What is money? May 23, 2008
Coins and notes are obviously money. Is the balance in your check account money? Banks don’t really have sufficient cash in their vaults to cover clients’ demand account balances so money is more than just notes and coins. What about the available credit on your credit card? You can use it to buy stuff; is it money? What about the balance in a savings account? I am not suggesting all the above are money, but what is money?
Some people may think it’s not important to know exactly what constitutes money, but I don’t know if it is possible to know how much money has been created without knowing what money is, and it sure would be useful to know how much money there is so we can accurately measure inflation.
Economists working for the Federal Reserve created several monetary aggregates to estimate how much money has been created. You’ll recognize them by their names, such as M1, M2, M3, L, MZM, etc. They do not define what money is; they are merely aggregates of components of the banking system and were in and out of favor at different times. None is ideal, and none brings us any closer to understanding what constitutes money.
On February 17, 2000, then Federal Reserve Board Chairman, Alan Greenspan, was answering a question from Congressman Ron Paul during a House of Representatives Committee on Financial Services hearing, when the following exchange took place (link):
Mr. Greenspan: “Let me suggest to you that the monetary aggregates as we measure them are getting increasingly complex and difficult to integrate into a set of forecasts.
“The problem we have is not that money is unimportant, but how we define it. By definition, all prices are indeed the ratio of exchange of a good for money. And what we seek is what that is. Our problem is, we used M1 at one point as the proxy for money, and it turned out to be very difficult as an indicator of any financial state. We then went to M2 and had a similar problem. We have never done it with M3 per se, because it largely reflects the extent of the expansion of the banking industry, and when, in effect, banks expand, in and of itself it doesn't tell you terribly much about what the real money is.
“So our problem is not that we do not believe in sound money; we do. We very much believe that if you have a debased currency that you will have a debased economy. The difficulty is in defining what part of our liquidity structure is truly money. We have had trouble ferreting out proxies for that for a number of years. And the standard we employ is whether it gives us a good forward indicator of the direction of finance and the economy. Regrettably none of those that we have been able to develop, including MZM, have done that. That does not mean that we think that money is irrelevant; it means that we think that our measures of money have been inadequate and as a consequence of that we, as I have mentioned previously, have downgraded the use of the monetary aggregates for monetary policy purposes until we are able to find a more stable proxy for what we believe is the underlying money in the economy.”
Dr. Paul: “So it is hard to manage something you can't define.”
Mr. Greenspan: “It is not possible to manage something you cannot define.”
Here we have possibly the most influential and powerful banker in the world, who is in charge of managing the most widely used money in the world -- the US dollar -- telling us not only that he doesn’t know what money is, or how to measure how much of it there is, but admitting that it’s impossible to manage the money supply precisely because they have not yet figured out what it is or how to measure how much of it there is. Yet, somehow, he believes in sound money.
What struck me about what Greenspan said is that they stopped using monetary aggregates for monetary policy decisions. In other words, money itself is no longer considered part of monetary policy. He also thinks that a debased currency leads to a debased economy, yet conveniently he is unable to measure the extent to which he and other Federal Reserve Board Chairmen have been responsible for debasing the dollar. Mr. Greenspan can not define what money is, yet in real life we can clearly see the debasement of the dollar when we look at the increase in the cost of fuel, food, commodities and gold.
Paul van Eeden
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