The money supply of each country is diverse and is divided into categories that differ from each other by their liquidity level. These categories are marked as M0, M1, M2, M3, M4, etc. In different countries, the number of categories and their depiction differ.
In this article, the RESERVEUM group continues studying the weaker and stronger points of the modern-day money system to use this knowledge for creating a fair currency.
Main Money Supply Types
There is no single standard on how to classify money, so we will take M0, M1, and M2 money supplies used by the FED, the European Central Bank and the Bank of England.
Federal Reserve System
M0 is the cash in circulation including banknotes and coins both in and out of the banking system.
M1 includes M0 and all the current accounts, demand accounts, and traveller’s cheques.
M2 is M1 and all the savings accounts, money market accounts, retail funds of the money market, as well as time deposits (certificates) for up to 100 thousand dollars.
European Central Bank
M1 is the cash in circulation and overnight deposits.
M2 is M1 and deposits due up to two years as well as deposits that require repayment in less than 3 months.
M3 is M2 and all the REPO deals, money market funds, and bonds with a repayment period of up to 2 years.
Bank of England
M0 is all the cash in circulation as well as all the money in banks and bank account balances in the Bank of England.
M1 is M0 and the money in all the individuals’ current and deposit accounts that may be transferred with a cheque.
M2 is M1 and non-interest bank deposits along with building societies deposits and National Savings and Investments accounts.
We dwelled on the Central banks and their activities in our article “FED – the Structure of the World’s Biggest Central Bank”.
What is Money Supply Used For?
These and other money supplies are used to count the money in the economy, understand what amount of cash and e-money is there in circulation, and estimate the financial stability.
For instance, a fast-growing money supply shows that there is more money in the economy than goods, which is the main characteristic of inflation.
There is a strong connection between money supply, inflation, and interest rates. Central banks, such as FED, lower the interest rates (in other words, they make loans cheaper) to increase the money supply and therefore stimulate the economy. And vice versa, in times of high inflation, the interest rates are increased, and loans become more expensive which leads to a lower money supply and lower prices.
This process reminds a financial game where the money supply is the instrument for defining the measures that need to be taken to influence the economy. In theory, it all looks simple and effective; however, in practice, all these mechanisms are bulky, they reflect the market situation with a huge delay, and the results are to be expected in months or even years.
This is why this money system is not effective.
The money supply is just a theoretical indicator that does not reflect the real state of affairs. The main reason is the nontransparent banking system and the centralised money emission.
In an economy where banks make money out of thin air, finances cannot be effective. Like when a client puts their savings into a deposit and the bank gives this money to another client as a loan. But it doesn’t count as a money transfer, the deposit exists on paper, and this amount, though practically given to another person, still exists on paper and is counted as a part of the money supply, as well as the loan. So, from one sum of money, the bank made two, and such operations are processed on an everyday basis. This is why the money mass is constantly growing artificially and grows into a huge bubble.
Add the centralised emission when the Central Bank uncontrollably prints new money, and we have an absolutely uncontrollable money system with ever-growing inflation on our hands.
If you want to know more about the schemes Central banks use to make more money, we recommend our article called “Seigniorage”.
How can we re-organise the financial system?
A well-organised and clearly operating financial system would play a vital role in the stability of the national production, lower unemployment rates, and price stability. But to get there, it should be based on the principles contrary to the ones that rule the finances today.
First of all, the economy needs a decentralised currency that would not be affected by interested parties and organisations. This can be made with the help of a smart contract – an algorithm that would estimate the production and consumption volumes and would distribute the money units among the system participants according to their input into the economy and their needs.
Secondly, loan institutes should operate only with the finances they already have; while using the money deposited by their clients, they should show the money movements to eliminate artificial money supply growth and higher inflation rates.
Central banks can incessantly come up with arguments against this idea of a transparent and effective currency, but all of these arguments are aimed at retaining the power in the authorities’ hands – the power to rule the money system in their own interests, not in the interests of the economy or the society.
The money system can be changed now; with our research and published articles, we are trying to draw the attention of the crypto community to this problem and try to solve it together.
According to the analysis group findings: reserveum.org