The velocity of money is a lesser-looked-at metric which I think holds a tremendous amount of value. I see this metric as a leading indicator for an economic recovery.
In this article, I’m going to dive into this metric and describe what it means for the average investor contemplating whether this economic turmoil is over and if we’re indeed on the other side of this bear market.
The idea behind the velocity of money is to look at the speed with which banks lend out capital to corporations and households. Our economic recovery requires increased lending to thrive, and the speed at which banks lend to those who need money will, in theory, approximate the speed and slope of the economic recovery. When central banks lower interest rates, financial markets expect banks to lend out more money.
Consumers will then spend more and save less. This is a central idea underpinning monetary stimulus.
When we look at the velocity of money, we see that it has plunged to new recent lows of late. This means less capital is circulating in the financial system than central banks would like to see.
This could spur negative interest rates (which could be extremely bearish – look at Japan or Europe for examples), or simply force more dramatic action. This metric underscores what I believe is a faux-recovery we’re seeing reflected in stock prices, and I’d encourage investors to be extra cautious right now.
Invest wisely, my friends.
