The Shostak Inconsistencies

Frank Shostak is out with an article at Mises.org that argues that money market funds should not be considered part of the money supply. I will argue that he is in error because his argument looks at the wrong part of the transaction. Indeed, I will argue that he implicitly looks at a similar transaction differently from the way he looks at money market funds. Thus, there is internal inconsistency within his article.

Here are the details.

Shostak is dismissing the concerns about the huge decline in M3, and while we focus on M2, when monitoring money supply (which is showing zero growth, rather than a decline) the general argument still holds.

Shostak writes, and this is where his confusion begins:

In order to account correctly for money, one must make a distinction between money that is deposited and money that is loaned out.

He continues:

Individuals can exercise their demand for money in a variety of ways. For example, they can keep money in a jar, or under the mattress, or in their wallets, or place the money in a bank warehouse. From this it follows that the overall amount of money in individual holdings should be the sum of money they hold in bank warehouses also known as demand deposits plus the money they hold outside banks warehouses.

Here's where his confusion becomes obvious:

This, in turn, means that the inclusion of various term deposits such as large time deposits and money market mutual funds deposits into the definition of money such as M3 produces an erroneous account of the amount of money in the economy.


For instance, Tom places $1,000 into a long-term saving account with Bank 1. The bank in turn lends this $1,000 to Mike. This type of transaction temporarily transfers the ownership of the $1,000 from Tom to Mike. Consequently, to add $1,000 in Tom’s long-term saving deposit into the definition of money will lead to double counting since this money resides either in Mike’s pocket or in Mike’s demand deposit.

Notice that Shostak doesn't mention demand deposit money that is loaned out. In such a case, the recipient of deposited demand deposit money and the original depositor of the demand deposit use their funds in the economy bidding for goods and services. Thus, the key IS NOT, as Shostak originally states, whether money is loaned out or deposited BUT which accounts are in fact actively used in the economy at any given time.

Since M3 includes money market funds and large time deposits, some of the supply (the money market factor) is indeed money, but not the large time deposits. Why so? Because money market money is out being used actively in the economy. Some people use money market funds  to pay their monthly bills, from rent to electric bills etc. Thus, it is actively being used. M2 incorporates this, but does not include the non-money large time deposits (No one uses a large time deposit to pay bills). This is why I use M2 instead of M3. However, Shostak dismisses M2, as well as M3, because of the inclusion of the money market funds measure.

Yet, it should be clear that if he identified how demand deposits are used in his money supply measure which he labels AMS, it would become clear that he is caught in an inconsistency by including demand deposits and not money market funds, since demand deposit money is loaned out bidding up goods as is the original depositor of the demand deposit funds. Further, it would reveal his confusion of his definition of money as being determined by "the distinction between money that is deposited and money that is loaned out."


From here, Shostak does reach the same conclusions that an Austrian monitoring M2 would that there is a slowdown in money printing that should result in a slowdown in the economy (a double dip) and a decline in the stock market, like the type we are currently witnessing.

However, AMS and M2 do not always move in tandem. For example, during a flight to safety, many may (as they did during the recent crisis) move funds from money markets to cash or demand deposits. This is a move within the forms of money and will give false signals to anyone watching AMS. AMS watchers will interpret this as a huge growth in money supply when it is a transfer between types of money.

Bottom line: Keep an eye on M2 to understand what is going on with the money supply not Shostak's AMS, which, btw, is based on Murray Rothbard's True Money Supply.