Money Supply and Velocity

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DLRCohasset
Posts: 55
Joined: Sun May 16, 2010 7:48 pm

Money Supply and Velocity

Post by DLRCohasset »

I've just reviewed some quite unusual and, for me, shocking monetary statistics and wonder if there is any action that one might consider in response:

- M2 is up 20% in the last six months to a historical high (from $15.3T to $18.3T)
- Velocity is down over 20% in 6 months (from 1.4 to 1.1)
- Velocity is at a low for the past 60 years about 40% below its average during that period
(Source: FRED - St Louis Fed)

Intuition suggests that the high M2 is offset by the low velocity leading to limited inflation for the time being. However it seems more likely that the velocity will return to more normal levels sooner than will M2. But the historically high M2 and low velocity also suggest that we have entered into some sort of crazy new paradigm that may require reconsideration of the composition of the debt portion of a portfolio (which in my case is in short term investment grade and limited term municipal Vanguard funds). Have any others focused on this?
acegolfer
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Re: Money Supply and Velocity

Post by acegolfer »

Quantity theory of money will help your understanding. https://en.wikipedia.org/wiki/Quantity_theory_of_money

The key equation is M * V = P * Q
Valuethinker
Posts: 41129
Joined: Fri May 11, 2007 11:07 am

Re: Money Supply and Velocity

Post by Valuethinker »

DLRCohasset wrote: Thu Aug 06, 2020 1:54 pm I've just reviewed some quite unusual and, for me, shocking monetary statistics and wonder if there is any action that one might consider in response:

- M2 is up 20% in the last six months to a historical high (from $15.3T to $18.3T)
- Velocity is down over 20% in 6 months (from 1.4 to 1.1)
- Velocity is at a low for the past 60 years about 40% below its average during that period
(Source: FRED - St Louis Fed)

Intuition suggests that the high M2 is offset by the low velocity leading to limited inflation for the time being. However it seems more likely that the velocity will return to more normal levels sooner than will M2. But the historically high M2 and low velocity also suggest that we have entered into some sort of crazy new paradigm that may require reconsideration of the composition of the debt portion of a portfolio (which in my case is in short term investment grade and limited term municipal Vanguard funds). Have any others focused on this?
Expect the Fed to take away the punchbowl before the party really gets going if inflation ticks up.

Inflation insurance ie TIPS are expensive right now suggesting the market has some worries.
Angst
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Joined: Sat Jun 09, 2007 11:31 am

Re: Money Supply and Velocity

Post by Angst »

I guess those $600 unemployment supplements have had something to do with the bump in M2, and the economy on its knees d/t Covid might explain the drop in velocity, but I'm not qualified to state this as fact. Still, I felt like responding to a post about M2 in another thread a day or so ago: viewtopic.php?t=321967#p5413199
pepys
Posts: 153
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Re: Money Supply and Velocity

Post by pepys »

Valuethinker wrote: Thu Aug 06, 2020 4:40 pm Inflation insurance ie TIPS are expensive right now suggesting the market has some worries.
I think TIPS would be expected to be much more expensive even if inflation concerns didn't change at all, because rates have dropped. Their performance relative to treasuries with similar maturity dates is probably the best measure, and TIPS have slightly underperformed treasuries this year.

The 5-Year breakeven inflation rate is currently at 1.53% (https://fred.stlouisfed.org/series/T5YIE). So the market seems to expect the Fed to be below target for the foreseeable future.
Valuethinker
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Re: Money Supply and Velocity

Post by Valuethinker »

Angst wrote: Thu Aug 06, 2020 10:45 pm I guess those $600 unemployment supplements have had something to do with the bump in M2, and the economy on its knees d/t Covid might explain the drop in velocity, but I'm not qualified to state this as fact. Still, I felt like responding to a post about M2 in another thread a day or so ago: viewtopic.php?t=321967#p5413199
Rather it us there has been a stunning rise in the preference for all households to hold cash? UK it has gone off the chart, the amount if cash & demand deposits per household.

It looks on a chart like 1929 to 1930 in that regard vs say even 2008/9. Discretionary income is just not being spent.

Unemployed households are probably *spending* their money. Groceries. Rent. Gasoline. No fall in velocity there?
JBTX
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Re: Money Supply and Velocity

Post by JBTX »

Valuethinker wrote: Thu Aug 06, 2020 4:40 pm
DLRCohasset wrote: Thu Aug 06, 2020 1:54 pm I've just reviewed some quite unusual and, for me, shocking monetary statistics and wonder if there is any action that one might consider in response:

- M2 is up 20% in the last six months to a historical high (from $15.3T to $18.3T)
- Velocity is down over 20% in 6 months (from 1.4 to 1.1)
- Velocity is at a low for the past 60 years about 40% below its average during that period
(Source: FRED - St Louis Fed)

Intuition suggests that the high M2 is offset by the low velocity leading to limited inflation for the time being. However it seems more likely that the velocity will return to more normal levels sooner than will M2. But the historically high M2 and low velocity also suggest that we have entered into some sort of crazy new paradigm that may require reconsideration of the composition of the debt portion of a portfolio (which in my case is in short term investment grade and limited term municipal Vanguard funds). Have any others focused on this?
Expect the Fed to take away the punchbowl before the party really gets going if inflation ticks up.

Inflation insurance ie TIPS are expensive right now suggesting the market has some worries.
In the past I would have said similar but at this point I'm not sure there will ever be a withdrawal of the punchbowl. The total debt load is simply getting too high to be able to afford the debt service if rates go up. The last time the punch bowl was taken away markets went down 20% and the fed brought back the punch bowl post haste.
Valuethinker
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Joined: Fri May 11, 2007 11:07 am

Re: Money Supply and Velocity

Post by Valuethinker »

pepys wrote: Thu Aug 06, 2020 11:41 pm
Valuethinker wrote: Thu Aug 06, 2020 4:40 pm Inflation insurance ie TIPS are expensive right now suggesting the market has some worries.
I think TIPS would be expected to be much more expensive even if inflation concerns didn't change at all, because rates have dropped. Their performance relative to treasuries with similar maturity dates is probably the best measure, and TIPS have slightly underperformed treasuries this year.

The 5-Year breakeven inflation rate is currently at 1.53% (https://fred.stlouisfed.org/series/T5YIE). So the market seems to expect the Fed to be below target for the foreseeable future.
You make some excellent points.

I was riffing off a piece in The Economist, without checking my numbers.

I suppose I would say "TIPS are more expensive than they have been, suggesting the market has greater worries about inflation". But the counter would be to that "relative to nominal bonds, TIPS are not massively more expensive than they were. All bonds have risen in price".

One really has to keep an eye, I think, on the drivers of 1970s inflation: commodity prices (but those rises did not in the early 2000s lead to a rise in general inflation) & wage settlements (signs the labour market is tightening across the developed world). For the next year or two I suspect the latter just won't move up a lot - there's too much unemployment out there. Even if it is "the wrong kind" of unemployed - people whose skills and/or personal situations make it harder for them to move into the jobs that are available, in the places where they are available.

Retail workers, say, won't move easily into construction & homebuilding.
Valuethinker
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Re: Money Supply and Velocity

Post by Valuethinker »

JBTX wrote: Fri Aug 07, 2020 1:54 am
Valuethinker wrote: Thu Aug 06, 2020 4:40 pm
DLRCohasset wrote: Thu Aug 06, 2020 1:54 pm I've just reviewed some quite unusual and, for me, shocking monetary statistics and wonder if there is any action that one might consider in response:

- M2 is up 20% in the last six months to a historical high (from $15.3T to $18.3T)
- Velocity is down over 20% in 6 months (from 1.4 to 1.1)
- Velocity is at a low for the past 60 years about 40% below its average during that period
(Source: FRED - St Louis Fed)

Intuition suggests that the high M2 is offset by the low velocity leading to limited inflation for the time being. However it seems more likely that the velocity will return to more normal levels sooner than will M2. But the historically high M2 and low velocity also suggest that we have entered into some sort of crazy new paradigm that may require reconsideration of the composition of the debt portion of a portfolio (which in my case is in short term investment grade and limited term municipal Vanguard funds). Have any others focused on this?
Expect the Fed to take away the punchbowl before the party really gets going if inflation ticks up.

Inflation insurance ie TIPS are expensive right now suggesting the market has some worries.
In the past I would have said similar but at this point I'm not sure there will ever be a withdrawal of the punchbowl. The total debt load is simply getting too high to be able to afford the debt service if rates go up. The last time the punch bowl was taken away markets went down 20% and the fed brought back the punch bowl post haste.
If you mean the debt load on the US Federal government? I don't think the Fed much cares, but remember the duration of the US Treasury bond market is c 8 years. It takes quite a long time for a rise in interest rates to feed through to US Federal budgets. Interest is not a crippling part of the US budget, and the US tax system is anything but static.

Or did you mean the private sector? In which case, it means the dampening power of an interest rate rise is increased. The car is more sensitive to braking pressure.

The Fed has an inflation target and I expect they will stick with that. In addition, the next proposed new member of the Fed Board, Alice Shelton, has called for a return to the Gold Standard. She's hardly going to be an inflationist.
Angst
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Joined: Sat Jun 09, 2007 11:31 am

Re: Money Supply and Velocity

Post by Angst »

Valuethinker wrote: Fri Aug 07, 2020 1:20 am
Angst wrote: Thu Aug 06, 2020 10:45 pm I guess those $600 unemployment supplements have had something to do with the bump in M2, and the economy on its knees d/t Covid might explain the drop in velocity, but I'm not qualified to state this as fact. Still, I felt like responding to a post about M2 in another thread a day or so ago: viewtopic.php?t=321967#p5413199
Rather it us there has been a stunning rise in the preference for all households to hold cash? UK it has gone off the chart, the amount if cash & demand deposits per household.
Yes indeed, and I believe that the savings rate during this period actually supports your point, but you have to have cash in order to save it. :wink:
alex_686
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Joined: Mon Feb 09, 2015 2:39 pm

Re: Money Supply and Velocity

Post by alex_686 »

I would reference 2008. M2 Money supply increased, M4 decreased.

Money Supply and Velocity mean less and less. It less dependent on hard high-power currency (M2), and more on M4 - the stuff created by banks, near-banks, and shadow banks.

As a counter I will point to Japan. They have been pumping money into the system and are getting deflation. Money is being routed to deleveraging the balance sheet. Thus it is not making its way into the real economy so little impact to inflation.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
petulant
Posts: 1901
Joined: Thu Sep 22, 2016 1:09 pm

Re: Money Supply and Velocity

Post by petulant »

DLRCohasset wrote: Thu Aug 06, 2020 1:54 pm I've just reviewed some quite unusual and, for me, shocking monetary statistics and wonder if there is any action that one might consider in response:

- M2 is up 20% in the last six months to a historical high (from $15.3T to $18.3T)
- Velocity is down over 20% in 6 months (from 1.4 to 1.1)
- Velocity is at a low for the past 60 years about 40% below its average during that period
(Source: FRED - St Louis Fed)

Intuition suggests that the high M2 is offset by the low velocity leading to limited inflation for the time being. However it seems more likely that the velocity will return to more normal levels sooner than will M2. But the historically high M2 and low velocity also suggest that we have entered into some sort of crazy new paradigm that may require reconsideration of the composition of the debt portion of a portfolio (which in my case is in short term investment grade and limited term municipal Vanguard funds). Have any others focused on this?
There's a lot of room in CPI-U for inflation to pick up because velocity increased before the Fed can tighten M2. In other words, overshooting to inflation at 3% for a year is not a big worry, especially given how often we've been under 2%.
JBTX
Posts: 6950
Joined: Wed Jul 26, 2017 12:46 pm

Re: Money Supply and Velocity

Post by JBTX »

Valuethinker wrote: Fri Aug 07, 2020 4:40 am
JBTX wrote: Fri Aug 07, 2020 1:54 am
Valuethinker wrote: Thu Aug 06, 2020 4:40 pm
DLRCohasset wrote: Thu Aug 06, 2020 1:54 pm I've just reviewed some quite unusual and, for me, shocking monetary statistics and wonder if there is any action that one might consider in response:

- M2 is up 20% in the last six months to a historical high (from $15.3T to $18.3T)
- Velocity is down over 20% in 6 months (from 1.4 to 1.1)
- Velocity is at a low for the past 60 years about 40% below its average during that period
(Source: FRED - St Louis Fed)

Intuition suggests that the high M2 is offset by the low velocity leading to limited inflation for the time being. However it seems more likely that the velocity will return to more normal levels sooner than will M2. But the historically high M2 and low velocity also suggest that we have entered into some sort of crazy new paradigm that may require reconsideration of the composition of the debt portion of a portfolio (which in my case is in short term investment grade and limited term municipal Vanguard funds). Have any others focused on this?
Expect the Fed to take away the punchbowl before the party really gets going if inflation ticks up.

Inflation insurance ie TIPS are expensive right now suggesting the market has some worries.
In the past I would have said similar but at this point I'm not sure there will ever be a withdrawal of the punchbowl. The total debt load is simply getting too high to be able to afford the debt service if rates go up. The last time the punch bowl was taken away markets went down 20% and the fed brought back the punch bowl post haste.
If you mean the debt load on the US Federal government? I don't think the Fed much cares, but remember the duration of the US Treasury bond market is c 8 years. It takes quite a long time for a rise in interest rates to feed through to US Federal budgets. Interest is not a crippling part of the US budget, and the US tax system is anything but static.

Or did you mean the private sector? In which case, it means the dampening power of an interest rate rise is increased. The car is more sensitive to braking pressure.

The Fed has an inflation target and I expect they will stick with that. In addition, the next proposed new member of the Fed Board, Alice Shelton, has called for a return to the Gold Standard. She's hardly going to be an inflationist.
I typed out a long response and somehow lost it. I'm talking about federal debt. At 26 trillion, and growing even at 4%, not high from a historical perspective, would be $1 trillion per year of debt service. There will be a lot of incentive to hold that down
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