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GaveKal Research, The Daily Feb. 26,
2020, 2 pgs. diagram
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Reviewer comment:
The fundamental problem for nearly everyone is the conceptual way they compare
the 'value' of a unit of 'money' say a dollar versus the 'value' of a thing
(material or immaterial) in the exchange. They think of the 'value' of the
thing in terms of 'money'. But they should think of the 'value of 'money' in
terms of things. For instance, people think how many dollars I need to buy a
pan - but they should be thinking how many pans can I buy for a dollar.
"Money" it self is a concept - it was developed when it became
necessary to quantify the different 'values' of debts and things being created
and exchanged. Initially it was expressed only in ledgers showing credits and
debts in which it was necessary to have a uniform set in terms of quantities of
value for different things such as grain versus labor days versus houses versus
beer, etc. First among the 'debts' were physical transgressions such as
personal injuries. Thus the quantity of debt=credit is created and destroyed
when a cause is created and dissolved when the cause is satisfied. Money
represents a standard quantification of the amount of the debt=credit
outstanding - which means the value of the transactions NOT completed.
In the early civilization -societies - Debt was a measure of the promise of
producers (farmers or slaves) to produce the value of the amount of goods (such
as grain) that was due to the government (temple or palace). Property including
the means of production was OWNED by a GOD and when an individual consumed some
production he incurred a debt to the GOD. This occurred when the government
rationed back to the producer a quantity of the production previously deposited
in the government storehouse. The governments periodically decreed 'jubilee'
time and canceled the debts owed by the individuals because they needed the
people to keep producing.
With the change to the concept of private ownership of property and production
the relationship switched 180 degrees. Now when the government exchanges
privately created production for a government promise to produce something in
the future (credit) it is the government that owes so it incurs the debt. As
long as the people maintain belief that the government will ultimately pay what
it owes the 'money' in which that debt is denominated (quantified) can be used
as a transferable representative when individuals exchange things.
But, according to the Christian and Islamic Religions (among others)
individuals still owe debts to their god by virtue of having been created by
him. That debt is removed by performing pious acts, adhering to commandments,
and maintaining beliefs, while the gods give in exchange entrance into heaven.
Dr. Gave has developed his own method for predicting market 'recessions' based
on analysis of such prior indicators as he found statistically relevant. But he
terms this 'my velocity indicator'. And, as the title indicates, believes in
such a thing as 'velocity of money'. I agree with his method, but disagree that
he has actually based it on anything to do with 'velocity'. For one fundamental
thing, 'money' itself is an abstract concept - the measurement system created
to quantify 'value' which also is a concept. Thus 'money' has no velocity and
the tokens used in commerce to represent relative 'value' vary in quantity more
than in velocity. For instance, when the exchange of products in a market is
accomplished by COINS being the medium of exchange and then when there is said
to be a 'shortage' of 'money' it is because the Quantity of tokens available
for use as medium of exchange is insufficient, not that the tokens lack
'velocity'. "Liquidity" likewise refers to a shortage of monetary
tokens, not that they lack 'velocity'. But even then much exchange was conduced
by exchange of credit instruments or by book keeping of accounts. The political
struggles over 'money' that wracked the U.S. during the 19th century were all
about the Quantity of what was used as 'money' rather than something called its
'velocity'. That was because theoretically even the quantity of bank notes
(credit) was to be regulated by the quantity of gold backing. The quantity
available for farmers, for instance, varied with seasonable demand. It was not
adjusted by varying its 'velocity'.
But today the quantity of money is CREDIT - not coins - and credit does not
MOVE - it expands and contracts, sometimes rather rapidly. And creation of
credit is equal to the creation of debt. The issue then becomes who has the
credit and who has the debt. When an individual buys a vehicle on 'credit' the
dealer puts an asset on his account books and the purchases has a debt in his
account (or a bank shows both credits and liabilities if it was the
intermediary. When the buyer pays off the loan the quantity of credit-debt
disappears. But when the sovereign government gives credit to private 'persons'
(either in exchange for real products or in exchange for nothing) it puts the
liability - debt - created on ITS OWN books and announces it will cancel both
at some future time Meanwhile the private sector can use that government
supplied credit instead of government supplied currency as a medium of
exchange. But when doing so it is not increasing or decreasing any 'velocity'
of credit but rather it is increasing or decreasing the Volume of credit-debt
outstanding. Credit does not move.
I will discuss the popular formula while commenting below on Dr. Gave's text.
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Introduction:
The author begins by referring to the standard economists' equation MV=PQ - M
meaning money supply, V meaning 'velocity' of money - P being the general price
level and Q being total 'output'. He notes that analysts and everyone must wait
for M, P and Q to be published by the government or private organizations that
develop them from gathering relevant data about the real market and economy.
Then it is possible to CALCULATE V. He recognizes that this is a 'tautology'
since V must be a dependent variable. Of course, V ALWAYS is a dependent
variable - the meaning of Velocity is the rate of change of position over TIME.
V is the first level derivative of position. (The second derivative of position
is Acceleration and the third derivative of position is Jounce. One surely
recognizes this in the standard school boy equation V=D/T.
So Dr. Gave tells us that he, long ago, 'computed' a 'leading indicator for V
rather than waiting for publication (after the fact of course) of M, P and Q.
He accepted the then number for V that corresponded to the then equation. Then
he studied real market data and developed a set of those variables that were
and would be published and available at some time prior to the future
publishing of a V - which in turn he relates to its identification of a major
market move - up or down. The establishment thinking is that a shift down in
this V - 'velocity of money' which is computed in near real time, will show a
significant decline - slowing down of the 'velocity' of 'money'.
He provided an excellent and well illustrated description of his surogate
indicator in an article published in 2013 see my comments on it at "Velocity in Asset Allocation".
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Body:
In the current market situation, due to the rapid expansion of illness from
Covid-19, he expects, logically, that there will be a 'preference for
liquidity'. What does that mean? I believe this means that economists predict
that the public (individuals and companies) will want to have and hold MORE
money tokens. (In the modern economy the huge majority of these 'tokens' are
actually computer generated numbers that constitute everyone's assets and
liabilities in banks and other financial institutions - which is Credit). They
mean, then, that people won't Spend those tokens - meaning people will not
reduce their credit in their bank account - and or that banks will not use
their reserve credit at the central bank to generate MORE credit in the economy
by extending loans . No doubt, but the result is that the FED and banking
system will generate MORE quantity of such tokens to increase this 'liquidity'.
The story of what the FED does in the 'repro' markets and banks do with
'fractional banking' is another huge discussion. Even today we see again as in
1987 and in 2008 that the FED acts to increase quantity (not velocity) of
liquidity - that is inject More 'money' into the market.
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Next, the author notes that his proprietary
indicator for 'velocity' has been in what he considers 'negative' territory
since Dec. 2017. Apparently it has been declining over time during 2018. But,
he notes that it 'rose' in 2019 while remaining 'negative'. I presume he is
referring to HIS indicator and not to V itself. This brings up the question of
how a change in V (which has no time dimension in its calculation) is
determined to be and shown in graphical form on a time scale. He provides an
interesting time graph from 2000 to 2020 that depicts his 'strategy when
velocity wanes'. But what the graph actually shows is a plot of a ratio that is
static at each point in time. What has changed is the Ratio which means either
M or PQ has changed or actually that both have changed but resulting in a new
ratio.
Again, I stress that I think his method and probably the investment advice that
it generates are excellent. But it is not this mythical V or its theoretical
movement that is the causation. It is changes in those variables that DO
change, namely the M, P and Q. Especially the M, because now M is a measure of
the Quantity of credit being used as the medium of exchange - NOT the quantity
of potential credit that is sitting in bank accounts. In fact there are
different definitions of what constitutes M and each of these naturally
generates a different V. And those are Quantities, each having Size not
velocity. Their measurement in the equation reflects a static condition at the
time they are measured. The practical problem that faces the FED is that when
IT creates more credit for the economy by accepting the Treasury debt and
passes this on to the commercial banks it cannot automatically insure that this
new credit actually enters the market as the medium of exchange. But it for
sure alters the M as a standard of value.
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I suggest Dr. Gave stick to relating his own
'indictors' that he has (shown?) determined to be successful as predictors of
coming market movements and skip thinking about this V. Rather he might focus
on the different roles of M as a medium of exchange and as a standard of value.
For the remainder of his essay he discusses movement of HIS indicator and its
relation to the market (rather than V itself). His graphical representation
relates the determination - by him - of whether his indictor is negative or
positive and from that he decides if the market will 'perform' or 'under
perform' and recommend investments accordingly. Of his special interest is the
relative performance of equities versus gold and long bonds. Their relative
performance will really be a reflection of their relative 'value' in the minds
of private sector investors, which means their performance relatively as a
'medium of exchange' (currently) versus a 'standard of value' in the future,
which in tern means as a real 'store of value'.
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Then he ventures into the future and again
relates HIS indicator, which he expects will 'likely' remain negative, to
suggestions on what the investor should do about it. Seems to me that Dr.
Gave's long experience and success warrants strong consideration of his advice
and acting upon it. But, please, simply skip thinking that this has anything to
do with this mythical 'velocity'.
Actually, Dr. Gave's indicator might be indicative of the public's current
assessment of the relative 'value' of M as a 'medium of exchange' now versus
its 'value' as a future 'standard of value' - which is its 'value' as a 'store
of value'.
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PS:
His statement; "This suggests that central bankers should be replaced by
computers as they constantly destroy VALUE". Is the best advice of all.
But of course this depends on who is going to program those computers. But what
central bankers are creating and destroying is the 'value' as well as quantity
of the thing itself - credit - which is used to transmit 'value' between
parties in exchanges. The more units of credit are created the less relative
'value' each such unit in comparison to real things exchanged or as a 'store of
value' pending such uses.
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For a full understanding of Dr. Gave's essay
and his other essays the reader needs to learn about 'money' itself, its origin
and history. The history of money's origins goes back at least to 3000 BC.
Actually, something like 'money' began much earlier in history when people
began to want to quantify the differences they recognized in the relative
desire they had for different things.
But there is no consensus among historians (not to mention economists who don't
care about history) about what 'money' really is. I am compiling information
and references on the subject in other articles.
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For full understanding the reader also should
know something about the history and development of the concept of 'velocity of
money'. At least for this we need only to review the subject in the 20th
century and Lawrence White provides a summary of this in his excellent book -
The Clash of Economic Ideas. He relates
this to Irving Fisher's book - The Purchasing Power of Money (1911) and that
author's development of the 'quantity theory of money'. Fisher based his idea
on the accepted accounting identity known as 'equation of exchange'. For a
economic market in total the quantity measured in value of
everyone's purchase equals that of everyone's sales. Fischer posits this as
MV=PT in which M is the total quantity of money, V is the annual 'velocity of
circulation' of currency, P is the price level of goods and services bought and
sold, and T is in index of the volume of transactions. In this the idea of
'velocity' is the average number of times during the year that a unit of
'money' (which in his time meant currency) changes hands during market
exchanges. But it is defined as this ratio PT/M. And MV is the total value in
money (dollars for instance) of what is spent during the year. This conforms to
that accounting identify that what buyers spend equals what sellers receive.
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Fisher later amended his ideas and
equations. He could obtain real data to calculate M but had to estimate V.
Remember that when Fisher was thinking about this M was mostly tied to the
Quantity of gold and paper representatives of gold. Soon T was replaced by a
quantity - Q - designated as the purchases ONLY of newly produced goods and
services, meaning national income. But, of course, units of currency (and today
of credit) are transferred during exchanges of many other items. And another
famous economist, Alfred Marshall substituted a k - 'fudge factor' for V.
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The next step was to posit that this
'quantity of money' - M - causes various real results in the national economy.
From there the whole topic gets murky and convoluted. The 'school' of
economists who promote it are generally termed 'monetarists'. This entire
concept is based on a different ideas about what 'money' IS than those believed
by Chartalists and Austrian School libertarians. And there are still others who
have different theories about M.
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References
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Charles Gave - Velocity in Asset
Allocation
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Louis-Vincent Gave - The Knowledge
Revolution And Its Consequences
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Jacob Goldstein - Money: The True Story of
a Made-up Thing
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Felix Martin - Money: The Unauthorized
Biography
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L. Randal Wray - Money: An Alternative
Story
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L. Randal Wray - Credit and
State Theories of Money
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L Randal Wray - MMT Modern Money Theory
- I include an extensive reference list to money
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L. Randal Wray and Stephanie Bell - A
Chartalist Critique of John Locke's Theory of Property, Accumulation and Money
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Markus Brunnermeier and Yuli Samnikov -
The I Theory of Money
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Pavlina Tcherneva - The Nature, Origin,
and Role of Money: Broad and Specific Propositions and Their Implications for
Policy
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Wikipedia article on 'credit theory of money'
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Wikipedia article on "velocity of money'
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Frank Ryan - The Velocity of Money
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Frank Wood - Monetary Policy in Democracies:
Four Resumptions and the Great Depression
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