'Velocity Of Money' Is Superfluous, And Gresham's Law Is A Myth

Posted: Jun 11, 2018 10:58 AM
'Velocity Of Money' Is Superfluous, And Gresham's Law Is A Myth

“The sole use of money is to circulate consumable goods.”

– Adam Smith, The Wealth of Nations

Though economists of the various Schools will frequently tell you differently, money is not wealth.  Money is at best a facilitator of wealth exchange.  It’s important to stress “at best” given the basic truth that an Argentine peso will facilitate little to no trade around the world, while a U.S. dollar is an accepted medium of exchange just about anywhere humans roam.

Important here is that when we produce, we’re not seeking money per se.  We instead want the goods and services that money can be exchanged for.  With trade, it’s always and everywhere products for products.  “Money” is merely an agreement about value that we use to measure our own output so that we can attain equal output from others.  In working for money, we individuals who comprise the economy are working for what money can be exchanged for.

Which brings us to the “velocity of money,” a measure that pretentious economists like to contemplate.  And talk about.  "Velocity" measures the number of times a unit of measure (like the dollar, euro or yen) is used to purchase goods and services within a certain timeframe.  The correct reaction to the previous sentence is for readers to roll their eyes.  What a waste of time.  Does anyone seriously think Nike co-founder Phil Knight, or Apple CEO Tim Cook contemplate “V” in projecting present or future sales? The blindingly simple subject that is economics has been perverted by economists desperate to make opaque what is rather basic.

Back to reality, money “velocity” is merely an effect of production.  With trade always being about products for products, velocity is high where production is high.  Money’s role is once again solely as a facilitator.  That’s why good money that holds its value is heavily circulated on the way to high velocity.  Producers seek goods and services in return for their production, so the last thing they want is limp, credibility-free money when they 'export' what they create to buyers.

Looking at the above in terms of the dollar, there’s a reason it factors into nearly half of all global transactions on a daily basis.  It does because the dollar, despite its myriad weaknesses related to instability since 1971, is globally accepted.  That’s why it liquefies so much exchange.  Producers broadly know what they’re getting in return.  They know the dollar will command goods and services nearly everywhere.

Contrast that with the Argentine Peso.  Given the sick-inducing devaluations that have historically defined the Peso, its velocity is logically light.  Of course it is.  No reasonable producer wants a globally rejected currency in return for his production.

All of this is important given the belief among economists that rising velocity signals inflation.  What a laugh. They get it backwards.  Good money that holds its value is used everywhere.  Inflationary money, as in money that's persistently exchangeable for less and less, isn’t broadly accepted.  Which means it isn’t used very often to purchase goods and services.  That it isn’t is a statement of the obvious.  Why on earth would a producer accept a junk currency in return for his production? Going back to post-WWI Germany, while history books tell us about wheel barrows full of devalued Marks, the reality was that the collapsed Mark was hard to find.  Of course it was. No sane producer would exchange real goods and services for what was exchangeable for fewer and fewer goods and services by the minute, hour and day.

Which brings us to the silly myth that is “Gresham’s Law.” The latter says that “bad money drives out good.” Except that it doesn’t.  That it doesn’t is yet another one of those obvious truths that could only elude economists.  Since most produce nothing of value, and this includes the supposedly wise “theories” running through their heads, they can’t see that good money by definition drives out bad.  That it does is merely a confirmation of the basic truth that producers trade products for products.  When we accept money in return for what we’ve produced, we logically want the money to be exchangeable for commensurate goods and services.

Implicit in the non-law that is Gresham’s is that producers would accept debased money in return for their production even though the latter would be exchangeable for fewer and fewer products.  Except that few would.  Producers want equal value.  They want to get as much or more than they produced.  That’s why bad, debased money is generally driven out by the good.  For it to be otherwise would be for producers to voluntarily accept less in return for their production.  The very notion is laughable.

So when economists and those who pretend to be economists talk “money velocity,” readers can confidently dismiss them.  To trade is the basis of all economic activity, so the more we’re producing, the more that the velocity of credible currencies rises.  As for Gresham’s “Law,” let’s not call what quite simply isn’t a law.  It’s a myth.  And a very backwards one at that.

This article originally appeared on Forbes.com.