As the Money Turns Not!

If you’re wondering why the economy is weak (and likely to weaken further) the answer is the velocity of money: The average frequency with which a unit of money is spent on new goods and services produced domestically in a specific period of time. Velocity has to do with the amount of economic activity associated with a given money supply.

For example, if a farmer and a mechanic, with $50 between them, buy new goods and services from each other in just three transactions over the course of a year (farmer spends $50 on tractor repair from mechanic; mechanic buys $40 of corn from farmer; mechanic spends $10 on barn cats from farmer), then $100 changed hands in the course of a year, even though there is only $50 in this little economy.

The velocity of money today is slightly less than it was in the 1960s, when the economy was booming. That can’t happen now, because there is far too much debt within the system. Money supply has jumped sharply in the last few years thanks to low interest rates and lots of QE. Meanwhile the consumer, instead of spending on goods and services, has been paying down debt, a significant contributor to a fall in the velocity of money.

In theory, pumping money into the financial system is supposed to help improve the velocity of money. But it can’t; there is too much debt and, until that debt is lowered either by default or paying it down, the economy will continue to slump. Another crisis like the one of 2008 could push the economy over the edge into a steep recession, or even a depression.

The debt-cleansing cycle is still young. The excesses of the 1990s and early 2000s will likely take years to resolve, and the resultant fallout from that cycle of excess will be with us for some time. The fallout has increased societal tensions, social unrest and even the potential for global warfare.

To read David Chapman article: As the Money Turns Not!

Tagged as: Economic, Money supply