Yesterday, I wrote a post titled "Who Killed M3?
" that explored a Bush-era decision to stop tracking a key measure of money supply, and its link to the housing bubble. Today, I explore that further.
What did George W. Bush have against M3 that made it important enough to risk the world economy to get rid of? It was an inconvenient measure of inflation -- a kind of inflation that Bush really liked, being monetary inflation rather than price inflation. Monetary inflation tends to lower the long-term cost of deficits, because they are repaid with cheaper dollars. But it is inflation nonetheless, and a potential political embarrassment. Was that
It could well have been. Think for a moment about W's character. If there was something potentially embarrassing he really liked, whether it was an arcane type of inflation or cocaine, what better way to deal with it than to pretend it didn't exist?
So M3 had to die.
M3, along with its sister numbers M1 and M2, was a measure of the money supply -- the amount of money available for use in the economy at a given moment. M1 is currency in circulation, commercial bank demand deposits, automatic transfers from savings accounts, savings-bank demand deposits and travelers checks -- money you could spend this afternoon. M2 is overnight repurchase agreements between banks, overnight eurodollars, savings accounts, CDs under $100,000 and money market shares -- money you could get to in a few days if you needed to, though possibly with an early withdrawal penalty. M3 was M1 plus M2 plus everything else, which came over the past decade to include exotic instruments that could add hundreds of billions to the money supply overnight.
You might think the amount of money is pretty constant and defined by printing presses down at the Mint, but that's not true. Banks make money all the time from nowhere and nothing simply by advancing credit to customers with that credit backed hardly at all by reserves or collateral. Banks -- not governments -- make money. And the more money the banks make to represent the same economy -- the same production of goods and services -- well THAT increase in money supply is inflation.
And inflation is bad, right? We hate inflation. Inflation is evil.
That's what Milton Friedman always thought.
Unless you are a strict monetarist, inflation has only two causes. First there is price inflation, which is based on the idea that prices go up with demand, so that piece of art suddenly represents more $100 bills than it used to even though the Mint hasn't printed any more bills. Nearly everyone hates price inflation and Fed chairmen always do what they can to contain it. The second cause of inflation is growth in the money supply, based typically on supply and demand fluctuations in the value of money, itself.
Milton Friedman said, "Inflation is always and everywhere a monetary phenomenon." We saw this in action in the late 1970s when Fed chairman Paul Volcker starved inflation by tightening the money supply, driving interest rates through the roof.
But the Fed under Greenspan and Bernanke behaved as if money supply growth didn't matter and price inflation was all that mattered. Even if they raised interest rates, for example, in an effort to slow the economy and reduce demand, they let the money supply grow at double-digit rates.
The Fed could appear to be fighting inflation with interest rate policy while simultaneously allow the money supply to grow without restriction. They did this, we were told, because the Greenspan/Bernanke view was that money supply by itself was not a good indicator of future inflation.
This view is nonsense on many levels. It completely ignores, for example, the very conversion of the banking system from being backed by demand deposits (M1 and M2) to being almost entirely backed by collateralized REPO exchanges (M3 minus M2) built of money made from nothing. For another, it ignores the fact that money supply increases are inevitably connected to the growth of asset bubbles like the dot-com bubble of the late 1990s and the recently-popped U.S. housing bubble.
When asset prices increase beyond reason and that increase is accompanied (and fueled by) a comparable increase in the money supply, you know you have an asset bubble and sooner or later that bubble is going to pop.
Deciding to no longer even measure the total money supply makes it much easier to ignore bubble growth and to deny that a pop is coming, which is what happened to the U. S. in 2007 and beyond.
So, rather than killing-off M3 in 2006, you'd think the Federal Reserve would have spent money to develop and publish data for an M4 and maybe an M5 to track the ebbs and flows of an even-more-expansive definition of money that includes some of the new forms of money manufactured on Wall Street and in other global banking sectors.
The Fed decided to kill M3 because it was the measure that showed the fastest growth in the money supply. M3 always grew faster than M2 and way faster than M1. M3 was embarrassing, then, for the supposed inflation fighters.
This was exactly the kind of monetary policy you'd expect from the world's greatest debtor nation. Use your credentials as a short-term inflation fighter to convince global savers it's safe to buy U. S. dollars and U. S. debt, while at the same time supporting the long-term inflation that would cut the future value of that debt and thus let the U. S. pay back its current debt in less-valuable future dollars.
It was all about fooling the Saudis and the Chinese, then, and the American people, too.
It is doubtful that M3 was killed to deliberately set the stage for the Great Recession. But that's what happened.