Less Cost in the Money

I got some great comments from Jim, on my debt productivity post of the 10th. I'm ready now to respond to one particular theme in those comments.

My argument in the post is that, for a time, total debt grew unusually slowly and M1 money (spending money) grew unusually fast. And that people's spending shifted away from using new credit, toward the use of existing money. This saved on interest costs, and the cost savings helped to boost economic activity and economic growth.

That's fine, Jim says, but where's the evidence that more M1 money was actually spent?

He points out that banks started paying interest on checking in the late 1970s, and the rules evolved thereafter. This suggests that the rapid bursts of M1 money growth that are visible on my graph could have been a response to banking policy.

With banks paying interest on checking, Jim says, people would have been willing to move money from savings to checking. There were minimum balances, he says, and checking balances below the minimum were not paid interest. So people would move money from savings to checking, enough to exceed the minimum balance. This way, the money in checking earned interest.

The kicker is that you always had to exceed the minimum balance. So you needed to keep the extra money in the checking account. You couldn't spend it, or you'd risk losing interest on what remained in checking.

In other words, the banking rules encouraged a transfer of funds from savings to checking, and discouraged the spending of that money. Since money in checking is part of M1 money, the banking rules would have encouraged the creation of those increases in M1 money that I showed in my graph.

As Jim put it,

In order to get the interest depositors have to maintain a minimum balance of $500. That is $500 of savings that is sitting unused in checking accounts. That shows up in the M1 graph, but I can't think of any reason it would show up in the economy.

It's a very good argument.

Actually, I remember that "interest on checking" thing from the late 1970s. I got married in 1977. The wife and I deposited a decent amount of wedding-gift money in a "NOW account" -- a "negotiable order of withdrawal" account, a checking account that pays interest -- at the local Savings and Loan.

It's like a savings account, I thought.

But the next thing I knew, that money was all gone. We spent it before I even knew.

So I can personally vouch for the fact that moving money from savings to checking-with-interest increased not only the quantity of money readily accessible for spending, but also increased the spending.

I suspect there was a lot of that going on. Maybe people would replenish checking balances from savings accounts, then gradually spend down the checking balance, so that further replenishment was needed. Perhaps this was the mechanism by which the dis-saving in this country was implemented.


M1 is the money we use for spending. M2 is M1 plus the money we have in savings. When you move money from savings to checking, M2 stays the same, M1 increases, and savings decreases.

Graph #1: M2 Money (blue) and Components

The green line shows M1 money. The red line shows the other money in M2, other than M1. At any particular date, the value of the green line and the value of the red line, added together, should equal the value of the blue line. You can see for example that between 1991 and 1995 the green line goes up, and the red line goes down. Added together they give us the blue line, which goes up -- but not as much as the green line.

The red line going down in those years is money coming out of savings. The green line going up is money going into checking, or into the money we use for spending. Jim is right, of course: the fact that money goes into a checking account does not guarantee that it will soon be spent.

Probably, both things happened. Some people successfully refrained from spending their enlarged M1 balances. Others did not. If that's what happened, then there must have been a net increase in spending of this money. For none of it was being spent when it was in savings, but some of it was being spent after it moved to checking.

Thus, I conclude that the humps of M1 money on my graph indicate increases in the spending of M1, though perhaps smaller increases than the hump sizes suggest.


In mine of the 10th, and the 12th at noon, to show money growth I showed M1 money in particular. Why M1? Because it's the money we spend. As opposed to base money or money in savings, for example.

Also the 13th at noon. But in yesterday's nooner I showed three forms of money, and I showed the same three humps in all three forms. The unusual bursts of growth that appear in M1 money also appear in base money, and they also appear in Federal debt held by Federal Reserve banks.

I think I have this right: If money is being moved from savings to checking, new money is not being created. The increase in M1 is balanced by the decrease in savings. Since no new money is being created, there is no requirement for additional reserves or additional base money. Actually, now that I'm putting it into words I'm not sure about that. (The reserve requirements are not the same for money in checking and savings.) But such was my thinking when I made the graphs.

In any event, it wasn't only M1 money that grew quickly in those years.

If the Federal Reserve supported the faster money growth, which it did, then it was not just a shift out of savings. It was policy.

If the humps of money were policy, and the decline of debt was policy, as I also think, then the shift in the Debt-per-Dollar ratio was policy.


Jim says

there is no evidence that growth in spending increased.

There is some evidence that Gross Private Domestic Investment increased in the 1990s -- not only the latter '90s when the economy was doing well, but also in the early '90s when M1 was growing rapidly and debt growth was slow:

Graph #2: Real GPDI Growth Was Strong in the 1990s

The early '90s investment boom stands out as evidence that the downshift in Debt-per-Dollar had an immediate, positive effect on economic growth.


I have one more point to make. Just above, I quoted Jim saying there is no evidence that spending increased.

Here's the thing. And maybe it's a subtle thing, I don't know. But there doesn't need to be an "increase" in spending. There needs to be less cost in the money. Imagine two worlds, and we're spending the same amount in both. But in one world we use a lot of credit and pay lots of interest. In the other we use only a little credit but we have plenty of money that doesn't bear the cost of interest.

In the one world interest costs are higher; in the other they are lower.

In the one world taxes are higher because their government must pay interest on a lot of debt. In the other they are lower because there is little government debt.

In the one world prices are higher because producers must pay a lot of interest on the money they use to finance the production of goods and services. In the other, prices are lower because embedded interest costs are less.

In the one world living standards are lower because consumers must pay a lot of interest on the money they use to finance the purchase of goods and services. On the other, living standards are higher.

It is not so much that we should see an increase in spending, but that we should see a reduced cost of the use of money -- a cost composed not only of interest rates but also of the level of debt, which determines how many dollars require interest payment.

But when we reduce the Debt-per-Dollar ratio and reduce the cost of the use of money, the results are lower interest costs, lower taxes, smaller price increases, and higher living standards. And the reduced costs encourage economic growth.