The True Money Supply

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The money supply in a country is the total nominal value of money ready to be spent in its respective territory. Money is a medium of exchange. This is its ultimate purpose. All other so called money functions, like value storage medium, measure of utility, etc. are nothing but derivatives of this function. More precisely, money is that medium which is accepted by virtually everyone as a medium of payment in exchange for products and services rendered.

As explained in 'Credit Expansion', the major business cycles, booms and recessions are caused by an increase and subsequent slowdown in money supply, respectively.

If one carefully tracks the true stock of money and its growth or contraction over time, one can make fundamental assessments and predictions about the state of the economy and the outlook for asset and consumer prices in general.

The Federal Reserve Bank employs two measures for the money supply: M1 and M2. It also supplies other data, called 'Other Memorandum Items' which in its opinion is not part of the money supply.

We shall analyze each component of the data provided, and figure out whether or not it should be included in the money supply.

A lot has been written about the true money supply. There are completely different views on this matter. However, the solution to the question is pretty simple so long as one agrees that the definition of money is that it is the medium of exchange accepted by everyone.

Each component simply has to pass the following test: Is this item accepted by virtually everyone as a medium of exchange?

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M1: Currency + Traveler's Checks + Demand Deposits + Other Checkable Deposits

Currency: This is cash money in the pockets, lockers, mattresses, or hands of individuals. Cash, when printed and used by the federal reserve to purchase assets and thus channeled into circulation increases the nominal amount of media of exchange available in society. Virtually everybody accepts cash as payment. It is without a doubt a component of the money supply.

Traveler's Checks: Traveler's checks are issued by American Express and other credit institutions. A traveler's check has to be purchased in exchange for currency or checking deposits. Money is transferred from the purchaser's account to the company issuing the traveler's check. When used, money is transferred from the issuing company's deposits to the person redeeming the check. Hence, traveler's checks do not add to the overall availability of media of exchange, they are merely a means to facilitate the transfer of actualy money. Traveller's checks are not commonly accepted as a means of payment inside the US. They are not to be included in the money supply.

Demand Deposits: Demand deposits are checking accounts. Additional checking account money can be created in different ways: When people deposit cash money in exchange for demand deposits, the overall money supply does not change. However, if we observe both figures, then all cash deposits will reduce the 'Currency' account, and increase the 'Demand Deposit' account. Another way of creating demand deposits is when the central bank issues new demand deposit money instead of printing new money, and purchases bank assets with it. In addition to that, banks may issue credit themselves by making out loans that are not fully backed by deposits. This money will appear on the loan recipient's checking account. Checks can be written against them. Virtually everyone accepts payment in demand deposit money. Demand deposits are thus to be included in the money supply.

Other Checkable Deposits: These are savings deposits that can be drawn upon when demand deposits are overdrawn. But a savings deposit is not part of the money supply. A savings deposit does not function as a medium of exchange. When someone deposits money in a savings account the bank turns around and invests the money in credit instruments. It will then appear on the checking account of the seller of the credit instrument. The does not change when the savings deposit can be partially drawn upon. A buyer of a good cannot write a check against his savings deposits. At the best he writes a check against demand deposits that he is going to obtain after liquidating a fraction of his savings deposits. It would be rather impossible to try and use one's savings deposits as a means of payment. No one would accept a payment 'in savings deposits'. This even applies to that portion of it which can immediately be turned into checking account money. The recipient of a check written against the checkable portion of a savings deposit still demands checking account money as final means of payment. Thus the payer's savings deposit dollars need to be converted into checking deposit dollars settling the transaction. (If this was NOT the case, savings deposits and other checkable deposits would indeed be a part of the money supply.) Other checkable deposits are hence not part of the money supply.
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M2: M1 + Savings Deposits + Small-Denomination Time Deposits + Retail Money Funds

Savings Deposits: As explained above under 'Other Checkable Deposits', savings deposits don't function as media of exchange. Nobody would accept a payment from someones savings deposit straight to his savings account. But our definition of money is that is is precisely that medium which is broadly accepted as payment. Savings deposits are hence not part of the true money supply.

Small-Denomination Time Deposits: These are deposits where the depositor contractually commits to not withdrawing the money for a fixed time frame. Time deposits cannot be used as media of exchange and are hence not part of the true money supply, even less so than savings deposits.

Retail money funds invest in short-term debt, such as US Treasury bill and commercial paper. They are not used or accepted as media of exchange, and are hence not part of the true money supply.
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Other Memorandum Items: Demand Deposits at Banks Due To Foreign Commercial Banks and Foreign Official Institutions + Time and Savings Deposits Due To Foreign Commercial Banks and Foreign Official Institutions + U.S. Government Deposits + IRA and KEOGH Accounts

Demand Deposits at Banks Due To Foreign Commercial Banks and Foreign Official Institutions: These are checking account deposits held by foreign banks and institutions at American banks. Foreigners hold funds in checking accounts of other countries in order to cover expenditures in those same countries. These expenditures are covered using that contry's medium of exchange, money. They clearly are to be added to the true money supply.

Time and Savings Deposits Due To Foreign Commercial Banks and Foreign Official Institutions: As already explained above, time and savings deposits are not to be included in the true money supply.

U.S. Government Deposits: These are demand deposits held by institutions of the the U.S. Government at commercial and the Federal Reserve Bank. It is a curious fact that they have been excluded from the official money supply data. The money does not disappear from circulation. If A pays taxes to government entity B the funds are merely transferred from one account to another. The funds are used to cover expenses during day to day operations, pay employees, etc. and are hence a part of the true money supply.

IRA and KEOGH Accounts: These are, like savings and time deposits, merely investments in credit instruments and other investment vehicles and are not part of the true money supply.

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Retail Sweeps

One more important item to be mentioned are so called bank 'retail sweeps'. Retail sweeps were introduced in January of 1994 when the Federal Reserve Board allowed commercial banks to use a software that classifies certain portions of customers' checking account deposits as money market deposits accounts (MMDAs). Researchers at the regional Federal Reserve Bank of St. Louis have summarized it as follows:

"At its start, deposit-sweeping software creates a “shadow” MMDA deposit for each customer account. These MMDAs are not visible to the customer, that is, the customer can make neither deposits to nor withdrawals from the MMDA. To depositors, it appears as if their transactionaccount deposits are unaltered; to the Federal Reserve, it appears as if the bank’s level of reservable transaction deposits has decreased sharply. Although computer software varies, the objective is the same: to minimize a bank’s level of reservable transaction deposits, subject to several constraints."

This means that customers don't notice the slightest change to their demand deposit account. In effect, their behavior doesn't change at all, no matter whether or not their checking deposit has been reclassified. Retail sweeps are nothing but an accounting fiction that enable banks to lower their minimum reserves and lend out more money.

But this means that the statistics on demand deposit accounts have been inaccurate since 1994. That portion which has been reported as MMDA when it was actually demand deposit money to customers needs to be included in the money supply. The Federal Reserve Bank of St. Louis provides a monthly estimate on this number. Retail Sweeps are part of the true money supply.
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Conclusion: Thus the true money supply ( we shall call it M(t) ) is defined as follows:

M(t) = Currency + Private Demand Deposits + Demand Deposits Due to Foreign Banks and Institutions + Government Demand Deposits + Government Federal Reserve Deposits + Retail Sweeps

Below please find the development of the true money supply in the USA since 1960:



Click on image to view it in full size.

Antitrust and Monopolies

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The Objectives of Antitrust Intervention

Public opinion believes that the societal apparatus of compulsion and coercion, the government, should protect society from monopolies: Monopolies restrict the supply of products and harm the welfare of the common man. The government has to step in and put and end to this injustice. It's intervention is supposed to foster free enterprise and fair competition and protect the poor and hapless from powerful corporations.

The term monopoly needs to be defined more precisely here. There are two types of monopolies which, from a praxeological perspective, have completely different implications.

The supporter of antitrust enforcement by the government does not make a distinction between the two and hence arrives at completely flawed conclusions.

There are the 'Coercive Monopoly' and the 'Market Monopoly'.

The Coercive Monopoly is simply a monopoly based upon aggression or the threat thereof. It is not the monopoly that we need to discuss here.

The type of monopoly in question is the 'Market Monopoly': Antitrust proponents claim that an unhampered free market produces market monopolies and that it is the government's job to prevent this from happening.

The Market Monopoly

The market monopoly is a company that operates on the free market, meaning a market unhampered by aggression. A company in that environment is a group of people that jointly works towards withdrawing factors of production (raw materials, labor, etc.) from the market in voluntary contracts, and combines them in lines of production where they create products/services that are, from the consumer's point of view, worth more than where the factors were employed prior to withdrawal (which is implicitly expressed in a price premium).

This in itself is nothing but the schoolbook definition of a company on the free market, seeking to make a profit. The particular thing about a company that holds a market monopoly is that there is no other company that sells the same product. (The fact that every company in that sense has a monopoly over its own products, shall be passed in silence, and is a fact that antitrust proponents would not even bother looking into. For our purposes it shall suffice to consider similar products.)

But this does not change the fact that, based upon the law of marginal utility, the market monopoly company has to lower the price for every additional unit it sells to the consumers, in order to increase its profit. It also does not change the fact that it has to produce a useful product that satisfies a consumer demand. It also does not change the fact that this whole process is completely voluntary and peaceful on the part of the seller, as well as on the part of the buyer. It also does not change the fact that venture capital always stands ready to provide capital to entrepreneurs who are completely free at any time to identify cheaper processes and sell at cheaper prices and/or better quality, outstripping the previous monopoly, and ultimately reaping a profit to satisfy the profit-seeking venture capitalists, while at the same time improving the consumer's situation.

Yet, for the sake of the antitrust proponents' argument, we shall pass in silence all these facts and inquire as to what effects the government's antitrust intervention will have regardless.

The Antitrust Intervention

What antitrust proponents now ultimately suggest is that the social apparatus of compulsion and coercion, the government, impose a maximum number of products to be sold by this monopoly company, and step in with police force if the company dares to satisfy more consumers than allowed by its decree. The fact that the company, as well as the consumers, are merely acting voluntarily towards what they consider to be their best choice, does not interest the antitrust proponents: In their minds, the fact that the people, in their role as consumers with every penny and every dollar, are casting a conscious vote, by choosing to purchase the product they seek, is a mere expression of the ignorance and the gullibility on the part of the public. The government is omniscient, its will supreme. Its decree has to be followed and enforced when violated. How dare the consumers make the decision who to buy from!

Usually the government employs market share statistics, based on the revenue generated from the products in question. It decrees, for example, that company XYZ, is not allowed to sell more than the equivalent of 40% market share worth of its, say, operating system software ABC. Why exactly 40%? Why not 39.95% Why not 40.1%? There is no logic whatsoever behind this approach. It is so blatantly arbitrary that the antitrust doesn't even bother to justify it on scientific, or at least somewhat logical, grounds.

The Consequences of Antitrust Intervention

After the government steps in and limits the supply of the product in question, who ultimately suffers? The marginal consumers, who would have purchased the additional unit of the product whose supply has been cut off. How this attains the objective of fostering free enterprise and fair competition and protecting the poor and hapless (those who cannot afford it at higher prices until their margin is met) from powerful corporations, is yet to be answered by antitrust proponents. (Term explained: Marginal Utility) In fact, the policy attains the exact opposite.

True, after the government has intervened, sooner or later a new entrepreneur will step in and fill the gap with a similar product. (The fact that this can occur just as likely without any restriction of the market monopoly company shall be passed in silence.) However, he will not be under any pressure from from the previous market monopoly company. He merely stepped in to fill the gap, because the police intervened and outlawed by force any more sales from the market monopoly company. At this point, his position is not threatened at all. Due to his inexperience and lack of competitive pressure, his product will most likely be inferior to the previous market monopoly's product. It will take him much longer to get to a point where his product can measure up to the previous market monopoly company's product. Economies of scale will set in at a much later stage for this entrepreneur, so as he increases production, his prices will not drop as fast as previously. Marginal consumers will have to do with his inferior product for the time being.

The fact that a new entrepreneur steps in to fill the gap will not in the slightest make the market more competitive or fair. Quite the opposite: The coercive intervention creates a less competitive environment with less competitive pressure and the consumers ultimately suffer.

The policy of antitrust intervention is bound to fail.