A reader says the velocity of money is a “useless” measure; Is he correct?

Velocity of Money = GDP / Money Supply

We can use dozens of math formulas to verify economic research, but we need to make certain these formulas do not take on a life of their own. My prior research tried to answer why M2 growth was rising much higher than GDP growth without a commensurate pickup in inflation. We were able to show this dynamic via the drop in the velocity of money, however it doesn’t tell us why.

The velocity of money has been dropping since 2008, and its fall is just a verification of our ongoing research and theories

Hello:
Nearly all your assumptions make sense.

An exception is money velocity — you & Martin Armstrong treat money velocity as if it had meaning. It’s a component in a formula but doesn’t exist independently of that formula, thus it’s useless.

The formula itself is useless — it stems from mechanics, which has nothing to do with the economy.
Cordially,
Henry

Here was my response;

Hi Henry,
Thanks for the email. Please don’t equate me with Martin Armstrong 🙂

The velocity of money in the context of my prior discussion was a measure of how much money there is in the economy and how actively it’s being used by the economy. The charts in the article I think you reference demonstrated that M1 and M2 growth were rising much higher than GDP growth. That, by definition, tell us that the velocity has to be dropping. That’s all. I have no opinion on it, other than to say it is not a useless measure. It’s what we make of it.

With that said, nothing is ever useless, per se, and the measure of the velocity of money can serve us as a verification of research. It is one of a number of measures we can use to determine if what we are saying is correct. What is of importance is this; we need to figure out why M2 growth is rising relatively higher than GDP growth without stoking a commensurate rise in price inflation. In other words, we need to figure out why this velocity is dropping and what dynamics are at play. The rest of my research explains why, and from what you said, you generally agreed.

I submit that this money has lost its effectiveness in driving up prices levels, because of the active monetary sterilization from IOER, the general economic and sovereign overindebtedness, and the active offshoring of USD currency. The Fed and Treasury have developed a number of schemes to make certain that currency and money stocks are effectively taken off the economic balance sheet. I say job well done.

All these dynamics are reflected in the velocity measure; it is not the other way around, and velocity is not the tail wagging the dog. We can easily verify our theories by seeing the velocity, since it’s 2+2=4 math. If someone were to tell me that the current velocity of money was 2.2 vs. 1.2, I would have to conclude that prices were rising higher, ceteris paribus, since there are only so many goods and services that this money can bid up. Moreover, if the velocity was rising I would be concerned that the Fed would no longer be able to carry out its QE programs.

As the money stock measures climb by percentage of GDP, the velocity, by definition, has to fall. It is and has been for a long time. I put this in my analysis as a verification to show the reader of this simple algebraic relationship.

Where I also differ from Armstrong; My concern is that the velocity of money will begin to rise over time. I think his concern is that the velocity is dropping. My desire is to continue to see the velocity value drop, as this would be an “ex post facto” or hindsight verification of my theories as well as the viability of QE and its ability to drive up the markets over the longer term and keep the U.S. government in business.

Now, I have a suggestion for you; stop reading Martin Armstrong and concerning yourself with anything he says. 🙂 I would be careful in assuming something where there is nothing. We all have biases and I struggle to leave them at the door before entering.

Once again, thanks for the email.

Regards,
Chris