Friday, June 19, 2009

Money velocity is likely stabilizing (2)

This chart is a followup to an earlier post, whose point was the velocity of M2 is probably close to beginning to turn up. The slowdown in M2 growth we have seen in recent months is most likely an indicator of that very phenomenon. Money velocity is the inverse of money demand, so a decline in money demand shows up as an increase in velocity. It has long been my belief that M2 is a much better indicator of money demand than it is of money supply. The best measure of money supply would be the monetary base, which is composed of bank reserves and currencies, and those are directly controlled by the Fed. So slowing M2 growth is a good indicator of declining money demand.

As this chart shows, money growth (i.e., money demand) typically reaches a peak in the wake of recessions. That's because people's risk aversion declines dramatically in recessions, and since most recessions have been the by-product of tight money, money demand is in part driven by a desire to deleverage. Money growth rises as people accumulate cash and pay down debt, and the Fed accommodates this increase demand for money by reducing interest rates. Then, when conditions start to improve, the opposite happens, and people start to want less and less money and more debt. The M2 that was stored up during the recession is unleashed and spent, and that is one of the things that powers the subsequent recovery.

In the three months ended June 8th, the annualized growth rate of M2 fell to 2.3%. If nominal GDP growth in the current quarter is 1.7% (I'm assuming growth of -0.8% and inflation of 2.5%), then velocity will be only modestly lower than it was in the first quarter. If the slowdown in M2 continues and the economy starts to recover, it will be because M2 velocity is starting to pick up. In short, there's an M2 mountain of cash out there that could power the economy for the foreseeable future.


alstry said...

Could money velocity come to a griding halt????

Madoff, Petters, Stanford, Scrushy.......Bernanke??????

WASHINGTON – A House panel has subpoenaed documents that lawmakers say could shed new light on Federal Reserve Chairman Ben Bernanke's role in Bank of America's acquisition of Merrill Lynch.

The subpoena comes ahead of a hearing next week in which Bernanke is scheduled to testify.

Lawmakers have accused Bernanke and President Bush's treasury secretary, Hank Paulson, of pressuring Bank of America Corp. Chief Executive Kenneth Lewis into the deal and urging him to keep quiet about Merrill's financial problems.

What would happen to America if its citizens woke up one morning and learned its entire economy was one big Ponzi Scheme run by the Federal Rerserve just like the clients and shareholders of the above named individuals????

Is the U.S. an economy primarily based on borrowing and spending to create the illusion of a booming economy.

My friends....without an ability to borrow, soon you will learn there is just no money.

No money to fund out schools.

No money for our hospitals.

No money to pave our roads.

No money for welfare or unemployment.

No money for our military or many dozens of bases around the world.

No money for our police and firefighters.

No money to keep our airports operating.

Unless of course we can convince others to lend us MORE money than they have......Good luck.

Scott Grannis said...

Alstry: the one problem we most certainly do not have is a shortage of money.

alstry said...


I agree with you long as there are those with the capacity or willingness to fund the creation money.

Such a willingness is based on productivity or the perception of productivity.....for while, we were able to live off the former, then we adopted the latter, now we will see who is standing naked when the tide pulls out........sorry for stealing that quote from our friend Mr. Buffett.

Mark A. Sadowski said...

This might be nitpicking in this context but your forecast of real GDP growth and GDP deflator is on the optimistic side (not surprisingly). The most recent OECD Outlook forecasted a real GDP growth of -4.3% and a GDP deflator of 1.5%. I predicted a real GDP growth rate of -2.4% in late May.

I don't make formal predictions of the deflator but I predicted headline PCE to be 0.7% in late May, and the GDP deflator likely will be greater than that.

The OECD will update their Outlook on the 24th.

Scott Grannis said...

Mark: the day the OECD makes an intelligent and accurate forecast I'll sit up and take notice. Meanwhile I will continue to ignore what they say.

In any event, we both agree that the economy's rate of decline is slowing.

alstry said...


Are you aware OVER 21,000,000 Americans work for Local, State, or Federal Government. There are countless oters that work for our University and College system.

State budgets have become so contrained they are now starting to layoff important workers in the court system. As an attorney I am profoundly aware of the shortage that existed PRIOR to the staff reductions.

Here is an example from Florida today:

SARASOTA - Clerk of the Circuit Court and County Comptroller Karen E. Rushing has announced a reduction in the size of the workforce at the Sarasota County Clerk's office.

"In spite of skyrocketing case load in foreclosures, recently-passed and ill-conceived legislation forces me to terminate a number of highly skilled workers needed to process record high case load. This is the saddest day of my career," said Rushing.

The reduction plan calls for the elimination of 39 positions. Twenty-four Clerk employees lost their jobs today....

The problem now is even if you fired half of all government workers, it still wouldn't close the gap on the deficit.

No matter how much work exists for government workers......IF THERE IS NO MONEY......THERE IS NO MONEY!!!!!!!!



I have been reading about more and more government workers around the nation getting fired. The pace is really picking up in recent weeks. Expect this story or ones similar to be repeated over and over and over again as the summer progresses.

My wife is a public school teacher........

The are a number of counties in California approaching 20% unemployment.....Michigan approaching 15%......the West now over 10%......and that is U3........U6 is over 16% across the nation.

If few are working......our economy will evaporate !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

I rarely hear economists discuss the economic impact of layoffs from government workers likely to reach into the millions. Further, even if we fire 10,000,000 workers, mathematically we would still run a deficit.

Why do you think economists pay so little attention to the millions of government workers likely to get fired in the next year and its economic impact?

Bill said...

Apparently, if you use a lot of exclamation points, question marks and all capitals, then the points you make have more validity.

Bill said...

BTW Scott, can you tell me why your blog alone offers pop up ads which attempt to entice me into dating young latinas? Is there a way to turn off the annoying ads?

Scott Grannis said...

Bill: I'm distressed about the popup ads. I myself have never seen them, but you are not the first person to complain about them. I don't know where they come from. I use a popup blocker on Safari and on Firefox, and have never had a problem. Have you tried Firefox? I"m sure it's much better than Explorer.

ronrasch said...

Scott can up forward me some of those ads-just kidding Thank you for your great work on money, gold, and health care. This blog rocks-bring on the Latinas

Bob said...


As to alstry's comments, my rebuttal is the fewer government workers the better off we will all be in the future. Lawyers too for that matter. Perhaps if we didn't make criminals out of everyone who f**ted in the wind and didn't sue everyone who offended us at the drop of a hat we wouldn't need the massive economically sucking legal system we have. All due respect.


Bob said...

This is from Ed Yardeni and offers a counterview to the "inflation is imminent" arguement. (Part 1)
I) INFLATION: Art Laffer is alarmed. In the 6/11 WSJ, he wrote an op-ed piece titled, “Get Ready for Inflation and Higher Interest Rates.” It was subtitled, “The unprecedented expansion of the money supply could make the '70s look benign.” Art is a bright and creative economist with an unusually sunny disposition…Art is alarmed by the unprecedented increase in the monetary base, which is the sum of currency in circulation and the reserves of the commercial banks. These reserves totaled $8.0bn on September 10, 2008, just before Lehman and AIG hit the fan on September 15. A week ago, on June 10, these reserves were up 100-fold to $804.4bn! That is unprecedented, but is it inflationary? Actually, it isn’t all that unprecedented. It happened in Japan, when bank reserve balances soared 575% from mid-2001 through early 2004. During that time, the Bank of Japan (BoJ) adopted Quantitative Easing (QE) in a desperate effort to stop deflation and revive bank lending. Nevertheless, bank loans plunged during this entire period, and have been rising anemically since 2005. Japan’s CPI inflation rate, ex food and energy, on a y/y basis has been below zero this decade, with a brief peek just above zero late last year.
Japan was in a liquidity trap. All the reserves pumped into the commercial banking system by the BoJ had absolutely no stimulative impact on bank lending and the economy, and no inflationary consequences. The BoJ abandoned QE in early 2006. Reserve balances plunged 76.2% from January 2005 to November 2006. In other words, the BoJ executed its exit strategy from QE and once again there was no obvious impact on the economy or inflation.
Art believes that the Fed must reduce the monetary base immediately to avoid a serious inflation problem. I’m not sure that the Fed can implement such a rapid exit strategy without prolonging the recession and increasing the risks of deflation. The Fed would have to sell the Agency and Treasury securities it has been buying. That would push yields higher at first, endangering the recovery.
In any event, Japan’s experience confirms that inflation isn’t always and everywhere a monetary phenomenon. It is more complicated than that. Market structure plays an important role. Competitive markets tend to be less prone to inflation than highly regulated and monopolized ones. Labor costs are the key drivers of inflation. Unions don’t have the power they once had, and productivity has been growing even during this recession. By definition, stimulative monetary policy isn’t inflationary in a liquidity trap, when the banks aren’t lending and the borrowers aren’t borrowing.A fund invested in assets that benefit from inflation may still generate great returns even if CPI inflation remains subdued. While the liquidity provided by the central bank may not revive bank lending and economic growth, it may boost asset inflation, especially in the commodity pits. This seems to be happening now.

Bob said...

Ed Yardeni Parat 2

CPI: How’s consumer inflation? Subdued. Headline CPI showing little change the past three months, falling 1.3% y/y in May, the largest decline in nearly six decades. Core CPI rose 1.8% y/y, hovering just below 2.0% since the end of last year.
PPI: What’s up with the PPI? Not much relative to finished goods, though there were some gains in intermediate and crude goods prices last month. Core finished goods prices fell in May for the first time since the fall of 2006, with the y/y percent change slowing to 3.0%, down nearly 2pps from October’s two-decade high. Higher energy prices pushed the headline PPI up 0.2%, though prices dropped 5.0% y/y, the most in half a century! Intermediate core good prices fell for the eighth straight month, with the y/y rate down a record 5.5%. Headline prices rose for the first time in ten months, boosted by higher food and energy prices, though prices still tumbled a record 12.5% below a year ago. Total and core crude goods prices rose 3.6% and 6.7%, respectively, in May. It was the second straight increase for the former, though y/y decline fell to a record low 41.1%. Core prices dropped 36.8% y/y, narrowing slightly from April’s record 39.9% drop.
PPI & Import Prices: Is the US importing inflation? Not much. Nonpetroleum import prices, which include natural gas, edged up 0.2%, its first gain in ten months, with the y/y decline widening to 5.8% in May. A sharp slowing in core consumer goods import prices recently stopped the ascent in the core PCED consumer goods inflation rate which fell below 2.0% y/y during the first two months of this year, though was back above 2.0% in subsequent months. Capital goods import prices turned positive on a y/y basis during 2007, with PPI capital goods rate moving out of multi-year flat trend last year. Capital goods import prices slipped into negative territory y/y, with PPI capital goods rate slowing to 2.4% in May from 4.3% at the end of last year. Latest import price data suggest disinflation in both core consumer and capital goods prices this year. Prices for goods from Japan rising at a slower pace y/y, with China’s rate turning negative again, and the NICs price decline the steepest this decade.
OECD CPI: What’s the trend for core CPI inflation among the 30 member countries of the OECD? Still low and stable. The OECD rate, ex food and energy, slowed to 1.8% y/y in April, hovering around 2.0% since July 2006. Of the 30 countries, three inflation rates below zero, three have inflation rates from zero to 1.0%, eight have rates from 1.0%-2.0%, and ten have rates from 2%-3.0%. Only six have rates at 3.0% or above.
Emerging Markets CPI: How’s inflation in the emerging economies? No longer straight up as in early 2008. Within Asia, virtually all the rates we track are heading lower, with China, Singapore, and Thailand rates negative, and Taiwan’s unchanged. In Latin America, rates have already peaked or are peaking. In Eastern Europe, rates disinflating in Bulgaria, Croatia, Hungary, Ukraine, and the Czech Republic.

Scott Grannis said...

Bob: thanks for the Yardeni article. He's a good economist and I usually agree with him. But not on this subject. Most of the things he cites are coincident, not forward-looking.

Forward looking indicators all point to higher inflation: a weak dollar, $950 gold, big increases in commodity prices across the board, a very steep yield curve, rising breakeven spreads on TIPS.

I've noted in several posts on the CPI and PPI that this is one of those "dogs that didn't bark" times. What is notable about core inflation is that it hasn't gone down, not that it hasn't gone up. Given the huge supposed "slack" in the economy, conventional thinking about inflation would have predicted a significant decline in core inflation. But it hasn't happened. I think that reinforces the eternal truth that inflation is a monetary phenomenon. Monetary policy operates with long and variable lags, and that explains why inflation hasn't yet gone up. But that doesn't mean it won't go up.

I remain very vigilent, watching for signs of rising inflation. Of course, once the CPI starts rising then the cat will be out of the bag and it will be harder/more expensive to hedge oneself.

Bill said...

Scott: I use firefox with popup blocker and I only get popups on this blog for some reason. Also, I reread my previous post on this and I apologize that it sounded a little more sarcastic than intended. I just cant figure out how it happens and it happens on both my home and office computers too.

Scott Grannis said...

It's a mystery to me, I'll admit. I have checked my blog from many different computers and using a variety of browsers, and have never seen a popup. But every now and then I hear from someone like you who has seen an annoying popup. I wonder how this can happen and if there is anything I can do to stop it?

Rob said...

Someone wrote this today on another website:

"This index from Harper Petersen is for container shipping, while the more famous Baltic Dry Index is for commodity shipping (dry bulk goods).

So while China stockpiles commodities instead of USA government bonds the shipping of later stage produced things hasn't even bottomed:"

What think you Scott ?

Scott Grannis said...

Rob: Thanks for the info--I learn something new everyday it seems. I'm not sure what to make of this. The Ports of Los Angeles and Long Beach are reporting huge increases in the number of outbound containers (see previous posts on this) through May '09. As you note, the Baltic measures shipping rates for dry bulk goods. This Harpex index measures shipping rates for container ships (I think). I detect what could be a bottoming in rates, but it certainly doesn't look anything like the outbound container numbers from Los Angeles. More study is needed.

Regardless, two indicators are showing big increases, and one is possibly bottoming. All in all that doesn't sound too bad. Certainly nothing like a global recession.

Rob said...

Scott, the same guy (a brit living in Thailand) also just posted this addendum:

"... and internal land shipping in USA is going from awful to worse
as I see it if total goods traded in America have fallen by at least -20% then surely the economy has shrunk by that amount too, despite 'government statistics'?


Thailand is planning a lot of permanent national holidays "

alstry said...


I am very familar with the shipping business....I was once a former CIO for a trucking company with a national footprint and the owner and I are still good friends.

I can tell you with great confidence that shipping is DOWN at least 20% and the trends have deteriorated materially in the last four months.

But don't bother Scott with reality, it simply interferes with his living in his world of theory.

One night, a few years ago, I was at a social dinner attended by an Economist from the Federal Reserve with the requisite pedigree education. I had a few in me and made it a point to loudly tell him that the Fed should pay serious to the looming mortgage crisis and it would have a PROFOUND impact on our economy.......he confidently dismissed my warning and responded that mortgages would not be an issue because housing has never declined in value in America....ever since that evening those in attendence have come up to me and asked me how did I know.

Simple, America is overleveraged to a degree we have NEVER even come close to and now we are about to pay the price with massive job losses, bankruptcies, and almost certainly the WORST depression our nation has ever experienced.

In essence, my response was simple, economist live in theory, Alstrynomics is all about reality.

Why do you think I have so much fun with Scott...he has no clue what is going on in the real guess is he rarely reads a buddies are the CEO's of companies.....he reads government data.....which do you think is more credible???

It is not a knock on is a knock on Economics as taught in America....I have first hand knowledge....I have an Economics degree and have spent a lifetime trying to unlearn what I was taught.