The Disastrous “X Cross”: Velocity of Money vs. Money Printed


The light blue line shows the “velocity of money,” a measure of the average number of times a unit of currency is spent over a given time period.  The pink line shows US currency supply in USD billions.

Many implications can be drawn from this chart, but if one were to summarize it, it essentially shows how massive amounts of currency were printed into existence though quantitative easing (mass purchase of bonds short of their maturity date) and fed into the economy through Wall Street speculation.  This money did nothing but pump up asset prices in stocks, bonds, real estate, and other forms of loans (including junk bonds).  The light blue line is where the economy hurts.  The average American consumer has reduced spending on consumer goods and is saddled in paralyzing amounts of debt.  We all know the American consumer saddled with student loans while simultaneously working in a mediocre job and paying off a car loan and sometimes even a mortgage.  To make ends meet, people cut their spending on consumer goods and services, instead focusing on that whopping interest payment and hopefully chopping off some principal in the process.  (The reason why loans have increased is due to low costs of borrowing led by Federal Reserve policy.  The base rate of borrowing is essentially 0 percent meaning consumers find it attractive take out loans relative to when the base rate is 4 or 5 percent.  The other policy is, of course, quantitative easing, which we already discussed.)

The prevailing school of thought (Keynesian/Neoclassical) says: “CLEARLY what we need is more spending.  Consumers need to be turning over money at a quicker rate; therefore, we need to cut interest rates into negative territory so that consumers will be penalized for keeping money in their bank account!  Add to that some more guidance in the form of “helicopter money” which will help coerce spending and induce inflation as the metric of observation.”

The Austrian School: “Interest rates need to be raised and the recession needs to occur.  The only way to get out of a recession is to let the recession take its course and allow prices to deflate.  Unemployment will rise and it will be painful at first, but it is the only way to get consumers saving again. High interest rates will also create attractive returns for savers.  Ultimately capital investment comes from savings, which is the key to the growth of a sustainable economy.

The Austrian school is correct here.  Unfortunately Austrian economics has been demonized by political academics with deep ties to the IMF and their respective central banking institutions.  The problem is that Austrian suggestions have never been implemented on a scale that would be necessary to see improvements because people are scared of letting a true recession play out.  In fact it would take a complete reversal of current policies in order to see any positive changes take place.  No country has come close to this, yet many academics continue to demonize this “austerity.”

Do Keynesians do this out of spite?  Not at all.  Keynesians genuinely believe they can fix economics through government assistance.  However, the failures of this approach have been documented intensely, yet brushed under the rug, and Keynesian economics in its many forms and manifestations has failed every single time.  This can be dragged out into a much longer discussion, of course, although the short descriptions above are a decent primer into how both schools would approach the problem of consumer demand and spending.