If there’s so much money available, where is it?

On the Money
From the October 4, 2002 print edition

According to Applied Reasoning, Inc. (an economic indicator research firm), there was $1.19 trillion in the U.S. money supply on September 8, 2002. If you’re like many businesses these days, you might ask “OK, so where is it?” In order to answer that question, we must examine two basic components of the economic system. They are money and velocity.

Most of the time we talk about money in terms of simple amounts. Such as, “I have $10,000 in savings,” or “I need $35,000 to buy that car.” However, underneath those statements is the implied definition of “fiat” money: something that represents control over goods and services. The $10,000 in savings is meaningless unless it is connected to some item or service that we desire. It’s really not the $35,000 we want; it’s the car. Money has no value if it doesn’t move from one person to another. The rate at which the money moves is called velocity.

What makes an economy thrive is not just how much money there is, but rather the amount that travels between people and organizations. We’ve all heard the term “money is tight.”  That statement is more than just a clever catch-phrase. It means: of that $1,192 billion dollars, not much of it is moving around.

The money supply turns over on average about three times a year. When economists fail to predict the future, it’s not because they don’t know how much money has been created by the Federal Reserve Board and released through the banks. It’s because they don’t know what people are doing with it. When people feel threatened, they put their money in the bank and the velocity goes down. When they feel good about life, they buy everyone a beer and the velocity goes up.

The velocity of money is affected by two sophisticated sounding terms: “propensity to save, and propensity to spend. Two other words that might be used are “keep” and “give.” The velocity of money is directly affected by more than one person’s (or company’s) willingness to give; which implies an exchange for something of value, rather than simply keep. As this is repeated from one entity to another it’s called the “multiplier effect.” That is, person A gets $10, keeps a dollar and gives $9 away; hopefully in exchange for something useful. Person B gets $9, keeps 90¢, and gives the rest away, and so forth. Continuing with the original keep/give ratio of 10%, 50 exchanges will multiply the initial $10 into almost $90 in economic activity. That’s what makes the economy either thrive or throttle.

There is little doubt that today’s financial climate is not encouraging. There doesn’t seem to be any money. That is not quite a true statement.

The basic amount of money in the system has not dramatically changed. It is simply stuck. Velocity has dropped to what some might call a snail’s pace.

In order to stimulate a faster velocity of money, or in other words motivate people to “give” rather than “keep,” a variety of fiscal and monetary tools are usually employed. The Federal Reserve Board uses interest rates as a tool to stimulate or slow the velocity of money. It is discouraging to see that recently this utensil of lowering interest rates has not had an immediate affect on the velocity of money and hence economic stimulation. Fiscal and monetary policy may not be enough for today’s conditions. The bottom line lies with those who are keeping the money.

A recent phenomenon in business is that many of the same services are being performed, and at the same rate as two years ago. But, the providers of the services are not being paid. For example, a consultant provides services to a client, that same consultant engages an attorney to provide services to him. The client doesn’t pay the consultant and the consultant doesn’t pay the attorney. The same services were rendered between the parties and the work was done but the only thing created were accounts receivable and accounts payable. No cash (money) changed hands. Removing the “monetizing” layer reveals that the real measure of economic activity may reside in accounts receivable/payable growth; which is directly reflective of just how much work is actually being performed. Maybe the Department of Commerce should be measuring that?

If fiscal and monetary policies are having no effect and work is still being performed, then “Where has all the money gone?” It’s stuck. It’s stuck with people and institutions for emotional reasons that have little to do with traditional financial evaluation. Interest rates could be virtually zero, but unless someone makes an intentional decision to spend based upon both intellectual and emotional confidence, the money will stay stuck.

© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.