Velocity

Sometimes you read something and think, only a Fed economist could come up with something that ridiculous. This paper put out by the Federal Reserve of St. Louis postulates that money hoarding is causing the velocity of money to collapse in the US economy.

In the paper they utilize the quantity theory of money equation as follows:

MV = PQ

In this equation:

• M stands for money.
• V stands for the velocity of money (or the rate at which people spend money).
• P stands for the general price level.
• Q stands for the quantity of goods and services produced.

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?

Declining Velocity

The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below . 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.

They perform some algebra and show that Velocity equals nominal GDP/monetary base. Over time, this number has been falling. In their estimation, the recent gargantuan growth in the monetary base should have produced inflation. In their world, it has not. Their conclusion, people are hoarding money.

Ridiculous.

Nobody is hoarding money. These Fed economists think inflation is low because they are looking in the wrong place. We have phenomenal levels of inflation in the securities markets and in real estate. Household net worth is exploding, up nearly $10 trillion last year alone. Velocity in the financial markets is rocketing higher and there is clearly a race on to spend “money” as fast as possible.

Monetary debasement is creating copious amounts of inflation and a surging rate of velocity, or turnover of the monetary base, that only a Fed economist could miss. Of course, all of this inflation, unbacked by savings or incremental output, is the Austrian definition of malinvestment and wealth destruction. This is something missed by everyone at the Fed as well. 

 Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.