A key component to understanding the inflation/deflation debate is to understand the money supply, and whether it is increasing or decreasing. Unfortunately, there are many ways to measure the money supply (M0, M1, M2, M3, MZM are the most common, but there are others), and very little consensus on which definitions are the best. What they have in common is that they seek to define money and seek to measure the size of the money supply that fits the definition. I’m not going to concern myself much with the measurement problem. Instead, I want to focus on the first problem: defining money.

What is money? Wikipedia gives us some help:

Money is anything that is generally accepted as payment for goods and services and repayment of debts. The main functions of money are as a medium of exchange, a unit of account, and a store of value.

This definition is sufficiently vague. This makes things interesting because it leaves a lot up for interpretation. In fact, if you are concerned about high inflation, you might argue that our own currency isn’t a very good store of value, and therefore fails to fit the definition of money. Oops!

I’m not actually concerned with a narrow definition of money. I’m actually more interested with the “medium of exchange” part, which is rather important (the unit of account is not very important, as I’ll assume that everything is denominated in dollars). For example, if I borrowed $5 from hilker and gave him an IOU, I probably haven’t increased the money supply by $5 (I gained $5 and hilker lost $5, so there was zero net change). However, if everyone agreed that I was good for the money, CNJ IOUs might be accepted the same as cash. In that case, I would have increased the money supply. While a CNJ IOU is unlikely to be treated the same as cash any time soon due to counterparty risk, US government bonds are considered quite safe. If the US government failed to make good on a bond, the US dollars wouldn’t be much good either. If someone offered me $1000 of 3 month US treasuries, I’d probably be willing to part with $999 in goods and services. In many ways, treasuries are more money than the money in savings accounts in excess of the FDIC limit. So shouldn’t treasuries be considered money? This idea isn’t that far fetched, Japan already includes government bonds and foreign bonds in one of their monetary aggregates. Of course, if you do consider treasuries money, then the issuance of government debt is probably inflationary.

This idea is better summarized by Friedrich Hayek (via Zero Hedge):

There can be no doubt that besides the regular types of the circulating medium, such as coin, notes and bank deposits, which are generally recognised to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money. Now while for certain practical purposes we are accustomed to distinguish these forms of media of exchange from money proper as being mere substitutes for money, it is clear that, other things equal, any increase or decrease of these money substitutes will have exactly the same effects as an increase or decrease of the quantity of money proper, and should therefore, for the purposes of theoretical analysis, be counted as money.

In particular, it is necessary to take account of certain forms of credit not connected with banks which help, as is commonly said, to economize money, or to do the work for which, if they did not exist, money in the narrower sense of the word would be required. The criterion by which we may distinguish these circulating credits from other forms of credit which do not act as substitutes for money is that they give to somebody the means of purchasing goods without at the same time diminishing the money-spending power of somebody else. This is most obviously the case when the creditor receives a bill of exchange which he may pass on in payment for other goods. It applies also to a number of other forms of commercial credit, as, for example, when book credit is simultaneously introduced in a number of successive stages of production in the place of cash payments, and so on. The characteristic peculiarity of these forms of credit is that they spring up without being subject to any central control, but once they have come into existence their convertibility into other forms of money must be possible if a collapse of credit is to be avoided.

If you accept this view of money, you’ll realize that no static definition of money is really suitable. The money supply includes anything that is currently accepted as money (which is subject to change — nobody’s going to accept a GM bond same as cash).