Inflation has become the issue of our time. It’s affecting everyone in many ways. Whether we’re talking about food, energy, housing, transportation, clothing, electronics, or cars…prices are way up.
Ever since the Fed started calling inflation “transitory”, I’ve been calling them out on it. While the rise in the inflation rate may stabilize or even fall back, I wouldn’t bet on that happening. Even if it did, I would not expect that to last. The other point is that even if we had real zero inflation at this point, we’re still faced with prices at a new and much higher level. And wages are not keeping up. So this is a problem.
And in my view, odds are good that it’s only going to become an even bigger issue. That’s because Money Velocity has crashed, but it’s unlikely to stay this low for too much longer.
Money Velocity is a simple but very important concept. It’s the rate at which money changes hands in the economy. It indicates the level of demand for money.
A lower money velocity generates deflation, with falling prices. A higher money velocity is naturally the opposite, creating upward pressure on prices, leading to inflation.
OK, so first consider that the U.S. is currently dealing with 7.5% official annual inflation, the highest in 40 years. We all know the reality is certainly considerably higher. Now, what if I told you that this is happening while money velocity is at its lowest in over 120 years?
The next chart demonstrates money velocity has been falling dramatically since the late 1990s. Interestingly, this coincides with the big ramp-up in public debt since then. Remember, the more money in the system, the more transactions it takes to maintain the same velocity. And money velocity absolutely crashed when the pandemic lockdowns were followed by massive stimulus money printing and debt expansion.
There is precedent in 1933, at the depths of the Great Depression, and in 1946, after World War II. Note these lows in the chart above. Both times dramatic steps were taken by central planners to trigger inflation.
The annual In Gold We Trust report is an authoritative review on gold investing, written by Ronald-Peter Stöferle and Mark Valek of asset management firm Incrementum AG. It’s also considered an industry standard on gold, money, and inflation. As they stated in the 2021 report:
In 1933 and 1946, the velocity of money was similarly low, and in both cases, the US government resorted to radical measures. In January 1934, it devalued the US dollar against gold by almost 70%, and in the period 1946–1951, it enforced financial repression in cooperation with the Federal Reserve, which capped interest rates at a low level. Both times, this massive intervention resulted in significantly higher inflation rates in the years that followed. Currently, the velocity of money is at even lower levels than in 1933 or 1946. We expect history to repeat itself and central banks to seek their salvation in financial repression.
Piling on record historical global debts and holding rates down at 5,000-year lows is stoking inflation like we haven’t seen in a long time.
As COVID-19 pandemic restrictions on business and leisure start to fade, money velocity should kick into high gear. The trigger is likely to be a release of pent- 8 up demand. As the economy ‘reopens,’ people are eager to travel, renovate, go to concerts and sporting events, or just enjoy a restaurant meal. And then there’s the risk of rising inflation expectations, with consumers and businesses trying to get in front of it. That could accelerate things even further.
If money velocity just returns to pre-pandemic levels, then it needs to rise by 30%. Remember, the Fed has no control over Money Velocity. Imagine the effect of money changing hands 30% more often than it does currently? Now think what that will do to inflation. That’s one big reason I expect inflation rates will stay high and could easily head even higher.
I will be tracking Money Velocity for any significant changes and looking for its effects on inflation. Despite 40-year highs, inflation may not ease meaningfully for some time. We may, in fact, be headed for even higher levels still.
Gold is clearly poised to benefit. Its characteristics as an inflation hedge are obvious and long-established. What’s likely to happen to Money Velocity makes gold all the more crucial in your portfolio for diversification and profits. Gold investors shouldn’t fear inflation. Instead, we should embrace it knowing we’re properly hedged.
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Thank you so much for this excellent Maven letter. Your market analysis and logic is again exceptional. Your insights, knowledge and feel have given me a wonderful couple of hours. I am now planning my activity. I look forward to seeing you tonight on the Virtual Metals forum, I am pleased that you start first as I am a morning not a night person.
I hope you and your family stay well.
BTW - I really enjoy reading your newsletter - very comprehensive and you do an excellent job of integrating a macro perspective into your analysis.