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Many Times I Have Commented About the Lack of Monetary Velocity or the Turnover of Money and Its Impact Upon the Economy.

Many times I have commented about the lack of monetary velocity or the turnover of money and its impact upon the economy.  The St. Louis Fed recently published a report quantifying the impact of this lack of velocity.

On June 30, 2014 the St. Louis Fed stated excess bank reserves were $2.8 trillion, up from $2 billion in 2007.  Households are now sitting on $2.5 trillion in cash, up 50% from five years ago.

Hypothetically demand and inflation should accelerate when liquidity grows at a pace faster than the economy.

According to the authors of this report, monetary velocity during the first and second quarter of 2014 was a record low 4.4x, down from 17.2x just prior to the recession. To write it differently, each dollar is now turned over 4.4 times versus 17.2 times in December 2007, thus greatly impacting economic activity.

If historical relationships held true, inflation would be around a whopping 33% not 2% according to the St. Louis Fed and economic growth would be considerably higher.

The report further stated, based upon models and historical benchmarks, the Fed’s QE program of buying the 10-year treasury, monetary velocity should have been reduced by 0.085% but instead declined by 5.85% or 69x greater than the models would have suggested.

There are an infinite number of conclusions that can be drawn from this study.  In my view, two might be of great significance.  One is that models can not accurate predict behavior and second no one really has a clue as to how this inevitable change in monetary policy will impact economic activity, inflation and interest rates.

Commenting upon the here and now, the Beige Book or the statistical compilation utilized at the upcoming Fed meeting offered no great economic insights.  Growth is moderate with little change in hiring though companies are having “greater difficulties in finding qualified workers across most skills and occupations.”

Today the private sector ADP Employment Survey is released.  While the correlation between this and tomorrow’s BLS labor report has waned considerably, the ADP data can offer some insight as to whether there will be a surprise in Friday’s report.

Monetary policy is now statistically mono dependent upon labor.  The upcoming data can tentatively set the tenor of trading for the intermediate future.

Commenting upon yesterday’s activity, markets were relatively quiet with all attempting to digest and interpret today’s hostile geopolitical environment in an economic setting.

Last night the foreign markets were mixed.  London was up 0.40%, Paris up 0.89% and Frankfurt up 0.42%.  Japan was down 0.33% and Hang Sang down 0.08%.

The Dow should open considerably higher as the ECB unexpectedly lowered interest rates.  The 10-year is off 5/32 to yield 2.42%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.