The following chart is extracted from the St. Louis Federal Reserve web-site. More specifically it is the FRED database section of that web-site. Years ago (pre-internet) I had a monthly subscription to the St. Louis Federal Reserve Monthly Review - it provided an excellent update on all financial and economic indicators as well as recent economic research on monetary affairs. Nowadays, of course, the whole thing is available on the web. Very handy and I would recommend it to my readers.
The chart provides some information on M2 money supply over the past several years. In particular you might note it has been in relative decline since the mid-1990's. In fact the decline appears to be quite pronounced. If you ever have taken a basic 101 economics course you might recall the basic equation of MV=PQ where:
M = total amount money supply
V = velocity of money (or turnover)
P = price level of output
Q = total economic output
In theory if you increase the money supply you will increase econonic output and/or prices. Well, maybe. BTW, there have been historically 3 measures of money - M1, M2 and M3. Reporting on M3 was discontinued a few years ago. I will briefly define M1 and M2 (if you don't know already). M1 is basically currency in circulation and demand deposits. M2 is M1 plus savings accounts and money-market funds.
(of course this is one theory of economic output - I believe the Keynesians have something to dispute here but that will be another post)
OK, why do I present this chart? The velocity of money measures the turnover of money in an economy. For example, you go to the your friendly neighbourhood bank and get a business loan for expanding your business. the bank approves your loan and you deposit the money in your bank. Over the next several months you expand your business by hiring people and expanding capacity. The people that you hire get salaries and they in turn deposit their money in the banking system. In this manner the money supply increases in what is commonly called the multiplier effect.
In recent years (since the 2008 crisis) there has been great debate on where the economy is going. The Federal Reserve has been "printing money" with QE programs measuring in the trillions (or is it billions?). No doubt we are going down in blaze of hyper-inflation! Well, there has been absolutely no sight of inflation yet. Long term treasury bond yields have come down over that last several years in response. I believe that given the serious decline in velocity Bernanke has been correct in implementing a very loose monetary policy. Unless velocity turns upwards in the near future I believe we could see low interest rates for many years to come. A Japan like scenario could very well be in the cards (but not as bad).
I generally do not invest based on long term forecasts of the future because it is ultimately unknowable. However, I do like to be familiar with general trends in the economy. Once in a blue moon I will make an investment decision based on economic trends. I see low interest rates for many years to come as debt levels are worked off and behaviorial shifts take place. Low interest rates might sound great for stock market investors but hold on a second. Deflation also leads to lack of pricing power as companies cannot increase prices due to lack of demand.
I hope the above explanation provide some background for my readers.
No comments:
Post a Comment