The Scariest Chart In The World Part 1

I am re-posting this as the charts didn’t show in the prior version for some reason.  I’ve pasted them in a different format.  Please view the post in your browser if need be.

All that money the Fed has been printing?  It’s not actually circulating.  The faster the Fed prints it, the slower it seems to go.  Money went from flowing like water in the 90’s to maple syrup in the 2000’s to molasses in 2010’s. 

You don’t need to know anything about monetary policy to read the three charts below (same data series starting from 1959, 1987, and 2007 respectively).  Something has clearly down-shifted drastically since the 2007 bust after starting to slide ahead of the 2000 bust.

That something is “monetary velocity.” Best understood by its folk definition – how fast a dollar bill changes hands as it moves around the economy.  Calculated as the quantity of money floating around at a given level of GDP.  A little money moving quickly = high velocity.  A lot of money moving sluggishly = low velocity.

What makes this double scary is the final chart, which is (roughly calculated) monetary velocity for Japan since 1996.   The Japanese have been printing money like mad, but its circulation has just decelerated.

I’m going to pick this up in a subsequent post, but take a look at these charts.  Take a look at the excellent post cited below.  Let it all rattle around for a bit

Velocity 1959 – Present

Velocity 1989-Present

Velocity 2007-Present

Japan chart (roughly calculated myself as GDP divided by M2 Money)

Rough Calculation of Japanese Monetary Velocity 1996 – Present

A more textbook explanation of Monetary Velocity follows (the linked piece is excellent BTW)

Money velocity, as might be suggested, isn’t necessarily how frequently a certain $1 bill exchanges hands in the economy through financial transactions. Hence the concept of money velocity spuriously suggests that its increase comes as a consequence of economic actors’ increased willingness to spend the same amount of money at a faster pace. But that’s not actually what’s taking place. Rather, money velocity is more accurately a measure of the rate of credit formation.

If the product of the money supply, M, and the velocity of money (i.e., credit formation), V, increases – i.e., M*V – this will either increase prices, P (i.e., inflation), increase real output, Q, or both.  The relationship was first expressed by Irving Fisher back in 1911: M*V = P*Q

P increases through an increase in spending. Q increases if the sum of productivity growth and growth in the number of hours worked in an economy increases.

One common criticism of central banks in recent years has been seemingly profligate monetary printing, or the idea that vast expansions of the money supply are inflationary. This is not correct, given that this money needs to be spent before it can influence prices and therefore inflation.

This is, for example, why Japan is expanding its money supply so rapidly. For demographic and other reasons, Japan has been fighting the ogre of deflation for nearly three decades. If the demand for lending remains low and credit isn’t formed in sufficient enough quantities – i.e., a fall in V – then the Bank of Japan has no other option but to keep expanding the money supply, M, in order to keep M*V above its previous mark.

If M*V falls, deflation sets in. This is bad, given some low level of inflation is necessary to incentivize consumption, which is primarily how developed economies grow.

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3 Responses to The Scariest Chart In The World Part 1

  1. Dominique Watkins says:

    This is VERY interesting, please continue !

  2. Spencer Hall says:

    DFIs do not loan out existing deposits. That is the macro error.

    • Steve Kamman says:

      Spencer, I totally agree. Any ideas as to WHY would be very welcome. I do wonder if the availability of that nice, fat, risk-free IOER rate might be part of the problem. The Fed didn’t used to pay interest on reserves so banks had to look for returns elsewhere. Now they can just leave the $$ at the Fed. I also suspect that IOER was really a subsidy to get banks solvent again after the financial crisis when we were all in “extend and pretend” mode on a lot of loans. It might actually be stimulative if they could end the program, but most subsidies take on a life of their own so…. Thanks for the comment.

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