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Where Did All The Money Flow Go ?
MONEY VELOCITY IS AT AN ALL-TIME LOW . WHY DOES IT MATTER ?
BY IVAN ILLÁN
UNITONE VECTOR / SHUTTERSTOCK . COM
There are many economic measurements that could be referenced when formulating a forecast . You ’ re probably familiar with economic data like unemployment figures , Fed funds rate and the inflation rate . Those are important , but don ’ t tell the whole story on the state of the economy , much less the direction in which things may be headed . In our own research , part of our investment committee decision-making discussions , we often like to seek out more obscure data . The velocity of money ( a . k . a ., Velocity of M2 Money Stock or simply , money velocity ) is one such metric .
Money velocity ( MV ) isn ’ t a complicated concept . The Federal Reserve might describe it as the turnover rate of a dollar through the U . S . economy . A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently . Conversely , a lower figure would mean the exact opposite , which could indicate a slowing economic backdrop . Referencing data on MV from the Federal Reserve Bank of St . Louis , we see something noteworthy . In Q4 2021 , the velocity of M2 money stock slowed to a stunning 1.123 . Essentially , this means that $ 1
USD cycled through the US economy in Q4 2021 about 1.123 times . During the Great Financial Crisis ( GFC ), MV went from a high of 1.989 at the GFC ’ s start in Q3 ’ 07 to a low of 1.712 by end of the crisis in Q1 ’ 09 . Now surprisingly , MV is – 34.4 % lower than where it was at coming out of the GFC . This seems troubling .
It ’ s possible that a declining MV could have been directly attributed to record low interest rates , which resulted from record high growth of money supply . Afterall , the formula for MV is simple : GDP / Money Supply . Therefore , a huge increase in the denominator naturally results in a lower figure without the same corresponding increase in GDP . If not cycling through transactions , where did all that newly minted money go ?
Instead of spending new money injected into the economic system over the past 13 years , consumers and businesses have been either ( 1 ) hoarding , ( 2 ) investing , or ( 3 ) paying down debt . Household savings rates spiked during the past couple of years , which resulted in cash hoarding in checking and savings accounts . Since the GFC , and because of record low interest rates , investors allocated monies towards various asset classes , primarily corporate stock shares and real estate . Households took some of that new money and paid down debt , while corporations took advantage of the low rates and issued record amounts of new debt . U . S . corporations are now sitting atop the highest corporate debt mountain in U . S . history .
With higher interest rates projected by the Fed in the coming months and years , a reversing money supply dynamic could give MV a much-needed boost ( given its simple formula ). That boost will depend on GDP remaining at least at its current level . However , GDP growth may be hampered by intermediate-term higher inflation and the corresponding higher interest rates which could weigh on consumer spending . This could effectively pump the breaks on continued U . S . economic expansion and may even become a stronger headwind . Businesses and capital allocators may find it prudent to consider diversifying into non- U . S . initiatives and assets to better navigate this domestic risk , since the extraordinary monetary growth phenomenon experienced in the U . S . has been less pronounced in most other developed economies .
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