How Should The Money Supply Be Defined?
Mike Shedlock argues against the view that there is strong inflationary pressures in the
Mike Shedlock is generally a good economic analyst, but he suffers from one fatal flaw: he believes in Frank Shostak's definition of the money supply. The problem with that is that Shostak have a far too narrow definition. Exactly which items are included in that definition is not clear, as he in his article about the money supply only argues against including certain items, rather than specifying exactly what is included. But it seems fairly similar to M1.
Shostak for example excludes Money Market Mutual Funds despite the fact that you can use your holdings in them as a means of payment by for example writing a check on the ground that when you write a check you instruct the fund to sell assets and then the money is transferred to the holder of the check and so money is only transferred, not created. But this is just another case of Shostak being completely clueless. Advocates of including MMMF:s in the money supply have never argued that money is created when people reduce their MMMF holdings by for example writing a check. Quite to the contrary, here the money supply is being reduced as MMMF holdings fall while the amount of cash is held constant and transferred from the buyer to the seller. The money creation instead occurs when people deposit money in MMMF as the seller of the assets receives cash while the depositor simultaneously also has money in the form of MMMF assets, while before the transaction only the future depositor had money in the form of cash.
Shostak also argues against including saving deposits because banks formally have the right to insist on a 30 day waiting period. But to this Murray Rothbard pointed out:
"The objection fails to focus on the subjective estimates of the situation on part of the depositors. In reality, the power to enforce a thirty day notice on saving depositors is never enforced; hence, the depositor invariably thinks of the savings account as redeemable in cash on demand. Indeed, when in the 1929 depression, banks tried to enforce this forgotten provision in their savings deposits, bank runs promptly ensued"
Thus, since money deposited in savings deposits can be used as a means of payments they should be included in the money supply. That should be the general principle in determining what is and what isn't money: can it be used as a means of payment. That would indeed include both savings deposits and MMMF:s.
Shedlock also tries to put up an empirical defense of Shostak’s definition. He claims that it accurately predicted 6 out the latest 6 recessions, although he concedes it gave two false signals, in 1985 and 1995. However, looking at his chart, it did not in fact predict the most severe of all recessions, the one in 1981-82, where it fluctuated between 5 and slightly above 10% during and before the recession, but did not show a downward trend.
What's worse, the measure failed to predict the late 1990s tech stock bubble, as money supply growth remained moderate during the entire era. By contrast, measures like M3 and MZM did rise in reflection of the tech stock bubble.
Also, recessions need not be associated with falling money supply growth if there is stagflation. Money supply growth has been extremely high and rising in