The Nature of Transactional Velocity?
Following up on The Cash Balances Paradox?
The second underlying cause? It's not just the paradoxes effect of lower spending and lending, it's also the type of spending, lending or transactions that economic actors engage in, and the quantity thereof.
We Nattered about this transactional aspect in our speculations on The Transactional Velocity Effect Of Speculation And Financialism?
Validation of those speculations can be found in the Proof Of The Transactional Velocity Effect Of Speculation And Financialism.
There are two types of transactions which involve cash, assets, collateral and loans:
Type (1) would be consumption PCE contributing or GDP generating aka economically beneficial.
Type (2) the purchase of financial assets, asset swapping and transfer payments aka non PCE or GDP contributing, and being deleterious when in excess.
Examples of type 2 or non GDP - PCE transactions include transactions involved in financial engineering and speculation. i.e. equities and bond markets, RE loans, house flipping, debt issuance, rehypothecation, derivatives and central bank quantitative easing.
Let's try to demonstrate how the demand for money, credit creation and the velocity of the monetary base are influenced by type (2) transactions.
Since 1970, type 2 transactions have been on a exponential rise in frequency and dollar volume globally, with particular concentration in the US, Europe and Asia.
Rather than just transactions involving the purchase of final output or GDP, both the demand for credit and the demand for money are influenced by total transactions.
Any increase in non GDP transactions precipitates a rise in (total) transactions and an increase in the holding of transaction balances.
A rise in total transactions relative to income increases both the demand for credit (and hence the deposit counterparts) and the demand for money, relative to income and hence income velocity falls.
With real incomes in negative growth, nominal incomes are not keeping up with "advertised as tame" inflation, much less the real rate of inflation.
Very simply, if total transactions increase more rapidly than income (type 1) transactions, broad money will expand more rapidly than income and so income velocity will fall.
In addition, (real) broad money rises proportionally with (real) non GDP transactions, thus reducing velocity proportionally with the rise in non GDP transactions (and vice-versa).
Thus, type (2) transactions have a reverse relationship with both monetary base and credit creation velocities viz. they cause reductions in both.
At the end of the day, type (2) transactions lead to increased broad money stock, demand for money, lower credit creation and velocity.
Excessive Type (2) or non GDP PCE transactions lead to:
over speculation
obfuscation of true price discovery
asset bubbles
non wage price inflation - Stagflation
increased debt service ratios
decreased discretionary spending
misallocation of capital
retardation of non housing small business investment, formation and lending
economic malaise
When increases in type 2 transactions are in conjunction with ZIRP, the following self reinforcing side effects also occur:
excessive carry trade margin
artificial interest rate suppression
negative interest rates and spread margins
More to come in The Velocity of Black Holes? Stay tuned, no flippin.
Liquidity preferences can be altered through natural and un-natural market conditions, viz. there is something in this more than natural.
Those preferences can lead to capital, which otherwise might be working towards PCE and GDP economic endeavor, being malinvested in pursuits (non PCE and GDP) which are deleterious to economic growth.
Those funds which become ensconced in the system, increase the demand for money, and reduce the transactional velocity of money. What are the underlying causes?The first underlying cause? Ceteris paribus, wanting more money leads to an economic contraction with lower aggregate demand. Lower aggregate demand dictates less spending which is the primary driver of the economic engine.
The second underlying cause? It's not just the paradoxes effect of lower spending and lending, it's also the type of spending, lending or transactions that economic actors engage in, and the quantity thereof.
We Nattered about this transactional aspect in our speculations on The Transactional Velocity Effect Of Speculation And Financialism?
Validation of those speculations can be found in the Proof Of The Transactional Velocity Effect Of Speculation And Financialism.
There are two types of transactions which involve cash, assets, collateral and loans:
Type (1) would be consumption PCE contributing or GDP generating aka economically beneficial.
Type (2) the purchase of financial assets, asset swapping and transfer payments aka non PCE or GDP contributing, and being deleterious when in excess.
Examples of type 2 or non GDP - PCE transactions include transactions involved in financial engineering and speculation. i.e. equities and bond markets, RE loans, house flipping, debt issuance, rehypothecation, derivatives and central bank quantitative easing.
Let's try to demonstrate how the demand for money, credit creation and the velocity of the monetary base are influenced by type (2) transactions.
Since 1970, type 2 transactions have been on a exponential rise in frequency and dollar volume globally, with particular concentration in the US, Europe and Asia.
Rather than just transactions involving the purchase of final output or GDP, both the demand for credit and the demand for money are influenced by total transactions.
Any increase in non GDP transactions precipitates a rise in (total) transactions and an increase in the holding of transaction balances.
A rise in total transactions relative to income increases both the demand for credit (and hence the deposit counterparts) and the demand for money, relative to income and hence income velocity falls.
With real incomes in negative growth, nominal incomes are not keeping up with "advertised as tame" inflation, much less the real rate of inflation.
Very simply, if total transactions increase more rapidly than income (type 1) transactions, broad money will expand more rapidly than income and so income velocity will fall.
In addition, (real) broad money rises proportionally with (real) non GDP transactions, thus reducing velocity proportionally with the rise in non GDP transactions (and vice-versa).
Thus, type (2) transactions have a reverse relationship with both monetary base and credit creation velocities viz. they cause reductions in both.
At the end of the day, type (2) transactions lead to increased broad money stock, demand for money, lower credit creation and velocity.
Excessive Type (2) or non GDP PCE transactions lead to:
over speculation
obfuscation of true price discovery
asset bubbles
non wage price inflation - Stagflation
increased debt service ratios
decreased discretionary spending
misallocation of capital
retardation of non housing small business investment, formation and lending
economic malaise
When increases in type 2 transactions are in conjunction with ZIRP, the following self reinforcing side effects also occur:
excessive carry trade margin
artificial interest rate suppression
negative interest rates and spread margins
More to come in The Velocity of Black Holes? Stay tuned, no flippin.
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