2.1. The Roots of Divergence
2.2. The Liquidity Continuum
2.3. The Role of Expectations
3.1. The Overall Economy
3.1.1. Money, Transactions and GDP
- If x is total transaction volume (e.g., expressed in US$ transacted per year) we are dealing with the original Equation (4) and the variables are defined as above, but including also all asset purchases and sales in the financial economy. Specifically, Broad Money.
- If x is GDP, then the relevant monetary mass is defined as a subset of M, namely , that corresponds to the product and service transactions that actually made use of it; V and P are unchanged in concept although clearly they can change in value; and T refers only to those product and service transactions recorded within GDP. In this case we set . We note also that in this case V is dubbed the ‘income velocity of circulation’.
- If x is set as traded GVA, or J, then our output measure no longer equates to GDP, the difference being due to non-traded GVA such as . For traded GVA we should be using in place of P, i.e., the average difference in price between two steps in the same supply chain, which measures the value added. Adopting this input/output approach allows our value-added measure to be evaluated independently of a specific stage of production, obtaining
- Finally, x could also be , non-traded GVA, whose monetary mass we call .
3.1.2. The Role of Value Added
3.2. The Two Economies
3.2.1. Different Kinds of Circulations in the Two Economies
3.2.2. Linkages Between the Real and Financial Economies
3.3. Monetary Mass
3.3.1. Real Economy Endogenous Money Demand
3.3.2. Financial Economy Endogenous Money Demand
- Traded derivatives, options and futures
- Government bonds (T-Bills/Gilts etc)
- Commercial investment-grade bonds
- Non-investment-grade bonds
- Residential real estate
- Commercial real estate
3.3.3. Exogenous Money
3.4. The Velocity of Circulation in the Financial Economy
3.5. Crisis Onset and the Minsky Moment
3.6. Healing the Real Economy
- a shortage of liquidity (working capital) on the supply side; here targeted intervention during the same circulation should lead to a rapid upward adjustment of J, since freeing the working capital constraint should lead to a significantly larger number of supply-chain transactions;
- a shortage of demand due to a lack of purchasing capability: this is an area that traditional helicopter money has targeted;
- a shortage of capacity or lack of productivity on the supply side due to financing constraints on new capital investment. Investment is needed to raise both productivity and capacity of the supply side. There will be some increase in J during the same circulation due to expansion activities (building, new machinery, etc), but the increase in J will keep going in subsequent years due to the greater output that the larger capacity affords. This third intervention increases the value of our coefficient .
4. Materials and Methods
4.1. Economic Analysis
- Circulation. The term circulation is used by both Keynes (1930) and Schumpeter (1934). In Keynes’s case he uses it to split the real from the speculative economy and as a tool to understand monetary flows and income distribution. Schumpeter uses it to express a trading flow through a series of Walrasian-type self-clearing markets.
- Quantity Equation. We make extensive use of the Fisher (1911) Quantity Equation. This identity offers many insights when it is combined with understanding the definitional challenges relating to which transactions are implicated in a monetary circulation. Specifically, we believe that transactions associated with GDP only tell part of the story, which is why there is a need to incorporate the financial economy explicitly in the analysis.
4.2. Data Sources
Conflicts of Interest
Appendix A. Definitions of Key Terms
- Collateral is pledged assets available to be sold to repay a debt.
- Financial Economy is the set of markets where buyers and sellers trade assets for both yield and capital gain.
- Leverage is the financial multiplier that is applied to a ‘margin’ deposit in a trading account and is underpinned by collateral security held against the permitted leverage.
- Lifetime Income, sometimes referred to as the Permanent Income Hypothesis, refers to the process economic actors use to plan savings, withdrawals and returns on assets held to allow them to optimize their income over their whole expected life.
- Liquidity describes the free cash available to meet liabilities.
- Liquidity Preference refers to economic actors’ preference to hold cash even if it means they miss out on financial returns that could be available from holding other assets.
- M1 is cash and money held in ‘on-demand’ bank accounts.
- M2 is M1 plus savings deposits, small (under US$100k) time deposits, and retail money market funds.
- Margin is the deposit that is made into a trading account that allows the trader to trade a nominal value of specified assets that is up to some preset multiple of the deposited margin. The margin is held as immediately liquidatable security by the market maker (operator of the trading platform) against potential trading losses. Should losses exceed the required ‘margin’ amount the trader is subject to ‘margin calls’.
- Margin Call is a demand for an additional deposit into the trading account to cover existing or anticipated trading losses.
- Minsky Moment is when asset markets reset themselves to bring Ponzi asset financial economy valuations into line with real economy cashflows (Minsky 1989).
- Neutral Rate of Interest is the rate of interest needed to keep financial markets in balance with inflation as per the central bank target inflation rate (Lavoie 2003).
- Non-Traded Gross Value Added is the value added in the non-traded goods sector (principally government-provided services) and is represented by the symbol for ‘non-traded services’.
- Portfolio Balance refers to the process economic actors use to mix their asset holdings so as to optimize their yield, risk and access to cash.
- Real Economy is the set of markets in which consumers, firms, and government economic actors buy and sell products and services from each other.
- ‘Repo’ is a short-term (often under 24 hours) agreement to sell to and (via a reverse repo) repurchase the previous repo’d security at a pre-agreed price.
- ‘Reverse Repo’ is the original repo seller’s commitment to repurchase the security after the specified time-period.
- Saving means national income Y minus consumption C, where consumption includes consumption by individuals, firms and households. In formal models the definition requires adjustment for capital flows.
- Securities Settlement is the period of time specified by a trading platform between when a transaction is made and when it is netted against any others to establish an amount to be paid to or received from the agent trading.
- Shadow Banking denotes a group of financial institutions that mediate credit to borrowers but who are not subject to banking regulations.
- Solvency refers to the assets of an economic actor being sufficient to cover their liabilities.
- Traded Gross Value Added represents the value added between inputs and outputs in traded goods and services and corresponds to J.
- Velocity of Circulation is how many times the monetary mass circulates in a given period (or, more precisely, how many times each unit of account circulates, on average, in a given period). Normally ‘Income velocity of circulation’ and is calculated as GDP/Monetary mass, whereas in other situations V could be defined as Transaction volume/Monetary mass.
- Wealth Effect is the indirect impact on the real economy of changes in the asset wealth of an economic actor in the financial economy.
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They argue that this unlimited capability is due to the supremacy of state-issued money, meaning that government debt should be seen as a financial asset for the private sector, not as a liability.
This article draws on many of the same concepts and is complementary but not intended as a specific follow-on to Werner’s work.
Please see Appendix A for definitions of technical terms.
For conceptual clarity, we assume that M is constant during the time-period used to calculate these variables.
Although we do not treat it in this article, as already mentioned the duration of a circulation can differ between the real and financial economies.
This savings/investment divergence is not associated with trade balance changes (Obstfeld and Taylor 2005).
As already stated, the implication is that the time duration of different circulations may be different, but this does not present a problem in the present analysis.
This is a major modelling step as it represents a strict additional constraint whose validity will need to be verified ex post by future empirical and mathematical research. This paper presents only the first tentative steps towards a possible model, modulated by the interactions shown in Figure 12 and Table 4, which could be expressed as additional equations.
In mathematics or physics this is called the ‘coupling’.
We note that changes in post-Pandemic saving behaviour are not yet clear.
In the macroeconomic identity for saving this diversion of funds to investment is seen as saving deployed as investment.
In a dynamic setting, to these must be added the import propensity to consume (how much of each $ of national income is spent on imports vs. home production) and the propensity to save (how much of each additional $ of income is saved).
Capital flows have special importance with respect to exchange rate constraints on central bank policy.
Open loan balances mean the amount of credit still available to be drawn down by the economic actor.
Since the 1970s, money has been created endogenously in both the real and financial economies unless there are ‘emergency’ administrative constraints (Badarudin et al. 2013), such as the UK 1973 Supplementary Special Deposits Scheme (BOE 1982) where credit creation levels were specified by the central bank.
L Albert Hahn had considerable influence on Josef Schumpeter.
Banks and central banks are the only institutions able to create official national currency.
The exception to this is when trading platforms (which may or may not be part of banks) create trading liquidity through margin trading prior to platform netting and settlement of any outstanding liabilities.
Professional traders in the USA are limited to a 1:50 leverage by the Dodd Frank Act of 2010, whilst commodity traders have a leverage limit of 1:20.
Surpluses can be reinvested into financial assets in anticipation of further price rises.
Short-term changes can be later reflected into M2 changes (Tarassow 2019).
Onset of the Euro-Dollar market in the 1960s, the dollar standard from 1971, the Depository Institutions Deregulation and Monetary Control Act of 1980, and the 1999 repeal of the Glass-Steagall Act.
Each asset carries a future price change expectation, either “inheriting” this from the asset class or having its own expectation. For example, in late January 2021 GameStop had a different and more extreme price expectation than that of its asset class.
Say 50 or 100 basis points over the costs of the funds.
|Broad Money leveraged to:|
|Contribution to ...|
|Productive Value Added||Non-Traded Services||GDP Calculation||Wealth Calculation|
|Agriculture and Forestry||Yes||No||Yes||No|
|Mining and Quarrying||Yes||No||Yes||No|
|Electricity, Gas, Steam & Air Conditioning||Yes||No||Yes||No|
|Wholesale and Retail||Yes||No||Yes||No|
|Transportation and Storage||Yes||No||Yes||No|
|Information and Communication||Yes||No||Yes||No|
|Financial and Auxiliary Services||Yes||No||Yes||No|
|Insurance and Pensions||Yes||No||Yes||No|
|Real Estate Services||Yes||No||Yes||No|
|Professional, Scientific and Technical Serv.||Yes||No||Yes||No|
|Administration and Support Services||Yes||No||Yes||No|
|Public Admin., Defence, Social Security||No||Yes||Yes||No|
|Human Health and Social Work (Gov.)||No||Yes||Yes||No|
|Human Health and Social Work (Private)||Yes||No||Yes||No|
|Arts, Entertainment and Recreation||Yes||No||Yes||No|
|Asset Value Changes||No||No||No||Yes|
|Account||Account Variable||Mass Variable||Relation to Other Mass Variables|
|Whole economy||Tot. Transac. Vol.||M||= Broad Money|
|Non-traded Govt. GVA|
|Change in gross wealth||H|
|Real Economy||Financial Economy|
|Flow||GDP||Asset Valuation||Impact Type||Assumptions|
|Savings||-||–||+||+||Direct||All new savings deployed into financial assets|
|Savings withdrawal||-||+||–||–||Direct||All savings withdrawals taken from assets|
|Equity investment||+ (indirect)||+||+||–||Direct||Funded by existing, not new money|
|Bond issue||-||+||+||–||Direct||Funded by existing, not new money|
|Profit and loan interest||-||–||+||+||Direct||Assumes reinvestment of proceeds received|
|Management charges||+||+||–||–||Direct||Assumes funded by reduced reinvestment of profits|
|Savings returns||+||+||–||–||Direct||Assumes funded by reduced reinvestment of profits|
|Inbound capital flow||-||-||+||+||Direct||All deployed into financial assets|
|Outbound capital flow||-||-||–||–||Direct||All withdrawn from assets|
|Wealth effect||If it can increase consumption and vice versa||Indirect|
|Name||Description||Real Economy||Financial Economy||Source|
|M1||Physical notes and coins, and money in current accounts at banks||Yes||Yes||FED (2020)|
|M2||M1 + savings, small time deposits, and retail money market funds||Yes||Yes||FED (2020)|
|Broad Money||M2 + eligible debt securities (paper that can be repo’d). In the USA this includes MZM.||Partial||Yes||Table 61, p. 182 in IMF (2016)|
|Net Broad Money||Broad Money − M2||No||Yes|
|MZM||(M2 − small term-deposits) + institutional money market funds||No||Yes||US Federal Reserve System (2020a)|
|Trading Leverage||Creation of trading credits against margin deposits||No||Yes|
|Impact on:||Real Economy||Monetary Mass||Leakages||Other|
|Intervention||Method||C||Traded GVA||non- TGVA||M||Real Econ.||Fin. Econ.||Saving||(Prod- uctivity)||Capital Gain|
|Additional working capital||Mutual credit||+|
|VC Conv. Debt||+||+||+|
|Friedman helicopter drop||Cash to consumers||+||+||+||+||+||+||+||?|
|Smart helicopter working capital||Convertible tokens||+||+||+||+||+||+||?|
|Smart helicopter tokens||Tokens for domestic spend||+||+||+||+||+||+||?|
|Smart helicopter investment cash||VC equity & debt||+||+||+||?||+||?|
|Conventional QE||Asset purchases||+||+||+|
|Rise in G||MMT||?||+||+||?|
|Structural monetary policy||Asian development model||+||+||+||+||?||?||?|
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