Reality Check

Cash Flow - How fast what goes around comes around

What this is all about is the role of cash flow in an economy. The amount of money in circulation is important, and we discuss this elsewhere (see below).

BUT the speed of the circulation is equally and sometimes even more important. The speed makes a limited amount of money available to more people, and it means that the money eventually can get back to the person that spent it. What goes around comes around, and the faster that happens, the better.

This can be a mite difficult to understand, so we'd like to use an example, a really, really, really simple example. In real life, this cash flow stuff can be pretty complex, as money flows in and out of many hands. For our example, we'll just use two. And in our example, there is just $1.

Person A makes Whatchama-callits, which he sells for $1 each

Person B makes Thinga-mabobs, which he sells for $1 eadh

Exchange of Money: So we have two people and $1. Now, lets look at the exchange of money for goods.

1. Since Person A and Person B are the ONLY two in this simplified economic system, they sell and buy from each other. A sells Whatchamacallits to B and buys Thingamabobs from B, and vice versa. So what goes around comes around (money and goods) between just two imaginary people.

2. Let's say there is only $1 available in this closed economy, and Person A has it. Person B has no money but does have thingamabobs to sell. So Person A buys a Thingamabob from Person B. Now Person B has $1 and person A has no money.

3. But since Person Be has $1, Person B now spends the $1 to buy a Whatchamacallit from Person A. Now Person B has no money but Person A has $1. This is cash flow, not unlike the story about the cobbler and his wife above.

Rate of exchange of money (cash flow): So far so good, but we now need to look at the rate of cash flow: Why? Because, while there is only $1 in this little closed economy we're using for our example, that does not limit how much Person A and Person B earns. We need to know how fast they exchange that $1.

Slow rate: Person A and Person B buy from each other once a day. Given there are 365 days in a year, this means they each earn $365/year.

Fast rate: Person A and Person B buy from each other 100 times a day. Given there are 365 days in a year, this means they each earn $36,500/year.

Conclusion: Even though there is only $1 in this example, how much Person A and B earn depends on how fast the money exchanges hands.

In other words, what does around comes around, and the faster it goes around, the more people benefit.

To read about the affect of money supply on the economy

To go to the Articles Page