From Wikipedia:

• M0: The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency.
• M1: The total of all physical currency part of bank reserves + the amount in demand accounts ("checking" or "current" accounts).
• M2: M1 + most savings accounts, money market accounts, retail money market mutual funds,and small denomination time deposits (certificates of deposit of under $100,000).
• M3: M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements.

They M's start off with just currency and each successive number adds more stuff that is counted as "money."

As you increase the M number you begin to count as "money" things which are not money but are monetary obligations (credit).

Since a loan creates a monetary obligation it creates a "form of currency" that can be used for payment. If I am the holder of a mortgage, I may not have currency but I have something that many will be willing to exchange currency for. This makes it a form of currency. But since the person can default on paying the mortgage it is money with risk. There is no risk other than sovereign risk with government issued currency. That risk is usually not even considered. (welcome to the new world)

Since credit is a form of money and it has been defaulting, deflationists say the "money supply is being reduced. We are experiencing deflation." The only way the amount of currency has been reduced is that the loans have dried up. Someone who is dependent on loans will experience hard times. Someone who has no need of loans experiences little change. That is where we are now for the most part.

In a true deflation the actual, physical currency becomes scarce. So little currency is available that it actually increases in its purchasing power. Goods and services exist but there is no currency to facilitate the transfer. People are forced to barter. We see a trace of these things taking place; but nothing like the depression of the 30's even though the people are hurting as badly in terms of their hardship.

Massive amounts of credit were made available to the banks for close to zero interest through the Fedral Reserve. This sits on the balance sheets of the banks to make them look whole. Actually, with mark to market accounting, most of them would still be insolvent. But gradually they will (at least the favored big banks) work their way out of the insolvency problem. Then the question is will all that credit/money be nullified and destroyed or will it make its way into the economy.

If the banks do what they usually do which is to loan out credit/money for profit, that which is currently on the balance sheets will be loaned into the economy just as soon as possible and then watch the prices which are already going up soar as there will be enough currency around to compete for the right of purchase.

Right now only the prudent ones have cash with which to buy things. My life style hasn't changed one Iota; but most people I talk with daily in my ministry are in a state of shock and awe. They have been turned upside down and wiped out. They can buy nothing. Twenty to Twenty-five percent of the houses are vacant. I see repo trucks with reguarity. Still prices on everyday goods have not gone down; they are rising even though these people are doing without to the extent they can.

When the same people that maxed out their credit cards and HELOC'ed their home have access to credit again the prices will go bonkers. All they buy now is the absolute essentials and that's why those prices continue rising. All prices will be rising as soon as these people have access to credit again and the banks will facilitate that as soon as possible.

The necessities will increase their rate of price rise and all the other prices that have stagnated with only partial demand will begin heading higher too.

It may feel like deflation but behind the scenes, unless the government makes a huge mistake, the buildup is inflationary.

P.