Lets start from the very beginning:
"The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy."
There are a lot of different analysts out there. It seems every single on has a different indicator or data set to provide insight into economy health. However, the velocity of money is one of the most reliable because it reflects consumers behavior and habits, rather than investigating corporate behavior via earnings, employment, debt levels, etc..
People are not spending money. Period.
A vast majority of in-person commerce has been prohibited. Restaurants have closed. Gyms have filed for bankruptcy. Mortgage down payments have sky rocketed. Nobody is buying new vehicles or luxuries. Since everyone is staying home, they don't need to pay for gasoline. The situation we have found ourselves is so multifaceted that is hard to imagine an industry on earth which isn't adversely affected by the astounding lack of productivity and consumer spending.
(apart from Costco, they have taken all my money as I hunker down lmao)
Old data for new scenario:
Lets break down the important components of this graph, and what they mean within the context of modern market dynamics.
1. Highlighted regions represent periods of time where there was a recognize recession. Data goes back all the way until 1957, so there is quite the lengthy history. The trend is that generally the velocity of money decreases with economic contraction. This is logical and attune to what most people believe to be true: recession = tighten the wallet and batten down the hatch.
The housing market crash in 2007 was the steepest drop in velocity of money seen to date, and it introduced a long lasting affect on consumer behavior.. While previous times there was a net increase in the velocity of money following, there was a sustained decrease leading to where we are today.. The lowest velocity of money ever recorded.
2. This data hasn't been updated in two months. Majority of the market downturn occurred in March. It is for this reason that the current situation is very concerning, and we don't have a full understanding of the dynamics in play.
If we are at the LOWEST M2 Velocity of all time BEFORE a recession hypothetically has started, then two months later it will be even lower. Its logical, and time tested: when economy contracts, the velocity decreases. However, we have not had the official data from the Fed to confirm this theory: its pure speculation based on past trends.
3. Unproven theory, but the evidence of outcome is all around us! Chances are you know someone who has been laid off, or does not have the same income they had three months ago. Corporations are missing earnings, filing for bankruptcy, and half off all the national members of IMF have asked for a bailout. Further, the Fed has estimated and is preparing for a 33% unemployment rate.
These problems are not caused by a virus overnight. Yes there has been a massive decrease in expenditure and productivity, but that is not the only problem here. Within the context of velocity of money, COVID was the fuel to the fire. Velocity was at an all time low before mandatory quarantines came into affect, let alone how the prospect will look in the coming months.
How the fuck is this fixed?
Good question, but you probably already know the answer!
If there isn't enough money circulating in the economy "to keep the lights on", then obviously there isn't enough money circulating! This is where the Federal Reserve comes into play with their broad stroked band aid solution:
1. Infinite Currency Expansion
2. Repurchasing Operations
We've talked about these two factors so much that I won't dive into them. If you'd like to learn more, read previous blog posts, or read our Modern Finance eBook available for free on our Discord server.
If we look historically, since 2008 the currency supply has increased five times.. At that point in time, the velocity of money was approximately 30% higher then it is now. This is a graphical representation!
Outlook and predictions!
When the next data comes available, you can expect it to make headlines. Personally I think M2 Money Velocity tracked by the Fed to retrace even further to 1.25 - 1.35 (currently at 1.45). We're entering a positive feedback loop where the typical solutions won't cut it.
This downtrend has massive correlations because it feeds a positive feedback loop between consumer habits and institutional action. Velocity decreases, and the response is to increase liquidity and supply. This "economic benefit/stimulus package" is rarely passed onto the average consumer, rather used to prop up the economy by making debt more affordable and holding up sovereign bonds.
Unrelated, but think about this..
When people say "the economy is doing well", how much does the AVERAGE person even benefit? The answer is very little. You're obviously financially competent if you are still reading this, and consequently don't fit within that category. Fact of the matter is that the average don't invest, buy property, or take advantage of what a "good economy" has to offer.
Back to the feedback loop at hand.. Consumer spending decreases, and the government responds with economic stimuli. When looking back at history, if they stimulate the economy enough it will eventually spring back up. This will confer confidence to the consumer and the feedback loop will end. IN NORMAL CONDITIONS.
However, COVID/global dynamics complicate the scenario. Consumption has sharply dropped, and the money is being pumped into the market with no end in sight. Macro economic trends shift when the consumer and investor behavior changes. With experts predicting pandemic problems to extend into 2021, we're not in a place to have that tangible transition in consumer behavior and the consequent increase in the velocity of money.
TLDR: Air is being pumped into a bicycle tire with a hole in it. The air is never accumulating pressure to hold the tire inflated because there is a constant leak.
Replace air with money, and bicycle tire with economy. The "hole/leak" is a metaphor for the lack of spending and commerce occurring. The more air you pump, the more air escapes.