Over the years, I've written a lot about money supply and money velocity and their importance on indicating the condition and direction of the U.S. and global economies. These metrics showcase a fundamental aspect of any economy's financial "plumbing". To me, understanding the state of money supply and its velocity through an economy provides unique insights, particularly on the general effectiveness of monetary and fiscal policies.
The accompanying charts show various trends for both money supply and money velocity (Figure 2.), as well as the relational implications for overall increased market liquidity on various risk-on assets (e.g., S&P 500 and bitcoin, Figure 3.). The basic idea is that when money supply increases, overall liquidity increases within an economy. When there's more money stock available within the system, that money should find its way to be invested, borrowed, loaned, and spent. However, it's this last characteristic that continues to lag, as the recovery in money velocity remains well behind the overall increase in money stock. In the most simplest terms, this means that even though there's more money available within the economy, there are fewer transactions circulating that money throughout the economy. This is an unsettling, undesirable, and unsustainable trend.
As a matter of fact, based on Federal Reserve Bank of St. Louis data, the velocity of M2 money stock is significantly below its long-term historical average. As you'll note in Figure 1., money velocity began its consistent decline post-Great Financial Crisis (GFC) in 2008. This structural shift could be attributed to the much higher baseline money supply created from permanent Quantitative Easing (QE) effects from two separate crises (e.g., GFC + Pandemic). Additionally, there could be a lingering risk aversion that originally took root during the GFC, which led many households and businesses to hoard cash. This is particularly relevant for older demographics approaching or in retirement who tend to save more and spend less. Lastly, wealthier households have chosen to invest more into the stock market, instead of a contributing a proportional increase in their own spending, which could further induce lower levels of money velocity. Though the causes for velocity malaise are myriad, its impact is simple - less money circulating through transactions ultimately means a more sluggish economy.
It's likely that one of the most impactful tools the Fed implemented during the GFC was the interest it pays on bank reserves, which currently stands at 4.4%. When banks make so much money without taking any risk, they have some incentive to lend out those funds, but not an urgency to lend which the economy might otherwise prefer and need for more robust growth.
Until money velocity shows signs of more vigor, the impact of such strong money supply growth remains limited to inflating risk asset pricing.
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Figure 2.
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