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A theoretical approach to understanding money must start by defining it. This definition is taken from the glossary to von Mises’s Human Action: “The most commonly used medium of exchange in society. A community’s most marketable economic good, which people seek primarily for the purpose of later exchanging units of it for the goods or services they prefer. The circulating media most readily accepted for the payment for goods, services and outstanding debts. Money is an indispensable factor in the development of the division of labour and the resulting indirect exchanges upon which modern civilisation is based.

What makes this statistical approach acceptable to neo-Keynesians is the denial of Say’s law, which describes the rationale behind the division of labour and points out that money is the most marketable intermediate good whose primary function permits production to be turned into consumption.

“The mathematical economists refuse to start from the various individuals’ demand for and supply of money. They introduce instead the spurious notion of velocity of circulation according to the pattern of mechanics.” Ludwig von Mises, Human Action.

In other words, velocity is not a valid expression of the relationship between money and prices; it is merely there to balance an equation that otherwise does not exist.

The truth of the matter is that the utility of a fiat currency in the short-term is entirely dependent on the subjective opinions of individuals expressed through markets and has little to do with a mechanical quantity relationship.

An illustrative example of the consequences is given to us from the Icelandic krona, which on 8th October 2008 suddenly halved in value, which had nothing to do with changes in the quantity of money, its velocity of circulation or Iceland’s GDP.

Monetarist theory in its current form is at the very least still a red herring until monetarists finally discover velocity is no more than a factor to make their equation balance. It is indicative of the false mechanisation of human behaviour by modern macro-economists. However, it should also be noted that it is impossible to square the concept of velocity of circulation with one simple fact of everyday life: we earn our salaries and make our profits once and we dispose of them. That’s a constant velocity of exactly one, assuming no change in cash levels over the period under consideration.

This is the irrefutable conclusion of Say’s law. But it was dismissed by Keynes in his General Theory to make way for his macroeconomic fallacies.


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