Money Supply and Definitions

Money Supply Definitions

• There are various definitions of how much money is in circulation.

• The lecture will cover different definitions of the money supply (M0, M1, M2, M3), their connection to inflation, and the size of the Canadian broad money supply (M2) compared to the US.

Barter System

• The barter system involves trading goods and services for other goods and services.

• Challenge: Finding someone who wants what you have and offering fair trades.

• Example: Trading a service like washing a car for a haircut. The value of the trade depends on various factors (e.g., type of car).

From Gold Standard to Fiat Money

• Wealthy business owners issued IOUs for products, which circulated as currency.

• Governments created their own currency but initially backed it with gold to instill confidence.

• Over time, governments nationalized gold and eventually moved to fiat money, which is backed by law.

• Fiat money is legal tender, meaning it must be accepted as payment.

• The value of fiat money is based on collective belief and agreement.

Fractional Reserve Banking

• Banks pay interest to lenders (e.g., Kathleen) for deposits.

• Banks loan out a portion of these deposits to borrowers (e.g., James) and charge a higher interest rate.

• Fractional reserve requirement: Banks must keep a percentage of deposits in reserve.

• In Canada, the fractional reserve ratio is currently zero, allowing banks to lend out the entire deposit.

Functions and Characteristics of Money

• Three main functions of money:

  • Medium of exchange

  • Store of value

  • Unit of account

• Six characteristics of money:

  • Acceptability

  • Divisibility

  • Durability

  • Portability

  • Difficult to counterfeit

  • Convenience

• Counterfeiting: Counterfeiters often target smaller denominations because they attract less scrutiny.

Ways Money is Exchanged

• Three ways money is exchanged:

  • Banks: Borrowers and lenders interact through banks.

  • Bond market: Governments or corporations borrow money directly from lenders by issuing bonds.

  • Stock market: Companies sell shares to raise capital; investors lend money in hopes of capital gains or dividends.

Bitcoin as Currency

• Whether Bitcoin is a currency is debatable.

  • Challenges:

    • Limited acceptance as a medium of exchange.

    • Volatility

    • It is primarily regarded as a risk asset.

  • Bitcoin's price is determined by the agreement between buyers and sellers (the invisible hand).

Money Creation

• Money is created through the central bank and private banks.

• When money is deposited in a checking account, it can be withdrawn at any time.

• Savings accounts have withdrawal restrictions or fees.

Definitions of Money Supply

• M0 (Base Money): Bills and coins in circulation.

• M1: M0 plus money in checking accounts.

• M2: M1 plus savings accounts, money market accounts, and short-term deposits (e.g., six-month GICs).

• M3: M2 plus longer-term deposits (e.g., one- to two-year GICs).

• Liquidity Scale: M0 is the most liquid, followed by M1, M2, and M3 (least liquid).

Canadian Broad Money Supply (February 2025)

• M0: $223,153,000,000$ (money outside of checking accounts)

• M1: $1,600,000,000,000.0$ (base money plus checkable deposits)

• M2: $2,700,000,000,000$

• M3: Almost $4,000,000,000,000$

US Money Supply

• The US is the global reserve currency.

• M0: $5,800,000,000,000$ (base money supply)

• M1: $18,600,000,000,000$

• M2: $21,800,000,000,000$

• The US does not report M3.

Japanese Money Supply

• Japanese M3 money supply is $1.6$ quadzillion yen.

Inflation and Money Supply

• More money in circulation leads to more inflation.

• New money is lent into circulation at an interest rate.

• This interest rate represents the growth rate in an exponential function.

• There will always be inflation and markets will always return to their previous level.

Here are the answers to your questions based on the provided note:

• Question: Outline the 4 components of the money supply

  Answer: Term deposit, money market mutual funds, checking accounts, and current accounts demand deposits

• Term deposits: Funds deposited for a fixed term with restricted access until maturity.

• Money market mutual funds: Investment funds that invest in short-term, high-quality securities.

• Checking accounts: Accounts that allow for withdrawals and deposits, providing liquidity for everyday transactions.

• Current accounts: Accounts commonly used by businesses for everyday transactions, often designed to facilitate higher transaction volumes.

• Question: Describe the 4 definitions of the money supply, including M0, M1, M2, M3

  Answer: The four definitions of the money supply are:

  • M0 (Base Money): Bills and coins in circulation.

  • M1: M0 plus money in checking accounts.

  • M2: M1 plus savings accounts, money market accounts, and short-term deposits (e.g., six-month GICs).

  • M3: M2 plus longer-term deposits (e.g., one- to two-year GICs).

• Question: Explain the connection between money supply and inflation

  Answer: The connection between money supply and inflation is that more money in circulation leads to more inflation. New money is lent into circulation at an interest rate, which represents the growth rate in an exponential function.

• Question: List the size of the Canadian and American money supply in the following definitions using the Trading Economics Website from your lesson: M0, M1, M2

  Answer: The sizes of the Canadian and American money supplies are:

  • Canadian Broad Money Supply (February 2025):

  • M0: $223,153,000,000$

  • M1: $1,600,000,000.0$

  • M2: $2,700,000,000,000$

  • M3: Almost $4,000,000,000,000$

  • US Money Supply:

  • M0: $5,800,000,000,000$

  • M1: $18,600,000,000,000$

  • M2: $21,800,000,000,000$

The US does not report M3.

• Question: How does the graph of global money supply compare to the graphs of the NASDAQ and S&P 500? How can you use this information as an investor?

  Answer:

• they are similar

• The graph of global money supply typically shows an upward trend, indicating that as more money is printed and circulated, it can often correlate with rising asset prices, including those of the NASDAQ and S&P 500. As an investor, understanding this relationship can be crucial; increasing money supply can lead to inflationary pressures, which may boost equity valuations, but also necessitates careful monitoring of economic indicators to gauge potential market corrections.