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… it seems that if you have a doctrine, a version of rationalism … that makes it so that you have to be worried about using the word mystery, you’ve got yourself too constraining a doctrine.   Jennifer Michael Hecht

Professor [Max] Planck, of Berlin, the famous originator of the Quantum Theory, once remarked to me that in early life he had thought of studying economics, but had found it too difficult! Professor Planck could easily master the whole corpus of mathematical economics in a few days. He did not mean that! But the amalgam of logic and intuition and the wide knowledge of facts, most of which are not precise, which is required for economic interpretation in its highest form is, quite truly, overwhelmingly difficult for those whose gift mainly consists in the power to imagine and pursue to their furthest points the implications and prior conditions of comparatively simple facts which are known with a high degree of precision.     John Maynard Keynes


The simplest statement of the theory of exchange first formulated by John Stuart Mill based on ideas derived from David Hume and used by Milton Friedman among others to justify monetarism is:

MV = PQ     or     MV/Q = P

Or, in the simplest possible terms, the more you’ve got to spend (M) and the faster you spend it (V), the higher will be inflation (P) if what there is to buy (Q) is fixed.

The proof is in the pudding. Does the theory work?  Well, as with so many things in life, that depends. This is not going to be an economics lecture (we provide links below to sources that will do the lecturing), but we are going to talk a little about what’s going on in the economy because an election is coming up and as you all know: “It’s the economy stupid.”

We have a problem, a mystery you might say.  The problem is that the money supply (as best we can determine) is growing by leaps and bounds but the price level (by which we mean consumer prices as they are measured) is being very patient about rising in conjunction.  So, “Mr. Theory of Exchange, what do you have to say for yourself?”

“I’m not a theory, just an equation, an “accounting identity” to be exact.”

“I get it.  You don’t want to be hammered with the “just a theory” crowd of religious zealots who use that trope to undermine evolution.  But, if you’re an accounting identity what gives? Your two sides don’t seem to be so equal today.  You’re looking a little Janus faced.”

“I hate Greeks.  All they do is philosophize.  Look, the problem is no one knows how to measure M, V, P and Q.”

“Aha!  Just tweak the measurements and your identity is back again. Are you a politician in the guise of an equation?”

“How dare you!”

“Sorry.  Please just explain why with all the money Uncle FED has sloshing around your inflation side isn’t a mirror image of your money side. You lack symmetry.  Maybe you’re just ugly?”

“Ahem.  I will ignore that insult.  Look, the economists have put me through so much cosmetic surgery that the question should really go to them but they’ll just say “on the one hand” and “on the other hand” so I’ll take my best shot.  The first thing you should know is that my cholesterol has been very high for years without any treatment.  The plaque has clogged my arteries.  It’s on account of all that dough.  No throughput.

“So, Uncle FED’s dough has to go somewhere.”

“Please.  Try to pay attention.  Follow the money.  Haven’t you ever heard of excess reserves?  My banks are full of them.  Uncle FED encourages those fat banks to hold on to their reserves by paying interest on them.  Why would banks make risky loans when they can make risk free interest from Uncle FED?”

“I see.”

“Another thing.  I’ve got arthritis in my V.  Because of a series of injuries and bouts of depression my V has slowed way down.  Consumers are wary of spending because they’ve been on such a roller coaster over the past twenty years with the dot-com boom and bust, the real estate boom and bust, and now this whatever-it-is going on around us. Besides, they’re already mortgaged up to the gills.  Last year household debt hit a 14-year high.  They’re feeling a little sick from all the candy Uncle FED’s been feeding them. So they’re holding on to their dough.”

“So, let me get this right: people aren’t spending because they are afraid and being cautious?  Ah, I get it, the precautionary demand for money has increased.”

“No need to use those big words.  Leave that to the economists who got me into this fix.  Look, ordinary people (the ones you call homo economicus), they’re hurting.  They haven’t seen their wages rise in years.  They lost a ton of wealth in the Great Recession.  They spend practically all their income because they have to feed their yappy kids (I think one of those economist guys Malthus had something so say about this).  The savings rate is at all time lows.”

“So, where is all that new money from Uncle FED going Mr. Theory of Exchange?”

“Equation!  Accounting identity!”

“Okay.  Okay.  But tell me where?”

“You want to know? Ask Pete Seeger.  You know the song.

Where have all the dollars gone?
Long time passing
Where have all the dollars gone?
Long time ago
Where have all the dollars gone?
Into stocks every one
When will they ever learn?
When will they ever learn?

“You mean …?”

“Yep, almost all the new money and wealth has gone to the rich like that French guy Piketty said in his book.  The rest of us (I mean those other than the 1%) are in denial.  Admitting that we are poor is admitting failure.  So we blame welfare queens, foreigners, immigrants, and sometimes even our own inadequacies.  The rich get richer.  The rich buy stocks.  The rest of us buy stuff.  Follow the money, it goes to the rich and they don’t need it so they stash it in stocks. QED.”

“Gee, so the Theory, I mean Equation of Exchange still works.  We’ve just been looking at the wrong prices?”

“Bingo!  I’m still fully employed Mr. Homo Economicus, even with the lockdown.  In fact, I’ve been working harder with the lockdown.  Look how quickly the stock market roared back after Uncle FED passed out all those new dollars.”

“Hmm.  There must be more to it than that.  It’s too simple.”

“Oh yea, that’s what the real players want you to think.  They’re the ones that hire the economists to come up with tons of ideas to trip you up.  Like this, inflation is low because of cheap online pricing and the ease of comparing prices online, because unemployment and inflation are no longer working at odds as they used to, because of globalization and technology advances, because of a decline in brand loyalty, because wages are low and not rising, because …”

“Wait a minute.  Why aren’t wages rising?”

“That’s not part of my equation.  I can’t be everything to all people.

“But you must have thought about it?”

“I don’t think, I equate. What do you think?”

“Well, there’s higher job insecurity with all these dot com jobs where everyone is a self-contractor like Airbnb, Uber, etc.  There’s more women in the labor force and everyone knows women get paid less.  Stuff like that.”

“Makes sense.”

“Look, I’m sorry about the plaque in your M and the arthritis in your V.  But, what about your Q?  What’s going on there?”

“I was hoping you would ask. Q’s a mess with the coronavirus lockdown.  Imagine operating a cruise ship, an airline, a restaurant.”

“What about those essential workers?”

“They’re putting their lives at risk but the idea of paying them more, Pfft!  No one ever thinks of that.  You are right though, I’ve been shedding Q like those infected folks are shedding virus.  That could be deadly for all of us.  You’re worrying about inflation?  Ha!  If my Q keeps dropping we could be heading for a deflation and that’s a whole lot worse.”

“Damn.  Do you have any idea what’s going to happen?”

“I’m an Equation, remember? I don’t think.  I don’t have ideas.  I can, however, refer  you to my friend who knows everything or to my other friend who can’t make up his mind. Just click on the blue links to get to them.”

“Oh hell, I’m not going to worry about it anymore.  After all, your just a theory.”

“God damn it.  I’m an equation.”

“So you say.”


Some Links if you want to delve deeper


Nobody Seems To Know Why There’s No U.S. Inflation

Think Big: The Velocity of Money and How the U.S. Has Put The Brakes On

U.S. Money Velocity

Velocity of Money

Terminal Deflation Is Coming

Priorities For The COVID-19 Economy

Good Economics For Hard Times

Markets Have Jumped The Shark