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Money: East vs. West

Posted by
August 28, 2012

By Steve H. Hanke

A country’s money supply is made up of two distinct components. State money — the monetary liabilities of a central bank (typically referred to as base, or high-powered, money) — is one element, and is by far the smallest component of the money supply. The second and most important component of the money supply is bank money. This is the money (deposit liabilities) that is created by the banking system, broadly defined.

Changes in the money supply are a dominant force in the economy — a force that determines changes in prices and in economic activity, measured by nominal GDP. Accordingly, we must pay the most careful and anxious attention to movements in a country’s total money supply, as well as to the movements in its components (state and bank money).

When it comes to forecasting economic activity, most people fail in their diagnoses because they ignore money. That said, those who do pay attention to money often come up short, because they focus exclusively on central banks and developments in state money, at the expense of the allimportant bank-money component.

A review of the accompanying money-supply chart for the U.S. tells the economic story. The money supply has been growing at a rate lower than the trend rate, resulting in a money supply “deficiency”. In consequence, the U.S. has been in a growth recession — positive, but weak, economic activity, accompanied by subdued inflationary pressures.

But, most people believe that monetary policy has been ultra-loose since the collapse of Lehman Brothers in September 2008. Well, by standard accounts, it has been — the quantity of state money has almost tripled since September 2008. When looked at through the proper lens, however, the picture is quite different….

Continue reading at Cato.org…