Money Supply and How It Affects You
What It Means, How It's Measured
The U.S. money supply is all the physical cash in circulation throughout the nation, plus the money held in checking and savings accounts.
It does not include other forms of wealth, such as investments, home equity, or physical assets that must be sold to convert to cash. It also does not include various forms of credit, such as loans, mortgages, and credit cards. People use these as money to improve their standard of living, but they aren't part of the money supply.
How the Money Supply Is Measured
The Federal Reserve actually measures the U.S. money supply in a few different ways.
The most liquid form of money is M1. It includes currency in circulation, though not currency held in the U.S. Treasury, Federal Reserve banks, and bank vaults. It includes all traveler's checks and domestic checking account deposits, including those that pay interest. However, it does not count checking deposits held in U.S. government accounts and in foreign banks.
M2 includes everything in M1. It adds savings accounts, money market accounts, and money market mutual funds, along with time deposits under $100,000. It does not include any of these accounts held in IRA or Keogh retirement accounts.
M3 includes everything in M2, as well as some longer-term time deposits and money market funds. M4 includes M3 plus other deposits.
The Size of the Money Supply
M1 was $3.737 trillion in January 2019, the latest figure available as of this writing. Of that, $2.1 trillion was held in checking accounts. The rest was cash and traveler's checks. More than $1 trillion is in $100 bills. Another $300 billion is in $20 bills and other lower denominations. There's $300 million in higher-denomination bills that are collectors' items.
That works out to be about $11,000 in cash per U.S. household. Banks don't hold this currency: It's all in circulation. Of this, an astonishing two-thirds is held outside of the country. Many emerging market economies use the greenback as a substitute for their volatile currency. As many travelers know, a $20 bill is good throughout the world.
M2 was $14.466 trillion. Most of it, which amounts to $9.3 trillion, was in savings accounts. Money markets held $857 billion and time deposits held $566 billion. The rest was M1.
The Money Supply and Inflation
Basic economic theory teaches that an increase in the money supply leads to higher prices. In fact, expansion of the money supply does not always cause inflation. For example, in April 2008, M1 was $1.4 trillion and M2 was $7.7 trillion. The Federal Reserve doubled the money supply to end the 2008 financial crisis. The Fed's quantitative easing program also added $4 trillion in credit to banks to keep interest rates down.
Many people worried that the Fed's massive injection of money and credit would create inflation. As the chart below shows, it didn't.
|Year||M2 (trillions)||M2 Growth||Inflation|
(Source: "Money Stock Measures," The Board of Governors of the Federal Reserve System)
The Fed's expansion of credit benefited investors instead of consumers. The Fed gave banks the credit to lend to consumers and small businesses. That should have stimulated demand, but banks complained they couldn't find credit-worthy borrowers.
Instead, the Fed's money created a series of asset bubbles. In 2011, investors turned to commodities, sending gold prices to a record high. Investors then switched to Treasury notes in 2012, then stocks in 2013, and the U.S. dollar in 2014 and 2015.
Significance of the Money Supply
For much of U.S. history, the money supply traditionally expanded and contracted along with the economy and inflation. For that reason, the economist Milton Friedman said the money supply was a useful indicator of the state of the national economy.
But in the 1990s, that relationship changed. People took money out of low-interest bearing savings accounts and invested it in the booming stock market. M2 fell, even though the economy and inflation were growing. As a result, then-Federal Reserve Chairman Alan Greenspan questioned the usefulness of the money supply measurement. He said if the economy were dependent on the M2 money supply for growth, it would be in a recession. For this reason, the Federal Reserve no longer sets a target for the money supply.