It is correct to say that money velocity does not do anything.
It does not do anything in the way that the speedometer on your car
does not do anything.
But it is an important measurement, a ratio of the amount of money being
created and it relationship to productive, organic growth in the economy.
And it is well known that money velocity peaked in 1997, and has been in a
steady decline since then. It is now at lows never seen before in the
US economy.
Why is this?
Below is a
recent article from Anthony Sanders of George Mason University that makes
a good case that it is do to the 'bubble economy' which began with the
expansion of the money supply to promote housing ownership.
Tony is an expert on financial aspects of housing, among other things, and as
you know I follow what he writes closely.
But as I have a slightly different perspective on that period of time, I
would take this a step further and draw a broader conclusion. The
article does not account for the massive tech bubble, covered by the fig leaf
of a 'new era internet economy,' giving it the name of the dot-com bubble,
with which I happened to be intimately familiar.
Who can forget Chairman Greenspan's irrational exuberance speech which
shanked the stock market in December of 1996.
Clearly, sustained low inflation implies less uncertainty
about the future, and lower risk premiums imply higher prices of stocks and
other earning assets. We can see that in the inverse relationship exhibited
by price/earnings ratios and the rate of inflation in the past.
But how do we know when irrational exuberance has unduly escalated asset
values, which then become subject to unexpected and prolonged contractions as
they have in Japan over the past decade?
Alan Greenspan, The Challenge of Central Banking in a Democratic Society,
1996-12-05
As it turned out, Chairman Greenspan was blinded by ideology, as he himself
admits years afterwards, never seeing a bubble that he didn't like. But
his successors have followed the same sorry route of feeding the financiers
to the detriment of the broader economy.
The problem was not the mortgage credit bubble per se, but rather
the policy bias towards managing and regulating the economy itself, with an
aggressive expansion of the money supply under Alan Greenspan (remember the
Y2K scare) and Treasury Secretary Robert Rubin, along with bubbles in the
usual suspects, in this case the financialization of housing and the
tremendous bubble in the equity markets.
And how can we forget the Rubin doctrine of propping up the financial markets
using the SP 500 futures before the fact, which he thought was cheaper than
cleaning up the mess of a market crash after the fact. Remember The
Working Group, aka The Plunge Protection Team, housed
within the Exchange Stabilization Act, that came out of the scarring
experience of the Crash of 1987, which itself was a precursor to the woes
created by weakly regulated, artificially exotic financial instruments and mispriced
risks?
And let us not forget the overturning of Glass-Steagall in a decades long
campaign richly underwritten by the Wall Street Banks, and the infamous Financial
Services Modernization Act of 1999.
One might conclude that Reagan made the nest, and Clinton laid the egg.
And Bush II and Obama have nurtured this chimera economy along.
The causes for this are debatable and many, and I have considered it
here many times as the credibility trap,
What we have now, an economy based on artificial support market resulting in
a series of asset bubbles and crashes, with a growing inequality in income
distribution. This is the natural outcome when a policy body decides to
manage or 'stimulate' the economy by shoving freshly minted dollars top down through
a weakly regulated, increasingly corrupt financial system whose outsized and
largely unproductive profits act like a private tax on the real economy.
It enriches a few, and enervates the productive working class.
This is why I have said that until there is financial and political reform,
there will be no sustainable recovery. And the longer this continues,
the more that the organic productivity of the economy will decline.
'Stimulus' is no panacea. It must be productive and targeted towards
increasing aggregate demand within a healthy economy which distributes the
rewards for productive efforts broadly amongst its participants.
And so I continue to say that significant financial and political reform are
the sine qua non for a genuine economic recovery. Doing more of the
same may seem neurotic, but it is richly rewarding to a small group of very
powerful people, something which we have seen in the history of this country
before.
Confounded
Interest
Dying Money Velocity Began in 1995 with Massive Mortgage Credit Expansion
M2 Money Velocity (GDP/M2 Money Stock) peaked back in Q3 of 1997. And it has
mostly gone down hill from there. As of Q2 2016, M2 Money Velocity is
at the lowest point in history.
