Economist 1, “Look, there is a $20 bill on the ground!”
Economist 2, “Can’t be. If there was a $20 bill on the ground, somebody would have already picked it up.”
It’s an old joke, not exactly very funny, but it does illustrate how economists think. Economists have the luxury of making assumptions. If the government decreases taxes, all things equal, people will spend more money. Economists also create economic models. These models are to make complicated ideas easier to understand. The following is a simple economic model of cryptocurrency and the output it services. There are lots of assumptions here and it’s not supposed to be taken literally. But it can give us an understanding of bitcoin’s relationship in a complex, crypto-world.
The Equation of Exchange
Essentially, the equation of exchange is an economic equation that showcases the relationship between the money supply, the velocity of money, the price level and real output. The equation was derived by John Stuart Mill 150 years ago and is a staple in any Macro or Monetary Theory class.
MV=PQ
M=money stock
V=velocity of money
P=the overall price level
Q=real output.
We can first apply this to the US economy and apply some real-world numbers to this equation.
PQ= Fourth quarter, nominal US GDP in 2017 was 19.73. This is the 2017 price of goods and services produced within the country during 2017.
Next, how much money is needed to service that GDP?
M=According to the St. Louis Fred database, https://fred.stlouisfed.org/series/M2, we use 13.82 trillion dollars to service the 19.7 trillion dollars of output. They are using M2. Go way back to your college days and remember M1 is more or less cash and checking accounts and M2 is more or less your savings accounts.
Since we have these numbers it’s easy to find the velocity of money. Remember velocity is how fast money changes hands. We divide the nominal GDP, 19.7 by the money stock, 13.82. This comes out to 1.42. This is exactly what the St. Louis Feds’ velocity number is as well. https://fred.stlouisfed.org/series/M2V
That was easy. Our US dollar equation of exchange looks like this:
M(13.82) V(1.42)=PQ(19.7)
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