CHAPTER XII

VELOCITY OF CIRCULATION

For the quantity theory, it is important to treat velocity of circulation of money and of deposits, as self-contained entities, really independent factors. This is true of Fisher's theory. It is particularly necessary that V and V' should vary from causes unconnected with M and M'. The V's are to be a sort of inflexible channel, through which M and M' run in their influence on the passive P, which is to rise or fall proportionately with them. If an increase of M or M' should lead to a reduction in the V's, if people, having more money available, should be less assiduous in using every bit of it in effecting exchanges, then P would not rise in proportion to the increase in M. Complete demonstration of Fisher's thesis, therefore, requires the proof of the negative proposition that V does not change as a consequence of changes in M or M'. This proof Fisher finds in the contention that the V's are fixed by the habits and conveniences of individuals, whence they are not influenced by such a cause as a change in the amount of money.[205]

V is defined,[206] not as the number of times a given dollar is exchanged in a given year (the "coin-transfer" notion), but as a social average based on the average number of coins which pass through _each man's_ hands, divided by the average amount held by him (the "person-turnover" concept of velocity.) V' is similarly defined. Fisher asserts that both concepts, if correctly employed, lead to the same result. I would point out one important difference between them here: if money is _short-circuited_, if, _i. e._, a part of the economic community loses its incomes, or finds its incomes reduced, then the "velocity of money," on the "coin-transfer" basis is reduced, provided the "person-turnover" average remains the same, while on the "person-turnover" basis the velocity will remain unchanged. It is clearly the "coin-transfer" concept which is fundamental, from the standpoint of the equation of exchange, and Fisher feels justified in using the other method only because he considers it an equivalent of the "coin-transfer" concept. I shall later show cases where the distinction between the two concepts is all-important, particularly in the case where T is reduced by the elimination of _middlemen_.[207]

The conception of velocity of circulation as a real, unitary entity, a _cause_, in the process of price-determination, is, I suppose, almost as old as the quantity theory itself. It is an essential part of the quantity theory. To me "velocity of circulation" seems to be a mere name, denoting, not any simple cause or small set of causes, which can exert a specific influence, but rather a meaningless abstract number, which is the non-essential by-product of a highly heterogeneous lot of _activities of men_, some of which work one way, and others of which work in another way, in affecting prices. It is at best a passive _resultant_ of conflicting and divergent tendencies, and has, to my mind, no more _causal_ significance than the average of the abstract numbers of yards gained by both sides, heights and weights of players, kick-offs, and minutes taken out for injuries, would have on the result of the Yale-Harvard game. The real causes of changes in prices lie deeper! I should expect V and V' to be the most highly flexible factors in the equation of exchange, and should expect to be able to keep the equation straight, in a great variety of situations, by allowing the V's to vary.

Before undertaking detailed analysis of the causes governing V, I shall discuss Fisher's specific argument, typical of the quantity theory, that an increase of money cannot change the V's. "As a matter of fact, the velocities of circulation of money and deposits depend, as we have seen, on technical conditions, and bear no discoverable relation to the quantity of money in circulation. Velocity of circulation is the average rate of 'turnover,' and depends on countless individual rates of turnover. These, as we have seen, depend on individual _habits_. Each person regulates his turnover to suit his individual _convenience_.... In the long run, and for a large number of people, the average rate of turnover, or what amounts to the same thing, the average time money remains in the same hands, will be closely determined. It will depend on density of population, commercial _customs_, rapidity of transport, and other technical conditions, but not on the quantity of money and deposits nor on the price-level." (Italics mine.[208]) He proceeds to assume that money is doubled with a _halving_ of the V's, instead of a _doubling_ of P. Everybody now has on hand twice as much money _and deposits_ as his convenience has taught him to keep on hand. He will then try to get rid of this surplus, and he can only do it by buying goods. But this will increase somebody else's surplus, and he will likewise try to get rid of it. This will raise prices. "_Obviously_ this tendency will continue until there if found another adjustment of quantities to expenditures, and the _V's are the same as originally_."[209] The foregoing argument rests in part, it will be seen, on the assumption that a fixed ratio between M and M' obtains, else the increase of _money_ in everybody's hands would not mean a corresponding increase in their _deposits_. I have already criticised this doctrine. For the contention that the V's will finally be _just the same_ as before, I find no specific argument at all--"_obviously_" presumably making that unnecessary.

As the point immediately at issue is that V's will be _unchanged_ by the increase in M (otherwise P would not increase _proportionately_--let us see if considerations can be adduced which will make this a little less "obvious." First, it will be noticed that Fisher, in the foregoing, in one sentence speaks of the matter as resting on _habit_, and in the next sentence, on _convenience_. He speaks, also, of business _custom_. Now it is important to note that habit and custom, on the one hand, and considerations of convenience on the other, do not necessarily coincide. Many habits and customs are highly inconvenient. And it is not at all likely that habit and custom should govern so highly complex a thing as the ratio between cash on hand and the price-level. Rather, in so far as custom and habit rule, one would expect them to relate to a simpler matter, namely, the _amount of cash on hand_. If the amount of cash kept on hand should remain controlled by habit, while the amount of money is increased, then V, instead of remaining unchanged, would actually be increased, unless the habits should be broken in on. I shall show in a moment that considerations of convenience would probably lead to a reduced V, in so far as individual turnover is concerned. But which tendency will prevail? Well, that will depend on the degree to which custom and habit rule as compared with considerations of convenience--_i. e_., there would be no rule valid for all communities. That convenience would lead to a larger amount of money on hand--and I am following Fisher's temporary hypothesis that there has been no rise in prices prior to the movement to restore the V's to their old magnitudes--will appear from considerations like these. Few men have as much on hand as they would like to have, including both their cash in hand and their deposit balances. Most people have the tendency to hoard, though it is usually held in check by necessity. If money on hand be increased suddenly, without prices being increased, and without any prospect of increased incomes in the future--and there is nothing in Fisher's provisional hypothesis to call for increased incomes, as they could, in fact, come only from an increase in prices--why might not there be a considerable saving of money, with a corresponding reduction in V? If it be objected that people, in saving their money, will in considerable degree put it into the banks, and that the banks, with larger reserves, will increase loans and deposits, I would urge, that it is on the part of banks that this tendency to increase hoards in times of abundant money is particularly marked, and for proof would point to the figures quoted from Keynes[210] for the great banks and treasuries of Europe in the last fifteen years. It is not necessary for my purpose at this point to do more than show that there is reason to expect an increase in money to _change_ the V's. Fisher's argument rests on the contention that the V's will be neither increased or reduced--otherwise an increase in money will not _proportionately_ raise prices. The appeal to habit and custom in the matter is particularly unsatisfactory. Custom and habit could not possibly regulate things so complex as velocities of money and bank-deposits.

Whatever be the ultimate effect of an increase in money, the immediate effect is commonly to reduce the money-rates. Banks have less inducement to pay interest on deposits, and charge lower rates for loans. Now merchants, especially small merchants, are often embarrassed in making change for customers. The man who has tried to make payment with a ten dollar bill in a country store has not infrequently put the storekeeper to much inconvenience. To offer a ten dollar bill, or even a five dollar bill, to a storekeeper on Amsterdam Avenue in New York City may well mean that the one clerk in the establishment, or the proprietor's wife will run out with the bill to three or four neighboring stores before finding change with which to break it. If money is more abundant, if money-rates are easier, for a time, it may easily happen that many small merchants will experience the superior convenience of having a more adequate amount of change in the till, and will, even after the money-rates have risen--if they do rise again to the old figure--find a new reason for keeping more cash on hand. There is a marginal equilibrium between the interest on the capital invested in cash in the till, and the wages of the clerk,[211] whose active legs assist the velocity of money. Not only banks and small dealers, however, find it advantageous to increase their supply of ready funds, held idle for special occasions. The United States Steel Corporation has kept as much as $50,000,000.00 to $75,000,000.00 in idle cash or idle deposits, as a means of being independent of banks in times of emergency.[212] The motive for accumulating reserves and hoards, either of cash or deposit accounts, is at all times strong. In times of financial ease, it may easily find the difficulties which ordinarily repress it give way, and, by being gratified, grow stronger.

I conclude that there is positive reason for expecting an increase of money to reduce the velocity of money.

Horace White, in his _Money and Banking_, in the earlier editions, speaks of the velocity of money, "_alias_ the state of trade." Is not this the truth? Is not money circulating rapidly, when business is active, and slowly when business is dull? Is not the velocity of circulation a highly flexible and variable average, a _cause_ of nothing, and an index of business activity? Or, better, perhaps, are not the V's and T both governed, in large degree, by more fundamental causes which are largely the same for both? Fisher would admit something of this for transition periods. Even for normal adjustments, he admits that an increase in T, unaccompanied by an increase in M, leads to some increase in the V's, though he doesn't say how much.[213] He denies, however, that an increase in the V's will increase T.[214] In general, it is clear that he regards the V's and T as governed by different causes. The control of the V's by T is not the only or the chief control of the V's. The V's can increase greatly without an increase of T, in his scheme. That this is so, will appear from a comparison of the list of causes which he gives as governing the V's and T respectively:

Causes governing V's:

1. Habits of the individual. (a) As to thrift and hoarding. (b) As to book credit. (c) As to use of checks.

2. Systems of payments in the community. (a) As to frequency of receipts and disbursements. (b) As to regularity of receipts and disbursements. (c) As to correspondence between times and amounts of receipts and disbursements.

3. General causes. (a) Density of population. (b) Rapidity of transportation.

Compare this list with the causes governing T:[215]

1. Conditions affecting producers: Geographical differences in Natural Resources; the division of labor; knowledge of technique of production; accumulation of capital.

2. Conditions affecting consumers: the extent and variety of human wants.

3. Conditions connecting consumers and producers: (a) Facilities for transportation. (b) Relative freedom of trade. (c) _Character_ of monetary and banking systems. (Not their _extent_.) (d) Business confidence.

These two lists are quite different, and indicate that in Fisher's mind the magnitudes, T and the V's, in general obey different laws. The only factor in both lists is facilities for transportation ("rapidity of transportation," in the first list). Strangely enough, T, though later recognized as having influence on the V's[216] is not included in these lists in ch. 5. The "character of the monetary and banking systems" in the second list is evidently not the same as "use of checks" in the second list, though it will doubtless affect that factor, as also the "habits as to thrift and hoarding," in some degree. "Business confidence," which is, in the view I am maintaining, as in the view, I should take it, of Horace White, the great variable affecting both T and the V's, does not appear in the first list. Indeed, one wonders why business confidence appears in either list, if only "normal," and not merely "transitional" causes are to be considered, but it appears from the fuller discussion on p. 78 that Fisher is not thinking of business confidence as a _variable_ at all--his normal theory has nothing to do with _variables_--but as a thing which either is or is not present, a sort of Mendelian unit, not a thing of degrees.[217] It will be noted, further, that most of the causes which Fisher lists as affecting T are really causes affecting _production_--they would be just as important under a socialistic as under an exchange economy.

Now I propose to show, on the basis of Fisher's own list of causes, that most, if not all, of the factors affecting the V's, will also affect T, _and in the same direction_. He admits this as to transportation facilities. It is surely true of thrift and hoarding. The miser neither circulates money nor buys goods. It is emphatically true--though Fisher's theory, as will later appear, is obliged to deny it,--of both book credit and banking facilities. Without the use of credit, much of the business now done simply would not be done at all. For Fisher, and the quantity theory in general, the contention would be simply that the same business would be done _on a lower price-level_. I reserve a full discussion of this fundamental point till later, noting here, in passing, that the function of banks is to assist in effecting transfers, that that is why, from the social standpoint, banks are encouraged, and that the extension of banking would be folly if they did not, in fact, do this. As to book credit, let us suppose that, for example, in the great cotton section of the South the stores should cease to give advances of supplies on credit to negroes and small white farmers, pending the "making" of the crop. The outcome would be starvation for many of them, and no cotton crop at all. Under a system of private enterprise, the very division of labor itself, including the specialization of the capitalist, involves credit, and it is difficult to conceive a form of credit which does not either dispense with the use of money, or increase its "velocity." Admittedly, the division of labor increases trade.

The three factors listed under "Systems of payment in the community" also affect trade. To the extent that receipts are frequent, regular, and synchronous with outgo, we have a smoothly working economic system, which facilitates commerce.

Finally, density of population enormously increases trade. The concentration of men in cities is essential for modern factory production, and the great cities have necessarily grown up about good harbors, or at strategic points for connecting lines of railroads. It seems almost trivial to insist on so obvious a point, but Fisher seems totally to ignore it, for he says: "We conclude, then, that density of population and rapidity of transportation have tended to increase prices by raising velocities. _Historically this concentration of population in cities has been an important factor in raising prices in the United States._"[218] (P. 88. Italics mine.)

This is an astounding proposition. It is not merely that the concentration of population in cities has _tended_ to raise prices through raising velocities. It is a statement that this has been an important historical cause of the actual increase in prices. For Fisher's own theory, if the same cause had tended to increase T,[219] that would have offset the rising V's on the other side of the equation, and left prices little affected. But he sees in the V's an independent cause here, divorces them from their connection with T, and follows his logic fearlessly where it leads. I do not see how one could more strikingly illustrate the essential vice of erecting the V's into causal entities.

In concluding the discussion of the role of velocity of circulation, I think it worth while to mention Fisher's own efforts to measure them. I examine his statistics in a later chapter. I do not regard the points at issue as points which can properly be handled by inductive methods, primarily. I do not accept his conclusions with reference to the magnitudes of V, the velocity of money, partly because I do not accept his doctrine that "banks are the home of money" (p. 287).[220] He finds for V a fairly constant magnitude during the thirteen years from 1896 to 1909, the range being from 19 to 22, the figures for all the years except 1896 and 1909 being interpolations.[221] For V, however, which is much the more important magnitude, from the standpoint of his equation of exchange for the United States, since deposits do so much more exchanging than does money, he finds a wide range of variation, from 36 to 54, and he states: "We note that the velocity of circulation has increased 50% in thirteen years and that it has been subject to great variation from year to year. In 1899 and 1906 it reached maxima, immediately preceding crises" (285). I think Fisher's own statistical results show that V', at least, is a child of the "state of trade."[222] Critical analysis of these statistics show that they greatly underestimate the variability of the V's.[223]

In summary: V and V' are not, as Fisher contends, independent of the quantity of money. Instead of resting on "technical conditions," and having large elements of constancy and rigidity, they are highly flexible, and vary, on the whole, with the same highly complex and divergent sets of causes which govern the volume of trade. The biggest factor affecting the variations of the V's on the one hand, and volume of trade on the other is business confidence--a factor which Fisher's normal theory is not concerned with, so far as it is considered as a variable, but which, more than anything else, does affect the concrete figures which go into the equation of exchange, either for a single year, or for an average of a good many years. The V's are not true causal entities, but merely abstract summaries of a host of heterogeneous facts. I have indicated before, and shall later demonstrate more fully, that the same is true of T. Even the "normal" causes governing the V's, however, are factors which likewise affect T, and in the same direction.

Among the factors affecting both V and T, there is one which sometimes makes them move in opposite directions, and that is the _value of money_ itself. This is so well stated in Wicksteed's interesting criticism of the quantity theory that I content myself with a quotation:[224] "Again, the history of paper money abounds in instances of sudden changes, within the country itself, in the value of paper currency, caused by reports unfavorable to the country's credit. The value of the currency was lowered in these cases by a doubt as to whether the Government would be permanently stable and would be in a position to honor its drafts, that is to say, whether this day three months, the persons who have the power to take my goods for public purposes will accept a draft of the present Government in lieu of payment. It is not easy to see how, on the theory of the quantity law, such a report could affect very rapidly the magnitudes on which the value of the note is supposed to depend, viz., the quantity of business to be transacted, and the amount of the currency. Nor is it easy to see why we should suppose that the frequency with which the notes pass from hand to hand, is independently fixed. On the other hand, the quantity of business done by the notes, as distinct from the quantity of business done altogether, and the rapidity of the circulation of the notes may obviously be affected by sinister rumors. Two of the quantities, then, supposed to determine the value of the unit of circulation, are themselves liable to be determined by it."