The Federal Reserve Board recently announced that it will stop publishing figures for M3 in March of 2006. It is one of the most commonly referenced measures of the U.S. money supply. This is not a momentous event, but it is another sign that the Fed would rather tell us less than tell us more.

As financial markets have changed, the classical measures of the money supply have become less relevant. The US economic system is vastly more complex today than when those measures were developed over half a century ago. With less regulation of the banking system and more substitutes for simple cash, it’s no longer clear what to include in “money.”

Money used to mean the cash people carried in their pockets and the checking and savings account balances they had in their banks, because that is what they would use to buy goods. But now they have money market funds, which function almost as checking accounts. And behind many small-balance checking accounts are large lines of credit. And with credit cards acceptable for almost everything, it is possible to get by with little cash at all.

Today if you buy a house, most of the money probably comes from a mortgage that will be fed into a complex pool of securitization (mortgage backed securities) managed by Fannie or Freddie Mac. The money might not come from the traditional banking system. And if you get a floating-rate loan, your mortgage may end up in the portfolio of an institution that issues commercial paper, which in turn could be purchased by a money market fund whose shares look a great deal like… money. The point is that credit is what we use to buy things so credit is a form of money. The broadest definition of credit is all debt. As our financial system has expanded in form and types of debt, the traditional measure M3 encompasses less and less of the total credit. The chart below shows graphically the decreasing importance of M3. It is the ratio that M3 is of all outstanding debt:

M3 Represents Less of the Economy

M3, which had been equivalent to 45% of all US debt, is now only 25%, as new sources of credit outside banks have ballooned. This is the key point made by the Fed, when they say that the M3 relevance has diminished. Other forms of credit have grown dramatically.

Here are the components of M3:

Components of M3 Savings and Time Deposits have Grown,
while Retail and Institutional Money Funds Contracted ($B)

Here is a more detailed breakdown of the internals of M2. All of M2 is included in M3.

M2 Components Have Grown ($B)

There used to be a measure from the Fed called L, for Liquidity, which was supposed to capture additional debt instruments not included in M3. It was discontinued in 1998.

Another restriction of the new releases is that they will not be provided in easily used time series. Limiting the reporting to memorandum numbers for MMF will make following the data for analysis a painful exercise in compilation. This is the same problem for the Large Time Deposits which will be provided in the Fed’s H.8 reports. This combination is a slap in the face for economic analysts. There should at least have been an explanation with the announcement.

The Fed will be discontinuing all reports on Eurodollars and repurchase agreements. The Fed isn’t measuring all Eurodollars in this statistic. The Eurodollar component of M3 includes Eurodollar deposits payable to nonbank U.S. addressees. The repurchase component of M3 includes those repurchase agreements that are issued by depository institutions and purchased by: (1) nonbank brokers and dealers in securities; (2) individuals, partnerships, and corporations (including bank holding companies and their nonbanking subsidiaries); (3) nonprofit organizations; (4) nondepository financial institutions; or (5) state and local governments in the U.S. and their political subdivisions. You can see from the above that these definitions are relatively complex, so their argument may be valid that they may not be useful.

Just to see how big those elements have grown, I have graphed the discontinued components:

Eurodollars Growth Rate of 20% is Very Rapid

And

Repurchase Agreements Have Jumped

Figures for M3 were often revised, usually without explanation. Attached is a chart showing the difference between the history of M3 published in Dec 1999 and the M3 history published most recently. It shows that for some dates M3 has been revised upward from its initial report by as much as $60B. This is not a big number, but it makes the comparison of growth look slightly smaller, because the historical numbers were raised. Such changes add to the question of just what the Fed is up to.

M3 Seasonal Adjusted has been Revised Up $60B in 10 years

To confirm that I had covered bases, I contacted the Federal Reserve who gave me the following weak answer:

"The decision to discontinue publication of the M3 monetary aggregate was based, in part, on a determination that the M3 does not appear to convey any additional information about economic activity that is not already embodied in the M2 aggregate. In addition, the role of M3 in the policy process has diminished greatly over time. Consequently, the costs of collecting the data and publishing M3 now seem to outweigh the benefits."

That is as close to saying nothing as I can imagine. This is just not credible in my opinion as the Fed has so much money that they routinely turn in $10 to $20 of their excess profits back to the rest of the government. They earned the $20 B as interest on the huge stash of Treasuries that are bought to keep interest rates low, and are the backing of the paper dollars they issue. There are buildings of economists at the Fed that could do the job.

The discontinuation of M3 reports is a relatively minor matter compared to growth in areas of the U.S. payments system that are not regulated by the Fed and not well monitored by them. But it is unsettling. It detracts from the transparency the Fed preaches and adds to the suspicion that the Fed wants to hide anything showing money growth high enough to fuel inflation, just so people won't know how bad it is and possibly react and thus make it worse.

© 2005 Bud Conrad
Editorial Archive & Bio

www.caseyresearch.com  and www.kitcocasey.com