What is the velocity of money?
The velocity of money “is the number of times one dollar is spent to buy goods and services per unit of time.” (The Federal Reserve Bank of St. Louis). In a recession, the velocity of money typically slows down because consumers hold on to their money longer and spend less.
Over the past few weeks the velocity of money has hit a brick wall. I am not going out to my favorite restaurant for dinner. Because the restaurant owner has no customers, she is not going to buy a new car. Since she is not going to buy a new car the salesman at the car dealership will not receive a commission. You get the idea. In a recession, we stop spending money and the gears of our consumer-driven economy slow down.
Why I am (somewhat) optimistic
In past recessions, there was something structurally wrong with the economy. The Great Recession of 2008 was caused largely by the subprime mortgage crisis. There was something fundamentally wrong with the banking system that almost led to its collapse. The recession of 2001 was caused by the bursting of the dotcom bubble, the 9/11 attacks, and accounting scandals at major corporations. Except for the 9/11 attacks, there were again problems with our economic system.
The recession of 1990 was caused by Iraq invading Kuwait which caused oil prices to spike and manufacturing trade to decline. At the same time manufacturing was moving offshore and the North American Free Trade Agreement (NAFTA) began. Disruption in oil prices, trade, and manufacturing combined to create a recession. Recessions in the 1970s and 1980s were largely the result of oil supply disruptions and high inflation.
We are likely headed toward a recession or are currently in a recession. This recession is not actually caused by the novel coronavirus (fortunately millions of people are not dying). It is caused by the global response to COVID-19 which is shutting down activity to prevent the pandemic from getting worse. Other than the stock market being somewhat overvalued, there was nothing structurally wrong with the economy or the markets. Life as we know it shutting down has caused the velocity to hit a brick wall. Once this wall is torn down, we will hopefully witness a strong recovery.
Stay safe and healthy everyone.