Velocity vs. Tapering

As the government shutdown and debt ceiling debate gets behind us, perhaps we will start to see a better picture of where the economy is going.  Treasuries and bonds have been very steady, except for 30-day treasuries which have seen a higher yield due to fear of a possible short-term default.

The stock market has been bouncing up and down a few weeks at a time.  There is about a 900 point range that the Dow has been in, sometimes dipping below the 15,000 mark.

As the dust settles from Washington DC, investors will start looking at the Fed again.  The next FOMC statement will be released on October 30, 2013.  The question again will be whether or not the Fed starts to taper (scale back on its monetary inflation).

I think if the Fed does taper, it will not be by a huge amount, at least in comparison to what QE looks like now.  The Fed is currently buying assets and increasing the monetary base by $85 billion per month.  Maybe the Fed will cut back to $70 billion or $75 billion per month.  Either way, it will still be unprecedented when compared to anything prior to 2008.

But even with the Fed continuing to inflate by massive amounts, most of this money has still been going into the banks and kept as excess reserves.  It is not being loaned out and not being multiplied through the system.  This holds down consumer price inflation.

Also, the Austrian Business Cycle Theory tells us that an artificial boom can go to bust even with monetary inflation.  The only way to avoid the bust is to continually increase the rate of monetary inflation.  Eventually you would hit hyperinflation and then you would get a bust anyway.  So a bust is inevitable.  It is just a question of how long it will be drawn out and how severe it will be.

At the same time, I have a sense that velocity has been picking up.  I can see it with people around me.  It seems that confidence is a little better and that more people are taking out loans, even as people continue to struggle.  I don't have any hard statistics to back this up.  It is just a sense I get from the people around me and the things I see and hear on the news.

There continues to be this tug-of-war between an artificial boom and a bust.  If velocity is picking up, meaning people are spending more and money is changing hands faster, then this points to a boom phase.  If the Fed slows down its rate of monetary inflation and the banks continue to pile up excess reserves, then this points to a bust.  We will have to wait and see which one wins out in the short run.

As the news about the government shutdown and debt ceiling gets behind us, we will start to get a better sense of what is happening.  We will also see what the Fed decides to do on October 30, the day before Halloween.  It's not trick or treat.  It will only be a trick.