As we have seen in the previous two blogs the world is awash
with debt and dollars and the problems associated with these are rapidly coming
to the fore. So why do the central
bankers of the world think that continuing down the same asinine path will
actually work? I believe that it all
comes down to the expectation that the velocity of money will turn its head up
at some point creating the windfall everyone expects. As you can see from the chart below the
velocity of money has been in a tailspin for the past 15 years. Dissecting this further you can see that entering the 1990's velocity of money was relatively stable. The years prior were relatively quiet on the
debt front with central bankers tinkering with free exchange rates and leaving
the gold standard. Once all of this was
done they were free to explode onto the scene armed with the modern tools of
economic warfare; control over interest rates and the money supply.
Now no man is ever going to let his toys lie idle so they put them to work and under Greenspan the games began. At first the velocity of money went into
orbit as fresh dollars came into the market providing the stimulus that was
expected. In fact the stimulus worked so
well that money velocity exploded higher through 2000 creating the NASDAQ
bubble. Once this burst the theory was
that a little more debt ("stimulus") would fix the problem (it had before right?) and so
more money was added. This time however
the amount of money required far exceeded the paltry $40 billion of the first
test but velocity bounced creating the second bubble, the housing bubble (see the bounce in the velocity of money around the time of the housing bubble). After this bubble burst the theory has been
that more money should be added (as it worked the first and second time right?). The thought is that once the velocity of money increases it will return us all to
prosperity (read another bubble).
The problem with this theory is that the utility function of
new money has not only lost its ability to provide stimulus but the amount of
money has crowded out the private market, both of which have resulted in a
velocity of money that continues to historic lows. Adding more money to this pot of debt will
not make it taste better; as any chef knows,
adding more salt into a stew does not make it less salty! As an aside the utility function refers to
the perceived value of adding one more dollar to a person’s net worth. So for example giving a dollar to a beggar
will be meaningful but giving the same amount to a billionaire will be
meaningless.
Now should this velocity of money return to normal levels, based on the amount of “stimulus” ($30 trillion and counting) there would be
massive bubbles across the globe. It
would be the boom of all times and it would all end in one massive global
depression. This however is what the
central bankers of the world are hoping for, a return to "normal" velocity levels, but they they believe (unlike me) that that they can somehow control everything with their useless tools and provide us with a soft landing. Furthermore the prosperity will result in such a tax and economic windfall that all debts can be brought down to normal levels avoiding any calamities. Their argument is to print more money – just give it more time and it will work.
As we have seen in the
past two blogs the pot is boiling over with little effect and so until
they get their hands out of the pot there will be little in the way of growth
and more than likely a debt laden slowdown and possible deflation. In the meantime should a recession appear on the horizon they have
no new tools with which to assist so this time around the markets will be left
to sort themselves out and that will cause a lot of pain.
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