Money Supply

Trade Winds

Yes we're caught up in the trade winds
The trade winds of our time
We are riding on the trade winds
The trade winds of our time

Trade is a good thing.  Not accounting for trade is a bad thing. 

The money supply should allow all buyers to complete their transactions with all sellers.  A problem is identifying buyers and sellers within the existing administrative /political boundaries.  Because there is no accepted international currency, the US Dollar serves as a major medium of international trade. According to SWIFT, 52% of international trade is in US Dollars.  Thus the money supply of the United States should not just be the US Gross Domestic Product, i.e. the  buyers and sellers in the United States. It should also include the use of the US Dollar in international trade, even if that trade does not contribute to US GDP. According to the World Bank, the US GDP was 21.43 Trillion US Dollars in 2019. The amount of international trade was 19 Trillion US Dollars in 2019.  If 50% of that is in US Dollars, then the US money supply should not be $21.43 trillion but should include an additional 8 trillion US dollars. The US money supply should be increased not only to accommodate the growth of the US economy but to accommodate the growth in this international trade.

The US currency in circulation in 2019 was $1.2 trillion.  But the total money supply incudes not only this cash, but also all liquid assets. According to the Federal Reserve in 2021, the M2 money supply was $19.4 trillion or about equal to the US GDP.  However  this does not include the use of US dollars in international trade, where this currency is used even when neither party in the trade is based in the United States.  Inflation has in recent times been continuous and pervasive in the United States.  In fact the Consumer Price Index, CPI, a measurement of inflation, shows a dramatic change in the early 1970s, when the Nixon Shock removed the conventions established at Bretton Woods. In fact inflation, as measured by the change in the CPI, was not a factor before Bretton Woods, was modest when the US Dollar was convertible into gold at a fixed rate as established at Bretton Woods, but became dramatic after the Bretton Woods conventions were abolished but the US Dollar remained a major international trading currency.

Year to year inflation was dramatic in the 1970s but has become persistent but lower than  2% per year in recent times.  This is exactly the situation that one would expect if the CPI changes were viewed year to year and not over a longer period.  The changes in the CPI have been consistent since the Nixon Shock.  It is only when the changes are viewed compared only to the previous year that the inflation rate has changed. The finding ins the blog post on the CPI from 2018, https://dbeagan.blogspot.com/2018/08/the-happening-riding-high-on-top-of.html, has been updated to use more recent CPI data, but the finding remains the same.  The best fit to observed data is still no inflation prior to 1945 ( the year that Bretton Woods convention took effect); modest inflation from Bretton Woods to the  Nixon shock ; and a constant and dramatic increase in the CPI in the period after the Nixon Shock.

The growth in US Money supply should consider not only the growth in the US GDP, but also the growth in international trade. If the demand for dollars increases because of increasing international trade, but the supply of dollars is fixed only to the US economy, then is it any surprise that inflation in the US economy is the result?

It has been observed that the relationship between the money supply and US GDP and other domestic measures has been unstable in recent decades.  It is proposed that it became unstable when global trade became significant compared to the US economy.