It would be deflation, as M1 is only a component of M3.
Also,
This is quite interesting. The monetary base has more than doubled in just over a year. Quite incredible really. I noticed this a few months ago, when it was at 1.6 trillion, now it’s at over 2 trillion…
That is the result of the bank run and the central bank trying to stop it by rapidly increasing reserves through short-term loans at the discount window.
Once the banks no longer need to protect themselves from a “liquidity run”, they will return the cash to the central bank and the monetary base will plummet again.
If we assume that inflation is a measure of the cost of “everything”, i.e. not just the “cost of living” but also including the cost of things that banks buy, like shares and derivatives, then surely that would correlate better with M3 than M1 - so I’d have to disagree with you.
And why would “we” assume that?
Sure. First of all, John Williams of shadowstats.com has computed CPI according to the old methodologies. It was changed radically in 1983 (correct date?), and then changed again around 1993 (and again in '99). Here is a comparison of the data: http://www.shadowstats.com/alternate_data/inflation-charts
The major changes for the early 80’s I believe were in real estate. I’m having trouble finding the exact dates, but it appears around 1983 that house prices were taken off the CPI and replaced with Owner’s Equivalent Rent. Note that calculating OER is an arbitrary process. They likely take a house for rental in an area, take its square footage, and extrapolate that rental price against other houses by square footage. Of course this misses pertinent info. Rental houses are more likely to be in worse condition than homes that the owner lives in. In any case, OER is obviously not a perfect substitute for house prices. What it tries to do is eliminate house speculation (just like the CPI doesn’t include stocks or other investments). Of course, houses don’t fit easily into either category of investments or consumer goods. The change pushed the CPI downward significantly, likely by design. In theory, I agree with using OER for a consumer price index. Unfortunately, we can’t get a CPI with OER before the 80’s. Of course, a CPI is no substitute for a general price index.
The Clinton-era changes are much more questionable. They sought to include hedonic adjustments, which basically means that if the quality improves for some product, then they adjust prices to attempt to capture this gain in quality. The most basic example to illustrate how stupid this is is by seeing how the BLS would compute computer prices. In 2006, a 1 GHZ laptop costs $400. In 2007, a 2 GHZ laptop costs $400. Consumer inflation = 0%, right? WRONG. The BLS would say this is … NEGATIVE 100% inflation. Why? Because they calculated that a doubling of speed equals double your enjoyment. Following this dingbat logic, you could expect to find new Pentium 3 computers today for around $20. Good luck.
There is also some kind of weighting done to measure substitute goods effects. For example, let’s say the price of beef doubles. Many consumers will consume less beef and more chicken. Let’s say the CPI for food is composed simply of 50% chicken prices and 50% beef prices. Let’s say chicken prices remain constant while beef doubles. You’d expect a CPI rate of 25%, right? WRONG. The BLS would say that more people are eating chicken now, so it deserves a larger weighting - now the index is 25% beef prices and 75% chicken prices, yielding a CPI rate of 12.5%.
If you look at these last two policies, they are almost the inverse of each other. One says that if quality improves, it equals a decline in the measured CPI. The other says that if quality decreases, it equals a decline in the measured CPI. So if you buy a more expensive good, that price is offset by your quality increase; but if you buy a lower quality good to substitute for a preferred good that rose in price, suddenly the BLS is not worried about your personal enjoyment factor and reduces the weighting of products you demonstrably preferred.
All the adjustments pushed inflation calculation downward. Duh! That’s the entire point.
Also, remember that CPI is only a fraction of prices. Producer prices and investment asset prices must also be taken into account. Also remember that M2 and M3 are inaccurate measures of money supply, containing numerous credit items like short-term time deposits and money market mutual funds. I find M Prime the best measure, which is basically M1 + sweeps. Of course, consumer credit also effects prices, as does real estate credit, etc. So prices tend to match M3 (or even broader measures) best, I find.
This last decade banks have bought mostly houses and other real estate. The price of them has tracked money supply inflation.
If we assume that inflation is a measure of the cost of “everything”…
Inflation is a measure in the rise in costs of goods and services, with weightings in proportion to how much of each of them is actually purchased. CPI is not the whole story because it only measures the things that households buy. What we should consider is goods and services that anybody can buy, and that includes governments and banks.
Thant sounds very believable. Presumably Austrians should(do?) say that inflation IS the growth of the money supply (M3). And certainly not M1.
Again, why should “we” assume inflation is that…? How do ratios get “inflated”?
Do. They don’t limit themselves to narrow money supply.
WRONG.
Bernanke has already stated his long-term strategy to wind down the Fed’s balance sheet will NOT come from the banks returning liquidity to the Fed. He said it would involve paying banks interest on reserves they choose to sit on for specified periods of time. Right now the Fed is paying banks to sit on excess reserves without a term. The new plan would simply add a term to these deals → something like 1.5% interest for excess reserves held for 1 year, etc.
The reason is that the banks aren’t simply borrowing money from the Fed. They are selling their toxic assets to the Fed, likely for well over their market value. There is not a snowball’s chance in hell that the banks are willing to buy these toxic assets back from the Fed, especially not at the price the Fed bought them.
So let’s say the Fed tries to sell all these toxic assets in the open market. It created $1 trillion to pay for them. Now, it can only sell them for $50 billion. Thus, the Fed created a net $950 billion increase to money supply with no further means to withdraw this money from circulation.
On the other hand, it could sell Treasuries, which have a much better market value. However, they are also likely to lose money on that deal as well, just not as much. Furthermore, this would push up the government’s borrowing costs, which it will not allow.
The Fed owns the MBS’s it bought from the banks at top dollar. It has no deal to return them to banks at buying price. In order to bail out the banks with money created from thin air, the Fed has been turned into a toxic asset graveyard.
Actually, Austrians say that inflation (as defined by increase in money supply) is neither. On the other hand there is a more accurate measure: True Money Supply
I don’t know why we would refer to them as toxic assets when their actual name is worthless assets, or non-assets.
Anyway I’m not sure that buying MBS explains the entire increase in the monetary base. It may be a significant part of it, but I think the Fed bought MBS in return for other bonds, not liquidity.
The ratios of what to what?
Ok, that’s fine. By “M3” I, perhaps sloppily, meant “the money supply”.
One good exchanging against another. What a price is, essentially.
Re: “true money supply”
Ok, so M3 includes some things that aren’t strictly money. But I am curious to know if banks and/or hedge funds ever use some non-money financial instruments to buy things with (directly, without ever translating them in to normal money)? If they did, then those instruments would be a kind of “money” and so could (perhaps should) be counted as part of the money supply.
I was being serious. If inflation is defined as “growing X” then “growing X” would be inflation and “declining X” would be deflation. Replacing M1, M3 or CPI with X does not change my understanding of the processes. By trying to “precisely” define inflation (which, as in the case of CPI, is constantly “updated” and re-defined) you’re missing the forest for the trees, which is the main obfuscating goal of the status quo.
Z.
My goal is not “to precisely define inflation”. Its actually pretty easy to define different types of inflation, CPI,“house price”,M1,M2,“money supply” etc. etc. What I am trying to do is understand the relationships between the different types, and in order to do that, you must be precise.
On the True Money Supply page, you should read the articles explaining what composes the True Money Supply. I do not find that TMS is entirely accurate, as it includes savings accounts. Savings accounts can technically be used as money and they have no fixed term, but they are generally used as a loan to the bank, not as checkbook money. At the very least they are a demand for a cash balance, which means they shouldn’t effect prices.
There is one important exception to this - sweeps. For those who don’t know, sweeps are bank operations done via computer which sweep demand deposits into savings deposit accounts in order to avoid reserve requirement regulations. To the bank customer, they don’t appear to exist or happen at all.
…Actually, now that I think about it, sweeps seem not that much different from savings accounts - they are presently available money, but they are being held, not spent.
Anyway, there is no accurate money supply measure. Our banking system conflates money and debt. Anything the government secures against a loss and can be liquidated immediately is virtually money.
Furthermore, because debt and money are conflated, it is difficult to correlate money supply and price inflation.
That being said, M1, M1 + sweeps, and M2 minus small time deposits seem to most accurately measure money supply. (M1 has some non-money items but they are almost insignificantly small). MZM, M2, and M3 likely track prices better.
Looking at any one measure shows you the distortions I mentioned above. You’ll notice, such as around 1983, a surge in savings accounts, matched by a decline in small time deposits. This makes M2 minus and MZM appear to skyrocket, but really very little happened. M3 is nice because it is so broad - you don’t have distortions based upon individuals shifting from one form of money to another.