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Velocity of Money and the Crack-Up Boom

by John Rubino on May 18, 2013 · 26 comments

Based on both recent history and mainstream economic theory the past few years should not have been possible. When you cut interest rates to near-zero, run deficits of 10% of GDP and buy up every government bond in sight with newly created currency, you get a boom, end of story. That’s just the way capitalism works.

But this time was different. After four years of QE and ZIRP and all the other easy-money acronyms, we entered the month of May with Europe in a deepening recession and the US recovery petering out.

The culprit? The one piece of the puzzle that governments can’t control: the velocity of money. This is simply a measure of how quickly holders of currency, i.e., banks, consumers, businesses, hand their currency off to someone else. The faster and more frequent the hand-offs, the more stuff gets bought and the more robustly an economy grows. But after their 2009 near-death experience, the world’s banks have been in no mood to lend. Instead, they’ve been sticking all the new currency their governments have been giving them under the proverbial mattress. This reluctance to lend means record low money velocity and little or no economic growth.

Velocity of money 2013

But in just the past month something fundamental has changed. US home sales and prices have accelerated, with prices returning to 2006 levels in some markets and bidding wars, flippers and interest-only mortgages once again becoming common. Stock prices pierced old records and then spiked rather than corrected. Suddenly we’re back in an asset-driven boom.

But it’s a boom with a twist because it coincides with unprecedented amounts of “excess reserves” in the banking system. This is the raw material for new loans, and banks across the country are worrying that they’re missing the boat by remaining in cash. Marginal mortgage applicants now look a lot more attractive because their collateral is appreciating. Private businesses, judged by the share prices of their publicly-traded peers, are becoming more valuable and hence more creditworthy. Families with rising stock portfolios and appreciating houses suddenly look like better bets for car loans.

So what happens if a tidal wave of bank reserves are suddenly converted to business and consumer loans at a time when asset markets are already overheated? Maybe the fabled crack-up boom of Austrian economics. A couple of weeks ago Daily Reckoning addressed this issue in an article that quoted Ludwig von Mises’ famous definition of a crack-up boom:

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against ‘real’ goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last.

So how close are we to the point where “finally, the masses wake up?” Hard to say. Stocks and houses are back at previous-bubble levels and there’s even talk of a shortage of government bonds. And based on the excited emails pouring in from people who, after a decade of bad returns have seen their aggressive growth funds rise by 25% in a quarter and are feeling like geniuses, animal spirits are back and happy. All while bank lending has barely started to ramp up.  It’s safe to assume that banks getting into the game would heat the markets up even more.

How would today’s financial system handle the resulting volatility? Prudent Bear’s Doug Noland addresses this in his most recent Credit Bubble Bulletin:

I don’t mean to imply that today’s environment is comparable to 1999. The U.S. economy was sounder in 1999 – and the global economy was a whole lot more stable. Global imbalances in 1999 were insignificant compared to the present. The U.S. economic and Credit systems had yet to be degraded by a doubling of mortgage debt and a massive misallocation of resources. The federal government hadn’t doubled its debt load in four years. Europe had not yet terribly impaired itself with a decade of runaway non-productive debt growth. China and the “developing” economies had not yet succumbed to historic Credit booms, overinvestment and economic maladjustment. Central banks hadn’t yet resorted to really dangerous measures.

The implication: This world, levered to the hilt in response to the policy mistakes and financial crises of the past few decades, is more complex and fragile than the systems that (barely) survived the bursting of the tech stock and housing bubbles. So this bubble and its aftermath might be a whole different animal.

  • http://twitter.com/kooblet Bill Johns

    Excellent column. Much to think about. Will we see an acceleration in the velocity of money? Is this insane rally due to short covering as some suggest? Is the rally due to money pouring in from Euroland and Japan? All of the above? Zerohedge is already reporting an increase in new car repos possibly do to liar loans on new cars. Lots of good questions.

    The one point in your discussion I trip over is the statement “That’s just the way capitalism works.” I’ve gotten into several heated discussion about that very question, what form of economic system do we operate under? Text books in civics classes will tell us that we are free market, capitalist economy. Free markets functioning to determine price discovery of stocks went out the window with HFT. Capitalism is the question. In capitalism, good companies survive and bad companies don’t. Except in the US where if you are big enough irrespective if how bad you are you are not allowed to fail. Massive loans to questionable start-up companies as a results of raw politics is the norm. What form of economic system do we have?

    Pelosi gave us a hint when the Obamacare law was passed and she was happy since now they could find out what was in the bill??? Lobbyists for major industries and companies write the major legislation to best fit their company needs. Congress passes those bills and why not, our elected officials need the money those same companies will give them for reelection. We have big companies working hand-in-hand with the administration and congress for their benefit and the benefit of the members of congress and the administration. How many major economic positions in the administration are not filled by someone from Goldman Sachs, JP Morgan, etc. How many employees of the major banks have been investigated-prosecuted-convicted for the major fraud that lead to the collapse to 2008? None. How many major companies have been prosecuted for blatantly ignoring the laws of price manipulation via HFT. None. This economic system of intimate cooperation between government and private industry is called fascism. Perhaps we think of our economic system as fascist instead of capitalism we might better understand how the system works, or doesn’t work for the benefit of the electorate.


    • wexfordcoin

      Well said, Bill. A Capitalistic Democracy we no longer have. Benghazi, I.R.S., and AP to name just 3x scandals of this administration have shown the American people that our Government is corrupt to the core and at the TOP. We the People will take back our country, I am certain. My late father fought in two major wars with 3x tours of duty in Vietnam, and I am not about to see his and others’ brave efforts be for naught. The question is: By what means will we do so, and will we have martial law before the Liberty Bell rings again?? Rise up America. TAKE BACK YOUR COUNTRY. Sage of Wexford

      • Erc Seitz

        The Federal Gov’t today is being run like the City of Chicago. Thank you all for electing the Chicago mafia. I’m sure of one thing, the rest of us are screwed.

        • stevah

          Years ago after a consummate liar-politician was elected President, I head someone on the radio say, “this country will always get the President it deserves.” Although I don’t like it one bit, I can not dispute that.

  • Sculptor Bill

    the helicopers have dumped out the money, but everyone picks up, puts it in a pickle jar and buries it in their garden…..velocy? its zero and falling….it looks like deflation along with the defaults that are vaporizing capitol,……. but there is potential for a great conflagration, there are piles of dead wood and kindling heaped on the forest floor, lightning on the ridge. All these folks with buried jars of money, credit cards with 100k unspent, all believe they are rich rich rich. When they start to buy, then the buying panic starts………look TF out. All of a sudden there are 100 claim tickets for one or two seats and the music stops. Remember the pictures of folks burning wheel-barrows of 1000000Mark notes to heat their home when that paper was cheaper than coal or wood?

    look up “Weimar currency” on google, click “images” (you should be 50% in real things now.)

    • bill again

      you can’t even burn computer digits…..when wealth becomes vapor, we realize it was an illusion, not ever really existing. everything is levered 100 to one…paper to physical….oil, gold, etc. get real folks.

      • brian scrocca

        Gold has never gone to ZERO while in the monetary system of Central Banking. Paper has…………….1000’s of times to ZERO.

    • esqualido

      Except that’s not how it worked. Ben never said he would be dropping the money interest-free on the banks that own the Fed, not you and me(if you’ve been seeing some, let me know). The diminished “velocity” is them sitting on the dough, like vultures, picking the bones of distressed businesses, commodities, industries. That is the seemy reality of “Quantitative Easing”

      • sculptor Bill

        Good point escuallido, they who get the benefit of dollar printing first, buy up real assets at lower dollar value…devaluation comes later as the money they bought real stuff with turns to water. Seems a gutsy play here to buy gold now with a low interest credit card loan at 3% for 30k for 15 months….should I do it? gold at $42,000 per kilo..hmmm tempting…….But then there is Robert Prechters voice in the back of my head whispering “but what if there is massive deflation Bill?” I might have to pay back in very hard to earn/find dollars, The difference is, if you are a big bank, you get bailed out,your bad assets bought up by the Fed,…if youre me….you lose big with no bail but food stamps.

        • http://www.facebook.com/douglas.m.green.1 Douglas M. Green

          In a deflationary environment, there are cascading defaults. Unlike paper securities, PMs have no counterparty risk.

  • Bruce C.

    Another intriguing post.

    JR wonders where we are within the context of Mises’ “crack-up boom” development and I agree that it’s “hard to say”. Not just because predictive timing is so elusive but because the entire framework that Mises describes seems to be inverted.

    Mises describes the “masses” as those who at first don’t understand that they operate within “…a price revolution which will finally result in a considerable rise of all prices…” and thus believe “that prices will one day drop.” I submit that today those people are the ones within the global financial markets, the ones who buy bonds and dis gold in particular, NOT the majority of the public. It is they who think that inflation is benign and indeed “deflation” is more in the cards. Most consumers don’t seem to think so.

    Furthermore, Mises “first stage” involves people restricting their purchases and saving their cash instead. I would submit that today most people don’t have that luxury. They may seem to be restricting their purchases but not so much by choice in the strategic sense but for the lack of disposable income, and household savings is once again negative because of the renewed use of credit. Therefore, I don’t see “money velocity” picking up because of consumer spending because I think they spend pretty much all they have already.

    One could argue that the housing “recovery” and the accelerated stock market activity are fueled by expectations of price inflation – not deflation – as well, but I think in both cases it’s more because of a reach for relatively safe yield. Both housing prices and equity prices have been specifically targeted by the Fed for support and so as a response to financial repression in general those two areas of risk are considered the most “protected.” I would argue further that both areas involve mostly the “financial class”, not the “masses”, because most real estate purchases and investments are coming from large corporations and not individuals, and the stock market is mostly the domain of the top 10% or so of the population.

    My point is that for Mises’ crack-up boom scenario to play out today, it will be the “massive” bond market – not the general public – that will “finally, wake up” and suddenly become “aware of the fact that inflation is a deliberate policy and will go on endlessly.” The GP seems to already know that but can’t do any more about it. Then I could see a breakdown occurring – “the crack-up boom” – because everybody will be trying to preserve their wealth and there will be no other place to go other than traditional hard assets like gold and silver.

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  • Robert

    Actually while all this may be right in the long run, none of it was based on a world reserve currency. Even more, today central banks are coordinating their money printing policies so all of the world’s currencies may be viewed for all practical purposes, as almost a single currency.

    So if you are a currency investor trying to maintain the value of your wealth, lots of luck!

    How long does it take then for all of the world’s currencies to “crack up” simultaneously? With all due respect this is nothing that Von Mises was able to study and no a study of ancient Rome wouldn’t have been a blip on the radar as to what is happening today.

    While the fundamentals may be the same, today we are in a whole new environment. So time frames are likely to play out very differently.

  • brian scrocca

    I’m confused, so the BOOKS are not cooked then? Cause if they are then all the happy talk is for nothing.Deflation is what may happen if they become any more draconian than they already are.A number of issues come to mind the biggest one being is will BAIL-ins spread? All in Western Finance have seemed to sign on to it all. People do hoard as history has shown when governments get to big.They are coming after everyone it seems. Politicians seem to be driven by self interest.They will promise anything to stay in power yet have no intention or any way to pay for it all.

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  • mh505

    Clearly, what is needed here is the “Economy Doctor” ::))


  • Steven Goodwin

    >> This world, levered to the hilt in response to the policy mistakes and …
    Not so sure these are “mistakes” in the classic sense. I believe that there is a sector in society who has found a way to milk the “system” for personal profit in a way that leaves the bill/consequences for the remaining 99.9% of us to pay off and deal with. So in essence we are being enslaved with paper chains.

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  • stevah

    Consider the cycles. 09-11-2001 (stock market crisis) + 7 years = 2008 (banking crisis) + 7 years= (monetary crisis) 9-2015.


    The money multiplier has also collapsed. This means that banks are hoarding cash and pushing the equity markets higher. The general public is starved for liquidity and is basically just servicing debt, but still not saving. The savings rate is less than 3%. A poll from 2008 inferred that people would rather default on their mortgage rather than their credit cards. To me this suggests that the GDP (generally dumb public) are hopelessly addicted to credit.

  • David Reischer

    It is like 1921 Germany in America today


    These years be right for ones who save gold. One good ear knows meaning
    of wind in trees. The leaves come down as seasons change. Fools see
    falling price of gold as “death of tree”, they chase its price as leaves
    on the ground. Know you all, it is the season that has died.

    Time will prove all things. Ones of simple thought, such as I will save
    the wood, not the leaf as they buy the gold, not the price!

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