Ken Fisher Explains Inflation Impacts from Velocity of Money

A title screen reads “Ken Fisher Explains Inflation Impacts from Velocity of Money”

A man in a blue shirt and yellow tie appears on screen. A banner identifies him as Ken Fisher, Founder and Co-Chief Investment Officer of Fisher Investments.

Ken Fisher: I’ve been asked why it is that velocity of money matters and particularly why it matters now. And in this I need to take you on a little bit of back trip into some historical evolution to portray now, correctly. So before I do that let me just say that the fear arises because the broadest measure of money, as defined in recent times, M4, which is very broad, exploded last year through US central bank activities in America. And that legitimately causes concerns about inflation and then questions legitimately arise about how do you see that correctly? And traditionally, it's always been true that there is both the quantity of money and how fast the money turns over--because if the money turns over faster that actually speaks to more potential for inflation. If the money turns over slower, less.

Ken Fisher: So traditionally going back, way, way, way back before there was actually calculations on the quantity of money, there was theory derived in the late era of the classical economists of the day, particularly by no relation namesake Irving Fisher, who was a famous economist at the time who got heavily debunked after the 1929-32 stock market crash, that there's this model MV = PQ. M meaning the quantity of money, V meaning how fast it turns over, equals P, the price of all goods and services produced, and Q, the quantity of them. Price times quantity, later being defined to be GDP inclusive of inflation.

Ken Fisher: So the MV = PQ model was something that was and still is in sort of intro economics taught as a macro simplistic framework and therefore velocity factors in. But the early subsequent monetarists led predominantly by legendary Milton Friedman, presumed that velocity, A) couldn't really be precisely predicted, and B) was probably pretty stable. Now in the very beginning money was gold, coins, banknotes, and bank reserves. And that was the first money that was calculated and then we moved to progressively bigger and broader definitions of money. So by the time Milton Friedman was most popular in the 1960s you had M1 and M2, and then that included time deposits in banks, M2, with M1. And then you moved on to broader definitions in M3 and then broader still definitions in M4 that include things like certificates of deposit and US treasury securities with a maturity less than one year, and much broader that.

Ken Fisher: M4, the broadest measure--and there was always the view that the broadest measure was the best--it exploded, a growth of almost 30% percent last year tied to COVID. Expansions on the part of the central bank, Federal Reserve, and with that this fear of inflation the reality of that, however, is that from the introduction of M4 after in the decade around 2005, after the 2007, 8, 9 crash and with it velocity just kept falling. The velocity of M4 has been falling steadily ever since and then plunged in 2020 as M4 grew by 30% percent offsetting the growth of the quantity of money almost perfectly--almost perfectly. So that if you were a traditional monetarist that believed that velocity should be steady state--which by then you probably should have gotten over but a lot of people hadn't--you'd believe that inflation should explode immediately. But inflation didn't explode immediately, and therefore: quandary. And in that quandary you come to what I consider to be a very important point: we don't have a good measure of velocity for what's the real quantity of money. What is the real quantity of money? Because it's not M4 and in fact I’m thinking, and I’ve actually written in a piece that has run on Real Clear Markets that I think pretty soon they'll come up with M5 which might include crypto, and might include a longer term treasury securities, and might include high quality stocks. And then after that to probably come up with M6 it includes scrap plastics, and a basket of used antiques and maybe some Tesla batteries. I don't know, but you get my point that these things aren't real money.

Ken Fisher: Money is what is used as a medium of exchange when you buy and sell things. Money is something you use to transact for the purchase of real things. You don't use one-year treasuries to buy things. You sell one-year treasuries to get money, which you then use to buy things. And that understanding leads you back to the core of what money really is and what the velocity has to be that would be important--but we have no calculation for that today.

Ken Fisher: And so what I believe has happened is that the velocity of money has fallen tied to savings, paying back debt--most of the money for example that the federal government spent last year on COVID was not spent on buying goods and services but was spent paying back debt and saving, which is repaying loans. And in repaying loans you're actually offsetting the increase in these other monies. And these near monies aren't real monies--it's the velocity of real monies that matter. And that may actually have been steady state because that didn't really increase very much. It's the near monies that increased so much--that's what the Federal Reserve impacted hugely. And in fact, now as I speak, for the last nine months bank lending has been shrinking. And as bank lending shrinks that's a negative impact on the quantity of real money because people borrow money to spend it on things.

Ken Fisher: So with that I would say that the velocity is important--it's hard to get a handle on. We don't really have the impact of real money having exploded the way the appearance of real money has exploded and the fact that people are so concerned right now about inflation is fundamentally an underlying bullish thing because it says while there's more optimism than there used to be, people aren't over the top optimistic. They're still worried about things, there's still wall of worry to climb for this bull market which, oh by the way--as I speak hit a new all-time high today.

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