillion in July 2020 to $133 billion in November.
Overall, such a sizable drop in TMS growth in recent months continues to point toward a weakening economy. As commercial banks make fewer loans, they create less new money. And as the Federal Reserve buys fewer assets, it creates less new money to do so. That's good for price inflation, but a drop in new money can be a big problem for zombie companies and bubble industries that rely on a constant influx of new money.
Money supply growth slowed again in May, falling for the third month in a row, and to a 15-month low. That is, money supply growth in the US has come down from its unprecedented levels, and if the current trend continues will be returning to more "normal" levels. Yet, even with this slowdown, money-supply growth remains near some of the highest levels recorded in past cycles.
During May 2021, year-over-year (YOY) growth in the money supply was at 15.3 percent. That's down from April's rate of 23.1 percent, and down from the May 2020 rate of 29.5 percent. Growth peaked in February 2021 at 39.2 percent.
Historically, the growth rates during most of 2020, and through April of this year, were much higher than anything we'd seen during previous cycles, with the 1970s being the only period that comes close.
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The central bank continues to engage in a wide variety of unprecedented efforts to "stimulate" the economy and provide income to unemployed workers and to provide liquidity to financial institutions. However, "emergency" government spending appears to be slowing from the unprecedented levels experienced during 2020, and this is likely showing up in declining money-supply growth. Nonetheless, Congress continues to turn to very large amounts of borrowing, and in order to keep interest rates low, the Fed has been buying up trillions of dollars in assets—including government debt. This has fueled new money creation.
The money supply metric used here—the "true" or Rothbard-Salerno money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler's checks, and retail money funds).
Similar to the TMS measure, the M2 growth rate slowed in Spring 2021, dropping to 14.1 percent during May 2021, down from 18.3 percent during April 2021, and down from May 2020's rate of 21.8 percent. M2 growth peaked at a new high of 27.0 percent during February 2021 before declining in March, April, and May.
Money supply growth can often be a helpful measure of economic activity, and an indicator of coming recessions. During periods of economic boom, money supply tends to grow quickly as commercial banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowing rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of recession. As recession nears, the TMS growth rate typically climbs and becomes larger than the M2 growth rate. This occurred in the early months of the 2002 and the 2009 crises. A similar pattern appeared before the 2020 recession, suggesting the US was headed for a recession even before the covid shutdowns.
Recession did become a reality in the Spring of 2020 with the the second, third, and fourth quarters of 2020 all showing negative growth in real GDP. Real GDP was down 9 percent, year over year, during the second quarter, and still down 1.8 percent for the fourth quarter of 2020. Although year-over-year GDP growth was positive during the first quarter of 2021 (at 0.5 percent) this represents very weak growth given the enormous amounts of monetary and fiscal stimulus that have poured into the larger economy. Considering the Fed's reluctance to scale back stimulus plans, it appears there is little confidence that the economy would stay in positive territory without ongoing stimulus. At Last month's FOMC meeting, Fed officials announced there would be no increases in the target interest rate until 2023, at the earliest.
Another factor in money supply growth has been growth in the Fed's balance sheet. After initial balance sheet growth in late 2019, total Fed assets surged to nearly $7.2 trillion in June and have rarely dipped below the $7 trillion mark since then. Assets have now reached a new all-time high above $8 trillion. These new asset purchases, fueled by newly-created money, are propelling the Fed balance sheet far beyond anything seen during the Great Recession's stimulus packages. The Fed's assets are now up more than 600 percent from the period immediately preceding the 2008 financial crisis.
Total Fed assets, going back to 2007:
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Some other factors are working to depress money creation, however. For example, commercial and industrial loans have been slowing, year over year, since February, with loan growth dropping from 10.1 percent in February to negative 16.1 percent in May. This is the largest decline since 2009. When loan activity drops, this will put downward pressure on money-supply growth. [[{"fid":"124894","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"tms","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"tms","class":"media-element file-image-no-caption","data-delta":"3"}}]]