Money Supply

The Basics of Money Supply

Money supply is basically the total amount of money available in the country. While the basic concept of money supply is very simple, its implication is very strong to the country and even for the worldwide economy. Every business, corporation and the government are always looking out for the latest money supply because it will dictate the country’s future or use it as a tool for their progress.

But before looking at the effects of supply, it is first important to know the real concept of “money.” By understanding these concepts, its supply and its intended effects will be understood.

The Scope of Money

In economic terms, money refers to anything that would represent a value other than itself. This means coins and paper money represents an amount but they can never be sold because of its content. Paper money, as it is, is just paper but becomes $5 or $10 because of its value.

But aside from tangible things representing value, money also refers to savings and checking accounts deposited by individuals and business to various banks. A person who deposited their entire life savings in cash to a bank account as a savings deposit is also considered money.

Measuring the Supply of Money

Counting the exact amount of money supply every country has is not just about the actual printed and minted money. Central banks of each country classify the money supply based on their types aptly named “M”. The scope of the classification of M comes with another prefix in a number. The common prefix for M is 0, 1, 2 and 3. The lowest number refers to the narrowest representative for money. Conversely, the highest number has the broadest coverage in interpreting money supply. Each central bank of every country has different interpretation on what is the narrowest and broadest coverage but the following the general interpretation of each M:

M0 – refers to the actual coin, paper money and anything that can be easily converted or used for transaction and could be regarded as part of the currency. Since this only refers to cash and other liquid assets, it has the narrowest coverage.

M1 – this category refers to everything in M0 but also expands its coverage on accounts deposited in banks. This includes checking, accounts that that can be withdrawn and used immediately.

M2 – the coverage expands to savings and time-bound accounts.

M3 – also considered as the broadest measure of money, this category includes everything that can be considered as value; asset or anything believed that can be used as alternative to money.

Classification is very important for central banks, the government and businesses. Through classification, business and government should have a good idea on how the money is spent or stored. This gives them some useful information on how to work the economy or create measures to ensure its stability. Governments, on the other hand, use money supply in order to determine the recommended interest rate.

Money Supply and Inflation

Money supply in every country is very important because of its direct effect on inflation. When there’s ample money supply, the interest rate is lowered which increases consumers confidence in spending. The increase in spending will also boost the prices of the products simply because the demands will increase. As the price increases, inflation will start to happen. This is the reason why the government has to limit money supply since it could have a devastating effect on the country’s economy.

A good example is the country of Zimbabwe. As the central bank pumped more and more money to be used, the prices of products become more expensive because people now have more money. But the excessive printing of money did little to improve the country’s economy. Hyperinflation occurred and Zimbabwe’s economy went down. Although people have access to millions of their currency, its purchasing power is very little. Hyperinflation devalued the Zimbabwe currency (Zimbabwe Dollar) so much that in July 2008, an egg costs 50 Billion Zimbabwe dollars. Hyperinflation was stopped when the currency was suspended and trading is only done in foreign currency.

Money Supply and Interest Rate

Money supply also has directly effect on interest rate which ultimately changes consumer behavior and business plans. To fully understand the relationship of money supply and interest rate, one should think about demand and supply on its relation to pricing. By using this concept, understanding the relation of money supply and interest rate is easier.

The rule of demand and supply dictates the pricing of goods. When there is ample supply with lesser demand, the price of a specific good will most likely go down. Inversely, the price of an item will go up when that demand for that specific item is higher than what is available.

This concept is also applicable to money supply and interest rate. The money supply is the goods and interest rate is the price. In this setting, when money supply increases the interest rate will also go down since there is enough funds for everyone. Consumers will be more active in purchasing products since they can easily gain the money they need without worrying about the interest rate. On the other hand, when the money supply decrease, interest rate will be higher and consumer behavior will be affected since their access to available funds will cost more.

The relation of money supply to inflation and interest rate are the main reasons why consumers should also look out for this data from the central bank (Federal Reserve in USA). It’s a data that will affect loan transactions and business in the immediate future.

Money Supply Quotes (8)

When confronted with the possibility of economic contraction, politicians and bankers frequently discuss the need to "expand credit" by increasing the amount of money available to be lent. But can this be done on command? In the case of our fishing friends, how can Able legitimately lend out more fish than he has saved? The island's total supply of credit is limited by its total supply of saved fish.
— Peter Schiff; How an Economy Grows and Why It Crashes

Give me control of a nation's money supply and I care not who makes the laws.
— Mayer Amschel Rothschild

First, the total stock, or supply, of money in society at any one time, is the total weight of the existing money-stuff.
— Murray Rothbard; What Has Government Done to Our Money?

Changes in the total gold stock will be governed by the same causes as changes in other goods. Increases will stem from greater production from mines; decreases from being used up in wear and tear, in industry, etc. Because the market will choose a durable commodity as money, and because money is not used up at the rate of other commodities—but is employed as a medium of exchange—the proportion of new annual production to its total stock will tend to be quite small. Changes in total gold stock, then, generally take place very slowly.
— Murray Rothbard; What Has Government Done to Our Money?

What happens, then, if the supply of gold increases, demand for money remaining the same? The “price of money” falls, i.e., the purchasing power of the money-unit will fall all along the line. An ounce of gold will now be worth less than 100 loaves of bread, 1/3 of a television set, etc. Conversely, if the supply of gold falls, the purchasing power of the gold-ounce rises.
— Murray Rothbard; What Has Government Done to Our Money?

What is the effect of a change in the money supply? Following the example of David Hume, one of the first economists, we may ask ourselves what would happen if, overnight, some good fairy slipped into pockets, purses, and bank vaults, and doubled our supply of money. In our example, she magically doubled our supply of gold. Would we be twice as rich? Obviously not. What makes us rich is an abundance of goods, and what limits that abundance is a scarcity of resources: namely land, labor, and capital. Multiplying coin will not whisk these resources into being. We may feel twice as rich for the moment, but clearly all we are doing is diluting the money supply. As the public rushes out to spend its new-found wealth, prices will, very roughly, double—or at least rise until the demand is satisfied, and money no longer bids against itself for the existing goods.
— Murray Rothbard; What Has Government Done to Our Money?

An increase in the money supply, then, only dilutes the effectiveness of each gold ounce; on the other hand, a fall in the supply of money raises the power of each gold ounce to do its work. We come to the startling truth that it doesn’t matter what the supply of money is. Any supply will do as well as any other supply. The free market will simply adjust by changing the purchasing power, or effectiveness of the gold-unit. There is no need to tamper with the market in order to alter the money supply that it determines.
— Murray Rothbard; What Has Government Done to Our Money?

Using long, drawn-out processes to put money into circulation to meet an emergency is like mailing a letter to the fire department to tell them that your house is on fire.
— Thomas Sowell; Dismantling America