What happens when the money supply grows too slowly or too quickly? From gold-standard deflation to QE-driven inflation and inequality, we trace the lessons of monetary history, and what we can do today to protect ourselves in an age of infinite money.
Topics covered include:
- How is the money supply measured, and why is it a subjective exercise
- What is an example of a negative money shock
- Why an optimal monetary policy would lead to deflation, and why that is a good thing
- What causes inflation
- How quantitative easing contributed to wealth inequality
- What is demurrage currency
- The unorthodox way Richard Nixon sought to combat high inflation and a strong dollar
- How to increase our wealth in an era of infinite money
Show Notes
Distribution of Household Wealth in the U.S. since 1989—The Federal Reserve
Speech by Richard Nixon (15 August 1971)—CVCE
US – Total Market Cap Divided by M2 Money Supply—MacroMicro
Does Quantitative Easing Affect Inequality: Evidence from the US – Nektarios Michail
Demurrage currency—Wikipedia
Debt: The First 5,000 Years by David Graeber
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 539. It’s titled “Resilient Wealth in an Era of Infinite Money.”
What If the Money Supply Was Fixed?
Recently, I got an email from a listener that asked, “If the U.S. had a fixed money supply, how would assets behave?” Now, money supply is the amount of physical currency—think U.S. dollar bills, coins—it is checking and savings account balances at banks and credit unions, and it’s retail money market mutual funds. These are savings vehicles that invest in short-term government bonds, Treasury bills, and with the Federal Reserve.
Now, this is just one definition of the money supply, that would be M2. And that’s one of the challenges when we say “Well, what if the money supply is fixed?” What’s included in the money supply? I wrote about this in our email newsletter last week, as I tried to look at the growth in the money supply, with M2 over $22 trillion right now in the U.S. That’s the highest level ever. Back in March 2020, it was $16 trillion, and half that amount about a decade or so ago. But it’s not a perfect measure of the money supply, because, for example, there are U.S. dollars floating around overseas that are not included in the official M2 measurement.
Now, what we know about the money supply is it does need to grow. And this listener’s question is “What if it doesn’t grow?” Or we could say, “What if it doesn’t grow fast enough?” There’s something called a negative money shock, and that occurs when there’s not enough money in the economy to facilitate transactions. We saw this in Venezuela during their period of hyperinflation. There wasn’t enough money around. People were paying for parking with granola bars.
Negative Money Supply Shock
If there’s a negative money supply shock, and so there’s not enough money relative to the amount of goods available, is you get prices falling. This happened in the late 19th century in the United States. It was a period of rapid industrialization, but the U.S, U.K., Germany were on the gold standard, which means the money supply would only grow as fast as new discoveries of gold.
There was a lot of discoveries of gold from 1848 to 1855 in the U.S, California, the gold rush, in Australia in the 1850s, and so the supply of gold accelerated back then. But in the 1870s to 1890s, gold discovery slowed down, and so that led to not enough money in the U.S, and prices fell. Ideally, we live in an economy where the money supply is growing at a rate that meets with the growing population, the desire to spend money to facilitate transactions, so there’s essentially enough oil to grease the wheel of commerce.
I’ll link to a paper, research paper, that looked at that period of the late 19th century, where we saw price deflation because there wasn’t enough gold. And they write, “Deflation has had a bad rap, possibly as a consequence of the combination of deflation and depression during the 1930s.” People think deflation, depression, but the economy actually grew during that period of deflation in the late 19th century.
There are some economists—Milton Friedman, for example, suggests that deflation, if it’s anticipated, is the result of optimal monetary policy. If the money supply grew not too quickly, but just the right amount, sort of Goldilocks amount, we would see falling prices due to technological advances, due to productivity improvements as companies got more efficient at making things. And if the money supply wasn’t growing at 6% a year like it does now, faster than it needs to, we would see price decline.
When we get the money supply increasing too quickly, we get inflation, a rise in the price of goods and services, but we also get asset price inflation. When we think about inflation, there are three ingredients that cause inflation. There needs to be too much money, but we also need people wanting to spend that money, their willingness to transact, and then there needs to be enough goods and services to buy.
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