A question about money created by central banks

[feargach]

Friends,

As we mostly know, central banks create new money essentially by creating loans to financial institutions.

In the western world the rate at which the money supply grows in this manner is roughly 12% a year, give or take three or so points.

Yet the official inflation rates for developed economies outside Ireland rarely approach half that figure.

This is perplexing to me because at a 12% annual rate, the money supply cannot help but double every six years.

I've asked this question before: what on earth happens to this money?

I've seen it referred to in various articles that "the newly created money never enters the real economy, thus preventing it from causing inflation".

If it doesn't enter the economy, where does it go?

Does it simply vanish? Roughly, what is the mechanism by which it vanishes? Does some entity simply forget to record that it has 100 billion euros of freshly created ECB money in its possession?

I've asked this before on many websites and received answers that were far from useful. It appears that, so far, nobody on the web has the faintest clue. Often a poster will say that it is all about the "velocity of money". To this I can positively retort: no it bloody isn't!

The "velocity of money" is a simple measure of how many times a particular unit of money is spent in a time period.

Obviously that tells us nothing about how, when the Fed creates twenty trillion dollars in under three years, that doesn't cause inflation to go into the high forties.

Clearly one of two things are happening:

- Massive fraud is taking place to hide the fact that double-digit inflation is actually taking place.

- Much of the newly-created money really is prevented from entering the economy, and is essentially destroyed.

Clearly, until we understand this process, we know far less about economics than 5th century wizards knew about quantum physics.

[Auditor #9]

feargach where have you been, the financial discussions haven't been as theoretical without you but now you come back with this beauty...

Are you sure the money supply grows at 12% pa? If it did last year, does it usually? or does it every year? because

some fraud, robbery, loss will disappear some of it ("it" being the difference between the 12% swelling of our money supply and the 5% swelling of inflation, so around 7% of our money is unexplained - that's a lot of money )

is a lot sent back home overseas by the immigrants?

people will have unused lines of credit - banks especially, which could account for a large amount of it, but that would mean that they'd have plenty left over from last year so we'd need to print less the year after until they needed more credit ...

great question

[Auditor #9]

maybe there is also spending going on which can't be captured by economists, banks etc. (govt funding directly to e.g. schools)

will some spending not be inflationary? again, schools and jobs created which are well-paid but contract or non-permanent so the employee can't get himself a huge loan on the back of it?

[feargach]

Yeah, I believe it's referred to as M3 by those in the biz, and it's normally at double-digit rates.

Wikipedia says that money destruction can exist, in the form of repaying loans. But it just doesn't seem as if enough money exists to actually repay such loans.

The only vaguely half-plausible explanation I have seen is that perhaps most of these hundreds of billions are simply written off by the central banks, thus effectively destroying the money.

[seabhcan]

I've often wondered about this myself. But one point is that almost all of this created 'money' is electronic - It isn't printed paper - and it just exists to settle debts between financial institutions. Before electronic money was used, they used to actually print enormous denomination notes, deliver them from one government dept to another, and then destroy them.

[Auditor #9]

M3? I'll look that up. Destroying money - old legal tender has to be disposed of too. Do you know how much money is in circulation in Ireland, how much is produced, spent, etc.? Where would one get this exact info? The CB site? Maybe we could do some calkellations here. (it costs millions per year to look after money and to pay people to count it - is that counted?)

Hang on - I have an old laser card which... nah, hardly.

[seabhcan]

M3? I'll look that up. Destroying money - old legal tender has to be disposed of too. Do you know how much money is in circulation in Ireland, how much is produced, spent, etc.? Where would one get this exact info? The CB site? Maybe we could do some calkellations here. (it costs millions per year to look after money and to pay people to count it - is that counted?)

Hang on - I have an old laser card which... nah, hardly.

The amount of physical cash which exists is only a tiny fraction of the amount of currency in circulation. M0 is this value. Wikipedia states that there is 760 billion printed US dollars in circulation and 610 billion euros. Each represents less than 10% of annual GDP of each area.

M3 includes physical cash and all other forms of money (electronic, interbank loads, bonds, etc) When the Fed stopped publishing M3 figures, the value had reached 10 trillion.

[Auditor #9]

Finfacts article on M3

Says the ECB has a target of 4.5% p.a. for M3 growth but has exceeded this since 2001, although it has slowed in the last few months. Won't this happen when there is a spurt of growth, though? The housing boom is one very obvious place the money went - overpriced properties as mentioned on another thread. After all, isn't the world economy growing?

Now you have me asking what M1 and M2 are.

[seabhcan]

The M0-3 naming system is a US invention. Other countries use slightly different definitions, it seems. The UK published an M4.

Probably, as the M3 money isn't physical it can't enter the general economy and cause inflation in consumer goods. However, it surely should cause inflation in areas of the economy it does enter. So what can you buy with M3 money? Company shares? (massive inflation in the stock market) Oil? Debt of other countries?

[Corroboration]

I thought it was being used to buy the gold reserves that are sold off. We know who sells, but who buys, and with what?

See the video by the gold anti trust action committee:

http://www.goldrush21.com/