QTM: Four Disastrous Mistakes

One of the theories that we believe in by economists is the Quantity Theory of Money. It says that money is a veil and don’t think about it as it does not have value. The reason of it is that if money is doubles then prices will also become doubled and so everything will remain the same. Level of money that is in the economy is irrelevant and it does not have any effect on real economy. Quantity theory is actual a veil over money. But in fact money is very important as everything depends on it as lives of people depends on it like who has it, who does not has it. Reality is quite different from the projection. It is propagated that money is not important so don’t look at its importance but contrary to this all crucial things in economy are took place by money. If we look at the real role of money in economy then we will be able to fight against those who are taking tremendous amount of benefits from keeping masses in ignorance.

Quantity Theory of Money says that it is only total amount of money that matters instead of its distribution among different classes. But in reality it how money is distributed among people is only important. Lucas said in 2006 that economists had solved the great problem which is of preventing recessions but after one year he was proven wrong when Financial Crisis occurred. Lucas also said that most poison is to study the distribution of income as it does not matter at all. But in real world distribution is all that is important because lives of people depend on it. In reality money is not neutral, prices do not adjust and everything depends on who has the money. If the money goes to the millionaires then they will buy luxury items but if money goes to poor people they will spent on necessities but there is no neutrality. If we take all of the money and we doubled the in proportion of population then neutrality of money is possible otherwise it does not hold. But when money supply in increased then it does not happened that if money is doubled then everybody is has in his pocket twice as much money as they used to but it goes to certain group of people. In this case everything depends on what they do with it.

Then there is famous specie flow mechanism that is related to Quantity Theory. It is actually the attack against mercantilism. The idea was if we are importing more than exporting then gold is flowing out of the economy which is bad. But according to Hume it is not a problem as when gold goes out money supply will go down, prices will go down, exports will become more attractive and people will start buying our product. When the gold flow out that why the prices of commodities of other countries will become higher due to increase of money supply as higher money means higher prices. So at the end there will be no problem at all.

But this whole argument is wrong because when we study economics we don’t study history but only study equations. If we want to study about trade between India and Pakistan then we will start drawing curves, production possibility frontiers and solving equations but will not ask about what does Pakistan grows, what India grows, what is their history etc. These are all the things that matter. These are particular things but not science and on these are the forces that derive the trade between two countries. We have been deeply conditioned to believe in superiority of West while reject our own experiences.

One of the wrong ideas that perpetuated is that markets are self-regulating means that we don’t need to interfere and everything will be settled down automatically. This is extremely dangerous idea because if markets are self-regulating then it leads to huge damages but it is in the interest of some to do believe otherwise. Specie Flow Mechanism teaches that free markets are best for overall society.

Economic theory tells us that if money doubles then prices will also be doubled is the false way of thinking because it ignores the casual mechanisms that how will it happen. Actually we should ask about how money is created, how it will be doubled, to whom it will go, what will they do with it, and how will it leads to increase in prices. This is mechanism that leads to complete understanding. QTM teaches us the wrong thing because it doesn’t explain the mechanism but all of the understanding lies in mechanism.