Yet another wild one. For the week, the Dow gained 0.8% (down 17.1% y-t-d), and the S&P500 rallied 1.6% (down 14.9%). The Morgan Stanley Cyclicals surged 6.7% (down 25.3%) and the Transports 4.0% (down 28.8%). The Utilities jumped 8.1% (down 13.3%), and the Morgan Stanley Consumer index increased 3.0% (down 12.4%). The S&P400 Mid-Caps rallied 1.7% (down 13.7%), and the Russell 2000 small caps gained 1.8% (down 19.9%). Tech continues to outperform. The Nasdaq100 increased 1.6% (down 2.0%), and the Morgan Stanley High Tech index jumped 3.8% (up 4.2%). The InteractiveWeek Internet Index gained 3.4% (up 6.6%), while the Semiconductors slipped 0.6% (up 3.1%). The Biotechs rose 3.5% (down 3.6%). The Broker/Dealers added 0.6% (down 7.2%), and the Banks rallied 1.8% (down 41.2%). With Bullion surging $23, the HUI Gold index surged 13.6% (up 8%).
One-month Treasury bill rates ended the week at 8 bps, and three-month bills were at 21 bps. Two-year government yields declined 9 bps to 0.84%. Five year T-note yields sank 23 bps to 1.60%. Ten-year yields dropped 24 bps to 2.65%. The long-bond was not as thrilled with the Fed, with yields slipping only 3 bps to 3.71%. The implied yield on 3-month December ’09 Eurodollars fell 19 bps to 1.395%. Benchmark Fannie MBS yields fell 22 bps to 3.94%. The spread between benchmark MBS and 10-year T-notes widened 2 to 129 bps. Agency 10-yr debt spreads widened 2 to 80 bps. The 2-year dollar swap spread declined 6 to 63.75 bps; the 10-year dollar swap spread increased 8.5 to 31.75 bps, and the 30-year swap spread declined 5.5 to negative 28 bps. Corporate bond spreads narrowed further. An index of investment grade bond spreads narrowed 8 to 261 bps, and an index of junk spreads narrowed 16 to 1,252 bps. GE Capital Credit default swap prices fell below 700 bps.
It was a another large week for corporate debt sales. Investment grade issuance included Pfizer $13.5bn, State Street Bank & Trust $2.45 TN, UPS $2.0bn, Smith International $1.0bn, Duke Energy $900 million, Progress Energy $750 million, Southern Cal Edison $750 million, Marsh & McLennan $400 million, John Hopkins $400 million, and Peco Energy $250 million.
Junk issuers included Barrick Gold $750 million.
International debt issues this week included Societe Financement (SFEF) $4.0bn, BHP $3.25bn, Shell $2.5bn, Panama $1.47bn, Swedish Housing Finance $1.1 TN, and Posco $700 million.
U.K. 10-year gilt yields rose 8 bps to 3.03%, while German bund yields dropped 9 bps to 2.97%. The German DAX equities index increased 2.9% (down 15.4%). Japanese 10-year "JGB" yields fell 5 bps to 1.26%. The Nikkei 225 surged 10.4% (down 10.3%). Emerging markets rallied. Brazil’s benchmark dollar bond yields sank 43 bps to 6.56%. Brazil’s Bovespa equities index gained 2.7% (up 6.7% y-t-d). The Mexican Bolsa rallied 2.6% (down 13.5% y-t-d). Mexico’s 10-year $ yields dropped 31 bps to 6.19%. Russia’s RTS equities index jumped 6.8% (up 10.3%). India’s Sensex equities index gained 2.4% (down 7.1%). China’s Shanghai Exchange surged 7.2% (up 25.3%).
Freddie Mac 30-year fixed mortgage rates declined 5 bps to 4.98% (down 89bps y-o-y). Fifteen-year fixed rates dipped 3 bps to 4.61% (down 66bps y-o-y). One-year ARMs jumped 11 bps to 4.91% (down 24bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down a notable 45 bps this week to 6.47% (down 65bps y-o-y).
Federal Reserve Credit inflated $164bn last week to an 8-wk high $2.041 TN. Fed Credit has dropped $205bn y-t-d, although it expanded $1.163 TN over the past 52 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt last week (ended 3/18) dipped $1.2bn to $2.590 TN. "Custody holdings" have been expanding at a 13.9% rate y-t-d, and were up $422bn over the past year, or 19.4%.
Bank Credit added $1.7bn to $9.810 TN (week of 3/11). Bank Credit rose $318bn year-over-year, or 3.3%. Bank Credit increased $418bn over the past 27 weeks. For the week, Securities Credit increased $3.5bn. Loans & Leases slipped $1.8bn to $7.139 TN (52-wk gain of $221bn, or 3.2%). C&I loans increased $1.6bn, with one-year growth of 5.0%. Real Estate loans jumped $16.1bn (up 5.7% y-o-y). Consumer loans added $2.9bn, while Securities loans dropped $24.2bn. Other loans increased $1.8bn.
M2 (narrow) "money" supply surged $39.8bn to a record $8.343 TN (week of 3/9). Narrow "money" has now inflated at an 18% rate over the past 25 weeks and $766bn over the past year, or 10.1%. For the week, Currency increased $2.5bn, and Demand & Checkable Deposits rose $13.3bn. Savings Deposits jumped $23bn, while Small Denominated Deposits slipped $2.2bn. Retail Money Funds increased $3.3bn.
Total Money Market Fund assets (from Invest Co Inst) dropped $42.9bn to an 11-wk low $3.863 TN. The 52-wk expansion was reduced to $396bn, or 11.4% annualized. Money Funds have expanded at a 4.1% rate y-t-d.
Asset-Backed Securities (ABS) issuance jumped to almost $10bn. Year-to-date total US ABS issuance of $16.5bn (tallied by JPMorgan's Christopher Flanagan) is a fraction of the $42.8bn for comparable 2008. There has been no home equity ABS issuance in months.
Total Commercial Paper outstanding declined $7.5bn this past week to $1.477 TN. CP has declined $205bn y-t-d (58% annualized) and $354bn over the past year (19.3%). Asset-backed CP sank $17.4bn last week to $700bn, with a 52-wk drop of $105bn (13%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $190bn y-o-y, or 2.9%, to $6.634 TN. Reserves have declined $313bn over the past 22 weeks.
Global Credit Market Dislocation Watch:
March 18 – Bloomberg (Liz Capo McCormick): “Federal Reserve Chairman Ben S. Bernanke faces additional headwinds while seeking to repair the link between the easing of monetary policy and lower consumer borrowing costs, as foreign investors take money home. …According to international capital flow data reported by the Treasury Department… Foreign investors withdrew $148.9 billion in funds from the U.S. in January, after purchasing $86.2 billion the prior month.”
March 20 – Bloomberg (Scott Lanman and Sarah Mulholland): “The Federal Reserve’s effort to unfreeze markets for securities backed by loans kicked off with requests for $4.7 billion of financing, a total that officials hope will surge to as much as $1 trillion after investors resolve contract terms with dealers and other concerns. Investors could have used the Term Asset-Backed Securities Loan Facility to finance purchases of as much as $8.3 billion of securities. They asked for $1.9 billion in loans to buy securities backed by auto loans and $2.8 billion for debt linked to credit-card loans…”
March 20 – Bloomberg (Bill Koenig): “Wells Fargo & Co. said it extended $51 billion in loans and loan commitments to customers in January. The company said it has extended $144 billion in loans in the past four months.”
March 16 – Bloomberg (Gabrielle Coppola): “Non-financial investment-grade companies seeking to replace $300 billion of debt maturing over the next three years face higher refinancing risk because of weakening economic conditions and tightened credit markets, according to Moody’s… About $99 billion of the debt is maturing in 2009, $83 billion in 2010 and $117 billion in 2011…”
March 17 – Bloomberg (Mayumi Otsuma): “The Bank of Japan said it may provide as much as 1 trillion yen ($10 billion) of subordinated loans to banks to replenish capital depleted by falling stock prices and revive lending. The central bank will provide details of the ‘extremely extraordinary’ measure, the length of the loans and the interest rate it will charge ‘as soon as possible,’ Governor Masaaki Shirakawa told reporters…”
March 18 – Bloomberg (Caroline Binham): “Financial Services Authority Chairman Adair Turner has promised to start a ‘revolution’ in financial regulation with new rules for banks and hedge funds to address the worst economic crisis in 80 years. The U.K. regulator said last month that a report to be issued today will discuss liquidity and capital rules, compensation, accounting, and how the FSA and the Bank of England can monitor risks to the financial system. ‘This will be a very polite revolution,’ said Simon Gleeson, a regulatory lawyer at… Clifford Chance LLP. ‘It’ll be a very British revolution, where not much is going to happen and everyone will be nice to each other.’”
March 18 – Bloomberg (Paul Abelsky): “Russia’s government will increase spending this year to tackle the country’s first recession in a decade even as plunging commodity prices threaten to pare revenue by 28%. The federal deficit should total 2.98 trillion rubles ($86.5 billion), or 7.4% of gross domestic product, the Finance Ministry said…”
March 18 – Bloomberg (Bob Ivry and Jody Shenn): “General Electric Co.’s future may depend on folks like Yelena Zoshchenko. GE Capital, the financial services unit of the world’s biggest maker of jet engines and power turbines, gave the Moscow real estate agent a car loan at a 15% interest rate in June 2007. Then the Russian currency collapsed. ‘The banks here used to literally grab you by your lapels and ask you to borrow,’ said Zoshchenko… ‘But not since the crisis started.’”
March 18 – AFP: “Another long, hot summer is looming for Pakistan’s 160 million people, who are bracing for an inferno as the government yet again fails to meet basic electricity demand. ‘This summer is going to be a nightmare and even more horrible than the one we suffered last year,’ said Mohammad Atif, an official in the already steamy port city of Karachi.”
Currency Watch:
March 18 – Wall Street Journal: “Chinese Premier Wen Jiabao created a useful stir late last week when he said he’s a ‘little bit worried’about the safety of U.S. assets -- meaning the Treasury bonds his government owns. Whatever Mr. Wen’s political motives, his concerns about the integrity of U.S. sovereign debt are timely and apt. U.S. debt held by the public has now hit $6.6 trillion -- up from $5.3 trillion only a year ago. That doesn’t count another $5.3 trillion in Fannie Mae and Freddie Mac liabilities… And it doesn’t count the many ways that both the Federal Reserve and Treasury have guaranteed financial assets more broadly -- such as $29 billion in Bear Stearns paper, $301 billion in dodgy Citigroup assets, and hundreds of billions in Federal Housing Administration loans.”
March 18 – Bloomberg (Judy Chen): “China’s foreign-exchange reserves fell by about $30 billion in January, the China Business News reported… The reserves totaled $1.95 trillion at the end of last year…”
March 20 – Bloomberg (Kim-Mai Cutler): “Currencies of countries that are using quantitative easing, or printing money to buy government or corporate bonds, are plunging against those of nations sticking to conventional monetary policy… ‘The foreign-exchange market has clearly gotten its arms around the notion that quantitative easing is a negative for currencies,’ said Jim McCormick, Citigroup Inc.’s… global head of currencies. ‘It’s clearly a moment of selling the quantitative easing currencies -- the franc, sterling and the dollar -- against all others.’”
March 17 – Financial Times (Bertrand Benoit): “Mounting public debt and excessive liquidity in the economy could tip the US into an inflationary spiral, a senior economic adviser to Angela Merkel, German chancellor, has warned. The comments by Christoph Schmidt, one of the five ‘wise men’ who advise the German government on economic policy, cast fresh light on the transatlantic rift over how to tackle the global economic crisis… ‘I see an inflationary risk in the US in the medium term because of the development of money supply there… There is a danger that [governments] could start considering inflation as a way to reduce the burden of public debt.’ The… economist did not see such a risk in Europe.”
The dollar index sank 4.1% this week to 83.8 (up 3.1% y-t-d). For the week on the upside, the Norwegian krone increased 6.8%, the New Zealand dollar 6.3%, the Swedish krona 5.8%, the Swiss franc 5.1%, the Danish krone 5.1%, the Euro 5.0%, the South Korean won 5.0%, the Australian dollar 4.3%, the British pound 3.1%, the Canadian dollar 2.7%, and the Japanese yen 2.2%. On the downside, the Iceland krona declined 0.6%.
Commodities Watch:
March 19 – Bloomberg (Claudia Carpenter and Glenys Sim): “Gold jumped the most since September and oil exceeded $50 a barrel for the first time in two months on speculation the Federal Reserve’s steps to spur growth will revive demand for commodities as a hedge against inflation.”
Gold jumped 2.5% this week to $953 (up 8% y-t-d), and silver surged 4.3% to $13.78 (up 22% y-t-d). April Crude surged $5.03 to $52.06 (up 17% y-t-d). April Gasoline gained 7.7% (up 37% y-t-d), and April Natural Gas rose 7.9% (down 25% y-t-d). May Copper surged 8.4% (up 28% y-t-d). May Wheat rose 6.2% (down 10% y-t-d), and May Corn increased 2.1% (down 3% y-t-d). The CRB index rallied 7.1% (down 1.5% y-t-d). The Goldman Sachs Commodities Index (GSCI) surged 8.6% (up 6.6% y-t-d).
China Reflation Watch:
March 16 – Bloomberg (Michael Patterson): “China, the world’s third-largest economy, is in the early stages of a ‘credit-fueled investment bubble’ that may boost banks’ profits and shares, according to JPMorgan Chase & Co. analyst Sunil Garg…. Banks extended 1.07 trillion yuan ($156 billion) of local- currency loans in February after a record 1.62 trillion yuan the previous month… Garg estimates credit in China may expand twice as fast as the economy this year as banks finance the government’s 4 trillion yuan stimulus package with new loans.”
March 20 – Bloomberg (Tom Kohn): “China’s banks may increase lending by as much 8 trillion yuan ($1.2 trillion) this year on demand from government-backed investment projects, according to JPMorgan… ‘The extent of credit easing at China’s banks since November last year has been remarkable,’ JPMorgan analysts led by Frank Gong said… ‘China’s loan growth has been surprisingly strong in recent months, and new loan creation is likely to stay elevated in the coming months.’”
March 20 – Bloomberg (Li Yanping): “The Organization for Economic Cooperation and Development may cut its forecast for China’s economic growth this year to as little as 6% because of the deepening global slump, Secretary-General Angel Gurria said. In November, the estimate was 8%.”
Japan Watch:
March 18 – Bloomberg (Toru Fujioka): “When Yumiko Iwate’s pay was cut last year, she and her female colleagues all agreed there was only one thing to do: find a husband. ‘I want to get married soon, hopefully by the end of this year,’ said Iwate, a 36-year-old employee at a mail-order retailer in Tokyo. ‘The recession made me realize I’m not going to make as much money as I expected, and I’d be more stable financially if I had double income to fall back on.’ …Marriages surged to a five-year high of 731,000 in 2008 as wages stagnated and the unemployment rate rose for the first time in six years."
India Watch:
March 17 – Financial Times (James Lamont ): “India faces as much as a $190bn shortfall in financing key infrastructure projects as the global financial crisis starves them of urgently-needed capital, according to… McKinsey… Infrastructure development is one of the most important challenges facing India as it strives to sustain high levels of economic growth. The Indian government has identified the need for $500bn in infrastructure spending between 2007 and 2012. But a liquidity squeeze in the local banking system and the draining away of foreign investment has brought reaching anywhere near this goal into doubt."
March 18 – Bloomberg (Kartik Goyal): “India may fail to achieve the government’s 7.1% economic growth forecast if crop harvests don’t meet expectations, according to the finance ministry’s top economist.”
Asia Reflation Watch:
March 19 – Bloomberg (Seyoon Kim and Kevin Cho): “South Korea is planning an extra spending package of as much as 29 trillion won ($21 billion) to support an economy headed for its first recession since the Asian financial crisis a decade ago.”
Latin America Watch:
March 18 – Bloomberg (Thomas Black and Crayton Harrison): “Mexico will apply tariffs of 10% to 45% on at least 90 products from the U.S. in retaliation for the U.S. scrapping a test program allowing Mexican trucks to deliver goods beyond a U.S. border zone.”
March 19 – Bloomberg (Matthew Walter and Daniel Cancel): “Venezuela is holding up payments to contractors, oil services companies and targets of President Hugo Chavez’s nationalization drive, indicating the country is running short of cash after petroleum prices collapsed. Service providers to the state oil company are idling rigs for nonpayment, and Brazil’s Odebrecht SA said last week it’s slowing work on the Caracas metro because the government is past due on its bills. Chavez also owes $10.2 billion for companies he’s taken over, according to…consulting company Ecoanalitica.”
Central Banker Watch:
March 19 – Washington Post (Neil Irwin): “The Federal Reserve yesterday escalated its massive campaign to stabilize the economy, saying it would flood the financial system with an additional $1.2 trillion… Combined with the billions already deployed by the Fed, the new money dwarfs even the biggest government bailouts of financial companies… The new purchases come with risks. They will balloon the value of the assets the Fed holds by about 50%, to more than $3 trillion… The newest intervention includes a plan for the Fed to buy up to $300 billion of long-term U.S. Treasury bonds over the next six months… The Fed said it will increase its purchases of mortgage-backed securities by $750 billion, on top of $500 billion previously announced, and double, to $200 billion, its purchases of debt in housing-finance firms such as Fannie Mae and Freddie Mac. At the current pace of home-purchase and refinancing activity, the central bank could end up funding 60 to 70% of mortgages issued this year, Wachovia economists estimated… The steps are the latest in the Fed’s attempt to stimulate the economy through unconventional means, many of which include massive expansions of the central bank’s balance sheet. At the beginning of September, before the financial crisis deepened, the Fed had $894 billion in assets. That figure had risen to $1.9 trillion last week, and will rise above $3 trillion…”
Fiscal Watch:
March 20 – Bloomberg (John Hughes): “General Motors Corp. and Chrysler LLC, which have requested as much as $21.6 billion in additional government aid, may need ‘considerably’ more than that, said Steven Rattner, the Treasury’s chief auto adviser. ‘It could be considerably higher, I won’t deny that,’ Rattner said, when asked whether U.S. aid sought could rise.”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
March 18 – Bloomberg (Michael McDonald): “South County Hospital Chief Financial Officer Thomas Breen thought he’d seen the worst of the credit market’s seizure when the interest rate on $52 million of its debt doubled to 12% a year ago. That was just the start. The… hospital has also been forced to give Merrill Lynch & Co. $12.7 million of collateral for an interest-rate swap that backfired. South County could have used those funds to counter a drop in state aid for treating uninsured patients, compensate for declining admissions or buy four years’ of orthopedic supplies. Instead, the facility is firing workers and cutting pay.”
Unbalanced Global Economy Watch:
March 17 – Bloomberg (Greg Quinn): “Canada's household net worth fell the most since at least 1990 in the fourth quarter… The value of families’ assets, such as houses and savings accounts, minus their liabilities fell 4.4% between October and December, Statistics Canada said… This represented a loss of C$252 billion ($199 billion) in Canadians’ net worth.”
March 17 – Bloomberg (Svenja O’Donnell and Brian Swint): “U.K. unemployment rose at the fastest pace since at least 1971 in February… The jobless figure rose 138,400 to 1.39 million…”
March 19 – Bloomberg (Gonzalo Vina): “Britain had a 9 billion-pound ($12.8 billion) budget deficit in February, the largest for the month since at least 1993… The deficit in the first 11 months of the fiscal year reached a record 75.2 billion pounds from 23 billions pounds.”
March 16 – Bloomberg (Svenja O’Donnell): “U.K. households have lost 1.9 trillion pounds ($2.7 trillion) of their wealth since July 2007 because of the financial crisis, PricewaterhouseCoopers LLP said… The value of Britons’ housing and stocks has fallen by 28%, a total loss of around 130% of gross domestic product… This is equivalent to an average 40,000-pound loss per person.”
March 20 – Bloomberg (Jurjen van de Pol): “European industrial production dropped by the most on record in January… Production in the euro region fell 17.3% from the year-earlier month, the biggest decline since the data series began in 1986…”
March 17 – Bloomberg (Zoltan Simon): “Hungarian industrial production slumped in January as western Europe’s recession cut export demand and helped drag the economy into its worst decline in 15 years. Output fell a workday-adjusted 21% from a year ago…”
Bursting Bubble Economy Watch:
March 19 – Bloomberg (Timothy R. Homan): “The number of Americans collecting jobless benefits swelled to a record 5.47 million… The number of people staying on benefit rolls jumped by 185,000 in the week ended March 7… Initial jobless applications last week topped 600,000 for a seventh straight time, the worst performance since 1982…”
March 20 – Wall Street Journal (Kelly Evans): “Spending on travel and tourism declined last year for the first time since the Sept. 11, 2001, terrorist attacks, the Commerce Department said… Spending fell at a 22% annualized rate in the October through December quarter… The decline was the sharpest since the government’s quarterly records began in 2001, topping the 19% drop after the terrorist attacks that year.”
Real Estate Bust Watch:
March 19 – Bloomberg (Oshrat Carmiel): “Manhattan apartment sales declined 23% last year… Now co-operative and condominium prices are dropping as Wall Street firms cut the bonuses that contributed to the property market boom of the past decade. A 50% reduction in bonuses would push down prices by about 24% from their peak through mid-2010, said Sam Chandan, chief economist at…Real Estate Economics… That would mark the biggest slide since 1980 when appraiser Miller Samuel Inc. started tracking Manhattan prices. ‘This will probably be the worst price correction the city has seen,’ said Marisa Di Natale, senior economist at Moody’s… When bonuses climbed 114% between 1998 and 2000, Manhattan co-op and condo prices followed, rising 51% during those years, data… by Miller Samuel show.”
California Watch:
March 20 – Bloomberg (Bob Willis): “California’s jobless rate surged in February to the highest level since 1983 while unemployment in Oregon and Nevada climbed above 10% for the first time in more than two decades. Unemployment in California rose to 10.5% from 10.1% in January…”
Speculator Watch:
March 19 – Bloomberg (Tomoko Yamazaki): “Investors pulled out a total of $25 billion from hedge funds in February, the seventh consecutive month of redemptions, as stocks worldwide tumbled and a global recession deepened, an industry report shows. Total hedge-fund assets stood at $1.36 trillion at the end of February, down about $600 billion from their peak in June 2008, according to… Eurekahedge Pte. In January, final net withdrawals totaled $95 billion…”
March 18 – Bloomberg (Saijel Kishan): “Hedge-fund liquidations rose to an all-time high last year as managers posted record losses, according to Hedge Fund Research Inc. About 1,471 funds, including fund of hedge funds… The closures exceeded by 70% the previous record of 848 set in 2005… In the fourth quarter, about 778 hedge funds closed as investors withdrew $150 billion from the investment pools…”
Inflationist Watch:
March 18 – Bloomberg (Gabi Thesing): “Bill Gross, manager of Pacific Investment Management Co.’s $138 billion Total Return Fund, said the European Central Bank should turn its focus to the dangers of deflation, ‘the true enemy of the economy,’Manager Magazin reported… Gross, who also advises the U.S. government, said inflation is ‘the only way out of the crisis,’ according to a pre- release of the article…”
Crude Liquidity Watch:
March 18 – Bloomberg (Camilla Hall): “The United Arab Emirates central bank plans to cut interest rates as the economy, the second largest in the Arab world, may contract this year, Governor Sultan bin Nasser al-Suwaidi said. ‘The current financial crisis will reduce the horizons for economic growth in the U.A.E in 2009 from a growth level of a high single digit to a low growth level or even a contraction.’”
Mistakes Beget Greater Mistakes:
March 18 – Bloomberg (Kathleen Hays and Dakin Campbell): “Bill Gross, co-chief investment officer of Pacific Investment Management Co., said the Federal Reserve’s purchases of Treasuries and mortgage securities won’t be enough to awaken the economy. ‘We need more than that,’ Gross said… The Fed’s balance sheet ‘will probably have to grow to about $5 trillion or $6 trillion,’ he said.”
“The problem with discretionary central banking is that it virtually ensures that policy mistakes will be followed by only greater mistakes.” Here, I’m paraphrasing insight garnered from my study of central banking history. Naturally, debating the proper role of central bank interventions - in both the financial sector and real economy – becomes a much more passionate exercise following boom and bust cycles. The “Rules vs. Discretion” debate became especially heated during the Great Depression. It was understood at the time that our fledgling central bank had played an activist role in fueling and prolonging the twenties boom - that presaged The Great Unwind. Along the way, this critical analysis was killed and buried without a headstone.
I believe the Bernanke Fed committed a historic mistake this week – compounding ongoing errors made by the Activist Greenspan/Bernanke Federal Reserve for more than 20 years now. I find it rather incredible that Discretionary Activist Central Banking is not held accountable – and that it is, instead, viewed as critical for a solution. Apparently, the inflation of Federal Reserve Credit to $2.0 TN was judged to have had too short of a half-life. So the Fed is now to balloon its liabilities to $3.0 TN, as it implements unprecedented market purchases of Treasuries, mortgage-backed securities, and agency and corporate debt securities. And what if $3.0 TN doesn’t go the trick? Well, why not the $5 or $6 TN Bill Gross is advocating? What’s the holdup?
Washington fiscal and monetary policies are completely out of control. Apparently, the overarching objective has evolved to one of rejuvenating the securities and asset markets and inciting quick economic recovery. I believe the principal objective should be to avoid bankrupting the country. It is also my view that our policymakers and pundits are operating from flawed analytical frameworks and are, thus, completely oblivious to the risks associated with the current course of policymaking.
Today’s consensus view holds that inflation is the primary risk emanating from aggressive fiscal and monetary stimulation. It is believed that this risk is minimal in our newfound deflationary backdrop. Moreover, if inflation does at some point rear its ugly head the Fed will simply extract “money” from the system and guide the economy back to “the promised land of price stability.” Wording this flawed view somewhat differently, inflation is not an issue - and our astute central bankers are well-placed to deal with inflation if it ever unexpectedly does become a problem.
Our federal government has set a course to issue Trillions of Treasury securities and guarantee multi-Trillions more of private-sector debt. The Federal Reserve has set its own course to balloon its liabilities as it acquires Trillions of securities. After witnessing the disastrous financial and economic distortions wrought from Trillions of Wall Street Credit inflation (securities issuance), it is difficult for me to accept the shallowness of today’s analysis. In reality, the paramount risk today has very little to do with prospective rates of consumer price inflation. Instead, the critical issue is whether the Treasury and Federal Reserve have set a mutual course that will destroy their creditworthiness - just as Wall Street finance destroyed theirs. Additionally, what are the economic ramifications for ongoing market price distortions?
The counterargument would be that Treasury and Fed stimulus are short-term in nature – necessary to revive the private-sector Credit system, asset markets and the real economy. That, once the economy is revived, fiscal deficits and Fed Credit will recede. I will try to briefly explain why I believe this is flawed and incredibly dangerous analysis.
First of all, for some time now global financial markets and economies have operated alongside an unrestrained and rudderless global monetary “system” (note: not much talk these days of “Bretton Woods II”). There is no gold standard - no dollar standard – no standards. I have in the past referred to “Global Wildcat Finance,” and such language remains just as appropriate today. Finance has been created in tremendous overabundance – where the capacity for this “system” to expand finance/Credit in unlimited supplies has completely distorted the pricing for borrowings. As an example, while Total US Mortgage Credit growth jumped from $314bn in 1997 to about $1.4 TN by 2005, the cost of mortgage borrowings actually dropped. It didn’t seem to matter to anyone that supply and demand dynamics no longer impacted the price of finance. Yet such a dysfunctional marketplace (spurred by unrestrained Credit expansion) was fundamental in accommodating Wall Street’s self-destruction.
Today, the markets will lend to the Treasury for three months at 21 bps, 2 years at 84 bps and 30 years at 371 bps. I would argue that this is a prime example of a dysfunctional market’s latest pricing distortion. As it did with the Mortgage Finance Bubble, the marketplace today readily accommodates the Government Finance Bubble. And while on the topic of mortgage finance, the Fed’s prodding has borrowing costs back below 5%. This cost of finance also grossly under-prices Credit and other risks.
I would argue that market pricing for government and mortgage finance remains highly distorted – a pricing system maligned by government intervention on top of layers of previous government interventions. These contortions become only more egregious, and I warn that our system will not actually commence its adjustment and repair phase until some semblance of true market pricing returns to the marketplace. Yet policymaking has placed peddle to the metal in the exact opposite direction.
The real economy must shift away from a finance and “services” structure – the system of “trading financial claims for things” – to a more balanced system where predominantly “things are traded for other things.” Such a transition is fundamental, as our system commences the unavoidable shift to an economy that operates on much less Credit of much greater quality. But for now, today’s Washington-induced distorted marketplace fosters government and mortgage Credit expansion – an ongoing massive inflation of non-productive Credit. I would argue this is tantamount to a continuation of Bubble Dynamics that have for years misallocated financial and real resources. In short, today’s flagrant market distortions will not spur the type of true economic wealth creation necessary to service and extinguish previous debts – not to mention the Trillions and Trillions more in the pipeline.
Market confidence in the vast majority of private-sector Credit has been lost. This Bubble has burst, and the mania in “Wall Street finance” has run its course. The private sector’s capacity to issue trusted (“money-like”) liabilities has been greatly diminished. The hope is that Treasury stimulus and Federal Reserve monetization will resuscitate private Credit creation; that confidence in these types of instruments will return. I would counter that once government interventions come to severely distort a marketplace it is a very arduous process to get the government out and private Credit back in (just look at the markets for mortgage and student loan finance!). This is a major, major issue.
The marketplace today wants to buy what the government has issued or guaranteed (explicitly and implicitly). Market operators also want to buy what our government is going to buy. In particular, the market absolutely adores Treasuries, agency MBS, and GSE debt. There is no chance that such a system will effectively allocate resources. There is today no prospect that such a financial structure will spur the necessary economic overhaul. None.
There is indeed great hope policymakers will succeed in preserving the current economic structure. On the back of massive stimulus and monetization, the expectation is that the financial system and asset prices will stabilize. The economy will be, it is anticipated, not far behind. And the seductive part of this view is that unprecedented policy measures may actually be able to somewhat rekindle an artificial boom – perhaps enough even to appear to stabilize the system. But seeming “stabilization” will be in response to massive Washington stimulus and market intervention – and will be dependent upon ongoing massive government stimulus and intervention. It’s called a debt trap. The Great Hyman Minsky would view it as the ultimate “Ponzi Finance.”
As I’ve argued on these pages, our highly inflated and distorted system requires $2.0 TN or so of Credit creation to hold implosion at bay. It is my belief that this will ONLY be possible with Trillion-plus annual growth in both Treasury debt and Federal Reserves liabilities. Private sector Credit creation simply will not bounce back sufficiently to play much of a role. Mortgage, consumer, and business Credit – in this post-Bubble environment - will not re-emerge as much of a force for getting total system Credit near this $2 TN bogey. In this post-Bubble backdrop, only government finance has a sufficient inflationary bias to get Trillion-plus issuance. But the day that policymakers try to extract themselves from massive stimulus and monetization will be the day they risk an immediate erosion of confidence and a run on both government and private Credit instruments. Also as I’ve written, once the government "printing press" gets revved up it’s very difficult to slow it down. This week currency markets finally took this threat seriously.