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Economics/Stock market as part of money supply

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Question
Dear Warren,
Why isn't the stock market or the bond market part of the money supply (M0, M1, M2, or M3)? Or is the market capitalization of these markets already part of the broadest money supply?

Answer
Hi, Choo--

"The stock market" (there's not just one of those, you know) isn't part of the money supply because the stocks are not money. They are not legal tender--that is, the government has not mandated that they be accepted as payment for debts. And the government has not done that for good reason. Let's explore what "money" is since I believe that's probably at the core of your question.

Money has three functions. It is a medium of exchange . It is a store of value . And, most important for this discussion, it is a unit of account . A unit of account is a standard monetary measurement of the value of assets, liabilities, goods, and services. We say that a company gross $X billion of annual revenues. We couldn't do that if we substituted "stocks" for "$," could we? And we couldn't because the "value" of a given stock fluctuates, sometimes from second to second.

And how would we express the value? If, say, a 2013 Lexus ES-350 was for sale, would the price be "20 stocks"? "35 bonds"? Or what? And what exactly is "1 stock"? How many euros does "1 stock" equal?

If we try to convert the value of the stock to, say, dollars--which completely defeats the idea of a unit of account--how would we determine how much a stock was worth? Would that be before or after commissions and regulatory fees? And, since commissions are not standard, that were be vast inconsistencies that would make the use of stocks and bonds very inefficient and burdensome to any economy. We'd be returning to the days of barter. If you know anything about the liquidity of non-government bonds, the problem of inefficiency would be even greater for them. Just determining a price (forget accrued interest) can be a heckuva problem since most non-government bonds don't trade very often and, when they do, just finding a price can be a challenge.

Hope this is helpful, Choo. Please do me the favor of completing the rate-the-expert e-mail you'll receive on the heels of this reply. Your ratings and, especially, your written comments help me do a better job of answering people like you who ask such interesting questions. Thanks for your inquiry, and Happy New Year to you.

Warren

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Warren D. Miller, CFA, CPA, ASA

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My expertise in economics is limited to three sub-disciplines: Austrian economics, industrial organization, and evolutionary economics. Questions dealing with macroeconomics and other sub-disciplines of the subject should be submitted to those who have the appropriate expertise. N.B.: I DO NOT ANSWER QUESTIONS MARKED 'PRIVATE' because I believe that knowledge should not be hoarded. I also believe that such questions are likely to come those trying to cheat. Also, as one who was a full-time academic for half a decade, I can recognize test/homework questions several time zones away. Do not demean yourself by submitting such questions to me. Those who do so are cheating; I WILL call you out publicly. I have a zero-tolerance policy for cheating and dishonesty. In addition, please don't emulate the businessman who posted a request for help in August 2008. He expressly denied that he was seeking "investment advice" and said that his query was for, and I quote, "educational and informational purposes." Later, he allowed as how his questions related to the possible purchase of a $500K piece of equipment. I said I thought he had misrepresented himself. Bottom line: high-end business consulting is how I make my living. I am the sole support for my family. Please respect that fact and don't try to get for free what our clients pay for. If your company is big enough to have a sophisticated problem, it can afford to pay for the expert advice we and others provide. Beckmill Research, LLC, is a 95-octane firm. We're small, but we've been at this for nearly 20 years. We know what we're doing. Segue: Early on, some asked me for career advice; I gave it. I now get many such requests. The demand for a valuable good that is free is unlimited, so I now charge for that advice. Email me: cfa2005@gmail.com. Finally, PLEASE DO NOT ASK FOR INVESTMENT ADVICE. I am not licensed to provide such advice. If you want such counsel, talk to your financial planner or other financial adviser.

Experience

I work with Austrian economics (which differs in major respects from the traditional economics), industrial organization (which is about industry structure, conduct, and performance), and evolutionary economics (almost, but not quite, the economic analog of its biological counterpart) every day in my work. I appraise closely-held businesses, provide exit-planning services, and offer high-level strategic analysis, advice, and solutions to CEOs and owners of mid-sized businesses. Understanding, applying, and writing about these disciplines is an essential part of how I have made my living since 1993.

Organizations
CFA Institute, Strategic Management Society, American Society of Appraisers, Academy of Management, Culver Legion, National Association of Scholars.

Publications
CFA Magazine, Strategic Finance, Valuation Strategies, Journal of Advanced Property Economics, Harvard Business Review, American Fly Fisher, CFA Digest, CPA Expert, Business Valuation Review, among others

Education/Credentials
Chartered Financial Analyst designation (2006); Accredited Senior Appraiser in Business Valuation (2006); Certified Public Accountant (1992); MBA - Oklahoma State University (1991); Completed all of my Ph.D. coursework in strategic management - Oklahoma State University (1983-87); BBA in finance and accounting - U. of Oklahoma (1975)

Awards and Honors
Business Valuation Volunteer of the Year (2001) - American Institute of CPAs; Winner - Oklahoma Humorous-Speaking Contest - Toastmasters International (1971)

Past/Present Clients
Names are confidential. However, the "sweet spot" of our target market is companies that are too big to be small and too small to be big. Usually, those are companies with employees in the 15-to-100 range. At the low end of that range is where companies can first take advantage of the specialization of labor. However, having everyone do everything is a tough habit for many--most, I would argue--small enterprises. That is why they not only remain small, but also fail to survive beyond a second generation. Only 5% (one in twenty) companies make it to the third generation of ownership.

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