Daily Archives: July 22, 2013

A Brief Note on Gold As a Currency

With the refinements our ideas on money in Understanding Money: Part 5 – It’s All Money, we decided to apply them to a topic we have addressed in the past, that of the return to a gold standard.

There is an audience for the idea that the change from a gold standard to a pure fiat paper currency is a root cause for the current financial crisis. In particular, a paper currency allows for the expansion of the monetary base in an undisciplined fashion. We suggest that a pure fiat currency and a gold-backed currency both represent MZMc or the currency component of money with zero maturity whose composition or nature is irrelevant to the money creation process. To understand our thinking, refer to the series of articles on “Understanding Money” at the end of this essay.

A Brief Note on the Velocity of Money

Mathematicians understand the simple fact that in an equation containing a number of variables, at least one has to be a dependent variable. That is, when you have a number of properties you are measuring independently and try and relate them mathematically, you need a dependent variable to make the equation work. A classical relationship in economics is GDP = MV where GDP is just that, M is a measure of the money supply, and V is the velocity of the money being referenced.

As Wikipedia describes velocity, V:

The velocity of money (also called velocity of circulation) is the average frequency with which a unit of money is spent on new goods and services produced domestically in a specific period of time.

We would add spending to buy debt to the above definition. Velocity can be considered to be a function of the amount of our cash we intend to spend and the length of time we hold it before we spend it. It is inversely related to the duration of ownership of money based on whatever definition of ‘money’ is used.

Velocity increases when the economy is growing faster than the money supply. The inverse relationship also holds. Generally, V is viewed as an indication of the health of the economy. When V is decreasing, we are holding money in reserve longer and economic activity is slowing. The economy may be headed for a recession. If V is increasing, the economy is growing because we are spending our money faster.

We discuss the current state of V in our economy below and examine some aspects of its changes. Click on any graph to enlarge in a new window.

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