Monday, August 5, 2013

Bugos on the Money Supply, Again

Ed Bugos writes:
>> “even funds in a checking account can shrink the money supply if a person that is given a check that is drawn on a bank checking account cashes the check by going to the bank and asking for currency”

Robert: that is nonsense.  Currency in circulation is counted as money supply.  The cancellation of a demand deposit may reduce deposit liabilities but shouldn’t reduce money supply.  If it does it is a technical error.

I am Cc’int Salerno on this, and emailing him separately in hopes of settling the matter.

I disagree with your criticism even after having read that section in Salerno’s book.  Dr. Mark Thornton confirmed with me in a private email that MMF’s do in fact introduce a double counting error, as they are already counted in the firms who originally borrowed the funds, he said.

You also kind of misled your readers on what I meant by a priori and the use of the term “objective”.  I never said it the way you did.  I could just as easily say there is no such thing as “subjective money” in criticizing your objection.  I meant an objective definition, not objective money.  Re read my post.  There is so an objective “definition” of money.  The value of money is subjective but its definition shouldn’t be –IF THE PURPOSE IS TO ISOLATE THE EFFECT ON MONEY SUPPLY COMING FROM THE BANKING SYSTEM, and if you want any hope in hell of some sort of consensus among economists.

I think Rothbard is right to define money subjectively in one sense, but from the sense of trying to count the money supply it is problematic for the reasons I’ve mentioned.  Again, I found it useful in constructing my index to settle on two basic rules: 1) defining money as the good that can be used in the final payment of goods, services and legal debts (MMF’s fail this criteria); and 2) no double counting (despite your objection they fail here too).

#1 is an attempt at keeping the definition of money objective.  #2 is just a logical check.


Ed Bugos


1. I never said that currency is not counted as part of the money supply. However, the removal of money from a bank by requesting cash most certainly has the potential to shrink the money supply on very technical grounds that almost any monetary economist would acknowledge. In fact, I don't think there is any dispute about this fact in the economics profession at all. In The Concise Encyclopedia of Economics, George G. Kaufman writes:
[...] because currency (an important component of bank reserves) would be removed from the banking system. Banks operate on a fractional reserve basis, which means that they hold only a fraction of their deposits as reserves. When people try to convert their deposits into currency, the money supply shrinks, dampening economic activity in other sectors.

Here's Milton Friedman and Anna Schwartz on the topic in A Monetary History of the United States, 1867-1970 (p.51):
The ratio of commercial bank deposits to currency held by the public: The higher the ratio, the larger the fraction of high powered  money that will be in use as bank reserves, and hence the larger the money stock[...]

In  America's Great Depression, Rothbard explained how this actually occurred during the Great Depression (p.261):
Normally, money in circulation [currency] declines in the first part of the year, and then increases around Christmas time.The increase in the first part of this year [1931] reflected a growing loss of confidence by Americans in their banking system—caused by the bank failures abroad and the growing number of failures at home. Americans should have lost confidence ages before, for the banking institutions were hardly worthy of their trust. The inflationary attempts of the government from January to October were thus offset by the people's attempts to convert their bank deposits into legal tender[...] 
[In the latter half of 1931] Money in circulation [...] continued to increase sharply, in response to public fears about the banking structure as well as to regular seasonal demands. Money in circulation therefore rose by $400 million in these three months. Hence, the will of the public caused bank reserves to decline by $400 million in the latter half of 1931, and the money supply, as a consequence, fell by over four billion dollars in the same period.
Far from being nonsense, it is a simple technical point understood by monetary economists across the economic spectrum.

2. With regard to your exchange with Dr. Thornton, I  simply believe that both of you are viewing what occurs with MMFs after they have done bidding in the market. At the time they are used in market bidding, they are certainly functioning like money, that is they are generally accepted for exchange, specifically via debit card or check.

It would be interesting to know what Dr Thornton's view is of  including the cash value of whole life policies as part of the money supply, as Rothbard does in America's Great Depression.

3. As for your use of the term, a priori “objective” definition of money, in your original comment it sure looks to me as though you are contrasting Rothbard's subjectivism with your, a priori “objective” definition of money. You write :
You are correct that Rothbard had a very broad definition of the money supply.  I chose to discount the reach of his subjectivism based on an a priori “objective” definition of money (whether it can be used as final pmt for goods, services and legal debts) and based on the double counting problem.
It seems to me you are mixing the definition of money, with what people specifically use as money. Money is a medium of exchange, beginning and end of story. That's the definition. But, what people consider the medium of exchange can only be known by observation not by a priori thinking. Indeed, Ludwig von Mises, no fan, generally, of empiricism over a priorism, drove this point home in Human Action (p. 468)
That gold--and not something else--is used as money is merely historical fact and as such cannot be conceived by catallactics. 
To move further in along this chain of thinking, if, say, dollars are used as a medium of exchange, then any assets held by an individual, which he believes provides him with immediate access to cash in a known quantity, should be considered part of the money supply. Cash in his wallet, cash in a safe, cash in a bank checking account and cash in an MMF (which can be immediately be withdrawn via debit card or check.)

1 comment:

  1. My company holds investments that it can quickly sell for cash. While not as liquid as pure cash, they are considered to be readily available reserves. Rather than haggle about the precise definition of money, the important thing is that under the current system, some people are getting it unjustly through the Fed and the fractional reserve banks.