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Does Dropping Money Velocity Mean The Rally Will Reverse?
A frequent theme on Zero Hedge is the structural limitation imposed on corporate revenue and profitability absent an overall increase in the currency in circulation, or said otherwise, in the "velocity" of money. If banks do not lend out the money, and the money does not somehow find its way to companies' top lines, there is logically less revenue thus lower EPS (especially with the key layoff rounds already having taken place). We were gratified to see Rosenberg pick up on this theme in his latest "Latkes with Dave" piece. As Rosenberg points out, the banks continuing unwillingness to lend money out will end up transforming not only the political landscape in D.C., but could very easily be the end of the seemingly endless bear market rally.
Chart 1 maps out the S&P 500 with money velocity (GDP/M1 ratio). There is a 90% correlation between the two. It is one thing to have the Fed pump liquidity into the system but it is quite another for the liquidity to be re-leveraged into credit and recycled into the economy.
The Fed’s easing program is over two years old and the rampant Fed balance sheet expansion 15 months old, and still to this day, what the commercial banks have done (to Obama’s wrath) with all that liquidity is to keep it as cash on their balance sheet to the tune of $1.2 trillion. We’re not sure why Obama is as rankled as he is because the banks are in fact lending out a good chunk of that Fed-induced liquidity — right back to Uncle Sam (the banks now own a record $1.3 trillion of government securities).
Back to the chart — there is obviously a close connection between money turnover and the stock market. But we can get periodic divergences as we did in the first leg of the rally in 2003. But the carry-through from 2004 to 2007 hinged critically on that multi-year acceleration in money velocity. If we don’t see the banks begin to extend credit in 2010, it is hard to see the 2009 bounce from oversold lows as being sustained in the coming year.
On the other hand, money velocity is closely tied to general availability of credit. So the long-term chart could be simply falsely correlating two indirect derivatives of a broader systemic issue over the past 20 years: Greenspan's ever cheaper and abundantly available credit. In other words, if banks do not loosen up their "stingy" ways (which of course was the very reason why we are in this place to begin with), before the Fed tightening begins sometime in 2010/2011, then one can kiss the idea of money velocity increasing goodbye.
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Lets hope the Ghosts of Christmas past visit the Scrooge Bankers.
banks are lending money because they are taking the fed cash and buying (their own) equities. hence the rally. Banks to dont have to lend to consumers for the rally to continue. there is more free reserves now then ever which means the rally will keep on trucking until rates increase or you see the fed subtract free reserves. The consumer has nothing to do with this rally.
Simple formula:
Banks take reserves buy equities low sell equities high then pay back the reserves at nearly zero % interest. and this whole crisis is nothing but a speed bump. Once the banks are off the mother's milk they start lending their own cash again without a fed noose around their neck. They then they jack up the risk/leverage and we are right back to 2003 all over again. then they come back with the CDOs and the bullshit paper, soon bonuses, DOW 20,000 and a house for every American who cant afford one. Take the equity and go buy a Ferrari. Car dealer buys a yacht.
Yacht dealer buys a prostitute, and the hooker rents a room from Kevin Bacon that has a tremendous view of his new ferrari.
All of a sudden we come full circle, everyone's employed, we all get what we want and socialized medicine can take care of the Car dealer's gonorrhea for nothing.
Also, a unicorn craps a rainbow and Barack Obama turns out to be a rich white guy in coalface.
I do agree with you though. That's a big portion of it. I also think they are shitting their pants a little bit over this whole homeowner/commercial real estate thing. There's only so many times you can smack that pinata before the pinata realizes it only has a fraction of equity in the beast and it's credit will recover in a couple years.
They know that while they can rely on the government for a lot of support, they can never get enough to cover it all. Also, they're paper pushers - looking to skim off the top. They have no interest in being landlords.
The fatal flaw in this theory is "who" do they sell the equities to to payback the reserves? Themselves? Nobody else is in the equity market, look at the volume.
banks are lending money because they are taking the fed cash and buying (their own) equities. hence the rally. Banks to dont have to lend to consumers for the rally to continue. there is more free reserves now then ever which means the rally will keep on trucking until rates increase or you see the fed subtract free reserves. The consumer has nothing to do with this rally.
Simple formula:
Banks take reserves buy equities low sell equities high then pay back the reserves at nearly zero % interest. and this whole crisis is nothing but a speed bump. Once the banks are off the mother's milk they start lending their own cash again without a fed noose around their neck. They then they jack up the risk/leverage and we are right back to 2003 all over again. then they come back with the CDOs and the bullshit paper, soon bonuses, DOW 20,000 and a house for every American who cant afford one. Take the equity and go buy a Ferrari. Car dealer buys a yacht.
banks are lending money because they are taking the fed cash and buying (their own) equities. hence the rally. Banks to dont have to lend to consumers for the rally to continue. there is more free reserves now then ever which means the rally will keep on trucking until rates increase or you see the fed subtract free reserves. The consumer has nothing to do with this rally.
Simple formula:
Banks take reserves buy equities low sell equities high then pay back the reserves at nearly zero % interest. and this whole crisis is nothing but a speed bump. Once the banks are off the mother's milk they start lending their own cash again without a fed noose around their neck. They then they jack up the risk/leverage and we are right back to 2003 all over again. then they come back with the CDOs and the bullshit paper, soon bonuses, DOW 20,000 and a house for every American who cant afford one. Take the equity and go buy a Ferrari. Car dealer buys a yacht.
Let us hope that the Ghosts of Christmas visit the Scrooge Bankers.
thanks for the velocity update / lesson, TD.
The volume of credit can't just be viewed superficially. Credit becomes available at some price. The demise of the shadow banking system removed an artificial compression of credit spreads. Part of the new normal is the credit market finding a new equilibrium between credit supply and the project cash flow economics of credit demand. It is difficult to avoid the Keynesian psychosis contagion.
Fallacy in the equation of exchange courtesy of Murray Rothbard...
"The "price level" is allegedly determined by three aggregative factors: the quantity of money in circulation, its "velocity of circulation"... and the total volume of goods bought for money. These are related by the famous equation of exchange: MV=PT" http://en.wikipedia.org/wiki/Equation_of_exchange
but this equation is fallacious - there is no "equality" in any trade, since both parties BENEFIT from any voluntary exchange, one gains a good he values more than the money, the other the money that he values more than the good...
"The equal sign is illegitimate in Fishers eqation."
As for P... "the concept of an average for prices is a common fallacy. It is easy to demonstrate that prices can never be averaged for different commodities..."
As for T... "the total physical quantity of all goods exchanged, is a meaningless concept and cannot be used in scientific analysis."
finally V... "V is an absurd concept... what is the velocity of an individual transaction?... Velocity is not an independently defined variable... it is absurd to dignify any quantity with a place in an equation unless it can be defined independently of the other terms in the equation."
"The Fisherine eqation has been popular for many years because it has been thought to convey useful economic knowledge. It appears to be demonstrating the plausible quantity theory of money. Actually, it has only been misleading."
Rothbard - Man, Economy, and State pgs...832 - 842...
Poor Dave.... all you need to know is to keep buying.
Everything is good. You can depend on it:)
Its a stagplosion! Its a slowflation!
Velocity, with respect to equities, is now provided by HFT and not anything that might resemble velocity as described in a text book. No velocity equals no movement in the price of equities, NOT a fall in the price of equities. As long as volume is controlled by HFT, velocity is a trading concept now, not a macro economic concept.
Stock prices are a function of money available to put in the market and trading volume. Equities and all asset classes are simply priced by cash available to invest and HFT churn. Macro economic velocity is not a factor any more and will not be again until markets once again take on the appearance of a place where buyers and sellers meet without the control of middlemen in the form of HFT churn.
As a result, markets no longer provide the pricing function of assets, and simply reflect cash supply and HFT churn. Nobody on earth can say oil is worth $70 in an intrinsic sense. Thus, no real investment occurs since nobody knows the true intrinsic value of anything in relation to anything else. This aids in job loss and job destruction since nobody knows if it is a good idea to invest in alternate energy projects or in new oil wells. Ditto for other forms of investment that traditionally create jobs.
Velocity, as it exists now, is a reflection of parasitic asset pricing activities and available cash. No velocity is a reflection of no new money in. In fact, one could easily say that money + velocity as defined today create a static stock market ... a kind of stock market floor at a minimum. Add money and velocity increases and asset classes rise in value to a new floor that will remain until more cash enters. We are at a floor today and will remain in one until HFT is outlawed or QE returns.
Dead Hobo
Interesting. I think it is becoming clear that, under current market conditions, that macro-economic extrapolation from velocity to equity market price, does not apply. Also, in many ways the traditional economic fundamentals have been skewed in relation to real growth for over 10 years. Real estate asset price is also being influenced by government intervention.
So the stock rally is fueled by stimulus. Perhaps. But, this is immaterial when we try and understand the true health of the nation's engine, the nation's economy. Stimulus will end eventually, and as the tide recedes what will we find exposed on the beach?
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I find it a bit strange, when I try an imagine what it is like to be an economist for the Federal Reserve System. Because we no longer have an academically driven economy, based on long term models and theory. We have a FED driven economy. So what will happen to our economic health, given this new "thing". Well your guess is as good as anyone elses. Except if you work for the FED, you get paid for your guess.
For me this would be a very funny SNL skit. Where the FED chief economist puts up a chart on the stand, and we can see the center graphic, but there appears to be panels folded out of sight on all sides. The discussion starts as the economist talks to the larger center graphic. When a question is asked that perhaps disputes the center graphic, a panel is folded open which modifies the overall graphic to then look plausible. So depending on what people say each one of the panels fold out one at a time to make a plausible argument.
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I think the word you were looking for was trust. Trust is what really drives investment. I would argue that you can still estimate intrinsic value for specific companies, and do so readily across a sector. But, the many times the share price relative to earnings, and other fundamentals, including risk, do not justify a purchase.
Once, government exists from real estate, we should see common pricing phenomenon. For financials we are looking to see if accounting changes reveal off balance sheet risk exposure.
Mark Beck
It was never about 'cheap' credit, it was about suspension of loan underwriting.
Increasing the money velocity will require a return of NINJA and Option-ARM loans.
If they had followed the Swedish model and nationalized they could have saved a few steps and made more progress no???
(Mr. Grant comes to us, in part, via Grant's Interest Rate Observer Vol 27, No.24, 'The case of the reluctant recovery' -AM)
Anonymous Monetarist : Mr. Grant thank you for imagining yourself for this conversation. You originated the "Current Yield" column in Barron's before founding Grant's Interest Rate Observer in 1983 and pride your medium as that which least resembles CNBC.
James Grant : Thanks. Surprised to be here.
I get that a lot. I have heard you say that in the past you were a bear in a bull market, and you admitted that was wrong. You said that the really seasoned observer is supposed to be in step with things, not credulous of the existing trend, but still not fighting it. Does that explain your heralded conversion from bear to bull?
In part. We built our case for a growth spurt in hiring and GDP on the long-established tendency for strong recoveries to issue from deep recessions and weak recoveries to follow mild ones. In this country, the business-cycle record of the postwar era, and, indeed, of the past 100 years, seems to admit no exception to this rule (if rule it be).
So it's a Zip-a-dee-doo-dah recovery and Mr. Bluebird is on your shoulder?
Well we did just come out of a briar patch. Compared to the 10 preceding postwar downturns, this one will almost certainly prove to be the longest and, in terms of loss of employment, the costliest. Financially, we rank it as the scariest, what with the world almost coming to an end.
We are on record predicting a jobful, not a jobless, recovery in the context of red-blooded GDP growth.
You initiated this call around Labor Day and have put out a few newsletters since expanding upon and supporting this position. So far how would you mark this thesis to market?
A recovery of some kind, we are going to assume, got under way in June, though it seems not to be the kind we had predicted. We say "seems." Revisions to real-time data can be extensive, even transforming.
The stock market, it's true, has caught fire. Credit spreads, too, have collapsed. However, our anticipated barn-burning recovery has -evidently- smoldered.
Since the hypothetical trough in June, nonfarm payrolls have dropped by 20 basis points, only slightly less discreditable than the declines of 30 and 40 basis points registered in the certifiably jobless and joyless aftermath of the recessions of 1991 and 2001, respectively. A year after their (1991 & 2001) respective troughs, payroll employment was actually down by .2 and .4 of a percentage point, respectively. To judge by payrolls alone, this recovery is stronger than the jobless, but weaker,by far, than the jobful.
Per the Bureau of Labor Statistics joblessness by duration in three of the four segments (fewer than five weeks, five to 14 weeks, and 15 to 26 weeks) appears to have peaked for this cycle. Initial claims for state unemployment insurance have fallen by 32% from their evident peak in March.
The 27 weeks and over segment does not appear to have peaked yet. On average, and excluding the outlying cycles of 1991 and 2001, the 27-week segment peaks 7.4 months after the trough.
Do you believe that segment is about to put in a top?
It would be a very good thing for the Grant's job thesis if it did.
Earlier you stated that data revisions can be transforming. The opposing thesis to a V recovery is in part based on the empirical evidence that unemployment levels are at Great Depression levels.
Would agree to disagree that joblessness bears any comparison to the tribulations of the early 1930s however the most one can say about the integrity of real-time data is that it will most certainly be revised. Consider for instance, January-March 1983, the first full quarter of the retrospectively brisk recovery from the 1981-1982 recession, the last cycle where the unemployment rate topped 10%. Growth at an annual rate of 3.1% was the advance, or flash, estimate, disclosed in the second quarter of 1983. In the first revision to that advance estimate, however, released in the third quarter, 3.1% was whittled down to 2.6%. But that was not the final word, nor anything close to it. Ten revisions later -the most recent produced in the third quarter of 2009, just the other day- annualized growth for the third quarter of 1983 was fixed at 5.1%.
So rather than waiting a quarter century for the final numbers what would you say, per the admittedly flawed data available, the recovery looks like so far?
After one quarter, GDP has shown real, unannualized growth of 0.7%, or less than half the postwar average of 1.8%. The three prior recoveries that interest us most -the ones beginning in 1982,1991 and 2001 -led off with gains of 1.2%,0.7% and 0.9%, respectively. So far,then,GDP, is tracking much closer to the subdued pace of the prior two recoveries than that of the unbound 1982 experience. In 1983, real GDP jumped by 7.7%. The half-hearted upswings following the recessions of 1990-91 and 2001 produced 12 month growth of just 2.6% and 1.9%,respectively. Score a point for the GDP bears, although, as noted, they may be laughing out of the other side of their faces in 25 years.
What other data series are you following?
Industrial production constitutes another marker of cyclical progress. It too, is subject to extensive revision, but as the data reach back to 1919, you can hardly beat it for perspective. Studying the prewar data, you may stare in wonder (as we do) at their volatility.Thus, industrial production fell by 32% in 1920-21, by 52% in 1929-33 and by 32% in 1937-38. Then again in the four quarters following the troughs of those respective slumps, it zoomed by 32%,45% and 27%.
In the recession lately (presumably) concluded, industrial production fell off the table, down by 15%, peak to assumed trough. It seems to have bottomed in June, which is notable, because it so happens that industrial production inflection points have tended to correspond almost to the month of the cyclical reference dates of the National Bureau of Economic Research. Industrial production bottomed in June and has grown every month since, for a cumulative increase of 3% after four months. This puts our current (presumed) recovery above the postwar average of 2.5% after four months and well ahead of 1991(2.2%) and 2001(1.3%) and even 1982(1.5%). Of course, four months is not much of a test. The question is, after one year, will the recovery look like 1991 or 2001, with 3.5% and 3% growth in industrial production, respectively, or 1982, which started slowly but finished up with 9.6% growth in 12 months following the cyclical low-ebb? Then, again, 9.6% was not how it looked in real time. What the investors and traders and pundits of 1983 saw was a leap of 15.9%. Only with 13 revisions was it whittled down to 9.6% -pending further revision, of course.
As a fellow skeptical empiricist I'm sure that you would agree that, the claim of a V shaped recovery, like any proper scientific hypothesis, can only be falsified. Are there signs in your opinion, that perhaps this time it is different?
Notwithstanding the succession of synchronously volatile American contractions and expansions being just a coincidence there is a rather glum data point for us macroeconomic bulls. Real income less transfer payments is still falling, down after one quarter from our June trough, compared to a one-quarter increase of 1.3% for all previous postwar recessions. In the post-1945 era, real income less transfer payments have never declined in the first quarter of a recovery, although it did come close in what turned out to be a pretty fair recovery, that of 1975. In the cases of 1982, 1991, and 2001, through one quarter, growth in real wages and salaries (which includes employer contributions to retirement and Social Security, proprietors' income, rental income and interest and dividend income) was higher by 0.5%, 0.4% and 0.3%, respectively. Another series we like, manufacturing and trade sales, sends no clear signal about our cyclical progress or lack thereof.
Any additional risks to the V theory?
Bank lending has fallen by 4.2% in the past five months. Loans and leases were flattish in the opening months of the recoveries from the recessions of 1981-1982, 1991 and 2001, but in no case was there weakness on the scale of today's. Also money supply is troubling. We have collected data back to 1959. Therefore, looking at recessions of 1961-vintage and after, we find that M-2 has risen by an average of 9.2% in the 12 months following a cycle trough. This time around, over the last four months, M-2 has fallen slightly. There is a risk too, that debt destruction, or de-leveraging, might get rolling again, crushing jobs and incomes as it proceeds. There has only been one sustained de-leveraging since the 1920s. From 1933 to the early 1950s, the debt-to-GDP ratio fell from around 260% to 130%. Yet, over, the same period, real GDP grew at an average compound average rate of 6.1%. That was a notably different world of course. Today, the ratio of total credit market debt to GDP weighs in at more than 370%. Any takers on the proposition that a massive new cycle of de-leveraging would form the credit backdrop for another 20 years of wonderful growth? We wouldn't bet that way.
Neither would we. Final word?
One of our favorite epigrams is the following one from English economist Arthur C. Pigou :'The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. The new error is born not an infant, but a giant...' So we hew to history, contrary opinion -and to the profound professor. However, if 2010 growth comes in at less than 4%, considerably less than the average 6.6% inflation-adjusted growth in the 12 months following the trough of all postwar slumps, we will have to admit that, as a certain number of subscribers are already convinced, we have utterly missed the boat.
Roger that. Thanks James.
There's another factor in this which has not been addressed. We recently purchased a townhouse at $80k which previously sold for $250k. The same bank that lent us the mortgage also held the prior motgage (a short sale). In this transaction, the bank made a loan, but their loan portfolio dropped by $170K. This appears to be a reduction in the velocity of money, but the bank holds the same property as collateral for a smaller mortgage.
Making predictions about the stock market is complicated by the fact that it is manipulated. The near-financial collapse of the banking system triggered a vicious bear market. But, come March 9th, the stock market has been walked higher with barely a hick-up.
So, if you're looking to go short, you have to ask yourself, who is going to sell enough to drive prices down in the face of the plunge protection team and other manipulators.
Don't forget cash is trash so in the absence of disaster what else are you going to do?
However, on second thought, if the system is imploding like Japan under a moutain of debt slowly spoiling, then, cash is, in fact king, as deflationary pressures take hold.
Right now its nip and tuck. I'm a little concerned about the state of foreign banks and default risk in Greece etc. If we have a blow up in one of these many problem areas all asset classes could take a hit providing a nice dip to buy. The dollar will spike as well.
Agreed.
I've given up believing there's ever even going to be a pullback. The upward pace will slow but that's it - at best it might start stagnating and moving sideways but it'll never go down. Maybe once the carbon exchange is up and running the big banks will just move their bubble to that area but until then we're stuck with the DOW over 10K and oil over $70 and it'll be defended tooth and nail.
A couple of better charts (interactive), so you can measure the correlation:
http://www.crystalbull.com/stock-market-timing/Velocity-Of-Money-chart/M2
and
http://www.crystalbull.com/stock-market-timing/Velocity-Of-Money-chart/M1
And, don't forget the cause of falling Money Velocity: the Money Supply. This chart is astonishing:
http://www.crystalbull.com/stock-market-timing/Money-Supply-chart