Wednesday, July 28, 2010

Of Money (2)

When I look at inflation I use M1 money, the "funds that are readily accessible for spending." My graphs show that M1 has had a reduced influence on inflation since the late 1950s or early '60s.

Hardly anybody uses M1. Most economists use M2 or new measures. Milton Friedman in his book Money Mischief used M2 for his graph of U.S. inflation. M2 includes the same spending-money that I use, plus the money in savings. So of course M2 is a much bigger number than the spending-money number.

But we don't spend money that is in savings. It does not increase effective demand. It does not facilitate transactions. There is no direct relation between prices and money in savings. Friedman's graph used bad arithmetic to give the appearance of a direct relation that does not exist in fact.

We don't spend the money in savings. And if we do spend it, it comes out of savings and goes into circulation. So then it counts as spending-money. If we spend it, it counts as M1. If that money affected demand or prices, it would show up in the spending-money (M1) numbers. It does not show up in M1.

Maybe economists would say there is a "wealth effect." In other words, because we have more money in savings, we are more willing to borrow and spend. Well, that could be true. But if it is true, it still isn't the money in savings that affects prices. It is the money that we borrow and spend -- credit-money -- that facilitates transactions and influences prices.

Money in savings is not the same as money in circulation. Only circulating money is spent. The money in savings is used to make loans, and create debt, and to create the credit-money that we spend, which also contributes to inflation. But economists don't seem to worry about credit-use when they worry about inflation. They always want us to use more credit. That's how we got into this mess.

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