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1. The Importance of Money

Today, money supply figures pervade the financial press. Every Friday, investors breathlessly watch

for the latest money figures, and Wall Street often reacts at the opening on the following Monday. If the money

supply has gone up sharply, interest rates may or may not move upward. The press is filled with ominous

forecasts of Federal Reserve actions, or of regulations of banks and other financial institutions.

This close attention to the money supply is rather new. Until the 1970s, over the many decades of the

Keynesian Era, talk of money and bank credit had dropped out of the financial pages. Rather, they

emphasized the GNP and government’s fiscal policy, expenditures, revenues, and deficits. Banks and the

money supply were generally ignored. Yet after decades of chronic and accelerating inflation—which the

Keynesians could not [p. 2] begin to cure—and after many bouts of”inflationary recession,” it became obvious

to all—even to Keynesians—that something was awry. The money supply therefore became a major object of


But the average person may be confused by so many definitions of the money supply. What are all the

Ms about, from M1-A and M1-B up to M-8? Which is the true money supply figure, if any single one can be?

And perhaps most important of all, why are bank deposits included in all the various Ms as a crucial and

dominant part of the money supply? Everyone knows that paper dollars, issued nowadays exclusively by the

Federal Reserve Banks and imprinted with the words “this note is legal tender for all debts, public and private”

constitute money. But why are checking accounts money, and where do they come from? Don’t they have to

be redeemed in cash on demand? So why are checking deposits considered money, and not just the paper

dollars backing them?

One confusing implication of including checking deposits as a part of the money supply is that banks

create money, that they are, in a sense, money-creating factories. But don’t banks simply channel the savings

we lend to them and relend them to productive investors or to borrowing consumers? Yet, if banks take our

savings and lend them out, how can they create money? How can their liabilities become part of the money


There is no reason for the layman to feel frustrated if he can’t find coherence in all this. The best

classical economists fought among themselves throughout the nineteenth century over whether or in what sense

private bank notes (now illegal) or deposits should or should not be part of the money supply. Most

economists, in fact, landed on what we now see to be the wrong side of the question. Economists in Britain,

the great center of economic thought during the nineteenth century, were particularly at sea on this issue. The

eminent David Ricardo and his successors in the Currency School, lost a great chance to establish truly hard

money in England because they [p. 3] never grasped the fact that bank deposits are part of the supply of money. Oddly enough, it was in the United States, then considered a backwater of economic theory, that

economists first insisted that bank deposits, like bank notes, were part of the money supply. Condy Raguet, of

Philadelphia, first made this point in 1820. But English economists of the day paid scant at tention to their

American colleagues.