Speed Kills

When the walls come tumblin' down
When the walls come crumblin' crumblin'
When the wall come tumblin' tumblin' down
--John Mellencamp

The below charts are taken from John Mauldin's fine piece on the velocity of money.

Note that velocity falls during economic slowdowns and was negative during the Great Depression (note also that we're on the cusp of negative velocity right now). When velocity falls, so do prices.

Why should falling prices freak people out? Shouldn't we welcome falling prices?

For those with little or no debt, the answer should be a resounding 'yes,' because falling prices increase purchasing power. Prior to 1900, the US saw multiple periods of such 'deflation' while standard of living ripped higher as businesses became more productive.

But in a world lugging massive debt, falling prices are a curse. People borrow money using assets or income as collateral. Falling prices reduce the value of collateral, thereby increasing leverage ratios. At some point, debtors face margin calls from creditors. Or defaults.

In a free market, responsibility for handling this situation lies in the hands of debtors and creditors. Borrowers and lenders have to manage the risk of slowing velocity and falling prices by correctly sizing their loans. They bear the consequences of poor decisions (read: excessive risk taking).

In an interventionary world, responsibility for this situation lies with central banks and government. Each time money velocity falls, bureaucrats intervene to pump money supply higher.

Such a situation invites two chronic conditions. One is that people are motivated to borrow and take more risk than they otherwise would (read: moral hazard). Saving is discouraged. Standard of living appears to be higher than it otherwise would be, convincing people that interventionary policy must be the right thing to do. The chart below expresses this condition.

The other chronic condition is inflation. More money printed means decreased purchasing power per monetary unit . People have larger banks accounts but their money buys less.

It's the Jedii Mind Trick of inflation.

Critical thinkers should be asking whether there might not be a supercycle to this moneyprinting scheme that collapses under its own weight at some point. They should also be considering plausible conditions that could drive the collapse--and where we currently stand vis a vis the list.