Chart of the Week

By: David Chapman | Thu, Sep 13, 2012
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In last week's COTW the report centered on the massive growth of the monetary base since the financial crisis broke in September 2008 with the collapse of Lehman Brothers. Since the end of August 2008 when the monetary base was reported at $877 billion it has grown 3 fold to $2,651 billion as of the report on September 5, 2012.

In percentage terms that doesn't seem like much when stacked against the growth from February 1984 that saw the monetary base grow from $184 billion to the aforementioned $877 billion in August 2008.

That was a growth of almost 5 times but it did take 24 years. That works out to only about 15% a year vs. the roughly 50 % annual growth of the past few years.

With all of this money sloshing around the financial system one would think it would actually do some good and help the economy grow again. Now they seem poised to start another round of QE that could once again send the monetary base up over the next year. If the 50% growth of the past few years holds true the monetary base could be almost $4 trillion by this time next year.

But if one looks at the money velocity chart above it is not doing much good. The money is simply not getting into the economy or in this case circulated. First what is MZM. MZM is a measure of the total amount of monetary assets available in the economy at any specific time. Generally this contains at least the money in circulation, demand deposits plus money market funds. One can think of it as supercharged M2. Money stock today sits at roughly $11.1 trillion vs. $8.8 trillion just before the financial crisis of 2008 broke. The velocity of money is a ratio of nominal GDP to a measure of the money supply (M1 or M2 or MZM).

It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP. The velocity of money has been falling for years. In fact, it peaked at about 3.5 all the way back in 1981. Today it is at 1.4 and still falling.

So what does that mean? In 1981 that meant for every $1 of GDP, $3.50 was spent on new goods and services in the economy. Today it is only $1.40. The falling velocity of money is a prime reason that the economy is so sluggish. Money is simply not turning over fast enough.

It is interesting to note that while the economy was said to be booming during the 1990's the velocity of money was actually falling giving a false impression that the economy was better than it really was. The rot as they say was already creeping in. Today the velocity of money is falling and despite 2 rounds of QE already the decline has barely received a bump.

While a further round of QE is expected its impact will only be felt in a further rush into financial assets. If the past holds true a further round of QE should have little or no lasting impact on the economy. Throughout the 1960's and the 1970's the velocity of money was growing reflecting the strength of the economy at the time. Moreover, the 1970's was known as a period of stagflation. Today the monetary base grows; MZM grows, but the velocity of money or the turnover of that money just keeps falling.

Not a good sign going forward.



David Chapman

Author: David Chapman

David Chapman

David Chapman

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