The Quantity Theory of Money is the Flat Earth Theory of Economics.

There’s an old joke that you can prove that the earth is flat with a simple experiment you can do anywhere: Jump!

Since scientists claim that Earth is rotating at a very high rate of speed, by simply jumping up as high as you can, you can prove it’s not true! If the Earth were indeed spinning at such a fast speed, wouldn’t you land hundreds of feet away instead of in the exact same spot you jumped from? Obviously the Earth is flat! QE god-damn D!

Quantity Theory believers also often start with a similarly personal scale from which to understand a macroeconomic question. They have a fixed amount of money. Money, to them, is like a pile of stuff. If you imagine that everything else there is to buy in the world is a similar pile of stuff, then, obviously, if you take the total amount of money in the pile of money and divide it up by total amount of stuff in the pile of stuff: you have the value of money.

If you increase the amount of money, by, for instance (in the flat earth vernacular) “printing” it, each “piece” of money in the pile goes down in value, because the pile of stuff still has the same amount of stuff. “More money chases fewer goods” as they say.

Joan Robinson frequently recounts that the great Michal Kalecki once exclaimed to her “I have found out what economics is; it is the science of confusing stocks with flows!” The trouble with the flat earth economists, is that they confuse the dynamic flows of production and consumption that make up an economy with static piles of stuff. Robinson further reasoned that “it is this confusion that has kept the Quantity Theory of Money alive until today.”

Just to start with, money is not something that is “printed,” the physical number of paper bills or minted coins is simply an artefact of the retail demand for such to conduct cash transactions. Money is either spent into existence by the government, or lent into existence by the banks. The amount of money created by government spending is a matter of government policy, the amount of money created by banks is a matter of the level of qualified demand for borrowing there is in the economy. In neither case is there any pile of paper, coins, or anything else that limits how much they can spend or lend.

A flat earth economist reasons that if more money is created (“printed”) the value of money necessarily goes down. This would only be the case if the total number of things to buy where a fixed stock. Not only that, it also assumes that any new money would be necessarily spent on buying things, and these things are locally produced.

In reality, of course, the number of things to buy is not fixed, in most economies, particularly in down-cycles, unemployment exists, and so does underutilized productive capacity. New money can be created in such a way so as to put more people to work and more capital to work to produce more things, as such, the flow of money and the flow of goods both increase.

And of course, not all new money is spent on locally produced goods, thus newly created money is also sometimes simply saved, or used to repay debt, or is sent abroad and results in greater imports and foreign savings.

When you add it all up, it becomes very clear that the amount of money that is “printed” (aka spent) by the government tells you very little about the level of prices on it’s own, this can only be understood within the context of sectoral balances, taxation levels, unemployment, utilization of productive capacity and local and foreign propensity to save the currency.

To put this in terms of a macroeconomic identity, the quantity theory of money can be expressed as MV = PQ. M is the number of units of money in our pile of money, and V is the number of transactions that occur in a given period, this must, by definition, be equal to the price level (P) multiplied by the real GDP (Q), our pile of stuff.

As Bill Mitchell argues, following Kalecki and Robinson, to render this a theory of inflation one has to assume that V and Q are fixed, in other words that propensity to save, invest and import never change and that the economy is always operating at full capacity. Since that is empirically demonstrable to be not the case, the assertion that an increase in M necessarily results in an increase in P is demonstrably false. This theory is as dead as they come.

So what is the real reason that zombie economic theories like the Quantity Theory continue to stalk the earth when they have been unequivocally refuted ages ago? Remember that all money is created in one of two ways, it is spent into existence by the government or lent into existence by the banks.

The Quantity Theory and the related monster mash of undead theories that go along with it are popular among proponents of social austerity because they falsely imply that “printing” money necessarily leads to inflation. This means that government should be artificially limited to spending only as much as it taxes. When tax revenues fall as a result of economic downturns, government should cut spending, just as the communities it serves need government spending the most.

This is really a win-win for financial elites with lots of money! On one hand, the immiseration of workers by way of austerity allow capitalists to push for lower wages and benefits, as the workers are in a weaker position to resist, on the other hand, without any infusion of money from the government, additional money needs be borrowed instead, thus increasing interest income for all those financiers smart enough to be very rich!

The Quantity Theory of Money is nothing more than a fable invented to convince the whole of society that they should have less, so that the very rich can have even more!

In any case, as is is my tradition, I will bring a small pile of money to spend on a signification volume of beer on Tuesday night, so join me at Toronto Stammtisch at The Embassy in Kensington Market, the rest of the Telekommunisten crew and friends and will be at Cafe Buchhandlung in Berlin. Please come!

2 comments

  1. Pingback: » stocks and flows ecological economics
  2. K

    Awesome article! I loved it. :) … I think I understood most of it. :)

    Hey, but the Earth IS flat!… JK :)

    K

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