Sunday, July 26, 2009

US vs. Canada in charts: the velocity of money

I have received a lot of requests to visit the velocity of money -the rate at which money changes hands. And I thought that it would be instructive to compare the US velocity to another non-QE G7 economy. And since I have a lot of Canadian readers, I chose Canada. The velocity has seriously slipped in both economies.

The chart above (or to the left, depending on your browser) illustrates the monthly MZM and M2 measures of velocity for the US. The quantity theory of money specifies that the velocity of money = nominal GDP/money supply, but I use personal income rather than nominal GDP, as the BEA reports this on a monthly basis. Given a level of money supply, the recent drop in economic activity, i.e., personal income falls, dragged the velocity of money down quickly. It has started to stabilize since March 2009.

Same in Canada: the money supply dropped sharply in Q1 2009 (velocity = nominal GDP/broad money).

Notice that the velocity in Canada has been on a downward trend spanning 1973-2009, however, the negative slope is falling. I am not too familiar with Canada's velocity (perhaps some of my readers may be more so), but usually a declining velocity of money is associated with a drop in GDP or inflation. I would have to look into this further, but Canada did experience a term of disinflation from the early 80's to mid 90's.

Rebecca Wilder


  1. Anyone seeking to express a true measure of the velocity of money would use the ratio of economic transaction (sales) to money in circulation (notes and coins).

    Those who include credit in the denominator commit a logical error.

    Most fail to see that credit, hence debt, is a product, a kind of legal transaction. Credit, hence debt, is something you buy with money in circulation (notes and coins).

    Simply, they don't get money and credit (debt).

    Checking accounts and savings accounts are products, not money. Only notes and coins are money.

    As central bankers deflate (purposefully reduce credit) purportedly to reign in excess speculative credit, a recession follows as output declines and with a recession, a decline in the velocity of money.

    When central bankers inflate (purposefully increasing credit), central bankers seek expansion.

    The velocity of money increases as economic output (things + services + credit) rises relative to the money in circulation (notes + coins) used to pay for such output.

    Enjoy your day Rebecca!

  2. First, there is no ambiguity in forecasts: In contradistinction to Bernanke (and using his terminology), forecasts are mathematically "precise” :

    (1) nominal GDP is measured by monetary flows (MVt);

    2) Income velocity is a contrived figure (fabricated); it’s the transactions velocity (bank debits, demand deposit turnover) that matters;

    (3) “money” is the measure of liquidity; &

    (4) the rates-of-change (roc’s) used by the Fed are specious (always at an annualized rate; which never coincides with an economic lag).

    The Fed’s technical staff, et al., has learned their catechisms;

    Friedman became famous using only half the equation (the means-of-payment money supply), leaving his believers with the labor of Sisyphus.

    Contrary to economic theory, the lags for monetary flows (MVt), i.e. proxies for (1) real-GDP and the (2) deflator are always exactly the same.

    Roc’s in (MVt) are always measured with the same length of time as the specific economic lag (as its influence approaches its maximum impact; as demonstrated by the clustering on a scatter plot diagram).

    Not surprisingly, adjusted member commercial bank "free" legal reserves (their roc’s), corroborate or mirror, both lags for monetary flows (MVt) –-- their lengths are identical (as the weighted arithmetic average of reserve ratios remains constant).

    The lags for (1) monetary flows (MVt), & (2) "free" legal reserves, are synchronous & indistinguishable.

    Consequently, this makes economic forecasting mathematically infallible (for less than one year),

    All bubbles, which includes housing, commodity,, bubbles, etc., are exceptionally obvious.

    This is the “Holy Grail” & it is inviolate & sacrosanct.

    The BEA uses quarterly accounting periods for real GDP and deflator. The accounting periods for GDP should correspond to the economic lag, not quarterly.

    Monetary policy objectives should not be in terms of any particular rate or range of growth of any monetary aggregate. Rather, policy should be formulated in terms of desired roc’s in monetary flows (MVt) relative to roc’s in real GDP.

    Note: roc’s in nominal GDP can serve as a proxy figure for roc’s in all transactions. Roc’s in real GDP have to be used, of course, as a policy standard.

    Because of monopoly elements, and other structural defects, which raise costs, and prices, unnecessarily, and inhibit downward price flexibility in our markets, it is probably advisable to follow a monetary policy which will permit the roc in monetary flows to exceed the roc in real GDP by c. 2 – 3 percentage points.

    I.e., monetary policy is not a cure-all, there are structural elements in our economy that preclude a zero rate of inflation.

    In other words, some inflation is inevitable given our present market structure and the commitment of the federal government to hold unemployment rates at tolerable levels.

    Some people prefer the devil theory of inflation: “It’s all Peak Oil's fault" or it’s all ”Peak Debt's fault".

    This approach ignores the fact that the evidence of inflation is represented by "actual" prices in the marketplace.

    The "administered" prices of the world's monopolies, would not be the "asked" prices, were they not “validated” by (MVt), i.e., validated by the world's Central Banks (“inflation is always and everywhere a monetary phenomenon"—Milton Friedman).

  3. Cartesian coordinates: Contrary to economic theory, monetary lags are uniformly fixed in length. The statistical analysis of these crests and troughs confirm that the rates-of-change in these monetary flows (our means-of-payment money times its rate of turnover) are not random.

    Specifically, the rates-of-change (roc’s), in the monetary lags (the proxies for real-growth, & for inflation), oscillate unvaryingly along the X axis. Their maximum and minimum reference frames (as demonstrated by the clustering on a scatter plot diagram) correspond to the economic lag, and not to any of our federal government agencies’ weekly, monthly, quarterly, or annual statistics.

    These oscillations do however suffer from errant data. Errant data may originate from faulty theoretical interpretations, flaws in defining the data, and errors in the survey, collection, calculation, and publication of the government’s call reports, etc. (for both the (1) seasonal mal-adjusted data, as well as the raw (2) non-seasonally adjusted data). And it is problematic that there are also undetected mistakes in the raw data.

    In the first sentence of the Federal Reserve Act of 1913 it calls for the Federal Reserve Banks to “furnish an elastic currency”. The Board of Governors has liberally interpreted this statement to support its policy of seasonal accommodation.

    The corresponding data is then reported using periodic revisions to seasonal factors (hence the mal-adjustments).

    The technical staff's economic justification for this practice (using last year’s seasonal factors for this year’s release), has its roots in the fallacious “Real Bills Doctrine”.

    The problem with the “Real Bills Doctrine” is that an injection of new bank credit for financing inventories, or any other phase of merchandising, or processing, is obviously inflationary when the theory applied under the assumption that labor and facilities are fully employed, as for example, during the Christmas and New Year’s holidays.

    And the raw data may be revised, reconstructed, or spliced, causing noticeable changes and distortions. Geographical statistical areas and sample sizes’ may change. The data might not conform to the data from original release. And when some statistical releases are revised, these time series overlay (wipe out), the original data. I.e., the government’s reporting agencies don’t always keep separate iterations of the old historical data. Reporting may also be delayed, published less frequently, or only available as seasonally mal-adjusted.

    It is instructive that the FED has never cooperated by supplying continuous, comparable, and timely data. Supporting data is required for the proper investigation, the subsequent proof, and ending conclusion, for any economic research

    That understood: the roc’s in the Y coordinates for monetary flows (MVt), closely parallel the roc’s in GDP figures. I.e., the roc’s in bank debits closely correspond to the roc’s in monetary flows (for both real growth, & for inflation).

    Likewise, it is no accident that the roc’s in adjusted member bank “free” legal reserves corroborate these roc’s.

    The roc’s between both time series is synchronous (what is being compared is the rate-of-change, not the absolute figure).

    That given: “reliance on the data compiled by the Government agencies is subject to the limitations of all analyses based upon statistical aggregates, i.e., data cannot be compiled accurately, or by a method which conforms to rigid theoretical concepts” (Dr. Leland James Pritchard, Chicago, Economics, 1933; Masters, Statistics, Syracuse).

    It is more likely that statistical calculations are at odds with the real world, estranged from scientific economics, inconsistent with mathematical modeling, not because of faulty economic theories, but because of non-conforming, or non-existent, raw data.(“History is full of bad jokes”).

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