Thursday, May 13, 2010

There is no such thing as velocity of money circulation

The service that money renders does not consist in its turnover. It consists in its being ready in cash holdings for any future use.

Money is never "idle." It always renders to somebody the only service that it can render, namely being a part of a man's cash holdings.

Cash holdings are sometimes greater and sometimes smaller with the same individual. But nobody ever has cash holdings greater than he wants to have. If he thinks that his cash holding are excessive, he invests the surplus either by buying (producers' or consumers' goods) or by lending it. (Time deposits are one method of lending money.) It is a judgment of value to call somebody's cash holding "hoarding." The individual concerned believes that under the given state of affairs, the best policy (let us say: the minor evil) is to increase his cash holdings. It does not matter whether I approve of his behavior or not. His behavior — not my subjective opinion about its expediency — is a factor influencing the formation of market prices.

It is futile to distinguish between "circulating" money and "idle" money. Money changes hands without being ownerless for any fraction of time. Money may be in the process of transportation, traveling in railroad cars or in other means of transportation. But it is, even from the legal point of view, always in somebody's possession.

In a changing world everybody is under the necessity of keeping an amount of ready cash on hand. This desire creates the demand for money and makes people willing to sell goods and services in exchange for money. A realistic theory of the value and the purchasing power of money must therefore start from a recognition of these desires. The changes in the purchasing power of the monetary unit are brought about by changes arising in the relation between the demand for money, i.e., the demand for money for cash holding, and the supply of money.

The main deficiency of the velocity of circulation concept is that it does not start from the actions of individuals but looks at the problem from the angle of the whole economic system. This concept in itself is a vicious mode of approaching the problem of prices and purchasing power. It is assumed that, other things being equal, prices must change in proportion to the changes occurring in the total supply of money available. This is not true.

Read more: The Velocity of Circulation - Henry Hazlitt - Mises Institute

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