From:	THE ALBERTA POST-WAR RECONSTRUCTION COMMITTEE
REPORT OF THE SUBCOMMITTEE ON FINANCE (March, 1945)

Part II: THE MONETARY SYSTEM IN UNIVERSAL USE
6. VELOCITY OF CIRCULATION

It is generally assumed that the purchasing power of 
money is increased or decreased by its "velocity of 
circulation". However, this theory will not bear 
examination in the light of the facts regarding the 
issue and withdrawal of money under the established 
system.

For purposes of analysis the following simple 
illustration of the velocity of circulation theory 
will suffice.

A wage-earner A uses a $10 bill of his income to buy 
two pairs of shoes from a shoe merchant B, who 
immediately goes into the adjoining store and spends 
the $10 to purchase some shirts from C; C in turn 
immediately goes across the street to grocer D. and 
buys some provisions costing $10; grocer D then 
takes the $10 bill across to the local garage E, to 
buy some gasoline and oil.

The contention is that the $10 bill provided 
purchasing power to the extent of $40 during the day 
by virtue of its "velocity of circulation" in 
enabling $40 worth of goods to be purchased by 
consumers. On the face of it this would appear to be 
the case, but on examination it will be found to be a 
complete fallacy.

Because all money issued creates a debt of the 
corresponding amount at its source of issue, for all 
practical purposes merchants B, C, D, and E can 
be assumed to be operating on credit loans from their 
banks with some "savings" invested in their stock.

The proceeds of every sale they make can be divided 
into three parts: (1) repayment of a bank loan before 
a new line of credit can be obtained to replace 
stock, (2) payment of operating costs, and (3) net 
profit--i.e., personal income for services. Suppose 
that in each case B, C, D, and E work on a 15% 
net profit, From each purchase amounting to $10 they 
would be obliged to set aside, say, $8.50 repayment 
of their bank loans for replacement of stock and 
overhead costs, and only $1.50 as personal income.

This is likewise true of C and D. Therefore, by 
spending the $10 both of them created a liability 
against their future purchasing power.

When A obtained the $10 in wages there was against 
it a corresponding cost in the prices of goods coming 
on the market. This liability must be kept in mind.

On buying the two pairs of shoes from B, A 
surrendered his right to $10 purchasing power and B 
acquired the right to $1450 of this, the balance 
going for the repayment of his bank loan and 
cancellation of the money as shown previously.	(If 
he was operating on his own capital it would make no 
difference, for the $8.50 would have to go to the 
replacement of working capital with the same result.)

If B does not repay his bank loan, but spends the 
whole $10, he will have a liability of $8.5O 
outstanding which will constitute a debt against 
future purchasing power. In other words he will have 
to sell over $50 worth of goods without getting any 
portion of it for his own use in order to make good 
the deficit.

Thus while it is true that in the example quoted the 
$10 bill resulted in $40 worth of goods reaching 
consumers, there was created a trail of debts against 
their future purchasing power amounting to $10 (the 
liability against the original issue of the money) 
plus $8 . 50 (B.'s undischarged liability) plus $8.50 
(C.'s undischarged liability) plus $8.50 (D's 
undischarged liability), making a total of $35.50. 
Suppose E now meets his obligations of $8.50, he 
retains $1.50 as his net profit--i.e., as purchasing 
power.

It will be evident that the effect is exactly the 
same as if A bought gasoline, etc. from E, and B, 
C, and D, had obtained goods from each other "on 
time", pledging their future purchasing power.

The so-called "velocity of circulation" did not 
increase purchasing power at all.  The fallacy in the 
theory lies in the incorrect assumption that money 
"circulates", whereas it is issued against 
production, and withdrawn as purchasing power as the 
goods are bought for consumption.
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