Velocity

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The velocity of money and the US dollar
Posted by Izabella Kaminska on Dec 11 08:44.

MV = PY, that’s the formula for the theory of money. M is the quantity (or supply) of money, V is the velocity of money, P is the price level and Y is the aggregate economic output.

Interesting to note currently, according to Standard Chartered, is the V part of the equation and where exactly it’s contracting. The theory initially assumed that V was constant. Of course, the Great Depression showed that that was in fact not true, because the velocity of money fell.

Standard Chartered says that while the Fed may be losing a few battles here and there, it will eventually win the war. This is largely because it understands the V part of the equation. What’s troubling, however, is what’s happening to V elsewhere:

In Asia, money supply growth continues to slow in China, India and South Korea, albeit from high levels. In Japan, M1 is contracting (again). Although suitable data is not readily available, it seems reasonable to assume that Asian velocity of money is declining due to the global credit crisis. The same could be said for the Eurozone.

Standard Chartered remains hopeful though. The Fed may have been the first to respond to the problem, but others will follow suit. Inevitably, however, all of this is a major negative for the US dollar as global money supply growth is mostly USD-denominated. But timing the dollar’s descent will be tricky. Standard Chartered says:
What we do know is that the world‟s central banks, not just the Fed, are actively debasing the value of their currencies to support money supply growth and thus overall economic activity. For this precise reason, we think that USD weakness in 2009 will be slow and gradual.

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