Guan Jondred Dolar and the Velocity of Money - Café with Mario
Thursday, May 28, 2015

Guan Jondred Dolar and the Velocity of Money

“Guan Jondred Dolar” is an incredibly well produced Mexican short film offering an artistic interpretation of the function and importance of the velocity of M1 in stimulating economic activity.  More important it provides an opening to explore the velocity of money in the relatively stagnant US economy.  But first a little background on the film (Watch the video at end of the article).

“Guan Jondred Dolar” is a clever piece by Antonio Galicia; a funny story that reveals Mexican mischief, wit and how a $100 bill which can travel within a small town whose residents are cross indebted.  With agile dialogues and scenes, the short is a well-made allegory illustrating the velocity of money (M1 in this case) in stimulating a local economy through a story whose characters, reminiscent of Latin American idiosyncrasies, give it a unique touch and implant evocative smiles on Latin American viewers.

The film begins with the arrival of an American tourist (the “Gringo”) who injects money into the local economy by making a $100 deposit so as to preview a room of a hotel in the small Mexican town. Then the adventure begins as the bill passes through the hands of the town's lively characters each having a credit relationships with another.  In the end, the money exits the economy when the “Gringo” gets back his $100 the moment he passes on the hotel’s “suite presidential” but not before his $100 bill changes hands 7 times during which time the town characters are able to pay off the various debts amongst each other.  All this happens during the half-time of the soccer match playing on the hotel’s television; 15 minutes to be exact.  The film also manages to introduce economic class symbolism through the method of transportation used by the various characters, from walking to bicycling to motor biking all the way to an automobile (more precisely a pickup truck).

Cast: Alejandro De La Rosa, Roberto Molina, Lila Lombardi, Raún Ramírez, Cynthia Torash, Enrique Altamira, Antonio Zagazeta, Jorge Almada, Aida Salazar.
Director: Antonio Galicia
Script: Ignacio Guzmán.
Runtime: 10 minutes
Language: Spanish with English subtitles
Filming Location: Mexico

In the film, the $100 dollars represents the M1 in circulation in the local economy.  M1 is the narrowest component of the money supply and consists of all of currency in circulation (notes and coins, traveler’s checks [non-bank issuers], demand deposits, and checkable deposits).  M1 does not contain "near money" or "near, near money" as M2 and MZM do.

One key measure of economic activity is the velocity of money.  The velocity of money is the frequency at which one unit of currency is used to purchase (domestic) goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy.  In terms of economic growth, the faster (or rising money velocity) it moves the better.

For M1 the velocity of the money stock is calculated by the Federal Reserve as the ratio of quarterly nominal GDP to the quarterly average of M1 money stock.  In the film “Guan Jondred Dolar” the $100 bill turned over 5 times, excluding the deposit and its return, generating $500 in economic activity from $100 in just 15 minutes.

Understanding velocity, or the lack of it, is one of the keys to understanding why the current economic recovery is so much slower than most of those in the past.  Higher monetary velocity should translate into stronger economic growth and more employment. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place.

Looking at the first figure shows that the velocity of M1 money stock continues a free fall since its peak in Q2 2008.  In fact as of Q1 2015, the latest for which data is available, the velocity of M1 money stock is the lowest since Q3 1975. In other words, money continues to decrease in circulation in the economy.

Taking a glance at the broader M2 component of the money supply could shed further insight in the growth of the U.S. economy.  M2 includes M1 in addition to saving deposits, certificates of deposit (less than $100,000), and money market deposits for individuals.   The next figure shows velocity of M2 money stock.  It is clearly evident that the velocity of M2 money stock, as in the case of the velocity of M1 money stock, continues to slide.  The velocity of both M1 and M2 money continues to slow and, in fact, the velocity of M2 money is at its lowest level since 1959.

To compound the situation, the financial markets are anticipating the Federal Reserve will raise interest rates rate at some point in the not so distant future.  The Federal Reserve has kept U.S. interest rates abnormally low for a historic period of time. Since 2008, the federal funds rate has sat at zero to 0.25%, compared to a more "normal" historical rate around the 4.0% area.  The central bank simply has to start the policy normalization process at some point.  However rising interest rates, which will impact home mortgage rates, could pressure rates of home purchases. The higher level of mortgage rates could shut some buyers out of the market or discourage the process.  Again, that would keep money parked, not moving through the economy and would probably exacerbate the fall of the velocity of both M1 and M2 money stock.  As illustrated in the velocity of M2 money stock figure, despite historically low interest rates people are keeping their money in saving deposits, CD, and money market accounts.  It is unlikely that higher interest rates will change that behavior.

So far the discussion has been centered on the velocity of money.  However another economic measurement is the money stock itself.  The next two figures show the M1 money stock and the M2 money stock respectively.  A line of “best fit” has been visually added and is shown in red.  Interestingly for both figures this red trend line crosses at the end of the 2001 recession.  But more important to note is the surge in M1 and M2 money supplies. In the case of the M1, for the 20-year period of 1980 to 2000 the money stock increased by 5.56% on an annualized basis but for the 7 year period of 2008 to 2015 the M1 money stock increased by a staggering 11.52% on an annualized basis.  Together with historically low interest rates, the Fed has tried to stimulate the economy by increasing the money supply.  So the economy currently has both decreasing money velocity and increasing money supplies.  Generally speaking one would expect to see a significantly higher consumer price inflation index, which is not the case.  So rather than causing consumer prices to increases the inflation could have been exported by buying more foreign product (not current case) or the excess money is causing other assets (stocks, housing) to increase (both the current case) excessively (also known as an “asset bubble”).

Economic growth in this recovery has been modest at best. And with interest rates expected to increase while money velocity continues to decline and the money supply continues to increase there is unlikely to be any significant change in economic growth.  Rather if history is any indicator one of two outcomes may be expected:  either significantly higher consumer price inflation or another asset bubble.  At least for the moment one can enjoy “Guan Jondred Dolar” and hope the Fed's policy making can successfully manage the economy to avoid either of the two potential outcomes referred to above and instead yield a similar velocity of money as the injection of the $100 bill did.

Watch the "Guan Jondred Dolar" video below.

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Item Reviewed: Guan Jondred Dolar and the Velocity of Money Rating: 5 Reviewed By: Mario Larach