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Countries are in lockdown, companies have no customers and thus no income.

They have to lay off staff which in turn means ex-staff have no income. Everyone simultaneously and quickly depletes any savings so they can no longer buy goods and services.

Where is the money that was circulating in the economy before lockdown?

Frank
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Orchid
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    "companies have no customers and thus no money" (i.e income) is hardly the same thing as "money that was circulating in the economy before lockdown". The fact that you used the word "circulating", clearly suggest that money might err... still be there but not be circulating, i.e. less money velocity, which is actually said (correctly) in an answer below that unfortunately makes some other statements which prevent me from upvoting it. – the gods from engineering Apr 01 '20 at 21:25

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A very insightful question. The thing I'll add here is the famous identity, MV=PQ. Essentially you're asking why Q dropped (real goods & services), while M (money supply) likely is the same. There are (at least) two answers:

  1. V (Velocity) could have dropped - which has the same effect as shrinking M. $100 making 10 round trips is very different from $100 making only 1 round trip.

  2. More nuancedly (sp?) - You could be seeing a collapse in the "composition" of the Money Supply. I.e. Maybe M2 collapsed back into M1, etc. If lots of people called in their loans (M2+) & converted to cash (M0), the same amount of money might be there...but it would have been "sucked" from the system, in a sense.

David
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  • "If everybody called in their loans (M2+) & converted to cash (M0)". There's nowhere near enough "cash" for that. Google "money multiplier". – the gods from engineering Apr 01 '20 at 21:21
  • Of course...I simply meant that statement to help develop the intuition. I was hypothesizing that if everyone is rushing to liquidity, that could give the "appearance" of a contraction in the money supply. Hence. my comment on "collapsing" down into different Monetary "Classes." – David Apr 01 '20 at 22:06
  • I changed 'everybody' => 'lots of people' -- we good? – David Apr 01 '20 at 22:07
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This is called a "Liquidity Crunch".

There are firms, households, and institutional investors. Households have mortgages, firms have to service their debts and pay suppliers, and institutional investors have to make money on the capital they hold.

We hit this crisis. Suddenly, institutional investors need to get cash out of the market so that they can buy back in at the bottom: if they hold the assets they have right now, which are losing value, they will look awful to shareholders. This sucks the cash out of the market. Now firms are worried: they know demand is going to plummet and total revenue is going to drop, and they need to service their debts or they will go bankrupt, so they need to hoard cash in order to avoid going bankrupt in the near future. So they start firing employees to save on payroll. Suddenly households are terrified of the future: are they going to get laid off? What if they get sick and need care? They start hoarding cash.

Everyone wants cash because it is the only asset that won't lose value in the very short run (a stimulus package will cause inflation and reduce the value of cash, but at least its not a stock). Even bonds and commodities were both simultaneously losing value a week or two ago, because people were afraid they wouldn't be able to get out of those assets if they were unlucky and their investments really tanked; this would never happen under standard theories of investment.

So in the end, there is a flight to cash, essentially a "bank run" on the entire economy, because everyone is worried, essentially, that they won't be able to pay their bills.

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I think this simple question needs a simple answer.

So imagine your entire economy is 10 people sitting in a circle. Each guy always buys things (goods/work/services) from the guy sitting on their right.

For example, guy #1 buys farm produce from guy #2, guy #2 buys water from guy #3 etc.

As a circle they are a completely self sufficient economy. You can imagine it any way you like so that that is true.

Guy#1 has 1 Euro. S/he buys from guy #2 with that one Euro. They buy from guy #3 with that one Euro.

There is only one Euro. It goes round in a circle, in the opposite direction to the flow of goods/services.

The economy is such that the flow of 'stuff' they each need requires them to purchase approximately every day.

By the end of the month each has produced 30 Euros worth of stuff and each has earned 30 Euros (while spending 30Euros). The total earnings for the group is 300 Euros. All of them broke even, and all of them are completely satisfied, happy, and praise their social order as a marvel of modern economic theory.

This is what is meant by 'velocity of money'. (The terminology is actually incorrect, and is better described using signal theory, such as frequency and amplitude, but 'velocity' is what is used by most economists).

In that economic model there is only one Euro.

Now imagine along comes a C19 for this society and everyone is told to stay at home.

Suddenly there is no production and no consumption.

Your question 'what happened to the money' sort of does not make sense, now that you understand it all right? You now know there is only one Euro there, but it does not matter.

Of course, the above is a ridiculous oversimplification, but as an explication in response to your question it is at an appropriate level.

Now imagine a much more complex economy, our society, with many, many such loops arranged in a vast tapestry. Essentially you have the same thing, with many emergent dynamic properties, chaotic behaviors, a huge 'game of life', but by suppressing activity you are suppressing that which 'they' call 'velocity'.

Frank
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