True “Austrian” Money Supply Definitions, Sources, Notes and References
Austrian economists distinguish between two types of money substitutes – covered and uncovered money substitutes, a categorization centered on the impact the issuance each has on the supply of money:
Covered Money Substitutes. Perfectly secure and immediately convertible, par value claims to standard money (currency) issued by banking institutions, where the issuing banks keep against the whole amount of money substitutes a 100% reserve of standard money (currency) – those reserves being monies held either as vault cash or as defacto standard money (currency) in the form of deposits at the central bank. The issuance of covered money substitutes is the purview of both the central bank and the central-bank-controlled private banking system.
Uncovered Money Substitutes. Perfectly secure and immediately convertible, par value claims to standard money (currency) issued by banking institutions, where the reserves kept by the issuing banks against those money substitutes are less than the total amount of those substitutes. The issuance of uncovered money substitutes is the purview of private banking institutions.
The impact the issuance of Covered Money Substitutes has on the supply of money is a function of the issuer:
The issuance of Covered Money Substitutes by Private Banking Institutions has no impact on the level of the money supply. Being 100% covered by the issuers reserves, meaning the issuing banks keep 100% of the monies entrusted to them by depositors as reserves against their money substitutes, their issuance is only to change the composition of the money supply, increasing the amount of money substitutes while simultaneously decreasing the amount of standard money (currency) in circulation by the same amount.
The issuance of Covered Money Substitutes by a Central Bank always serves to increase the supply of money. Most often issued through the purchase of assets by the central bank – by writing checks on itself, and later, when those checks are deposited by the sellers of those assets in their respective banks, completing the issuance by crediting those banks’ deposits at the central bank for the amount of those checks – its effect is to increase both the supply of money and the reserve cover against that supply by the full amount of the checks written. A “covered” issuance is a fete de compli because the central bank has the unrestricted ability to create reserves and or currency at will and hence provide full “cover” each and every time it writes a check. This activity is popularly known as asset monetization.
The issuance of Uncovered Money Substitutes by Private Banking Institutions always serves to increase the supply of money. In today’s fractional reserve banking system, through what is called the pyramiding of reserves, uncovered money substitutes can and are literally created out of thin air by the issuing banks. The amount of that increase; i.e., the pyramid is a function of the form of issuance:
One-to-One Pyramid. Where the issuing banks simply lend out the money entrusted to them by their depositors, the banks “spending” the money so entrusted to purchase investment securities or to make loans, even though, indeed, despite of the fact that their depositors maintain full ownership of that money as an immediately redeemable, at par claim to that money. The theoretical upper limit to the issuance of this form of money substitute is 100% of the amount of the money so entrusted to the issuing banks by their depositors. Thus the term one-to-one pyramid. In practice, the upper bound to such issuance is usually something less, that residual being the monies set aside by the issuing banks to accommodate depositor redemptions. This issuance is most closely associated with the issue of bank savings accounts.
Multiple Pyramid. Where the issuing banks literally create what amounts to “fake” claims to money, on top of their money reserves, these “fake” claims being by and large loans to their clients. In this way, the issuing banks can create money substitutes at a multiple of their reserves, the reserves they hold against these “fake” claims being set at whatever amount the issuing banks deem appropriate to meet depositor redemptions. This issuance is most closely associated with the issue of bank demand deposits, as part of the issuing banks normal loan practices.
The fuel for the issuance of uncovered money substitutes comes about either via a decline in the public’s demand for currency in favor of bank-issued money substitutes, or more commonly and persistently, via the creation of credit and bank reserves by the central bank. The extent of the consequent expansion in the supply of money is a function of the extent banks are willing to pyramid money substitutes on top of their reserves, albeit an expansion capped by the reserve requirement ratios set by the central bank.
Money held by private banking institutions against the money substitutes issued by those banks, those monies being immediately ready to meet depositor redemptions. Reserves include both standard money (currency) held in bank vaults and deposit balances held by same banks at the central bank. Deposit balances held at the central bank are defacto currency, call it currency-in-waiting, in essence same as vault cash, as the central bank stands ready to convert those deposits into currency on demand when called upon by banks.
Commonly defined as standard money (currency) held by private banking institutions or by the public plus private bank reserve deposits held at the central bank. In Austrian terms, alternatively defined as standard money held by the public plus covered money substitutes issued by the central and private banks. Since covered money substitutes issued by private banks are 100% covered by those banks’ money reserves – held either in currency form in the banks’ vaults or as reserve deposits held at the central bank, in the end, base money represents that portion of the money supply issued by the central bank, the remainder – uncovered money substitutes – being that portion issued by private banks.
Fed Credit, ECB Credit and BOJ Credit
Credit provided by the central banks of the Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BOJ), respectively. This credit is literally created out of thin air, primarily in two ways – either through the purchase of assets via checks the central bank writes on itself (commonly called asset monetization), or via the granting of loans to private banking institutions by crediting those banks’ deposits at the central bank for the amount of the loans. The net result of this credit creation is to increase the supply of money – either directly through the creation of covered money substitutes or standard money (currency) by the central bank or indirectly through the pyramiding of uncovered money substitutes on top of this credit by private banking institutions.
Thus, when central bank credit is expanding; i.e., when the central bank on net is buying assets and making loans, there tends to be an expansion in the money supply. And when central bank credit is contracting; i.e., when the central bank on net is selling assets and retiring loans, there tends to be a contraction in the money supply.
The M’s – M1, M2, M3, etc
Money supply as formulated by the various central banks around the world, a definitional approach centered on the liquidity characteristics of the various bank deposit and financial market claims – and their correlations with economic activity – in the respective jurisdictions of those central banks. Under this definitional approach, one will find both money substitutes (claims to present money) and credit claims (claims to future money) in these “M” aggregates. As such, according to Austrian economists, these mainstream monetary aggregates are misleading measures of the ebb and flow of the money supply.
True “Austrian” Money Supply Definitions, Sources and Notes, each Currency Block
U.S. True “Austrian” Money Supply Definitions
TMS1: Austrian measure of money supply based on a narrow interpretation of U.S. money substitutes. It is the sum of Currency in Circulation plus Demand and Other Checkable Deposits plus Demand Deposit Sweeps; i.e., deposits which are immediately convertible, par value claims to currency, transferable on demand by check or electronic transfer. Under this formulation, Savings Deposits are excluded from the money supply on the basis that they, being legally subject to a potential 30-day redemption notice period, are credit claims – i.e., not immediately convertible par value claims to money, but instead claims to future money – and thus not true money substitutes. Excluded are Time Deposits and MMMFs as they represent true credit claims. The TMS1 formulation is most closely associated with economist Frank Shostak’s AMS metric.
TMS2: Austrian measure of money supply based on a broad interpretation of U.S. money substitutes. Here, Savings Deposits are included in the money supply on the basis that the 30-day notice period has rarely if ever been enforced, and unlikely to be enforced except perhaps in a systemic banking crisis where the government would very likely mandate a freeze on all bank deposits (making savings deposits no different than demand or any other deposit). For these reasons, the notice period is effectively non-existent, making savings deposits true money substitutes. TMS2 is most closely associated with economists Murray Rothbard / Joseph Salerno’s TMS metric.