11/25/2005 A Quickie on 'Money' *

The Dow this week gained 1.5%, and the S&P500 rose 1.6%. The Transports gained almost 1% to a new record high. The Utilities gained 1.6%, and the Morgan Stanley Cyclical index rose 1.5%. The Morgan Stanley Consumer index increased 0.4%. The broader market rallied continued. The small cap Russell 2000 jumped 1.7%, and the S&P400 Mid-cap index rose 1.9%. The NASDAQ100 gained 1.2%, and the Morgan Stanley High Tech index rose 1.8%. The Semiconductors rose 1.3%, increasing y-t-d gains to 11.8%. The Street.com Internet Index added 0.2%. The NASDAQ Telecommunications index gained 1.6%. The highflying Biotechs were about unchanged (up 25.8% y-t-d). The financial stocks were strong. The Broker/Dealers gained 3% and the Banks added 2%, both to new record highs. With bullion up $10.30 to $496, the HUI gold index rose 3.9%. Indications that the Fed may be pondering a pause supported the bond market rally. For the week, two-year Treasury yields dropped 4 basis points to 4.35%. Five-year government yields declined 9 basis points to 4.33%, and bellwether 10-year yields fell 6 basis points for the week to 4.43%. Long-bond yields dipped 2 basis points to 4.66%. The spread between 2 and 10-year government yields fell to 8bps. Benchmark Fannie Mae MBS yields sank 10 basis points to 5.76%, this week outperforming Treasuries. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note increased 2 to 38 and the spread on Freddie’s 5% 2014 note increased one to 38. The 10-year dollar swap spread dipped 0.5 to 54.25. Investment grade corporate bond spreads widened slightly, while junk spreads narrowed somewhat. The implied yield on 3-month December ’06 Eurodollars fell 11.5 basis points to 4.69%. Investment grade corporate issuance slowed to about $8 billion (from Bloomberg). Issuers included HSBC $1.5 billion, Pemex $750 million, St. Paul Travelers $400 million, Archstone-Smith $200 million, and Cleco Power $150 million. Junk bond issuers included Avago Tech $1.0 billion, Wind Acquisition $500 million, Tronox Worldwide $350 million, Chaparral Energy $325 million, Metals USA $275 million, Gibraltar Industries $200 million, Greektown Holdings $185 million, Network Communications $175 million, and TTX $110 million. Convert issues included Richardson Electric $25 million. Foreign dollar debt issuers included Irish Life $1.5 billion and Eletrobras $300 million. Japanese 10-year JGB yields dipped 1.5 basis points this week to 1.44%. Emerging debt and equity markets continue to perform well. Brazil’s benchmark dollar bond yields declined 10 basis points to 7.48%. Brazil’s Bovespa equity index jumped 2.7%, increasing y-t-d gains to 21.9%. The Mexican Bolsa added 2%, with 2005 gains rising to 30.6%. Mexican govt. yields fell 7.5 basis points to 5.39%. Russian 10-year dollar Eurobond yields declined 7 basis points to 6.41%. The Russian RTS equity index rose 2%, increasing y-t-d gains to 68.5%. Freddie Mac posted 30-year fixed mortgage rates dropped 9 basis points to 6.28%. Rates were up 56 basis points from one year ago. Fifteen-year fixed mortgage rates declined 9 basis points to 5.81%, but were up 66 basis points in a year. One-year adjustable rates fell 6 basis points to 5.14%. One-year ARM rates were up 77 basis points from one year ago. The Mortgage Bankers Association Purchase Applications Index dipped 1.2% last week. Purchase Applications were up 2.7% from one year ago, with dollar volume up 7%. Refi applications declined 6.9% to the lowest level since June 2004. The average new Purchase mortgage rose to $241,800, while the average ARM jumped to $362,700. The percentage of ARMs increased to 33.2% of total applications. Broad money supply (M3) expanded $8.3 billion (week of November 14) to $10.071 Trillion. Over the past 26 weeks, M3 has surged $446 billion, or 9.3% annualized. Year-to-date, M3 has expanded at a 7.1% rate, with M3-less Money Funds expanding at a 7.9% pace. For the week, Currency added $1.3 billion. Demand & Checkable Deposits dipped $1.0 billion. Savings Deposits fell $15.5 billion. Small Denominated Deposits increased $2.5 billion. Retail Money Fund deposits dipped $0.6 billion, while Institutional Money Fund deposits rose $5.4 billion. Large Denominated Deposits gained $7.3 billion. Year-to-date, Large Deposits are up $266 billion, or 27.9% annualized. For the week, Repurchase Agreements jumped $7.5 billion, and Eurodollar deposits gained $1.4 billion. Bank Credit jumped $23.0 billion last week. Year-to-date, Bank Credit has inflated $667.5 billion, or 11.2% annualized. Securities Credit increased $3.9 billion during the week, with a year-to-date gain of $152.6 billion (9.0% ann.). Loans & Leases have expanded at a 12.3% pace so far during 2005, with Commercial & Industrial (C&I) Loans up an annualized 15.5%. For the week, C&I loans rose $5.0 billion, while Real Estate loans declined $4.5 billion. Real Estate loans have expanded at a 13.9% rate during the first 46 weeks of 2005 to $2.855 Trillion. Real Estate loans were up $336 billion, or 13.3%, over the past 52 weeks. For the week, Consumer loans expanded $4.9 billion, and Securities loans increased $7.6 billion. Other loans gained $6.1 billion. Total Commercial Paper increased $6.2 billion last week to $1.663 Trillion. Total CP has expanded $248.8 billion y-t-d, a rate of 19.5% (up 19.7% over the past 52 weeks). Financial CP jumped $6.9 billion last week to $1.497 Trillion, with a y-t-d gain of $212.7 billion, or 18.3% annualized (up 19.4% from a year earlier). Non-financial CP dipped $0.8 billion to $165.6 billion (up 30.8% ann. y-t-d and 23.2% over 52 wks). ABS issuance was a holiday-week robust $30 billion (from JPMorgan). Year-to-date issuance of $713 billion is 21% ahead of comparable 2004. Home Equity Loan ABS issuance of $465 billion is 21% above comparable 2004. Fed Foreign Holdings of Treasury, Agency Debt jumped $11.6 billion to $1.50 Trillion for the week ended November 23. “Custody” holdings are up $163.9 billion y-t-d, or 13.6% annualized (up $182.9bn, or 13.9%, over 52 weeks). Federal Reserve Credit declined $2.4 billion to $806.5 billion. Fed Credit has expanded 2.2% annualized y-t-d (up $26.6bn, or 3.4%, over 52 weeks). International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $574 billion, or 16.7%, over the past 12 months to $4.05 Trillion. China’s reserves increased 49.5% over the past year to $769 billion. Currency Watch: The dollar index was about unchanged this week. On the upside, the South African rand gained 2.5%, the Canadian dollar 1.7%, the New Zealand dollar 1.4%, and the Polish zloty 1.3%. On the downside, the Jamaica dollar fell 2.6%, the Iceland krona 2.3%, the New Romanian leu 1.0%, and the Argentine peso 1.0%. Commodities Watch: November 25 – Bloomberg (Wing-Gar Cheng): “China’s consumption of crude oil may rise 6.7 percent next year, little changed compared with this year’s estimated growth, because high oil prices increased refiners’ raw material costs, a government report said. China may consume 331 million metric tons of crude oil next year, the State Council’s Development Research Center said… Oil consumption this year may gain 6.2 percent to 310 million tons, it said.” November 25 – Bloomberg (Simon Casey): “Zinc rose to a 15-year high in London amid forecasts that demand for the metal, which is mostly used to protect steel from corrosion, will exceed production this year and in 2006.” December crude oil gained $1.50 to $58.71. December Unleaded Gasoline was about unchanged, while December Natural Gas rose 1.8%. For the week, the CRB index gained 0.6%, increasing y-t-d gains of 10.8%. The Goldman Sachs Commodities index rose 0.6%, with 2005 gains increasing to 34.1%. China Watch: November 23 – XFN: “China’s industrial firms’ profits rose 19.4% to 1.11 trln yuan in the first 10 months of this year, the National Bureau of Statistics said…That compares with an increase of 20.1% in the first nine months of this year and 39.7% for the first 10 months of last year.” November 25 – Bloomberg (Wing-Gar Cheng): “China, the second-largest oil consumer, said its bill for importing the fuel jumped 70 percent in October from a year earlier. The amount the nation spent on oil imports increased to $4.9 billion last month… In the first 10 months, the nation spent 47 percent more on oil imports for a total of $39 billion. China’s oil imports rose 21 percent to 11.25 million tons in October…” November 25 – Bloomberg (Joshua Fellman): “Hong Kong’s economy expanded more than expected in the third quarter and the government raised its full-year growth forecast, citing robust exports, consumer spending and capital investment. Gross domestic product rose a seasonally adjusted 2.7 percent from the second quarter… From the same period of 2004, the economy expanded 8.2 percent, the fastest in more than a year.” Asia Boom Watch: November 23 – Bloomberg (Kartik Goyal): “Foreign direct investments into India in the fiscal half year rose 18 percent, boosted by investments in the automobile and energy sectors… India, Asia's fourth-biggest economy, wants to attract $150 billion of overseas investments in public works in the next 10 years to sustain an economic growth rate of 7 percent to 8 percent…” November 23 – Bloomberg (Yu-huay Sun): “Taiwan’s export orders reached a record in October and industrial production grew at the fastest pace in more than a year as global electronics spending picked up and a weaker currency helped exporters compete. Orders, indicative of actual shipments in one to three months, surged 21.6 percent from a year earlier to $24.6 billion… Growth in industrial output accelerated to 9.3 percent from a revised 6.9 percent.” November 23 – Bloomberg (Seyoon Kim): “South Korea’s economic growth is expected to accelerate to 5 percent next year, driven by gains in exports and domestic demand, according to forecasts… by the government and the central bank. ‘The economy has bottomed out and is gradually entering a recovery phase,’ Finance Minister Han Duck Soo said… ‘Exports and domestic demand are balanced and this trend of recovery will continue through next year.’ Next year’s projected growth would be the fastest in four years.” November 23 – Bloomberg (Chan Tien Hin): “Vehicle sales in Malaysia, Southeast Asia’s biggest passenger car market, rose 29 percent to a monthly record in October, as low interest rates and new models spurred demand. Sales of passenger cars and commercial vehicles rose to 56,696 last month from 43,914 a year earlier, its third month of gains…” November 22 – Bloomberg (Laurent Malespine): “Thailand’s economy probably accelerated in the third quarter as exports of electronics and cars surged, Central Bank Governor Pridiyathorn Devakula said. Southeast Asia’s second-largest economy probably expanded more than 4.5 percent in the three months…after gaining 4.4 percent in the second quarter…” November 25 – Bloomberg (Jun Ebias): “Philippine imports climbed to a record in September and the trade deficit tripled as higher crude oil costs boosted the nation’s fuel bill. Imports rose 7.8 percent from a year earlier to $4.11 billion… Purchases of fuel and related materials jumped 86 percent to $758 million and the trade deficit tripled to $516 million.” November 22 – Bloomberg (Jason Folkmanis): “Vietnamese inflation accelerated in November for the third consecutive month, driven by higher prices for food and construction materials. Consumer prices rose 8.5 percent in November from a year earlier after gaining 8.3 percent the previous month, the Hanoi-based General Statistics Office said in a report today. Prices rose 0.4 percent in November from October.” Unbalanced Global Economy Watch: November 22 – Bloomberg (Sandrine Rastello): “French consumer spending on manufactured goods unexpectedly fell for a second month in October, suggesting growth in Europe’s third-largest economy is slowing.” November 25 – Bloomberg (Jacob Greber): “Swiss leading economic indicators rose in November to the highest in five years, supporting the Swiss central bank's case for a rate increase.” November 25 – Bloomberg (Jonas Bergman): “Swedish central bank Deputy Governor Villy Bergstroem said that the bank will need to raise interest rates to keep inflation from accelerating as conditions in the economy are ‘very expansionary.’ ‘My assessment - and this is my personal opinion – is that financial conditions are very expansionary and that it would now appear that tighter monetary policy is required to ensure that inflation is not allowed to accelerate and threaten the 2 percent target,’ Bergstroem said…” November 23 – Bloomberg (Samantha Shields): “At the end of Moscow’s Ruble Road lies a plot of land 30 times the size of Red Square that locals already call ‘Millionaire Town.’ The Russian capital’s planning office last month approved a $3 billion project to turn the land into accommodation for 30,000 people, replete with a yacht club and horse paddocks. The average cost of the villas will be $5,000 a square meter compared with an average monthly wage in the city of $400… Moscow now has 23 billionaires, lagging behind only New York, according to Forbes magazine. About 25.5 million people, or 18 percent of the country, live in poverty.” November 23 – Bloomberg (Tracy Withers): “New Zealand’s central bank Governor Alan Bollard says slowing the pace of domestic demand is a ‘priority’ and another interest-rate increase cannot be ruled out. In a briefing for the new government, Bollard said core inflation remains high even as economic growth is slowing. This makes setting interest rates ‘challenging,’ he said.” Latin America Watch: November 23 – Bloomberg (Patrick Harrington): “Mexico’s exports rose in October, led by a surge in automobile production for sale in the U.S. market. Exports rose 14 percent to $19.2 billion in October from $18.3 in September and $16.9 billion in the year-earlier period, a Finance Ministry report showed. The country’s trade deficit widened to $631 million in the month from $331 million in September.” November 21 – Bloomberg (Patrick Harrington): “Mexican retail sales rose 5.2 percent in September led by increased vehicle, pharmacy and supermarket purchases. The rise in sales from a year earlier followed gains of 5.6 percent in August and 3.3 percent in July” November 22 – Bloomberg (Elzio Barreto and Andrew J. Barden): “Brazil’s benchmark bond climbed to a record high after Standard & Poor’s credit rating company said the outlook for the country’s rating is the best ever. Reduced spending and increased exports have Brazil headed toward obtaining an investment grade rating and it has a one-in-five chance of doing so within five years, said David Beers, S&P’s head of sovereign and international ratings…The yield to the 2015 call date on Brazil’s benchmark 11 percent bond due in 2040 fell to 7.610 percent…” November 23 – Bloomberg (Matthew Walter): “Chile’s economy grew 5.2 percent in the second quarter, as the world’s biggest copper producer benefited from record high prices for the metal, and investment and consumer spending rose. Chile’s economy benefited from surging demand for copper in China and the U.S. in the third quarter and capital spending increased 24.7 percent…” November 23 – Bloomberg (Alex Kennedy): “Venezuela’s economy may expand as much as 9 percent in the fourth quarter, fuelled by growth in construction and manufacturing, pllanning Minister Jorge Giordani said.” November 21 – Bloomberg (Alex Emery): “Peru’s economy is set to grow 7 percent this year, faster than originally projected, President Alejandro Toledo said. The pace of growth in 2005 will make Peru the world’s sixth-fastest expanding emerging market economy…” Bubble Economy Watch: November 21 – Bloomberg (Andy Burt): “U.S. spending on Visa brand cards rose last week compared with the same week last year, according to VISA. In the week ending Nov. 20 purchases with Visa debit and credit cards rose 16.6 percent to $22.627 billion…” November 25 – New York Times (John Broder): “After four years of tight budgets and deepening debt, most states from California to Maine are experiencing a marked turnaround in their fiscal fortunes, with billions of dollars more in tax receipts than had been projected pouring into coffers around the country… In Sacramento, officials are setting aside part of a multibillion-dollar revenue windfall to build up California’s depleted cash reserves. Delaware has appropriated money for a pilot program for full-day kindergarten, and Florida will spend nearly $400 million on a new universal preschool program for 4-year-olds. Some states, including New York, New Jersey, Hawaii and Oklahoma, are pouring significant new sums into public colleges and universities after several years of sharp cutbacks. One sign of the improved fiscal health…is that only five states were forced to make midyear budget cuts, totaling $634 million, in the fiscal year… In 2003, by contrast, 37 states cut spending in the middle of the budget year, by a total of $12.6 billion…”  Mortgage Finance Bubble Watch: November 25 – Bloomberg (Kathleen M. Howley): “Massachusetts’ five-year housing boom, which lifted the average home price by 71 percent and bolstered the local economy, is over, according to homeowners and real estate agents. Rising mortgage costs, an outgrowth of 12 consecutive interest-rate increases by the Federal Reserve since June 2004, have cooled demand, they said. Prices have dipped and sellers are rushing into the market even as weekend ‘open houses’ attract few prospective buyers.”  A Quickie on “Money”: “Money” connotes quite different things to different people. Some would argue that gold – a store of value over the ages that is nobody’s liability – is money in its purest form. Others have a more traditional (narrow) focus on currency and banking system reserves (“money stock”), and would generally analyze “money” primarily in terms of its role in consummating transactions. Many still view the money supply as something under the Federal Reserve’s control, holding “Fed pumping” responsible when the monetary aggregates expand rapidly. It is common for pundits to focus on what they believe “money” should be rather than the distinguishing characteristics of the creation, intermediation, risk profile, function and various effects of today’s extraordinary inflation of myriad financial claims. And while most will view it as unconventional, I believe my “money” analytical framework is consistent with the thinking of some of the leading monetary economists of the past. Consistent with Ludwig von Mises’ “fiduciary media” approach, monetary analysis must be quite broad in scope and focused on the “economic functionality” of new financial claims. Allyn Abbott Young was keen to appreciate the “preciousness” attribute of money throughout history. It is the perceived preciousness (“moneyness”) of specific types of contemporary financial claims that leave them highly susceptible to over-issuance. Traditionally, when it came to financial claims expansion it was government issued currency and central bank created reserves that generally enjoyed the type of persistent (“store of value”) demand conducive to protracted Credit inflations. These days, the defining feature of contemporary Wall Street finance is the amalgamation of financial sector intermediation, the proliferation of credit insurance, financial guarantees, derivatives, implied and explicit GSE and government guarantees, and myriad sophisticated risk-sharing structures that have created to this point unlimited capacity to issue perceived “precious” financial claims. It is the Inherent and Dubious Nature of The Moneyness of Credit that Supply Creates its Own Demand. I will loosely define contemporary “money” as financial claims perceived to be a highly safe and liquid store of nominal value. Simple enough, one would think, although it is a definition quite problematic for most. The catch is “perceived.” You can’t model perceptions, so my definition would be unacceptable to most academics, econometricians and trained economists (including Fed economists that measure and monitor money growth). Nonetheless, it is my view that the type of financial claims that demonstrates the “economic functionality” of “money” can vary greatly depending on evolving marketplace perceptions with respect to safety, liquidity, and the capacity to maintain nominal value. And, importantly, I strongly argue that over the life of an inflationary boom the marketplace will come to perceive characteristics of “moneyness” in an expanding array of financial claims, and that this expanding universe of readily accepted instruments plays a defining role in perpetuating the boom. This is particularly the case when it comes to asset Bubbles and the underlying claims backed by inflated collateral values (i.e. after a protracted real estate boom, ABS and MBS today enjoy perceived moneyness qualities). Almost by definition, the final precarious boom-time speculative blow-off is financed through the frenetic expansion of dubious, yet momentarily treasured, financial claims. With the above as background, I will attempt to clarify my view that we are at no analytical loss with the upcoming relegation of M3 to the government data scrapheap. First of all, M3 is today definitely not reflective of marketplace perceptions with respect to “moneyness.” With each boom year, the spectrum of perceived safe and liquid instruments expands. This year will see record ABS and commercial paper issuance, with the combined growth of these two categories of financial claims likely in the range of total M3 growth. M3 captures little of this imposing monetary expansion. The monetary aggregates (“M’s”) were constructed for a bygone monetary era largely dictated by banking sector liabilities, intermediation and payment clearing. The expansion of deposits and other bank liabilities (“repos,” euro deposits, etc.) would sufficiently capture total system Credit growth, with the M’s generally correlating well with nominal economic output and indicative of general financial conditions. However, several fundamental developments have profoundly altered the monetary landscape and the capacity for the M’s to reflect relevant economic and market developments. The rise to prominence of non-bank lending mechanisms has profoundly changed the nature of financial sector liability creation and intermediation. Market-based securities issuance is now a major aspect of monetary expansion, and the M’s are undoubtedly ill-equipped for such an environment. The unprecedented expansion of GSE obligations (debt and MBS) created several Trillion dollars of perceived safe financial sector liabilities. The enormous growth of Wall Street intermediation has spurred both a boom in securities issuance and incredible growth in (individual and institutional) account balances held throughout the (international) broker/dealer community. Technological advancement has also played a key role in expanding “moneyness.” For example, the Internet now allows households and institutions to directly purchase Treasury bills and myriad securities online, when much of these funds would have in the past been held in bank or money fund deposits (and included in the M’s). I also believe our massive Current Account Deficits and the corresponding ballooning of foreign central bank dollar holdings have impacted the relevancy of the M’s. Every day now, a couple billion dollars of Credit growth immediately flows to overseas institutions, where much of it is recycled back to financial claims (Treasuries, agencies, MBS, and ABS) not included in the monetary aggregates. If these funds were instead held domestically as savings, it is quite likely that a large percentage would be held in instruments included in the M’s. It is also worth noting that the M’s can at times prove especially flawed indicators of Credit expansion. In periods marked by a significant augmentation of Marketplace Risk Embracement, disintermediation out of low-yielding bank and money fund deposits into riskier instruments may meaningfully distort the M’s (recall 2003’s 4th quarter). Not only would stagnant monetary aggregate growth fail to reflect system Credit expansion, it would give decidedly erroneous signals with respect to system liquidity. And I know this is unconventional thinking, but I have come to completely disassociate the M’s from system liquidity. I would argue that system liquidity is today determined by the capacity of the broader financial system (including Wall Street, hedge funds, the “repo market”, foreign bank and global central bank dollar holdings) to expand, almost irrespective of the M’s. In summary, the M’s no longer reflect either system Credit growth or system liquidity, and are prone to give erroneous signals at critical junctures (when Marketplace Risk Embracement is modulating). I have watched repeatedly over the past few years as analysts have pounced on any slowdown in the M’s as an indicator of waning Credit growth and liquidity. This year, it was the stagnation of MZM that captured analysts’ attention, notwithstanding that this development was largely related to continued disintermediation from the money fund complex and the shift to higher-yielding term deposits; Credit growth remained on record pace, and the Bubble economy carried on. Moreover, M3 is clearly not capturing the historic expansion in the securities-financing repurchase agreement (“repo”) marketplace. While primary dealer “repo” positions have expanded $975 billion over the past two years, the M3 component bank net “repo” liability position has increased $27 billion. And while some “repo” positions are being captured in Money Funds holdings, there are enormous perceived “money” assets held in the ballooning securities financing arena outside the purview of the M’s. If the Fed endeavored to shroud the extent of current monetary inflation, I suggest they stick with publishing M3. And it is inconceivable at this point to expect the Fed – or the economic community – to embrace a broad-based measure of monetary instruments that would include Wall Street marketable securities and “repos.” Anyway, contemporary “money” is a moving target that changes at the whim of marketplace perceptions. And while I question the premise that the Fed has much to gain by eliminating M3, this nonetheless misses the much more salient point: The Fed has lost control of our nation’s “money” and Credit creation processes. The Greenspan/Bernanke Fed can now only administer feeble attempts to remove accommodation, hoping that over time baby-steps makes some headway but without ever attempting to impede, interrupt or discipline Wall Street Monetary Processes. The market today believes that a slowing real estate market is in the process of restraining system Credit growth. I am skeptical. It is my view that after the past year’s boom in energy and commodities prices, along with booming exports and a strong inflationary bias throughout much of the economy, it will now take considerably more restraint in mortgage Credit to meaningfully moderate total system Credit growth. And the greater U.S. and global stocks and bonds rally, the more likely the Credit Bubble refuses to miss a beat. The late 1920s saw the Benjamin Strong Fed acquiesce to the demands of the broker call market after it had evolved into a commanding source of monetary inflation and system liquidity. Today’s securities finance Bubble – certainly including the massive “repo” market – is at a scope unlike any in history. And once a substantial component of a nation’s (world’s) “money” supply is wrapped up in financing market Bubbles – well, you have one hell of a predicament. On the one hand, such powerful Bubbles are (as we have witnessed) strongly self-sustaining. On the other, the consequences of popping the Bubble ensure policymaker timidity and ongoing accommodation. Dr. Bernanke certainly has no intention of administering any meaningful restraint. Yet, inevitably, financial Bubbles do burst and the downside of boom-time Perceived Moneyness and Marketplace Risk Embracement manifest in financial dislocation and a crisis of confidence.