First quarter GDP numbers were, well, bad. The economy grew at 0.2 percent. I'll sum up the problem, their simply is not enough money. Money can have many meanings. M1 is the total amount of M0 (cash/coin) outside of the private banking system plus the amount of demand deposits, travelers checks and other checkable deposits. M1 velocity is how quickly this moves through the economy. It involves both how quickly people spend the money in their accounts and the amount of credit available. If a quarter gets passed around from buyer to seller every day, the transactions increase GDP more than a dollar that sits in your wallet all year. The smaller M1 velocity, the less money is being passed around.
The fed lists the recent trend as:
2015:Q1: 5.965
2014:Q4: 6.141
2014:Q3: 6.203
2014:Q2: 6.212
2014:Q1: 6.276
Here's the thing. The data series is scewed. You get the same economic result if you have a lot of money moving slowly or a smaller supply of money moving around the economy more quickly. Prior to the 1960s, velocity ranged from around 2 to 3.
Friedman & Schwartz In the 1960s, LBJ pressured the Federal Reserve Board to keep rates low during the Vietnam War.
Califarno Lower interest rates mean money is moving more quickly. In order to keep inflation in check, the board reduced the pace at which the created money, relative to population growth. Unfortunately, Federal Reserve governors sit for only 13 years. The war lasted so long that the institutional knowledge of why the fed was setting the money supply at a certain level was lost. Due to retirements, delays in appointment and moves into the private sect only one member of Federal Reserve Board in 1965 remained on the board when the war ended in 1975, and he had other political issues.
List of Fed Governors Even more unfortunately, the modern fed data set starts in 1959. The choice between monetary base and velocity, made as a wartime measure, became baked in to many of the fundamental economic assumptions going forward.
Things came to a head in the late 1970s. The rising price of oil caused in inflationary spiral. In order to attempt to bring this under control, the fed jacked interest rates sky high.
With higher oil prices driving inflation, its unclear how much good the feds rate hike did. Here's the thing though. The feds actions caused interest rates on government bonds to spike to unheard of levels.
The Feds actions caused rates paid by every government to rise. The United States paid some very high interest rates on its bonds in the years just after the revolution. That makes the US, somewhat, of a poor point of comparison. Here is one showing British bond yields going back to 1701.
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If Britain ever saw interest rates on government bonds like those found in the 1980s, it was before the Glorious Revolution.
So what does all of this mean? Well remember that we're talking about the M1 money supply * m1 Velocity. The fed hiked interest rates so high that it could, in effect, buy off the need to increase the money supply to an adequate level by dropping interest rates to goose velocity. And this worked until rates hit zero. Well worked as long as you mean keeping GPD numbers up instead of looking at the hollowing out of the middle class and the rise of the financial sector.
We've reached the point that velocity really can't be increased by dropping interest rates. To make matters worse, conservatives - both in the United States and elsewhere - have been on a single minded crusade against monetary velocity. To give just one example, Republicans seem to think that the Roosevelt administration enacted unemployment insurance to maintain the lifestyle of the beneficiary. Unemployment insurance isn't about the unemployed, it's about their creditors. It means that bills can still get paid while people search for work. Without unemployment insurance, everyone becomes a worse credit risk - slowing the economy. The war on the welfare state is a war on the creditworthiness of the American people. Or to put it another way, would you rather make a loan to an American who might face a medical bankruptcy or a Canadian with the same job and income but with universal health insurance?
So what happens now? Their are a couple of options:
1. The Fed begins a new program of quantitative easing (QE) until increases in the money supply bring velocity down to around 3, in effect buying off the decline.
2. GDP essentially stagnates until the slow increases in the money supply that the fed makes brings M1 velocity down to around 3.
3. Something really bad. When economies become resource constrained, the free market has a way of finding more of the needed resources. In the case of fracking and the like we might not like it, but it does take place. The one resource that the market cannot create without intervention of the elite is monetary base. Revolution is a free market activity. Among governments clinging to hard money policies were the United States right before the Great Depression, France before the Revolution and Germany prior to the rise of Hitler. While I don't, seriously, think we will see a revolution in America, Europe has been followed even more stringent hard money policies. Vast geopolitical instability would not surprise me in the least.