This is how money really works. I’m going to answer the question in this article, “What is the velocity of money?” What does that mean? You better put your seat belt on because I’m going to blow you away. When I do this in front of audiences, I get this deer-in-the-headlight look because they never thought about this or been taught about this. So, get ready.
I’m going to share with you just some snippets on how money really works and hopefully you’ll understand what is meant by the term velocity of money. So, I’m going to start out with a little scenario here. Okay? Here we go.
A traveling salesman is riding through a rural area and his car has a tire that goes flat just outside of a small town. Got it? He then discovers that his son borrowed the jack and the lug wrench and didn’t return it. He’s in trouble. A passerby gives him a lift into town, so that he can borrow a jack and a wrench to change the tire.
Now, the town’s cash and crews repair shop is willing to loan him the tools with $100 cash deposit. Until he returns with the borrowed tools. Got it? He gives the only 100-dollar bill that he has tucked in his wallet for such emergencies. And thanks the shop owner for trusting him and says that he’ll be back in about an hour to return the tools and retrieve his $100.
So far, so good. Now, in the mean time, the shop owner takes the 100-dollar bill to the part store next door and pays for the parts he put on hold which he needs to fix a car that a customer is coming in to pick up in one hour.
Hmm, so he used that 100-dollar bill for that. Now, the parts store owner takes the $100 across the street to the grocery store and buys the meat for the company barbecue that evening. What does the grocery store do with that 100 bucks?
They immediately pay $100 to the butcher for the meat he cut for the store that day. I wonder what the butcher is going to do with the hundred bucks. The butcher promptly goes to the beef ranch owner’s place a block away and pays for the beef that he bought on credit that morning.
The beef rancher heads off immediately to the co-op across the street to pay for the feed he needed for his cattle. The co-op takes the $100 and runs out to pay its debt to the local truck driver. The truck driver hurries over to his dentist on the corner to pay for the emergency drill and fill that he had done the day before.
The dentist then hurries and gives the $100 to the local pharmacy next door for the supplies he purchased on credit. The pharmacy owner then takes the $100 over to the local cash and crews. Oh, we’ve come full circle here.
Repair shop to pay the balance of the repair they were just finishing with the parts they just purchased. It’s the $100 that the repair shop went over to pay for at the automobile shop, okay? Just as the Traveling Salesman arrives back at the shop to return the borrowed tools and retrieve his 100-dollar bill.
You got it? Here’s what’s funny: The salesman noticed the town was really booming. A mid a rather sluggish national economy and wondered “What was the town’s secret? What’s their secret here? They seem to be booming?”
As he drove out of town, he thought to himself, “Wow, I retained my 100-dollar bill. It’s safely tucked back in my wallet.” As he drives out of town, he sighs and begins to wonder. When his own customers are going to order more supplies, so he can pay the people he owes money to. He didn’t even understand what took place in one hour with his $100.
Do you know how many times that $100 was used? Over 10 times. That’s the velocity of money. So, what does all this mean? So, as you think about that little story, there was only 1 one 100-dollar bill. But it ended up representing over $1,000 of transactions. That is called the velocity of money. The amount of money that is created and traded in the United States is way more, 17 times more than the amount of money in print. Sometimes even greater than that.
In a recession, money may turn only 17 times, sometimes only 12 times. Sometimes it will turn over 30 times. So, this is how money works. Banks, if they want to bring in million dollars of deposits, we collectively go deposit money there.
We lend them our money and they’re willing to pay us let’s say 1% because that was the average for about 15 years here. And so, they pay $10,000 an interest a year to borrow our money. O-P-M, other people’s money. Now, they turn around and loan it back or put it into institutions ranked 6 notches higher in safety than they are.
The multi-trillion dollar legal reserve insurance industries where they put 30 to 40 percent of their tier 1 assets for liquidity and safety. And they earn 5% just on the general account portfolio. They don’t even use my favorite strategy indexing.
How much more is 5 than 1? I hope you don’t think 4. It’s 500%. Would you hire an employee for 10,000 that made you 50? Would you buy a widget machine for 10 grand that made you 50? That’s a 500% return unemployment cost or equipment cost. So, when I talk about how money really works, banks do this. But you can borrow at 3%, okay? And if banks borrow at one and invested 3, they’re making 300%.
Well, I’ve been borrowing money at 3%. If I borrowed money at 6%, I’m paying 60,000. Let’s say on a home mortgage. But if it’s tax-deductible, it doesn’t cost me. That it only cost me 4% because I get 20,000 back in actual tax savings.
So, borrowing 6% at a tax-deductible interest rate is only really paying 4% or 40. In my universal life insurance contracts, I’ve earned an average of 8.2% for over 47 years. Let’s round it down to 8. How much more is 8 and 4? That’s 100%. You can be making 100%. This is how you become your own banker. So, lately, I’ve been able to borrow money at 4.5%. That’s a net cost of 3. I’ve borrowed money sometimes at 3% and that cost of 2. I turn it around and make 9.
How much more is 9 than 3. I can make 300% just like the banks do. I can make 500% sometimes just like the banks do. You can’t believe how many people don’t get this. So, let’s connect all the dots here. I’ve been showing you that banks borrow our money at 1 or 2 percent. And if they borrow it at one and they turn around and put it into institutions rank higher and safety than they are, insurance companies and they earn 5.
That’s a 500% increase. They pay 10,000, they make 500,000. But is it really that? Based on that story I told you, sometimes people say, “Well, why in the world would a bank or a credit union loan you or me money for a house at 5 or 6 percent interest when they can put it into an insurance company which is far bigger and safer and earn the same 5%” Why would they do that?
Here’s the secret: Because if I borrow let’s say a million dollars to go build a house, what am I going to do with that money? I’m going to pay a general contractor. What’s the general contractor going to do with the money? Pay subcontractors and suppliers. What are all of them going to do with the million when I pay them? They’re going to loan it back to the bank.
They’re going to put it in the banks at 1%. So, the bank’s get the money back. The same money back at 1% and they loan it out at 5. They get it back at 1, loan and out at 5. How many times a year? The average bank 17 times a year. During the recession, maybe only 12 times a year, shucky darns.
That’s the velocity of money. The banks are loaning out money and getting it back at 1 loaning it out at 5. They’re making 500%, 17 times a year on the same money. Just like the story of the Traveling Salesman. Folks, that’s the velocity of money. And that’s what makes America tick.