The long-promised exploration of monetary velocity! Starting with a quick shot of “Animal Spirits.” And no, that does not mean some bearded hipster’s liquor distilled from dead squirrels and other roadkill. But we desperately need a swig of the stuff…
“Animal Spirits” have been THE key missing factor in the economy (and stock market outlook). The term is often narrowly confined to investor sentiment. That in itself points to how much investors tend to (wrongly) conflate “the economy” with “the market.” The original coinage was by John Maynard Keynes.
“Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”
That “spontaneous urge to action” is what leads a consumer to take the family out for dinner or a CEO to build that new plant. And you really don’t need a chart to tell you we are still suffering from global angst… But a chart does offer a way to track the (hoped for) return of those happy feelings.
Which brings us to the woeful tale told by monetary velocity….Chart: Monetary Velocity
Monetary velocity is my (imperfect but informational) tracker for “animal spirits.” Velocity is “the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy.” If velocity is high, money is changing hands quickly and the economy “feels” like it is humming along. A lot of that activity may be non-productive “taking in each other’s washing” but the pace is a powerful social cue and economic driver.
If velocity is really high? Look at 1999 and 2007 in that chart and sniff a remembered whiff of the electricity (or crack cocaine/meth) in the air back then.
And if velocity it low? Per the Fed “A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. We can think of shorter- term transactions as consumption we might make on an everyday basis.”
The Fed has been printing money like mad since 2008. The chart above tells you its just not circulating. It is possible the world has changed irrevocably (the “secular stagnation” thesis). It is much more likely that we will eventually revert to our free-spending ways. Velocity starts to trend back up. With an eventual mania to follow.
Think of low velocity as potential energy that could/will convert to kinetic energy. Kinetic energy that feeds animal spirits. That drive the real economy and (probably) the stock market. “Dry brush piling up” in the absence of a spark to light that metaphorical forest fire. The assumption is that a spark comes along eventually – hopefully lower oil prices, rising wages, and higher employment. Pumping more of that money into parts of the economy where it is likely to circulate faster.
- Low velocity explains why that M2 supply (all that Fed easing) isn’t translating into more economic activity. They are printing money like mad, but it is circulating a whole lot slower than in the past.
- Why the slowdown? A weak multiplier effect from the sectors where the Fed is pumping that money (multiplier = how much a dollar of spending is “multiplied” by follow-on dollars of economic activity). Instead of re-spending that money back into circulation, it has just pooled there. Deeper and more stagnant over time.
- A lot of that money came to rest in the hands of the top 10% (via wealth effect), banks, and commodity producing countries. It ended up going to “assets” not “activity.” They pooled it in squirreled-away “savings-like” activity – bonds, bank balance sheet repair, high end Real Estate, offshore slush funds (see “high end real estate”), and sovereign wealth funds.
- The historically lousy multiplier effect in those sectors only got worse as the money pooled deeper and stagnated further. Their response was to squirrel away more money, further slowing velocity. Cue today’s negative long-term interest rates. Rates aren’t negative because of central bank “manipulation.” At least not long-term rates (which are set by markets not central banks). It is because the stagnation has gotten so bad and deep that people are paying to store money. A bit like the cost of oil storage keeps going up as oil pumping goes deeper into glut territory.
- Those stagnant pools represent tremendous potential energy. Dam’s waiting to burst. Dry brush piling up waiting for a spark. Oil stores waiting to hit the market. (Insert your favorite metaphor here). Take another look at the chart above. Velocity is clearly low. Getting back to 2000’s level of velocity implies a 50% increase. Getting back to peak is almost a double. Even 1980’s levels imply a hefty jump. That’s a nice heady feeling we just don’t have today. Animal spirits.
My hope (and it is just a hope) is that a shift of that money flow to the pockets of broader-based, lower 90% developed world consumers will lead to faster circulation. Animal spirits re-awaken. Velocity turns upward. Things start to hum again. Ordinary consumers have a MUCH higher multiplier (higher propensity to spend on an incremental “new” dollar). And they spend it on higher-multiplier stuff than fancy real estate, art, and tasting menus.
How does that happen? Fiscal stimulus? Government borrowing (at negative rates = free money) to fix our rotting infrastructure? I’d say “insert guffaws here” but it really isn’t funny. Even our central banker’s can’t summon up the courage to state the obvious need for fiscal stimulus.
But maybe, just maybe we can claw our way there via lower oil prices. Higher minimum wages. Higher employment. Slower and with (much) more lasting damage done than if we’d followed the smart playbook of fiscal stimulus.
And admittedly consumers haven’t being doing much obvious spending so far. But every week that gas stays cheap is another week the money piles up in the pockets of someone who might actually (gasp) spend it on something useful. I am hoping last week’s GDP report (stronger consumer spending offsetting weakness elsewhere) is the start of a velocity upswing. All big moves start small.
If animal spirits do start to revive, that catalyst will convert huge stores of potential energy into kinetic energy. The stagnant pools drain in a flood. The dry brush burns. And the animal spirits course faster and faster. Velocity returns!
It could get out of hand and drive silly-stupid stock market valuations until it all comes crashing down. It probably will. Today’s mis-match between paper wealth and productive potential seems too great. You need a bubble (and subsequent bust) to destroy paper wealth on the appropriate scale. We probably end up with a bonfire of the vanities. So sell that art collection….
Of course, a lot of
paid shills for the wealthy “serious observers” argue we are in that bubble now. My sense is they are confusing that squirreling-away-of-money-activity with the forgotten art of actual-investment-in-productive-assets. Regardless, low/negative long-term rates and that velocity chart say otherwise. They’d both be riding high and happy if we were in bubble territory. And they aren’t.
Admittedly, the stock market might or might not follow along with rising velocity. It may already be partially discounting in a positive scenario. But my general rule is that market hasn’t topped out until friends and family stop asking you for stock tips and start giving you stock tips. That hasn’t happened to me so far, so….