Saturday, January 9, 2016

Looking for significance

Start with my re-creation of Sumner's graph:
Step #1: Currency Relative to GDP (blue) and the Interest Rate, à la Sumner

Invert the blue line, as Sumner does:
Step #2: The Blue Line now shows GDP Relative to Currency

Show the blue line as percent change from year ago:
Step #3: The Blue Line expressed as "Percent Change from Year Ago"

And show the red line as change from year ago, percent:
Step #4: The Red Line expressed as "Change from Year Ago, Percent"
The lines now run pretty close and somewhat similar. Close enough and similar enough that I went back and did the above steps a second time, and captured the images for this blog post.

Consider that last graph. That scribble in the middle, the up-and-down red lines just after 1980, that's Paul Volcker fighting inflation. After the scribble, the red and blue lines show roughly equal size* changes, and patterns that I think are impressively similar. Before the scribble there is some size discrepancy, but the patterns still match up pretty well.

I notice that both the red and blue lines tend to have low points when there are recessions. That accounts for a lot of what looks like similarity. So maybe the pattern similarity is not as significant as I first thought.

Why does the blue line start out so much higher than the red? (In the 1950s, I mean.) Blue shows GDP relative to the currency component of money. In the early years after World War Two there were some very high peaks in GDP growth, real growth. So that pushes the blue line up at the start.

To the left of the Volcker scribble, there is a lot of size difference between the red and blue lines. I did say that already. But despite the size difference, it appears that every time the blue goes up the red goes up. And every time the blue goes down, the red goes down. I know it is recession-related, but it is still impressive.

To the right of the scribble also. One big difference between the lines is from the 2009 recession to the end of the graph, where the blue line  drops way low, and then stays well below zero where the red line sits.

The other big difference in that half of the graph occurs in the early mid-1990s where the red line rises to peak, and the blue lags behind. A pretty good gap opens between them. This difference and this gap occur just as the debt-per-dollar ratio regains upward momentum and we enjoy the good years of the 1990s.

Probably not a coincidence.


The behavior of the blue line is more the result of GDP than currency, as I recently pointed out. And the inverse relation between the red and blue lines on Sumner's graph is due more to GDP than to currency. I'm definitely not saying Sumner is right. But the graph is interesting.

* NOTE: The word "size" needs a footnote. These graphs have two vertical axes, one for the red line and one for the blue. This is done so that the graphing program will re-size and re-position the lines, to make comparison easier. It is still valid to say, for example, that the lines are roughly equal in size, or that there is a size difference. But the word "size" does need a footnote.


Oilfield Trash said...


Like the graphs to me they show that Macro recession pressures causes short term interest rates to go down, and or increases the demand for currency.

Nothing special about that.

As you say it is all about GDP, all the ink spilled by Sumner for much to do about nothing.

The Arthurian said...

Thanks Trash.

Hey I found an old graph of MZM velocity and the interest rate --

There is definitely some relation between velocity and interest rates.

My Step 2 graph above shows GDP relative to currency. Sumner shows this and calls it "cash velocity". That is absurd. "Velocity" (or "income velocity") is the average number of times a dollar is spent. Sumner is looking at only part of the money that is spent.

For spending, they only count GDP. That's ridiculous too, but that's another story. Pretend GDP = total spending.

No matter what velocity you are looking at, the spending number doesn't change. It is always GDP. Only the "money" number changes. The graph I linked in this comment uses MZM money. I don't think MZM is a measure of spending-money. M1 is a measure of spending-money. I think if you want to measure velocity you should look at the spending we do, divided by the money we spend. So: GDP/M1. And then there is a lot of money, other than M1, that is *not* in the spending stream and doesn't get spent. That money is very important. But it doesn't get spent, so the velocity of that money is zero. It is incorrect to use MZM or M2 in a velocity calculation -- incorrect and meaningless.

By the way, if somebody takes money out of savings and spends it, that money becomes part of M1. So it remains true that we should use M1 for velocity calculations.

We should definitely look at the quantity of money that doesn't get spent, but we should look at it in a way that economists fail to: We should look at the money that doesn't get spent, relative to the money that does get spent. Beside the point here.

Sumner takes only part of spending-money, just the part of it that is currency. He looks at GDP relative to currency and calls it "cash velocity". This is absurd. The money seems to move much faster when you only consider part of it (because the spending is still the same).

Economists often look at M2 velocity. The quantity of M2 is bigger than M1. (M1 is the quantity of spending-money.) So M2 velocity is less than M1 velocity. Sumner is doing the opposite, looking at currency velocity. The quantity of currency is smaller than the quantity of spending-money. So currency velocity is greater than M1 velocity. It's all meaningless bullshit.

// sorry about the rant!

Velocity is irrelevant to Sumner's post and irrelevant to my complaint about the graph in his post. I want Sumner to use a currency ratio that suits his purpose. Sumner's choice (currency relative to GDP) does not suit his purpose. In his post he says

Interest rates are the opportunity cost of holding cash.

But say that more clearly, and it comes out like this:

Interest rates are the opportunity cost of holding money as cash.

Therefore, when he shows it on a graph, he should show cash or currency relative to all the money we hold -- probably M2 or MZM. This would show our preference for holding money as cash.

Our preference for holding money as cash appears to have no consistent relation to the interest rate.

Sumner shows currency relative to NGDP. Immediately, inflation has an impact on his results. Inflation, and god knows what else. His graph his garbage.

But his graph gives him a result he can use to support his argument.