Velocity Of Money: Demand In The Current Moment by Miller Howard Investments
WE ALL LEARN, IN ECON 101, that the prices of goods and services are set in the marketplace by the “invisible hand” within whose palm sits Supply and Demand, two figures always battling for supremacy in the never-ending dialectic through which prices are determined. Conservatives embrace the interaction of supply and demand with an almost religious fervor, asserting that the “hand” always produces optimum results that will balance resources and social needs, while progressives see the hand as a tool enabling the greediest to abscond with resources and the fruits of society’s labor. We’re not here to decide which position is ultimately correct, but we do know that within the remarkable landscape visible today, supply and demand aren’t always functioning as they used to, or as some might say, as they should.
This is especially true when viewing demand in relation to money, which makes the economic world go round. We’ve had a zero-rate policy from the Federal Reserve and its equivalents across the developed world effectively since the financial crisis of 2008. Perhaps the low rates saved the day—one can’t know what an alternative scenario might have produced. But one thing is certain: Essentially free money (supply) has not induced the swell of borrowing and commerce (demand) that monetarists would have predicted. (Milton Friedman’s famous comment that “inflation is always and everywhere a monetary phenomenon,” has been upended, at least to date, as money has been loosened and injected into the world’s economies at a rate never seen before without generating inflation.) Indeed, most policy makers are actually hoping to generate inflation, or a general increase in prices and fall in the purchasing value of money. This is a crazy thought for investors who’ve always assumed that the first qualifier of an investment is that it should be able to overcome the inflation that is presumed to be ever-present.
In fact, the availability of money is running far ahead of investors’ and businesses’ ability or capacity to use it. For us, the telltale number that reveals demand in the economy is the velocity of money—the rapidity with which a dollar is exchanged. Velocity of money serves as a barometer of economic activity, as well as a measure of how much money is actually circulating, or is needed.
In the fall of 2008 we wrote that nearly all economic numbers were “off the charts,” and that there would be no quick snap-back of the sort that MBAs schooled in the “cycles” of economic activity had come to believe in. Everything will be all right, went this thinking—the economy is cyclical and we were due for a downturn anyway. Yet if velocity of money is the telltale of economic vibrancy, and we believe it is, what can one make of the chart below, published by the Federal Reserve?
The velocity of money is off the charts, without doubt, but in the wrong direction. In the 1990s velocity turned upward as money chased first the consumer nondurables bubble (recall Coke selling at a P/E of over 40) and soon thereafter the tech bubble, reaching what appears in retrospect to be an unsustainable level of activity, then tumbling from the beginning of this century to levels not seen since records have been kept. What does this mean? It means there is enough money. Banks are reluctant to lend, and borrowers reluctant to borrow. Lending and borrowing are the primary ways in which velocity increases, since $1 deposited in a bank can become $10 in the economy—if anybody wants it.
But no matter if it is off the charts, believers in the inevitability of cyclical return continue to suggest that rates will go higher, and that the Fed will increase rates even in the face of the slack demand articulated in the velocity chart. Below is what the futures markets have said every year since 2008, estimating what rates will be:
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