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scepticus

The Velocity Problem - Not Going Away Any Time Soon

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http://ftalphaville.ft.com/2015/11/26/2145920/the-declining-velocity-of-end-of-year-predictions-and-money/

Well worth a read. Finishes noting that without QE4 liquidity will continue to evaporate. All developed and most emerging economies suffering from inexorably slowing velocity.

My own view is even QE4 would only kick the can a very short distance.

And without more QE it won't be rate rises that will be generating the next shock - quite the opposite. Also a lot of talk recently about global fiscal policy being loosened for the first time in 5 or 6 years - but not by enough I am guessing (and whats the difference between that and QE really?).

Don't look for sustained rate rises till you see the velocity of money tick up. No sign - anywhere - of that yet.

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http://ftalphaville.ft.com/2015/11/26/2145920/the-declining-velocity-of-end-of-year-predictions-and-money/

Don't look for sustained rate rises till you see the velocity of money tick up. No sign - anywhere - of that yet.

By the same standard don't expect the velocity of money to tick up until; you get rate rises.

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http://ftalphaville.ft.com/2015/11/26/2145920/the-declining-velocity-of-end-of-year-predictions-and-money/

Well worth a read. Finishes noting that without QE4 liquidity will continue to evaporate. All developed and most emerging economies suffering from inexorably slowing velocity.

My own view is even QE4 would only kick the can a very short distance.

And without more QE it won't be rate rises that will be generating the next shock - quite the opposite. Also a lot of talk recently about global fiscal policy being loosened for the first time in 5 or 6 years - but not by enough I am guessing (and whats the difference between that and QE really?).

Don't look for sustained rate rises till you see the velocity of money tick up. No sign - anywhere - of that yet.

We're appear to be a bit closer to the point where more QE actually can't support further imbalances that have been created post-crunch.

Tiny spark....

- Extraordinary easy money and stability in the commodity markets are important factors working to that end [making for prosperity]. - Wall Street Journal (April 1930)

- ...fundamental credit conditions have undergone a marked change for ease not only in this country but all over the world. - New York Times (April 1930)

- "An outstanding development is the sharp drop in interest rates, marking the end of a period of credit strain and bringing rates to the lowest point in several years. In its bearing on general business conditions the advent of really cheap money has been widely heralded, and rightly so, as the most important and promising feature in the general situation. That cheap money is a tonic for the recuperation of business has been proven by long experience.'" - New York Times (April 1930) - quoting April bulletin of the National City Bank.

- "Money rates declined rapidly to the lowest levels since early 1925, the April 1 review of the Federal Reserve Bank of New York states, and accompanying this ease in money, the bond market in March made a vigorous recovery." - New York Times (April 1930)

- "The Federal Reserve policy of cheapening credit through the purchase of government bonds has been unable to make a dent in the conservatism of borrower or bank lender, in short, every anti-deflationary effort has yet to provide positive results"” (Editorial, Barron’s, July 11, 1932)

[..]Falling interest rates were not accompanied by a growth of money aggregates. A repeat of this would be an early confirmation of a coming deflationary collapse. The notion that easy money is a magic tonic that can counter the forces of contraction is likely to seem alluring as an argument than it proves to be a fact.

[..]With enterprise "collapsing," the forces making for contraction were too strong to be overcome by the stimulus of artificial reducing short-term money rates below the very low levels actually reached”.

Also notice the recurring references to monetary policy. Contrary to the current wisdom that stupidly tight money turned the '29 stock market crash into depression, accounts of 1930 speak of "extremely easy money." What seemed to be easy money at the time was denounced later as "too tight" may only show that the dynamic of contraction works behind the scenes. More muscular attempts to counter that dynamic process by inflating faster would paradoxically strengthen the deflationary impulse.

What seems to be lost in the monetary debate is that this persistent drop in inflation defies the primary purpose of quantitative easing, which is designed to lower real interest rates. In fact, with nominal yields rising in the face of falling inflation and thus raising real interest rates, the US economy is now closer to a deflationary death spiral than at any time during the Fed’s unprecedented policy designed to prevent just such an outcome.
Though he wouldn’t admit it, Bernanke met his match in 2011. The consumer balked at attempts to stimulate aggregate demand via inflationary policy of negative real interest rates, and ever since, has been raising real interest rates by reducing inflation through lower aggregate demand. This is perhaps the most unappreciated yet significant market development since the financial crisis.
The search for scapegoats is in many respects silly. But it unintentionally makes a point that you should take to heart. When the news is bad and apt to get worse you cannot draw your bearings about the economy or the market from channels of mass communications. Can you imagine a major newspaper (much less the leaders of the country) saying that stocks fell because objective conditions no longer supported their further rise? Has it ever been recognised politically that a market has topped out? Or that an economy needed to go through a painful slump to facilitate a transition and shake out dead wood? In every case which we know, politicians have continued to pretend that all was well long after events provided impressive evidence to the contrary. This is a game that President Hoover, in retirement, described as “sustaining the morale of the people.”

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By the same standard don't expect the velocity of money to tick up until; you get rate rises.

 

Spot on.

QE is killing the velocity because QE is the purchase of bonds and speculators suck all money out of the economy to join this risk free bond buying fest, underwritten by the infinite money of the central bank. QE is absolutely killing the economy outside of the bond market. It is causing producers to realise that the cheap loans available can be used to grow the stock options by borrowing and buying their own company's stock rather than capital investment to grow the business.

Because the markets are now so irretrievably skewed, the end of QE and the bond bubble will be a sharp spike in rates and the velocity of money will go to infinity. That is another way of saying we will get hyperinflation.

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As private sector increasingly dump their bonds (why wouldnt you) liquidity/velocity will pick up.

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As private sector increasingly dump their bonds (why wouldnt you) liquidity/velocity will pick up.

 

why should the private sector, or anyone else, dump their bonds when the central bank is guaranteeing that they will buy them at any price with unlimited funds ? In fact, that encourages everyone and their dog to get into the bond bubble game. And that includes, although they don't realise the underlying reasons, the property speculator. The latter is nothing more than a bond bubble frenzy participant. Because the entire world is in on the game, when (not if) it does burst, the only effect can be hyperinflation. IMO

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why should the private sector, or anyone else, dump their bonds when the central bank is guaranteeing that they will buy them at any price with unlimited funds ? In fact, that encourages everyone and their dog to get into the bond bubble game. And that includes, although they don't realise the underlying reasons, the property speculator. The latter is nothing more than a bond bubble frenzy participant. Because the entire world is in on the game, when (not if) it does burst, the only effect can be hyperinflation. IMO

+1

The bond market is Job No. 1 for central bankers. They'll defend it to the death (see Japan).

Personally, I think we get an asset collapse before we see helicopters, but who knows? The alternative wouldn't surprise me. Yellen and co. are obviously prepared to do just about anything to hold up nominal prices.

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As private sector increasingly dump their bonds (why wouldnt you) liquidity/velocity will pick up.

The charts covers 60 years which includes multiple 'bond selloffs'. Didn't do much for velocity then so not sure why it would in future?

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Spot on.

QE is killing the velocity because QE is the purchase of bonds and speculators suck all money out of the economy to join this risk free bond buying fest, underwritten by the infinite money of the central bank. QE is absolutely killing the economy outside of the bond market. It is causing producers to realise that the cheap loans available can be used to grow the stock options by borrowing and buying their own company's stock rather than capital investment to grow the business.

Because the markets are now so irretrievably skewed, the end of QE and the bond bubble will be a sharp spike in rates and the velocity of money will go to infinity. That is another way of saying we will get hyperinflation.

I don't think you can point at QE as a fundamental cause of declining velocity since the trend is steady and clear since the 60's according to these charts.

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By the same standard don't expect the velocity of money to tick up until; you get rate rises.

Historically it is quite clear from the data that velocity increases have always preceded rates rises, not the other way round. This is consistent with the real economy/market leading the Central bank, rather than the other way round.

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Surely the key metric is velocity of money x volume of money ? = total purchasing (aka demand in the economy)

That doesn't tell you anything about the level of debt and leverage though. Interest rates (at least, nominal ones) appear to be strongly correlated with velocity. That is if you look closely at various charts one sees that velocity climbs and so do nominal rates and then velocity falls and so do nominal rates.

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http://www.hussmanfunds.com/wmc/wmc141103.htm

Velocity point reminded me of this interesting article on the topic.

Yes that's the one I was thinking of - nice chart that shows the velocity to rates exponential/ inverse square law relationship.

The only thing I take issue with is the idea of rates causing velocity rather than velocity causing rates.

Question is then what driver velocity?

My answer would be the level of leverage in the economy versus is potential minimum and maximum levels. I would assert that a fiat economy would naturally trend towards the maximum level of leverage and minimum velocity since all other points are not stable. Minimum leverage (e.g. a pure cash middle-ages style economy) is not an 'attractor' in the 20th/21st century.

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Question is then what driver velocity?

My answer would be the level of leverage in the economy versus is potential minimum and maximum levels. I would assert that a fiat economy would naturally trend towards the maximum level of leverage and minimum velocity since all other points are not stable. Minimum leverage (e.g. a pure cash middle-ages style economy) is not an 'attractor' in the 20th/21st century.

I'm not well versed enough on these things to comment. But I know this is a recurring theme in Hussmans letters:

http://www.hussmanfunds.com/wmc/wmc130304.htm

http://www.hussmanfunds.com/wmc/wmc140825.htm

http://www.hussmanfunds.com/wmc/wmc150914.htm

I think he is arguing that velocity drives rates.

This image is interesting as it shows the stages (as he see things):

wmc150914c.png

I think his take is that QE has increased the monetary (whilst not meaningfully impacted GDP) and therefore velocity (by definition?) falls (MB / GDP). This collapse in velocity leads to interest rate falls (along the curve up to a point beyond which each £ of QE has no impact on short term interest rates).

Re. your first post:

Don't look for sustained rate rises till you see the velocity of money tick up. No sign - anywhere - of that yet.

Given that velocity is Monetary base / GDP (noninal), an increase would require significant unwing of QE, GDP growh and/or inflation. In terms of mechanics, my understanding was that (prior to QE and massive balance sheet expansion) short term interest rates were manged by central banks by selling / buying treasuries along the curve per the first article but now that their balance sheets are so large, in order to raise rates massive balance sheet contraction would be necissary and therefore the FED is planning to pay interest on reserves (with reverse REPOs?) to manage rates instead.

I know that Hussman has been arguing that rate rises are not appropriate at present (I think he argued they should have been following the tailor rule previously) but that QE should be unwound ASAP.

I don't have a complete idea of how these things fit together but it seems to be that low velocity is the natural outcome of QE (from the articles above).

Edited by growlers

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But the Wall Street media narrative is still looking at rate rises in December.... why are they tree shaking like this.

Edited by 200p

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I'm not well versed enough on these things to comment. But I know this is a recurring theme in Hussmans letters:

http://www.hussmanfunds.com/wmc/wmc130304.htm

http://www.hussmanfunds.com/wmc/wmc140825.htm

http://www.hussmanfunds.com/wmc/wmc150914.htm

I think he is arguing that velocity drives rates.

This image is interesting as it shows the stages (as he see things):

wmc150914c.png

I think his take is that QE has increased the monetary (whilst not meaningfully impacted GDP) and therefore velocity (by definition?) falls (MB / GDP). This collapse in velocity leads to interest rate falls (along the curve up to a point beyond which each £ of QE has no impact on short term interest rates).

Re. your first post:

Given that velocity is Monetary base / GDP (noninal), an increase would require significant unwing of QE, GDP growh and/or inflation. In terms of mechanics, my understanding was that (prior to QE and massive balance sheet expansion) short term interest rates were manged by central banks by selling / buying treasuries along the curve per the first article but now that their balance sheets are so large, in order to raise rates massive balance sheet contraction would be necissary and therefore the FED is planning to pay interest on reserves (with reverse REPOs?) to manage rates instead.

I know that Hussman has been arguing that rate rises are not appropriate at present (I think he argued they should have been following the tailor rule previously) but that QE should be unwound ASAP.

I don't have a complete idea of how these things fit together but it seems to be that low velocity is the natural outcome of QE (from the articles above).

Off topic (but linked to my above post):

http://www.zerohedge.com/news/2015-11-28/unintended-consequences-lift-world-excess-reserves

I have wondered whether lifting rates in a world with excess reserves might be problematic. The above article is interesting. I don't think I fully understand what he means by collaterising excess reserves but reinforces the point that it is an unusual situation to be raising rates with the balance sheet as large as it is.

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the US economy is now closer to a deflationary death life spiral than at any time during the Fed’s unprecedented policy designed to prevent just such an outcome.

Corrected - for those that consider lower prices to be a good thing. Alternatively just leave the emotive d word out and then deflation sounds far more beneficial.

Edited by billybong

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Historically it is quite clear from the data that velocity increases have always preceded rates rises, not the other way round. This is consistent with the real economy/market leading the Central bank, rather than the other way round.

Without wishing to state the obvious,historically, ZIRP/QE are unprecedented.

Ergo,you can't really draw parallels between then and now.

Also,demographic changes over the last 40/50 years mean spending patterns have changed as-Paul Hodges is often saying-peak spending years are between 25 and 50.Post 50 people have different attitudes and priorities.Given pensioners reticence to eat into capital,it's hardly surprising they've cut back as ZIRP/QE have pushed IR's lower.

Your central point on velocity,attacks the nub of our current problems.And if there's a way out of this debt deflation without a cascade of defaults,then getting velocity moving higher is the key.

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Without wishing to state the obvious,historically, ZIRP/QE are unprecedented.

Ergo,you can't really draw parallels between then and now.

Also,demographic changes over the last 40/50 years mean spending patterns have changed as-Paul Hodges is often saying-peak spending years are between 25 and 50.Post 50 people have different attitudes and priorities.Given pensioners reticence to eat into capital,it's hardly surprising they've cut back as ZIRP/QE have pushed IR's lower.

Your central point on velocity,attacks the nub of our current problems.And if there's a way out of this debt deflation without a cascade of defaults,then getting velocity moving higher is the key.

As I keep pointing out, the declining velocity trend pre-dates QE by 40 years at least. The underlying 'issue' with velocity ergo has nothing to do with QE.

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Off topic (but linked to my above post):

http://www.zerohedge.com/news/2015-11-28/unintended-consequences-lift-world-excess-reserves

I have wondered whether lifting rates in a world with excess reserves might be problematic. The above article is interesting. I don't think I fully understand what he means by collaterising excess reserves but reinforces the point that it is an unusual situation to be raising rates with the balance sheet as large as it is.

Paying IOER is akin to trying to turn excess reserves back into the bonds they started out as. All that has changed essentially is the maturity of the instrument. One suspects that doing so will cause a flattening of the yield curve or even an inversion which would leave the FED in a very odd situation. For a rate rise to work the whole term structure needs to rise in tandem.

I agree that using IOER to try and raise rates is likely to fail within the current framework for some of the reasons pointed out in the ZH link and others. It might work if non-banks are given access to FED balance sheet but that does indeed represent a wholesale re-engineering of the transmission mechanism.

I presume that 'collateralising excess reserves' means using them as collateral rather than money?

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As I keep pointing out, the declining velocity trend pre-dates QE by 40 years at least. The underlying 'issue' with velocity ergo has nothing to do with QE.

Most of the charts in the FT article refer to Global velocity.

I'm can't quite see the relevance of those stats.

Country by country is a different ball game to me.

St Louis Fed indicates peak in the mid to late 90's with a steady decline-including bounces-through 2008 to current timeframe.

US QE is relevant to US velocity.Not quite sure why you're trying to draw parallels with global velocity.

Also,I'm not trying to say say declining velocity is solely a function of QE.

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A few posts back the case was made that a bond crash /liquidity trap and then rising rates would lead to hyperinflation. I'm struggling to see it work on that order?

Likewise to me or sounds that velocity is of course correlated to interest rate rises but it doesn't have a causal effect. Velocity rises in an upward cycle when employment rises, confidence therefore outlook increases, investment increases, spending goes up, therefore confidence riders, and round we go etc etc, then when velocity goes up rates follow to tighten supply.

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A few posts back the case was made that a bond crash /liquidity trap and then rising rates would lead to hyperinflation. I'm struggling to see it work on that order?

Likewise to me or sounds that velocity is of course correlated to interest rate rises but it doesn't have a causal effect. Velocity rises in an upward cycle when employment rises, confidence therefore outlook increases, investment increases, spending goes up, therefore confidence riders, and round we go etc etc, then when velocity goes up rates follow to tighten supply.

Edit : good point earlier on that you cannot really point a global picture here other than that there are some similar trends in the major western economies

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