Diminishing Velocity => Increasing Impotence

Monetary velocity has been steadily declining, with increasing deceleration after every Fed intervention (see chart going back to 1959 here).  That gnaws at me (see prior post here).  Why does it worry me so much?

“How did you go bankrupt?”
Two ways. Gradually, then suddenly.”
― Ernest Hemingway, The Sun Also Rises

The Fed’s Growing Impotence

Over the last 30-40 years, monetary policy (the Fed) became the only politically acceptable tool of economic intervention.  That reached its apogee with popular lionization of “the maestro” Greenspan. When crises hit, Congress got used to sitting back and letting the Fed do the heavy lifting.  Fed intervention worked great in the 1990’s, OK, in the early 200’s and barely at all in 2008….

Why?   Over-use of any economic input leads to diminishing returns – less bang for every incremental buck.  Even if the tool is more actual dollars at ever-lower interest rates.  By leaning harder and harder on one-dimensional Fed intervention, we’ve limited the impact of that intervention.

The evidence?  That steady decline in monetary velocity, with those downward kinks of deceleration after every successive recession (and Fed intervention). We printed more and more money.  We got less and less growth from it.  Some of that declining velocity is from “natural” factors (aging demographics and increased global trade).  But the kinks in the curve – coming after every recession/intervention – tell a clear story of diminishing returns. Velocity deceleration will kink down further/faster after the 2020 recession.  The Fed has cranked out around $6 trillion (~28% of 2019’s $21 Trillion GDP).  Unless/until GDP grows, velocity (just “GDP” over “money supply”) will plummet.

Pumping out more and more money to less and less effect.  That growing impotence was already growing increasingly obvious – see my October 2019 post “The Fed Isn’t Manipulating Mr. Market. Mr. Market is Manipulating the Fed.”  The poor Fed has ended up like the Wizard of Oz – trapped into sustaining a naive folk belief in its limitless power.  Every time we face a crisis, the Wonderful Wizard will solve all our problems!  Painlessly! No effort or loss or tough choices! See this post for more.  Or just watch the video below.  With sympathy for the poor guy behind the curtain…  🙂


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