Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
The Only Thing Systematic Is The Destruction Of America - 29th Sep 20
Fractional-Reserve Banking Is The Elephant In The Room - 29th Sep 20
Gold And Silver Follow Up & Future Predictions For 2020 & 2021 – Part I - 29th Sep 20
Stock Market Short-term Reversal - 29th Sep 20
How Trump co-opted the religious right and stacked the courts with conservatives - 29th Sep 20
Which RTX 3080 GPU to BUY and AVOID! Nvidia, Asus, MSI , Palit, Gigabyte, Zotac, MLCC vs POSCAPS - 29th Sep 20
Gold, Silver & HUI Stocks Big Pictures - 28th Sep 20
It’s Time to Dump Argentina’s Peso - 28th Sep 20
Gold Stocks Seasonal Plunge - 28th Sep 20
Why Did Precious Metals Get Clobbered Last Week? - 28th Sep 20
Is The Stock Market Dow Transportation Index Setting up a Topping Pattern? - 28th Sep 20
Gold Price Setting Up Just Like Before COVID-19 Breakdown – Get Ready! - 27th Sep 20
UK Coronavirus 2nd Wave SuperMarkets Panic Buying 2.0 Toilet Paper , Hand Sanitisers, Wipes... - 27th Sep 20
Gold, Dollar and Rates: A Correlated Story - 27th Sep 20
WARNING RTX 3080 AIB FLAWED Card's, Cheap Capacitor Arrays Prone to Failing Under Load! - 27th Sep 20
Boris Johnson Hits Coronavirus Panic Button Again, UK Accelerting Covid-19 Second Wave - 25th Sep 20
Precious Metals Trading Range Doing It’s Job to Confound Bulls and Bears Alike - 25th Sep 20
Gold and Silver Are Still Locked and Loaded… Don't be Out of Ammo - 25th Sep 20
Throwing the golden baby out with the covid bath water - Gold Wins - 25th Sep 20
A Look at the Perilous Psychology of Financial Market Bubbles - 25th Sep 20
Corona Strikes Back In Europe. Will It Boost Gold? - 25th Sep 20
How to Boost the Value of Your Home - 25th Sep 20
Key Time For Stock Markets: Bears Step Up or V-Shaped Bounce - 24th Sep 20
Five ways to recover the day after a good workout - 24th Sep 20
Global Stock Markets Break Hard To The Downside – Watch Support Levels - 23rd Sep 20
Beware of These Faulty “Inflation Protected” Investments - 23rd Sep 20
What’s Behind Dollar USDX Breakout? - 23rd Sep 20
Still More Room To Stock Market Downside In The Coming Weeks - 23rd Sep 20
Platinum And Palladium Set To Surge As Gold Breaks Higher - 23rd Sep 20
Key Gold Ratios to Other Markets - 23rd Sep 20
Watch Before Upgrading / Buying RTX 3000, RDNA2 - CPU vs GPU Bottlenecks - 23rd Sep 20
Online Elliott Wave Markets Trading Course Worth $129 for FREE! - 22nd Sep 20
Gold Price Overboughtness Risk - 22nd Sep 20
Central Banking Cartel Promises ZIRP Until at Least 2023 - 22nd Sep 20
Stock Market Correction Approaching Initial Objective - 22nd Sep 20
Silver Bulls Will Be Handsomely Rewarded - 21st Sep 20
Fed Will Not Hike Rates For Years. Gold Should Like It - 21st Sep 20
US Financial Market Forecasts and Elliott Wave Analysis Resources - 21st Sep 20
How to Avoid Currency Exchange Risk during COVID - 21st Sep 20
Crude Oil – A Slight Move Higher Has Not Reversed The Bearish Trend - 20th Sep 20
Do This Instead Of Trying To Find The “Next Amazon” - 20th Sep 20
5 Significant Benefits of the MT4 Trading Platform for Forex Traders - 20th Sep 20
A Warning of Economic Collapse - 20th Sep 20
The Connection Between Stocks and the Economy is not What Most Investors Think - 19th Sep 20
A Virus So Deadly, The Government Has to Test You to See If You Have It - 19th Sep 20
Will Lagarde and Mnuchin Push Gold Higher? - 19th Sep 20
RTX 3080 Mania, Ebay Scalpers Crazy Prices £62,000 Trollers Insane Bids for a £649 GPU! - 19th Sep 20
A Greater Economic Depression For The 21st Century - 19th Sep 20
The United Floor in Stocks - 19th Sep 20
Mobile Gaming Market Trends And The Expected Future Developments - 19th Sep 20
The S&P 500 appears ready to correct, and that is a good thing - 18th Sep 20
It’s Go Time for Gold Price! Next Stop $2,250 - 18th Sep 20
Forget AMD RDNA2 and Buy Nvidia RTX 3080 FE GPU's NOW Before Price - 18th Sep 20
Best Back to School / University Black Face Masks Quick and Easy from Amazon - 18th Sep 20
3 Types of Loans to Buy an Existing Business - 18th Sep 20
How to tell Budgie Gender, Male or Female Sex for Young and Mature Parakeets - 18th Sep 20
Fasten Your Seatbelts Stock Market Make Or Break – Big Trends Ahead - 17th Sep 20
Peak Financialism And Post-Capitalist Economics - 17th Sep 20
Challenges of Working from Home - 17th Sep 20
Sheffield Heading for Coronavirus Lockdown as Covid Deaths Pass 432 - 17th Sep 20
What Does this Valuable Gold Miners Indicator Say Now? - 16th Sep 20
President Trump and Crimes Against Humanity - 16th Sep 20
Slow Economic Recovery from CoronaVirus Unlikely to Impede Strong Demand for Metals - 16th Sep 20
Why the Knives Are Out for Trump’s Fed Critic Judy Shelton - 16th Sep 20
Operation Moonshot: Get Ready for Millions of New COVAIDS Positives in the UK! - 16th Sep 20
Stock Market Approaching Correction Objective - 15th Sep 20
Look at This Big Reminder of Dot.com Stock Market Mania - 15th Sep 20
Three Key Principles for Successful Disruption Investors - 15th Sep 20
Billionaire Hedge Fund Manager Warns of 10% Inflation - 15th Sep 20
Gold Price Reaches $2,000 Amid Dollar Depreciation - 15th Sep 20
GLD, IAU Big Gold ETF Buying MIA - 14th Sep 20
Why Bill Gates Is Betting Millions on Synthetic Biology - 14th Sep 20
Stock Market SPY Expectations For The Rest Of September - 14th Sep 20
Gold Price Gann Angle Update - 14th Sep 20
Stock Market Recovery from the Sharp Correction Goes On - 14th Sep 20
Is this the End of Capitalism? - 13th Sep 20
The Silver Big Prize - 13th Sep 20
U.S. Shares Plunged. Is Gold Next? - 13th Sep 20
Why Are 7,500 Oil Barrels Floating on this London Lake? - 13th Sep 20
Sheffield 432 Covid-19 Deaths, Last City Centre Shop Before Next Lockdown - 13th Sep 20
Biden or Trump Will Keep The Money Spigots Open - 13th Sep 20
Gold And Silver Up, Down, Sideways, Up - 13th Sep 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Debt Fuelled Economic Recovery Leading to What?

Economics / Economic Theory Aug 21, 2009 - 04:27 PM GMT

By: Andy_Sutton

Economics

Best Financial Markets Analysis ArticleLast week’s essay centered on the fact that America has borrowed nearly $12 trillion dollars yet achieved very little, if any real economic growth in the last half century. If that wasn’t alarming enough, this week’s effort should suffice to turn some heads. While last week we used the broadest monetary aggregate M3 to discount GDP, this week we’re going to take a look at velocity of circulation in the M2 aggregate and translate that into some logical conclusions. Politicians, the Conference Board and nearly every alphabet soup media outlet known to man are trying to talk this economy out of recession. We already know that talk is cheap, but I have a distinct suspicion that we’re soon going to find out exactly how cheap it really is.


But why pick on M2? The reason here is simple. The Conference Board’s index of leading economic indicators (LEI) assigns M2 a whopping weight of 35.8%. So just creating money automatically means good things will happen? Here we get yet another insight into one of the many flaws of Keynesian economic theory. Average weekly hours in manufacturing is the second largest component of the index or LEI and is assigned a 25.49% weight. It should be immediately obviously that significant changes in M2 could easily overshadow diverging movements by other components of the Index. The full chart is displayed below, from the Conference Board’s website:

Thursday morning, the Conference Board reported that its LEI rose by .6% for the month of July and has in fact been rising for the past 6 months. Interestingly enough, M2 was cited as applying negative pressure in July’s number. However, even this number is not immune to hedonics. The Conference Board adjusts M2 by the Personal Consumption Index deflator which is based on guess what? The CPI. So by using a negative deflator, the Conference Board is alleging an increase in ‘real’ M2, which has been helpful to the LEI over the past few months. However, money supply doesn’t equal economic activity and we’ll show you why.

Before we get too far into this analysis, let’s present some baseline definitions of M1 and M2:

M1 Aggregate: M1 includes funds that are readily accessible for spending. M1 consists of: (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) traveler's checks of nonbank issuers; (3) demand deposits; and (4) other checkable deposits (OCDs), which consist primarily of negotiable order of withdrawal (NOW) accounts at depository institutions and credit union share draft accounts.

M2 Aggregate: Equals M1 + savings deposits, time deposits less than $100,000 and money market deposit accounts for individuals.

Many economists view M2 as a good measure of near term inflationary pressures. M3 is generally regarded as a longer-term inflationary indicator, which is why it was used in last week’s 50-year analysis.

What also needs to be looked at is the velocity of circulation of the aggregates. This is the turnover rate or the number of times each dollar within the aggregate changes hands in a given period of time, generally a year. Obviously, velocity of circulation or turnover is an indicator of the level of economic activity. The higher the velocity, the more times in a given year a particular dollar changes hands. And vice versa. The velocity of circulation is arrived at by taking GDP and dividing it by the appropriate aggregate.

In the chart below, we see the velocity of circulation for M2. It is interesting to note that M2 velocity peaked in 1997, then fell into a 2003 trough, rose again slightly, most likely in response to ridiculously low interest rates, then plummeted from 2006 through the present. Obviously, we would expect to see velocity decrease during a recession since there is diminished activity. The current plunge in velocity has happened despite over $1.3 trillion of deficit spending just in the last 10 months. A few weeks ago we made the case that deficit government spending should be discarded from or at least discounted in GDP. Following that logic and recalculating M2 velocity based on the lower GDP reading, we would currently have a M2 velocity of 1.54 vs. the 1.70 displayed in the chart; a decrease of 9.41%. In essence, the $1.3 trillion in deficit spending is causing a near 10% overstatement of activity as represented by M2 velocity.

The admission is readily made that perhaps not all deficit spending would find its way into M2; some might certainly end up in components which are exclusive to M3, and so the adjustment is meant to be illustrative in nature and indicative of the distortions that government spending is causing in metrics that were previously more closely related to the real economy.

Perhaps even more interesting is the obvious sluggishness in the response of M2 Velocity to interest rate stimulus in the form of the Fed Funds Rate.

Taking a look at the two preceding interest rate lowering campaigns, the Fed Funds Rate (FFR) peaked in 1989, then bottomed in 1993. Velocity responded fairly quickly, beginning a steady climb up towards the end of 1991 or about halfway through the rate-cutting cycle. The FFR peaked again in 2000 and the next rate-cutting campaign lasted until late 2004. Again, velocity responded rather quickly, bottoming, then beginning to climb in early 2003. The response to that stimulus, however, was much less than the prior, even though the magnitude of the stimulus was similar. The FFR peaked again in late 2006 and the next rate-cutting campaign began in earnest and has stopped only because rates have essentially hit zero. So this rate-cutting campaign has lasted nearly 3 years, and there has been absolutely no response in M2 velocity to speak of.

If this isn’t an indication that monetary policy has lost the majority of its effectiveness, then I don’t know what is. Perhaps the Conference Board could take into consideration that it is easy to inflate, but it is considerably harder to generate even cursory activity, let alone real economic growth simply by printing more money.

As is evidenced above, M2 Velocity is certainly not directly proportional to M2 growth. The determinant in velocity of circulation is GDP. Take for instance the period between 1991 and about 1996. M2 growth was relatively flat, yet velocity increased dramatically. This tells us that GDP increased despite the lack of increase in M2.

However, had one stopped there and not looked at consumer credit, (largely unaccounted for in the monetary aggregates) which went ballistic in 1993, the above chart would have led them to believe that there was genuine economic activity during that period. The only reason I chose to even mention this is to point out how the law of diminishing returns has played out again. Consumer credit, which was able to stimulate a significant increase in M2 velocity (activity) in the 1990’s, was not able to do so in the early part of this decade even though it increased steadily until the latter part of 2008.

As many readers have already noticed, recent essays have focused on picking apart the major economic reports and pointing out distortions and possible distortions where they exist. The reason is simple. Many self-directed investors, consumers, and even advisers make important financial decisions based on the fact that some number went up when it was supposed to go down or vice versa. It would make sense that those same people would want to know where that number came from, how it was derived, and what the risks to the presented analysis are before making those important decisions.

We have bundled together the series ‘Basic Financial Analysis’ in PDF format for anyone who would like a copy. Also included in the PDF is an unpublished section on portfolio monitoring. To obtain a copy, please visit: http://www.sutton-associates.net and click the report banner.

By Andy Sutton
http://www.my2centsonline.com

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. His firm, Sutton & Associates, LLC currently provides financial planning services to a growing book of clients using a conservative approach aimed at accumulating high quality, income producing assets while providing protection against a falling dollar. For more information visit www.suttonfinance.net

Andy Sutton Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules