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All That's Missing Is a Black Swan


"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

The Federal Reserve chart above only goes back to 1970, but its message is clear, nevertheless. The velocity of money has dropped below that which was necessary to maintain a productive economy in 2009 and has never recovered.

The velocity of money can be defined as, "the rate at which money circulates or is exchanged in an economy in a given period." It's generally measured as a ratio of gross national product (GNP) to a country's total money supply.

No money turnover… no economy.

But, if that's so – if the chart is correct and the money turnover is by far the lowest since 1970 - why did the economy recover after 2010 and why are we in a bull market? Surely, the quantitative easing programme initiated by the Fed corrected the problem and happy days are here again.

Well, actually, neither of those commonly-held assumptions is correct. Quantitative easing didn't pump money back into the failing economy and, more to the point, it wasn't intended to. Most of the money that was created through quantitative easing never actually hit the streets.

To back up a bit, in 1999, the Fed, then under Alan Greenspan, convinced the US government, then under President Bill Clinton, to repeal the Glass Steagall Act, an act created in 1933 to assure that banks would never again recklessly create loans to the public that could never be repaid. Mr. Greenspan argued that the Great Depression was long over and there would not be a reoccurrence but that, if the Clinton Administration would repeal Glass Steagall, it would usher in an era of investment of borrowed money that would create the greatest surge in business since World War II.

And he was correct in his argument. The repeal ushered in a period of reckless loans that accomplished two things – it allowed the Clinton Administration to end on a positive note – one in which the economy appeared to be vibrant. However, it also created a mammoth debt bubble.

As is always true, the creation of massive debt is like a shot of economic heroin in an economy. The euphoria is very real. Unfortunately, so is the withdrawal. This withdrawal kicked in with the real estate crash of 2007.

The Fed (which, if you remember, had created the bubble) recommended that, although the bankers had benefitted enormously through the creation of the debt, they were now in trouble. Rather than have them pay for their misdeeds, the Fed Chairman put forward the concept of quantitative easing (QE). Through QE, the government would pump money into the banks to bail them out. Therefore the banks benefitted hugely from the reckless loans, then benefitted hugely again, through the debt-funded QE.

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