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THE VELOCITY OF MONEY IN
THE TIME OF COVID-19

Charles Gave

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GaveKal Research, The Daily Feb. 26, 2020, 2 pgs. diagram

 
 

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.

 
 

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".

 

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.

 

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.

 

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'.

 

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'.

 

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.

 
 

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.

 
 

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.

 
 

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.

 
 

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.

 
 

A different explanation of "V" is described in Mishkin's editions of The Economics of Money, Banking and Financial Markets .{short description of image}

 
 

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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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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