The Money Horror Picture Show
All is not well with the economy in spite of rising home prices and soaring car sales. The disturbing news comes from money. Losing velocity with money is like losing altitude while flying. It can be hazardous to your health.
Economically, the velocity of money reflects how quickly people spend a new dollar once they get it. Technically, it’s the GDP growth that a rise in the money supply can’t explain. The general idea holds that if people are well off and feeling confident they will spend new dollars quickly and each dollar will change hands many times before the end of the year.
Here is an amusing tale about money velocity that I got from the Adam Smith Institute:
It is the month of August, on the shores of the Black Sea. It is raining and the little town looks totally deserted. It is tough times, everybody is in debt and everybody lives on credit.
A rich tourist comes to town. He enters the only hotel, lays a 100 Euro note on the reception counter and goes to inspect the rooms upstairs in order to pick one.
The hotel proprietor takes the 100 Euro note and runs to pay his debt to the butcher. The butcher takes the 100 Euro note and runs to pay his debt to the pig farmer. The pig farmer takes the 100 Euro note and runs to pay his debt to the supplier of his feed and fuel.
The supplier of feed and fuel takes the 100 Euro note and runs to pay his debt to the town’s prostitute who in these hard times, gave her “services” on credit. The hooker runs to the hotel and pays off her debt with the 100 Euro note to the hotel proprietor to pay for the rooms that she rented when she brought her clients there. The hotel proprietor then lays the 100 Euro note back on the counter so that the rich tourist will not suspect anything.
At that moment, the rich tourist comes down after inspecting the rooms and takes his 100 Euro note, after saying that he did not like any of the rooms and leaves town. No one earned anything. However, the whole town is now without debt and looks to the future with a lot of optimism.
Velocity in the little town picked up quickly when the stranger showed up. But velocity in the US dollar has plummeted to record low levels as this graph from FRED shows.
Here is a graph of the year-over-year change in the M2 money supply.
The Fed is trying to goose inflation at the same time that velocity and money growth have taken a nose dive. The overly simplistic equation of exchange, MV=PQ, states that increases in money (M) or the velocity of money (V) will cause prices (P) to rise in the short run because output (Q) is fixed. Of course adjustments take time and the equation doesn’t include time. So what is happening when MV is declining while P is rising? Limited to just the equation, production (Q) must be falling.
Part of the reason for the collapsing velocity and slow growth in M2 is that the private sector is paying down debt at record rates. Just as new lending increases the money supply, so paying back debt shrinks it. Another cause of both are the crushing new Dodd-Frank and Basel financial regulations that are forcing large banks to shrink and to hold more cash.
New loans and swelling money supply has been the chief fuel of rocketing profit rates and a stock market flying in the stratosphere. But the fuel is running out
Trending Now on Affluent Christian Investor
Sorry. No data so far.
The Affluent Mix
Biden Oblivious To Illegal Immigration Issues... August 2, 2021 | Frank Vernuccio

Rob Arnott On Bubbles, Inflation, And Once-In-A-Generation Investment Opportunit... August 2, 2021 | Jerry Bowyer

The Federal Reserve’s Massive Theft Of Stability... August 2, 2021 | Jim Huntzinger

What To Do About This Difficult Market? August 2, 2021 | David Bahnsen

Letter On The Politicization Of Corporations... July 26, 2021 | Jerry Bowyer

Peak Of The Fake Bull Market July 26, 2021 | Michael Pento

Woodrow Wilson’s Administrative State vs. Gold... July 26, 2021 | Jim Huntzinger

Dividends, Energy, And Crypto July 26, 2021 | David Bahnsen

Whose Side Are You On? July 26, 2021 | Frank Vernuccio

Media, Left Ignore These Dangers July 19, 2021 | Frank Vernuccio

Mark Skousen On FreedomFest And How To Measure The Whole Economy... July 19, 2021 | Jerry Bowyer

Quantifying The Quantitative, Or Making Easy The Easing... July 19, 2021 | David Bahnsen

The Gold Standard Means A Rising Standard Of Living... July 19, 2021 | Jim Huntzinger

Book Review: Brian Domitrovic Reveals The Monetary Genius Of Arthur Laffer... July 19, 2021 | John Tamny

Steve Forbes: Time To Worry About Inflation, Not Hyperinflation... July 12, 2021 | Jerry Bowyer

UFOs Rescue Biden July 12, 2021 | Frank Vernuccio

Read This Classical Economist’s 200 Year Old Warning About Paper Money... July 12, 2021 | Jim Huntzinger

How Central Banks Murdered The Markets July 12, 2021 | Michael Pento

Everything There Is To Know About The Stock Market... July 12, 2021 | David Bahnsen

AT&T CEO: We’re Ill Equipped For Politics, And We’re Spending A Lot Of ... July 6, 2021 | Jerry Bowyer

Internet Bias Distorts National Conversation... July 6, 2021 | Frank Vernuccio

The Halfway Point Of 2021 July 6, 2021 | David Bahnsen

Join the conversation!
We have no tolerance for comments containing violence, racism, vulgarity, profanity, all caps, or discourteous behavior. Thank you for partnering with us to maintain a courteous and useful public environment where we can engage in reasonable discourse.