Get Me Out

Following Tuesday’s election we offer one word of advice: Panic!

Not just because Obama was reelected – that’s just one reason.  But because, as John Embry, chief investment strategist at Sprott Asset Management notes, 2013 could be “one of the ugliest years on record.”

“I think we will see the first manifestations of the negative aspect (of money printing in 2013),” says Embry.  “To date, money velocity has been falling because even though all of this high powered money is being stuffed into the market by these central banks, the banks and the public really can’t seem to get the lending mechanism working.

“The banks are afraid, and the public is over-indebted.  But I think that will just make them push QE even harder, and at some point there will be a collective realization from all these people that are holding bonds and cash, etc., that ‘My God, the money is being destroyed.  Get me out.’

“That’s what will get the velocity to change direction, and then you will see mounting inflation very quickly.”

Velocity of Money Redux

Of course, the rapid increase in money flow that Embry warns of is what critics of quantitative easing have feared all along.  Once the banks start lending out all the credit the Fed has created, and the money begins to flow from the balance sheets of banks into the real economy, its rate of flow could rapidly accelerate.  When started, there will be no stopping it.

The velocity of money is simply the average frequency a unit of money is spent in a specific period of time.  For example, a mechanic buys $40 of maintenance supplies and detergents from a storeowner in the morning.  Midday the storeowner spends $50 to have his car tuned up by the mechanic.  That evening the mechanic picks up a $10 case of Budweiser from the storeowner.

Thus $100 changed hands over the day, even though there was only $50 of actual money.  The reason it was possible for the $100 to change hands is because each dollar was spent twice…the velocity of money was 2 per day.  For the day, based on these transactions, the storeowner and the mechanic each contributed $50 in spending to the economy.

But what happens if the storeowner takes the proceeds from the initial $40 sale and stuffs the money in his mattress…and the mechanic, not having earned $50 in tune up services, passes on the beer?

In this example, just $40 in gross spending would have taken place.

Today, while the money supply has greatly expanded, its velocity is lethargic…for now.  Here’s what we mean…

Get Me Out

The federal funds rate is set at practically zero, the Federal Reserve’s more than tripled its’ balance sheet, and the federal government’s run trillion dollar budget deficits for four straight years.  In other words, the Fed and the Treasury have overtopped the credit reservoir.  But the money still drips into the economy like cold molasses in February.

Following the 2008 financial crisis and credit freeze, banks have concentrated on repairing their balance sheets rather than lending money.  They’ve been given access to cheap credit from the Federal Reserve yet they don’t lend it; they hoard it…they stuff it in their mattress.  Moreover, what they do lend, they lend to the government in exchange for Treasuries.

But attitudes can change suddenly.  As noted above, John Embry thinks they could change this year.  In his words, people will collectively look around and come to the same conclusion all at once… ‘My God, the money is being destroyed.  Get me out.’

When that happens the velocity of money will rapidly spike upward…along with the price of anything and everything.  In the meantime, the latent inflation potential will increase with every Fed asset purchase.  Still, for the Fed, there’s no turning back.

If the Fed stops its money creation policies now, the great default will occur.  If they continue to destroy the currency, they can suspend the default only until they destroy us all.


MN Gordon
for Economic Prism

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