The "True Money Supply" Metric: Recent Trends

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The “True Money Supply” Metric: Recent Trends

Those who are familiar with money supply stats know that M2 is the usual go-to money supply metric for observers of the money supply and its growth. Investopedia has an explanatory video of M2 here. Basically, M2 is this:

A measure of money supply that includes cash and checking deposits (M1) as well as near money. “Near money” in M2 includes savings deposits, money market mutual funds and other time deposits, which are less liquid and not as suitable as exchange mediums but can be quickly converted into cash or checking deposits.

At least as early as the late 1970s, though, Murray Rothbard concluded that M2 and other “official” measures of money did not accurately reflect the true supply of money. That is, money, as understood by Austrian economists was something other than the definitions used by the Federal Reserve and government officials.

Rothbard explained this in his essay Austrian Definition of the “Austrian Supply of Money” in the 1978 book New Directions in Austrian Economics, edited by Louis Spadaro. Joseph Salerno later expanded on this in 1987 with “The 'True' Money Supply: A Measure of the Supply of the Medium of Exchange in the U.S. Economy.”

More recently, Michael Pollaro has presented a summary of recent usage of the true money supply metric. Pollaro notes there is some debate among Austrians as to exactly what the metric should include. Frank Shotak uses a slightly different method than the older Rothbard-Salerno metric.

Pollaro himself was publishing recent updates using the true money supply, but he seems to have abandoned this in late 2014.

Without a source for regular updates, I have reproduced the metric as used by Pollaro for the Rothbard-Salerno metric, which is called “TMS2.” My version of it matched up with Pollaro's metric, which can be seen in a 2014 update here

Here's his graph:

I reproduced this TMS2 measure using stats on M2, retail money funds, small time deposits, treasury and US government deposits at the fed, and travelers checks. I have not attempted to reinterpret the measure, but only to recreate it using Rotbard's and Salerno's commentary on the measure.

You can see that my measure matches up with Pollaro's:


Back in November, Pollaro noted that TMS2 growth had recently reached a six year low. That is, from 2009 to 2014, TMS2 growth rates dropped significantly, which pointed to a slowing in the true money supply, and suggesting an overall slowing in the economy. I find the same results. And once we incorporate in new data for 2015, we find that TMS2 growth has not accelerated much since then. TMS2 growth rates are only up slightly since the lows of late 2014. But, these growth rates are still well above the danger zone experienced back during 2005-2007 when slowing in the true money supply correctly pointed toward a slowing economy in 2008.

But is TMS2 notably different from the usual M2 measure? In the next graph, I've plotted M2 growth against TMS2 growth. We can see they follow roughly the same pattern, but TMS2 picks up on the swings in the growth rates that M2 fails to note. For example, the slowing of money growth in 2005-2007 was more severe in the TMS2 measure, and gave a better sense of the likely severity of the 2008-2009 recession, which caught non-Austrian economists by surprise. Moreover, growth in the TMS2 shows up as more severe during the 2009-2010 stimulus period, which also likely is more helpful in gauging the truly large money growth that was occurring during that time. Note also that, proportionally speaking, money supply growth has dropped more from the 2011 peaks in the TMS2 measure than in the M2 measure.

In general, TMS2 growth rates are useful in understanding boom and bust movement, and Frank Shostak often employs this analysis in his own articles, as with this recent article in which he notes (using his own modified money supple measure) that the recent drop in the Personal Consumption Expenditure index was likely a function of slowing money growth that had occurred during 2014.

Generally speaking, over the past two cycles, a big drop in money supply growth points toward recession, while big increases in money supply point toward continued boom in the short term. For example, in the lead up to the dot-com bust, money supply growth was down around 4 percent, and it went even lower prior to 2008.

Just as a final note, keep in mind that we're looking at growth rates and not total money supply amounts. Actual money supply rarely does down. As we can see in the last graph, both M2 and TMS2 show unrelenting growth in the money supply, so it's the growth rate we're looking at, not the supply itself:


August 31, 2015

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