Velocity of Money and the Connection to the Economy
There is a fundamental premise in economics that the faster money changes hands, the better the growth of the economy should be. In our view, when you look at the velocity of M2, you get a fair representation of what is happening to the velocity of economic activity. A debate is raging among economists about the validity of the velocity of money. Some believe it doesn't matter because after all, the economy is growing.
I like the way Economist Steve Ladd coined a response to this when he said that "if the increase in money is matched by a decrease in velocity, GDP stays flat." He continued, "Reduced velocity keeps the economy from heating up, which precludes price inflation." In other words: although the velocity of money is accelerating and coming off of all-time lows, we could interpret this to mean there is still a tremendous amount of room for the velocity of money to increase and economic activity to improve as a result. Some blame this lack of activity on too much money sitting with the wealthy; some blame corporations for still not investing cash they are sitting on; some still want to point to too much money being pumped into the economy by the Fed in the 2009-2011 period (too much money printed to get it moving back to historic levels). Lastly, it is taking too long to strip that liquidity out of the market (since it's just sitting anyway). It's probably partly all the above.
We said last summer that: "The bottom line is if the Trump Administration wants to get economic activity flowing faster, it needs to focus on items that can increase the velocity of money." Maybe it did that with the tax reform bill and the repatriation component of it. The latest M2 Velocity of Money ratio showed that it came in at 1.455 in Q2 of 2018 (a bit quicker than the 1.44 in Q1, 1.438 in Q4 of 2017, etc.). Still, this remained the absolute lowest velocity recorded since the series was started in 1959.
Until this starts to take off more aggressively, we probably won't have an inflation spike worry that many have feared. This slow "fits and starts" inflationary period is likely to continue as long as the velocity of money stays this slow.
The Plot Thickens
The mess in Saudi Arabia is getting worse and worse as various stories are trotted out to see if there is one that will be acceptable. The global leaders who have ventured an opinion are now scrambling to retract the opinions they had provided. The first assertion by Saudi Arabia held that Jamal Khashoggi had left the consulate in Istanbul and it had no idea where he had gone. The Turkish asserted there had been a politically motivated murder and they claimed proof. The next round of excuses came from the Saudi government. They admitted Khashoggi had not left, but might have been the victim of rogue forces. This was jumped upon by the U.S. and others. There were public assertions of these rogue elements. Now, the Saudi Arabian position has changed again. The assertion is that Khashoggi was killed during an interrogation gone wrong. Again, this has been attributed to rogue elements, but that leaves a lot more questions. Why was there an interrogation and who authorized it? Who were the interrogators and did they extract from him what they wanted?
Analysis: This incident has severely damaged the reputation of the Crown Price Muhammed bin Salman. It does not appear the current explanation is going to help much. His reform agenda has been under attack from those who think it has gone too far and from those asserting it has not gone far enough. This is an uncomfortable position for him even as he continues to have support from his father. There are now three scenarios in play. All three seem plausible enough.
The first is Saudi Arabia will be shunned by several important allies such as the U.S. Turkey is very angry and has some weight in the region as do the Europeans. They may well find the whole assassination story too unsavory to tolerate. This would likely involve some diplomats being pulled. It could mean a whole series of broken deals and arrangements. There have already been many business deals abandoned and demands for action have been increasing.
The second scenario is that Saudi Arabia's official version of events will be accepted and there will be a certain level of support for the Crown Prince as he works through the crisis. This all comes down to how important the kingdom is to the other nations involved. The Trump comments are about as blunt as any have been. He pointed out the arms sales that have been made to the kingdom support jobs in the U.S. and he doesn't want to put them at risk. There is a sense the U.S. will accept the statements of the Saudi government and will move on. The trick will be maintaining the impression that these were unauthorized agents and the killing was not intended. That may be hard to assert now that the Turks seem desperate to prove otherwise.
The third scenario would be years of suspicion and investigation that drags the Saudi government deeper and deeper into the story. Was the interrogation itself authorized? If so, what was it expected to gain? Khashoggi has not been at all secretive about his displeasure with the Saudi leadership. There was an ill-thought-out attempt by Trump. Jr. to assert there were ties between Khashoggi and radical Islam, but there has been no proof on any kind produced to back this up. If the Saudi position is to vilify Khashoggi, it will be seen as having colluded with the attackers, which means bringing the attackers to swift and certain judgment.
China Tries to Spin Detention of Uighurs
The Chinese have been rounding up thousands of Uighur Moslems living in the far west of the country and placing them in detention camps. The Chinese assertion is they are being reeducated and cleansed of the ideas placed on them by extremists. The reality is these are concentration camps and there have been deaths already. Those attacked have included women and children as well as the elderly. Whole villages and communities have been detained and are facing indeterminate sentences. There have been many deaths and bouts of sickness. Reports from the area have been all but impossible to obtain.
Analysis: This has been a tactic China has used against many minority groups in the country. Tibet is the best-known example. The Han Chinese dominate the economy and culture and others are held in far less esteem. The repression has been constant. It has accelerated of late as China has also started to worry about the threat from some of those attracted to Islamic extremism. This has been the excuse for the concentration camps, but the vast majority of those interred have had nothing whatsoever to do with this issue. China has thus far avoided much attack for this behavior—even from the Islamic nations, but this Teflon behavior has started to shift as the stories of oppression keep emerging.
Not a Good Sign for Retailers
This is the most critical time of the year for the vast majority of the country's retailers. There are more important periods for those that sell flowers (Mother's Day and Valentine's Day) and for those that peddle fireworks (Fourth of July and New Year's Eve), but for the rest of those seeking to sell things to the vaunted American consumer, this is it. The reason the term Black Friday was assigned to the day after Thanksgiving is this is supposedly when retailers can expect their ledgers to be in the black after having limped along in the red the rest of the year. This is the reason retail analysts study every move of the consumer this time of year. The expectation had been this would be a pretty good year, but there are some concerns starting to develop. The question of consumer motivation is coming into focus.
Analysis: There have been four reasons for optimism up to this point. The first and perhaps the most important was the expected impact of the tax cuts. Granted, the majority of that cut was enjoyed by the business community. Indeed, there has been a considerable increase in the corporate level of spending. The consumer was slower out of the gate, but that was explained by the fact this cut took place at the start of the year—not a big spending period as a rule. Consumers are still getting over the bills that came in after their holiday splurge. Now, they have to be thinking about their taxes. On top of that, there is no real consuming holiday in there to stimulate much. Valentine's Day would be more potent if it were not for the fact single males avoid dating anyone until after the 14th. Consumers start to come to life during the summer vacation days. Then they really get geared up when the big holidays start to beckon. Now is when they would be expected to come alive.
The second motivator has been the exceptionally good jobs data. It is not just that so many people have jobs, there is the psychological impact. If the employment situation looks good, the average person starts to relax about their job status and begins to believe in their secure job. This allows people to consider buying things with a credit card or through a loan as there is confidence in the ability to pay it off. The third reason for optimism has been the consistently good consumer confidence surveys. They have been solid all year—both the big ones from the Conference Board and the University of Michigan. Both have even set records in the past year. A confident consumer is one more likely to spend. Much of that confidence stems from the good employment news, but there are other issues that liven up the consumer such as housing prices. The last of the motivators would be the performance of the stock market. This is often used by people as a gauge of overall market health despite the fact it often isn't all that reliable. It is just a very public means by which the economy can be judged. Lately, it has been performing well.
With all this good news, what explains the less than stellar readings as far as retail is concerned? The latest numbers from September showed only a 0.1% rise. The expectation had been for a hike closer to 0.7%. Some even thought they would see 1%. This would mark the second month in a row with numbers less than expected. There are many reasons cited, but none seem to answer the question completely. There was doubtless an impact from the hurricane, but it did not hit a particularly wealthy area of the country. There is the fact weather was warmer than usual. That could have cut into the desire to start buying winter clothes. There is the election to consider as well—the campaigns are so nasty many people end up disliking both candidates and then start to feel some despair over the fate of the nation. The growth in retail was solid during the summer with months at 0.6% and higher, but now that has started to taper off.
The factor worrying the retailer the most is the possibility consumers are becoming disillusioned. If there really is a genuine worry about impending inflation or some kind of economic reversal, there will be a tendency to become more cautious. Of course, if people really begin to anticipate real inflation their most likely reaction will be to spend on some of those big-ticket items sooner than later so that they can beat price hikes. There is also some evidence people are worried about fallout from trade wars and tariffs. This is not top of mind for most, but it is there somewhere. The retailer worries that some bad news from the stock market or a big jump in oil prices will be enough to send the consumer back into retreat and leave them with a mediocre holiday till.
Much Bigger Deficit in the Offing
The gamble thus far is not paying off and few economists are surprised. The big tax cuts were going to deny the government revenue. There were only two ways to deal with that. Spending might have been cut to offset the lost revenue, but that was not the path chosen. The other alternative was to run a bigger deficit and borrow. That has been the chosen course and the deficit swelled in response—by 17% over the previous year, the highest level in six years.
Analysis: The most distressing aspect of this situation is now would be the time to see the deficit and debt shrink. The economy has been growing at close to 3% a quarter for over a year. All that growth means more revenue to the government and an ability to reduce debt and deficit. The problem is the tax cuts meant less revenue and thus a wider deficit. The criticism of the tax cut from the start was it was going to make both deficit and debt worse. It would require the U.S. economy to grow at more than 5% for several consecutive quarters. The U.S. is nowhere near that kind of growth number. It is argued we are at maximum speed already and issues like debt and deficit will only get worse as the economy slows a bit from its current pace.
More Uber Adventures
I still have not had a bad Uber experience and I take this option several times a week. This is compared to my old track record with taxi drivers in many cities. I rode in utterly filthy cars, was ripped off by fare gouging and feared for my life with truly bad drivers. None of this has ever happened in my Uber travels. This week, I had some interesting drivers indeed.
Last night, it was a flight attendant. She was very pleasant and talkative—not one order to put my tray table up or put my cell phone down. Just great stories about how weird passengers on planes can be. The day before, I had a retired small-town police chief. We swapped stories of criminals that were obviously a few bricks shy of a load. Then the guy from Cuba was fascinating and had stories of how things could change quickly in his former home.
The point is this service has emerged quickly. It works and is pleasant as opposed to miserable and dangerous. It is a lesson that many businesses seem to miss.