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2. The Present Money Supply

In considering the present monetary situation, the observer is struck with a phenomenon we mentioned

at the beginning of this work: the bewildering series of Ms: Which of them is the money supply? The various

Ms have been changing with disconcerting rapidity, as economists and monetary authorities express their

confusion over what the Fed is supposed to be controlling. In particularly shaky shape are the Friedmanite

monetarists, whose entire program consists of ordering the Fed to increase the money supply at a steady, fixed

rate. But which M is the Fed supposed to watch?4 The puzzle for the Friedmanites is aggravated by their

having no theory of how to define the supply of money, which they define in a question—begging way by

whichever of the Ms correlates most closely with Gross National Product (correlations which can and do


Everyone concedes that what we can call the old M-1 (currency or Federal Reserve Notes + demand

deposits) was part [p. 255] of the money supply. The controversial question was and still is: Should anything

else be included? One grievous problem in the Fed’s trying to regulate the banks is that they keep coming up

with new monetary instruments, many of which might or might not be treated as part of the money supply.

When savings banks began to offer checking services as part of their savings accounts, it became clear even to

Friedmanites and other stubborn advocates of only checking accounts as part of the money supply, that these

accounts—NOW and ATS—must be included as part of any intelligible definition of the money supply. Old

M-1 then became M-1A, and NOW and ATS figures were included in a new M-lB. Finally, in 1982, the Fed

sensibly threw in the towel by calling a new M-1 figure the previous M-1B and scrapping the M-1A


The inclusion of new forms of checking accounts at savings and savings and loan banks in the new

M-l, however, by no means eliminates the problem of treating these thrift institutions. For regular savings

accounts at these institutions, and indeed at commercial banks, while not checkable, can be easily withdrawn in

the form of a cashier’s or certified check from these banks. What genuine difference, then, is there between an

officially checkable account and one that can be drawn down by a simple cashier’s check? The typical answer

that a savings account must be withdrawn by presenting a passbook in person hardly seems to offer any

genuine obstacle to withdrawal on demand.

No: The crucial distinction, and the crucial way to decide what is part of the money supply, must focus

on whether a certain claim is withdrawable instantly on demand. The fact that any bank may be able legally to

exercise a fine-print option to wait 30 days to redeem a savings deposit is meaningless, for no one takes that

fine print seriously. Everyone treats a savings deposit as if it were redeemable instantly on demand, and so it

should be included as part of estimates of the money supply.

The test, then, should be whether or not a given bank claim is redeemable genuinely and in fact, on

demand at par in cash. [p. 256] If so, it should be included in the money supply. The counter-argument is that

noncheckable deposits are transferred more slowly than checking. Indeed, we saw above how commercial

banks were able to engineer credit inflation in the 1920s by changing from demand to alleged time deposits,

which legally required much lower reserves. We also saw how several bank runs on these savings deposits

occurred during the 1930s. Everyone treated these deposits as if they were redeemable on demand, and

began to redeem them en masse when the banks insisted on the fine-print wait of 30 days.

The test, then, should be whether or not a given bank claim is redeemable, genuinely and in fact, on

demand at par in cash. If so, it should be included in the money supply. The counter-argument that

noncheckable deposits are transferred more slowly than checking accounts and therefore should not be

“money” is an interesting but irrelevant fact. Slower-moving money balances are also part of the money supply.

Suppose, for example, in the days of the pure gold coin standard, that individuals habitually had kept some

coins in their house to be used for day-to-day transactions, while others were locked up in vaults and used

only rarely. Weren’t both sets of gold coins part of their money stocks? And clearly, of course, the speed of

spending the active balances is deeply affected by how much money people have in their slower-moving

accounts. The two are closely interrelated.

On the other hand, while savings deposits are really redeemable on demand, there now exist genuine

time deposits which should not be considered as part of the money supply. One of the most heartwarming

banking developments of the past two decades has been the “certificate of deposit” (CD), in which the bank

flatly and frankly borrows money from the individual for a specific term (say, six months) and then returns the

money plus interest at the end of the term. No purchaser of a CD is fooled into believing—as does the savings

bank depositor—that his money is really still in the bank and redeemable at par [p. 257] at any time on

demand. He knows he must wait for the full term of the loan.

A more accurate money supply figure, then, should include the current M-1 plus savings deposits in

commercial banks, savings banks, and savings and loan associations.

The Federal Reserve, however, has not proved very helpful in arriving at money supply figures. Its

current M-2 includes M-1 plus savings deposits, but it also illegitimately includes “small” time deposits, which

are presumably genuine term loans. M-2 also includes overnight bank loans; the term here is so short, as for all

intents and purposes, to be “on demand.” That is acceptable, but the Fed takes the questionable step of

including in M-2 money market mutual fund balances.

This presents an intriguing question: Should money market funds be incorporated in the money supply?

The Fed, indeed, has gone further to bring money market funds under legal reserve requirements. The

short-lived attempt by the Carter Administration to do so brought a storm of complaints that forced the

government to suspend such requirements. And no wonder: For the money market fund has been a godsend

for the small investor in an age of inflation, providing a safe method of lending out funds at market rates in

contrast to the cartelized, regulated, artificially low rates offered by the thrift institutions. But are money market

funds money? Those who answer Yes cite the fact that these funds are mainly checkable accounts. But is the

existence of checks the only criterion? For money market funds rest on short-term credit instruments and they

are not legally redeemable at par. On the other hand, they are economically redeemable at par, much like the

savings deposit. The difference seems to be that the public holds the savings deposit to be legally redeemable

at par, whereas it realizes that there are inevitable risks attached to the money market fund. Hence, the weight

of argument is against including these goods in the supply of money.

The point, however, is that there are good arguments either [p. 258] way on the money market fund,

which highlights the grave problem the Fed and the Friedmanites have in zeroing in on one money supply figure

for total control. Moreover, the money market fund shows how ingenious the market can be in developing new

money instruments which can evade or make a mockery of reserve or other money supply regulations. The

market is always more clever than government regulators.

The Fed also issues an M-3 figure, which is simply M-2 plus various term loans, plus large

denomination (over $100,000) time deposits. There seems to be little point to M-3, since its size has nothing

to do with whether a deposit is a genuine time loan, and since term loans should not in any case be part of the

money supply.

The Fed also publishes an L figure, which is M-3 plus other liquid assets, including savings bonds,

short-term Treasury bills, commercial paper, and acceptances. But none of the latter can be considered

money. It is a grave error committed by many economists to fuzz the dividing line between money and other

liquid assets. Money is the uniquely liquid asset because money is the final payment, the medium of exchange

used in virtually all transactions to purchase goods or services. Other nonmonetary assets, no matter how liquid—and they have different degrees of liquidity—are simply goods to be sold for money. Hence, bills of

exchange, Treasury bills, commercial paper, and so on, are in no sense money. By the same reasoning, stocks

and bonds, which are mainly highly liquid, could also be called money.

A more serious problem is provided by U.S. savings bonds, which is included by the Fed in L but not

in M-2 or M-3. Savings bonds, in contrast to all other Treasury securities, are redeemable at any time by the

Treasury. They should therefore be included in the money supply. A problem, however, is that they are

redeemable not at par, but at a fixed discount, so that if total savings bonds, to be accurately incorporated in

the money supply would have to be corrected by the discount. Still, more [p. 259] problems are proffered by

another figure not even considered or collected by the Fed: life insurance cash surrender values. For money

invested for policyholders by life insurance companies are redeemable at fixed discounts in cash. There is

therefore an argument for including these figures in the money supply. But is the Fed then supposed to extend

its regulatory grasp to insurance companies? The complications ramify.

But the problems for the Fed, and for Friedmanite regulators, are not yet over. For should the Fed

keep an eye on, and try to regulate or keep growing at some fixed rate, a raw M-l, or M-2 or whatever, or

should it try to control the seasonally adjusted figure?

In our view, the further one gets from the raw data the further one goes from reality, and therefore the

more erroneous any concentration upon that figure. Seasonal adjustments in data are not as harmless as they

seem, for seasonal patterns, even for such products as fruit and vegetables, are not set in concrete. Seasonal

patterns change, and they change in unpredictable ways, and hence seasonal adjustments are likely to add

extra distortions to the data.

Let us see what some of these recent figures are like. For March 1982, the nonseasonally adjusted

figure for M-1 was $439.7 billion. The figure for M-2 was $1,861.1 billion. If we deduct money market

mutual funds we get $823 billion as our money supply figures for March 1982. There are at this writing no

savings bonds figures for the month, but if we add the latest December 1981 data we obtain a money supply

figure of $891.2 billion. If we use the seasonally adjusted data for March 1982, we arrive at $835.9 billion for

the corrected M-2 figure (compared to $823.1 billion without seasonal adjustments) and $903.6 billion if we

include seasonally adjusted savings bonds.

How well the Reagan Fed has been doing depends on which of these Ms or their possible variations

we wish to use. From March 1981 to March 1982, seasonally adjusted, M-1 increased at an annual rate of

5.5%, well within Friedmanite parameters, [p. 260] but the month-to-month figures were highly erratic, with

M-1 from December 1981 to February 1982 rising at an annual rate of 8.7%. Seasonally adjusted M-2,

however, rose at a whopping 9.6% rate for the year March 1981-March 1982.

The numerous problems of new bank instruments and how to classify them, as well as the multifarious

Ms, have led some economists, including some monetarists, to argue quite sensibly that the Fed should spend

its time trying to control its own liabilities rather than worrying so much about the activities of the commercial

banks. But again, more difficulties arise. Which of its own actions or liabilities should the Fed try to control?

The Friedmanite favorite is the monetary base: Fed liabilities, which consist of Federal Reserve notes

outstanding plus demand deposits of commercial banks at the Fed. It is true that Federal reserve actions, such

as purchasing U.S. government securities, or lending reserves to banks, determine the size of the monetary base, which, by the way, rose by the alarmingly large annual rate of 9.4% from mid-November 1981 to

mid-April 1982. But the problem is that the monetary base is not a homogeneous figure: It contains two

determinants (Federal Reserve notes outstanding + bank reserves) which can and do habitually move in

opposite directions. Thus, if people decide to cash in a substantial chunk of their demand deposits, FRN in

circulation will increase while bank reserves at the Fed will contract. Looking at the aggregate figure of the

monetary base cloaks significant changes in the banking picture. For the monetary base may remain the same,

but the contractionist impact on bank reserves will soon cause a multiple contraction in bank deposits and

hence in the supply of money. And the converse happens when people deposit more cash into the commercial


A more important figure, therefore, would be total bank reserves, which now consist of Federal

Reserve notes held by the banks as vault cash plus demand deposits at the Fed. Or, looked at another way,

total reserves equal the monetary base minus FRN held by the nonbank public. [p. 261]

But this does not end the confusion. For the Fed now adjusts both the monetary base and the total

reserve figures by changes in reverse requirements, which are at the present changing slowly every year.

Furthermore, if we compare the growth rates of the adjusted monetary base, adjusted reserves, and

M-1, we see enormous variations among all three important figures. Thus, the Federal Reserve Bank of St.

Louis has presented the following table of growth rates of selected monetary aggregates for various recent


While total reserves is a vitally important figure, its determination is a blend of public and private

action. The public affects total reserves by its demand for deposits or withdrawals of cash from the banks. The

amount of Federal Reserve notes in the hands of the public is, then, completely determined by that public.

Perhaps it is therefore best to concentrate on the one figure which is totally under the control of the Fed at all

times, namely its own credit.

Federal Reserve Credit is the loans and investments engaged in by the Fed itself, any increase of which

tends to increase the monetary base and bank reserves by the same amount. Federal Reserve Credit may be

defined as the assets of the Fed minus its gold stock, its assets in Treasury coin and foreign currencies, and the

value of its premises and furniture.

Total Fed assets on December 31, 1981 were $176.85 billion. Of this amount, if we deduct gold,

foreign currency, Treasury cash and premises, we arrive at a Federal Reserve Credit figure of $152.78 billion.

This total consists of: [p. 262]

1. float-cash items due from banks which the Treasury has not yet bothered to collect: $10.64 billion

2. loans to banks: $1.60 billion

3. acceptances bought: $0.19 billion