Wednesday, 25 January 2017

Recap 2016: The "Austrian" True Money Supply for the U.S.

Over the years, there have been some debate about the proper way to define the money supply. This debate centres on the broader components of the money supply as there is no debate that the most liquid components such as currency and demand deposits should be included. 

As a response to this debate, Austrian school economists Murray N. Rothbard and Joseph T. Salerno responded by compiling a measure of the money supply “…that is consistent with the theoretical definition of money as the general medium of exchange in society” [1] and which was “…based on the definition of money [in the broader sense] as originally formulated by Ludwig von Mises in his book The Theory of Money and Credit.” [2] This Austrian school definition of the money supply is better known as the “Austrian” True Money Supply, or simply as the True Money Supply (TMS).

A distinguishing feature of whether an item should be counted as money according to Rothbard and Salerno is if it serves as the final means of payment in all transactions. The use of credit cards illustrates this point. When payments are made with a credit card, the debt is not finally discharged until money is transferred from the bank account of the credit card holder to the credit card issuer. The credit card transaction is hence just an intermediary transaction, while money transferred from the bank account is the final payment. Therefore, credit card balances are not counted as part of the TMS, while cash in the bank account is. 

A second test for including items in the TMS is that they should be instantly redeemable, par value claims to cash. For example, Large Time Deposits do not qualify to be included in the TMS since they are not par value claims to immediately available money. Why? For the simple reason they are time liabilities not payable by the issuing institution before maturity. It could perhaps be possible to draw on them immediately, but this would come with a financial penalty of some sort. In a similar fashion, Small Time Deposits are excluded from the TMS because they “… involve loans by the public to banks and thrifts.” [3] Also, Retail Money Funds are not money as they pass neither of the two tests.

Based on these two tests described above, the TMS consists of the following components, all of which can be downloaded individually from the Federal Reserve website on a monthly basis (items are hyperlinked so you can click for a closer look at each): [4]

The first four of these components are also included in the widely cited Federal Reserve definition of a broader measure of the money supply - the M2 money supply  - while the last four are not included in any of the money supply aggregates reported by the Federal Reserve. The TMS hence include money balances held by the government and official institutions while the official definitions of the money supply do not. 

The reasons these government/official institution money balances are included in the TMS are straight forward. First of all, money held by government institutions can be just as readily spent as money held by the non-bank public. Secondly, these balances pass the two tests of what should be defined as money.

As they did not pass the two tests described above, Travelers Checks, Small Time Deposits and Retail Money Funds - all included in the M2 aggregate - are all excluded from the TMS. Large Time Deposits is not included either for reasons mentioned above. 

We see therefore that the main difference between the frequently sited M2 money supply and the lesser known TMS is that the former includes Small Time Deposits and Retail Money Funds while the latter excludes both. Additionally, the TMS includes balances held government institutions while the M2 money supply does not. 

For reasons already mentioned, the TMS is superior to M2 as it applies a precise definition of money. Naturally, there is a close correlation between the two as both count currency, demand- and other checkable deposits, and savings deposits as part of the money supply. These items make up the bulk of the money supply in the broader sense no matter how it is defined. For example, at the time of writing these items make up about 88% of the M2 money supply and 96% of the TMS. Given the dominance of these items, the M2 money supply is useful as a measure of monetary inflation. But, since the TMS is superior as a definition of the money supply and as significant differences can occur between the two at times, especially with respect to the growth rate (which is more important than the absolute quantity of money), TMS should be the monetary aggregate of choice. Today, this is more true than in a long time since Treasury deposits with the Federal Reserve have grown rapidly in recent years.

Historically, U.S. Treasury deposits with the Fed played a negligible role for the money supply as it averaged just US$5.8 billion on a monthly basis during the January 1986 to September 2008 period. Since 2009 however, the average has jumped to US$103.5 billion. At the end of 2016 the balance was US$311.3, the highest ever recorded and representing about 2.6% of the TMS. 

This component of the money supply has therefore become increasingly important of late. Why this change? The answer appears to be twofold. Firstly, there are indications the Federal Reserve is now actively using this account as part of monetary policy. In an effort to reduce bank reserves, tax revenues are now collected in this account with the Fed instead of in U.S. Treasury accounts with commercial banks. [5] Secondly, the account balance has apparently also increased due to the treasury receiving interest payments from the Federal Reserve’s large holdings of treasury- and mortgage-backed securities. These interest payments to the Treasury have grown significantly in recent times following the substantial increase in interest-paying assets accumulated by the Fed during the 2009 to 2014 period (QE 1, 2 and 3). [6] Unless the Federal Reserve undertakes a policy shift and decides to dramatically shrink its balance sheet, this component of the money supply will be of significance going forward as well. [7]

A feature of the elastic money supply (soft currencies) employed today is that the quantity of money constantly increases at a high rate. In contrast, a largely inelastic currency (hard currencies) such as money backed by gold, would only increase relatively modestly over time. As mentioned briefly above, it is not the absolute amount of money per se that matters to economic developments. Instead, it is the rate of change in the money supply that affects developments, of which the business cycle is of great importance. That is why investors, economic pundits, and any student of economic developments must include monetary developments in their analysis - the analysis would be half-hearted without. 

Following the surge in the money supply during the four-year period spanning 2009 to 2012, the money supply growth rate dropped significantly in 2013. Until summer 2016, the growth rate was characterised by unprecedented stability (certainly when based on data since 1986) before it increased sharply until October 2016, caused by a surge in Treasury deposits with the Federal Reserve. The growth rate then fell sharply in October and November, but ended the year up  8.7% - the highest year-end growth rate since 2013. The money supply expanded US$973 billion during 2016, the biggest increase ever in monetary terms, to end the year on US$12,158 billion (more than US$12 trillion). 

Here are some other observations based on the table:
  • The money supply has more than doubled since 2008 - an annual growth rate of 10.5%.
  • Since 1986, the money supply has expanded an average of 7.1% every year.
  • The money supply has contracted on only two occasions on a yearly basis since 1986: 1989 and 1995.
  • On a 5-year annualised basis, the growth rate of the money supply prior to 2001 looks moderate compared to what has been the case ever since. 

An increase in the quantity of money confers no benefit to overall society. What people really desire is increased purchasing power. Sadly, an ever-inflating money supply achieves the exact opposite. So, while any economic aggregate measured in monetary terms, e.g. GDP (both nominal and real) and stock market indexes, have increased as a consequence, many people have found that their purchasing power has declined significantly. True, there has been no financial bust and crisis yet since 2008. What has happened instead is a substantial loss in purchasing power for the great majority of Americans. This can be seen clearly in the chart below where personal income as a percentage of the money supply has fallen more or less consistently since the early 2000s. Currently, the ratio is at the lowest level ever based on data since 1987. 

Personal income / True Money Supply

Whether we get another bust or not in 2017 remains to be seen. But as long as the money supply growth rate remains high, we should not become surprised if the purchasing power of most Americans continues to slump further this year. 

[2] True Money Supply (Mises Wiki 2016).
[3] (Salerno, 1987, p. 4).
[4] The first four items are also available on a weekly basis. Definitions of the items are taken from the Federal Reserve website.
[5] Federal Reserve Watch (Mason, 2016).
[6] See The Cozy Relationship between the Treasury and the Fed (Howden, 2016) and Treasury Deposits at Fed Prop Up Money Supply Again in January (McMaken, 2016). As McMaken notes: “With the economy weakening and deflationary pressures mounting, this close relationship between the Fed and the Treasury has proven to be an easy way to increase the money supply.” It should here be noted that these interest payments do not actually lead to an increase in the money supply as the initial interest payments from the U.S. Treasury to the Federal Reserve lead to a reduction in the money supply. When the treasury then next receives interest payments back, this merely helps to offset part of the initial reduction in the money supply. Howden points out that the Fed returning interest payments to the Treasury means the U.S. government’s net interest expense is reduced accordingly (as almost 55% of the Fed’s assets, or nearly US$2.5 trillion, consists of U.S. Treasury Securities as of March 2016 according to the Federal Reserve balance sheet). This arrangement with the Fed hence reduces the Treasury’s borrowing costs and effective interest rate on debt significantly. Also, this arrangement means the government gets its hands on more money than otherwise would be the case if these securities were in the hands of the non-bank public instead of the Fed (as investors, and not the Treasury, would then receive the interest payments).
[7] The Treasury Borrowing Advisory Committee (TBAC) has recommended the treasury keeps a US$500 billion balance in this account: “…the TBAC recommended that Treasury hold a $500 billion cash balance, or 10-days of liquidity, to ensure that all government obligations could be met in the event that Treasury lost market access” (U.S. Department of the Treasury, 2014). If there ever was a firm commitment to keep an emergency balance of say $500 bn, this would mean we could exclude that amount from the money supply as long as the Treasury has access to markets. Removing it would of course reduce the money supply accordingly.


  1. Is there any way to estimate growth rate of eurodollar (USD in Europe banks)?

  2. Hi Dmitry,
    Good question: the Fed doesn't publish it. I think they used to, but not anymore. I looked unsuccessfully elsewhere for that data some years back. Do let me know should you ever find a reliable source.

    Atle W.