This is not good news. The latest reading of the Velocity of Money, for the 3rd quarter ended showed another decline. This is something that is having a tremendous impact upon the economy.
When the Velocity of Money is slowing, we know there is a problem. This is especially true when we see an expansion of the money supply. Yet, in spite of all that is taking place, we keep seeing declining numbers.
In others words, the growth is not resulting as forecast. This is common when exiting a recession, albeit this one was very brief. Usually, the modus operandi is to stimulate like there is no tomorrow. This leads to some decent numbers, especially Year-over-Year (YoY). The result is that people start screaming about all the money being spent, so the stimulus stops.
Of course, the economy cannot handle it, just like we are seeing now.
Why Is The Velocity Of Money Important?
The Velocity of Money is vital because it shows the relationship between the money supply and GDP. We have a system that believes will we see widespread economic activity during inflationary times. After all, according to the economists with the fancy degrees, people will rush out and buy as prices are increasing. They believe an economic form of FOMO takes place.
Just like most things that deal with economists and the central banks, they have things completely backwards. When prices go up, people spend less. This is especially true when we are dealing with a supply chain shock like we had the last 20 months.
We are seeing the impact on the Velocity of Money. Of course, this is not a new situation. As this chart shows, we got on this path decades ago.
After peaking in the 1990s, the VoM is on a downward trajectory. Since the onset of COVID, we really plummeted. Since bottoming out, we have one quarter, Q3 2020, where there was a bounce up. After that, it is 4 straight quarters of heading down.
When money is not flowing through the economy, it is hard to attain growth. One scary thing is the USD has the fasted VoM of any of the major currencies. Countries like Japan and China have a rate that is half of what we are seeing in the USD.
Think of it this way: a low VoM means there are a lot of hodlers as opposed to investors. But why would this occur?
QE Is Not Easing
For much of the last 14 years, we had a ton of Quantitative Easing globally. This was started by the Japanese in the early 2000s and the US along with EU jumped on board after the Great Recession. While the US eased up for about 5 years in the 2010s, the EU kept going.
The challenge is that QE does not ease. The name is actually misleading. Instead, it actually tightens financial conditions. This is counter-intuitive yet it is exactly what happens. We saw it for two decades in Japan and now are seeing it throughout the EU and US. In fact, the slowing of growth in China should be no surprise considering what their central bank is doing.
How are tightened conditions tightened?
Simply, the act of easing actually locks more cash into the banking and financial system. Couple this with massive fiscal stimulus and we can see why banks are sitting on a ton of cash while the general economy is suffering from a liquidity crisis.
Part of this is evidenced by the reserve balances. These are the assets the Fed "prints" during their easing. Contrary to what most people believe, the Fed does not create dollars. Their printing is not legal tender.
Here is the chart showing the reserve balances.
These reserves are on the balance sheets of commercial banks, as assets. They are liabilities to the Fed. We can see from there chart, there is almost $4.2 trillion sitting in reserve accounts at the Fed.
The problem with this is none of this money can be spent on real estate, wages, stock buybacks, or even taxes. It is not legal tender. In fact, the commercial banks have no say when it is converted (swapped) back. This is entirely up to the Fed.
We see this reversed only when the Fed decides to tighten. Short of that, nothing will change. This means the money is all locked up in the financial system, mostly floating around the Repo Market. It is not helping the general economy whatsoever.
For this reason, it is understandable why the VoM is slowing to a snail's pace. There is not enough money in the economy, both US and global (since the USD is the reserve currency). Nevertheless, the Fed has no choice but to keep following this path since they are backed into a corner.
Thus, we can expect economic conditions to keep deteriorating over time.
Even the Fed is expecting this. They have a growth rate of 2.5 in 2023. Keep in mind that last quarter, we saw a preliminary GDP of 2.0. It looks like this chart might be a bit optimistic.
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And people seriously believe the Fed is going to reverse course into that.
By the time, we might have a VoM under 1.0.
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