Money is but debt. Debt in the government that issued the money. The government represents the mass through taxation. The money is a bond you can redeem against the state and good for "all debt, public and private".
Therefore the definition of money is debt and measuring the aggregate debt levels, and therefore the amount of liquidity in the system, is what economists do when they talk about M3 levels. I think of it as a big volume of air.
All debt is equivalent to money. Debt level are therefore money levels and money levels control the face value of things. Monetary inflation or deflation are levers at the disposal of the FED for example. Controlling the amount of money supply is what the FED wants to do. However that control has partially been taken by the private sector and that lever has been activated by it of lately like the proverbial rabbit pushing the cocaine paddle until it dies.
Securitization has been a key innovation in moving those liabilities off balance, replacing them with cash and rinsing all over again, in a semi perpetual movement machine where the shadow banking system can almost set monetary levels by itself.
Money levels were left to be set by private interest. Believing an "invisible hand" emergent property would apply to this lot may have been our failure. Invisible hand is an emergent property that may appear in idealized systems, usually with many participants, as opposed to the highly conflicted few investment banks that devised the products in the first place and flooded the market with them.
With an incentive indexed on the volumes of business and money flowing through the system (hedge 2/20 incentive anyone?) , it was the interest of the investment banks to flood the shadow banking system with liquidity. And for the shadow entities to be little piggies at the trough. Self regulation of individuals was non existent and resulted in immediate death of the investment banks. Everyone had failed, why let Lehman fail???
Money is debt and money is going down. Money in the shape of debt. If that debt is invested in liquid instruments then good, if not you redeem said debt and unwind investments. The whole borrow short lend long service is so investments do not get bothered by this kind of movement. Yet there it is. As Krugman pointed out once, the problem with this dynamic is that if the context is nasty enough, unwinding debt to lower cash to asset ratios adds so much pressure on selling that assets go down faster than cash is raised. At that point, even trying to lower the ratios has the nasty effect of raising it. We were there last thing I think. The markets lost $8T... 8T is enough to snap the hedge industry (2 I read recently) in half. Mark to paulson will reset a lot of balance sheets, a good mark to market temporary suspension until pricing is applied.
Debt has been lost. Here is debt that materialized into real money that will never be recaptured. Money supply will not go down to zero as all bad debt has been transformed into free floating hard cash. Cash is but the residual form of bad debt written off, they are orphaned bonds. Yet they carry cash value.
By buying stricken assets, the governments provides transparency on the worth of assets that were up until then not priced or thinly priced. Hope here is to restart the credit markets. Second move is to buy preferred equity. So that Neel Kashkari, the 35 year old robot from Goldman, is walking around with a few trillion of goodies, courtesy of Hank.