Wait….we are so worried about deflation as a country that we might not hit our 2 percent inflation numbers? But I thought inflation was going up, and the feds are telling us they cannot seem to find it to hit their “2% target” rates. Why do THEY see deflation when we don’t???

Furthermore, how can the feds actually fix this deflation issue?

Fix inflation to fix deflation to fix the inflation we are seeing now.

Yeah. Fun times ahead!!

You are now scratching your head. Great, I have your attention!

I’m probably well out of my swim lane here, but I’m looking at some obvious numbers and seeing a psychology of lower velocity of money that appears to need to increase to fix GDP and our monetary inflation. While THIS might be obvious, the underlying reason of WHY we have lower velocity might not be so obvious to the casual observer – nor how to fix this.

For the goldfish and squirrels: I believe the SOURCE of the problem is a psychological based on which arose from 40 years of misreporting the inflation numbers, which has led those with the largest piles of money to pull it out of the system. This is the trickle down, or supply side economics apparently failing. The “demand side” economics is more on the Keynsian side of things, but you can see that failing too with massively increasing monetary supply. Our recent inflation is caused by deflation, which was caused because too much inflation existed and was under-reported to juke the interest rates lower and make stupid rich people more rich. Bend your noodle on that.

This all starts to get fixed with transparency to restore trust in the system. When our “free market is not “free”, then dysregulation happens – and you are seeing it here. I have a whole 40 min video coming out next week on how all of these things have dysregulated the systems causing problems in our systems. This then shows that unelected people are now picking winners and losers, rather than the free market systems.

When trust erodes in the markets, you may have massive amounts of people then leaving the markets permanently. And by looking at the velocity of money, I would contend that trust has left the building.

Velocity of money

Investopedia defines the velocity of money:

“The velocity of money is a measurement of the rate at which money is exchanged in an economy. It is the number of times that money moves from one entity to another. It also refers to how much a unit of currency is used in a given period of time. Simply put, it’s the rate at which consumers and businesses in an economy collectively spend money.”

From there, it “is measured as a ratio of gross domestic product (GDP) to a country’s M1 or M2 money supply.”

This means you take M2 or so and multiply the velocity of money to get GDP.

This is the velocity of money according to the Fed.

What you are seeing is since 2000, this is a steady decline. Let’s look at this over those last 20 years. See below.

On the flip side, no one wants the economy to “shrink”, so we make cheap money available by juking interest rates lower and providing all the liquidity to banks as needed to lend. This makes the GPD look like we “grew”, when actually we were simply juking a multiplication equation by artificially boosting up one number positively as we are losing control of the second number negatively.

For example, we might consider our GDP of 100 40 years ago may have been 10 on velocity and 10 on M2. Then, it went to 5 on velocity and we went to 20 on the M2 supply. Then, losing more control, it might have been 4 on the velocity and 25 on the M2. As you can see, all of those numbers equal 100. But one is falling for a particular reason (velocity) and the other is being artificially juked up (M2).

Now – let’s look at the GDP the last 20 years?

It went from about $10T in 2000 to $21T in 2021. Give or take. This chart stops at 2018, and goes to about $20.8T and last year was 20.9T but you get the idea.

If you look on the GDP chart, you see the M2 at maybe 4.5 and the velocity at just over 2, so there’s your 10T. Then look at see the $20T money supply and the velocity of money around 1. Maybe we are higher now due to spending, but just at a glance, these numbers appear to get you to the GDP.

To then show growth over that time, you then have to show higher M2. This might be observed by people buying houses and borrowing more. But I ask you this, if inflation that is NOT reported is causing ASSET PRICE inflation (one of 3 types inflation that Lyn Alden discusses), and your house is twice as much as it was in 2000 due to much lower interest rates (and therefore lower monthly mortgage, despite higher sticker cost), you can then see that while the GDP may have doubled in those 20 years, you can say that was a large dose of saccharin via lower interest rates.

Meaning – if inflation was reported CORRECTLY, then interest rates would have remained higher, and thus growth would not have happened, and thus we would NOT have doubled GDP in the last 20 years. But – we need this heroin of growth to then collect that tax money. Which is why we are juking interest rates lower in the first place.

This is your 10 yr rate over the last 40 years. Note: GDP gets much higher due to cheap money available, NOT organic growth.

Now…money supply. Is this just the Fed giving money out like candy? No, this stuff is lent into existence. Banks can use the fractional reserve system to then make loans. If people qualify for loans and risks are addressed, the banks then lend out money. In a booming economy, people want to borrow more to buy a bigger house, expand their business, or perhaps buy that new car. Lending money out helps the M2 supply.

But this whole velocity thing. People are not spending into the general economy as much?

I’m going to go back to my introduction to Keynes from the 1930s and the Great Depression. The idea was to get money to the people. Let’s say for example, we get tax money out to build bridges. We then pay people to work. People then take that paycheck and buy food, beer, smokes, movie tickets, etc. Then everywhere THEY buy things at, it helps those entities. Each exchange along with way taxes come off the top. The “velocity of money” gets money into the hands of people to spend.

However, the last 20 years or so, with money going into the financial systems to be lent out, perhaps this does go to building new houses and getting construction worker jobs. Perhaps it is going into the general economy, somewhat. But you cannot deny that we are lending more and more money IN to the economy, but less and less of it is moving. Why?

What I am guessing here is that hidden inflation at the “dinner table” is causing people to tuck dollars away. Perhaps instead of spending money at the local bar, Joe Sixpack now puts that money into his Etrade account. Perhaps he buys gold and silver. Perhaps you are a VERY wealthy person and you put it into large corporations.

When large corporations have massively high Price to Earnings Ratios, it signals that investors want them to spend that money to expand their operations. This chart shows EXTREMELY high P/E ratios on the S&P right now.

I once read that 12-20x is “normal”. You are now looking at 43.52x as the “average” P/E ratio. Are these companies hoarding this money? Yes, to an extent. I heard a lot of companies are also buying back their own stock rather than expand.

Everything is frothy. Asset inflation is all over the place. Everyone knows a pin is going to pop.

But what is the solution?

If you look above, the reduction in velocity of money is a deflationary event. Less money moving through the “real” economy can then lock it up. No one buying anything. This is what you are seeing. You are seeing people getting money and putting it into something, immediately. Crypto? Gold? Equities?

As people are perhaps hoarding piles of cash, the inflation in the monetary supply could risk hyper inflation down the road.

But WHY is the velocity lower?

Psychology? What if you REALLY understood the chart below I’m about to show you. Perhaps in 1980, you had $20,000 in the bank. Each year, your boss gave you a 3% raise. However, inflation was 5%. The government kept TELLING you it was 2%. This is stealing your wealth slowly, until you are actually negative in money and need to work more jobs just to make ends meet.

I’m using this as an example that perhaps the last 20 years, those “in the know” have perhaps parked large portions of their capital into businesses and assets like real estate?

What if the fact that they KNOW inflation is much higher than is being told is signaling to them to park their “financial energy” into business and property? What if this FEAR is causing the reduction of putting that cash into the real economy? Why wouldn’t businesses expand if they were at a 50x P/E ratio? What do they know that we don’t?

The solution

What if the solution here was to report inflation more honestly? Everyone with private insurance sees something like 8% more per year in health insurance costs – OR shrinkflation where they may pay about the same, but have higher deductibles?

In the short term, there might be pain getting interest rates at 2% for the 10yr. Or 3%. What if significant spending had to be cut back as interest rates went up? What if they re-did the CPI to actually reflect the 8% we see on shadowstats.com or chapwoodindex.com? Maybe you would have to start paying out more for cost of living increases for social security and pensions?

Maybe that causes pain? A lot?

On the flip side, if REAL inflation rates that we see are then perhaps met with REAL interest rates to reflect these conditions, could we perhaps see more of this money get back into the real economy, or would it scare more people into hiding cash under the couch cushions?

I’d contend that the DEFLATION we see in the velocity can ONLY EVER be defeated by actually acknowledging the real inflation going on. Once that is acknowledged, interest rates can rise. But you know what?

This will have the benefit of:

  • Restricting government spending to meet interest payments.
  • Being more transparent with inflation to the population, perhaps decreasing velocity of money further, for a short period of time
  • Rising interest rates to 5, 6, 10% could perhaps entice money into treasuries, savings accounts, and creating real yields for investment.
  • The enticement of money into the “real” economy could significantly increase GDP and increase tax revenues substantially.
  • While we may have 10% inflation for years, we might also have a 10% interest rate as well.

The problem is….

If interest rates rise and you acknowledge inflation is really 10%, how much downside pain do you have with velocity of money before you can get people to spend it from underneath their couch cushions? What incentives could you introduce to get businesses to expand and use all of that cash on the sidelines?

I believe that this deflation cannot be defeated with continuously upping M2. We have to address the velocity of money, and it is clearly apparent, at least to me, that those who have the largest share of money aren’t spending it into the real economy, but tucking it away. This “trickle down” didn’t trickle. To me, this is because it is apparent to everyone on the planet that 2% is not the real rate of inflation for most people who are paycheck to paycheck and if you want to heal your country, you’re going to need to start giving them doses of truth. CPI at 4.2% right now could be “transitory”.

But I’d like them to please start to ensure the numbers are more accurately reflecting of what people actually spend things on because….drum roll….THAT IS HOW YOU DETERMINE IF YOU WANT TO SPEND MONEY OR SAVE FOR A RAINY DAY. If everyone KNOWS prices are going up faster than their paycheck, they are hesitant to buy more.

If you want REAL growth, it is clearly evident you need to first be TRANSPARENT in the market conditions, TAKE YOUR BEATING, then allow rates to naturally find homeostasis with inflation. Only when the problem is revealed can the solution heal the nation.

Fix the money, fix the world.