The money supply or money stock is the total amount of monetary assets available in an economy at any specific time. The different types of money stocks start with the capital letter M followed by a Number or a letter.
Not all of the classifications are widely used, and each country may use different definitions for the classification. Because of this, each classification may mean something different depending on the country. For example, In the United Kingdom M0 includes bank reserves, so M0 is also referred as the monetary base. This is how all the classifications break down.
M0: =The total of all physical currency including coinage. M0 = Federal Reserve Notes + US Notes + Coins. It does not matter whether the currency is inside or outside of the private banking system.
MB: =The total of all physical currency plus Federal Reserve Deposits. These Fed deposits are special deposits that only banks can use at the Federal Reserve. MB = Coins + US Notes + Federal Reserve Notes + Federal Reserve Deposits
M1: =The total amount of M0 (cash/coin) outside of the private banking system plus the amount of demand deposits, travelers checks and other checkable deposits
M2: =M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).
MZM: =Money Zero Maturity. This M is one of the most popular aggregates in use by the Federal Reserve today because it has historically been the most accurate predictor of inflation. It is made up of M2 – time deposits + money market funds
M3: =M2 + all other CDs (institutional money market mutual fund balances, large time deposits). It also includes deposits of euro-dollars and repurchase agreements.
M4-: =M3 + Commercial Paper
M4: = M3 + Commercial Paper + T-Bills
L: =M4 + Bankers’ Acceptance
The Federal Reserve always published data on the M1, M2, and M3 supplies, but on November 10, 2005 The Federal reserve announced that it will no longer report M3 data. Since March 2006, it stopped all publication of M3 data. The Federal Reserve has stopped reporting on the M3 supply ever since.
Inflation happens when the current value placed on money decreases. The value of money is worth less. Deflation has the opposite effect of inflation. With deflation, the value of money increases. Three basic things can cause inflation. A counter balance of these three things can also cause deflation.
The first variable that can cause inflation is supply and demand. If there is a lot of demand for a particular product but little supply, the price can go up. If there is a big supply but little demand, the price can go down.
The second thing that can cause inflation is cost. When things cost more to make or costs associated with the sale of any given product goes up it squeezes the profit margin. In most cases, these costs can pass on to consumers as the price to produce those goods increase.
A good example of this is the price of gas. When gas skyrocket, it cost more to bring goods to market. As a result, the higher cost of fuel passes on to consumers. This is why groceries have gone up with the rising cost of fuel.
The third thing that causes inflation is the money supply. When the supply of money dramatically increases and more money becomes available to the public, the cost of everything goes up as people have more money to spend. This is the danger of printing too much currency.
The Federal Reserve Banks became operational during the second decade of the 1900’s. This was during World War I. Their first major task was to support the U.S. Treasury’s wartime financing needs. Most of the credit they created was during the years 1916–1920. This credit was meant to support Liberty Loans the government floated to help finance the war and its aftermath. Their subsequent contraction of credit in 1920 contributed significantly to the recession and the deflation that occurred in 1921–1922.
Average Inflation Rates Per Year
1921- minus 10.5 percent
In November of 1918, the inflation rate for that month alone was 20.7 percent
The economy quickly recovered after 1922 and America headed into the Roaring 20’s. By 1929, the money supply was expanded by 62 percent.
Meanwhile margin loans created access to the stock market. Anyone could now invest in the market due to these margin loans. This extra debt also aided in the expansion of the money supply during this decade, but it did not enter into general circulation. This kept inflation from rising dramatically but ultimately, this very loan process sparked the great depression. The Feds began to contract the money supply after 1929. At the same time the federal government began to confiscate America’s privately held gold. All these circumstances led to deflation and these events served to prolong the great depression.
Since the Federal Reserve took over in 1913, our money supply has been expanding at an unprecedented rate. The cumulative rate of inflation since 1913 has been 2302.5%. Today our money supply has been so debased and expanded that the value of 1 dollar in 1913 is equivalent to $24.03 in 2014. Twenty dollars in 1913 is equivalent in value to $480.51 in 2014.
Fiat is the Latin word for “it shall be”. Most currencies were based on physical commodities such as gold or silver at one time, but fiat money is based solely on faith. Fiat currency is money that a government has declared to be legal tender. Fiat currency cannot be exchanged by any commodity used to back it. It could also be that the fiat currency in question is not backed with a physical commodity, and it has no intrinsic value. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that the money is made of or the commodity it represents.
It is amazing to see how much the money supply has expanded in America since 1913.
Expansion and contraction of the Money Supply
Contractionary monetary policies and expansionary monetary policies involve changing the levels of the money supply. There are a few ways to do this but before I explain the methods involved let’s discuss why money is expanded and contracted.
An increase in the supply of money normally lowers interest rates. This in turn generates more investment there by putting more money in consumer’s pockets. In most cases, this will stimulate spending.
Businesses around the world respond by ordering more raw materials and increasing production. This increased business activity will always raise the demand for labor. The opposite usually occurs if the money supply falls too far.
The trade off for too much expansion is a higher inflation rate, which decreases the currency’s value. Central bank policies attempt to balance inflation with economic growth. This is why the Federal Reserve will contract or expand the money supply. These are just some of the ways the Federal Reserve can expand or contract the money supply.
The Federal Reserve may Increase the interest rate at which it lends money. This action will also increase the rates at which banks lend money. When rates are higher, it becomes more expensive for individuals to obtain loans. This will reduce spending among consumers. It will also reduce the amount of debt. This is one way the money supply is contracted.
Banks are required to keep a reserve from cash deposits to meet withdrawal demands. In the past, this reserve requirement has been 10 percent. If the reserve requirements are increased, the commercial bank has less money to lend out, thus over time, there will be a lower money supply.
Notice that these two contraction measures involve the loan process. This is because all debt becomes monetized through the loan process and it turns into money. This happens through the process of Fractional Reserve Banking. This also means when debt is fully paid and removed from the books money is taken out of circulation.
After the 2008 meltdown millions vanished, not only was this due to wrongly perceived values in the housing market, but it was also due to the abnormal amount of bankruptcies. Bankruptcy filings in 2008 rose 32% as compared to 2007. This was in part because credit was very limited and in part because of the new unemployment rates. As debt was removed from the books through bankruptcy, money also vanished from circulation.
Central banks can also contract from the money supply by borrowing money from institutions or individuals by selling bonds. When the Federal Reserve increases the interest rate paid on these bonds, investors will be encouraged to buy them. This will increase the sales of these bonds. This will also take money out of circulation. It will also pull money from the stock market.
Central banks can also reduce the amount of money they lend out or call in existing debts to reduce the money supply.
The Federal Reserve says that at any given time, between one-half or two-thirds of the U.S. money supply (M0) is overseas beyond our borders. Because the money overseas is not in circulation in America, it has no direct impact on Inflation in the United States. This is not even counting the electronic currency overseas.
Even though there is a lot of currency in print, only the currency in America has a direct impact on inflation or deflation in America. There is a lot of U.S. currency overseas that remains in central banks. This currency functions as a reserve to back other currencies. The currency overseas that is located in central bank reserves does not have a direct impact on inflation abroad because it is not in public circulation. Since 2008, there has actually been a dollar shortage in some countries. At the time of this writing, the global demand for dollars remains strong.
A Trillion Dollars
So how what does a trillion dollars look like? The video below shows what a trillion dollars looks like in 100 dollar bills.
The next video shows a trillion dollars in 1 dollar bills. It provides a unique perspective.