Butterflies may flap their wings in Brazil, with the effect felt in Europe, but a string pushed by a bulldozer can sometimes merely produce a crooked string.  The velocity of money is the Federal Reserve’s crooked string.

A simple calculation of the velocity of money is

V = GDP/ M2

Essentially, the above equation describes the gross domestic product (GDP) divided by the money supply, M2, which includes money markets, certificates of deposit, checking accounts, the sum of currency held by the public and transaction deposits at depository institutions, savings deposits, small-denomination time deposits, and retail money-market mutual fund shares.

The velocity of money, measured in this fashion, thus reveals the number of times money “turns over” in the economy per year.  Some economists say it is difficult to have an accurate measure of the velocity of money.  Yet attempts to do so are of interest.

From the Federal Reserve Bank of St. Louis:

The Federal Reserve attempts to stimulate the economy with more and more money, as shown below.

The simple conclusion from analyzing these charts is that the more the Fed attempts to stimulate the economy with more money (liquidity), the slower the velocity of the money in the system.  Why would the rate at which money “turns over” in an economy slow as the supply of that money expands?  Good question for the next Fed press conference.

Another conclusion, more cynical but more practical, might be that “the more artificial the level of interest rates, the more cautious decision makers in the economy become and thus the slower the economic activity.”  I think this is more to the issue, and one the economists at the Federal Reserve refuse to address.  Artificially low rates will prompt games such as stock buybacks, mergers, and acquisitions, but these are essentially accounting maneuvers yielding little new productivity and are of value only to shareholders.

What logic might suggest is that the Fed efforts are failing.  There are forces at work that offset the efforts by the Federal Reserve to stimulate the economy.  Economists like Paul Krugman would suggest that the monetary expansion has not been enough.  Einstein would suggest that doing the same thing and expecting different results is insanity.  I hold with Albert.

Contrived, protracted, and artificial is this economic situation.  In 2006, short-term interest rates were circa 5%.  The stock market was on its way to a new record, reached in July of 2007.  Yet now, with interest rates at essentially zero, the Fed wrings its hands on whether a ¼-point rate hike would damage the economy and the stock market.  How fragile must the Federal Reserve believe the economy and stock market are?

And this begins to explain the velocity of money decline.  The economy and stock market are just as fragile (and artificial) as the Federal Reserve must believe them to be.  Others sense it.  It is not inviting to invest at record-high stock prices just because interest rates are forced to zero.  It is not inviting for lenders to lend money at record-low interest rates.  And so, from the charts, we witness more of same.  Pushing on a string with a bulldozer doesn’t amplify the string’s reaction.  Maybe the Fed should put the big equipment away.