Sunday, September 9, 2012

The Mathematics of the Relationship between Money Velocity and Interest (AKA Everything You've been Taught about Money is a Lie)

Ergodicity (n): An attribute of stochastic systems; generally, a system that tends in probability to a limiting form that is independent of the initial conditions.

We in this modern era like to think we know a thing or two about money. The most basic of us understand money as a means of exchange where as the financial and academic elites further understand the role of money as a catalytic force in the economy with the power to create and destroy goods so long so as the preferred form of currency has the full faith and confidence of it's exchangers. However, we are are noticing some fundamental problems with our modern form of debt-based money. Debt-based money has long been a source of scorn from economists ranging from the Ludwig Von Mises Academics to the Libertarian Movement within the U.S. From their perspective, introduction of interest attached to money implies that economic growth must be commensurate with the growth in the money supply. Note that since all money comes with interest that must be repaid, the future supply of money must necessarily be larger than the current supply reflecting the necessary growth in the economy.

The Modern Keynesian crowd believes that the increase in the money supply can perturb the economy and awaken it from its sleep as the consumer becomes stimulated again and again by more money to spend. This act in turn (they believe) triggers an increase in the money velocity (the rate at which money gets spent on average) which then triggers more economic growth as businesses began to produce excess goods for consumption based on the implicit optimism displayed by the consumer's current spending - a sort of mass feedback illusion if you will. This will also necessarily force people to work harder and longer to increase their economic output so they can earn future money plus interest to pay for the goods they already spent. They are now the busy bees whose existence is tied exclusively to the illusion of growth under such a system - work harder, spend more, get more. In their minds, recessions only occur when one nefarious group or malevolent force in the Universe interferes with this infinite growth lending cycle - a credit contraction for instance. However the cycle itself, from their point of view, is sacrosanct.

The Libertarian /Von Mises thinks this recursive nature of interest based debt generating even more interest based debt causes the economy to go into overdrive followed by sudden recessions that harm the economy overall. Society is further traumatized by the unpredictable boom-bust economies that prevent them from knowing when to grow their business vs. when to contract which result in hoarding patterns and malinvestment. They furthermore see that money itself is largely illusory and subject to the change of the whims of the people and the governments that represent them. Therefore, one should fix the money supply  without interest. This is most often argued to be a gold-backed or precious metals backed economy with a fixed supply of money (i.e. allocated gold).

The modern Greenback Movement (aka Bill Still) takes the Von Mises Crowd as yet another illusion and insists that in addition to having sound money, the governments must never borrow from anyone but themselves. Then the government can decide for itself if more lending is needed or if debts should be forgiven or not based on the money supply. Furthermore a taxed population should never have to pay taxes to private individuals/corporations/groups who loan the money into existence to begin with - certainly not with interest attached to that money. Indeed the Government should be the sole creator of money and private companies should compete for that money in an open market where they bid on projects that reflect the needs of the people as deemed by a representative democracy.

Even this however does not go quite far enough into the true nature of money and how it should be managed. These additional properties required of true money are even more elaborate than this for it to be capable of sustainable economic growth. They are:
  1. That it be perceived as a means of exchange or "currency" that reflects, to some degree or another, a valid point of reference on a supply/demand state space of any fully enumerated market basket item of goods in an individual's mind. Such a basket of goods contains all conceptual items of value in the mind of the consumer/producer along with their corresponding price per unit or portion of ownership of that item per unit of currency.
  2. That the money be relatively liquid meaning "transportable". This means that the money need both be divisible and easily converted and "swapped" for the item of interest - however the latter comment implies a necessary infrastructure accompany it. Modern money relies somewhat on the infrastructure of the economy to deliver goods in a reasonable time frame of the transaction itself. Without this liquidity orders will freeze as it fails to deliver the goods in time for their usefulness to have any positive impact on the economy without a serious delay in productivity. In this scenario consumers will also retract their non-local orders to include only basic necessities that they can predictably and reasonably wait for at a moderate price and are within a reasonable physical distance from them. Therefore true liquidity requires infrastructural investment to ensure certainty of delivery for non local goods. Certainly if a global economy is to continue to grow or even sustain itself this infrastructural arrangement must be constantly operating and present.
  3. That the money be capable of changes in its own velocity as required by the economic needs of its users. In other words there should be no practical limitations to the change in the velocity of money - it should be able to ramp up or down according to the needs of the economy. People should not be impeded by force from spending due to interest rates which slow money velocity down unless the money velocity has exceeded certain agreed upon thresholds and raw goods are disappearing faster than they can be replaced. Only movements in reality-based supply-demand state space should be responsible for controlling the money velocity. Therefore the government should be objectively, openly and using good science, involved in the dissemination of economic indicators such as current, best guess supply demand relationships and negative utility information (i.e. potential product harm to the public well being) so the public can decide how best to spend their hard earned money and producers understand what prices are needed to support that demand.
  4. That the flow of money be steady-state, non-ergodic, aperiodic and with no net accumulation in any direction (i.e. should not be representable as a directed acyclic graph or DAG). Stated in layman's terms this means that the money ideally should never have a net flow in any one direction either from the lenders (i.e. governments and banks) or the consumers (private lending and payroll). Ideally, accumulation need only reflect the degree to which future purchases of a market basket of goods can be budgeted into the current system, not for personal or collective hoarding, force, fraud or coercion by any party. When the flow of money becomes ergodic (i.e. independent of initial conditions, it always tends to the same form/state where by it is accumulated by smaller and smaller groups), it necessarily loses its ability to budget itself and becomes disconnected from reality as no one is able to accurately price anything since it is unclear exactly how much money there is and how much of it is being accumulated vs. spent. Of course there will be an initial directed flow once the money is lent into existence but this should be followed immediately by random percolation of the money throughout the economy with the corresponding growth and construction of actual goods.
  5. That the velocity of said money stipulates the limitation of growth and is the truest reflection of the aggregate psychological state of consumers as opposed to the sheer volume of money. If the veloctiy and exchangeability of money is of no limitation, the economy can grow as fast as our minds, machines and physical bodies can build it, eventually almost as fast as we can imagine it. Granted, for sustainability purposes we may never want such an economy on steroids but my intention here is only to show how an ideal form of money would be useful under the most demanding circumstances.
When you add up all of the above, you come to one startling conclusion...

Everything we have been taught about money is a Lie!

Once we have identified the ideal properties of money working in an ideal system it is necessary and logical to immediately conclude that everything our modern banking system does is an assault on sustainable, organic, logical economic growth. It is the sole intention of the central banks to ensure that the economy does not have these properties. For instance the Federal Reserve lending to the US Government with interest rates that they dictate based on their projection of how large the economy "should be" are entirely unnecessary and unwarranted. In fact what the Federal Reserve and central banks do are antithetical to sustainable, organic growth and if anything are ultimately regressive forces in the economy. They ensure that money does not percolate randomly by it's consumer defined efficiencies and that it accumulates almost instantly in the account of a large bank, investment firm or wealthy patron before it even enters into the "free market".

Because these large pools of money sit on the side line, they then become permanent accumulators that can effectively distort, in any direction, the cash value of a given item in the market basket of the consumer's mind - artificially suppressing prices in some areas and inflating them in others. The less the consumer is involved in this process the better for the government and corporations who attempt to subsidize that which they deem must be cheap and penalize that which they deem must be expensive. This is done also through Bernaisian manipulation of the masses so that they too feel the need to consume certain items while eschewing others as well as Keynesian manipulation of the currency. This means that what ideally could be built now will likely be postponed indefinitely or at least until the system crashes. I dont believe the central banks will be successful in this endeavor forever however for the following reason: The natural state of any money system - i.e. a system that it is in its lowest energetic state (i.e. requires the least amount of external "force" to self-perpetuate) must be the system I just described for reasons that are purely mathematical and thus irrefutable - the economy can not grow indefinitely and the forces required by the centralized bankers to keep the current system in its current form are themselves unsustainable and futile. Manipulating the money supply and consumer sentiments alone to drive the economy has practical limitations and requires powerful forces constantly overseeing it. In the end though these forces become completely exhausted in a hyperbolic effort to micromanage every aspect of the economy and thus ensure it will crash totally and be replaced by the more natural system I have described with or without economic intervention - the only real question is how long they can sustain their efforts. Let me state my hypothesis openly and succinctly again for you to examine:

The velocity of money determines the growth cycle not the money supply. More precisely it is the change in the velocity of money that determines the growth cycle of the real economy - increasing velocity is a sign of economic expansion where as decreasing velocity is a sign of retraction. Furthermore, the velocity of money can be determined entirely by the consumer based on their real needs and desire to spend either globally (if the infrastructure allows it) or locally (if constrained). What is needed is money and infrastructural investments to ensure that the money velocity is adequate for the rate of exchange required to ensure sustainability (or if desired growth). In other cases where the infrastructure is inadequate we must let the price discovery mechanism itself be the sole determination of market utility.

Now that we have re-asserted cause and effect properly (increased consumer confidence and enabling economic infrastructure causes money velocity to increase) we can introduce true economic planning that recognizes this property and utilizes it to it maximum effectiveness. In short we must recognize that the natural state of the economy without the use of force is best described as "Productive Anarchy" where the irregular movement of money triggers the production of new businesses and novel products as well as infrastructure. It is not a giant cluster-fuck incapable of directing itself and in need of a parasitic banking system as we have been taught. The natural state requires little intervention of any kind to perpetuate itself and grow sustain-ably in the physical world. What is most unnatural to these naturally smooth (i.e. non-volatile) economic growth and retraction cycles, is the use of interventionism that attempt to grow the money supply and thus the money velocity to match whatever absurd targets of growth (positive or negative) our masters have planned for us. Let it be known that the money supply in this more natural system I speak of may increase at times and decrease at others with positive and negative interest rates cancelling each other out over time. This allows for the money supply to be essentially held constant or at least somewhat proportional to population growth.

If indeed we are going to have any kind of centralized economic planning it should be for enabling money velocity with flows of money that are overall ergodic (i.e. without a net increasing accumulation by any individual, institution or group therof) and aperiodic (i.e. not predictably cyclic). Banks should not be determining what the rate of growth should be based on population, demand, resources, greed, etc, but allow the system itself to choose and let the prices accurately reflect the true utility of those choices by enabling the money and corresponding supply of goods to respond quickest to any shifts in the demand-supply curve and by making negative utilization known to the public using good science (i.e. toxicity of a product to the environment) but without use of excessive force. Instead of increasing the money supply to encourage spending and thus triggering the growth of "accumulators" in the economy, the planners should only be involved in attempting to ease any restrictions or limitations in the velocity of money and the transport of goods - the latter through infrastructural investments lent out at negative interest.

For instance if the accumulators become too large and reduce the money velocity to effectively zero as money becomes hoarded, then and only then should the government begin lending and at negative interest to parties most likely to increase money velocity again - yes this does include the concept of "free money" but guess what? We are already there as the central banks are currently discussing such policies - the only issue being who they are lending to. The greater the accumulation of cash by institutions and individuals, the more negative the interest to those who want to continue to expand their businesses in the now depressed economy. In this scenario the accumulators are encouraged to begin spending down their own "money supply" by the negative interest as their money will be worth less and chase fewer goods in the future vs. spending it now. Likewise when the economy and money velocity is too high for productivity to keep pace, positive interest rates can be re-introduced so that savings are encouraged and savers begin to accumulate money again instead. In fact a mathematical formula relating the money velocity to the interest rates with the central or mean rate hovering around zero should be formulated, discussed and improved every year by cutting-edge economists trained in a variety of disciplines. In this way, the rate of inflation is kept relatively constant. Likewise, all forms non-essential derivatives or futures contracts would be banned - in other words the only legal derivatives would be for agricultural, mining and mineral goods. Derivatives trading based on stocks and bonds should be illegal as would naked short selling as these encourage money accumulation and price distortion. Hoarding money itself would not be illegal but when the money velocity is low, it will simply not be in the owner's best interest to continue to hoard vs. converting them to goods now before the money is worth less. Likewise when money velocity is so high that it becomes unsustainable, accumulation would be rewarded for a period of time in the form of higher interest rates until the system can catch up again to a steady-state equilibrium.

Such a system ensures that the velocity of money would be the primary measure of economic health which would ensure sustainable growth based on valid economic feedback for the forseeable future.

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