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Slow Money - Big Money
With the DOW blowing by milestones I went looking for other things that were at record levels. The first one that I looked at was M2. No surprise at all, M2 is bigger than ever. Charts of the long and short term trajectory of money supply:
The money supply is $3T higher than it was at the start of the 2008 recession. GDP is up $2T.
There is another component of M2. It has me baffled. It too is at a record. In this case it's a record low. I'm sure this important. I don't know why it's happening. I don't know what the consequences of this will be. This chart is screaming something:
My thoughts on the chart:
- It's fairly clear that sharp declines in the velocity of money is consistent with periods of recession. But..
- If recessions are the cause of the decline in velocity, what the heck is going on today? We are now three years out of recessions, and velocity keeps dropping.
- Behind each of the recessions is the Federal Reserve. To offset a slowdown in the economy, it drops interest rates. When interest rates fall, velocity declines.
- As interest rates have been forced to zero for years past the last recession, the velocity of money has continued to decline.
- There are no periods in history where sustained economic expansion has occurred while money velocity is declining.
If you buy into my (admittedly un-scholarly) assessment of money velocity, then you might conclude:
* The Fed's ZIRP policy has outlived its usefulness as a policy tool.
* The Fed's policy on Forward Guidance for short-term interest rates (another two years of ZIRP) is accelerating the decline in money velocity, and therefore counter productive.
Clearly, Bernanke and the other Fed Doves don't think there is a connection between record low money velocity and ZIRP. In fact, they must believe precisely the opposite. These folks are aware of the collapse in velocity, they know that this drop is a drag on the economy (particularly inflation), yet they have committed themselves to a policy that (IMHO) insures that money velocity stays historically low. Go figure.
One final thought on money velocity - it will return to a more normal level at some point. This may not happen until years into the future when monetary policy goes off "Fast Forward". But it will happen.
When it does, the high octane gas that is now M2 and not moving; will become the bloated M2 that is moving. Another dumb question comes to mind.:
The Fed has said that it will not back off until inflation gets to 3%. But when the Fed does back off, money velocity should accelerate very quickly - and this should give inflation another big boost. So when the Fed finally does respond to rising inflation, its actions will light a fuse on more inflation.
The Fed Doves are not thinking of that scenario. If they did, they would be not so confident in their ability to control the outcome. That, or they're bluffing.
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Excepting gov't being in involved in producing.
No, you can't look back for tired, you tried that once before.
aye...wouldnt be any worse than the lard assed sycophants feeding at the tax payers and central banks troughs right now...and he doesn't have nukes...wait...steve?
It's the same reason why we will never be allowed to have a recession again. The fed used to lower rates and buy bonds when the economy hit the skids. So if we were to ever acknowledge that we are in fact in a recession or may enter one soon, what the hell can the fed do about it? Nothing.
It's over. Now shut up and buy some stawks.
That's something I think about all the time... What the fuck do they do for the next recession while they are still stuck applying the "remedy" for the last one? And wouldn't they have to admit failure? Is that why no one's listening to Achuthan?
because some of those failures are quite old and very persistent? Take Nixon's 1971 one. He took the equivalent of key buttresses away from the USD "bridge", making it unstable. And yet the bridge is still being in use, despite the risk of breaking.
It's the same feel-good scenario the liberals in Cali use to justify the fact that $30 million homes are burning to the ground every summer.
"Oh, we can't let the forests burn. Why, why, if we just kept humans out of it, there would never be a forest fire again...but no! Somebody has to go smoking a <gasp!> cigarette and set everything ablaze!"
Ermm, wrong. Forest fires are a natural way to literally clear out the deadwood and help the forest thrive in an evolutionary environment. Temporary pain and death are actually what keep the forests healthy in the first place and have for billions of years. In fact, if it hadn't been for humans stamping out every lightning strike, there wouldn't be any uncontrollable blazes threatening homes and livelihoods.
It is the same principle in economics and finance. We should have let Lehman fail, and AIG, Goldman, Wells, BAC, all of them. Warren Buffet would've had it handed to him in a big way and he wouldn't have his smarmy self on TV every fifteen minutes. I wouldn't have liked to have seen the sight of him swimming naked when the tide went out. It would be okay that he did, I would just look the other way.
Deadwood. It's what's for dinner. Just not in my monkeysphere. Not my pals, my buds...
Great post. Creative destruction is the life blood of free markets and capitialism. So, both are dead under the current system. But the FED was created to enable endless bailouts, not bail-ins (bondholders take the haircut when misallocated capital is squandered) We have no negative feedback mechanism and without one, as any engineer understands, you have an unstable, run-away system.
Survival of the fittest will not be denied.
Philosophically speaking, it has always bothered me when we humans take a scientific approach to trying to figure out the machinations of the mind. Jung proved that Psychology was essentially an unattainable science when he spoke about acausal connecting principles and the fact that human existence is not a quantifiable instrument that can be measured without the use of tools that we (still...) don't have.
When science and mathematics (hence, Engineering...) is introduced into a human system, there are so many variables left unchecked that it makes itself a chaotic system.
Even George Soros (okay, "Boooo"...) says the system of markets is Reflexive and, not unlike Jung, realises that it cannot be measured by the tools at our disposal today and can probably never be measured in the futures because of chaotic and incosistent variables. His book about Reflexivity should be very enlightening from and Engineering stand-point, especially as systems become more complex and, by design, take on more human characteristics.
http://en.wikipedia.org/wiki/Reflexivity_(social_theory)
:D
+1 the social "science"'s physics's envy - humans ain't molecules
Humans are totally unpredictable. We don't even know with certainty what we will do ourselves when faced with given situations. The "social sciences" may use math and may perform tests/studies based on scientific principles, but the conclusions do not have true scientific application.
X may or may not equal y ;-)
You'd enjoy Nassim Taleb's book Black Swan. I hadn't read it because I figured I knew what it was about, I was wrong. Turns out the past is a very poor predictor of the future, simple as that. We construct belief systems to make ourselves feel better, but they're rubbish.
Human minds don't store or process information the same way that the universe works, Just the way that was most useful throughout evolution. Our minds weren't built to understand the univers, jsut to keep us alive long enough to pass on your genes. Using our minds to understand the way the universe works is like using a potato masher to pound nails.
Orly, been really enjoying your posts lately. Keep it up.
Many thanks...
Lately?
Ha!
:D
Lol yeah sorry, just started paying closer attention.
Yeah. Great stuff, Orly. Remember us poor slobs when you get tapped to be a contributor, eh?
Never gonna happen, 101, but I appreciate the thought.
:D
Never say never. This is mostly a boys fight club, and you fight damn well for a grrrrl.
This place has needed a woman's touch since Marla left
"The Fed's ZIRP policy has outlived its usefulness as a policy tool."
According to my admittedly limited understanding of Austrian economics, it is exactly the slow-down in the velocity of money that has caused this mess in the first place. As long as there is credit expansion in the economy; as long as someone is willing to take a loan on interest; as long as someone is willing to pay more for something than the last guy, then the "economy," as it has become known, will expand. If these things slow or indeed contract, then the velocity of money ceases moving forward and the economy begins to implode.
The path that we were set on may be called a "consumerist" economy and relies on people buying more iStuff and be willing to pay more for it each year. Or move up to a bigger house, which, of course, costs more money, thus the bigger the loan, hence the bigger the interest payment. What happens when the velocity of money has expanded to the point that it is not possible, in the aggregate, for consumers to go on consumering in an expanded fashion? It implodes.
What happens when the price of homes has been set at abnormally high levels for so long and even the offer of cheaper and cheaper credit is depleted such that it, too, is unable to expand? Again, that market implodes.
All that has happened in the last thirty years or so, is for the economy to constantly draw forward expansion (demand...) because it has been threatening stall speed since 1981. Cheaper and cheaper money was the result and that was to continue the forward velocity of money. Everyone knew what would happen if the velocity of money stalled. Everything would implde.
Alan Greenspan saw the Thelma and Louise scenario playing out for the global economy with his pedal to the metal, easy-money policy. Indeed, once he'd realised he'd made a giant mistake, he tried to reverse course and, seemingly out of nowhere, began to raise rates. He knew it was too late for that, so he gunned it and headed for the cliff at full speed, taking everybody but Brad Pitt with him.
What Dr. Bernanke and the Fed now have to deal with is the result of a systematic drawing forward of credit expansion that has been in place for many years. In his- perhaps arrogance?- he believed that he could pull the world out of credit contraction by blowing the biggest bubbles the world has ever seen, that of ZIRP, TARP and QE4evah.
Now, he is terrified because he, as Alan Greenspan, sees that it is too late for anything to stop the contraction of credit. He can't blow hard enough like he thought he could. In the words of the youth today: epic FAIL.
So in a roundabout way, I would suggest that you're looking at this the wrong way...backward, in fact. The Fed's easy-money policies are not now failing but have failed the entire time. In fact, there is no way they could have worked in the first place. Greenspan knew in 1995 that it was too far gone. Now he can only shake his head at the mess he helped create.
What we are left with is credit expansion not even sitting still any more but contracting in an exponential fashion, as your chart shows. All this will come home to roost sooner or later. There is no "out" of this one. We are in the midst of the biggest deflationary scenario in the history of global economics (that may be a bit of an exaggerration...), and there is nothing we can do to stop it. It is best to let it happen and get out of the way.
:D
Another well thought comment Orly.
Your conclusion is spot on. It is "pedal to the metal" not only for the US but the world economy. The FED as the debt supplier to the world has infected most other Central Banks. No other Central Bank or other Sovereign can break away without bringing the world economy to its knees. The powers that are currently in place all know this.
This is why we have seen no substantial reforms in the Basel Accords, Accounting Standards, Too big to fail, Criminal Procecusions, Reforms in Trade talks, etc. None of these can be alowed to happen. Its full speed forward heading for the cliff. They know it - few of us know it also - the bulk of humaity is ignorant, could care less or feal powerless to do anything about it.
The next worthy discussion and anlysis is; How far ahead is the cliff in time and or Central Banks Controls?
In a prisoner's dillema scenario, is there a benefit to central banks for defection?
Bruce's velocity of money chart show that, the sharp decline started around year 2000, well before the 2008 "crisis". And recall that is the thing that credit does, it pulls forward demand from the future. You want that big screen TV but instead of waiting two years until you've saved up, you borrow and buy it today. With the orgy of debt we've had, no wonder "demand" has dried up. The other thing easy money does is finance excess capacity. Empty Chinese cities but also lower and lower capacity utilization are the symptoms.
"He can't blow hard enough like he thought he could."
I think I'll write that one down and read it to my grandkids while when we are all in the bunker together. A childrens book of the future! Great post.
Henry Hazlitt has a chapter on "The Velocity of Circulation" at the Mises.org site that I found interesting.
They have a wealth of resources over there on Austrian Economics. Quite a few articles on this topic as well.
I haven't seen any detailed analysis that the U.S. economy can "grow" long term without credit expansion faster than the growth itself. Why is that? Because it can't?
I disagree that it can't. In fact, I am sure it can but...
(Pollyanna Warning...)
The money moving in the economy must be titrated to the creation of real goods and services, as well as the effective cost of living, including housing and rents. It is only when banks realise that they can pull forward demand from the future that we get into trouble.
It is possible to do but there must be rules in place to keep everything in balance. When government lowers rates, not to sustain a viable economic path, but to enhance the gravy train of bankers, it is poison in the well.
For a small example, whatever happened to the rules that required twenty percent down, so that owners have a chunk of skin in the game? Why did government allow banks to make NINJA loans?
Well, their banker buddies came to DC with the finest cigars and a cask of Amontillado and got the rules changed in their favour. Pollyanna says that was a grave mistake and should never have happened in the first place. It is short-term thinking for immediate gratification and no future planning at its worst and it is running rampant all over the globe.
Now, central banks have to run around playing Whack-a-Bubble, only with a bigger and bigger hammer each time. This time, it took the entire world to lift the hammer to try to quash this bubble...only to have it rear its hideous face somewhere else later on. But what happens next time when that hammer is too big for even all the central banksters in the world to lift? I'll leave that to your imagination.
News Flash: What we need is a government looking out for the people and not for banks. It really is that simple.
:D
Bruce,
Professor Fekete has long pointed out that the Fed's actions actually accomplish the opposite of what they want to do.
Here's just one of his arguments on that basis:
http://www.professorfekete.com/articles/AEFKrugmansMonetaryMadness.pdf
You have to ask yourself if you're a business owner:
"Do I take on that large capex project now when my competitors can do the same thing at an even lower interest rate in the future and use his rate advantage to margin me out of the market?"
"Or, do I take on that capex project now when with all this hot money, commodities have scarcely budged and generally fall in a low interest rate environment?"
"Or, do I spend the cash I have accumulated on hiring etc, while I'm still paying the mortgage on a factory I built 10 years ago and my competitor is building one now at a much lower interest cost?"
"Or, how do I find a bank willing to take on the risk of my large project when they're knocking risk free returns out of the park?"
ZIRP creates lethargy in the real economy. 20 years of Japan has proven that to us all. Bernank thinks what he is doing is inflationary, but it is actually contributing to deflation. Real wages are actually dropping. Boomers are retiring or reducing their work week or liquidating their investments. Aggregate demand has to drop. But Bernanke insists on pushing on a rope rather than letting the market find the right level of capacity.
What is velocity of money?
Velocity of money applies when GOODS AND SERVICES CHANGE HANDS.
I call this ROBINSON CRUSOE MONEY. Can you use money in a deserted island? The answer is no, no goods and services to change hands between people.
This is exactly what's happening. Not much going on, not much being produced, not much being serviced, not many securities are left to trade.
I'm 62 and have most if not more then then I can tend to. Many my age either are in the same shape as me looking at slowing things down or have lost their jobs and are so broke that they;re on SS disability or taking early SS. at the rate of 10,000 aday. Hence no matter what the goverment does aggregate demand is going to fall. I believe that those that have saved or have pensions are cooked. The goverment is going to wash all this debt out with the printing press.
Time to check off another comparable feature to the Japanese economy.
" A notable feature of the Japanese economy following the banking crisis of the late 1990s is the drastic decline in the velocity of money...."
http://econpapers.repec.org/paper/imeimedps/11-e-16.htm
According to Martin Armstrong, the decline in the velocity of money is due to people hoarding money. From his research this is what happens in times of extreme uncertainty. There are a number of obvious factors contributing to this uncertainty, the most prominate of which is the debt crisis.
My take is the velocity of money is declining because consumer debt is declining, and the increase in money supply is caused mostly by government spending (printing). The velocity of money I believe is described by borrower #1 getting a $100 loan and purchasing a car. The seller of the car deposits the $100 in his bank, and his bank can loan out $90 of the $100 because of the 10% reserve requirement. That $90 gets loaned to borrower #2 who purchases an asset and is deposited in bank #2. The cycle goes on to infinity but practically ends at 8.72 times the original loan with a 10% reserve, or $872 created from $100 of printed money via the fractional reserve system. The velocity should decrease if the reserve requirement is raised (from 10%), or fewer loans are taken out, which has the effect of creating less money.
The opposite effect happens if people pay down debt (instead of borrow), then the money outstanding reverses the other way so $100 reduction in loans pull $872 from the money supply.
The increase in money supply has to be solely from non-private creation of debt or literal money printing.
Only if the system isn't rigged.
2/3s of the so-called "beautiful deleveraging" is people defaulting, not people paying down their debt. That defaulted debt is not extinguished, it just goes from the bank to the Fed, where they stuff it under the rug at face value.
Good for the "rent collector" in DC, all that forgiveness is taxed as income.
Re: Non-private creation of debt
True until recently. Look at the St Louis Fed total credit market debt graph.
It must be based on a percentage basis,you would not notice ten apples missing from one thousand apples. The numbers are so big the velocity dont even show.
Bruce your observation of a massive increase in M2 and drop in money velocity comes from the simple fact we are in a deflationary environment. The printed money is entering into the economy and ending back in the vaults of the big 5 banks/Fed so they can cover their massive losses on real estate and etc. Consumers, corporations and gov't entities are all deeply in debt. Money goes from the Fed into the hands of a few select. It is passed around a couple of times before being sucked into the bank black hole. (Normal economic situation the money would move around continuously without restriction.) Velocity will continue to decrease unless debt is either forgiven or defaulted upon.
This is why the inflation rate has be low with the Fed printing like mad.