The other day I chatted to a man who knows a thing or two about managing bands. He was talking about the dance hall scene in Ireland in the days before world domination. He told me that there was no drink served in the dance halls so, in most cases, the lads went drinking until the pubs closed and the dance didn’t really start until closing time. Meanwhile, the girls who, in the main, didn’t go to pubs, waited for the lads for the thing to kick off.

Apparently, in the dance hall days lads had two grades of ‘dates’ with a girl. In the first, you met her ‘outside’. This meant you paid for her to get in. The other one – a cheaper date – was where you told the girl you’d meet her ‘inside’, in which case she had to pay her own entrance. Obviously this was a less committed affair.

He also told me about the key difference between managing bands in the dry dance halls and then later in the 1970s, when people started to serve drink in dance halls and clubs. By the time a band was paid in these later clubs, which was well into the night when the gig was hours over, the money actually stank.
This is because the same fivers and pound notes had been passed back and forth across the bar loads of times before they eventually settled in the till for the evening. It was those filthy fivers, soaked in stout and sweat that were doled out to the band at the end of the gig.

The manager then had to lodge the filthy lucre in the bank the following day. He explained the process of pressing damp fivers on the counter of the banks to the disdain of the coiffed and buffed tellers of the day.

The smelly money concept struck a chord with me, because my granny had a small pub in Cork, and I also remember she’d ask us – her grandchildren – to count out the takings at the end of the night. This was a source of great excitement. We’d never seen so much money before.

However, the smell of the stuff nauseated me. Like the band manager’s fivers, these fivers and pound notes on a busy night crossed the bar and the card tables loads of times and, in the end, it would be a sodden, dank Lady Lavery that peered out of the note at you.

The riddle of the dirty fivers holds the key to the Irish economic recovery because it explains one of the most important concepts in macroeconomics. What the music man described in his memories of the filthy, stinking money moving over the bar, back and forth, is a perfect example of what economists call the ‘velocity of money’.

The velocity of money is the number of times money changes hands in an economy. In economics, the velocity of money is crucial because GNP should be equal to the money supply multiplied by the velocity of money – or the amount multiplied by the amount of times that money changes hands in the economy.
In a boom, when everyone is spending and transacting, the velocity of money should shoot upwards: because the more we are trading, the more money is used.

The music man was describing a boom. In the mini-economy of a dance hall, it would be close to recession with few people spending and everyone waiting until closing time. The place filled up and then the period from 11pm till 3am was the perfect example of an economic boom.

The velocity of money in the club went from zero (the recession) to rapidly going through the roof (the boom) as everyone thronged the bar and spent money. Likewise, my granny’s bar had a boom from 10pm to 12am on a Friday night. Money changed hands and the till stank.

Then, on Saturday afternoon, when only the local diehards and bachelors with nowhere else to go and who drank slowly were in the bar and you could hear the clock, the velocity of money collapsed and the bar was in recession.

So, we know that velocity drops during a recession. The velocity of money in Ireland was rising up to the moment the economy really turned down in early 2008 and has collapsed since then.

What should a central bank do when the velocity of money falls? It should orchestrate an off-setting increase in the money supply to try and overcome the effects of the business cycle. If velocity falls, then money supply must rise for national income to grow.

The central bank should attempt to jump-start the economy back into growth by increasing the money supply. This is what the Federal Reserve is doing in the US.
What is happening here? Well, the Central Bank of Ireland isn’t capable of jump-starting the economy in any material or independent way.

Equally, as Ireland has been suffering a liquidity trap, where banks don’t want to lend and people don’t want to borrow, the velocity of money will head downwards – as it has done – and the ability of the Central Bank to kick-start the engine is limited.

However, the good news is that it seems that the velocity of money might have started to stop falling and may be stabilising of its own accord. The velocity of money collapsed in the past five years of recession.

Like a bar with no customers or customers who used to drink quickly and now drink slowly, the money didn’t change hands quickly across the bar. So yes, the bar was open, but the trade was awful and when the band came to get paid, they got paid less and the money was clean and crisp. But unused money isn’t half as potent as used money, so as the velocity fell, so too did the number of transactions and the level of activity – the bar’s nominal GNP.

Now, we are seeing the velocity of money stabilising as people are spending a bit more. The velocity of money is a more important leading indicator than many others. Taken together with the firming of tax revenues, better retail sales and house prices stabilising, suggests that the economy might bounce along the bottom from here.

Let’s see how we go. There are huge debt deflation issues yet to be solved and enormous potential for the economy to slide backwards, but the velocity of money plateauing is new and reassuring.

The ancient Romans had an expression: pecunia non olet – money doesn’t stink. No matter where it is made, it is still cash and its provenance can’t change its value. If a few more filthy, smelly fivers were changing hands like in a 1970s dance hall, it wouldn’t do anyone any harm in 2013.

David McWilliams’ new book The Good Room is out now.

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