Appendix C

Is M-1 Subtractive or Accumulative?

Below is a copy of the author’s letter to Mike Dubrow at the Public Information department of the Federal Reserve System. In a telephone conversation on February 14,1994, Mr. Dubrow said that the assumption stated in the letter would be correct if it were not for the fact that the system is under the control of a central bank. The Federal Reserve, he said, would not allow that to happen, because it would be inflationary. The Fed would reduce the money supply to offset the effect of monetary expansion as dollars moved from M-1 to M-2 and back to M-1 again. In other words, the assumption is correct, but the Fed has the power to offset it — if it wants to. The bottom line is that M-1 is accumulative. As such, it is the most meaningful measure of the money supply.

G. Edward Griffin
Box 4646, Westlake Village, CA 91359

January 19, 1994

Mike Dubrow
FAX #(202) 452-2707
Federal Reserve System

Dear Mr. Dubrow,

As we discussed during our phone conversation this morning, I am preparing a paper on the Federal Reserve System, and an interesting question has arisen. It is so fundamental that almost everyone with whom I have spoken thought they knew the answer but, upon analysis, have concluded they were not so sure after all.


It is my understanding that there are three optional definitions of the money supply:

M1 = currency + short-term deposits.

M2 = M1 + short-term time deposits,

M3 = M2 + institutional long-term deposits.

It is clear that, when money is paid out of a checking account and put into a savings account, it increases M2, but the question is: Does it remain as part of M1 or is it subtracted from it? Herbert Mayo, in his book Investments (Chicago: Dryden Press, 1983), says If individuals shift funds from savings accounts to checking accounts, the money supply is increased under the narrow definition (M-1) but is unaffected if the broader definition (M-2) is employed. This implies that, when money is moved from a checking account to a savings account, it is subtracted from M1. Otherwise, it would not increase M1 when it is moved back again from savings to checking. When we spoke on the phone, you confirmed that his interpretation is correct.

But how can that be? The money moved from checking to savings or any other investment does not disappear into a vault. It is spent in fulfillment of the investment project. It is given to a vendor or a contractor or an employee and reappears in their checking accounts where it becomes part of M1 once again. It would seem, therefore, that it doesn’t really leave M1 at all. It merely increases M2.

I have hypothesized one possible explanation. It is that the money does, in fact, disappear into a vault, or at least into a bookkeeping ledger, for a short period of time. That would be the time between its deposit into the savings account and its subsequent transfer to the checking accounts of borrowers. The time period might be short — perhaps less than thirty days on the average — but it still needs to be considered when calculating the money aggregates. Therefore, M1 is reduced when money is transferred from checking to savings, but that is only a temporary effect. M1 will be increased once again just as soon as the new M2 money is redirected to borrowers. Is that a correct explanation?

Thank you for your help with these puzzling items.



G. Edward Griffin
(805) 496-1649