Money Supply

This post is somewhat more edgy than usual. My readers (all three of them) will have to read carefully. Here is an excerpt of an email I sent to Paul Kasriel (Director of Econ research at Northern Trust):

I am writing to you with reference to the latest Econtrarian, in which you explain that a decrease in the amount of stocks that an individual buys as a proportion of its income does not lead to an increase in the money supply since "XYZ’s bank account is debited by the same amount that the employee’s bank account is credited. No new money is created in this process. All that has happened is that the ownership of money has changed".

I can try to extend the argument to the case where an individual sells previously owned stocks and decides to hold the proceeds in her bank account: since there has to be a seller for every buyer, the seller's bank account will decrease by the same amount as the increase in the buyer's account, and so no net new money has been created.

However, I am wondering what you think about the case where someone sells stocks to a foreign buyer (which is likely to have happened in the recent past, as holdings of foreign equities by U.S. investors have decreased significantly). Then, could it be that the U.S. money supply has increased in the process, while matched by an equal decrease in the money supply in the foreign buyers' countries? This could lend support to Asha Bangalore's February 19th argument that "Inflation adjusted money supply is advancing because currency, demand and saving deposits have risen sharply. At the same time, bank lending has contracted", which otherwise would be at odds with your view.

And here is his answer:

Unless the foreign buyer borrowed dollars to purchase the dollar-denominated stock or bond, there is no increase in the U.S. money supply. If no borrowing occurred, then the foreign buyer would have to purchase dollars in the forex market to pay for the stock/bond purchase, which, again, just changes the ownership of dollars but does not increase the supply. The foreign purchaser of stocks/bonds presumably purchases the dollars with her own currency, which changes the ownership of that currency.

I have to admit that I am perplexed as to why the U.S. money supply, excluding currency and retail money market shares, is increasing as rapidly as it is when bank credit and bank assets are declining. Assets equal liabilities plus net worth. With commercial bank assets declining in recent weeks (assets soared back in October due to JP Morgan's assumption of WAMU, a savings & loan), then liabilities plus net worth also must be declining. If net worth and other liabilities are declining, then it would be possible for deposits to be rising even though total assets are falling. The data indicate that this is what is happening. But I still do not understand the process by which this is occurring. I am skeptical that advances in the money supply are as "stimulative" as otherwise when bank assets and bank credit are contracting.

Paul

If anyone believes they can contribute to the discussion, feel free to do so.