A High Velocity Economy

Our children and grand-children are facing a far less fair and equitable society than the one people grew up in 30 or more years ago. The wealthy are far richer and the poor both poorer and more numerous. But yet the three main political parties all seem to accept that state of affairs, despite the overwhelming evidence that it is truly bad news for the well-being of both rich and poor alike. Britain is in danger of becoming a permanently divided society.

One of the main causes is the mainstream economic theory that the current elite were all taught to believe. The theory teaches that money paid to the wealthy will be invested in enterprise and the resulting benefits will trickle down to the poorest sections of society so that everyone gains. Therefore government should reduce taxes on the wealthy. It also teaches that privately own companies are much more efficient than publicly owned. Therefore state owned activity should, where feasible, be outsourced to the private sector for everyone to gain. There’s a whole raft of such arguments justified by the theory.

But the theory is deeply flawed, if not downright dishonest. For just one aspect, consider the pursuit of economic growth which dominates all the main parties. Economists used an equation MV=PT where M is money, V the velocity of its circulation, P is prices and T transactions. Overall the number of transactions in UK, multiplied by their prices would approximate – if it could be measured, which, of course, it can’t – to UK’s GDP (gross domestic product). That is the measure all the main party politicians want to grow.

To achieve growth, politicians have focused on increasing M, the money supply. That’s why they pumped around £400bn of tax payer’s money into the banks, referred to as quantitative easing (QE). But it had no effect. The reason was the banks, which had more or less bankrupted themselves through their own reckless behaviour, didn’t invest their QE in enterprise, as the theory dictates they should. Instead, they hung onto it to rebuild their balance sheets, which had about as much impact on the domestic economy as if it was stuffed under a mattress. The velocity of circulation of QE money was approximately zero. So the impact on the economy was also zero. Many years ago, J K Galbraith described that sort of allocation as trying to push the economy with a piece of string.

Another focus of politicians has been inflation, ie the level of P (prices) . The Bank of England’s committee of elite economists reports on P every month, despite the inflation rate having been fairly steady and not a big problem for years.

The politicians of all three main parties have studiously avoided considering V, the velocity of circulation. To do so would expose the falsity of their main theory.

Assume the government was prepared to pump £1m into the economy. In accord with their economic beliefs, they would propose to pay it to the wealthiest 1% which would include most of the bankers, for it to trickle down to the rest of us.

What would actually happen to that money? Would the 1% invest it in some new business which could grow and generate further new business and new jobs? No way. It would be passed to a professional investment advisor, wealth management consultant or trader, who would regard it as their professional duty to invest it where it will earn the quickest and biggest return. In all probability that would be into some global hedge fund or private equity fund to trade in speculative financial derivatives, ie the sort of opaque security which caused the crisis in the first place. It certainly wouldn’t be invested to help a start-up entrepreneur or some high tech widget manufacturer. In terms of the UK economy, the velocity of circulation would be approximately zero, with zero impact on the economy.

Alternatively, what would happen to the £1m if it was made available to the poorest 10% of the population? There’s nothing more certain than that it would be spent immediately. They have no choice. They and their dependents are already in debt and struggling to survive. They will spend it on essentials, food, clothes, shelter and debt repayment. And the people they spend it with are also not likely to be investing it with hedge funds and the like, but themselves spending it also in quick order. That £1m could be spent a dozen times or more over a year, ie the velocity of circulation (V), could well exceed 12 and would, of course, continue to circulate in subsequent years, further adding to economic activity. The cumulative impact on the domestic economy, of the £1m passed to the poorest sector could be some 20 or more times its original cost.

That is exactly the opposite of the impact suggested by the mainstream ‘trickle down’ theory, adopted, if not actually believed, by today’s politicians, who Keynes referred to as the ‘madmen in authority’. Making funds available to those who need them most would revive the economy quickest. Roosevelt’s New Deal had that impact in the US in the 1930s, creating jobs and growth. The New Deal was based on common sense, and common humanity, rather than dishonest economic theory. Not altogether surprising since, as Cambridge economist Ha-Jooon Change suggests, 95% of real economics is common sense.

The politicians accept that the UK economy has been extremely slow recovering from the 2008 crash, but argue that it is now showing vigorous signs of recovery. As evidence they point to national employment statistics. But these have been falsified by zero hours contracts, agency working and various other means of disguising under-employment. It doesn’t feel like a vigorous recovery, unless you happen to be a City banker.

If a high velocity circulation strategy was adopted, the economy would recover far more quickly. Then, a second stage strategy could be focused on repairing the infrastructure and a third stage could focus investment on a high tech sustainable green New Deal. But the Green Party is the only one supporting such a programme, the only hope of improving the future for our children and grand-children.

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