Amazing articles on just about every subject...


The Monetary Flow

( Originally Published Early 1900's )



WE have now to present the reader with a method of representing the exchanges within a social organism considered in their totality. The object of the method is to facilitate the study of the action of economic causes upon production and exchange.

There is no act of exchange the effects of which terminate with the act itself. When the ownership of any commodity passes from A to B, that passage may only pave the way for another transfer from B to C, and so on until the commodity reaches the person who is finally to consume it. A piece of money changes hands without end, since every person who receives it expects, unless in exceptional cases, to pay it out again to some one else.

We call to mind that under our present system every exchange is a double transfer of ownership—money passing in one direction, and the ownership or enjoyment of wealth in the other direction. We thus have two separate processes of transfer, one of money and the other of wealth or its enjoyment. We shall consider these two systems separately, and afterwards show the relation between them. The transfer of money is the most simple in its conception, and we shall therefore begin with it.

The Dual - Conception of Economic Quantities. We now have to draw a distinction between two measures or conceptions of economic quantities the neglect of which has been a potent cause of dispute between schools, and inexactness of thought. This distinction is that between a fund, or accumulated quantity, and a flow. Applied to a material substance like water, this would be expressed as the distinction between a reservoir of water and a flow of water. We have a conception of a certain number of gallons of water stored up in a mill-pond. We also have a conception of a rate of flow into the pond, or out of it, of so many gallons per hour. Now, there is no fixed relation between these two conceptions. A very large mill-pond may have a very small flow of water from it, and a small pond may have a much larger flow. If we were told that one pond had a much larger sup-ply of water than another, this statement would be ambiguous, and we could make no use of it until we knew whether "larger supply" meant a larger sum total of water or a larger flow per hour. To avoid ambiguity we define fund and flow as follows :

A fund is quantity or value pure and simple : so many dollars, for example.

A flow is so many dollars per hour, day, or year.

3. To form a conception of the total exchanges of a country or other social organism, we must first conceive of all the individuals who can make exchanges. This class includes all legal persons who can be owners of property. A firm or company of, any kind must be considered as a. person distinct from the men who form it. For example, if Brown and Smith are in partnership, there will be three persons among them, the firm and its two partners. But unless the combination forms a separate legal person, having dealings with all its members individually, it is not to be considered as a person. On the other hand, we are not to count as separate persons those who do not do business on their own account. As a general rule, husband, wife and minor children will all together constitute but a single person. In fact, any body of people whose separate interests do not concern society may be considered as a single economic person whenever we want to consider their relations to the rest of society.

In the following chapters we shall graphically represent economic persons by small circles.

Flow of the Currency. In this chapter we use the word "money" in its widest sense, so as to include everything of which the ownership is transferred from hand to hand in payment for goods or services. Let us consider all the money paid by any one person. To do this we record every payment that he makes, and write down its amount in a column of an account-book. At the end of some unit of time, say a year, we add up all these payments. We shall then have a definite sum, expressing all the payments of that particular person during the year. Let us imagine this sum calculated in the same way for every one of the thou-sands or millions of persons who make up the social organism. The sum total will express the amount of the entire payments within the organism during the year. This sum we call the flow of the currency.

Instead of considering payments, we might have taken the receipts of money. Under every person's name we should then write down all the sums of money paid to him. The sum at the end of the year would express the total annual payments to him, and this sum for the whole community would give another value for the flow of the currency. If we determined the flow by both methods, then, since every payment made by any one person must be made to some other person, we should register every payment twice, once under the payer and once under the payee. Hence we should get the same sum total of the flow in either case.

This, however, presupposes that we include no payments made to or from foreign persons, or persons outside the organism under consideration. Such payments form a very important economic factor; but in this preliminary discussion we have to omit them, and consider only internal payments. We may, if we choose, consider all the persons in the world as forming a single social organism, and the two measures of the flow will then always balance.

The conception of the flow of the currency is represented graphically in the following way : We draw a little circle for each person legally capable of being an owner of wealth. Whenever a payment of money is made we suppose it to pass from the circle representing the payer to that representing the payee through a little vein. This vein we represent by a line from one circle to the other, with an arrowhead showing the direction of the payment. These veins form a network through which we suppose the money to be flowing from person to person. This continual flow of money from owner to owner is called the monetary circulation:

It will readily be seen that when we speak of a flow we introduce a conception which does not strictly conform to the actual case, because at no time is money really flowing like a fluid from person to person. Excepting such cases as that of transmission by mail, money is always in possession of some one person, and it passes from one person to another in .a moment by the act of payment. It would therefore be more exact to consider the circles as representing reservoirs of money, and the motion along the arrows to take place by sudden transfers from one reservoir to another. But the' transfers have the same result as a flow, and a certain advantage is gained by conceiving of the money as regularly flowing from one reservoir to the other, as shown by the arrows. In fact, the familiar words "Currency" and "circulation" in English, and the yet more expressive phrase "argent liquide" applied by the French to ready cash, or money all ready to flow, show how natural the conception of a flow of money is.

We may imagine 'that on each connecting vein we write down the amount of all the money which has passed along that vein in the course of the year. The sum total of all the amounts passing from any one person will be his total payments, and the sum of all the amounts passing to him will be his total receipts. The sum of all the numbers written down upon the veins will be the total flow of the currency. The amount of this flow in dollars we represent by the symbol F.

The general rule will be that as much money flows from every person as flows to him. It is true that there is no law against a man collecting as much money as he chooses, just as he would collect books or pictures. Practically, however, he has no motive to collect any considerable sum of money, because he loses interest on it as long as he keeps it. Hence, as a matter of fact, nearly all the money received by persons is very soon paid out again for some purpose. To this rule, however, there are two important exceptions, that of banks and that of the government. We have shown that banks can create money in the form of credit. The stream of money may therefore flow from them for a considerable period without any stream flowing back. When the credits are paid off by their debtors, they are in receipt of money which they are under no legal obligation to pay out again. Still we shall generally find that in the long-run the receipts and payments will nearly balance in the case of banks as in other cases. In the case of a government, payments can be made only in accordance with certain legal forms, and there can be no assurance that they shall exactly balance the revenue. Hence large sums of money may be collected in the public treasury at one time, to be paid out at another time. But if, instead of taking a single year, we take a generation, the account of receipts and payments will still be nearly balanced.

We are therefore to conceive that the inflow to every person is equal to the outflow from him. But it does not follow that the number of streams to and from him must be equal. If his sole source of income is a salary, there will be but one flow of money to him, namely, that coming from his employer. But from him there will be currents to his grocer, his baker, his landlord, his tailor, and dozens of others from whom he buys. A retail tradesman may have streams flowing to him from hundreds or even thousands of customers, while the streams from him may be no more numerous than in the case of his salaried clerk.

Distinction and Relation between the Volume and the Flow of the Currency. We have to make in currency the distinction between a fund and a flow, the logical nature of which has been already pointed out. The volume of the currency is a fund. On our diagram the volume is the total number of dollars flowing through the network at any moment. If we introduce the more accurate conception of each person as a reservoir, then, since the reservoirs contain all the money at any one moment, we should say that the volume of the currency was the sum total contained in all the reservoirs at any epoch, say on midnight of a particular day.

The method of determining this volume has already been laid down (II. 96-98). For our present purpose we may consider it as made up of two parts, material money and immaterial money. The material portion consists of coin, bank-notes, and other forms of credit which pass from hand to hand without change or subdivision. The immaterial portion of the currency consists of bank credits, the ownership of which is transferred by cheques. The relations between the volume and the flow of these two kinds of currency have to be considered separately.

Let us on January 1st fix our attention on a dollar bill. We shall perhaps see this bill pass from a young man to a confectioner in exchange for ice-cream ; from the confectioner it passes to the grocer, from the grocer to his drayman, and so on. We may imagine it passing from hand to hand until December 31st. If we count up the number of times the bill has changed hands, we shall have the contribution to the flow of the currency made by that particular bill. Adding up the contributions for all the dollar bills in circulation, we shall have the sum total of their contributions to the flow F. In the case of the five-dollar bills we proceed in the same way, but multiply the number of transfers by 5. The product will be their contribution to F. Doing the same thing for the ten-, twenty-, and fifty-dollars bills, and for all the gold and silver pieces in circulation, we shall have that portion of F due to the circulation of material money. Let us call this sum total F'. If we divide F' by the sum total of all the bills and pieces of coin in circulation, we shall have the average number of times which material money changes hands in the course of the year. Dividing the 365 days of the year by this number, we shall have the average number of days which money remains in one man's hands.

It follows that if nothing but a fixed number of pieces of material money were in circulation in a community, we could obtain the annual flow of the currency in a third way, as follows :

Multiply the denomination of every piece of money by the number of times it changes hands in a year. We shall then have as many products as there are pieces of money. The sum of all these products will be the flow of the currency.

Let us see now how this conception is to be modified in the case of bank credits. As already shown, these credits are not material money, but consist simply in rights to money, which are represented by writing certain figures in the books of the bank. Yet they form a part of the volume of the currency. But we cannot separate them into individual dollars so clearly as we can the bank-notes. The results, however, do not offer any immediate difficulty. Every bank cheque drawn by A in favor of B is a contribution to the flow F; if B passes this cheque to C in payment of a debt, the cheque is again added to the flow. Moreover, it is only so far as the bank credit is thus transferred by means of cheques that it has anything to do with the flow. If then we call the sum total of payments by cheque F", we shall have

Total flow of the currency = F = F' + F".

If we call the average volume of bank credits or deposits D, then dividing F" by D, we shall have the average number of times which a dollar of bank credit changes hands in the course of the year, and hence we can determine the average length of time which it remains in any one person's hands.

We have now two quantitative conceptions before us : a sum total of payments, F, and the total volume of currency, which we shall call V, by which these payments are made. It may perhaps give precision to these conceptions if we compare them with that of the circulation of blood in the body. The body of an adult man contains a certain number of pints of blood. If we keep an account of all the blood which flows into any one organ or part of the body, the forefinger for example, in the course of one day, we shall have the circulation of that finger. Since the same blood may flow in over and over again, and must be counted every time, the circulation, even for the forefinger, may be expressed by a greater sum total than the entire volume of blood in the body. Moreover, this circulation C will be greater the greater the time we take, being sixty times as great for one hour as for one minute, and twenty-four times as great for a day as for an hour. If we add up C for every organ in the body, we shall have the total flow of blood for one day. Dividing this total flow by the entire volume of the blood, we shall have the average number of times which the blood circulates in the course of the day.

This analogy must not, however, be carried too far. Blood circulates by being always carried back to one central point, whereas money is not so carried, but may only pass from hand to hand without end. If we wish the analogy to correspond more exactly, we must suppose that to the circulation of a single molecule of blood from the heart to any organ and back again corresponds the passage of a unit of money from one person to another.

Let us now state the algebraic relation between the volume of currency V and the flow F. This relation is expressed by saying that F is equal to V multiplied by the average number of times which each unit of money changes hands in the course of a year. We may use the algebraic notation :

R', the average number of times a material dollar changes hands in a year ;

R", the average number of times for a bank credit;

R, the same average for the whole volume of currency. If this number R, which we call rapidity of circulation, is fixed —that is, if money always circulates with the same average rapidity—then the relation between F and V is fixed and definite, and one cannot be increased without increasing the other also. We therefore have between the volume, flow, and rapidity of circulation the equation F=YXR, which is the fundamental equation required.

We now have to consider whether there is any law which fixes the number of times R that each dollar can change hands in a year, or, what amounts to the same thing, whether there is any law which determines how long a dollar shall remain on the average in any one man's hands. A little consideration will show us that although this last period is not fixed by any precise law, being subject to changes through the action of various causes, yet it can only change between very narrow limits.

If every man could pay out his money the instant he got it, the time between two payments would be very short. But as a matter of fact he must in general keep more or less of his money a certain period before he can advantageously spend it. If he receives a salary payable at the end of every month, he probably pays a moderate grocery bill at once, and keeps the rest of his money to spend from time to time uniformly throughout the month. If he owes one half, but pays out the other half at a uniform rate, then the average time which his money stays in his hands is a quarter of the month. In a community of such men, such pieces of money would change hands forty-eight times in the course of a year. The change of hands is made with greater rapidity the higher we go in the financial scale. As a general rule every man feels that he is losing possible interest on his money by keeping it, and therefore tries to pay it out for something as soon as he advantageously can. The larger and wider the transactions in which he is engaged the better he can manage this, and therefore the quicker he can pass his money. It would probably be found that among the brokers on Wall Street every dollar changes hands at least once, and possibly a number of times, in the course of a day.

It might seem at first sight that the causes which determine how long a single dollar will remain in one man's hands must be so exceedingly transitory and variable that no average time can be fixed. This conclusion would be correct if we were required to consider the time sought as an absolutely fixed mathematical quantity. But although the quantity cannot be thus absolutely fixed, the conditions of society are such that the law of averages prevails with a near approach to rigor. The aver-age length of time which a dollar remains in one man's hands is fairly definite when we take the average of millions of people, each using hundreds of dollars. At the same time it is liable to change by the action of any cause, however slight, which affects the transactions of the whole community in the same way. There are, as we shall presently show, certain causes which accelerate the passage of money from hand to hand, and there are certain conditions under which this passage is retarded and money is kept longer in people's hands.



Home | More Articles | Email: info@oldandsold.com