## Monday, May 16, 2022

### How Velocity Doesn't Affect Prices

Edit: I will be offering a retraction of certain statements made in this post as of May 2 or so.

The actual money supply according to the market is #_transactions * average_transaction_size. If April saw 100 transactions with average price \$100, then the supply of money in April was \$10,000. Goods demanded \$10,000 dollars, and \$10,000 dollars demanded goods. The actual amount of coinage in circulation is irrelevant except that it has to be at least \$100 so that this set of transactions is logically possible.

If you increase transactions, you increase the money supply, lowering the price of money. Inflation.
However, to increase transactions, you also have to increase the amount of goods the market sees, causing deflation.
As it happens, these effects exactly cancel out.
Put  another way, if additional good production is zero (e.g. it's all arbitrage) then the velocity of goods rises in lock-step with the velocity of money. If it's not all arbitrage you get production increases of equivalent goodness.
Put a third way, velocity is measuring the price of money in money. If you increase transactions you increase the money supply, but if you increase transactions you also increase the demand for money. Price of money in money is always going to be 1.

Which is why, for example, the price of a bushel of wheat is 11 pence (or local equivalent; dram, drachma, denarius, &c). Any time production should cause deflation, it also increases velocity, cancelling the deflation with inflation, and wheat prices remain the same. Along with the price of everything else. Indeed it is likely that the very slight price increase that wheat did see (actually there was a low of 8 pence) was due to ongoing silver mining.

Absent central banks, long-run prices are absurdly stable.

Population growth: more people demand the same amount of money, causing deflation, but also demand goods, causing inflation. The additional food purchases raise the price of food, and then the additional velocity raises the price of money. Meanwhile, of course they are also adding labour, thus adding to goods, thus causing price to fall. Blah blah etc.

Check: the long-run price of oil (as in, neglecting the many price shocks) in grams of gold is absurdly stable.

Is productivity the same?
If you raise productivity you definitely decrease the price of the good. However, you then also free up some labour to go make something else....which seems like it shouldn't have a net effect. There might be something I'm missing, but it makes sense that productivity changes should properly affect good prices. It changes their relative cost. Indeed it's productivity which determines prices in the first place. In a sense, the labour theory of value is correct, at economic equilibrium: the only limiting input for any good is human labour, because labour can be transmuted into more supply of any good that can be supplied. Just don't forget labour is not created equal.

When you print or otherwise debase money, you don't increase the number of goods, so you don't change the number of transactions, you just increase the average transaction size near the money printer. Higher supply of money, lower price of money.

P.S. Population growth is equivalent to immigration from a market perspective. More demand for jobs + more demand for output of jobs => more supply of jobs etc etc. If the immigrants can take all your jobs, then your children can take all your jobs too. Eventually population grows so much that all the jobs are taken long before anyone can find one...that's how it works, right?

Anonymous said...

This is a long reply and I figure I'll put where I think you have it slightly wrong at the start.

You've already well defined your terms previously when discussing money and inflation, and when you have \$100 and print \$5 - your total money supply is then \$105, for the same amount of economy.

In this post I think, in particular, while this is true in terms of money theory, it misses something vital :

>Population growth: more people demand the same amount of money, causing deflation, but also demand goods, causing inflation.

Money is a representation of value. If you're dying of thirst how many kg of gold is a litre of water worth? The "demand" for money is proportional to the value of goods.

People can trade goods for goods directly - if money supply is limited, you just use it less. The convenience of money is a problem that solves its lack of supply with inflation.

>The actual money supply according to the market is #_transactions * average_transaction_size.

I always learn something from you. That's the same as sum(transactions). I played around in excel for longer than I'd like to admit to prove this wrong. Timandericmindblown.gif

>The actual amount of coinage in circulation is irrelevant except that it has to be at least \$100 so that this set of transactions is logically possible

Not necessarily. If money supply dwindles, purchasing power of money increases. You just change the prices of the goods to suit the money supply.

>If you increase transactions, you increase the money supply, lowering the price of money.
No. Money supply in your equation is fixed; if you increase transactions, you decrease the average transaction value, increasing the value of money. Deflation. See : Bitcoin.

The problem with deflation is people are psychologically very loss averse.

"So you put \$100 into producing these goods, reasonably expecting a \$150 return, but due to deflation of 50% they're only worth \$75 now".

Explaining to someone that they're getting \$150 in yesterdays money for the goods is nigh impossible. THERES LESS DOLLARS.

> However, you then also free up some labour to go make something else....which seems like it shouldn't have a net effect
It might free up labour to do something useless. Labour isn't valuable by default. Go dig a hole in the road with a pickaxe. That's your labour used to destroy value/ create a cost.

> In a sense, the labour theory of value is correct,
You could spend a whole bunch of labour producing things that aren't needed. This is why you can't have a centrally planned economy. Hopping on one leg is "labour", how much per hour are you willing to pay me for that?

Finally, inflation is the way people can hoard money without affecting the market. "I will only feel comfortable if I have the equivalent of 700 years worth of my current lifestyle as security", gotta print money cause if people just hoard it, someone's gonna notice that you're causing prices to drop. Like I said - prices drop, people think they're losing something.

Course this is an epic self own since you have to keep printing it, thus devaluing it, which means you have to print even more to feel satisfied.

Arqiduka said...

The reason why long-run prices in gold tended to be stable-ish is that when the price of gold increases too much people extract more of it, NOT because any supply of money is fine, the market will adjust prices. In terms of your model, number of transction and avg transaction size are independent, and nothing ensures that more goods will mean a greater product. Indeed, without an accomodating increase in the supply of money, the avg transaction size will go down so total circulation will remain the same, but prices will go down. So, prices are not self-adjusting by magic.