The Quantity of Money

Printing money causes inflation. Everybody's heard it. Everybody repeats it. Our economists tell us the government put too much money into circulation and that is why prices went up. It must be difficult to believe that the quantity of money declined. And yet here I am, saying the government kept too much money out of circulation and that's part of what caused the economic problems of the past 50 years.

The quantity of spending-money, as measured by M1, grew from $119.1 billion in 1950 to $1089 billion in the year 2000. During that half-century the money supply increased nearly a trillion dollars. I guess that's why people speak of "printing money." And I guess that's where people think our rising prices came from. But that trillion dollars is out of context.

The appropriate context for the quantity of money is to compare it to the size of the economy—to the market value of all the goods and services we produce in a given year. This is the context for money in the phrase, "too much money chasing too few goods." And it is the context we use when we say, "If the quantity of money doubles, we expect prices to double."

There was 9.1 times more spending-money in the year 2000 than in 1950. But in that time the economy grew 33.5 times larger. The quantity of money grew less than ten-fold; the economy grew more than thirty-fold. The actual ratio is about four-to-one. If the quantity of money was just right in 1950, then in the year 2000 it was four times too small. More to the point, if our economy had twice the money it needed in 1950, it had about half what it needed in the year 2000.

If the quantity of money grew as rapidly as our economy grew, by the year 2000 we would have had about four trillion dollars of M1 money instead of one trillion. But our anti-inflation policy limits the quantity of money in circulation. In the fight against inflation, monetary policy kept three trillion dollars out of the economy.

Dumping an extra three trillion dollars into the economy between 1950 and 2000 would have kept the quantity of money on a par with its 1950 level. But dumping three trillion extra dollars of M1 money into our economy would surely have been inflationary. Now here is the dilemma: They did not print that three trillion dollars, but prices went up anyway.

In the second half of the twentieth century the economy grew by more than a factor of 30 while the quantity of money increased by less than a factor of 10. The quantity of money did not increase enough to have caused the inflation of those years. Prices did not go up because they printed too much money. Prices went up because we started using credit for money. Credit-use caused the inflation.

The amount of credit in use (as measured by credit market debt) grew from $486.2 billion in 1950 to $27,521 billion in the year 2000. In the year 2000 there was 56.6 times as much debt as in 1950. The amount of credit in use grew almost twice as fast as our economy grew.

During that half-century the money supply increased almost a trillion dollars. The economy (as measured by GDP) grew by almost ten trillion dollars. Our use of credit grew by more than twenty-seven trillion dollars.

Prices went up, but not because the government printed too much money. Prices went up because we started using credit for money, and we used too much credit. Debt is the proof:  If there is too much debt, it means there is too much credit in use.

Still, the problem is not that you and I use too much credit. The problem is not that the government uses too much credit, nor all of us together. The problem is the combination of our economic policies: policies shorting us three trillion dollars of spending-money, but encouraging the growth of spending. Policy is the driving force behind the growth of credit use.

(c) 2005 by Arthur Shipman