Jan. 18, 2023

Velocity And The Slow-Walking Customer

A friend of mine ran the local sandwich shop. He was a fellow escapee from the corporate world and came to rural Pennsylvania to pursue a calmer lifestyle. You may know the type.

One day I was telling him how much I enjoyed having lunch here. He surprised me when he said, "enjoy it now because it may not be around much longer." That was a real shock. Many of us were accustomed to grabbing a quick bite or relaxing at one of their tables. So why would he be considering closing? He always retained a customer, and everyone raved about the food.

It is true, he said, all of my customers love coming here. They just don't come as often as they used to; the customers who used to eat here three or four times a week now only come by once or twice. And that made a massive difference in their cash flow. Their income was cut in half and was the reason they would likely close.

They close a couple of months later, and the community is worse for it.

What my friend said has a great deal of insight, and it's the key to this economy. However, it may not have seemed so to their customers. They still went in to buy those delicious lunches, and they may have even placed the same orders: like "Ham and Swiss in Rye." But the difference is that they weren't coming into the shop as often. The customers had cut back, just a little, but enough to make a gigantic difference in the shopkeeper's income.

We can see from the data that this is happening everywhere. The trend toward spending less began after the Great Financial Crisis of 2008, but it got underway after the Covid Pandemic.

Economists have a category for the spending rate; it's called Velocity. Velocity," according to the Fed, is the frequency of the dollar used to make a purchase. Velocity accelerates when times are good and the economy is humming along. Velocity decelerates when times are declining and the economy is slowing.



A note to my technical readers/listeners: today, we will be looking at M1-Velocity. M1 is the most narrow definition of currency and the measure of currency likely used for small business purchases.

So, consider Velocity to be the speedometer of cash. The higher the velocity reading, the faster a dollar changes hands, and the more financial activity occurs. Conversely, as Velocity slows, so too does the overall economic activity.

Now, in looking at our "money speedometer." Velocity back in the 1980s was always at least 6. It did have some ups and downs, but it constantly changed hands at least six times a year. And by 1995, the pace of Velocity began to accelerate, corresponding with the introduction of the internet, and e-commerce, which made online transactions possible. It was now more convenient for people to buy things, and they did so in a big, big way.

By 2008, M1, Money Velocity reached a record 10. The fastest that the dollar has ever moved through the economy. At that point, things broke. The Great Financial Crisis of 2008 saw the collapse of credit, the principal driver for all this spending. And Velocity began to fall back to levels roughly seen before the financial melt-up of the first part of this century.

If the story ended there, we'd look at a normal boom/bust cycle. But, as you know, things didn't stop there. Covid struck, and ever since, we've lived in a world that none of us have seen.

Considering the average M1 Velocity before and after the 2008 Great Financial Crisis was 5 or 6, then we are currently in an entirely different ball game. Since that dreadful Second Quarter of 2020, when the total Covid Lockdown occurred and the economy dropped by 30%, M1 Velocity has been below 1.5.

The exchange of the dollar is now just one-quarter an average rate. People's spending has gone into slow-motion.

Slow-motion spending is the reason my friend closed shop. He didn't lose customers; it is just that those customers changed their behavior. Instead of eating at his shop weekly, suddenly, they only came in once a month, not generating enough income for him to stay in business.

And this slow-motion consumer is happening everywhere all through the economy. It is the reason that those Stimulus Checks didn't generate more inflation. With that much money pumped into the economy, we expect that with average Velocity, inflation would still be accelerating. The Fed thinks that it is.

But the reality is that inflation is falling off the table because people have radially slowed their spending. They are sitting on their hands, not opening their wallets.

I will throw one caveat here: should the price of gasoline go up again, that will bring inflation back. And I am looking for that possibility later this winter. However, any gasoline-driven recurrence of inflation will likely be temporary.

The long-term driver of this financial system will continue to be Velocity, and we would have to see Velocity double from current levels to get back to normal.

As Money Velocity goes, so goes this economy.