Velocity of Money at 60 year lows


Interest rates are low right? Money is cheap, yes? Well the velocity of money is generally overlooked as an indicator but is a good benchmark to see how efficiently money is changing hands. If we analyse debt service ratios in the US, these are not at any significantly alarming rates if history is a guide but slowing velocity tends to suggest hoarding cash. In a sense if velocity doesn’t rise it is very hard to create inflation because every extra dollar creates essentially less GDP i.e. less bang for your buck.

The velocity of money is essentially the ratio of nominal GDP to  money supply (M1 or M2). It is basically the number of times $1 turns in an economy.

In 2006 Federal Reserve Chairman Maestro Alan Greenspan stopped reporting M3 which peaked out at around $10.6 trillion (from around $2.5 trillion at the start of the 1980s). Using the accelerated growth rates over the last 6 years before the data series was dumped  and extrapolating them forward to today we get a whopping $25 trillion. Looking at the trend of M3 implied velocity and it has fallen from 1.49x in the 1980s to 0.69x (i.e. less than half) implying it takes 2x as many dollars printed to create the same amount of GDP. Rolling those same rates forward to 2021 the implied M3 would stand at  $40 trillion which would imply around 0.48x.

So even though the unemployment rate has halved in the US, velocity of money post the tech wreck of 2000 has been on a downward trajectory apart from the 2004-2008 bubble. With interest rates so low, currencies, credit markets and equity markets manipulated from many sides, we are in deep trouble if we continue to avoid taking pain.

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