TheVelocity of Money: How It Shapes the Economy
March 5, 2025
The Velocity of Money: Unleashing Inflationary Forces
When the velocity of money (VM) increases, it exposes inflationary forces that were previously dormant. However, many mistake these forces for inflation itself. Inflation, in its true sense, is the expansion of the money supply—what we call “printing money out of thin air.” This has been a constant since the abandonment of the gold standard. The symptoms of this disease manifest as price increases, but the underlying cause is the flood of liquidity in the system.
Since the Great Recession, prices remained relatively stable because VM was kept in check. How? The newly created money was funnelled primarily into banks and financial institutions, not into the hands of everyday consumers. As a result, VM continued its long-term decline.
That changed after COVID. The Federal Reserve, openly advocating for “some inflation,” injected liquidity directly into the hands of the public through stimulus checks, enhanced unemployment benefits, and other direct payments. This jump-started the velocity of money, setting off inflationary forces that had remained subdued for over a decade.
The Money Supply: M1, M2, and the Inflationary Tipping Point
The relationship between M1 and M2 offers key insights into economic shifts. When M2 (a broader measure of money supply) increases faster than M1 (the most liquid assets like cash and checking deposits), it signals a heightened inflation risk. Historically, VM has been on a downward trajectory since 1997, making a reversal a significant event. M1 VM peaked in 2007, only to follow M2 in its long-term decline.
Despite the vast amounts of money in circulation, it has primarily influenced short-term trends rather than altering long-term economic trajectories. If VM does rise, history suggests inflation will spike—but whether that pattern holds in today’s financial landscape remains the trillion-dollar question.
The Immigration Factor: A Hidden Catalyst for Velocity
A crucial yet overlooked factor in the post-COVID economic landscape is the role of illegal immigration. Unlike traditional monetary injections, which primarily benefited financial institutions, the post-COVID era saw direct cash injections into the hands of consumers. Once stimulus programs ended, policymakers needed a new mechanism to sustain consumer spending. The surge in illegal immigration provided just that.
Housing, food, transportation, and direct financial aid given to undocumented immigrants effectively functioned as another round of stimulus, increasing VM and keeping inflationary forces alive. Historically, governments prioritize economic stability over social welfare, and this was no different—an economically strategic manoeuvre disguised as a humanitarian effort.
The Great Jobs Myth: A Data Manipulation Game
The Biden administration has widely praised the U.S. job market, but a closer look reveals significant distortions. The Bureau of Labor Statistics (BLS) recently admitted that nonfarm payrolls were overestimated by 1.2 million jobs—a staggering revision that has been adjusted multiple times.
According to the Heritage Foundation:
“It’s important to remember that this benchmark is on top of the existing downward revisions to the monthly jobs reports. Comparing the initial estimates to the latest data shows that nonfarm payrolls were grossly overestimated by almost 1.2 million for a 12-month period. That’s more than a third of the alleged job growth during that time.”
This casts doubt on the labour market’s true strength and raises questions about the sustainability of consumer spending in an environment of elevated inflation.
Bonds and the Billion-Dollar Question
Bond prices typically fall when VM rises. If historical patterns hold, deflationary forces reassert themselves, benefiting bonds. The anomaly in the bond market today suggests that something is fundamentally different. If VM tops out, bond prices should rise as they have in past cycles.
For M2 VM to break its downtrend, it would need to exceed 1.6, a feat requiring aggressive money printing and direct injections into the public’s pockets. Historically, banks retained liquidity, keeping VM low by investing in treasuries and low-risk assets. The COVID-era policies disrupted this cycle by distributing money directly to consumers.
So, the billion-dollar question is whether historical trends hold or whether we are entering a new paradigm in which economic disorder is the new norm.
Conclusion: The Crossroads of Inflation and Deflation
The first major resistance level (the brick-red trendline) is approaching. If VM fails to break through, deflationary pressures could intensify. However, it is crucial to differentiate between deflationary forces and the absence of inflation. Real inflation—the money supply expansion—has been relentless since the gold standard was abandoned. The key issue is whether rising VM will sustain price increases or if deflationary forces will take hold.
For instance, China is experiencing deflation, which would typically spill over into global markets, pulling prices down. However, U.S. tariffs act as a buffer, delaying the impact. Historically, deflation often follows after an inflationary spike driven by rising VM. More money must be injected directly into consumers’ hands to counteract this.
