Money Supply; Money Mess
Posted by Gail | Filed under Economics 101
The Money Supply refers to the amount of money in the economy, some or all of which can be used to buy stuff. In the U.S., the most common measures of money supply are termed:
- M0: The total of all currency plus accounts at the central bank, which can be exchanged for currency.
- M1: Measures M0 plus the amount in demand accounts, like your chequing account.
- M2: Measures M1 plus savings accounts, money market accounts, and certificates of deposit under $100,000.
- M3: Measures M2 plus all certificates of deposit over $100,000 along with deposits of Eurodollars and repurchase agreements.
In Canada, the terms are slightly different:
- M1: Measures currency in circulation plus the money in personal chequing accounts.
- M2: Adds in personal savings accounts and other chequing accounts, along with personal and non-personal deposits which require that notice be given before withdrawal.
- M2+ includes all deposits at non-bank deposit-taking institutions, money-market mutual funds, and individual annuities at life insurance companies.
- M2++, also includes all types of mutual funds and Canada Savings bonds.
In the U.K. there are just two official money supply measures:
- M0: Measures all cash outside the Bank of England plus private banks’ operational deposits with the Bank of England, and
- M4: Measures all cash outside banking institutes including money in circulation, deposits with private-sector retail and wholesale banks and building society deposits along with certificates of deposits.
Are your eyes glazing over? The point I’m trying to make is that different countries measure the money supply in different ways. But who can spot the one thing missing from it all?
The theory behind the importance of the money supply is that central banks monitor the rate of money growth and then exert their influence by changing short-term interest rates. When the central banks’ rates change, other rates like those paid by consumers for loans change along with them. In theory, when interest rates rise people are apt to borrow less and pay back existing loans, slowing in the growth of M1.
Okay, have you spotted the problem with the theory yet?
In economic theory, the availability of money and credit must expand over time, and central banks are responsible for ensuring that the rate at which more money is introduced into the economy is consistent with long-term stable growth. By influencing the rate at which the supply of money and credit is growing, total spending can be kept stable.
So what’s the bug in the ointment?
How about the fact that credit cards aren’t the traditional form of borrowing, that high interest rates in no way motivate borrowers to pay back their credit card debt, and that nothing the central bankers do ever has an impact on the interest rates that credit card companies charge? How about the fact that the credit available through credit cards is acting like money – it’s used to buy goods and services – but it is in no way reflected in the calculation of the money supply? And how about the fact that as a result of this oversight, we allow credit to be issued at a whim, to whomever credit card companies want to give it to, in whatever amount, without a whit of consideration to how that “extra spending power” is impacting on the economy as a whole? Sure we had unprecedented growth in spending over the past decade. But we didn’t use money to do it. We used credit.
What we’ve witnessed of late is the fallout of a rampant spending problem that comes from having an unlimited supply of money. Hey, that’s what credit has become in many people’s minds: disposable income. Never mind that it’s income that hasn’t yet been earned.
While there’s a lot of yackety-yak right now about a “cardholder’s bill of rights”, the one thing nobody wants to hear is that spending money on credit is an act of madness because you are spending money that has yet to be earned. And since you can’t predict what your earnings will be in the future, you’re spending money you may never have.
Once upon a time you had to have a good reason to borrow money. You wanted to build a business; you wanted to improve an asset; you wanted to invest in something that would generate a solid return. When borrowing became just another way to buy STUFF, credit moved from one part of the economic formula to another. If we don’t start taking “credit as money” into account in terms of it’s impact on our economy, we’ll just keep scratching our heads and wondering how things went so badly off the tracks.
And if we don’t stop spending money we haven’t yet earned on Stuff, we don’t have a hope in hell of ever fixing what’s broke!
February 23, 2009 at 8:21 am
Wow Gail…although the information you provided is technical, it is some rather disturbing and frightening piece of information. The fact that the calculations assume money in is money out and does not factor in the rampant abuse of credit shows a scary disconnect. What’s even scarier is that in the end, even with everything that is going on, people are still not going to learn that using future income (and that is a huge assumption because one can never know if a paycheque will arrive, let alone increase in time) to purchase “stuff” is ridiculous. Unfortunately, like the automobile, credit is so ingrained into the societal conscience that the long-term implications for society in general should keep people up at night. Things may get better, but how soon are we going to be back to where we are now? All it takes is to watch those “Clean Sweep” shows on TV (where the house is purged of stuff and reno’ed), especially in the US, to see just how much our “stuff-addicted” society is. G-d help us, may we all remember how it is to live simply and within our means.
February 23, 2009 at 10:23 am
Well put, Erran. I completely agree that credit seems to be so ingrained into our conscience that doing without it seems impossible. I wish that this recession would be a time for us all to learn how to live without it, but I wonder if that is really happening. I wish that we would all come together to support one another through bartar/trade systems, share more, talk to each other more, be more open about our needs and be willing to give a little more. Could we not learn to live on less and find a way to build sustainable communities even within urban living? There is so much that could be gained from forcing ourselves to get by with less.
February 23, 2009 at 11:28 am
I think you’ve made an important mistake, here. To quote:
“By influencing the rate at which the supply of money and credit is growing, total spending can be kept stable.”
That’s not at all the point of controlling the money supply. The whole reason to control the money supply is to control inflation. In particular, to maintain a steady, low-but-non-zero rate of inflation.
Now, the fiat system has been in place for, what, 30 years in the US? And credit cards have been around since the 50s. And yet we haven’t seen an uncontrolled rise in inflation as the money supply began to grow in an unbounded fashion due to rising credit card debt. So, ultimately, I wonder if the problem you’ve identified is really that big of a deal (from a macroeconomic standpoint)?
That said, US consumer and business culture clearly needs to change. Fortunately, we’re starting to see that as both businesses and households deleverage… but it’s going to be a long, painful process, one that’s necessary for the long term health of the US economy (not to mention the UK).
February 23, 2009 at 12:46 pm
“spending money on credit is an act of madness”
Thank you for that quote! It is SO TRUE!
February 23, 2009 at 1:36 pm
Did you say “cardholder’s bill of rights”? I am horrified to think of that. We always have rights as consumers!
The right to not get the card in the first place!
No-one forces us to borrow. Circumstances may force us into accepting that borrowing can be more comfortable than doing without, but the contract is there in it’s teeny, tiny print every time you apply for a card…. (things like rates are subject to change, they can recall the debt at any time, you are accepting the responsibility of the outstanding amount and agree to repay it)!
WHY NOT?
IT ISN’T YOUR MONEY THAT YOU ARE SPENDING!!!!! WHY SHOULDN’T THEY SET THE TERMS WITH THE CARDS TO WHATEVER THEY WANT? YOU DON’T HAVE TO ACCEPT THE TERMS BY GETTING THE CARD IN THE FIRST PLACE!!! THE LENDER NEEDS TO HAVE THE RIGHTS, IT’S THEIR MONEY ON THE LINE. (sorry for the yell, it had to be done).
That’s the part that ticks me off, people use that card like it’s their RIGHT to spend the money, but it’s not, it’s just not! There is a commitment, a contract, a legal obligation to honour your debt and by accepting the card, you are making a promise that you are responsible enough to take care of business. Taking that lightly is foolish and shortsighted.
Sure the card companies are sneaky and manipulative, but let’s all be grown-ups here, they want to make money, and if you want to spend THEIR money, they want to be compensated as much as they legally can squeeze out of you.
I borrow on a card with a polite “thank you for the 21 days grace”, and then pay it off. There have been times when I couldn’t get the big lump paid when times were tight, and I said “wow, THANK YOU for lending me the money to get by” and paid at least double the minimum payment cringing at how much this “easy fix” was costing me in interest. But it’s THEIR money I already used and I agreed to the terms on the card!
And if the terms don’t fit my life, then I ask for a different set of terms! There are loads of contracts to choose from, even some that take the money directly from your chequing account so you don’t ever carry a balance — they work like bank cards, only carry the features of a credit card (Excellent for things like reserving travel, etc without the temptation to go overboard).
Lets hope the madness stops and our society can break the cycle of consumer debt addiction soon!
February 23, 2009 at 3:46 pm
@ Pol*
I agree 100%….I completely agree with you, well said.
February 23, 2009 at 3:56 pm
You said it, Gail.
And what disturbs me even more is that the stimulus packages are about getting people spending again.
With what, exactly?
The people don’t have any money. They have debt.
Everyone has had a huge wake-up call, but we are saying that the good habits of saving and reining in the spending are really bad for the economy right now.
Is continuing with the same overspending behaviours really going to solve the problem or will it just prolong it?
Personally, I’d rather rip the band-aid off in one go than peel it off slowly, but that’s just me. And in all fairness, my household isn’t facing imminent job loss and we don’t have debt. So maybe I need to be a little more tolerant.
I just don’t see that the solutions proposed are really going to solve anything.
On the personal finance level, I think that Pol* is correct: at the end of the day, the credit card companies (nasty and devious as they may be) did not force anyone to borrow money.
I certainly question their decision to lend a lot of that money in the first place, though. They took a lot of risk by lending to people with poor credit ratings and they are now paying for that, I think.
Look at the way they target students and lower income earners. They approve huge credit limits and now the financial community is surprised that there is defaulting?
February 23, 2009 at 10:00 pm
Interesting how this post has so many fewer responses to a typical Gail post! I’m wondering if Gail’s post is from a background in the teachings from the CSI, or in economics (or maybe both – she’s brilliant!).
Interestingly, even in this ‘credit crunch’ where lending through mortgages and loans etc is difficult, most (if not all?) banks are really pushing for customers to take more visas and mastercards. Any thoughts as to why?
February 24, 2009 at 10:45 am
Mountain Girl:
The stimulus packages are about getting people to spend because the past ‘booming’ economy was based on people spending (or overspending). (Who knew how appropriate the word ‘boom’ is…) In order for people to purchase stuff, the stuff must be made so individuals must be hired (and payed) to do so.
By overspending, people got an impression of demand that could be met… and then reality set in that we could not keep going this way.
The best anyone can do long-term for the economy is to spend as much as they can WITHIN their means. The short-term benefits of overusing credit are finally clear to many!
February 25, 2009 at 5:12 am
Joke hmm maybe
A Farmer sold a horse to a man in a pub for $100 when the man came the next day to pick up the horse the farmer told the man the horse had died.
The man said “can i still have the dead horse?”.
The farmer said “sure”.
The guy held a raffle for the horse at $2 a ticket and sold 500 tickets making $1000 dollars.
The farmer delivered the horse and asked the guy what he was going to do when the winner wanted the horse he said “that’s fine I’ll refund his $2.”
The American mortgage crisis explained at last.
February 25, 2009 at 7:26 am
Land Down Under:
Interesting “joke” (?). I have to think whether that would explain the US situation, but does make a good point about humans and society regardless, that those who think outside-the-box/larger than the micro situation can benefit from the inherently self-interested-seeking person. Hmmm….(gears are turning on an early morning)…
September 3, 2009 at 10:56 am
Is anyone buying it anymore? After what we are going through… after having all those speeches in economics and how none of the experts ever saw this crisis coming…
Still, everyday the medias babble about the fluctuation of the market stating yet the same experts who never saw it coming?
When will it be commonly understood that the fairy tale is over? Most household got that allready… Still the politic class and the Wall street market clings on a passed era… no transition is suggested, only more way to hold on tight to the past… Reading over and over again that the US economy relies on personal spending for about 2 third of its economic reality and acknowledging that the average credit card held by individual is 5… there is no shortsighted end to the doo-doo the US economy is.
Our canadian average of 2,5 credit card by individual is alarming, but in comparison, we are better off aren’t we.
I so would like the Doom Callers and Hope sellers to get on with the program and realize that their credibility went down the drain.