On Inflation, M2, and the Velocity of Money

CrownThomas's picture

We often hear that the central banks printing money in order to keep the stock market inflated and broke countries afloat for just a few days longer is nothing to worry about. The reason we are given, is that even though the central banks are pumping trillions into the economy, inflation isn't an issue. And after all, the velocity of money has actually declined.

That's the message from the "smart" people anyway.

This chart shows that as M2 grows (Red), so does inflation ie: CPI (Green) - yes, this is the government's calculation, we'll leave it there for this chart's purpose. Also of note is the monetary base without the banking ponzi scheme of fractional reserve banking (Blue).



So as you can see, inflation actually follows M2 growth, even as the velocity of money (below) declines. Don't be fooled by those who tell you that printing money isn't causing inflation, because it is doing just that each and every day.

There are those who believe that velocity of money is a product of fast growing inflation (not a cause). Inflation has been rising consistently with the growth in money supply, but the velocity of money has declined. You can imagine what happens once velocity of money actually starts to turn (hint: something ZH has been warning about for years).


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MeelionDollerBogus's picture

I don't like this velocity chart. Something's just not right. Money chasing derivatives may have a higher velocity but not impact tangibles. Money chasing tangibles is a whole other animal, like water, food, electric/utilities/etc.

I can't see any information benefit to ignoring this critical division.

Lednbrass's picture

This is something I have wondered about but not seen stats for- the blue line on graph 1 is explained as "the monetary base without the banking ponzi scheme of fractional reserve banking."

Am I to assume that is is the total of all actual cash in the system, or is it something else? Does anyone have a handle on this?

This seems an interesting point to me, I would think a statistic like that would get more coverage.

flaunt's picture

Base money would include bank reserves.  I believe the base money increase in the graph represents the Fed "filling in the hole" of worthless banking assets, converting them from worthless pieces of paper that should have been credit money destroyed, into real spendable money.  Looking at these graphs, it appears we're in uncharted territory with the explosion of base money supply and simultaneous contraction of velocity.  It will be interesting to see what happens when the banks find something to spend that money on.  Will the Fed increase reserve rates to try to stop them?  Can they do that without destroying the bond markets and bringing the U.S. Gov't to a screeching halt?  Rock, meet hard place.

You Didn't Build That's picture

Velocity might be stagnant on the charts because European banks have been sucking up every bit of eurodollars available to fight their staggering deficits and disinflation. Yes?

It will pick up and then we will see it soar again along with robust inflation....but I suspect the CPI will be "revised' not to reflect it so COLA recipients will lose even more purchasing power.

linrom's picture

The velocity of money in real economy is always greater than ONE, even at the highest levels of inflation, money velocity has to be greater than one.

HardAssets's picture

From my research, the whole concept of 'velocity' of money is bogus -

Here's an article that explains why:

Is Velocity Like Magic ?


Carp Flounderson's picture

Mises articles on economics are always so bad its amazing.

shovelhead's picture

An amazing parallel to physics.

If the water volume is constant, then the larger the turd, the slower it will circle the bowl.

Nobel Prize please.

HardAssets's picture

Sorry engineer - - - economics is not physics !

No prize (or soup) for you !

FieldingMellish's picture

...or a science of any sort, really.

Bunga Bunga's picture

You can imagine what happens once velocity of money actually starts to turn (hint: something ZH has been warning about for years).

...like the NAR has been calling the housing bottom for years.

Republicae's picture

The fiat monetary system must rely upon a continual increase in supply is that there must be some way for the central planners to compensate for the continual decrease in the purchase power of each monetary unit through inflation. Strange isn’t it? They debase the money through the increase of the money supply, but they have to increase the money supply to combat the effects of increasing the money supply and on and on and on and on they go down their yellow brick road as though they know where they are going. Their dilemma, of course, is that there is no way for them to play catch-up with the loss of purchasing power of the currency, not matter how much money they create the currency will always lose more value quicker than they can “print” it out.

The cows come home when the public begins to loose all confidence in the currency. This is particularly true when interest rates, which have been kept at artificially low levels, begin to bend to market pressures and the FED can no longer keep them down. What triggers the wide-spread lack of confidence in the currency is when the people realize that they money is increasingly worthless even when interest rates are beginning to rise, which would normally indicate a stronger value within the currency, but during a highly inflationary environment, the opposite happens. At that point the people begin to spend their increasingly worthless dollars as soon as they get them in their hands. The wild demand for money stops even though they’re seemingly an unlimited supply of money available. People and markets suddenly realize that all the money in the world cannot substitute for purchasing power of money. It is a strange occurrence and it happens the same way every time. It is almost an overnight epiphany that occurs.

You see, hyperinflation is not only a monetary event, but it is far more of a psychological event. During boom periods of economic fiat expansion, there a demand for money, the problem comes when a deflationary period enters the economic fiat landscape. At that point, as we have seen, the central bankers push the “presses” into overdrive, full steam ahead to avoid facing the consequences of correction associated with a fiat bust. It is during this period that the danger of hyperinflation evolves because the supply of money is rapidly increasing but the demand for that money is decreasing. Eventually, everyone begins to understand that no amount of fiat money can replace the loss of value associated with the money. At that point everyone suddenly gets a mind, they suddenly come to a realization about just how much of a fraud they have been victimized by over the years and they are no longer willing to play the game.

This great psychological event, as I said, always happens suddenly, so fast in fact that the government must respond by revaluing each monetary unit, seeking to exchange old fiat money with lower denominations with new fiat money complete with ever-increasing numbers of zeros on its face. The system, along with the central bank and government, is effectively destroyed. It is all crippled, stripped of its power to enforce not only legal tender laws, but also all laws. The government is effectively neutralized by a hyperinflationary event and the fiat monetary system is dealt a final deathblow from which it simply cannot recover because it cannot regain the confidence of either the people or the market.

A deflationary depression can be devastating to a country with massive layoffs, bankruptcies, defaults and business closures, but the money is never destroyed through deflation that is not the case with hyperinflation. Deflationary will prolong the fiat monetary system, almost cleaning the system of excesses but hyperinflation will absolutely destroy everything that is even remotely associated with the currency. A deflationary depression will simply allow the Federal Reserve to continue its fiat shenanigans; hyperinflation will destroy the Federal Reserve, the fractional reserve banking system and the political machine that supports its criminal activity.

We have already been told, time and again, that the Federal Reserve will not allow a long deep deflationary event to occur; the other side of that coin is that their options will include, as we are now seeing, a drastic inflationary push of fiat economic instruments. Remember, our Dollar has already been debased by 97% or more, it will not take much to tip the scale of inflation where the people’s psychology is triggered and they cease any demand for the massive amounts of fiat money coming into the system.

HardAssets's picture

The problem with the deflationary scenario is that the real value of all debt increases - - private, business, and government debt. That debt is already unsustainable now, how would it be repaid if increased in real terms ?


LongSilverJohn's picture

Seems like gridlock, as the tectonic plates of inflation fears are held in check by a lack of money for consumers to spend.

I wonder if anxiety would trigger fight/flight response manifested in a run on the grocery store shelves? It doesn't cost so much to buy a few hundred dollars of food and if everybody does it, it could turn into a panic very quickly since there's only 3 days' of food in the supply chain, from what I read.

News of the worsening draught could be the trigger....

Don Levit's picture

As I understand the formula for GDP, it is money supply x velocity.

We are seeing our GDP increase, primarily because of the increase in the money supply, i.e., debt, as opposed to real consumer exchanges.


Don Levit

MeelionDollerBogus's picture

That is definitely not the formula. GDP is incorrectly formulated to begin with but you went off the deep end in error.

C (consumers spending) +G (government spending) + I (investment) + exports - imports

C + I + G + (X-M)

Nowhere is velocity part of this calculation. Nor can it be for the original formula is deeply flawed.

Government spending is always substracted from tax-payer and currency purchasing power. Currency is always printed from the central-controllers. The supply of the money isn't stable AND what's spent by government isn't a product at all.

C+I - G + (X - M) is a little better but of course no one uses this. That would be too honest.

After all, if consumers went broke and investment dried up but government spending was kept at the max until no one even paid taxes then for a time you'd see

official formula GDP = G + x - m

my take on it GDP = x - m - g

Conclusion: in reality exports would be the only real income for GDP and government would drain it. To write G+x-m when I and C are zero would mean that governments spending everything somehow boosts GDP. IT doesn't. And worse.... when debt is borrowed it is ADDED to GDP even though it is an exponential DRAIN on capital.

More funny math to make the government look better.

ebworthen's picture

The illusion of recovery via FED monetization and market fluffing has created inflation not only of prices but of expectations.

Johnk's picture

Excellent post and good comments by Quinvarius.

saycheeeese's picture

the nightmare before christmans for Ben...  recession and inflation   where do u run?

rwe2late's picture


V = PY / M


where M is the nominal stock of money





It would appear that increasing the stock of money

would theoretically DECREASE the velocity (V) of money, all else remaining unchanged.


Pareto's picture

I agree.  I might only add some qualification on Fisher.  If only (v) rises, then only income (Y) rises.  Prices remain flat, because like somebody said above, (v) rising reflects an increase in the rate of real goods and services being produced and exchanged.  Velocity is a reflection or indiciation of economic activity, IMO, and does not have, necessarily a significant impact on price.

The price level (P) is a function of the money stock, and scarcity of a good or service.

Income (Y) is a function of the velocity by which money trades, and (v) is a function of total debt, and intertemporal choice

Thats why I think that the price effect we might oridnarily see from a rising money stock (if balance sheets were robust), is being total offset by a declining velocity (as a result of debt), EXCEPT prices for the shit that we need.  The declining velocity has kept a lid on general price inflation, which is totally consistent with GDP measures around the world continuing to deteriorate and the fisher identity.  Debt/insolvency kills velocity, kills growth.  Prices, IMO have to fall to restore "affordability" and willingness to pay, and therefore, real income to rise.


blunderdog's picture

Velocity won't increase because the increased money supply is functioning *solely* to protect balance sheets.

There's no "organic" economic activity occurring, which is what velocity is really supposed to be about.  If I move money from my checking to my saving account, there's zero velocity.  If a bank allocates money from one paper (financial/fictional) asset to another, there's ALSO zero velocity. 

Exchange of currency for goods/services is diminishing because the vast majority of the population has no currency to spare.  It makes no difference where the big dollar-holders put their money.

HardAssets's picture

Yes, the Fed fulfills its real and only purpose - - - to protect the big owner banks.  The money is parked on their balance sheets.

In the meantime prices rise (despite the 'economic reporting' which excludes food and energy).  If you had tons of ever declining in real value dollars, where would you put them ?   All the worlds fiat currencies are suspect. There's the PMs and other real stuff.

Seer's picture

"Velocity won't increase because the increased money supply is functioning *solely* to protect balance sheets."

I've been saying this for years.

"It makes no difference where the big dollar-holders put their money."

No difference to the "people," but to the big players it DOES matter, as the more they're allowed to play with the their "compensation" [for doing "God's work"] (no matter if they lose or win- it's all about being IN the "game*").

* The day in which the majority of people realize that it's a game they no longer care to participate in (pawns) is the day in which there WILL be a definite difference for the biggies (game over).

casey13's picture

The velocity of money will pick up if people fear their dollars will buy less tomorrow than they do today or as misses put it.

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the [p. 428] country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German Mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last. 

blunderdog's picture

Can't happen.  The "real" economy cannot support the previously achieved "flow-rates" of money.  That's the problem, and that's why the big players are scared.

Even if ALL the non-rich (call it 307 million people in the US) decided to spend all their money as fast as they can due to inflation fears, there is NOT ENOUGH MONEY in their hands to make a lick of difference in the global economy. 

Lucius Cornelius Sulla's picture

Can't happen.  The "real" economy cannot support the previously achieved "flow-rates" of money.  

You hit on an important point here.  The fact is that the global money supply is debt.  To increase it you have to sell more of it.  The problem is that the economy is saturated with it.  Therefore, the transmission mechanism used to pump up the money supply is broken.  In other words, we are not facing a crisis of liquidity, we are facing a crisis of solvency.  The only way to get the economy growing again is to destroy the malinvestment by writing off the losses and passing it on to somebody.  Until that happens, the economy will continue to deteriorate.

HardAssets's picture

Who says dumping of the money would be restricted to within the U.S. ?  It may even be likely to come from outside the U.S. - - - what if they came with all their trillions wanting to use those claims on real U.S. goods while the getting was still good ?

MeelionDollerBogus's picture

I think they already know there's not enough real US goods to buy with those dollars. That's why the smart move is to cash out of USD overseas while it's an accepted currency.

Impotent_Smurf's picture

Correct, the money doesnt circulate enough with the plebs to spark inflation. It's all printed for the pigs to throw in their black hole of debt. Without helicopter Ben really throwing money out onto the streets, hyperinflation will not happen. A majority of the population are not getting raises, or very little. Where does the money come from to hyperinflate?

Bohm Squad's picture

Hyperinflation does not need a money base to happen - it's a loss of confidence in the currency.  Inflation and hyperinflation are different animals.

Concerning your comment on money not making it back into the "plebs" hands - you may want to consider this article:  http://www.zerohedge.com/news/verge-historic-inversion-shadow-banking

MeelionDollerBogus's picture

Without a large enough money base a loss of confidence in a currency will simply result in switch to another currency without the hyperinflationary phase. The "bidless market"

Impotent_Smurf's picture

Thanks for the link. I'm still learning, I'll admit it. Now I've gone from thinking it will be a biflationary slow kill to just an all out implosionary collapse. Whatever way it happens, it will be ugly. 

Ghordius's picture

bohm squad is 100% correct - and loss of confidence can happen in foreign countries, too, if the currency circulates there

Seer's picture

"The velocity of money will pick up if people fear their dollars will buy less tomorrow than they do today or as misses put it."

All fine and good until you realize that "people" don't have dollars, they're in debt!

What we did have was an issue of "velocity of credit," and that's in the toilet, it'll NEVER come back.

HardAssets's picture

American "people" not equal to "all people holding US dollars and dollar denominated assets"

Hmmm . . . wonder if theyve put up the state of California as collateral ?

LMAOLORI's picture



Another fantastic article and it makes perfect sense given the inflation we are seeing in the everyday items we need to live like FOOD! You could certainly teach the majority of the main stream Economic's clowns (including banana ben) a lesson.

Seer's picture

Food, Shelter and Water...  It's why I placed my bets on becoming a farmer... whether it'll only be for me and my immediate family or not is yet to be determined (depending on success).

jimod's picture

Me too.  Land and Cows, (and seed) are a better investments than gold and the all the other abstract  representations of value.     

SgtShaftoe's picture

"Inflation is always and everywhere a monetary phenomenon."  - Milton Friedman

"Monetary velocity is always and everywhere a social phenomenon.  Trust, monetary demand, and confidence may take a long time to become unhinged, then happens all at once"  - Me

"Financial crises take longer than you think to happen, and faster than you can imagine to unravel" - someone else

OpenThePodBayDoorHAL's picture

"How did you go broke?"

"Slowly at first...then all of a sudden"

Mr. Lucky's picture

How does loss of hedgemony play into this?

Alpha Monkey's picture

Probably increase velocity...

LongSilverJohn's picture

Would the increase in velocity during the 1990's have resulted from people cashing out their equity and spending the money? Or borrowing money and buying houses with inflated prices? So wouldn't the increase in home prices (inflation in housing) correspond to an increase in velocity? 

If huge amounts of money have been created, but are being hoarded (e.g., by the banks) and not being loaned out, then wouldn't that explain a drop in velocity, too? (people can't or won't borrow money to buy stuff, so spending sinks). Consumers are deleveraging, not borrowing and spending.

As unemployment pushes higher, consumers are going to feel like they are getting sucked into a black hole. They aren't earning wages and credit is hard to get or is cut off for them. That spells drop in velocity (no money to spend), deflation and perhaps an exaggerated monetary response from the Fed, leading to hyperinflation? 

I'm not opining here, just trying to understand how the pieces fit together... thoughts?

Dr. Kenneth Noisewater's picture

I should think that pricing and velocity are somewhat correlated, or at least pricing can act as a trigger for velocity.  When things are overpriced, velocity goes down, and when things are underpriced, velocity goes up.  Right now, thanks to all the balance sheet garbage that banks are marking to fantasy, houses are overpriced, so that depresses velocity.  Is credit overpriced?  Remember, the market isn't just the participants, it's also folks watching from the sidelines looking for a good price..

Seer's picture

Yeah, if something isn't priced desirably then one isn't motivated (that's why there's always these "sales" going on [psychological marketing ploys]).

"Remember, the market isn't just the participants, it's also folks watching from the sidelines looking for a good price.."

I'm not sure if you're implying that this is the "money on the sidelines" or not, but I don't think that there really is such a thing (other than stashes of PMs, and these, from what I believe, aren't all that sizable, not enough to prop everything back up).

Most of the "chips" ("money") is valued based on the value of the predominate sets of assets that we're operating off of.  Yeah, if this reads like a circular function it's because it [all] IS nothing but a self-referential function.  The Fed is basing the fundamentals of our currency ("money") on over-valued assets, which pretty means that our currency is also over-valued.  It is This overvaluation where "inflation" can be spotted.  As someone above noted, the money-printing is really only book manipulations: it's The Emperor's Clothes story; rather than giving the emperor clothes to wear (so that we don't see the horrors) the people are all cloaked with eye patches (the emperor is still running around naked and the people are all blind- the appearance that all is accepted/acceptable).

Muppet Pimp's picture

Just turn up the frequency on the HFT bots as high as needed to get M2 humming.  Once inflation starts to pick up, just turn em all back down a notch or two.

Panafrican Funktron Robot's picture

I tend to think of the velocity of money purely as "bang for your buck", ie., how useful each new dollar in the system is.  In this respect, I don't think it's actually a good measure of price inflation per se, but rather, purely a measure of how useful dollars are as an instrument of trade.  The fact that this has been plummeting is no particular surprise, and those of us who are already in the know about facts like the US debt to GDP ratio having already crossed the 100% rubicon (from which it cannot return without severe pain) tend to keep up with this number as we plan for the future.  

In other words, a collapsing velocity can indicate serious deflation AND hyperinflation (lack of confidence in the currency itself) risk.  The yen is a good example of this:


Substitute "japanese housewives" for "ben bernanke" and it's almost an exact repeat, strong (yet absurd) demand for bonds, high debt, strong deleveraging pressure, and most importantly, flatlined money velocity.  I know there have been some pretty incredibly bad and good discussions here regarding the hyperinflation vs. deflation argument, but it really is both in a sense; there is a bottomless pit of shit to delever, and we're very likely going to just continue feeding that pit until somebody/group o' somebodies decides "yeah, time to wipe this sucker out".  We saw what the extremely small test cases (QE, and yes, they were extremely small test cases relative to the pit size) did, and it's very very clear that the medicine would kill the host.  So, exactly like Japan, we're going to continue to see the housing depression, commodity inflation, real wage flatline/decline in order to feed the parasite.  The alternative is death (of the system).

NidStyles's picture

HFT's are measured, or rather were measured, as M3. It's all margin buying on credit, there is no real savings or currency being used there. Not sure what you mean by Inflation picking up. Several sources are estimating Inflation to be close to 14% right now.