Velocity of Money vs. M1 Multiplier: Mixed Signals

Despite the negative GDP surprise there was a silver lining; the velocity of money actually increased for the first time in over a year.

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This is a very positive development since it indicates that the Federal Reserve has not lost complete control of monetary policy. While this uptick alone is not enough to sound the all clear signal, it is enough for the reflation trade to gain momentum.

That is not to say that inflation will return, but this slight move up in velocity should be enough to keep prices stable in the short term. As an anticipatory vehicle the market is betting on reflation as evidenced in the strength of base metals and oil.

Money Supply

The weekly money supply figures paint a different picture than the velocity of money. In the latest release not only did monetary base increase but reserves increased as well and at a higher rate.

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The reserve multiplier dropped to a historic low of 1.91, as banks continued to stockpile money. As well, the M1 multiplier dropped to a stunning 0.86.

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Another record low that indicates the money the Fed is printing is not making into the economy. As well, M2 continues to fall below its 4 week moving average.

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We are left with a very mixed picture indeed. The economy will continue to struggle until the money that has been printed by the Fed actually makes it into the economy, as measured by the M1 multiplier. In the mean time, stable prices should be enough to let the markets exhale.

Dislcosure: none

Comments

[Dave Wrixon]

Yes, time to put up interest rates.

2009 May 04 05:02 AM

[Henrique Simoes]

Fantastic article Brian.

Where do you get the data?

Thanks

2009 May 04 12:27 PM

[Brian Kelly]

Thanks -- the raw data is from the Federal Reserve and the Bureau of Economic Analysis. The multipliers are calculations that I produced.

On May 04 12:27 PM Henrique Simoes wrote:

> Fantastic article Brian.
>
> Where do you get the data?
>
> Thanks

2009 May 04 12:36 PM

[Westcoaster]

Yes, great article. Rates need to go up. Banks need a return on all of the TARP money they are sitting on. The FDIC needs to announce new guidance and let banks become profitable. Their treatment of this crisis needs to end. Because they hammered everyone so early in the cycle they need to lighten up now. Announce that banks Capital Ratios can drop and that they will under no circumstances confiscate wealth. Constitutionally they can't (5th Amendment protection of Private Property) and must allow banks to go to 0% capital ratio, they have been closing them down today at 4 to 5%. Now they can claim that the future is so horrible that no banks have any capital left but how does that help our current situation?

2009 May 04 12:50 PM

[Fiquant]

Awesome article. Its going to be interesting to see what happens when the money supply from the banks moves onto the populace.

2009 May 05 01:35 PM

[flow5]

The real impact of monetary demand on the prices of goods and serves requires the analysis of “monetary flows” (MVt), and the only valid velocity figure in calculating monetary flows is Vt. Income velocity (Vi) is a contrived figure (Vi = Nominal GDP/M).

The product of MVI is obviously nominal GDP. So where does that leave us? In an economic sea without a rudder or an anchor. A rise in nominal GDP can be the result of (1) an increased rate of monetary flows (MVt) (which by definition the Keynesians have excluded from their analysis), (2) an increase in real GDP, (3) an increasing number of housewives selling their labor in the marketplace, etc.

The income velocity approach obviously provides no tool by which we can dissect and explain the inflation process.

To the Keynesians, aggregate demand is nominal GDP, the demand for serves (human) and final goods. This concept excludes the common sense conclusion that the inflation process begins at the beginning (with raw material prices and processing costs at all stages of production) and continues through to the end.

We know that to ignore the aggregate effect of money flows (MVt)on prices is to ignore the inflation process. And to dismiss the concept of Vt by saying it is meaningless (that people can only spend their income once) is to ignore the fact that Vt is a function of three factors:

(1) the number of transactions;

(2) the prices of goods and services;

(3) the volume of M.

Inflation analysis cannot be limited to the volume of wages and salaries spent. To do so is to overlook the principal "engine" of inflation - which is of course, the volume of credit (new money) created by the Reserve and the commercial banks, plus the expenditure rate (velocity) of these funds. Also overlooked is the effect of the expenditure of the savings of the non-bank public on prices. The (MVt) figure encompasses the total effect of all these money flows.

Some people prefer the devil theory of inflation: “It’s (Peak Oil’s) fault. This approach ignores the fact that the evidence of inflation is represented by actual prices in the marketplace. The “administered” prices of the oil producing countries would not be the “actual” market prices were they not “validated” by (MVt)

It is mathematically impossible to miss an economic forecast.

2009 May 06 03:31 PM

[flow5]

From the standpoint of monetary authorities, charged with the responsibility of regulating the money supply, none of the current definitions of money make sense. The definitions include numerous items over which the Fed has little or no control (e.g., M2), including many the Fed need not and should not control (currency).

The definitions also assume there are numerous degrees of “moneyness”, thus confusing liquidity with money (money is the “yardstick” by which the liquidity of all other assets is measured).

The definitions also ignore the fact that some liquid assets (time deposits) have a direct one-to-one, unvarying , relationship to the volume of demand deposits (DDs), while others affect only the velocity of DDs. The former requires direct regulation; the latter simply is important data for the Fed to use in regulating the money supply

2009 May 06 03:36 PM

[flow5]

If the “store of purchasing power” attribute of money, when applied to a given asset, is to have significant meaning, it ought to be defined in terms which are applicable to the whole economy. That is, no asset really has a “monetary store of purchasing power” quality unless there can be a net conversion of that asset into money, ceteris peribus.

In other words it must be possible to effect this conversion without necessitating that any present money holder reduce/liquidate his holdings/assets. Any other interpretation becomes mired in a futile discussion of relative degrees of confidence and liquidity.

But much more than monetary liquidity for the individual holder is necessary if an asset can be said to have the “store of purchasing power” quality; it must be simultaneously monetarily liquid for society as a whole.

It is mathematically impossible to miss an economic forecast.

2009 May 06 03:37 PM