Chapter 4: Malaysian Money Supply

As money is a claim on wealth, it also means that every additional crisp new RM 100 note
that is printed, and placed into circulation, dilutes the claim on wealth of the existing RM 100
notes. Of course the effect of one new RM 100 note entering circulation will be too small to
be felt or measured in any sense, but it is still there in some infinitesimal way. What we have
is more money (more RM 100 notes) chasing after the same amount of goods or services,
diluting the claim on wealth of all existing RM 100 notes. An additional twist is that each
additional RM100 need not be in physical form to add to the total money supply.

M0

Currency in circulation i.e. the physical money in hand is considered as the most liquid part
of the monetary system, as it is always available to purchase goods and services. It is usually
measured as part of M0 (M-zero) together with the deposits of the commercial banks with the
central bank. Since Bank Negara Malaysia (BNM) does not release M0 aggregates, we will
call only the physical currency in circulation as M0, to make things easy.

On average our M0 was around 8% of GDP in the eighties, and around 6% of GDP now. This
means that the physical currency in circulation is 6% of the total amount of goods and
services produced in the country. This is not where the alarm bells are ringing.

Fig 1: Malaysias M0 money supply. 1969 2012. (Data from Bank Negara Malaysia)

We also have broader aggregates of money, like M1, M2, M3, MZM and M4.

M2

M2 measures the total of all the currency in circulation (M0), all the money in current
accounts, savings accounts, fixed deposits, NID's (Negotiable Instruments of Deposit), Repo's
and foreign currency deposits in the banking system in Malaysia. It basically measures
money and quasi money stock in the country.

Fig 2: Malaysia M0 and M2 money supply. 1969 2012 (Data from Bank Negara Malaysia)

M2 and GDP

Through the fractional reserve banking system, the total amount of money stock we have is
many times the physical currency available at any one time. When the supply of money
exceeds its demand, the value of money falls. When the growth of the money supply exceeds
even the GDP growth, then supply has definitely exceeded demand. In other words we create
more money in the system than the rate by which the system itself grows.

There is also a crucial difference between the fractional reserve banking system of today with
how it was before the rise of a global fiat monetary system. The fractional reserve in those
days was gold or gold backed currency, the fractional reserve today is just fiat paper.

Fig 3: Malaysian M2 money supply as a percentage of GDP (Data derived from World Bank)

The chart above shows that the amount of M2 money stock in the country has grown at a rate
which is greater than the growth of the GDP of the country in nearly every year since the mid
1980s except for the three years from 1990 to 1992.

Does this mean that we are getting richer as a nation, because there is so much M2 money
stock? The answer is no. Money is not wealth; it is only a claim on wealth. When our total
stock of the claim on wealth (M2) is growing at the fantastic rate shown in the chart above,
and our total wealth as measured by GDP grows at a slower rate, then our claim on wealth is
being diluted at a rate that is not only measureable, but also hazardous to our economic wellbeing.

MYR vs Gold

The rise of gold against the Ringgit is partially due to the dilution of the value of the Ringgit
over the years.

The next chart, shows how the Ringgit which once bought an ounce of gold at around RM
800 in the mid 90s, has fallen in value to the extent that the same ounce of gold costs more
than RM 5000 in 2011.

Fig 4: Monthly Gold price per troy ounce in Ringgit Malaysia (chart courtesy of
indexmundi.com / data from World Bank)

While we can argue that gold has risen against all currencies, it is also a fact that not all
currencies have lost their value against gold at such a spectacular rate.

What does this mean to us as Malaysian citizens, investors and savers?

M2 vs FD

Let us see how this growth in money supply (M2) outpaces the growth we can expect from a
Fixed Deposit account in the long run. If we place RM 1 million into an FD account paying
3.8% p.a. in interest, compounded monthly, for 20 years, we will end up with RM 2.13

million at the end of 20 years. The same RM 1 million in money stock, growing at its average
rate of 10% p.a. as a part of Malaysian M2, will become RM 7.3 million in 20 years.

Fig 5: RM 1 million growing at a compounded rate of 3.8% vs 10% for 20 years

This means that our claim on wealth, the RM 1 million, which we had placed into an Fixed
Deposit account to grow at 3.8% p.a., has actually lost more than 70% of its claim on wealth,
despite doubling its nominal value in 20 years.

A simpler way to understand this insidious loss is to consider an investor who owns 10% of
the money stock in the country, who also successfully doubles the nominal value in 20 years,
by placing it in an interest bearing account paying 3.8% p.a. Because the total money stock
has grown seven fold in that same period (we make the assumption that the total wealth in the
country has remained the same) the investor now only owns 2.9% of the money stock (her
claim on wealth) in the country, and has in fact become less than a third as wealthy as she
was two decades before.

Why governments do not mind this happening?

The government meanwhile can use the inflationary policy of easy money to pay for goods
and services it needs or thinks it needs, as well as for hand-outs, without having to increase
taxes. And as mentioned earlier, the increasingly worthless currency will also be used by the
government to pay of its debts before the currency reaches its final value of zero. Another
way to understand this is that when the rate of inflation is greater than the interest rate, then
governments can actually borrow money at negative cost, which basically means that wealth
is transferred from the savers to the government.

If we approach the story from the opposite direction, it would mean that the RM 7.3 million
we have kept aside today in cash, which lays claim to RM 7.3 million of wealth, will only
claim RM 1 million worth of today's wealth in 20 years.

Now, how do we protect ourselves from this loss?