Friday, September 9, 2011

False, and false

In remarks following my recent It's full of bumps, Clonal wrote:

Base money is created by the Federal Government deficits, and removed by a surplus.

The post looks at an unusual pattern of M1 money growth -- "bumps" I call it. Base-money has the bumps, and M1 has the bumps, but money more distant from base-money does not.

Clonal seemed to suggest that the bumps originate with the Federal deficits. So I made a quick comparison of the deficits and the M1 bumps:

Graph #1

I did it quick, before work, just to see it. It's a pretty crappy graph. It compares one "index" series to another. All reality is removed from the numbers. But the bumps in M1 money on the graph are much smaller than the bumps in the Federal deficits. That should have given me a clue.

I did another quick graph, comparing numbers I'm more familiar with: M1 money and Base money. I knew that looking at "percent change from year ago" would show the bumps I was picturing, in both number-sets. And it did:

Graph #2

But I'm removing some of reality from these numbers, too, by looking at growth rates. I'm not looking at the size of the dollar-amounts. I thought about it at work, and realized that the FRED graphs can be used to show "change from year ago" in dollar amounts. That seemed a useful approach.

I started with receipts (blue) and expenditures (red) of the Federal government:

Graph #3
Pretty big gap, there at the end. Interesting how tax receipts rise and fall with growth and recession, but the expenditures do not. That used to be called "counter-cyclical" spending, and it was based on economic principles. Today, it's just called "excessive" spending.

The dark age begins with a decline of economic analysis.

Anyway... Then I took and subtracted receipts from expenditures. This puts budget surplus low on the chart (as around the year 2000), deficits high on the chart, and bigger deficits higher:

Graph #4
On Graph #4, the Federal deficit looks pretty small until around 1970. So I cropped off the earlier years and start with 1970. I also added trend-lines for M1 money (blue) and for Base money (green). Graph #5 compares the deficit (red) to changes in the money numbers. Why? Because a deficit is extra money put into the economy. Likewise, an increase in M1 or Base money is extra money put into the economy. Now we're looking at dollars added to the economy:

Graph #5
Surprise! The Federal deficits are significantly larger than additions to M1 money. And very significantly larger than additions to Base money.

I had no idea.

Graph #6 is a close-up of Graph #5. It looks at the 20 years from 1980 to 2000. The Federal deficits (red) add a lot of money to the economy that does not show up as addition to M1. I'm wondering where that money goes.

Graph #6

Also, Base money (green) is surprisingly small in comparison to the deficits. But I guess I shouldn't be surprised by that. My whole argument is that policy discourages the use of money and encourages the use of credit. My whole solution is that we must rely less on credit, and more on money.
But I don't know if my solution applies to these numbers.
In relation to graph #6, my solution is that we must increase the green, not the red. Increase the money, not the debt. It's not worth a crisis. It is a simple policy choice.
But again, I don't know if my solution applies to these numbers.

Graph #7 below looks at the 20 years before 1980:

Graph #7
On this graph, the Federal deficits started out lower than everything else, not higher. That was during the golden age, when the economy was doing well, before the accumulation of private debt started to hinder growth.

You can see how quickly things went bad. The red line peeks up over the blue briefly in 1967. It rises noticeably above the blue for 1970-1973. The red rises well above the blue in 1975-1978. And since 1980 (as Graph #5 shows) the red is almost never below anything.

Oh yes, the other thing. I was wondering where the money goes. When the Federal government spends a deficit-dollar, the dollar goes into circulation. Extra money gets put into circulation. So it should increase M1 money. So the blue line should be as big as the red line, or bigger. But it isn't.

Where does the money go? We lose some of it to foreign trade. But some of it simply goes out of circulation and into savings. That's what I'm looking at in Graph #8: savings. Additions to savings.

For Graph #8 I started with Graph #7, and added the orange line there, which is M2 money.

M2 money is M1 plus money in savings. The orange line is the blue line plus money in savings.

Graph #8
Everything between the blue line and the orange line on Graph #8 is additions to savings. So, you want to know where the money goes? It goes into savings. It goes into the financial sector. And then it gets lent back to the productive sector, at interest. That interest cost is the source of inflation. This process is the source of the growth of finance.

And the root of the whole thing? We think we need more credit for growth, and we think that raising the blue line is the cause of inflation. False, and false.


The Arthurian said...

...but I still don't know about the bumps!

Clonal said...


Look at the Accumulated deficits graph -- you will see the big bumps there.

Clonal said...


as stated above, compare M1 money stock to accumulated deficits and to the national debt. You will see a great deal of similarity.

Jazzbumpa said...

when the economy was doing well, before the accumulation of private debt started to hinder growth.

Here's one more thing to think about. What if this is exactly backwards, and hindered growth (along with ever-increase wealth and income disparity) caused the accumulation of private debt?

Even worse, it might be chicken and egg. How would you sort that out?

Yours in perpetual confusion,

Jazzbumpa said...

Hmmmm. If a correlates with B, and B does not correlate with C, then A does not correlate with C. Does that seem right?

Money stock correlates with accumulatd deficits.

Deficits do not correlate with inflation.

Therefore money stock does not correlate with inflation. I believe that is strike 3 for Friedman.


The Arthurian said...

Hmmmm. I love the logic. Imagine... If we undermine Friedman, perhaps Lucas and all the rest will topple.


"Here's one more thing to think about. What if this is exactly backwards, and hindered growth (along with ever-increase wealth and income disparity) caused the accumulation of private debt? Even worse, it might be chicken and egg. How would you sort that out?"

The accumulation of private debt is caused by policy -- or allowed by policy, which is very nearly the same thing, and which requires exactly the same solution.

Always, when you want to know where I'm coming from, go back to the DPD graph. Debt per dollar. The graph shows that total debt -- public and private debt -- increased relative to the quantity of money in circulation, right up to the very bottom of the Great Depression in 1933. Then, the ratio fell for the full term of the FDR presidency.

After World War II, the ratio started rising again and we had a golden age. My conclusion is this: The reduction of the DPD ratio was the solution to the Great Depression. The reduction of debt, relative to money in circulation, solved the problem.

Or, again: "What if this is exactly backwards, and hindered growth (along with ever-increase wealth and income disparity) caused the accumulation of private debt?"

After WWII, the low level of DPD was accompanied by a golden age for the economy. ALL DURING THE GOLDEN AGE, DEBT INCREASED. As long as the level of debt was sufficiently low, growth was not hindered. But we started to see signs of trouble in the late 1960s. (The economic troubles of those years are usually attributed to the VietNam war. But that war soon ended, while the troubles did not.) Since that time we have done everything in our power to INCREASE the access to credit, and to RESTRICT the quantity of interest-free money in circulation. These solutions have achieved nothing but the increase of accumulated debt.

Now, Jazz: Can you take my previous paragraph and turn it around, and make a solid argument that growth was hindered by something else, and debt increased as a result? CAVEAT: The growth of debt since 1947 followed an exponential curve. You are not allowed to look at debt only since 1980 to make your argument. You have to explain the whole 60 years of debt growth, 1947-2007. Please note that many causes strung together like beads on the thread of argument, when compared to debt growth as *the* one primary cause, will fail the test of Occam's Razor.

And one last time: "What if this is exactly backwards, and hindered growth (along with ever-increase wealth and income disparity) caused the accumulation of private debt?"

You are asking whether "ever-increase wealth disparity" could have "caused the accumulation of private debt". The answer is NO.

Jazz, one man's wealth is another man's debt. There is no cause-and-effect. Debt and wealth are the same thing, seen from the two different sides of the transaction. So, no, increasing wealth disparity cannot have "caused" the accumulation of debt. Wealth disparity IS the accumulation of debt.

Clonal said...

Art, Jazz

You may also want to read Randy Wray's - A Minskian Explanation of the Causes of the Current Crisis written in 2010

Much of the world emerged from the Great Depression and World War II with a combination of institutions, regulations, financial practices, and memories that together encouraged relatively rapid economic growth, high employment, growing incomes, and growing confidence in our future. Private debt was low (mostly wiped out in the bankruptcies of the 1930s), government debt was high (war finance), and the financial system had been “simplified” (in Minsky’s terminology). Big Corporations mostly used retained profits to finance expenditures; Big Unions kept wages growing so that workers could spend out of income rather than relying on debt; Big Government had filled portfolios of banks and savers with safe government bonds. Finance was kept small, constrained, and relatively irrelevant. Besides, memories of the Great Depression discouraged lending as well as borrowing. Strict regulation—especially in the US—kept risky financial practices segregated outside commercial banking.

Over time a complex combination of factors changed all that—memories faded, regulations were relaxed or financial institutions defeated them with innovations (including new types of instruments and institutions that took market share away from highly regulated banks). Private debt grew. Risky practices emerged.

Clonal said...


On the Friedman issue, as you said, the data was from "Money Mischief." Was there a reference to an original paper where he shows that inflation and money supply are highly correlated, was this was something original in the book? I currently do not have access to the book, and so cannot do the due diligence.

The Arthurian said...

"a complex combination of factors"

Sounds big. Means little.

The problem is policy.

The solution is policy.

Clonal said...


I don't think that Randy Wray would disagree with you there!

Jazzbumpa said...

From Wikipedia:

Inflation is always and everywhere a monetary phenomenon.
—Milton Friedman, Wincott Memorial Lecture, London, September 16, 1970[25]

Ref [25]

This paper, which I just discovered have not yet read, features the Friedman Quote.


The Arthurian said...

Jazz, that PDF is a friggin gold mine.

The Arthurian said...

Substantial inflation is always and everywhere a monetary phenomenon.

The Arthurian said...

...and the PDF agrees about the substantial thing:

"First, most studies that report a close connection in the long run use data for many countries, and it is sometimes noted that the finding appears to rely heavily on the presence of countries with high rates of money growth and inflation. It is much less clear that a close relationship exists within countries with relatively small changes in money growth such as the United States."

Jazzbumpa said...

I was away all day and still have not read the PDF. It occurred to me while driving, though, that the Friedman claim might be true of HYPERINFLATION, but not necessarily true of inflation in the low to moderate ranges we have seen in U.S. history. I don't think we've ever hit 20%, even for as mucg as a single quarter.


Jazzbumpa said...

OK. I read the PDF and am not exactly overwhelmed. Using 8-yr averages, you get a strong correlation between money growth and inflation - if you carefully chose your money aggregate, inflation measure, and time period.

1) Correlation is not causation.

2) Supposing there is causation - then maybe inflation causes money growth. Looking at concurrent 8-yr averages makes it impossible to tell who leads and who follows.

3) Eliminating data pre-1959 because it doesn't fit the theory is cherry-picking.

4) The time frame for robust secular inflation was about 1959 to 80, with disinflation after 80-ish. The entire set of observations could be data artifacts riding on the back of the underlying inflationary changes.

5) I'd like to see inflation and money supply growth on the axes, rather than paired lines over time.


The Arthurian said...

The think that bothers me most about the PDF is the conditional tone of it. This is what they teach in economics school, I think: to see ALL the sides of EVERYthing, and never to say "this is right" or "this is wrong."

I have 5 posts scheduled for tomorrow, all on various bits of this PDF.

Yeah, I also don't like that they eliminate the older numbers -- and even admit that they don't fit the theory. Amazing.