Escape velocity requires the red pill.

Monetary accommodation via QE has not ignited consumer price inflation, nor stimulated the real economy.

You stay plugged into an unreal world where QE Infinity manages down interest rates, pushing investors further out along the risk curve and into risk assets – and the economy stagnates.

It’s like Morpheus’ blue pill.

Fiscal is the better pill. It’s red. It’s the last active ingredient with the power to repair the primary market, i.e., the real economy. It’s what Neo chose.

And, if dealt out on the right street corners, it can help transform industries, job security and create wage growth, high participation rates and productivity – and this in turn has the potential to backfill the massive mountain of debt that has so far been used to leverage up secondary markets since before the GFC.

If the blue pill had worked, it would have shown up in debt productivity and GDP. But each dollar of debt creation since the GFC has translated into only 15c of GDP, by my estimates.

Today, I thought I’d look at it from a different perspective. That is, how quickly a unit of money (dollar) moves through the world’s largest economy, via lending, money transactions and activity. It’s what economists call the velocity of money.

In short, the velocity of money in the U.S. is the lowest it’s been for six decades. Less consumer transactions, low spending, high rates of savings and less assets switching hands.

Unpleasant, but it’s reality.

Left to our own devices and in the face of uncertainty as a result of COVID, we are saving and hoarding money and financial assets at unprecedented levels. Even after all of the QE, guarantees, debt monetisation/chimney money, debt deferrals, forgiveness and employment insurance - the economy is flat and we’re all plugged into a bizarre matrix of high asset prices in one pod, and dis-inflating consumer prices in the other.

Velocity plug-in.

So, what is velocity of money?

It’s the number of times one dollar is spent to buy goods and services for a unit of time.

If it’s increasing, more transactions are occurring between individuals in an economy. In the U.S., M1 is defined as the money supply of currency in circulation (notes and coins, travelers cheques (non-bank issuers), demand deposits, and cheque deposits). A decreasing velocity of M1 can indicate fewer short-term consumption transactions are taking place, i.e., day to day consumption.

The broader M2 component includes M1 plus saving deposits, certificates of deposit (less than $100,000) and money market deposits for individuals.

Comparing the velocities of M1 and M2 provides some insight into how quickly the economy is spending and how quickly it is saving.

And then there’s MZM, which refers to money with zero maturity and it’s the broadest component. It includes the supply of financial assets redeemable at par on demand: notes and coins in circulation, travelers cheques (non-bank issuers), demand deposits, other cheque deposits, savings deposits, and all money market funds.

The velocity of MZM helps determine how often financial assets are switching hands within the economy.

Are you ready to be unplugged?

M1 is currently at a six decade low. We are slow to spend.

M2 velocity has halved since the dot com days and is nearly 40% down on 1960 levels. It’s also the lowest it’s been in six decades and shows that we have been fast to save, particularly of late.

Even the broadest measure of money has reached a six decade low, and is now below parity, at 95 cents in the dollar.

Think of it like stock turnover of less than 1 (of low margin appliances) in a bricks and mortar store. You’d go out of business, right?

Take home points? Spending is the lowest it’s been since 1960. Savings are through the roof. Money has been taken out of the real economy and parked. Hoarded. Financial asset swapping has cratered below the $1 for $1 ratio, sitting at 95 cents in the dollar. Inventory is not turning over.

Yep, here’s that word again – unprecedented. While there was a little surprise inflation in August, it’s hardly enough to get excited about.

QE without fiscal acts like a vortex of digital credits into secondary markets.

Conclusion?

QE without fiscal is like a vortex into secondary asset markets, while the real economy stagnates. Money’s trapped there, and so too is the Fed and other central banks. Japan is evidence that you can’t get out of it by buying bonds and keeping rates low, although you can exist with a good supply of blue pill.

On the other hand, when the economy is highly productive, so too is the velocity of money, given money changes quickly in the form of banking activity and consumer transactions.

But there is no sign of that today. The charts clearly show there’s almost no money velocity left. Maybe it’s all in secondary markets and being enabled through fintechs and furloughs.

QE Infinity without fiscal growth has become a vortex for digital money sucked into miles and miles of towering secondary market assets, at the expense of real economy productivity and demand. It’s what happens when central banks and governments sell you the blue pill.

But without fiscal spending in the real economy (not welfare) by governments, it’s impact on consumer prices is yet to be revealed.

The unpleasant truth, or blissful ignorance?

So far, the blue pill fuels the matrix.

Janet Yellen flirted with the red pill, but after some normalisation activities and three rate hikes, Donald Trump decided to remove her and appoint Jerome Powell. In turn, Jerome Powell looked like he might have been happy to face the unpleasant truth, right up until his famous slow motion back-flip in January 2019 when he stopped the balance sheet run-off and cancelled interest rate hikes. Clearly, the blue pill became attractive to him.

While the blue pill is a recipe for buying inflated assets that will at some point fall back to earth (or burn in the sun), the red pill is a chance to reach escape velocity from under the weight of COVID, via real economy spending. A mixture of both during COVID would have been a good thing to provide some time to wean people off the blue.

Personally, I like the red pill and believe it should have been taken in January 2009, but that’s not what the market thought or thinks, and that’s the important bit. As long as the blue pill is being manufactured in great quantities by governments and central banks, price growth will be scarce, and we may see more growth in risk assets.

Businesses need to recalibrate if they are to find growth elsewhere.

Stay tuned.

Mike.

Next Level Corporate Advisory is a leading independent advisory firm with a multi-decade track record. We specialise in transformative M&A, IPO, growth capital, special situation and strategic corporate advisory solutions designed to take your business to the next level, in and out of Australia.

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