Reader Jeff asks “Since we appear to have record tax receipts in a record low-velocity environment, could we expect tax receipts to increase if the velocity of money picks up?”
Velocity vs Tax Receipts
Velocity is defined as (prices * transactions) / (money supply). Economists substitute GDP for (prices * transactions).
Real GDP is a flawed measure of output because it ignores asset bubbles, even home prices in its measure of pricing.
Moreover, there is no universal agreement whether to use M1, M2, MZM, Austrian Money Supply or something else as the denominator. This leads to numerous measurements of velocity.
M2 velocity is shown in these charts.
Velocity vs GDP
It’s possible for GDP to rise or fall with velocity either rising or falling.
Tax receipts can fluctuate independently as well thanks to tax policy changes and capital gains collected on rising asset prices.
Velocity Magic
Austrian economist, Frank Shostak, took apart conventional wisdom years ago with his column Is Velocity Like Magic?
The Mainstream View of Velocity
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.
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.
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).
Many economists employ GDP instead of P(T), thereby concluding that: M(V) = GDP = P x (real GDP).
Most economists take the equation of exchange very seriously.
Velocity Does Not Have an Independent Existence
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.
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.
Boom and Bust
Shostak wrote that in 2002. A housing boom and a housing bust followed.
We are now in an everything bubble with money supply rising like mad. Another bust is guaranteed.
Velocity will not cause the next bust no matter what it does (although I do expect velocity will decline for the simple reason I expect massive amounts of further monetary stimulus).
The cause of the next major decline will be the same as the cause of the last major decline: excess monetary and fiscal stimulus by the Fed, ECB, other central banks, and various government bodies.
Circulating Money
One irony in the velocity debate is that money does not even “circulate” as widely believed.
“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, Mises p. 403)
Garbage In = Garbage Out
Starting with flawed measures of money and flawed measures of GDP, a good summation of velocity is “garbage in = garbage out”.
Velocity itself does not predict anything, nor cause anything! It’s not an independent variable.
However, we can say that falling velocity now is a result of massive monetary printing.
It’s taken amazing amounts of central bank stimulus, junk bond offerings, and government spending to keep GDP rising.
Related Articles
- Bubblicious Debate: Greenspan Says “Bond Bubble About to Break”, No Stock Market Bubble
- Central Banks Puzzled as Global Inflation Hits Lowest Level Since 2009: Solving the Puzzle
- Reader Asks: Can the Bubbles Last Forever?
- Tracking the Amazing Junk Bond Bubbles in the US and Europe
For a detailed look at the stock market bubble, with thanks to John Hussman, please see Median Price-to-Revenue Ratio Higher in All Deciles vs 2007, 90% vs Dot-Com Bubble: THE Choice
Addendum
Pater Tenebrarum sent links to two more recent articles by Shostak on his blog:
Should we be concerned about falling velocity?
I love this chart from the first.
Mike “Mish” Shedlock
Thanks. An FYI: at 1 point sometime way back I expressed this point to a TOP econ analyst. He pointed out that the public switch to plastic, and other related (not carrying $200 in cash on me types) structural changes, debit cards, charge cards, and much more debt, for HIM made velocity unuseful. Just something to keep in mind. (I was big on it too!)
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Very good points. The mountain of debt clouds the picture about measurements that were developed with old school economy in mind: GDP, velocity…
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The concept of velocity is somewhat useful for understanding how recessions start and strengthen. However, as implied by what the econ analyst pointed out the concept of “money” in the equations is not easily defined or measured. The confusion starts with the multiple and changing definitions of “money” and the terminology used to describe the “money supply.” Many economists seem to think of M2 “money supply” as the amount of “money” in the system. Therefore, actions of commercial banks that increase or decrease M2 amount to creation or destruction of “money.” This is not really true unless one simply defines “money” = M2 (as a mathematical identity), which is likely different that most peoples definition of “money.” M2 is simply one (out of many) measure of liquidity and the level of confusion could be reduced if they stopped calling it “money supply” and started calling it liquidity measure #2 (LM2) and recognized that there are many other sources of liquidity that are not measured by LM2.
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Reblogged this on World4Justice : NOW! Lobby Forum..
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…one of the better posts you ever posted. There is one more component to it. It has to effect something, but that is hard to see, and a chapter or two in a book necessary to explain it. Nice post though.
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Thanks
My readers inspire me quite often. Had I not gotten a question I would not have done this post.
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If baker John spends $10 with tomato farmer George, one cannot automatically assume that tomato farmer George has ten dollars to spend with potato supplier Bob. Tomato farmer George’s cost on baker Johns $10 has to be factored in, which means that tomato farmer George’s actual spend forward is not $10 and so on down the chain. Baker John’s $10 was disposable income, one cannot say the same for George or Bob surely. Am I missing something here Mish?
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Velocity of money = how fast it escapes from your hands / (how slow it makes its way into your pocket * leverage available on property)
Velocity of money = debt ceiling / (number of protests * how many turn up)
Velocity of money = (how far you walk in a week * if you like counting your money all day) / amount of time you sit still
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Garbage In–Garbage Out summarizes most of macroeconomics these days, including such favorites as GDP and unemployment rates….
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What does a dollar bill look like? Ave not used one in years.
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The “conclusion” (that taxes and velocity are unrelated) makes sense, but the supporting argument is based on a flawed definition of velocity.
Even if an accurate definition were used… one should be looking at the money multiplier effect of reserve banking (not velocity) to understand both stagnant economic growth (even if GDP is a flawed measure thereof) and also the tax revenue mess.
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Thumbs up for Trump.
He pardoned Arpaio.
That’ll give the snowflakes something to talk about.
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The only real “velocity of money” I’ve witnessed is the speed at which it goes from my earning it to the government wasting it.
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+100
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For most, the velocity of money exceeds the speed of light…
they don’t see it…
future money pulled into the present…
spent…
before it is earned.
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Plan B: see if 1 right + 1 wrong = nothing ever happened.
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Since the 1980’s cycle peak, every GDP peak has been lower. This GDP cycle should be no exception. 40 Years is a strong pattern. What the news reports can’t possible influence a population that long, nor create consistent 10 year cycles.
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Therefore neither central bank policy nor government programs can change the underlying trends.
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I think it is quite obvious from the first chart that if velocity dropped by one over twenty years, in a quarter century or so it wants to be at 0. I expect as that time approaches people will start realising that they will not be able to offload their money, or even move it !!! and so they will all try to get rid of it at once, because otherwise it will take up precious space. So they will all have an extra room built with it for just in case some of it is left with them (like unkind neighbours dropping it over the fence, or a present instead of socks) so they have somewhere to leave it. Builders will do well until they realise they have been paid with bookends and so they will be forced to collect old literature, which they will read out of boredom and so become world masters at post industrial poetry. Thats how it is folks and remember you read it here first.
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Velocity may not be a stand alone item but if the velocity charts turn upward, maybe even flat line, we will finally see inflation because there is so much M out there.
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Deflation is the result of globalization. It is like a dozen different walmarts all competing against each other. Everyone seeking the lowest bidder. Deflation has an insidious effect on the velocity of dollars. Add artificial debt and flooding the market with dollars during QE and you have an environment that is difficult to measure. Also consider the amount of Internet purchases which are not reported. Such measurements have lost any significance.
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Deflation is the result of inflation. They are two phases of a cycle.
An economic boom is the inflationary phase of a cycle and the bust is the deflationary phase. Action, reaction. Then a new cycle begins.
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i disagree. Deflation and recession do not necessarily go hand in hand. Prices rising and falling are based on a myriad of factors. Prices stagnate but seldom fall in a recession except for specific markets like housing etc. Overproduction or too much competition can depress prices in the most robust markets. Too much fast food, too many restaurants, too many gas stations split the pie and everyone suffers. Too many countries competing for the world pie, i.e. Globalization is hurting growth for industrialized nations. Factor that into the overall calculation for velocity of money and we see why it is so hard to measure.
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https://www.armstrongeconomics.com/qa/velocity-of-money-boom-bust-cycle/
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Fake money.
#sad
DJT
_aleph_
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The more we’re taxed, the faster the velocity of money. Elegantly simple solution, and so gainful for the government: give money away by computer every microsecond and tax it at 100% for full effect. That must be what cryptocurrencies are for…
_aleph_
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“However, we can say that falling velocity now is a result of massive monetary printing.”
Newton’s law. For each action, there is an equal and opposite reaction.
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Quantum theory – when a dollar gets printed in office A, half of a dollar dissapears from pocket B.
A and B each remain as one dollar.
Their total is still one dollar.
Person of A and Person of B cannot both spend their dollar without it becoming not a dollar, but half a dollar.
So they keep it in their pockets.
Office A prints another dollar because of a perceived savings glut.
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Using “velocity” in this context could cause indigestion for anyone with a scientific training.
“Velocity” is a term originating from physics, and is a vector quantity with units of distance/time and a direction. For example the velocity of my car yesterday afternoon at 4 pm was 60 miles per hour northwest. How economists can end up using it to describe the movement of dollars is mystifying.
Even leaving the definition of “velocity” aside, in the expression V=PT/M above (the brackets are superfluous) V has the dimensions (dollars x dollars)/dollars = dollars, which is not even a rate let alone a velocity. Maybe there should be a “per year” in there somewhere which would produce the dimenstions dollars/year. But that is neither a speed nor a velocity, but more likely a turnover.
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Doesn’t this exercise really exemplify where the money supply is going ? If you included the bubble assets purchases in the numerator we would have a larger ratio/velocity . Just an
observation , might not be valid.
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Although I’m sure all economists understand that there are four variables in the identity MV=PQ, what they seem to fail to understand is that at most three of those variables can be independent in the sense that each can be set in the first order, independently of the other two.
This doesn’t mean that price, P, is always set independently of quantity of production, Q, in each specific case due to business and market considerations, but it CAN be.
Moreover each of the variables M, P and Q can in principal be measured with some degree of accuracy.
Back to the mathematics, if M, P, and Q are independent variables, then V must by the definition of identity be a dependent variable. V can never be measured and has to be calculated It is defined from the identity as V=PQ/M. It has no separate meaning and any meaning given to it is a fiction, a value that cannot be measured and can never be independently altered.
So what is the deal about velocity, V? If V is falling them either economic production is dropping while the money supply is fixed or the money supply is increasing while the economy is stagnant, or both. But these conditions we already know before we calculate V. So again, what is the big deal about V? It is basically useless and meaningless outside of its role as a place holder preserving the identity relationship among the independent variables.
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The only thing useful about it comes from understanding why it is falling now. It’s common sense why, and that explains perfectly well why economists cannot see it.
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94% of the means of circulation is credit which appears as no more than journal entries in the banks and corporations. Money as means of exchange takes place only in retail (cash sales). In industry and commerce money is reduced to means of payment, that is the settling of credit that has not been offset. Most goods change hands against IOUs not money, so looking at money or its velocity in isolation serves little purpose.
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