Comments (8)

• Dave Weilacher

  If M1 stays constant but goods become more scarce, doesn't that also increase prices?

  By example, if our government starts buying good and services for export to Iraq in direct competition with us, as individuals, for those same goods and services.

  If M1 stays constant but more folks decide that they want to buy equity in a corporation, doesn't that also increase price?

  Published: August 29, 2006 9:37 AM

• Alex MacMillan

  A couple of points: "The ten dollars that the baker has acquired are claims on real savings (i.e., unconsumed final consumer goods) to the tune of ten dollars." The $10 the baker has acquired represent claims on currently existing unconsumed goods or on yet to be produced unconsumed goods -or on services. Services are not savings. So the baker's $10 can represent more than just claims on savings.

  Also, If someone switches $10 from savings deposits to demand deposits but does not spend the $10, neither bank nor existing borrowers need liquidate any assets and M1 has increased by $10. The relative desirability of M1 and other M's is affected by a number of variables. When one or more of these variables change, the desirability of M1 can rise relative to the other M's. This can produce an equilibrium increase in M1.

  Published: August 29, 2006 10:12 AM

• Roger M

  The relationship of M1 to the stock market might be a little fuzzy, but it helps to consider the bond market. Everyone knows that an increase in the money supply will reduce interest rates initially, but it does so by increasing the price of the bond, another financial asset like stocks. So if an increase in M1 can cause an increase in bond prices (a lowering of yield or interest), it will do the same for stocks. The effect is the same on bonds and stocks, it's just that with bonds we're used to discussing yield while with stocks we're used to discussing price.

  Published: August 29, 2006 10:19 AM

• Stefan Karlsson

  Frank's chart is from South East Asia, but for America there is no positive correlation between M1 and stock prices.

  Indeed, during the by far biggest stock price bubble during the post-World War II period, the tech stoch bubble of the late 1990s, when the S&P 500 increased more than three fold between late 1994 and March 2000 and when the NASDAQ Composite index increased more than six fold, M1 actually fell. M1 was only $1107 billion at the peak of the stock market bubble in March 2000, 4% lower than in December 1994. That means that if M1 is accepted as money supply definition, the tech stock bubble occurred during an era of monetary deflation.

  Similarly, during the other big 20th century bubble, that of the 1920s, M1 increased only very slowly, at 2.5% at an average annualized rate between 1921 and 1929.

  Thus, if you accept a money supply definition as narrow as M1 you would have to agree with Alan Greenspan that this was all "irrational exuberance" completely unrelated to him. And this would support Milton Friedman's contention that the stock market bubble and the Great Depression was unrelated to Fed policy prior to 1929. Thus by implication you would have to contend that Rothbard's different contention in his America's Great Depression, that Fed inflating during the 1920s were the source of the depression.

  Friedman himself used M2 as money supply definition which increased at an average annual rate of less than 5%, whereas Rothbard used a broader definition that increased more than 6% per year. If M1 were accepted, this would in fact make the Milton Friedman interpretation of the Great Depression even stronger than he himself formulated it.

  I don't believe in that though, as agree with Rothbard that M2, not to mention M1 is too narrow. definition. Since Frank likes to quote Rothbard, I think I'll quote him on the issue of why savings deposits should in fact be included in the money supply:

  "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 30 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.

  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 Ills money
  supply.

  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.

  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).8 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."

  Published: August 30, 2006 10:07 AM

• Pete Canning

  I always enjoy Shostak's articles, it would be great if he could dig deeper into financial subjects, with less review.

  Published: August 30, 2006 3:05 PM

• adi

  For ordinary people it would probably be surprise that economists dont know what really is money. These "what M-aggregates should be part of money supply" debates dont contribute much to a economic theory.

  Published: August 31, 2006 9:04 AM

• Markymark

  Modeling of the self-reinforcing relationship between financial markets and the direction of asset prices, M1 would be in there somewhere?

  http://www.bis.org/publ/work212.pdf

  
  Would like your reaction.

  Published: September 11, 2006 6:11 AM

• Machine Ghost

  Last I looked at a chart pre-2000, there was a 99% correlation between the S&P 500 and M3.

  It would not be wise to confuse the Fed's control of its monetary base with the money supply. In the early 1990's, the Fed eliminated reserve requirements for virtually everything but checking accounts (M1). So nowadays, the Fed has very little control over the money supply relative to the late 1970's or the late 1920's.

  Machine Ghost
  

  Published: September 14, 2006 8:15 AM