Tuesday, September 9, 2014

05/04/2006 Money Analysis *

For the week, the Dow jumped 1.9% to a new 6-year high. The S&P500 added 1.2%. The economically sensitive issues were hot, with the Transports surging 6.3% to a record high (up 18.2% y-t-d), and the Morgan Stanley Cyclical index rising 4.2% to a new high (up 12.8% y-t-d). The Utilities gained 2.7%, and the Morgan Stanley Consumer index increased 1.2%. The small cap Russell 2000 rose 2.3%, increasing 2006 gains to 16.1%. The S&P400 Mid-cap index added 1.7% (up 10.7% y-t-d). Technology stocks somewhat lagged. The NASDAQ100 increased 0.8%, and the Morgan Stanley High Tech index gained 1.3%. The Semiconductors rose 2.3%, and the NASDAQ Telecommunications index gained 2.5% (up 22.8% y-t-d). The Street.com Internet Index declined 0.4%. The Biotechs added only 0.3%. The Broker/Dealers jumped 1.7% (up 20% y-t-d), and the Banks added 0.4% to a new record high (up 9.1% y-t-d). With bullion surging almost $30, the HUI Gold index was slightly positive for the week. 

For the week, two-year Treasury yields rose 7 bps to 4.93%, and five-year yields gained 7 bps to 4.98%. Bellwether 10-year yields rose 4 bps to 5.10%. Long-bond yields gained 3 bps to 5.19%. The 2yr/10yr spread declined 2 bps, ending the week at a positive 17 bps. Benchmark Fannie Mae MBS yields rose 7 bps to 6.18%, trading in line with Treasuries. The spread on Fannie’s 4 5/8% 2014 note ended the week one basis point higher at 24, and the spread on Freddie’s 5% 2014 note added one to 26. The 10-year dollar swap spread increased 1.5 to 52.25. Corporate bond spreads ratchet tighter, with junk bonds again outperforming this week. The implied yield on 3-month December ’06 Eurodollars jumped 9.5 bps to 5.34%.          

Investment grade issuers included World Savings $1.5 billion, National Rural Utility Coop $1.0 billion, Swiss RE $750 million, Centex $500 million, Ryder $250 million, and Sunoco Logistics $175 million. 

Junk issuers included Rouse $800 million, Allied Waste $600 million, Southern Copper $400 million, CMP Susquehanna $250 million, and IPayment $205 million. 

Foreign dollar debt issuers included Vimpelcom $600 million, ATF Bank $350 million and HSBK Europe $300 million. 

May 2 – Financial Times (Peter Smith): “Kohlberg Kravis Roberts, the leveraged buyout pioneer, is understood to have raised $5bn for an investment vehicle it is to offer on the Amsterdam stock exchange –more than three times the group’s original target.”

Japanese 10-year JGB yields were unchanged this week at 1.92%. The Nikkei 225 index added 1% (up 6.5% y-t-d).  German 10-year bund yields rose 5 bps to 4.00%. Emerging debt markets lagged surging equities. Brazil’s benchmark dollar bond yields rose 5 bps to 6.71%. Brazil’s Bovespa equity index surged 4.2% to a new record high and increasing 2006 gains to 23.8%. The Mexican Bolsa traded to a new record high, ending the week up 4.2%, with y-t-d gains rising to 19.3%. Mexico’s 10-year $ yields rose 4 bps to 6.12%. Russian 10-year dollar Eurobond yields added one basis point to 6.76%. The Russian RTS equities index jumped 7.6%, increasing 2006 gains to 55% and 52-week gains to 160%. India’s Sensex equities index rose 4.4% to an all-time high (up 31.5% y-t-d).

Freddie Mac posted 30-year fixed mortgage rates added one basis point to 6.59%, up 84 basis points from one year ago. Fifteen-year fixed mortgage rates gained one basis point to 6.22%, 81 bps higher than a year ago. One-year adjustable rates dipped one basis point to 5.67%, an increase of 145 bps over the past year. The Mortgage Bankers Association Purchase Applications Index jumped 11.3% last week to a four-week high. Purchase Applications were down 10.1% from one year ago, with dollar volume down 5.9%. Refi applications gained 5.1% last week. The average new Purchase mortgage was little changed at $231,600, while the average ARM jumped to $342,400.

Bank Credit surged another $30.9 billion last week to a record $7.827 Trillion, with a blistering y-t-d gain of $321 billion, or 13.1% annualized. Over the past year, Bank Credit inflated $754 billion, or 10.7%. For the week, Securities Credit dipped $0.8 billion. Loans & Leases jumped $31.7 billion for the week, with a y-t-d gain of $183 billion (10.2% annualized). Commercial & Industrial (C&I) Loans have expanded at a 17.2% rate y-t-d and 14.0% over the past year. For the week, C&I loans gained $8.6 billion, and Real Estate loans added $1.7 billion. Real Estate loans have expanded at a 10.4% rate y-t-d and were up 12.6% during the past 52 weeks. For the week, Consumer loans added $0.6 billion, and Securities loans jumped $12.6 billion. Other loans were up $8.2 billion. On the liability side, (previous M3 component) Large Time Deposits declined $1.5 billion. 

M2 (narrow) “money” supply gained $3.3 billion to $6.810 Trillion (week of April 24). Year-to-date, M2 has expanded $120.3 billion, or 5.5% annualized. Over 52 weeks, M2 has inflated $322 billion, or 5.0%. For the week, Currency added $0.6 billion. Demand & Checkable Deposits jumped $17.6 billion. Savings Deposits fell $22.6 billion, while Small Denominated Deposits gained $2.9 billion. Retail Money Fund deposits rose $4.7 billion.

Total Commercial Paper surged $37.1 billion last week (3-wk gain of $81.3bn) to $1.762 Trillion. Total CP is up $112.4 billion y-t-d, or 19.7% annualized, while having expanded $277 billion over the past 52 weeks, or 18.6%.  

Asset-backed Securities (ABS) issuance was a relatively slow $9 billion. Year-to-date total ABS issuance of $234 billion (tallied by JPMorgan) is running slightly ahead of 2005’s record pace, with y-t-d Home Equity Loan ABS sales of $171 billion 14% 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”) jumped $8.2 billion to $1.611 Trillion for the week ended May 3. “Custody” holdings are up $92.8 billion y-t-d, or 17.6% annualized, and $213 billion (15.2%) over the past 52 weeks. Federal Reserve Credit gained $2.9 billion last week to $823 billion. Fed Credit has declined $3.3 billion y-t-d, or 1.2% annualized. Fed Credit expanded 4.7% ($36.6bn) during the past year. 

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – are up $325 billion y-t-d (23% annualized) and $529 billion (13.8%) in the past year to a record $4.371 Trillion. 

May 4 – Bloomberg (Bradley Cook): “Russia’s foreign currency and gold reserves jumped $8.6 billion in a week to pass South Korea as the world’s fourth biggest amid record prices for oil and natural gas, the country’s biggest exports. The reserves rose for the 23rd consecutive week, reaching a record $225.7 billion…”

Currency Watch:

May 4 – Bloomberg (Robert Delaney and Amit Prakash): “China is ‘quite concerned’ about global imbalances and depreciation of U.S. dollar in recent weeks, Vice Finance Minister Li Yong said. Developed nations should take more responsibility to deal with global imbalances, Li said at the annual meeting of the Asian Development Bank…”

The dollar index dropped 1.1%, trading below 85 for the first time in a year. On the upside, the Polish zloty gained 3.7%, the Iceland krona 3.3%, the British pound 1.8%, the Australian dollar 1.7%, and the Brazil real 1.5%. On the downside, the South African rand declined 1.0%, the Thai baht 0.7%, and the Ukraine hryvnia 0.3%.

Commodities Watch:

May 3 – Bloomberg (Alex Emery): “Gold prices will rise over the next 18 months as China and India increase purchases and production stagnates, Newmont Mining Corp. president Pierre Lassonde said. Newmont’s own gold output will fall to 6 million ounces this year, from 6.4 million ounces in 2005, Lassonde told reporters…, which will stay above $600 an ounce during 2006, will be rise through 2008 because of static production and a lack of new gold deposits coming into operation, he said…”

May 5 – Bloomberg (Chanyaporn Chanjaroen): “Funds tracking commodities indexes may hold almost three times more copper contracts than physical metal stored in warehouses monitored by exchanges in London, New York and Shanghai, Bloomsbury Minerals Economics Ltd. said. The funds may hold positions equal to 465,000 metric tons of copper…”

Gold jumped 4.5% to $683.80 and Silver 1.9% to $13.89. Copper surged 8.5% to another record high. Zinc rose to a record high, with prices doubling over the past year. Aluminum prices are up 25% this year to a 17-year high. June crude slipped $1.69 to $70.19. June Unleaded Gasoline declined 2.3%, while June Natural Gas gained 3.4%. For the week, the CRB index gained 0.6% (y-t-d up 6.1%). The Goldman Sachs Commodities Index (GSCI) declined 0.5%, reducing y-t-d gains to 9.5%.   

Japan Watch:

May 2 – Financial Times (David Pilling): “Japan’s labour force has risen for the first time in eight years as women and over 60-year-olds re-enter the jobs market, marking a further sign of the strength of Japan's cyclical recovery… An analysis in yesterday’s Nikkei newspaper found that Japan’s labour force, comprising those in jobs and those seeking work, rose by 150,000 to 66.54m in the year to April…Surveys show that after years of excess labour capacity there are now more jobs than job-seekers. This year, the ratio rose to 104 jobs per 100 applicants…”

May 5 – Bloomberg (David Tweed): “Japan’s fiscal problems are severe and the nation's revenue and spending need to be addressed to find a solution, Finance Minister Sadakazu Tanigaki said. ‘Our fiscal situation remains extremely severe,’ Tanigaki said… Japanese policy makers are at odds about how to reduce the nation’s budget deficit and stop the expansion of the public debt, forecast to swell to 151 percent of gross domestic product by the end of March 2007.”

China Watch:

May 4 – Bloomberg (Rob Delaney and Amit Prakash): “China will help resolve global trade imbalances by increasing consumption and opening its markets because raising the value of the nation's currency too fast would hurt the economy, Vice Finance Minister Li Yong said…”

May 4 – China Knowledge: “China’s total power consumption during the first
half of this year is expected to increase 11.5%, said the China Electricity

Asia Boom Watch:

May 2 - New York Times (Wayne Arnold): “There was a time when coup threats and constitutional crises were turnoffs to foreign investors considering emerging markets. These days it seems no amount of turmoil can deter them. In Thailand, despite huge street demonstrations, foreign investors have poured $2.7 billion into the stock market so far in 2006, the biggest inflow of overseas funds in more than five years… In the Philippines, the president is facing protest and accusations of corruption after warning in February the elements of the military were planning a coup d’etat. Yet foreign purchases of Philippine stocks are at five-year highs… a glut of global savings that is making cheap capital available to both heavily indebted rich economies and riskier developing countries. The resulting avalanche of global investment capital has become largely impervious, they say, to political risks…”

May 1 – Bloomberg (William Sim): “South Korea’s exports rose 12.7 percent in April after companies shipped more electronics, machinery and other goods to China and the U.S., stoking growth in Asia’s third-largest economy. Exports increased to $25.8 billion from a year earlier…”

May 1 – Bloomberg (Anuchit Nguyen and Beth Jinks): “Thailand’s inflation rate unexpectedly accelerated to its highest level in six months as surging fuel costs drove up transport fees, raising prospects the central bank will increase its key interest rate again in June. Consumer prices rose 6 percent in April from a year earlier…”

May 4 – Bloomberg (Luzi Ann Javier): “Philippine economic growth likely topped 5.5 percent in the first quarter because of faster than expected agricultural expansion, Economic Planning Secretary Romulo Neri said…”

Unbalanced Global Economy Watch:

May 2 – Bloomberg (Evalinde Eelens and John Fraher): “Manufacturing in the dozen euro nations expanded in April at the fastest pace in more than five years, adding to evidence the economy is strengthening and may be better able to withstand higher interest rates.”

May 4 – Bloomberg (Fergal O’Brien): “Growth at service companies in the dozen euro nations accelerated to the fastest in more than five years in April, giving the European Central Bank more leeway to raise interest rates.”

May 3 – Bloomberg (Brian Swint): “Unemployment in the dozen countries sharing the euro fell to lowest in four years in March, adding to evidence of faster growth. The jobless rate declined to 8.1 percent, the lowest since April 2002, from 8.2 percent the month before…”

May 4 – Bloomberg (Brian Swint and Laura Humble): “U.K. house prices rose in April by the most in two years, HBOS Plc said, extending a revival in the country’s $6 trillion property market. Prices jumped 2 percent…”

U.K. March M4 money supply was up 12.3% y-o-y, with private sector lending up 11.3% from March 2005.   Lending has expanded at a 14.2% annualized rate during the past three months.

May 1 – Bloomberg (Craig Stirling): “U.K. house prices rose in April at the fastest pace in almost two years, fueled by gains in London and the southeast of England, a survey by Hometrack showed.”

May 2 – Bloomberg (Laura Humble): “U.K. manufacturing grew the most in almost 1 1/2 years in April, adding to signs an industrial revival is taking hold in Europe's second-biggest economy.”

May 2 – Bloomberg (Jonas Bergman): “The pace of domestic borrowing in Norway rose in March, raising pressure on the central bank to increase interest rates for a fourth time since June. Credit growth for households, companies and municipalities accelerated to an annual 13.9 percent…”

May 4 – Bloomberg (Bunny Nooryani and Jonas Bergman): “Norway’s jobless rate in April matched a low last set in December 2001 as surging energy prices spur investments in the nation’s petroleum industry, helping growth in the second-largest Nordic economy. the rate fell to 2.8 percent from 2.9 percent in March…”

May 2 – Bloomberg (Bunny Nooryani): “Norwegian oil workers began wage talks with employers today, seeking to increase their share of the profit oil companies…are making… Labor unions Nopef, SAFE and Lederne started negotiations with employer group OLF at noon in Stavanger, Nopef leader Leif Sande said…‘We expect to get higher wages. The industry is making a lot of money these days, and this should be shared with the workers.’”

May 3 – Bloomberg (Hans van Leeuwen): “Following is the text of a statement by Reserve Bank of Australia Governor Ian Macfarlane…: ‘Following a decision taken by the Board at its meeting yesterday, the Bank will be operating in the money market this morning to increase the cash rate by 25 basis points, to 5.75 percent. International developments are continuing to provide stimulus to growth in Australia. The world economy is growing at an above-average pace for the fourth successive year and, significantly, forecasts have recently been revised upwards. Commodity prices have been increasing strongly for some time, and they have risen further in the year to date. This suggests a strengthening in the outlook for Australia’s export earnings, with consequent expansionary effects on incomes and spending. In Australia, domestic spending has been growing at a solid pace recently and prevailing conditions suggest that this is likely to continue. High profitability and rising share prices are indicative of a favorable business environment in which investment growth is likely to remain strong.’”

May 5 – Bloomberg (Nasreen Seria): “South African credit growth accelerated to a record 24.3 percent in March, increasing speculation the central bank will increase interest rates for the first time since 2002.”

Latin America Watch:

May 2 – Bloomberg (Adriana Arai): “Mexican economic growth probably quickened to the fastest pace in five years in the first quarter, led by a recovery in agricultural output, according to a Finance Ministry estimate…”

Bubble Economy Watch:

Average Hourly Earnings were up stronger-than-expected during April, with the 3.8% y-o-y increased the strongest since the summer of 2001. March Personal Income growth was stronger-than-expected, with a y-o-y gain of 6.0%. Personal Spending was up 6.4% from March 2005. The April reading of the ISM Non-Manufacturing index was a stronger-than-expected 63, the highest level since last August. The Prices Paid component jumped 10 points to 70.5, the high since November. New Orders increased 5.1 points to 64.6 (2-mnth gain of 8.4) to the highest level since April 2004. March Factory Orders were much stronger-than-expected (up 4.2% from Feb.), with a y-o-y gain of 11.6% (Ex-transports up 6.8%). Capital Goods Orders were up 34.2% from March 2005. 

May 4 – Dow Jones (Rob Wells): “Surging tax revenues from final April tax payments are projected to narrow the U.S. federal budget deficit, a new research report says. Tax payments that weren't withheld from workers' paychecks through the end of April are running $26 billion ahead of last year's receipts, or nearly 13% ahead of last year's levels, according to JPMorgan Chase Bank economist Robert Mellman.”

May 3 – Bloomberg (Lindsay Pollock and Philip Boroff): “An unflattering portrait of one of Picasso’s most celebrated lovers, artist Dora Maar, sold for $95.2 million tonight at Sotheby’s…the second-highest auction price ever paid for an artwork. The 1941 ‘Dora Maar au Chat’…the eye-catching portrait almost doubled its presale estimate of about $50 million.”

Mortgage Finance Bubble Watch:

May 2 – Bloomberg (Alex Tanzi): “More homeowners received cash from home refinancings in the first quarter, according to Freddie Mac. In the first quarter of 2006, 88 percent of Freddie Mac owned loans that were refinanced resulted in new mortgages of at least five percent more than the original mortgages. That was up from 81 percent the previous quarter and is the highest since the third quarter 1990.”

Energy and Crude Liquidity Watch:

May 4 – Bloomberg (Andy Critchlow and Alan Katz): “When Omar bin Sulaiman takes delivery of the red Ferrari F430 he ordered in January, he’ll have two of the company’s sports cars in his collection. He also owns a Bentley Flying Spur and a Porsche Cayenne sport-utility vehicle. ‘If God blessed you with wealth, you should enjoy it,’ says Sulaiman, 33, who runs the Dubai International Financial Centre, a hub for investment banks in Dubai… Middle East magnates, flush with cash from high oil prices, are filling their garages with sports cars and SUVs… Buyers in the U.A.E. have ordered 15 of the $1.2 million coupes since Volkswagen AG’s Bugatti division began selling them in December.”

Fiscal Deficit Watch:

May 1 – Dow Jones: “The U.S. Social Security trust funds are expected to be exhausted by 2040, a year earlier than the previous year’s estimate, while the Medicare trust fund is projected to go broke by 2018, two years earlier than last year’s projections, according to the latest annual report from the funds’ trustees. The Bush administration had made Social Security overhaul an early second-term priority, but that push largely stalled in Congress… ‘We do not believe the currently projected long-run growth rates of Social Security or Medicare are sustainable under current financing arrangements,’ the trustees wrote.”

Speculator Watch:

May 1 – Bloomberg (Tak Kumakura and Michael Tsang): “Japanese assets held by hedge funds rose 38 percent last year as pensions and other institutions broadened investments amid a recovery in the nation's shares, the Nikkei Financial Daily said, citing a Columbia University study. The balance of assets held by the world’s hedge funds in Japan climbed to $54.8 billion at the end of 2005…”

“Money” Analysis:

May 4 – MarketNewsInternational: “Quick money supply and credit growth continue apace despite the European Central Bank’s two rate hikes, and must therefore be countered, ECB Governing Council member Axel Weber said… Asked whether a 50-basis-point rate hike was possible, Weber noted that the central bank never foreclosed on any possibilities...   …Weber observed that ‘we are in an environment with a very high liquidity dynamic. This liquidity dynamic is unbroken and has strengthened despite the two interest rate moves distributed over three months. We simply have to see in this environment that we have more liquidity than necessary for financing inflation-free growth. Therefore, we must brake and reverse this liquidity dynamic and this will play a role for us in future decisions.’”

May 3 – Bloomberg (John Fraher): “Otmar Issing is coming into fashion -- just as he prepares to retire as chief economist of the European Central Bank. Issing, 70, who attends his last interest-rate meeting tomorrow, argues that analyzing the flow of money through the economy helps central bankers identify asset-price bubbles. His view is attracting greater attention as property, stock and commodity prices surge globally. ‘Times are changing,’ said Thomas Mayer, chief European economist at Deutsche Bank… and a former researcher at the IMF.  Issing’s philosophy ‘is gaining more support among a broader audience.’ In Japan and Sweden, central bankers are adopting policies echoing the ECB’s focus on the inflation threat posed by money supply and credit growth. The Bank of Japan’s monetary policy review…pledged to gauge ‘longer run’ risks to inflation. Sweden’s central bank last month conceded it ‘cannot ignore’ the risks posed by an increase in loans. Interest in money supply ‘is on the rise,’ said Jim O’Neill…chief global economist at Goldman Sachs… ‘Without it, there’s a risk of underestimating the consequences of asset prices and their impact on further monetary policy.’ The U.S. Federal Reserve is the most prominent holdout from Issing’s view: Chairman Ben Bernanke says that policy makers shouldn’t use rates to interfere with the markets…”

 I can only hope that times really are changing and that money and Credit do begin to attract more analytical and policymaker interest. Regrettably, the Bernanke Fed will remain a steadfast holdout, wedded to a flawed analytical regime and a Credit system apparently too hot to handle. Could there be a less opportune juncture for disregarding Credit excess, asset inflation and Bubbles (broad inflationary manifestations) - focused instead on incorporating an (narrow and un-analytical) inflation targeting regime?

In previous CBB’s, I made some flippant comments, basically saying “good riddance” to the weekly M3 data. I’m not backing down, although I will attempt to underpin this view with some explanation and analysis. 

Years back I became convinced of the unreliability of the monetary aggregates. During the '90s, the evolution of ‘money’ creation and Credit expansion took a giant bound to a much more Wall Street, securities and mortgage centric dynamic.  Myriad new types of financial sector debt issuers and Credit instruments - along with novel avenues of financial intermediation - profoundly altered a Credit system previously dominated by bank assets (chiefly loans) and liabilities (largely deposits). Increasingly, it was the aggressive and enterprising “non-banks” dictating the pace and direction of the “flow of finance” throughout the markets and economy. 

In the context of this vastly altered financial landscape, the M’s at times provided an acceptably reliable reflection of underlying Credit and economic growth trends. At other times, however, they would seem to go out of their way to confuse and deceive. Worse yet, it’s been my view that conventional “money” supply data tends to deliver their most confounding signals at key marketplace and Credit system junctures (i.e. major shifts in market perceptions and attendant financial flows).

The 2003 experience provides an illuminating case in point. The year proved pivotal for the upsurge in Credit Bubble Momentum. The Fed lowered rates to 1% in June, just a few weeks subsequent to Fed governor Bernanke delivering one of his seminal “reflationary” dissertations, “Some Thoughts on Monetary Policy in Japan.” M3 expansion had been slowing markedly. For the year, broad ‘money’ growth had declined to a rate of only 3.6%, about half of 2002’s 6.6% expansion and a fraction of 2001’s 12.9%. M3 was actually little changed during the second-half of 2003 and even ended the year with a $60 billion contraction over a 4-month period. There was at the time a groundswell of Money Babble about the falloff in M3 and how this indicated a contraction of Credit. Readers likely recall all the deflation hoopla. 

The M3 aggregate had deceived. The reality of the situation was that Household Mortgage Debt was expanding at double-digit rates during this period, as the Historic Mortgage Finance Bubble shifted fully into overdrive. Total (non-financial) Credit was growing briskly, in the neighborhood of 7%, with Financial Sector borrowings expanding by about 10%. Several components of the monetary aggregates were stagnating, although the much more significant development was the major issuance boom in GSE, MBS, and ABS debt instruments (“structured finance” broadly).  Curiously, the data was all there to elucidate the burgeoning Credit and Asset Bubbles, although many analysts were steadfast in their fixation on the M’s (and deflation risk). 

Of course, the Fed had deliberately incited a frantic pursuit of yield. Investors of all sizes and stripes were liquidating bank deposits and money market accounts/instruments for richer pickings throughout the junk, agency, corporate and “structured products” marketplace. Hedge funds and bond managers were on the receiving end of massive ‘money’ flows (most emanating from mortgage borrowings), and Wall Street investment bankers were tickled to oblige with unlimited quantities of new (“money-like") securities, the preponderance of them mortgage-related. A strong inflationary bias had already taken hold throughout the nation’s housing markets (“home prices always go up and, besides, they certainly beat those bloody stocks!”). Instead of ‘deflation’ there was the opposite: an unfolding historic boom in securities issuance, Credit expansion, liquidity creation and asset-inflation.   

A major disintermediation out of the money market fund complex saw fund assets contract $249 billion during 2003 and another $131 billion during 2004. Retail and institutional investor alike were finding it advantageous to purchase higher-yielding GSE, MBS, ABS, and corporate debt securities directly (not to mention equities and the emerging markets). The Internet, the proliferation of brokerage accounts, the shift of retirement savings to active management, and the rise of the powerful tandem of the GSE’s and Wall Street investment bankers all exacerbated the trend to the direct purchase of securities. Keep in mind that Retail Money Fund assets are a component of M2, and Institutional Money Funds were part of M3. If investors prefer to invest directly in money market instruments rather than having them intermediated through the money funds, then the expansion of these instruments (Credit inflation) will not be reflected in the monetary aggregates. 

A change in the marketplace’s preference for duration can have a major impact on the M’s, especially M3.  A few years back I used the hypothetical example of a money market fund that held short term Fannie Mae debt instruments. With short-term rates at 1%, let’s say that fund investors came together and voted to convert to a bond fund. In this circumstance, the fund manager could simply call Fannie and negotiate a change in maturity structure on their securities (transform them from “money market instruments” to “bonds”). Such a situation would exact no change in the underlying quantity of outstanding Credit or liquidity, although “money” supply would decline (reduced money market fund assets). 

Importantly, M3 is a problematic indicator of system liquidity, while it can very well give completely erroneous signals at key junctures. In particular – and as we witnessed during 2003 – when the marketplace is moving aggressively toward higher-yielding and riskier financial assets, M3 growth would be expected to badly lag underlying Credit expansion. Indeed, at critical junctures, a stagnating M3 could be perfectly consistent with liquidity overabundance in riskier asset classes. And it is worth noting that MZM (“money at zero maturity”) is an especially flawed measure of system liquidity, specifically because it includes – and is distorted by the vagaries of - money fund assets (while excluding time deposits). MZM was a good enough indicator of system liquidity when GSE balance sheet growth (and money market borrowings) was a major factor, but has become an especially poor metric the past few years.  

As was the case in late-2003, a Credit system can be highly liquid despite contracting M3. While unavoidably ambiguous, system liquidity is determined by Credit creation, as well as the capacity for financial sector (liability) expansion (which hinges on marketplace perceptions and expectations). The M’s may or may not reflect underlying Credit expansion, while they provide little indication of the underlying capacity for a leverage and securities-based financial system to expand. 

The key to fruitful monetary analysis is to de-aggregate – to carefully examine individual monetary components (in the context of comprehensive Credit system analysis), endeavoring to decipher changes in lending patterns and financial flows – both at the margin. Is an expansion or contraction in an individual component signaling a change in the level of lending? If so, by whom and to what consequence - change in funding business investment, consumption or the asset markets? Or is a change in an individual component (or components) evidence of an adjustment in the marketplace “flow of finance”? And, again, to what consequence? If money market fund assets are contracting, is this primarily an indication of reduced Credit growth and declining investor liquidity, or is it instead associated with a shift in preference for other asset classes (changing perceptions are likely related to Credit developments elsewhere)? What are the ramifications? 

I can say a tearless adios to M3 because of the characteristics of the underlying components. Large-Denomination Time Deposits are available with the weekly (H.8) Commercial Bank data. I can look to other weekly sources to follow Money Market Fund developments.   As for “Eurodollars” (see definition below), this archaic component of deposits of “U.S. addressees at foreign branches of U.S. banks” is essentially meaningless in the contemporary globalized world of “offshore” international (securities-based) finance. There are today myriad dollar-denominated financial assets domiciled in U.S. and foreign financial institutions all over the world that share similar attributes to M3 components that are impossible to monitor on a weekly basis.

One of the biggest faults of M3 was that it included only the net U.S. commercial banking “repo” position (of Treasury and agency debt) – see the Fed’s definition below.   As such, it is worth noting that M3 “repo” component increased $52.4 billion (10%) over the past two years to $560.1 billion (as of 3/6/06), while over the same period primary dealer “repos” (reported by the New York Fed) jumped $735 billion (27%) to $3.46 Trillion. “Repos” have become a most integral aspect of the (global) money market, and it’s fair to presume the Fed doesn’t have a clear grasp of how to account for them (let alone manage them). I consider the M3 “repo” component essentially meaningless as well.

Taking a step back, I begin with a “Misesian” view of money. This analytical framework incorporates a broad range of “fiduciary media” demonstrating the “economic functionality” of (narrowly defined) money. Or, as I see it, “Money is as money does.” “Money” remains of great significance, as it has been throughout history. It possesses special attributes that ensure that it remains highly desired, almost without respect to the quantity issued. As such, it is invariably at risk of over-issuance, while becoming an increasingly integral aspect of major inflationary Bubbles. Money is, as well, invariably susceptible to abrupt shifts in perceptions and confidence (a thin line between love and hate). 

We operate in Credit-based financial and economic systems. So contemporary “money” is not distinguished by it transactional role (“medium of exchange”). Instead, Credit instruments realize the valuable attribute of “moneyness” when they are perceived as extraordinarily safe (to the loss of nominal value) and liquid. My view of contemporary “money” is reality-based, although it admittedly opens up an analytical “can of worms.” 

Marketplace perceptions dictate “The Moneyness of Credit” - or the faith in the underlying safety and liquidity of Credit instruments. For a list of reasons (some noted in this CBB), I suggest that it is today basically impractical to identify, aggregate, or model contemporary “money” dynamics. There is no definitive “money supply.” Credit instruments change and the nature of Credit intermediation changes. Perceptions change - and do so subtly over time, as well as abruptly in real time. Importantly, during periods of rapid Credit growth and asset inflation, it will be the nature of the ebullient marketplace to accept an ever broadening scope (and risk profile) of Credit instruments and intermediation as “money-like.” “Repos” and asset-backed securities are these days some of the most coveted “money” in a way unthinkable just a decade ago.      

There are some major developments that have impacted the nature of contemporary “money,” and certainly the relevance of now archaic aggregation methodology. Wall Street firms and their liabilities have become a centerpiece of the monetary system. The ballooning of the global leveraged speculator community has had a profound influence on all facets of “money.” It is likely that investor flows into funds has negatively impacted monetary aggregate balances (i.e. deposits and money market fund assets), while at the same time augmenting Credit Availability and Marketplace Liquidity. To be sure, much of current speculative leveraging is financed through the shorting of debt securities. In this manner, Credit and marketplace liquidity are created (in gross excess) through the process of expanding non-monetary aggregate liabilities (i.e. “repos” and borrowed securities). 

The massive U.S. Current Account Deficits and attendant ballooning foreign central bank holdings of American securities have also weakened the relationship between the M’s and system Credit growth and liquidity.  Each day an enormous amount of Credit is created and liquidity sent abroad, only to disseminate purchasing power for acquiring U.S. Treasury, agency, corporate, ABS, MBS and other “structured products.” In this manner, massive Trade Deficits may work to stem monetary aggregate expansion (household deposits used to buy imports), but they in no way impede marketplace liquidity or Credit expansion. Indeed, a strong case can be made that this liquidity recycling dynamic has been a key facet of the “conundrum” - playing a seminal role in over-liquefied U.S. securities markets.

Mushrooming derivatives markets are a monumental monetary development. Clearly, the capacity to readily hedge various risks – certainly including Credit, interest-rates, currency and liquidity – has significantly altered monetary analysis. Today, hedging non-monetary liabilities is straightforward, in the process modifying the characteristics of non-money Credit instruments to more “money”-like. Here, the combined instruments and their hedging vehicles mimic the attributes of “money,” making the identification and tabulation of contemporary functional “money supply” impossible. 

At this precarious stage in the cycle, most of my analytical focus is directed to Credit and Speculative Dynamics. As long as Credit expands sufficiently to sustain the boom (which it is clearly doing), analysis of “money” needn’t take up much of our time or attention. We don’t have to be concerned with the Fed covertly “printing” M3, as the jettisoned components are all financial sector liabilities.  And we can remain quite confident that financial sector liability expansion continues in earnest. Inflating asset prices and asset markets - through heightened speculative leveraging - create their own source of liquidity. 

But there will come a day when discerning the evolving nature of “money” perceptions will play a prominent role in our analysis. Sure, when the Bubbles begin to lose air we’ll be carefully watching the Fed’s balance sheet. But I would venture a prediction this evening that the more significant dynamic will be the degradation of at least some of the inflated asset-market-based (“Wall Street Finance”) dollar-denominated “money” into much less precious non-money. That’s the nature of bursting monetary Bubbles. And the longer the Wall Street “printing press” is left to its own devices To Inflate Scores of Bubbles at Home and Abroad, the more emasculated Dr. Bernanke’s printing efforts will play down the road. 

M3 Component Definitions:

“Repurchase Agreements”: “RP liabilities of depository institutions, in denominations of $100,000 or more, on U.S. government and federal agency securities, excluding those amounts held by depository institutions, the U.S. government, foreign banks and official institutions, and money market mutual funds.”

“Eurodollars”: “Eurodollars held by U.S. addressees at foreign branches of U.S. banks worldwide and at all banking offices in the United Kingdom and Canada, excluding those amounts held by depository institutions, the U.S. government, foreign banks and official institutions, and money market mutual funds.”