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Wichtiges zum nonsense der 'Umlaufgeschwindigkeit' / Artikel, engl.

verfasst von JÃœKÃœ, 21.03.2002, 20:00

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http://www.mises.org/fullstory.asp?control=918
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Is Velocity Like Magic?
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by Frank Shostak

[Posted March 21, 2002] [image]



If, for example, it was found that the quantity of money had
increased by 10 percent in a given year, while the price level as measured by
the consumer price index had remained unchanged, it would mean that there must
have been a slowing down of about 10 percent in the velocity of circulation.

If the quantity of money had remained unchanged but there had
been a 10-percent increase in the price level in a given period, it would mean
that there must have been an increase in the velocity of circulation of money of
10 percent in that period. It would appear therefore that velocity is an
important determinant of the purchasing power of money.

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The Mainstream View of Velocity
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According to popular thinking, the idea of velocity is
straightforward. It is held that over any interval of time, such as a year, a
given amount of money can be used again and again to finance people's purchases
of goods and services. The money one person spends for goods and services at any
given moment can be used later by the recipient of that money to purchase yet
other goods and services.


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For example, during a year, a particular $10 bill might have
been used as following: a baker, John, pays the $10 to a tomato farmer, George.
The tomato farmer uses the $10 bill to buy potatoes from Bob, who uses the $10
bill to buy sugar from Tom. The $10 here served in three transactions. This
means that the $10 bill was used three times during the year; its velocity is
therefore 3.

In short, a $10 bill, circulating with a velocity of
"3," financed $30 worth of transactions in that year. Consequently, if
there are $3,000 billion worth of transactions in an economy during a particular
year, and there is an average money stock of $500 billion during that year, then
each dollar of money is used on average six times during the year (since 6 x
$500 billion=$3000).

In short, $500 billion of money is boosted by means of a
velocity factor to become effectively $3,000 billion. This implies that the
velocity of money can boost the means of finance. From this it is established
that: Velocity = Value of transactions/supply of money. This expression can be
summarized as: V = P(T/M), where V stands for velocity, P stands for average
prices, T stands for volume of transactions, and M stands for the supply of
money.

This expression can be further rearranged by multiplying both
sides of the equation by M. This in turn will give the famous equation of
exchange: M(V) = P(T).

This equation states that money times velocity equals value of
transactions. Many economists employ GDP instead of P(T), thereby concluding
that: M(V) = GDP = P x (real GDP).

The equation of exchange appears to offer a wealth of
information regarding the state of the economy. For instance, if one were to
assume a stable velocity, then for a given stock of money one can establish the
value of GDP. Furthermore, information regarding the average price or the price
level allows economists to establish the state of real output and its rate of
growth.

Most economists take the equation of exchange very seriously.
The debates that economists have are predominantly with respect to the stability
of velocity. Thus, if velocity is stable, then money becomes a very powerful
tool in tracking the economy. The importance of money as an economic indicator,
however, diminishes once velocity becomes less stable and hence less predictable.
In short, it is held that an unstable velocity implies an unstable demand for
money, which makes it so much harder for the central bank to navigate the
economy along the path of economic stability.

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Does the Concept of Velocity Make
Sense?
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From the equation of exchange, it seems that money together
with velocity is the source of funding for economic activities. Furthermore,
from the equation of exchange, it would appear that for a given stock of money,
an increase in velocity helps finance a greater value of transactions than money
could have done by itself.

As logical as it sounds, neither money
nor velocity has anything to do with financing transactions. Here is why.

Consider the following: baker John sold ten loaves of bread to tomato
farmer George for $10. Now, John exchanges the $10 to buy 5kg of potatoes from
Bob the potato farmer. How did John pay for potatoes? He paid with the bread he
produced.

Observe that John the baker had financed the purchase of
potatoes, not with money, but with bread. He paid for potatoes with his bread,
using money to facilitate the exchange. In other words, money fulfills
here the role of the medium of exchange and not the means of payment.

The number of times money changed hands has no relevance
whatsoever on the baker's capability to fund the purchase of potatoes. What
matters here is that he possesses bread that can be exchanged by means of money
for potatoes.

How is it that the fact that the same $10 bill used in several
transactions can add anything to the means of funding? By what means does the
speed of money circulation add to the real pool of funding? Imagine that money
and velocity would have indeed been means of funding or means of payments. If
this was so, then poverty worldwide could have been erased a long time ago.
Moreover, since rising velocity is supposed to boost effective funding, then it
would have been to everyone?s benefit to make sure that money circulates as
fast as possible. This implies that anyone who holds on to money should be
classified as a menace to society, for he slows down the velocity of money and
hence the creation of real wealth.

According to Mises, the whole concept of velocity is hollow:

"In analyzing the equation of exchange one assumes that
one of its elements--total supply of money, volume of trade, velocity of
circulation--changes, without asking how such changes occur. It is not
recognized that changes in these magnitudes do not emerge in the
Volkswirtschaft [political economy, or more loosely?economy?] as such,
but in the individual actors' conditions, and that it is the interplay of the
reactions of these actors that results in alterations of the price structure.
The mathematical economists refuse to start from the various individuals'
demand for and supply of money. They introduce instead the spurious notion of
velocity of circulation fashioned according to the patterns of mechanics."
([i]Human Action, p. 399)
[/i]

Furthermore money never circulates as such:

"Money can be in the process of transportation, it can
travel in trains, ships, or planes from one place to another. But it is in
this case, too, always subject to somebody's control, is somebody's property.
"(Human Action, p. 403)

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Velocity Has Nothing To Do With the
Purchasing Power of Money
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Does velocity have anything to do with prices of goods? Prices
are the outcome of individuals? purposeful actions. Thus John the baker
believes that he will raise his living standard by exchanging his ten loaves of
bread for $10, which will enable him to purchase 5kg of potatoes from Bob the
potato farmer. Likewise, Bob has concluded that by means of $10 he will be able
to secure the purchase of 10kg of sugar, which he believes will raise his living
standard.

By entering an exchange, both John and Bob are able to realize
their goals and thus promote their respective well-being. In other words, John
had agreed that it is a good deal to exchange ten loaves of bread for $10, for
it will enable him to procure 5kg of potatoes. Likewise, Bob had concluded that
$10 for his 5kg of potatoes is a good price for it will enable him to secure
10kg of sugar. Observe that price is the outcome of different ends, hence the
different importance that both parties to a trade assign to means.

In short, it is individuals? purposeful actions that
determine the prices of goods and not some mythical notion of velocity.

Consequently, the fact that so-called velocity is
"3" or any other number has nothing to do with average prices and the
average purchasing power of money as such. Moreover, the average purchasing
power of money cannot even be established. For instance, in a transaction, the
price of $1 was established as one loaf of bread. In another transaction, the
price of $1 was established as 0.5kg of potatoes, while in the third transaction
the price is 1kg of sugar. Observe that, since bread, potatoes, and sugar are
not commensurable, no average price of money can be established.

According to Mises:

"Media of exchange are economic goods. They are scarce;
there is a demand for them. There are on the market people who desire to
acquire them and are ready to exchange goods and services against them. Media
of exchange have value in exchange. People make sacrifices for their
acquisition; they pay 'prices' for them. The peculiarity of these prices lies
merely in the fact that they cannot be expressed in terms of money. In
reference to the vendible goods and services we speak of prices or of money
prices. In reference to money we speak of its purchasing power with regard to
various vendible goods." (Human Action, p. 402)

Now, if the average price of money can?t be established, it
means that the average price of goods can?t be established either.
Consequently, the entire equation of exchange falls apart. In short,
conceptually, the whole thing is not a tenable proposition, and covering a
fallacy in mathematical clothing cannot make it less fallacious.

According to Rothbard:

"The only knowledge we can have of the determinants of
price is the knowledge deduced logically from the axioms of praxeology.
Mathematics can at best only translate our previous knowledge into relatively
unintelligible form." ([i]Man, Economy, and State, p. 730)
[/i]

Even if we were to accept that the essential service of money
is its speed of circulation, there is no way that this characteristic of money
could explain the purchasing power of money. On this Mises explains:

"Even if this were true, it would still be faulty to
explain the purchasing power--the price--of the monetary unit on the basis of
its services. The services rendered by water, whisky, and coffee do not
explain the prices paid for these things. What they explain is only why
people, as far as they recognize these services, under certain further
conditions demand definite quantities of these things. It is always demand
that influences the price structure, not the objective value in use." ([i]Human
Action, p. 400)
[/i]
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Velocity Does Not Have an Independent
Existence
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Contrary to mainstream economics, velocity
does not have a"life of its own." It is not an independent entity--it
is always value of transactions P(T) divided into money M, i.e., P(T/M). On this
Rothbard wrote:"But it is absurd to dignify any quantity with a place in
an equation unless it can be defined independently of the other terms in the
equation." (Man, Economy, and State, p. 735)

Since V is P(T/M), it follows that the equation of exchange is
reduced to M(PxT)/M = P(T), which is reduced to P(T) = P(T), and this is not a
very interesting truism. It is like stating that $10=$10, and this tautology
conveys no new knowledge of economic facts.

Should we then be alarmed with growing money supply despite
the fact that the so-called velocity of money is falling? Does the fall in the
velocity of money imply that no damage to the economy will occur?

What matters right now is the fact that money is growing at an
alarming rate, which sets in motion an exchange of nothing for something and,
hence, economic impoverishment and consequent boom-bust cycles. Furthermore,
since velocity is not an independent entity, it as such causes nothing and hence
cannot offset effects from money supply growth.

Finally, does so-called unstable velocity imply an unstable
demand for money, as the popular thinking has it? The idea to label the demand
for money as stable or unstable is preposterous. What does it mean? The fact
that people change their demand for money doesn?t imply some kind instability.
As a result of changes in an individual?s goals, he may decide that at present
it is to his benefit to hold less money. Some time in the future, he might
decide that raising his demand for money would serve better his goals. So what
could possibly be wrong with this? It is simply the same that goes for any other
goods and services: demand for them changes all the time.

Conclusion

The recent strong increases in money supply
raise the likelihood of acceleration in the rate of growth of prices of goods
and services in the months ahead. The effect of these increases cannot be
neutralized by the fact that the so-called velocity of money is declining.

Contrary to popular thinking, the velocity of
money doesn?t have a life of its own. It is not an independent entity, and
hence it can?t cause anything, let alone offset the effect of an
explosion in the supply of money on prices of goods and services.

The apparent simplicity of the equation of
exchange and its consequent widespread acceptance by mainstream economists has
been instrumental in the erroneous assessments of the true state of the economy.
Hence, it is an urgent requirement that this fallacy be removed from the
economic literature and >from economic textbooks, in order to prevent future
theoretical confusions and their practical consequences.


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Frank Shostak, Ph.D., is an adjunct scholar of the Mises Institute and a
frequent contributor to Mises.org. Send him MAIL
and see his outstanding Mises.org Articles
Archive. Dr. Shostak expresses gratitude to Michael Ryan for helpful
comments during the writing of this article.



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Wichtiges zum nonsense der 'Umlaufgeschwindigkeit' / Artikel, engl. - JÃœKÃœ, 21.03.2002, 20:00