Blog #5 – Money Velocity

By: L. Carlos Lara

Becoming Your Own Banker, by author R. Nelson Nash is an extraordinary book. And yet, it’s not actually a book as much as it is a book-let. A mere one hundred and seven pages in its entirety, it dispenses wisdom and logic of a kind that only an individual who has been educated in the Austrian School tradition could have written. Neither the brevity of its treatment nor its plain language takes away from the fact that it contains information of great intellectual and financial depth. What has become apparent since its initial writing is that the power of its message motivates its readers to read it not just once, but over and over again. With each reading, new insights are ascertained. Readers are moved to share its wisdom. Over 200,000 copies have sold, advertised predominantly by word of mouth. With the advent of the Internet there is no way to estimate the range or speed with which the information contained in this book will eventually spread. What is certain is that wherever it goes it brings good news.In this article, I want to take up the subject of one such nugget of wisdom contained in this book. If I am successful in explaining it correctly it may be helpful in unlocking the mysteries of the Infinite Banking Concept for you. In my opinion, I believe it is the key to its understanding. In fact, Nelson himself says that if you understand this one piece, the rest of learning how to be your own banker is “a piece of cake.”

The priceless information I am alluding to is found on pages 17 and 18 under the chapter heading, The Grocery Store. We are all familiar with what it says, but it may be fruitful to read it once more either before, or after, you examine this explanation.

Nelson begins this chapter by helping us to imagine ourselves in a business where we are both a consumer and a seller and points us to the grocery business. Here is an enterprise that most of us are familiar with and believe we understand perfectly. I suspect that if you are anything like me, you were all ready to skim over this material quickly and get to the bottom line. Fortunately, Nelson very early on in this explanation admonishes us to bear with him as he walks us through the fundamentals of this business. He underscores that “there is a significant reason for this exercise.”

As Nelson continues his explanation you will next notice that he begins emphasizing the set-up cost of such a business. Obviously, it will require a considerable amount of capital that is to be invested at great risk because the competition in the grocery business is enormous. He moves from there to the objective of the business, which is to provide us income and to build it so that it is eventually sold and can provide us retirement income. So far so good and everything explained up to this point makes perfect sense. But then here comes the moving parts that if we do not understand them here may keep us going in circles forever. Fortunately, Nelson sends us back to these two pages if we discover that we are failing to get the message. One such recommendation is found on page 22 and another is made on page 63. He is very clear about this and it is indicative of the fact that the concept explained here could be difficult to grasp.

“If you have trouble understanding this, go back to the grocery store on page 17. If you still don’t understand, then call me!”

What is it about the components mentioned in these two pages that make them one of the most central, if not the central components, of the entire book? To answer this question we really do have to have some basic knowledge of how the retail business works. After all, he is talking about a grocery store. Here again, this is a subject most people think they fully understand since all of us are food consumers and purchase this product everyday of our lives. But there is much more to retail than meets the eye and it centers squarely on “inventory control.” Please believe me when I say this because I make my living as a consultant to businesses in financial crisis and I happen to have cut my teeth in the retail industry. Here, at least, I do know what I am talking about. What I can tell you for certain is that in the retail industry, the inventory is the lifeblood of the business. Without a continuous flow of fresh inventory retail businesses will die. This is why retailers focus so much of their attention on this flow and refer to it as “inventory turnover.” Noticeably, so does Nelson. The idea is simply this: The higher the inventory turnover the more profitable is your retail business. What we see here, in the opening pages of his book, is Nelson’s methodical approach to drawing a correlation between the turnover of cans of peas and the dynamics and fluidity of money inside of an insurance policy. We begin to see what actually happens when a policy owner takes out a loan, pays it back and repeats these procedures over and over again. This turnover rate as it applies to the interest of policy loans is more specifically depicted in the chapter, Equipment Financing on page 59 of his book. It is this concept; or rather the importance of the rate of turnover that we must fully comprehend.

At our Night of Clarity event just this past week Nelson walked us through a picture diagram of the grocery store complete with a cashier at the front door, an inventory storeroom near the back door and shopping bins and aisles in the center. He then goes on to explain margin. Using a can of peas as an illustration he showed that the difference between the can’s full retail price of 60 cents and its replacement cost of 57 cents represents an incredibly low dollar margin of only 3 cents. He then announces, that in the pea selling business “You must turn the inventory 15 times just to break even!”. Here is what he means:

Tot. Retail Sales: 60¢ x 15 turns = $9.00

Tot. Cost of Goods: 57¢ x 15 turns = $8.55

Gross Profit: 45¢

Minus expenses: 45¢

Break-even: $0.00

Please notice that Nelson does not quantify the expenses in his written illustration. The reader must assume that the entirety of the categories listed in the book, such as the “interest you must pay on the huge sums of money you have borrowed to buy the land, the building, the signs, advertising, payroll and fringe benefits, utilities, legal fees, accounting, etc.,” all amount to the 45 cents in the above calculation. You must also assume that these expenses remain constant as the turns in inventory increase thereby moving your business toward profitability.

Now we begin to see why Nelson’s rule, “Don’t steal the peas!” makes absolute sense, especially when you have to sell 20 cans of peas to make up for the stolen one. This of course parallels his insistence that all policy loans must be repaid. Not to do so is equivalent to stealing from yourself. Furthermore, when he argues that the family should actually be paying extra, that is paying 62 cents on each can of peas instead of 60, the margin for profitability will increase that much more. The extra 2 cents is representative of more capital being poured back into the business. This equates to his admonishment, in the Equipment Financing chapter, to always pay more interest on policy loans than is actually due.

In the seminar, but not in the book, Nelson compares inventory turnover to “money velocity.” Money velocity, however, is more often associated with economics and money supply than as an accounting for inventory management. Is there a connection? Let’s look and see.

Wikipedia offers probably one of the best and more easily understood definitions of money velocity, with a simple illustration for purposes of clarification:

“The velocity of money (also called the velocity of circulation) is the average frequency with which a unit of money is spent in a specific period of time. Velocity associates the amount of economic activity associated with a given money supply. If, for example, in a very small economy, a farmer and a mechanic, with just $50 between them, buy goods and services from each other in just three transactions over the course of a year

  • Farmer spends $50 on tractor repair from mechanic
  • Mechanic buys $40 of corn from farmer
  • Mechanic spends $10 on barn cats from farmer

Then $100 changed hands in the course of a year, even though there is only $50 in this little economy. That $100 level is possible because each dollar was spent an average of twice a year which is to say that velocity was 2/yr”.

In this example of a small economy, what we see is that with each additional transaction — from 3 to 4 to 5 and so on, the total amount of revenues or gross income in the economy will certainly increase, but the initial money supply will remain the same. There is no need to increase the money supply because money, remember, is used for exchange purposes only. Today’s money is not consumable as in the days when gold was commodity money and was used for both jewelry and money. More money in the economy only reduces its value. On the other hand, more canned peas in the economy is good for all of us. We have more to eat, and because of its abundance, the price of each can of peas will come down. Our money will buy more of them.

But let’s not deviate too far away from the main point Nelson is trying to get across. The bottom line of his message is that the velocity of money and, or the turnover of money, increases wealth of the business owner!

Alternatively, inventory turnover is so similar to the definition of money velocity that Nelson calls it the same thing. Specifically, however, inventory turnover is more often associated with consumable products as in the types of products found in grocery stores. Although it is true that a bank’s inventory is money, fiat money is not consumable, and unfortunately for us, banks do increase the quantity of money through loans. This is why borrowing from your policy, rather than a bank, actually works at strengthening the dollar. The quantity of money is not increased.

In the retail business, a high inventory turnover, or high velocity, indicates efficient management of inventory. The more frequently the inventory turns, the less amount of money is required to finance the inventory. Once again, this is the bottom line of Nelson’s message. Retailers learn to re-stock fast selling products while cutting back on slow turning items. The goal is to achieve a high rate of turnover for the entire inventory of product lines. Profitability is achieved when, in addition to high inventory turnover, high margins are also maintained and operating expenses are kept low.

In essence the crux of pages 17 and 18 represent the groundwork to prepare the reader for the more difficult applications that are to be used beginning on page 59 in the chapter titled Equipment Financing. The principles learned in the example of the grocery store now make sense in the more advanced chapters. The importance of paying off your loan, and the concept of paying in more interest than is actually required on your policy loans, all fits together nicely. One is able to see that the extra interest and its turnover rate will over time produce more wealth as it accumulates within the infrastructure of the policy that is consistently compounding. The power of compounding is extremely important especially when it is consistent, safe from tax and inflation as I wrote about last month’s LMR in the article titled The Perfect Investment. Only dividend paying whole-life is able to perform in this manner. When you factor in the tax benefits and the expense right-offs when implemented alongside a corporate entity, the results do seem magical. But actually, it is nothing more than astute money management utilizing a financial product that practically does it all— so long as you combine it with Nelson’s advice and insight. As he recently stated to me:

“Think like a Forester—long range

Don’t be afraid to capitalize

Don’t steal the peas

Maybe I should add another—

DON’T DO BUSINESS WITH BANKS”.

The above article written by L. Carlos Lara was published in the July 2011 issue of the Lara-Murphy Report and is reproduced here under permission.

If you would like to learn how you can grow a substantial amount of cash that you have access to at any time without penalties, is unrelated to the stock market, and will generate income that is not included in your tax return, visit our website at / or feel free to email us your questions at ContactUs@InfiniteBankingSimplified.com or call us toll-free at 1-844-443-8422.

Isis B. Palicio, LUTCF, MBA
Pedro A. Palicio, MBA, Ph.D.
Infinite Banking Concepts® Authorized Practitioners

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