M2 velocity and $1.8 trillion in excess bank reserves delay Inflation and Aftershock Economy

M2 velocity and $1.8 trillion in excess bank reserves delay Inflation and Aftershock Economy


From 1950 on M2 velocity or M2V peaked at 2.15 during the 1997 economic boom but now has set a new low this year descending below 1964’s 1.6.


Velocity is a ratio of nominal GDP to a measure of the money supply. It can be thought of as the rate of turnover in the money supply–that is, the number of times one dollar is used to purchase final goods and services included in GDP.  A higher ratio strongly correlates with a stronger economy.  A higher ratio can boost prices up.  Please refer to chart below.


Chart:Velocity Of Money


Excess reserves, those in excess of what banks are required to hold, went from essentially zero in 2008 to almost $1.8 trillion today.  The major factor was the Federal Reserve’s Quantitative Easing, expanding the money supply, with the goal of stimulating the economy.  However, bank lending did not increase nearly as much as expected given a weak economy and the BO administration continuous assaults on the private economic sector.  Hence the banks are holding many dollars and dampening inflation prospects.


Reserves are the base upon which money and credit structures are erected. It is that explosive growth in reserves that formed the basis for the many predictions of price inflation made over the last four years.  This includes Robert Wiedemer, the author of 3 Aftershock Economy books.  However Wiedemer did not specify a detailed time frame.  He also noted that inflation would rise with increasing velocity. 


The process of reserve creation should, in normal times,  have led to rapid growth in money, and then price inflation. Based on history and theory, the predictions were sound.


The deleveraging process following the 2008 bank crisis put a spanner in the works of money creation.  As banks hoarded their extra reserves, consumers cut back.  This combination resulted in the turnover (velocity) of money, the number of times a dollar is spent per year, collapsed. Depending on the measure of money used (broader or narrower), the velocity of money has declined to historic lows or to a level going back decades.


So inflation is not a major threat right now.  Recall that severe inflation can cause an Aftershock economy.  But so can a sharp decrease in foreign investor confidence in the US dollar given our total debt that continues to increase 6% to 10% while our economy contracted in 2009 and now grows at approximately 2% for 3 1/2 years.  These are the 2 main factors that can cause an Aftershock economy that Robert Wiedemer predicts – high inflation and loss of faith in the US dollar due to explosive debt growth.  Please reference my 2 book reviews of Aftershock economy and Aftershock investor for more details.


What to do now?

This buys the US time and we must take advantage of this ASAP.  Cut debt while deregulating our private sector.  Cutting debt will further help to ward off inflation.  It is the private sector instead of the public sector that creates the most self sustaining jobs that also create many ancillary jobs.  This scenario accelerates our economic growth and Treasury revenues.  An excellent start would be for the BO admin to open up oil and gas drilling on public land.  This will have multiple benefits including:


Many more jobs thus Treasury revenue to pay down debt

Decrease in trade deficit, strengthening the US dollar

decrease energy prices to further battle against inflation



Therefore,  let us do all we can to hold inflation in check, decrease our debt, grow our economy.


twitter @Economics501







Calculated as the ratio of quarterly nominal GDP 

(http://research.stlouisfed.org/fred2/series/GDP) to the quarterly average of M2 money stock (http://research.stlouisfed.org/fred2/series/M2SL). 




About economics501

1 - free market Capitalist; 2 - Fitness Entrepreneur; 56 years old, VP at an Investment Bank in NYC, ex Venture Capitalist, happily married with 2 girls. Education: Rutgers and NYU. I allow Ted Hruzd, my friend to blog at will here. He has many posts here. I have known Ted since we were both students at NYU. Ted also works for an Investment Bank as a VP in Equity Global Markets. ------------------------- I was very very Socialist leaning as a 22 year old. I then strongly believed in Gov role in helping the poor. However, as a USDA Child Nutrition Programs, I personally accounted for millions of fraud, abuse, and waste of tax payer money. I came to believe that the poor would be best served with less Gov programs and more with direct aid via tax system. Then after 5 years I became a free market capitalist, was a venture capitalist in 2007 and helped start 2 high tech companies. I dedicate this site to champion free market capitalism as the best road to Prosperity. Please join in. If you disagree, fine, but please post with dignity and class and be civil. Argue with facts always.
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1 Response to M2 velocity and $1.8 trillion in excess bank reserves delay Inflation and Aftershock Economy

  1. Graham Carrington says:

    I absolutely agree with your analysis. Although inflation has been delayed, it is only a matter of time before we get hyperinflation, due to Q.E.

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