Economics for Lawyers (aka Dummies): M3 Money Supply

Pop the search term M3 into the Google toolbar and you are more likely to have images of the latest BMW returned than an explanation of economic theory. This is partly because people like high-performance sedans more than economics. Another reason is that this particular measure of the money supply has been out of use in the US since the mid-2000's. However, some interesting analysis out of the UK based on underlying Fed data is pointing to a decrease in the M3, a possible signal of deflation and therefore possible economic problems in the future.

In technical terms, this is because a decrease in the M3 indicates that there is less money in the economy. Less money chasing the same amount of goods increases the value of that currency (deflation) which is often a signal of a shrinking economy as investors and corporations will tend to hoard money when its value is increasing.

M3 is the broadest measure economists use to define the money supply in an economy. Although what, exactly, is counted in the category varies from country to country, it typically includes everything from currency to savings accounts and institutional money market funds. Although economists disagree over the usefulness of the measure due to its tendency to fluctuate significantly in the short-term, long-term trends can point to wider trends in an economy.

In the case of the US post-financial crisis and as the government attempts to increase jobs, home sales and GDP, a shrinking M3 should be viewed as a negative sign as it indicates that less money is available in the economy for investment. Though there could be many explanations for this, the most plausible one at this time is the proliferation of regulations on banks which has caused them to both increase reserves and decrease lending. Though this was to some extent necessary to stem the tide of the crisis and end the circle of bad loans, it has lead to further problems.

The greatest among these has been the government's response. If banks aren't doing the job of banks in an economy where companies are holding back on investment and hiring, and the government wants to increase economic activity, it has the option to step in with stimulus. The US government has done this in a historic way over the past year and a half under both the current and the former administration. Economists can and do argue all day, every day about what the impact of these programs has and will be.

However, the fact remains that it has meant both the printing of money and uncertainty about what this will lead to. Indeed, the situation as it stands is remarkably similar to what occured in Japan in the 1990's. For readers who aren't students of economic history, that is not a positive statement. Some believe that the only reason more cracks have not shown in the armor of the US is the fact that our currency, serving as the global reserve and currency of global trade, has been artificially floated.

If the M3 is indeed decreasing, and the US government continues to utilize Keynesian policies in an attempt to stabilize the economy, it is possible that it could lead to more problems in the long-run than it solves in the short. Combined with other issues, such as slowing global growth, present and future pension issues, and increasing financial industry regulation, it is not unrealistic to think that the long-term growth prospects of the country are as dire as they have been in generations.