04/06/2006 Banking and the Business Cycle *

Stocks were mixed. For the week, the Dow and S&P500 were slightly positive. The Transports jumped 2.7%, increasing y-t-d gains to 11.8%. The Utilities declined 0.9%. The Morgan Stanley Cyclical index gained 1.6%, while the Morgan Stanley Consumer index declined 0.7%. The small cap Russell 2000 declined 1.2%, reducing 2006 gains to 12.3%. The S&P400 Mid-Cap index was unchanged for the week. The NASDAQ100 gained 1.1% (up 4.7% y-t-d), and the Morgan Stanley High Tech index rose 1.2% (up 6.2% y-t-d). The Street.com Internet Index was unchanged, while the NASDAQ Telecommunications index declined 1.5% (up 20.9% y-t-d). The Biotechs were slammed for 4.2%. The Broker/Dealers gained 1.9%, increasing 2006 gains to 19.0%. The Banks added 0.5%. With bullion rising $5.60, the HUI Gold index rose 2.7%. Global yields lurched higher. For the week, two-year Treasury yields rose 8 bps to 4.90%, and five-year yields gained 10 bps to 4.91%. Bellwether 10-year Treasury yields jumped 13 bps to 4.98%, a high since June 2002. Long-bond yields surged 16 bps to 5.05%, the first move above 5% since September 2004. The yield curve steepened. The 2yr/10yr spread widened 5 bps, ending the week at a positive 8 bps. Benchmark Fannie Mae MBS yields rose 9 bps to 6.10%, this week outperforming Treasuries. The spread on Fannie’s 4 5/8% 2014 note was little changed at 30, while the spread on Freddie’s 5% 2014 note widened one basis point to 32. The 10-year dollar swap spread increased 1.0 to 55.0. Investment grade spreads were little changed, and junk bond spreads widened slightly this week. The implied yield on 3-month December ’06 Eurodollars rose 4.5 bps to 5.30%.           Investment grade issuers included BBVA $5.25 billion, Viacom $4.75 billion, SLM Corp $1.75 billion, Ford Motor Credit $1.5 billion, Credit Suisse $1.0 billion, Lincoln National $1.0 billion, Conocophillips $1.0 billion, Allergan $800 million, Appalachian Power $500 million, Popular Inc. $450 million, John Deere $300 million and Southern Star $200 million.  April 7 – Bloomberg (Mark Pittman and Walden Siew): “Ford Motor Co.’s finance unit is paying a high price for access to a corporate debt market that is anticipating the second-biggest U.S. automaker will default. Yields on $1.5 billion floating-rate notes that Ford Motor Credit Co. sold last week were the highest since 1992… Ford, whose credit  rating was reduced below investment grade in May, will initially pay a 9.45 percent yield on the notes due in 2012.” April 5 – Bloomberg (Walden Siew): “U.S. companies one step away from default are selling a record amount of bonds. Jostens Inc., the biggest maker of school rings, and a Hard Rock International Inc. affiliate are among borrowers rated CCC or lower who offered $20 billion of debt since December. The sales are the most since at least 1999, when Bloomberg began compiling the data, and are four times the amount from a year-ago.” Junk issuers included Autonation $600 million, Level 3 $550 billion, Hughes $450 million, Tech Olympia USA $250 million, Southern Star Gas $230 million, Multiplan $225 million, Basic Energy Services $225 million, PHI Inc $200 million, Transcontinental Gas Pipeline $200 million, and Owens & Minor $200 million. Convert issuers included Ciena $300 million. Foreign dollar debt issuers included Royal Bank of Scotland $3.0 billion, Lebanese Republic $750 million and Grupo Gigante $260 million.  Japanese 10-year JGB yields jumped 11 bps this week to 1.88%, as the Nikkei 225 index rose 3% (up 9.0% y-t-d).  German 10-year bund yields surged 22 bps to 3.89%. Emerging debt markets were generally weak, while the equities boom ran unabated. Brazil’s benchmark dollar bond yields jumped 26 bps to 6.89%. Brazil’s Bovespa equity index rose 2.6%, increasing 2006 gains to 16.4%. The Mexican Bolsa added 1.0%, increasing y-t-d gains to 9.4%. Mexican 10-year $ yields jumped 13 bps to 6.09% this week. Russian 10-year dollar Eurobond yields gained 6 bps to 6.63%. The Russian RTS equities index surged 6%, increasing 2006 gains to 35.3%. India’s Sensex equities index gained 2.5%, increasing y-t-d gains to 23.3%. Freddie Mac posted 30-year fixed mortgage rates jumped 8 bps to 6.43%, up 50 basis points from one year ago to the highest level since September 2003. Fifteen-year fixed mortgage rates rose 10 bps to 6.10% (up 62 bps in a year). One-year adjustable rates increased 6 bps to 5.57%, an increase of 134 bps over the past year. The Mortgage Bankers Association Purchase Applications Index jumped 8.4% last week to an eight-week high. Purchase Applications were down 1.9% from one year ago, while dollar volume was up 4.0%. Refi applications gained 5.3% last week. The average new Purchase mortgage slipped to $233,900, while the average ARM jumped to $355,800. Bank Credit jumped $21.9 billion last week to a record $7.723 Trillion, with a y-t-d gain of $217 billion, or 11.5% annualized. Over the past year, Bank Credit inflated $715 billion, or 10.2%. For the week, Securities Credit fell $17.5 billion. Loans & Leases surged $39.4 billion for the week, with a y-t-d gain of $157 billion (11.5% annualized). Commercial & Industrial (C&I) Loans have expanded at a 13.1% rate y-t-d and 13.4% over the past year. For the week, C&I loans gained $4.5 billion, and Real Estate loans jumped $11.1 billion. Real Estate loans have expanded at an 11.6% rate y-t-d and were up 12.9% during the past 52 weeks. For the week, Consumer loans added $1.2 billion, and Securities loans jumped $20.0 billion. Other loans increased $2.6 billion.   On the liability side, (previous M3 component) Large Time Deposits fell $8.4 billion. M2 money supply declined $7.0 billion to $6.772 Trillion (week of March 27). Year-to-date, M2 has expanded $82.3 billion, or 4.9% annualized. Over 52 weeks, M2 inflated $275.2 billion, or 4.2%. For the week, Currency added $0.3 billion. Demand & Checkable Deposits gained $5.4 billion. Savings Deposits fell $19.8 billion, while Small Denominated Deposits added $3.4 billion. Retail Money Fund deposits gained $3.5 billion. Total Money Market Fund Assets, as reported by the Investment Company Institute, rose $4.5 billion last week (week ended April 5) to $2.061 Trillion. Money Fund Assets are up $3.9 billion y-t-d, with a one-year gain of $152.3 billion (8.0%).  Total Commercial Paper dropped $47.6 billion last week to $1.663 Trillion (likely related to quarter-end position adjustments). Total CP is up $14.2 billion y-t-d (14wks), or 3.2% annualized, while having expanded $202.2 billion over the past 52 weeks, or 13.8%. Last week, Financial Sector CP borrowings fell $35.4 billion to $1.530 Trillion (up $21.7bn y-t-d), with a 52-week gain of $215 billion, or 16.4%. Non-financial CP dropped $12.3 billion to $133.3 billion, with a 52-week decline of 8.8%.  Asset-backed Securities (ABS) issuance began the quarter at a slow $6.5 billion. Year-to-date total ABS issuance of $193 billion (tallied by JPMorgan) is 11% ahead of 2005’s record pace, with y-t-d Home Equity Loan ABS issuance of $143 billion running 26% above last year. Fed Foreign Holdings of Treasury, Agency Debt (“US marketable securities held by the NY Fed in custody for foreign official and international accounts”) added $1.7 billion to $1.594 Trillion for the week ended April 5. “Custody” holdings are up $74.8 billion y-t-d, or 18.3% annualized, and $204 billion (14.7%) over the past 52 weeks. Federal Reserve Credit rose $6.4 billion last week to $820.5 billion. Fed Credit has declined $5.9 billion y-t-d, or 2.7% annualized. Fed Credit expanded 4.7% ($37bn) during the past year.  International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – are up $223 billion y-t-d (20.5% annualized) and were up $473 billion, or 12.5%, over the past 12 months to a record $4.270 Trillion. April 6 – Bloomberg (Jianguo Jiang): “China’s foreign-exchange reserves may rise by more than $100 billion this year, based on growth in the first two months, the official Xinhua news agency said. The nation added $34.7 billion of reserves in January and February…” Currency Watch: Currencies were volatile, although the dollar index ended the week about unchanged. On the upside, the South Korean won gained 1.9%, the Thai baht 1.7%, the Canadian dollar 1.7%, the Uruguay peso 1.5%, and the Australian dollar 1.4%. On the downside, the Colombian peso fell 3.1%, the Jamaica dollar 2.6%, the Mexican peso 2.5%, and the Iceland krona 2.1%.    Commodities Watch: April 5 – Bloomberg (Stewart Bailey): “Aluminum consumption may jump 59 percent by 2015 as China’s demand for the metal, used in beverage cans and car bodies, more than doubles, BHP Billiton said. Consumption of the metal is forecast to rise to 51 million tons a year from 32 million tons in 2005, Robert Guilbault, general manager of BHP’s Hillside aluminum smelter on South Africa's east coast, said…” This week copper traded to another record high, gold a 25-year high, and silver 22-year high. May crude rose 76 cents to $67.39. May Unleaded Gasoline jumped 5%, while May Natural Gas sank 6.5%. For the week, the CRB index gained 1.2% (y-t-d up 1.6%). The Goldman Sachs Commodities index rose 1.1%, increasing y-t-d gains to 3.6%.   Japan Watch: April 3 – Financial Times (David Turner): “Japan’s large manufacturers are short of capacity for the first time since the bubble era of the early 1990s, while employers across the country also face the worst staff shortages since around that time, according to the Bank of Japan’s Tankan survey. The gaps highlighted by the closely watched report, published on Monday, strengthen the case among the hawks at the central bank who want to end the BoJ’s zero interest rate policy as soon as possible to forestall inflation.” China Watch: April 3 – Bloomberg (Amit Prakash and Rob Delaney): “China’s economy is on course to grow 8 percent this year and domestic consumption will rise, Vice Finance Minister Li Yong said at a conference in Cambodia. ‘Strong economic growth is expected for 2006, with GDP projected to grow by 8%... Growth will rely more on domestic demand as opposed to external trade, when compared with 2005.’” April 4 – MarketNewsInternational: “China’s retail sales are expected to grow at around 13% this year to 7.5 trln yuan, the Ministry of Commerce said, while the consumer price index is seen growing by 2-3%.” April 6 – Bloomberg (Janet Ong): “China’s tax revenue in the first quarter rose 18.9 percent from a year earlier to 898.8 billion yuan ($112 billion) as economic growth boosted corporate profits and spurred trade.” Asia Boom Watch: April 6 – Bloomberg (Seyoon Kim): “South Korea’s economy probably accelerated in the first quarter and is heading for the fastest annual expansion in four years, Vice Finance Minister Bahk Byong Won said. Asia’s fourth-largest economy grew about 6 percent in the first quarter from a year earlier…” April 7 – Bloomberg (Anoop Agrawal): “India’s foreign-exchange reserves, comprising overseas currencies, gold and special drawing rights with the International Monetary Fund, rose $2.96 billion to $151.62 billion in the week ended March 31…” Unbalanced Global Economy Watch: April 4 – Bloomberg (Amit Prakash): “The International Monetary Fund may raise its forecast for global economic growth this year, buoyed by expansion in Japan and the rest of Asia. The IMF may increase its projection for world growth to 4.9 percent from a Sept. 21 estimate of 4.3 percent…” April 7 – Bloomberg (Alexandre Deslongchamps): “Canadian employers added 50,500 workers in March, more than twice the expected gain, led by hospitals and telecom companies. The unemployment rate fell to 6.3 percent, the lowest in more than 31 years.” April 3 – Bloomberg (Ben Sills): “Manufacturing in the dozen euro nations expanded at the fastest pace in more than five years in March, increasing the European Central Bank’s leeway to raise interest rates to counter inflation as economic growth picks up.” April 5 – Bloomberg (Fergal O’Brien): “Growth at European service companies including banks and airlines last month matched the five-year high reached in February as export-led expansion fed through to the domestic economy.” April 4 – Bloomberg (Meera Louis): “Unemployment in the 12 nations sharing the euro fell in February to the lowest in almost four years amid signs that the economy is accelerating. The jobless rate declined to 8.2 percent, the lowest since May 2002, from 8.3 percent in January…” April 3 – Bloomberg (Jacob Greber): “Manufacturing in Switzerland grew at the fastest pace in almost six years, reinforcing the Swiss central bank’s view that the country’s $340 billion economy is strong enough to absorb higher interest rates.” April 6 – Bloomberg (Kathrine Jebsen Moore): “Norway’s jobless rate dropped to 2.9 percent in March, the lowest since May 2002, as economic growth in the Nordic country of 4.6 million accelerates.” April 4 – Bloomberg (Mike Cohen): “South African vehicle sales surged an annual 29 percent to a record in March as tax cuts and the country’s lowest interest rates since 1980 boosted consumer spending…” April 6 – Bloomberg (Hans van Leeuwen and Gemma Daley): “Australia’s jobless rate fell to a 29-year low in March as retailers hired workers, adding to speculation the central bank may raise interest rates this year. Employment in the Asia-Pacific’s fifth-largest economy climbed by 27,000, cutting the jobless rate to 5 percent from 5.2 percent…” Latin America Watch: April 4 – Bloomberg (Carlos Caminada and Jeb Blount): “Brazil’s industrial output rose at the fastest pace in eight months in February as declining interest rates boosted demand for cars, machinery and other manufactured goods. Output by miners and manufacturers rose 5.4 percent from the year earlier…” April 3 – Bloomberg (Carlos Caminada): “Brazil’s trade surplus widened in March as a growing world economy boosts demand for Brazilian sugar, iron ore, cars and other goods. The surplus rose to $3.68 billion in March from $2.82 billion in February and compares with $3.34 billion a year earlier…” April 6 – Bloomberg (Alex Kennedy): “Venezuelan vehicle sales soared 46 percent in March from the same year-ago period as record oil revenue fueled increased government spending and a growing economy.” April 4 – Bloomberg (Andrea Jaramillo): “Colombia’s retail sales rose 9.1 percent in January from a year earlier, led by purchases of furniture, office equipment, vehicles and motorcycles, the national statistics agency said.” Bubble Economy Watch: February Construction Spending was up 7.4% from February 2005, with Residential up 6.5% and Nonresidential up 8.5%. Public Construction Spending was up 11.3% from one year ago.   April 4 – Bloomberg (Kathleen M. Howley): “Manhattan apartment prices rose at the slowest pace in three years during the first quarter… The average price for condominiums and cooperatives climbed 7.1 percent to $1.3 million from a year earlier, property appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman reported… Sales fell 1.1 percent and the number of apartments on the market rose 60 percent to a record 6,904.” Mortgage Finance Bubble Watch: April 5 – The Wall Street Journal (Janet Morrissey): “About two-thirds of lenders surveyed believe a housing bubble exists in the U.S., and many of them expect a correction within the next year, according to a new survey. A Phoenix Management report, released yesterday, found 66% of the 92 lenders who took part in the survey believe the country is in a housing bubble, up from 46% a year ago. ‘In the minds of lenders, the housing bubble has moved from Loch Ness Monster myth status to an economic reality that could have a significant economic impact on the lives of many Americans,’ said Michael Jacoby, managing director…of Phoenix Management…” April 5 – The Wall Street Journal (Ryan Chittum ): “After several years of restraint, hotel building is coming back. With travel soaring as the economy recovered from recession and worries about terrorism and war, developers mostly shunned building hotels for other types of property even as the industry has accumulated record profits. Much of available capital has flowed to residential buildings, particularly condos. Rising construction costs have also kept a lid on hotel construction. That appears to be coming to an end. PricewaterhouseCoopers projects hotel-room starts will jump 45% to 120,000 in 2006 after a relatively anemic 82,100 last year. The 2006 number is higher than any since 2000 and well above the 20-year average of 96,000 starts a year.” Energy and Crude Liquidity Watch: April 4 – Bloomberg (Carol Wolf): “Caterpillar Inc., the world’s biggest maker of earthmoving equipment, stands to gain as much as $5 billion in sales as a boom in oil squeezed from Canadian sand boosts demand for mining trucks and parts.” April 5 – Bloomberg (Will McSheehy):  “Dubai Islamic Bank, the world’s oldest provider of Islamic financial services, said it will work with the government of Dubai to create a $5 billion family of global private-equity funds. The seven funds will focus on energy, financial institutions, infrastructure, real estate, health and education, industrials and media and telecommunications, the United Arab Emirates-based bank said…”  Banking and the Business Cycle: A Bloomberg headline caught my attention earlier in the week: “Fisher Says Globalization Reduces Inflation Threat.” In his Tuesday speech -- “A New Perspective for Policy” -- Federal Reserve Bank of Dallas’ President, Richard W. Fisher, noted a finding from recent globalization research conducted by the Bank of International Settlements. “…[F]or some countries, including—and to my mind especially—the United States, the proxies for global slack have become more important predictors of changes in inflation than measures of domestic slack.” Mr. Fisher also noted “the realization of the importance of global economic conditions for making monetary policy decisions is becoming more widespread.” Reminiscent of the late-nineties view that extraordinary productivity gains had empowered the Greenspan Fed to let the economy (and financial markets!) run hotter, today it is “globalization” that supposedly keeps “inflation” in check, thereby bestowing the Federal Reserve and global central bankers greater latitude for accommodation. There is great irony in the fact that U.S. led Global Credit Inflation and attendant Asset Bubbles of unprecedented dimensions are fostering (over)investment in global goods-producing capacity, a backdrop that is perceived by the New Paradigmers as ensuring ongoing “slack” and quiescent “inflation.” This is dangerously flawed analysis, and I find it at this point rather ridiculous that policymakers cling to such a narrow (“core-CPI”) view of “inflation.” I suggest Mr. Fisher, Dr. Bernanke, Dr. Poole and others read (or, perhaps, re-read) the classic, Banking and the Business Cycle – A Study of the Great Depression in the United States, by C.A. Phillips, T.F. McManus, and R.W. Nelson, 1937. The authors brought a (refreshing) degree of invaluable clarity to complex – and pertinent - economic issues that are today simply omitted from the discourse. In particular, I much appreciate the use of the terminology “Investment Credit Inflation.” It is, after all, the creation of new financial claims (Credit) that augments purchasing power, and analysts must be vigilant observers of the sources and uses of this additional spending. The key is to recognize the nature of the Processes of Credit Creation and Dissemination, especially when marketable securities, leveraged speculation, and Asset Inflation are key facets of the boom. And just as the popular proxy index for the general price level utterly failed during the ‘twenties to indicate the prevailing massive Credit Inflation, the Fed’s favored (narrow) price level indicators today only work to palliate and mislead. But it is better to just let the timeless insights from “Banking and the Business Cycle” “speak” for themselves.   “It is sought to show that the main cause of the dislocation in trade and industry was, in [T.E.] Gregory’s language, the ‘disregard of the rules of common sense in the treatment of the money supply’ of the United States; the depression is proximately an effect of inflation. The post [First World] War inflation in the United States was an investment credit inflation, however, as distinguished from the commodity credit inflation of War-time.” (page 4) “The special character of the depression is traced to the hyper-elasticity of the Federal Reserve System, and to the operation of that system as exemplified in the ‘managed currency’ experiment of the Federal Reserve Board… The depression, in other words, was the price paid for the experimentation with currency management by the Federal Reserve Board…” (pages 5/6) “Through the purchase of investments, commercial banks impart a positive upward impulsion to the business cycle. Coming in as a marginal determining factor in the price of bonds, purchases of investments by banks force down the long-term market rate of interest so that it becomes profitable, in view of the existing realized rate of return to capital at important new investment margins, to float new bond issues and to embark upon new capital development; this results in an investment boom which affects a change in the structure of production… the purchase of investments by banks creates new deposits in the banking system in much the same fashion as does the granting of loans.” (page 6) “The term ‘inflation’ has long been the subject of interminable and diverse definition. In the view of the writers, inflation applies to a state of money, credit, and prices arising not only from excessive issues of paper money, but also from any increase in the effective supply of circulating media that outruns the rate of increase of the physical volume of production and trade, thus forcing a rise of prices… In the modern world of finance…the most important single cause of inflation is the multiplication of bank credit by the banking machinery, resulting in an increase in the volume of purchasing power…” (page 13) “‘Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency [quote from Keynes].’ How close the capitalist system in America has come to destruction in consequence of the inflationary debauch of the currency indulged in during and since the [First World] War by the manufacture of deposit currency is as yet uncertain.” (page 34) “One of the duties devolving upon economists is that of pointing out the errors in fallacious economic contentions…” (page 38) “Overinvestment, which must be assigned the role of a positive disturbing factor, has its ultimate source in an excess of credit… the policy of overinvestment, with its attendant misapplication of capital, could never have been carried to the lengths that it was during the decade of the ‘twenties' if the banks and the Government had not supplied abundant credits at artificially cheap rates.” (page 68) “…the position of Professor [Lionel] Robbins: ‘It may prove to be no accident that the depression in which most measures have been taken to ‘maintain consumers’ purchasing power’ is also the depression of the widest extent and most alarming proportions.’” (page 72) “The fall in prices would in itself serve to constitute an effective check upon inordinate capital development because it would bring about a decline in the rate of return going to capital; as the rate of return to capital declined consequently upon the fall in prices the rate of accumulation of capital goods would tend to diminish. Under such conditions the system is automatically self-corrective. It is just this self-corrective process which is essential to the smooth functioning of the economic machinery. And it is in this way that the system would work were it not for the disturbing factor of credit. The injections of new credit not only permit an increase in the rate of capital accumulation, but also tend to disrupt progressively the normal equilibrium relationships between costs and prices over many sectors of the pricing front. The fundamental disequilibria are not discernable until the new credits are withdrawn or cease to increase, when it then becomes apparent that the anticipated earnings of capital based on the prevailing (artificially pegged) price level will not be realized…” (page 77) “And for an understanding of the more immediate causes of the depression it is essential that the developments taking place in the American banking system be clearly in mind, as the changes occurring in the banking system were intimately connected with the structural changes in the economic system which led to the depression.” (page 78) “The immediate effects of this investment credit inflation were marked by important and interrelated changes in the character of bank loans and investment assets. There developed an indirectness in the processes of bank credit financing, bank credit entering into the channels of production and trade through operations in the securities and capital markets… As a result of the plethora of bank credit and the utilization by banks of their excess reserves to swell their investment accounts, the long-term rate declined and it became increasingly profitable and popular to float new stock and bond issues. This favorable situation in the capital funds market was translated into a constructional boom of previously unheard-of dimensions; a real estate boom developed, first in Florida, but soon was transferred to the urban real estate market on a nation-wide scale; and, finally, the stock market became the recipient of the excessive credit expansion. These three booms – the constructional boom proper, the real estate booms, and the stock market hysteria – combined to produce structural changes in the economic system which were directly involved with the immediate origins of the depression.  This trinity of booms contributed to sustain a seeming prosperity, the tragic speciousness of which was not widely apparent until after the bubble had burst. Hence the remote effect of the investment credit inflation was depression...” (page 81) “The growth of deposits for all the banks in the country from June, 1921, to December 1929, was over 19 billion dollars. This is to be compared with 18.6 billion in total deposits for all banks, in June, 1914… The banking years from 1922 to 1929, then, were characterized by a great credit inflation – an absolute quantitative inflation viewed from any angle, and a relative inflation viewed with respect to the needs of trade and in consideration of the price level.” (pages 82/84) “In the course of the time…increased flotation of corporate securities in an especially favorable capital market virtually surfeited some of the issuing corporations with liquid funds for which they found a profitable use in the stock exchange call-loan market, adding new fuel to the already raging flames of stock market speculation... Real estate bond issues were brought out on a scale unmatched in previous history… Our export trade was stimulated by extensive over-seas lending… All these factors…helped to carry business activity to the false bottom of credit inflation long enough for the term ‘New Era’ to become a byword…” (pages 112/13) “It was through these various booms of a capital nature that the ‘cheap credit’ policy of this period found its chief outlets. The net effect of these influences was to produce an alteration in the structure of production.” (page 113) “If the recent cycle has proved so puzzling to so many students of its devious course and manifold phases, it is because the full effects of the creation and operation of this central banking system upon the commercial banks have not been widely nor adequately understood; nor, furthermore, have the influences of the changing structure of the American banking system upon the structure of production been fully realized.” (page 140) “Most American observers who were concerned with the structural view of business cycles were unable fully to appreciate the monetary aspects of the situation; those who were advocates of the purely monetary theory were so obsessed with the stable-price level complex that they were unable properly to assess the importance of the underlying structural phenomena which were developing… The movement of wholesale prices occupies a central role in the usual monetary theory, and this concentration of attention upon the superficial phenomena of changes in the value of money has militated against an understanding of the channels through which newly created credit entered the economic system and of the effect of this new credit upon the structure of production. Further, there are certain aspects of the recent situation which render the usual monetary theory practically useless… commodity prices as measured by the wholesale prices index in this country were remarkably stable from 1922 to 1929…so that one point definitely established by the monetary experimentation involved is that stability of the price level is a doubtful safeguard against depression.” (pages 147/148) “In the first place, the depression was as exaggerated and as protracted as it was because the stock market crash itself was the most devastating… In the second place, the alteration of the structure of production…was greater than in any previous depression… And, in the third place, during no previous collapse was there such a complex entanglement of the banking system with the course of the depression… But underlying and supplementing all these factors was a stubbornly persisting lack of equilibrium in the entire economic and price structure.” (pages 150/151) “It has frequently been argued that the stock market boom was justified on the basis of rapidly rising corporate earnings. Some have contended that profits not only were large in absolute amount but that they were increasing at an accelerating rate… On sober afterthought, however, it appears that the stock market boom was largely a product of bank credit expansion, a mad speculative frenzy which had no rationale whatever.” (page 155) “Although wholesale commodity prices were relatively steady, prices in a more inclusive sense did rise. That is to say, the emissions of bank credit found expression in a rise of prices other than wholesale commodity prices, the index to which most persons are accustomed to refer when considering prices in relation to increased purchasing media. For ‘credit takes various directions, and the effects of inflation can only be measured best at those points in the business structure where the use of credit has been most active.’ The ‘points’ where credit played its most active part in affecting prices in the period from 1922 onward are those already referred to – real estate, stocks, and long-term investments.” “…the Board’s policies also had international effects that were of far-reaching import. During the period of the ‘twenties when the United States was not only the most powerful commercial and industrial nation in the world, but also was in possession of the major portion of the stock of monetary gold of the world, our domestic developments and conditions were bound to influence the course of economic events in other countries. The [Fed] in its efforts to inflate purchasing power and to support the price level in this country helped indirectly…to arrest the decline of prices in other important commercial nations…” (page 197) “As early as June 1927, the effects of the Federal Reserve Board’s domestic credit policies upon the international situation were diagnosed by Professor Bertil Ohlin of Stockholm University as follows: ‘The influx and efflux of gold in the United States has thus lost all influence upon the monetary purchasing power and the prices level in that country. The question of granting credit is instead determined by what the Federal Reserve Board considers suitable from an economic point of view. This implies nothing less than a revolution in the monetary system not only of the United States but of all countries with a gold standard…” (page 198) “Stability of the price level is no adequate safeguard against depression, it is contended, because any policy aimed at stabilizing a single index is bound to set up countervailing influences elsewhere in the economic system. Although the policy of stabilization may appear to be successful for a time, eventually it will break down, because there is no way of insuring that the agencies of control will be able to make their influence felt at precisely those ‘points’ of strategic importance.” (page 200) “A sharply contrasting objective of banking policy…and the one here advocated, would be the control of the total amount of credit, such that the violent inflations and contractions of credit would be eliminated, or at least greatly mitigated, and without special regard for any one index of economic activity.” (page 202) The authors’ delved into considerable detail and analysis elucidating the various factors and mechanisms that supported “a much larger superstructure of credit than was previously possible.” Certainly at the top of the list was the expansion of the Federal Reserve System, along with various factors and avenues that significantly reduced bank reserve-to-deposit requirements and financial innovation generally. To be sure, however, the “hyper-elasticity of the Federal Reserve System” and the fractional-reserve banking apparatus from the ‘twenties is Inflationary Child’s Play in comparison to the virtually unchecked securities-based Credit systems of our day.  The contemporary U.S. Credit system (evolving to the status of the backbone of the global Credit mechanism) comprised of banks, the GSEs, global central bank dollar holdings, brokerage firms, the MBS and ABS marketplaces, hedge funds, finance companies, insurance companies, etc., operate today generally unrestrained from either reserve or capital requirements (not to mention a gold standard). And, in the final analysis, ‘this implies nothing less than a revolution in the monetary system not only of the United States but of all countries…’ Moreover, ‘changes occurring in the [global financial] system [are] intimately connected with the structural changes in the [global] economic system…’  “The stock market crash provided the shock to confidence which definitely and dramatically started the depression on its downward course, revealing to most persons for the first time the inherent instability of the conditions which had prevailed for several years.” (page 161) And while “Banking and the Business Cycle” does not pursue this line of reasoning, it is my view that the 1929 crash was inevitable due to the extreme nature of speculative leveraging and deep structural maladjustment, and it was as well the impetus for an unavoidable collapse of system liquidity. One never knows from where the shock to confidence will emanate, while today’s intertwined global Credit apparatus has an unknown multitude of highly leveraged marketplaces that would qualify as potential financial dislocation catalysts. Yet one can look to today’s Highly Extraordinary Global Credit and Speculative Boom Environment and state unequivocally that the system is acutely vulnerable to any break in confidence, panicked speculator deleveraging, or even any meaningful downturn in Credit growth. Admittedly, the Global Credit Bubble has quite a head of steam. But, then again, so might global interest rates.