Velocity Of Money And Gold
Sunshine Profits | Aug 27, 2019 06:19AM ET
The velocity of money is declining. What does it mean for the gold market?
What is the velocity of money? It refers to how fast money passes from one holder to the next and is commonly defined as the rate at which money is exchanged from one transaction to another. Simply put, the velocity of money is the number of times one dollar is spent to buy goods and services per unit of time. It is the value of transactions (GDP) divided by the supply of money. For example, if the velocity is 2, it means that a $10 bill is financing $20 worth of transactions in a given period. Therefore, the higher the velocity of money is, the more transactions are occurring between people (and vice versa). This is why it is considered a good indicator of real economic activity.
Why we are writing about the velocity of money? The reason is that it is at its worst level since 1959. As one can see in the chart below, the velocity of M2 money has been systematically declining since 1997. And it plunged after the financial crisis, when banks and the private sector started hoarding cash.
Chart 1: The velocity of M2 money in the United States from 1959 to 2016.
The declining velocity of money partially explains why the Fed’s easy money is not helping the real economy. The U.S. central bank expands the money supply like mad, but people remain conservative and do not spend money, increasing their cash reserves instead. This is why the link between monetary policy and inflation has become loose recently.
Summing up, the velocity of money is declining. It should be positive for the gold market, as it indicates sluggish economic activity (the GDP grows slower than the money supply) and ineffective monetary policy. However, there is no clear correlation between gold prices and the velocity of money, therefore investors should not invest in gold only based on this indicator.
Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.
Get The News You Want
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.