Exploring Money Supply Over the Past 10 Years Through Charts

Includes: FXE, FXI, UDN, UUP
by: Robert Kientz

In Part 3 of the series Charting the Economy, we examine money. This series is intended to present a recent history of the economy in an easy to understand format using graphs. You can find Part 2 here.

Our opening chart looks at the broadest measures of cash and credit in the U.S. money supply, M2 and M3. We can see that both measures have been expanding this decade. Note: The Federal Reserve stopped reporting on M3 after 2006 due to what it considered low importance to the measurement of money in the system.

[Click all to enlarge]

M3 is the broadest measure of money and credit in the U.S. It consists of credit, savings, and cash in the system. For our purposes, we want to examine those elements of U.S. monetary measures that are inflationary and affect the prices of goods that people buy every day.

The following chart shows the pieces of M3 that are not included in M2, for a look at how they specifically are expanding. These non-M2 components of M3 include large time deposits, repurchase agreements, eurodollars, and money funds.

In addition, M2 also has some credit components in addition to cash. So we can examine how those specific parts of M2 are expanding.

Deposits moved out of the money markets and CDs and moved into savings accounts. People want liquidity while avoiding risk.

M1 is the leanest measure of money and credit in the U.S. system. It includes currency itself plus traveler’s checks, demand deposits, and other checkable deposits. M1 by itself, however, does not measure all inflationary money in the system that will affect prices. More on that later.

Most of the increase in M1, about 53%, is in currency in circulation. Most of the rest is in deposit accounts, including checking accounts. Currency circulation is up about 6 % from 2001, suggesting more is being spent and less is being saved from 10 years ago.

M1, M2, and M3 have shown that people are moving away from risk and into liquidity and "safe" returns.

Austrian True Money Supply (TMS)

True Money Supply, or TMS, is an Austrian economist’s tool for measuring “medium of exchange" and does not double-count money in the system. Any money measurement that is the result of a credit transaction requiring selling of one asset to produce money is excluded, and any measures requiring a lapse in time (not immediately available) are excluded because they result in those time-lapse deposits being lent out and not stored in the banks' vaults. In addition, TMS includes non-M3 money measures of U.S. government demand deposits, demand deposits due to foreign commercial banks, and demand deposits due to foreign official institutions.

TMS shows that we have had a substantial increase in money supply as a medium of exchange, which will more accurately reflect those amounts that can be spent on demand, and therefore are inflationary to the economy. As a corollary, the difference between TMS and M3 money measures represents those credit transactions in which money has been promised but is not held in vault.

For example, if a corporation wants its securities back from a repurchase agreement, it must come up with cash from another transaction -- sales of goods, issues of stock, or loans from other sources. If it had the cash on hand, it would not have pledged assets to obtain cash. These are exchanges of future production for current income. They may be temporarily inflationary when the money is spent, but this is a one-time proposition limited by future production, and not a continual inflation of the money supply.

U.S. Dollar and Other Currencies

A popular measure of the U.S. dollar is the U.S. Dollar Index. This index puts the dollar against a basket of other popular currencies, including the euro, British pound, Japanese yen, Canadian dollar, Swedish krona, and Swiss franc. Each currency is weighted differently against the dollar, with the euro having by far the largest weighting. This is an attempt to value the dollar against other popular currencies, though some very important currencies were left out of the index.

We can see that the U.S. Dollar Index is falling, meaning that the U.S. dollar is devaluing faster than the overall basket of currencies included in the U.S. Dollar Index.

The next chart examines Austrian TMS versus the U.S. Dollar Index to see if the U.S. Dollar Index is a good measurement of U.S. dollar strength.

Set to a reference value of 1 in 2001, this chart shows that the TMS has grown 84% by 2009 while the dollar, weighted against other currencies, has only fallen about 30% in value relative to other currencies measured in the U.S. Dollar Index. All currencies in the USD Index are inflating, and so therefore the USD Index should not be used as a measure of purchasing power for the dollar itself. The phrase "it’s all relative" applies here.

I set up the following chart to compare the USD Index, TMS, and M2 together. M2 is popularly used as a measure of the inflationary effects of the dollar, or the amount of currency in circulation and savings that would apply to the purchasing power of the dollar.

The USD loses 30%, compared to a TMS increase of 84% and M2 increase of 56% since 2001. M2, in this case, understates the real medium of exchange value of money growth in the U.S. by 28% since 2001. So when you see M2 used in economic analysis, remember that it does not include all the measures of money that can cause a subsequent inflation in prices, or reduction in consumer purchasing power.

Other World Currencies

To compare the dollar against other currencies, it is helpful to find corresponding values in those currencies. Here we look at the different measurements of the euro.

The euro measures are composed thusly:

M1: Currency in circulation + overnight deposits

M2: M1 + deposits with an agreed maturity up to two years + deposits redeemable at a period of notice up to four months.
M3: M2 + repurchase agreements + money market fund (MMF) shares/units + debt securities up to two years.

The closest comparison to TMS in euro measures would be M1, because M2 and M3 include time deposits and credit transactions.

The euro rate has exploded past the dollar starting in 2005. Euro issuance has increased by 102% since 2001, compared to the U.S. TMS of 84% and M2 of 56%.

Japan M1 is closest measure to TMS, excluding savings accounts which are part of M2. Other M2 data includes time deposits and credit transactions. M1 increased by 45% while M2 only increased by 15%.

Here we see the Austrian TMS against four major currencies in the U.S. Dollar Index basket (by weighting).

The euro is the highest-weighted currency in the USD Index basket, and has depreciated in value more than the dollar, which has allowed the dollar to appear less devalued than it is. Again, the USD Index is not a measure of purchasing power, as all currencies in the basket have been inflated.

Note: Reporting on British M0, the closest measure of the two made available to actual money in the system stopped in 2006. The British money measures were the following:

M0: Cash outside Bank of England + banks’ operational deposits with Bank of England. (No longer published.)

M4: Cash outside banks (i.e. in circulation with the public and non-bank firms) + private-sector retail bank and building society deposits + private-sector wholesale bank and building society deposits and certificate of deposit.

M4 is a poor substitute for actual inflationary money supply, so I did not graph it.


China is a large trading partner of the U.S., and currently holds the most Treasury debt behind the Federal Reserve. Therefore, China’s currency strength is an important factor in how the U.S. trades with it and how much debt the Chinese can afford to buy from the U.S.

China has been inflating money supply to support its rapid economic expansion. It appears as though it is very vulnerable to rising prices resulting from currency inflation. Japan has the lowest rates of currency inflation since 2001 as it tries to keep exports competitive.

Lastly, we have U.S. Austrian TMS versus other major currencies.

Notice China has been printing renminbi at a faster pace this decade than the dollar or euro. When researching for this project, this was quite a shock. While China’s currency is not a world reserve currency as the U.S. dollar is, the Chinese are following the same path the U.S. has. This piece of data reinforces the idea that at least part of China’s economy is in a fiat money-induced bubble, which is a topic for another article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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