Liquidity Can’t Always Trump Geopolitical Risks

By Vincent J. Truglia

It’s obvious to all that the world is awash in liquidity. The central banks of the major industrial nations have been on a printing press binge for years, with some more effective than others. Frankly, until recently that hasn’t posed an inflation risk because although money is available in seemingly endless abundance, the willingness to spend that money has been subdued to say the least.

Money Makes The World Go Round, But At What Speed?

What am I talking about? There are some really simple concepts regarding the relationship between the amount of money in circulation and prices. In a world of fiat currencies, or in another words, in a world where central banks print as much money as they want, with no anchor restricting such printing, other monetary behaviors become more important.

I hate to be technical, but there is a relatively simple relationship between money and prices. Remembering back to your Economics 101 course, most of us are familiar with the relationship between supply of money, prices and output. However, there is a fourth variable, which we ignore at our peril, and which is much harder to control, never mind quantify in advance. That variable is the velocity of money, or in other words, how fast does the money supply circulate?

Velocity Growth Has Been Moribund At Best

One of the biggest problems we have suffered since the beginning of the Financial Crisis has been that changes in the velocity growth have been moribund at best, and in many countries, and sometimes for extended periods of time, velocity has sometimes fallen.

We can debate why velocity has remained so weak, but it has made all the difference in the world between the massive creation of more money by the Fed and other central banks, and the little, if any inflation we have witnessed.

Velocity Is Usually Stable

Velocity is normally easy to predict because it is usually stable. It is generally based on on-going public behavior and attitudes towards the future, which don’t often change dramatically over a short period of time. However, if something dramatic does occur, such as the Great Recession, public attitudes and behaviors can shift suddenly, causing velocity to suddenly shift gears.


It doesn’t take a Wall Street economist to point out that the world’s geopolitical situation is less stable today than it has been for decades. The two most worrisome hotspots remain the Ukraine crisis and the growing maelstrom across much of the Middle East.

The Ukraine

As I have been writing for some time now, both crises are not likely to go away anytime soon. However, we may be nearing an inflection point in both.

In the case of the Ukraine crisis, the growing use/threat of sanctions may have untold consequences as we approach cold weather in Central and Eastern Europe. With the possible exception of Germany and its special gas pipeline going directly from Russia to Germany, other central and southern European countries are subject to major disruptions of natural gas supplies coming from Russia. Individual Western energy companies and petrochemical producers may also be negatively affected.

Mideast Maelstrom

A different, but equally vexing problem is the growing unrest across the Mideast. Once again, I am simply repeating what I have argued for a while now, except that today the Mideast may be on the cusp of a major conflagration. The problems in Gaza, problems in Iraq and Syria, with Sunni extremists facing Shiite-led governments, plus rising unrest in Libya, along with problems the West is having with Russia regarding the Ukraine, is setting the stage where the Western powers are acquiescing in allowing more time for Iran to advance its nuclear program. A nuclear-armed Iran is probably the most dangerous risk in the world today.

Iran recognizes, as does Russia, that they are in the driver’s seat regarding foreign policy.

Geopolitics and Velocity

Why is growing geopolitical risk relevant to my earlier discussion about central banks? The reason is that if geopolitics appears to be getting out of control, there can be a sudden shift in the velocity of money. Investors may decide that they want to own more real goods, which will hold value if inflation suddenly spikes, which would occur if velocity suddenly rises. This would be difficult to predict in advance, but you would know once it has begun. If the change in the speed of velocity differs much among the world’s leading nations, then inflationary expectations and exchange rates will become more volatile. Since velocity is behavioral in nature, geopolitically induced shifts in velocity are not likely to be linear. That has unpredictable implications and therefore risks for individual asset class prices around the world.

As always, Clear and Candid.