What is money?

The convenience of liquidation makes a liability money or not.

A security can serve as money from time to time depending on its price volatility.

Money supply data becomes increasingly useless in economies where security prices become less volatile.

In low interest rate environments, the possibility of incurring a loss due to the selling of a security minimizes and, thus, money covers a greater sort of debt.

All forms of money are debt

Before central banks, banks created money by issuing notes with no maturity. When central banks standardized notes, the money production mechanism did not change. Money remained to be debt. When banks issue a loan, they deposit loan amount to borrower's account. Thus, each time a bank debits a loan, it also credits a deposit account. Money supply hence rises alongside loans.

Not only banks issue debt. Governments, corporations and households can also produce debt. As their debt is not intermediated by an institution such as a bank, a loan and a deposit are not separately created. Borrowers directly issue debt in the form of treasuries or securities.

What is the difference between a security or deposit? A depositor can withdraw cash from a bank account whenever she desires. Banks must pay or transfer deposits whenever asked. Securities and treasuries transacted in a liquid market are close to the convenience of deposits. An investor can convert a treasury into cash whenever desired. However, she can lose or gain based on the price difference between the purchase and sell price.

A broader definition of money comprises other deposit-like debt instruments that can easily be liquidated without a significant loss. This description makes gauging the money supply complicated. A security can serve as money from time to time depending on its price volatility. In low interest rate environments, the possibility of incurring a loss due to the selling of a security minimizes and, thus, money covers a greater variety of debt.

Money supply definitions

Authorities may draw flawed conclusions from the money supply due to the static money definition. The debt instruments included in money are fixated by many central banks. The Fed defined money in layers. The first layer, M1, includes transaction deposits and currency in circulation. The second layer, M2, augments M1 by savings deposits and time deposits less than $100.000. Money at zero maturity (MZM) definition adjusts M2 by excluding time deposits and including institutional money funds. These definitions' scope might fall short due to changing financial conditions.

Financial liabilities can transform into other financial liabilities. When a bank sells its loans via securitization, it charges the deposit accounts of nonbank buyers in return. Thus, deposits diminish as much as the securitized loans in the banking system. The transformation of deposits into securities diminishes the money supply. In effect, bonds might also be monetized without losing money in a downward interest rate trend along with low interest rate volatility.

Accounting entries of a bank selling its bonds to its depositors

Deposit $100

Bonds $100

Both deposits and securities are liabilities of economic entities. Only the convenience of liquidation makes them money or not. Therefore, magnitudes defined as money and nonmoney may not differentiate in their effects as much as they did in the past. The Fed recognizes that the relationship between the money supply and economic variables such as GDP growth and inflation has weakened over decades. The money supply data becomes increasingly useless in economies where security prices become less volatile.