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.