Inflation Alert: The Velocity Of Money Has Finally Bottomed

Forget the Trump tax cuts, the Senate budget deal, the Fed's Quantitative Tightening and the collapse in foreign buying of US Treasuries: after years of dormancy, the biggest catalyst for a sharp inflationary spike has finally emerged, and it is none of the above. Behold: the velocity of money.

Over the past decade we have shown this chart on numerous occasions and usually in the context of failed Fed policy. After all, based on the fundamental MV = PQ equation, it is virtually impossible to generate inflation (P) as long as the velocity of money (V) is declining.

None other than the St. Louis Fed discussed this  in a report back in 2014:

Based on this equation, holding the money velocity constant, if the money supply (M) increases at a faster rate than real economic output (Q), the price level (P) must increase to make up the difference. According to this view, inflation in the U.S. should have been about 31 percent per year between 2008 and 2013, when the money supply grew at an average pace of 33 percent per year and output grew at an average pace just below 2 percent. Why, then, has inflation remained persistently low (below 2 percent) during this period?

The issue has to do with the velocity of money, which has never been constant. If for some reason the money velocity declines rapidly during an expansionary monetary policy period, it can offset the increase in money supply and even lead to deflation instead of inflation.

The regional Fed went on to note that during the first and second quarters of 2014, the velocity of the monetary base was at 4.4, its slowest pace on record. "This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. This implies that the unprecedented monetary base increase driven by the Fed’s large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP (either P or Q)."

So why did the unprecedented monetary base increase created by years of QE not cause a proportionate increase in either the general price level or GDP? The answer, according to the Fed at least, was in the private sector’s "dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of money, as the figure below shows."

In light of the recent collapse in the US savings rate to just shy of record lows, that explanation makes zero sense, and what the St. Louis Fed meant to say is that of spending (or saving) freshly created money was immediately invested into risk-assets, almost exclusively by members of the 1% who were "closest to the money" . This explains why there was almost a 1:1 correlation between the increase in the Fed's balance sheet and the S&P for years.

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In any case, for whatever reason, after declining for nearly a decade, the Fed's greatest wish after all these years appears to have been granted, amd it now appears that the velocity of money has finally bottomed, and is, in fact rebounding. And, in couldn't come at a worse time: with Trump dumping trillions into the economy to stimulate it further, the Fed is now painfully behind the curve, which means that chair Powell will find himself rushing to hike rates at virtually every opportunity to avoid getting Volckered.

It may be too late, however: since directional changes to the velocity of money take place at a glacial pace, the chart above from Deutsche Bank suggests that the Fed should have started its tightening cycle long ago.

Still, the jury is still out on just how badly inflation will overshoot once money "spills" out of capital markets and into the broader economy, and how many rate hikes the Fed is "behind". One thing that is certain, however, is that as we find out the answers, for risk assets and active managers, all of whom recently listed rising rates and inflation as the biggest risk factor... 

... it's only downhill from here. 



jaxville Yukon Cornholius Thu, 02/08/2018 - 17:00 Permalink

  It is shocking how the numismatic and collectible auctions have been realizing lower prices .  Only top level rarities seem to be holding their own and even they are looking shaky. It is clear that disposable income is drying up.  We will probably see inflation but something far uglier is going to happen first.

 When it becomes public knowledge, don't buy into the "gold doesn't do well in deflation" bunk.

 Before you begin telling me about how the price of chicken has gone up at your local store,  try to find a market that pricing is not the result of some sort of government intervention.  Wars, sanctions, subsidies, tariffs, currency devaluations, taxes etc etc all are the biggest factor in wholesale prices. 

 Now is the time to liquidate and move into cash and gold (and/or silver).  Some smokin' deals are soon to be had.  Make sure your cash is unencumbered so you can exit into more tangible goods once prices start rising due to monetary inflation rather than shortages that are the result of government policy.

In reply to by Yukon Cornholius

CheapBastard hedgeless_horseman Thu, 02/08/2018 - 15:12 Permalink

Inflation hit some sectors, but no others.

Houses soared off the charts, food rose, etc but many sectors like energy and retail got decimated.

Plus, there's huge money destruction with massive defaults that have been occurring.

When Wall Street stops malinvesting and when people actually have some discretionary money to spend (after years of middle class destruction and offshoring jobs by Hussein Obama) velocity will increase imho.

Some of the malinvestments are crazy esp in RE.

In reply to by hedgeless_horseman

itstippy CheapBastard Thu, 02/08/2018 - 15:57 Permalink

Incomes will never recover for middle-class America.  Legions of office workers, factory workers, salesmen, and retail clerks are now obsolete.  To make money in the new economy you will have to be above average intelligence and physically fit (tradesmen), or way above average intelligence and able to focus (technology whizzes).  Creative artistic people will be OK too.

Pear-shaped, glad-handing, alcoholic insurance salesmen and pretty, airheaded, chatty steno girls are Shit Outta Luck.  Mid-level manager jobs will disappear too - no workforce to manage, no manager needed.  

Short Men's Warehouse and Fashion Boutique and go long Carhardt Workwear and whatever it is that the Google Guys And Gals wear.

In reply to by CheapBastard

rbianco3 itstippy Thu, 02/08/2018 - 20:21 Permalink

I've been racking my brain trying to think about what us techies like to spend money on. Not much, but I'm an older one who's burned out. Maybe gold, prep's, amphetamines/coffee and the occasional electronic gadget. Been wanting a 4x4 for many years but apparently not bad enough. Too burned out to have the energy to spend.

I don't know why- but lately am usually 30-60 days behind my time sheets / invoices, which are paid on Net-30 so there's a 2-3 month pipeline of cash that isn't really needed. You'd think I'd be thrilled but rather it feels like life has no purpose and a lot of it has to do with the dumb liberal's making America suck again.

Maybe socialism is the only solution to the problem.

In reply to by itstippy

MK ULTRA Alpha gatorengineer Thu, 02/08/2018 - 15:51 Permalink

Very good, but the article is proving QE1, QE2, and QE3 failed to revive the economy.

Another poster said velocity of money was the rate money changed hands, that's text book economic 101.

Lower demand is a cause of a lower velocity of money. It doesn't explain why a lower and lower velocity of money during a time the Fed was dumping money on the economy.

Could deflationary waves from Asian manufacturing have something to do with the velocity of money?

In reply to by gatorengineer

AGuy nuerocaster Thu, 02/08/2018 - 17:21 Permalink

"More activity going to underground economy and fewer business startups is the solution to your big mystery."

Demographics! Boomers are past their peak spending years. A lot of boomers are now spending their remaing working years saving for retirement. The younger generations don't have the numbers or wages to replace boomer spending.

Debt is problem #2, as people hand over a lot of their cash flow to service their debt. Ditto for businesses.

In reply to by nuerocaster

SeuMadruga Bunga Bunga Thu, 02/08/2018 - 15:46 Permalink



If "GDP/M" ratio increases, either GDP is rising and/or money supply is falling, the latter being price deflationary on a ceteris paribus environment.

In other words, so-called "money velocity" cuts both ways, also and especially when prices are going down (e.g. during financial market crashes with high trading volume).

In reply to by Bunga Bunga

Bill of Rights Thu, 02/08/2018 - 15:04 Permalink

Truly amazing to witness the same bull shit year after year. These assholes we elect and these so called Economist haven't a clue whats going on or a vision for change.

ReturnOfDaMac Thu, 02/08/2018 - 15:08 Permalink

What a load of horsepucky. V=0 because all of the "M" is in the hands of only a few and those few keep it in the banking system.  It's really just that fucking simple.  No money in the real economy, no velocity of money in the real economy. Don't need an econ PhD to see that.  Really guys? Really?  If economists can't see the obvious we are in more trouble than I thought.  Maybe instead of BTFD I should be STFR.