What's On Tap..

Velocity of Money

There is (at least) one measure of economic health that is hitting all-time lows – one that suggests that the monetary policies of the last 8 years may not be having as much of an inflationary effect (beyond financial assets) as many are speculating. This measure is referred to as the velocity of money.

The velocity of money loosely refers to the number of times a dollar is spent to buy goods or services (i.e. contributes to GDP) over some rolling period. It is calculated directly by taking the ratio of quarterly nominal GDP to money supply. The assumption is that injecting money into the system should be met with a proportional increase in consumption, as those extra dollars are used to consume more goods and services. A common measure of money supply - M2 - is defined to be the sum of all cash, checking deposits, and money market funds. This is a popular measure used in economic analysis, as these categories directly capture all liquid money available for consumption:

Federal Reserve Bank of St. Louis, Velocity of M2 Money Stock [M2V], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/M2V, May 23, 2016

Federal Reserve Bank of St. Louis, Velocity of M2 Money Stock [M2V], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/M2V, May 23, 2016

The implications of this trajectory are unclear. As are many topics in macroeconomics, theories about what this measure represents is hotly contested. The only definitive statement that can be made is that growth in GDP has not kept pace with the growth in M2, and the differential has pushed this measure to all-time lows! Whenever a major measure of monetary policy is reaching new extreme levels it should draw scrutiny from the investment community.

One major message that could be gleaned from this is that inflation expectations may be a bit optimistic given some of the structural challenges that still exist within the U.S. economy. Yes, lots of new cash has been created through stimulus and QE, but that money is not translating into new economic growth. This could be due to a myriad of both old and new issues creeping up on the market – stagnating wage growth for uneducated workers, an increasing student loan burden (nearly $30,000[i] for new grads), a decreasing workforce participation rate, and home prices/rent again becoming a significant portion of the inflation number. The year over year (“YOY”) rise in the shelter category stood at 3.2%, while consumer items such as apparel, televisions, software, PCs, and telephone hardware are all facing steep YOY price decreases. Combined with the dramatically declining M2 velocity, a weak Q2 outlook from corporate earnings calls, and economic data that is mixed at best, the picture that is painted is quite bleak.

The Fed may - yet again - be behind the curve.

"The Institute For College Access and Success." Home. N.p., n.d. Web. 25 May 2016.

William Royer,    Portfolio Manager / Associate Vice President

William Royer,

Portfolio Manager / Associate Vice President

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