The Velocity of Money

The esoteric concept of money velocity is useless. The velocity of money is calculated by dividing the GNP by the money supply. OK, Let's take a peek at GNP: what is it? The Gross National Product is the total money value (price) of all final goods and services produced for consumption in a country during a particular time period. This definition suffers from several deficiencies. First, it is expressed in terms of the monetary unit, however if goods are traded directly in barter, they do not contribute to the GNP. Nor do goods and services sold which are not in view of the government accountants, such as illegal drugs, prostitution, smuggling, illegal gambling, volunteer activities, etc. So the actual GNP is somewhat larger in terms of goods produced than the figure reported. But in any case the GNP is reported in the monetary unit per year. Money supply has its own problems between M1, M2, MZM, etc. The most pertinent money supply number in this context is M1, which is the paper money and coins in circulation plus the demand deposits (checking account balances) in banks. So if we take the monetary value of all goods produced per year and divide by the total money in circulation, what are the units of our result? For example, in the uSA, Dollars / year (GNP) divided by Dollars (M1) gives units of ? / year. What does this mean? Apparently, it does not signify the average number of times the monetary unit changed hands during the year. That quantity would have units something like dollars per year per person. Yet nowhere does the number of people enter into the equation, and the actual monetary unit is irrelevant because it is cancelled out. This answer is similar to taking your vehicle speed and dividing by the distance you plan to travel. 70 miles per hour divided by 35 miles gives an answer of 2 / mile. 2 what? The answer is meaningless and tells you nothing.

The velocity of money is meaningless, but the demand for money means a lot. Money is a commodity and so is subject to the laws of supply and demand. People hold money as a store of value for future use, so if the supply of money is stable, the demand for money will also remain pretty stable fluctuating only when people's plans or perceptions change and they desire to hold more or less of this commodity for future use. The demand is for the value stored, not the unit itself, so if a society has a larger quantity of circulating money, the people in that society will tend to demand more of the monetary unit to be able to have the same value on hand and of course, that value is in the goods that the monetary unit can buy. But a problem occurs when the quantity of money in circulation fluctuates. If the money supply drops and its value increases, people actually need less money to satisfy their need for stored value, but they might tend to see money as a more desirable good and tend to hold more of it because of its increasing value. This would be especially important if they became concerned about future economic stability or employment. More ominously, when the quantity of money increases and its value begins to drop, people will at first hold more money in order to retain their ability to meet future needs, but at some point will begin to demand much less, or zero money, when it becomes obvious that the monetary unit has become useless as a store of future value. Forget velocity. Think demand, and the ability of money to perform its function as a store of value.