Continued Decline In Money Velocity
I’d thought I would show another chart of the velocity of money but from a somewhat different perspective. I last showed a chart on the velocity of M1 in a Chart of the Week – The End of Cash? - April, 30, 2015. This is a chart of the velocity of MZM money stock and prior to 1960 money stock. Money stock is the total amount of monetary assets available in an economy at any specific time. MZM money stock is defined as money with zero maturity. It includes notes & coins, travelers’ cheques & demand deposits, savings accounts and money market funds. MZM is not M1 or M2 but a hybrid of the two plus money market funds. The two time series don’t line up exactly but the MZM money stock effectively takes over from money stock prior to 1960.
What is interesting about the chart is that it shows that the velocity of money stock has fallen to Great Depression levels. The velocity of money peaked around 1980 a period when interest rates hit 20%. It has been declining ever since. While the US experienced growth rates in the 1980’s and the 1990’s those growth rates were never what they were back in the 1950’s through the 1970’s.
Since the velocity of money refers to the relationship between GDP growth and money supply it is not surprising that the velocity of money has been sliding since the 1980’s largely because the growth of real GDP has been growing more slowly than money supply (Velocity = GDP/Money Supply). It is another way of saying that it has taken more and more money to buy an additional dollar of GDP. Since much of the monetary growth has been attributable to debt growth, it could be rephrased to say that it has taken increasing amounts of debt to purchase an additional dollar of GDP. The chart below shows how GDP growth has slowed substantially since 1980 vs. the levels attained in the 1950’s through the 1970’s.
What is noticeable is the decline in the velocity of money got underway in the 1980’s, accelerated in the 1990’s and began to freefall after 1999. There was a brief respite for a few years following the high tech/internet crash of 2000-2002. What is significant about 1999 is that was the year the Clinton administration repealed Glass Steagall. Glass Steagall had existed since the 1930’s to separate commercial banking and securities firms. The end of Glass Steagall signaled a shift from relationship banking to transactional banking.
The rise of transactional banking actually got underway in the 1990’s with the introduction of numerous products often backed with derivatives. While transactional banking can vary from firm to firm its rise coincided with the rise of the large behemoth banks that dominate banking today. Banking today is all about products largely created in capital markets. The products may be for retail or institutions. Trading became a big part of the banks and trading often dominates the banks.
The financial collapse of 2008 can be traced to the rise of transactional banking with products such as the sub-prime mortgages that dominated at the time. While the securitization of mortgages is not as predominate securitization has spread to auto loans, credit cards and student loans. These three types of loans have been the fastest growing segments of consumer loans since the 2008 financial crash. Mortgage loans in the US have actually declined since the financial crash of 2008.
Some believe that student loans could become the next sub-prime mortgage collapse as millennials struggle to find good paying jobs. The struggle of the millennials is just one part of a broader equation that has helped contribute to the fall in the velocity of money. Society is aging and the large baby boomer cohort is shifting from spending to planning for retirement. The majority of jobs created since 2000 are part-time jobs or low wage jobs bringing a high degree of uncertainty into the job market. Additionally many companies have faced restructuring and waves of middle aged employees have found themselves unemployed as they were moving into their best earning years. Wages have been stagnant since the 1990’s and that has added to the uncertainty. According to studies, most Americans and Canadians are not prepared for retirement and as a result are potentially facing a decline in their standard of living. Income has grown unequally with the upper 20% of seeing increases to their income while the majority stagnate or regress. A lengthy period of low interest rates has added to the uncertainty forcing people to either accept no or little growth for their savings or force them into the more speculative stock market seeking higher returns at higher risk.
Governments have played a role adding to the uncertainty. Despite six years of low or zero interest rates, and three rounds of QE the GDP growth levels have failed to reach previous levels coming out of a recession. The constant beat of the so called “war on terror” has also added to the uncertainty. The “war on terror” has also been accompanied by acts such as the US Patriot Act and here in Canada Bill-C51 that have been according to many besides civil libertarians to be an attack on freedom and charter rights. The surveillance state of NSA in the US has added to that uncertainty. All of these and others in different ways have been contributing to uncertainty and the result is stagnating retail sales and the subsequent plunge in the velocity of money.
If zero interest rates were a panacea to encourage inflation and economic growth by that account Japan should be booming. But 25 years after the Japanese stock market topped in 1990 Japan has been plagued by a series of rolling recessions with at best anaemic growth. Europe has now moved to negative interest rates and the response has been for people to hoard money and withdraw their funds from the banking system. In Europe, the US and even in Canada the underground economy is large. With governments seeking new sources of tax money to help pay for their huge debts that in many cases now exceeds 100% of GDP there has been calls in the EU in particular to ban cash. Ostensibly, it is to prevent hoarding but instead it might cause a backlash as the end of cash could spell the end of privacy.
The problem facing the western developed nations (EU, US, Canada, Japan) is not inflation but deflation. High levels of debt and the potential for debt default is deflationary not inflationary. There has been asset inflation in high-end real estate, art and collectibles even as interest rates have collapsed. Some claim that asset inflation is also in the stock market but stock market growth has lagged the growth in the former. Surprisingly asset inflation has not yet hit gold that has in the past been a store of value. That could change later as the end of cash could see a larger shift into gold and other means in order to get around the restrictions of a cashless society.
There is also growing illiquidity in the bond market which has caused a shift from the long end of the yield curve to the short end of the yield curve. Short-term rates are stagnant but bond yields have been rising at the long end of the curve. Many financial institutions are now only transacting corporate bond trades on an agency basis rather than acting as market makers as they might have in the past. This has added to the uncertainty.
With interest rates at or near zero and following years of QE and other stimulus that has failed to push GDP growth to higher levels governments are running out of ways to further stimulate the economy. There has been speculation that the US could hike interest rates in the fall. But with no clear signs that the economy is growing hiking interest rates could cause a shock to the stock markets. The other side of this is the US in particular has no room to lower rates further if the economy should slow. Rates are already at zero. Or they could join the EU with negative interest rates. That in turn could spark hoarding and withdrawals from the banking system something that has already been seen in the EU.
The collapse in the velocity of money is a warning sign that something is amiss in the economy. That it has now fallen to Great Depression levels is not a positive sign. Recent OECD economic forecasts have downgraded growth potential for the western developed nations and China. The OECD is urging further stimulus methods. But given high debt levels the western nations have little room to manoeuvre. China will do its bit but China is beginning to experience debt defaults as their property boom slows. All of this is most likely going to add to the uncertainty and the velocity of money could fall further. And that is not necessarily a good thing.
Copyright 2015 All rights reserved David Chapman
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