Posts Tagged ‘M3’

Demand for money, inflation/deflation & its implication

Tuesday, December 2nd, 2008

Two years ago, we first covered the root cause of inflation in Cause of inflation: Shanghai bubble case study:

The mainstream economists? definition of inflation is rise in the general level of prices. However, according to the Austrian School of economic thought, the definition of inflation is the increase in the supply of money, in which the effect is the rise in the general level of prices.

As we have shown in yesterday’s chart in Australian money supply growth in September 2008, the supply of money in Australia had gathered momentum in the month to September 2008. In 12 months, the M3 money supply increased by 19.5%. The narrower definition of money, M1, increased by 8.3%. Does this mean that Australia is going to face runaway price inflation soon?

As a general principle, in the long run, there is a relationship between sustained monetary inflation and price inflation. In the same way, there is a relationship between a long-term lifestyle of eating excessive junk food and ill-health. In the interim, this relationship is more complicated. Using the junk food analogy, say that junk food eater dies of heart disease. What is the cause of death? Is it the heart disease? Or is it his sustained junk-food life-style?

Back to inflation, it is certainly possible to see continuing monetary inflation and slowing price inflation. In the US, the latest CPI figure even hinted of a price deflation! Therefore, in the short-term, there may not be a correlation between monetary inflation and price inflation. Part of the problem lies in the nature of how price inflation is measured and defined. As we said before in How much can we trust the price indices (e.g. CPI)?, price indices is a logically invalid idea. The implication is that it is possible to ‘define away’ price inflation and pretend that it is not a problem by torturing the statistics.

But setting aside the logical validity of price indices, what other dynamics is involved that can result in such non-correlation in the short-term? We will introduce one such dynamic- demand for money. This dynamic should not be confused with demand for credit. In lay-person’s terms, the demand for money is the desire for people to keep cash balance. As we wrote in The mechanics of deflation- increase in demand for holding cash,

Deflation happens when liquidity dries up. This can happen in a period of severe economic pessimism when the apprehension of the future drives people to increase their holdings of cash for the sake of peace of mind. When that happens, the quantity of money in circulation decreases, which means there are fewer money chasing after a given amount of goods and services. Consequently, prices have to decrease to accommodate for the decreased supply of money in circulation.

Let’s say the quantity of money increases in the system. But if people want to increase their holdings of cash due to fear and uncertainty of the future, they will withdraw these cash from circulation in the economy. Consequently, prices fall. As we wrote,

When deflation mentality gets a stranglehold on to the minds of the people, no one will dare to borrow money out of fear. Also, when prices are falling, the money that one borrows will be worth more by the time the debt is due. There is no point in spending money because if one waits a little longer, prices will fall further. Central bankers can print as much money as they can, but in such a deflationary environment, no one will want to borrow them.

Today’s credit crisis is an example of this. Banks are hoarding cash and are unwilling to lend while borrowers are repaying debts with every scraps of cash that they can get their hands on. As a result, liquidity dries up in the system even though the supply of money is desperately increased by the central bank. In such a situation, some broader measures of money supply will be shown to decrease.

The opposite can also occur. As we quoted Ludwig von Mises in What is a crack-up boom?,

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against ?real? goods, no matter whether he needs them or not, no matter how much money he has to pay for them.

In such a situation, the demand for money collapses. People want to keep their cash balance as low as possible as they constantly want to get rid of their cash for ‘stuffs.’ In the extreme case (i.e. hyperinflation), prices rise by the hour as people rush out to buy things the moment they are paid their wages, for fear that if they do not do so, price inflation will render their cash worthless.

Now, let’s look at what’s happening in the world. Merely 6 months ago, when oil prices was threatening US$150 and soaring food prices was driving people in poor nations to riots, the fear was price inflation. Today, with oil prices below US$50 and hardly any news on food prices, the fear is price deflation. Such extreme volatility is unprecedented in the history of humanity. It is this volatility and madness in prices that will wreck the real economy in the longer term (see Real economy suffers while financial markets stuff around with prices).

Where is the source of such extreme volatility?

As you may have already guessed by now, governments and central banks, in their attempt to solve the global financial crisis, is creating all these volatility through their interventions against the free market. Ironically, their ‘solutions’ are sowing the seeds of economic hardships for the next generation.

Australian money supply growth in September 2008

Monday, December 1st, 2008

We had just taken a look at Australia’s money supply growth for September 2008:

Australia's money supply growth for September 2008

Notice that money supply growth seemed to have slowed down from May to June 2008 before resuming its rapid growth again from July 2008 onwards. The M3 money supply is at a record high of AU$1090 billion. For those who are new here, we recommend What is money? to understand the monetary jargon that we used in this article.

Australia’s money supply growth till August 2008

Thursday, October 16th, 2008

The last time we reported on Australia’s money supply growth was on April (see Australia?s money supply & credit growth in April 2008). Today, we have an updated chart:

Free Image Hosting at

The year-on-year M3 growth is growing at a decelerating rate since November 2007. In August 2008, it was 18.9% when M3 was at the record high of $1065.9 billion. November 2007 had the highest year-on-year growth of 23.1%. Coincidentally, November 2007 saw the peak of the Australian stock market.

For those who are new here, we recommend What is money? to understand the monetary jargon that we used in this article.

Will deflation win?

Thursday, August 21st, 2008

In just a few months ago, the talk in town was price inflation. Oil, food and commodity prices were rising, as we wrote Who is to blame for surging food and oil prices?. Today, the talk is different. US house prices have never stop falling. Gold, oil and base metals are falling. There is even talk about the end of the commodity boom, the end of the commodity “super-cycle.” Economic slowdown and recessions are the expectations of the market.

Long time readers of this publication should never be surprised to see this is happening. As we said back in March last year in Inflation or deflation first?,

If you have been with us long enough, you may have heard us mulling over both the threats of inflation and deflation on the global economy (see Spectre of deflation and Have we escaped from the dangers of inflation?). You may be wondering whether we are contradicting ourselves. How can both threats exist simultaneously? Since one is a general rising of prices and the other is the opposite, are they not mutually exclusive?

At this current phase of the financial crisis, we are experiencing deflation. It is reported that the US M3 money supply is currently “collapsing.” A falling money supply is the definition of deflation, for which the symptoms will be falling asset prices, which if prolonged enough, will lead to falling consumer prices. But before we go off to celebrate falling prices, remember that this is an evil type of deflation because it is the type that is associated with bad debts, bankruptcies, unemployment, falling income, bank runs and so on. The angelic type of deflation is caused by rising output and production, which is clearly not the case in the debt-addicted Western economies but more true for China with its government-forced savings.

When the US money supply shrinks, it increases in value relative to the other currencies as the US dollar gets repatriated back to make up for the dwindling supply of cash back in the US. That’s why we are witnessing a rally in the US dollar and a fall in commodity prices as there is a mad scramble to liquidate whatever assets to raise cash.

With the current legal powers, the US Federal Reserve is quite powerless to stop deflation (see Are we heading for a deflationary type of recession?). It can cut interest rates, but it cannot force people to borrow. Even at 2% Fed fund rate, the shrinking M3 money supply is proof that monetary policy is still tight (see What makes monetary policy ?loose? or ?tight??). Will the Fed continue to cut interest rates? It had already tried but failed a few months, which resulted in skyrocketing oil and gold prices. We doubt Ben Bernanke is going to try it again.

Meanwhile, the US Treasury is preparing open up the bottomless coffers of the US government to nationalise Freedie Mac and Fannie Mae, who are essentially insolvent. The question is, with the US budget deficit already in the red (plus the massive current account deficits), where is the money going to come from to do that? If a savings-less individual spend more than he/she earns, that individual is basically bankrupt. But for governments, it is a completely different story. They can make up for the shortfall by borrowing from the public by selling newly issued government bonds. As a last resort, it can sell the bonds to the Federal Reserve, which is called “monetising debt” or printing money.

Will it get that bad? It can if the deflation threatens to shock and awe the entire nation into a Greater Depression. By then, as we said before in A painful cleansing or pain avoidance at all cost?,

Even if Ben Bernanke is an Austrian economist, political pressure alone will do the job of forcing him to act otherwise. This is the Achilles? heel of democracy. The mob will scream at the Fed to bail them out by ?printing? money (i.e. pump liquidity into the economy in the form of cutting interest rates). Should the Fed refuse to comply, we can imagine the mob storming the Federal Reserve to demand the head of Ben Bernanke. Therefore, the Fed will have no choice but to acquiesce to the desire of the mob, whose aim is to avoid immediate pain as much as possible.

Therefore, as we advised before in Recipe for hyperinflation,

Therefore, watch what the US government is doing with the monetary ?rules? in its attempt to fight deflation.

Australia’s money supply & credit growth in April 2008

Thursday, July 10th, 2008

Continuing from Australia?s money supply growth in March 2008, we will report on the growth of Australia?s money supply for April 2008. In that month, Australia?s broad and M3 money supply has reach yet another record high of AU$1089.4 billion and AU$1003 billion respectively (see What is money? on the explanations of the various measures of money). Between April 2007 and April 2008 (i.e. the year-to-date), Australia?s M3 money grew by 20.4%. The year-to-date growth for March 2008 and February 2008 was 21.1% and 21.6% respectively. No doubt, Australia’s money supply is still growing to record highs. But there seem to be some tentative indications that the growth is slowing since January 2008.

Credit growth is also exhibiting the same behaviour. While total credit reaches a record high of AU$1826.9 billion in April 2008, its year-to-date growth was slowing since January 2008.

The data for May and June 2008 is not out yet. If we see a sustained deceleration in both money supply and credit growth, this will mean that Australia is moving towards deflation, which is very bad for asset prices.

Australia’s money supply growth in March 2008

Thursday, June 5th, 2008

Today, we will continue from Australia?s monetary growth update?February 2008 and report on the growth of Australia’s money supply for March 2008. In that month, Australia’s broad and M3 money supply has reach yet another record high of AU$1080.8 billion and AU$992.2 billion respectively (see What is money? on the explanations of the various measures of money). Between March 2007 and March 2008 (i.e. the year-to-date), Australia’s M3 money grew by 21.1%. The year-to-date growth for February 2008 and January 2008 was 21.6% and 23.2% respectively.

From the news media, you can read a lot of reports that Australia’s credit growth (and hence, has a relationship on the money supply growth) has slowed down due to the string of interest rates hikes and slowing economy. Well, the fact remains that credit growth is still growing, although growing at a slower pace. We can argue that it is still growing too rapidly.

Think about this: if real GDP growth is growing at 3% per year while the M3 money supply grows at 21.1%, guess what will happen to price inflation? Hint: take a read at Cause of inflation: Shanghai bubble case study.

Australia’s monetary growth update?February 2008

Monday, April 28th, 2008

Today, we will show you the latest chart of Australia’s money supply growth from July 1959 to February 2008. Our previous update was at Aussie money supply growth- December 2007 update. Click on the below chart’s thumbnail to see it in full-size:

Australia?s monetary growth (July 1959 to February 2008)

The terms used in this chart was explained in What is money?.

The left axis: The dark blue line represents the growth of the monetary base, while the light blue and red line shows the growth of M3 and broad money respectively.

The right axis: The black line represents the ratio of the monetary base to broad money. As at February 2008, this ratio stands at a wafer thin margin of only 4.37%. As we said before in Australia?s monetary debasement & credit expansion, this means that approximately, every $4.37 of original cash

… in the economy gets lent and re-lent, over and over again until it becomes $100 of credit (broad money)

Please note that in that previous article, we used the currency/M3 ratio. Today’s graph uses the monetary base instead of currency in that ratio, which is more accurate representation.

Finally, the growth of M3 from February 2007 to February 2008 was still at a high level of 21.6%.

What is money?

Friday, April 25th, 2008

This is a deceptively simple question. Last time, money was simply gold and silver. But today, in this modern age of finance, money is far more complicated than what it was used to be. It has come to the point that it is very hard to even define what money is, let alone measure its quantity. Alan Greenspan, the former head of the US Federal Reserve was believed to have said ?We don?t know what money is, any more.? Today, we will explain what money is by explaining the various measures of money supply, according to the definitions of Australia’s central bank, the Reserve Bank of Australia (RBA).

A good way to see money is to think of it as an inverted pyramid, the apex of which is the most liquid form (and most favoured by drug dealers). This most liquid form of money is defined as currency. Currency is the (1) physical notes and coins that can be seen, touched and smelled and (2) held by the “private non-bank sector” (which is basically institutions, companies and individuals that are not banks and governments). Currency is mentioned in the graph in our previous article, Australia?s monetary debasement & credit expansion.

The next broader measure of money is the monetary base, which is (1) physical notes and coins held by the “private sector” (which is anything that is not of the government), (2) banks’ deposit at the RBA and (3) what the RBA owes to the “private non-bank sector.” The central bank (RBA) is the bank of the government and banks. Therefore, your bank will have an account at the RBA where it keeps its money, which is the previously mentioned (2). For (3), an example would be the Medicare rebate that you receive from the Australian Commonwealth government. It will come in the form of a cheque drawn from the RBA. The difference between component (1) of currency and component (1) of monetary base is that the former excludes physical money held by banks (e.g. notes stored inside the ATM machines).

The next measure of money is M1. It is comprised of (1) currency and (2) bank current deposit held by the “private non-bank sector.” In Australia, you may have a current deposit account that pays almost no interest and you can withdraw your money from it at any time. This money will be included in M1.

The next broader measure of money is the M3. It comprised of (1) M1 and (2) other deposits with bank (e.g. term deposits, certificates of deposits, etc).

The broadest measure of money is broad money, which comprised of (1) M3 and (2) borrowings of financial institutions from the private sector. Your money kept in high-yield cash management accounts will be part of broad money.

So, how can there be so many measures of money, from the most limited currency (AU$39.4 billion as at February 2008) to massive broad money (AU$ 1074.5 billion as at February 2008)? Well, you may want to read our earlier article, 363 tons of US dollars to Iraq?how much money will eventually be multiplied into the economy?.

Next article, we will show you an updated graph of Australia’s money supply.

Aussie money supply growth- December 2007 update

Friday, February 29th, 2008

In Australia?s monetary debasement & credit expansion, we showed you a graph of Australia?s (1) money supply growth (base money, M3 and broad money) and (2) the relativity between standard and fiduciary money since July 1959 to October 2007 (see Are we heading for a deflationary type of recession? for the meaning of standard and fiduciary money). The November 2007 update can be found at An update on Australia?s money supply growth. Today, we have an update of the December 2007 figures from the Reserve Bank of Australia (RBA):

  1. Year on year growth of M3 to December 2007 was 22.7%
  2. The standard money to fiduciary money ratio remained unchanged at 3.7%

It looks that up till December 2007, Australia?s monetary policy is still loose, despite the interest rates rise in November 2007. (see What makes monetary policy ?loose? or ?tight??).