The Great Expansion


By official estimates, the money supply (M3) has risen by more than 40 % since 2000. The chart below gives a graphical representation of the monetary expansion.


A 40% rise in M3 might not seem so troubling, if it were not for the fact that the "real" money supply might have grown a great deal more. That is to say, no one knows exactly how to define money these days, as Fed chairman Alan Greenspan has admitted in Congressional testimony (February 17, 2000). Rumors are afoot that the government has been souping up economic stats for years: using all kinds of "seasonal" adjustment tricks to make the job market and inflation rosier than they are in reality. Could they be doing the same thing in regards to monetary expansion?

Consider some more official stats, this time stats of net credit borrowing:



Total net borrowing has risen by more than 45%. Why is this important? Because, to put it briefly, most of the rise in credit borrowing arises out of monetary expansion. They are virtually one and the same thing. The savings rate during the same period was only about 2% of GDP, while net credit borrowing was over 20% of GDP! From these stats, we can see quite clearly where the money to fund net credit borrowing comes from! Indeed, the net credit borrowing and M3 are virtually one and the same; that is to say, the rise in net credit borrowing is primarily what caused the rise in M3.

But let's examine these numbers even more rigorously. Between 2003 and 2004, M3 rose only by 6.2%. Yet net credit borrowing, in roughly the same period rose by 20%. How do we explain this anomaly? Why isn't the immense rise in net credit borrowing (20%) reflected in a rise in the money supply? Where is all the borrowed money going?

Here's one explanation worth pondering: perhaps it's being absorbed by bad debts. Suppose you have an immense amount of net credit borrowing. Well, credit is really debt looked at from the other side of the ledger. So when we talk of net credit borrowing, we could just as easily say net debt lending. What happens when those debts aren't paid? Just as when the credit is created, the money supply expands, so when it is destroyed through debt defaults, the money supply shrinks. I have repeatedly in the last few years warned of the dangers of a massive deflation. The Fed and other monetary authorities have attempted to stave of the deflation by flooding the market with liquidity, using the method of credit expansion to get it done. In other words, more debt is created to plug holes created by previous debt.

How long can they get away with this? With the economy reeling in mediocrity, it's not clear that this policy can last too much longer. If we escape deflation, we'll only fall headlong into stagflation: high inflation coupled with a high unemployment rate.

Posted: Fri - August 13, 2004 at 04:14 PM          

©