The money supply today comprises coins, paper money, and checking deposits. In the United States, paper money is issued by the Federal Reserve, the central bank of the nation, and is known as Federal Reserve Notes. Checking deposits represent the largest component of the money supply today. Technically, they are not money but money substitutes, since they are claims to money held by the issuing bank. However, as long as the bank is not in financial trouble the checks circulate as the equivalent of money. When banks get into financial trouble, their checks might not be accepted in trade. In cases like these, the checking-account funds at such banks cease to be money because they are no longer a medium of exchange.² But this occurs infrequently and can be taken into account if necessary when measuring the money supply. It is proper to count checking deposits as a portion of the money supply under normal circumstances because they are generally accepted as a medium of exchange. As a part of the checking deposit component of the money supply, I include all accounts on which checks can be written. This includes personal and business checking accounts, money market deposit accounts (MMDAs), money market mutual funds (MMMFs), government checking deposits (at the federal, state, and local levels), and checking deposits of foreigners at US banks (whether foreign governments, banks, etc.). I discuss qualifications to some of these below. I also include certified checks, cashier’s checks, money orders, and traveler’s checks as a part of the checking deposit portion of the money supply.

Another category of money is standard money. While not a separate component of the money supply, standard money is important to have knowledge of if one wants to have a good understanding of money and be able to explain the business cycle. Standard money is money that has ultimate debt paying power and is not a claim to anything further. Today it consists of coins and paper money. It used to be gold when countries were on the gold standard. When countries were on the gold standard, paper money was merely a claim to the gold deposited in banks. Today, the coins and paper money that comprise the standard money are known as fiat money because they have been declared arbitrarily by the government to be money (i.e., to be legal tender). Fiat money has completely displaced gold today. It was not through a natural development of the free market that it displaced gold but through the use of government force (i.e., violations of the free market).³

The following example will help concretize the concept of standard money. When a man pays for his groceries with cash the transaction is complete. The man has paid everything he owes to the grocer. This is because cash is standard money. It has ultimate debt paying power. However, if the man writes a check to pay for his groceries the transaction is not complete. The grocer wants the funds deposited in the man’s checking account; he wants the standard money. At this point, the grocer only has a claim to these funds in the man’s account. Only after the grocer gives the check to his bank, his bank presents the check to the issuing bank, and the funds are transferred from the payer’s to the grocer’s checking account is the transaction complete. Now the standard money has been transferred to the grocer (or, at least, the appropriate debits and credits to each bank’s balance sheet and each depositor’s account have been made so that the balance sheets and accounts reflect the appropriate claims to standard money).

Above I said that MMDAs and MMMFs are a part of the money supply. Some might be confused by this statement because these accounts are typically designated as types of savings accounts. However, this is not a completely accurate designation. MMDAs (at banks) and MMMFs (at mutual fund companies) are accounts on which checks can sometimes be written but with some restrictions. For instance, the number of transfers (which includes checks written on the account) is limited on MMDAs. MMMFs typically have no restrictions on the number of transfers (including checks); however, a certain minimum amount must be transferred each time. The latter is also true of MMDAs.

Hence, these accounts are a part of the money supply, with some qualifications. They are a part of the money supply to the extent that depositors use them as a medium of exchange. It is generally believed that MMMFs are used more often as a medium of exchange than MMDAs, since the former accounts have fewer restrictions on them. Estimates have been made for the portion of MMMFs that have checking-writing capabilities on them. I use this to estimate the portion of MMMFs that should be included in the money supply. In the case of MMDAs, even though they generally have check-writing capabilities, because of their restrictions, it is generally believed that depositors do not use these as a medium of exchange as often. What portion of MMDAs to include in a measure of the money supply remains open to debate. I will have more to say about this below.

The last financial instrument I will discuss in this subsection is credit cards. They are not money. Credit cards give the holder electronic access to a loan; they enable the holder to borrow money and, of course, the loan must be paid off with money but the card itself is not money. The card, of course, does not change hands like money. In essence, the card gives the user temporary access to someone else’s money (the card issuer’s), which is borrowed to pay for goods purchased.

The economist Lawrence White has considered whether the signed charge slip handed over by the credit-card user to the seller at the time of purchase of the goods might be money. He says one might argue that “[w]ithin the retail sphere . . . an individual’s debt instruments in the form of signed charge slips are generally acceptable . . . [and thus] qualify as a form of money.” He goes on to reject this viewpoint because “the debt instrument in this case is not acquired through trade in order to be spent by anyone. The card holder . . . does not acquire it through trade. The merchant . . . does not intend to spend it.” (Emphasis is in the original.) He also says that the reason why the debt instruments are not considered to be money is not because they are a form of debt, since checking deposits are debt to the issuing bank and yet they are money.⁴

While White comes to the right conclusion, he omits a crucial point along the way. The claim that the charge slip does not constitute money because it is not acquired in trade by the card holder and the merchant has no intention of using it in trade to purchase goods does not provide a complete answer. Money must not only be readily acceptable in exchange and sought for the purpose of being re-exchanged, it must be an asset to the user as well. Neither the credit card nor the charge slip is an asset to the card user. They are liabilities. Specifically, when the credit-card holder borrows via the credit card he incurs a debt, and debt incurred via a credit card is no more money than any other form of debt one incurs (whether a car loan, mortgage loan, a loan from issuing Treasury bonds, etc.).

Furthermore, in saying that one cannot claim that something is not money because it is a form of debt, since checking deposits are debt to the issuing bank and yet they are a form of money, White commits the same error: he fails to keep in mind the essential characteristic of money as an asset to the user. The checking deposit is not money to the bank because it is a liability to the bank. However, the checking deposit is money to the depositor because it is an asset to the depositor (that is readily acceptable in exchange). So we can say the credit card and charge slip are not money because they are forms of debt. They possess neither of the essential characteristics of money: they are not an asset to the user and they are not “acquired through trade in order to be spent by anyone.” For something to be money it must possess both characteristics.

It must also be understood with regard to credit cards that their existence does not increase the amount of spending in the economy. If I take out a loan through the use of a credit card, as with any other loan, I am able to spend more money but the lender, at the same time, has less money and therefore is not able to spend as much.⁵ As with all loans, they merely transfer money from the lender to the borrower and allow the borrower to temporarily spend more and make it so the lender is restricted in his spending but can earn interest as compensation.

Credit cards do not decrease the amount of money people hold either. Sometimes it is believed that people hold less money when they use credit cards because people hold less cash. They hold less cash because they use credit cards to purchase goods instead. However, the money represented by the reduced cash people hold does not disappear. To the extent that people are holding less cash, they are holding more money in other forms (viz., checking account balances). So credit cards do not reduce the amount of money people hold, they merely change the form in which people hold money.

Up through the 1980s and early 1990s, the M1 measure of the money supply was the most accurate measure. This measure includes currency in the hands of the public plus traveler’s checks and accounts designated as checking deposits by the Federal Reserve. Typically, an account is designated as a checking account if there are no limitations on check writing. Therefore, checking accounts include some, but not all, accounts on which one can actually write checks. For instance, they include traditional demand deposits and negotiable order of withdrawal accounts, but they do not include MMDAs and MMMFs. Since these latter deposits have grown significantly in recent decades and have at least some check-writing capabilities, M1 is no longer an accurate measure of the money supply.

M1’s inaccuracy stems from the fact that it is too low as a measure of money. The next measure, M2, is too high. M2’s main inaccuracy is that it includes some funds that are not, in fact, money, although it does also fail to include some funds that are money. M2 includes M1 plus savings deposits (which includes MMDAs), small-denomination time deposits (deposits less than $100,000), and “retail” MMMFs. Retail MMMFs are those opened with initial investments of less than $50,000 (typically by individuals). About 75 percent of these accounts have been estimated to have check-writing capabilities. About 20 percent of “institutional” MMMFs (MMMFs with initial investments of $50,000 or more) have been estimated to have check-writing capabilities.⁶ M2 does not include institutional MMMFs at all. Not including the portion of institutional MMMFs that have check-writing capabilities on them results in M2 being too low of a measure of the money supply. The funds included in M2 that are not money are the savings deposits on which one cannot write checks (this includes the portion of MMDAs that checks cannot be written on), time deposits, and the portion of “retail” MMMFs on which checks cannot be written. In addition, the MMDAs and MMMFs included in M2 and on which checks can be written but that are not used as a medium of exchange by account holders are not money either. The net result of the inaccuracies of M2 is that it is larger than the money supply.

Money of zero maturity (MZM) is another measure of the money supply. MZM includes M2 minus small-denomination time deposits plus institutional MMMFs. Its drawback is the inclusion of savings deposits and the portions of MMDAs and MMMFs that are not used by account holders as a medium of exchange. All of the measures of the money supply I have discussed so far are easily obtainable because their values are reported by the Federal Reserve.

The most accurate measure of the money supply includes the following: M1 plus the portion of MMMFs and MMDAs that account holders use as a medium of exchange, the portion of “retail” sweep accounts not swept into MMDAs that depositors use as a medium of exchange, and the portion of “commercial” sweep accounts not swept into MMMFs that account holders use as a medium of exchange. Sweep accounts are accounts that allow banks to transfer funds back and forth between checking accounts and other accounts (such as MMMFs, MMDAs, Eurodollar deposits, and repurchase agreements). Sweep accounts are used by banks to reduce the amount of legally required reserves they must keep on hand and to earn higher interest rates for themselves and their customers. In a sweep account, the funds reside in a checking deposit during the day (when checks might clear on the account) and are swept into interest-earning accounts (or accounts with higher interest rates) at night (when no activity takes place in the account). Sweep accounts reduce the reserves banks must keep on hand because checking accounts have legally imposed reserve requirements, while the accounts into which funds are swept have no reserve requirements. It is proper to include sweep accounts in the money supply because the funds are us...