Chapter 31 - The Relationship Between Circulating Money and GDP

Circulating Money is money that changes hands frequently. Hoarded Money is money that sits in bank accounts for extended periods of time. I have chosen a cut-off time so that I can make calculations on the relative volumes of Circulating Money and Hoarded Money. To calculate the relative volumes of Circulating Money and Hoarded Money, I needed to make a decision about how long it was reasonable to hold a unit of money before spending it. I chose a time span of one month as a reasonable compromise. This works well. If money is spent within one month, it is considered to be in circulation. If it is held for more than one month, it is considered to be withheld from circulation. Thus Circulating Money is the amount of money that changes hands in one month. It follows that it is the national turnover for one month. The GDP is the turnover for a year. Thus the two are related. Circulating Money is twelve times GDP.

Circulating Money x 12 = GDP

There is an averaging effect here. It is not quite correct to say that Circulating Money is money that changes hands within one month or less. It is more appropriate to say that Circulating Money is changing hands within one month and that Hoarded Money is money that is hoarded for more than one month. Circulating Money is effectively money that is changing hands within one month. Hoarded Money is money that is effectively held for more than one month. Clearly, some money changes hands daily. This approach is extremely helpful in understanding the economics of the real economy. It is a very useful way of evaluating how much money is moving, how much is stagnant, and how the changes in these affect the economy. In fact, without a study of Circulating Money, it is not possible to understand the economy.

Cash currency is in discrete units and it might be possible to track transactions for each individual note, however, money in bank accounts is not in discrete units. It is held as balances in an accounting procedure that tolerates fractions of units, negative units and even fractions of negative units down to whatever number of decimal places a bank cares to use. Thus, it is not feasible to track individual units. One cannot track the life of an individual dollar note in a bank account because the dollar note has long gone and the bank account is merely a listing of the number of dollar notes the bank owes the customer at some time in the future. If money were in discrete units, some units of Circulating Money may have changed hands on the first day and some might be longer than one month. Clearly, if we have a velocity of one, on average, all money can be considered to have changed hands once in a year. At a velocity of twelve, money has changed hands twelve times in a year (on average) and so money can be considered to have changed once each month. A velocity of twelve is consistent with money changing hands once in a month.

Velocity x Money Supply = GDP

If the Money Supply of a small new state is one million dollars and they turn it over in one year, they have a national turnover (GDP) of one million dollars. If they turn over the Money Supply twelve times in a year, they have a national turnover of twelve million dollars.

Circulating Money is the money that on average changes hands within one month and Hoarded Money is money that remains idle for more than one month. The faster money moves, the more wealth-generation occurs and the higher the GDP or less money is required to do the same heavy lifting.

The faster money moves, the more wealth-generation occurs. The GDP is increased. Less money is required to operate the economy.

Change in Circulating Money

If one purposely increases the Circuiting Money one has immediately increased the volume of transactions and thus caused an increase in the GDP. If, for example, the government puts on a fireworks display, One million might go to the fireworks company who increases production and pays almost all the million to employees and other suppliers. Another million might go to a security company who immediately puts this to its employees as wages. Perhaps another million goes to an organizing company who immediately puts the money into employee accounts. Much of the million will come back to the government as tax. The government has spent three million which all went directly into Circulating Money.

If the volume of Circulating Money is not maintained, economic activity falls causing unpleasant unemployment figures. This graph shows a strong relationship between employment and Circulating Money:

Unemployment and Circulating Money. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

If the volume of Circulating Money is not maintained, economic activity falls causing a dramatic fall in tax revenue. Unfortunately, this also causes an increase in government expenditure causing an unpleasant deficit. As you might imagine by now, I have managed to demonstrate that the magnitude of the deficit can be greater than the fall in Circulating Money. This means that an injection of Circulating Money can cause a greater tax return than the volume injected into Circulating Money. This graph shows a strong relationship between Circulating Money and Tax Revenue:

GDP v Government Revenue. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

The effect is even more noticeable with Corporate Tax. A small fall in Circulating Money causes a large fall in Corporate Tax.

Corporate Income Tax and Circulating Money. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

This is a fascinating graph. Here I show Government Tax Revenue against Circulating Money. What is fascinating is that a fall in tax revenue is greater than the fall in Circulating Money. But be careful. Spending money to increase the Circulating Money is not easy. The money tends to rapidly fall into the hands of the hoarders and the money goes into hibernation.

A graph showing the relationship between Government Tax Revenue and Circulating Money. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

When one brings the Deficit into the picture, the problem is even worse. From around 2008 to 2010, Circulating Money fell from $1236 billion to about $1195 billion. A fall of $41 billion. The deficit climbed from $160 billion to $1412 billion. A fall of $1252 billion. It is not wise to let the Circulating Money fall:

A graph showing the Government Tax Revenue and Deficit. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

As soon as Tax Revenue starts to fall, government expenses rise as more people require government support and there is more frustration on the streets. The example above shows a Circulating Money fall of $41 billion leads to a Deficit of $1252 billion. The problem can be partly mitigated by having a better mix of taxes that are not susceptible to the transaction volume and income. Such taxes include Land Tax, Wealth Tax, Demurrage Tax, Financial Transaction Tax and a general low but all encompassing Transactions Tax.