| Despite the withering dollar, the stock market held its own. For the week, the Dow added about 1% and the S&P500 gained marginally. The Transports were unchanged, as the Utilities added 1%. The Morgan Stanley Consumer and Morgan Stanley Cyclical indices mustered 1% gains. The strongest S&P groups were Oil and Gas Drilling, Aluminum, and Paper Products. The broader market was somewhat weaker, with the highflying small cap Russell 2000 and S&P400 Mid-cap indices dipping 1%. The tech sector was soft, with the NASDAQ100 declining 1% and the Morgan Stanley High Tech index losing 2%. The Semiconductor’s 6% decline reduced 2003 gains to 72%. The Street.com Internet index dropped 1% (up 69% y-t-d), while the NASDAQ Telecom index was about unchanged (up 58% y-t-d). The Biotech’s 2% advance increased 2003 gains to 39%. Financial stocks were volatile, with the Broker/Dealers declining 1% and the Banks about unchanged. With bullion up $8.20, the HUI gold index was up less than 2%. Today’s unimpressive non-farm payroll data incited a bout of virtual buyers’ panic throughout the bond market. And it didn’t hurt that the Washington Post’s John Berry wrote this morning that the Fed was likely in no rush to abandon “for a considerable period.” Two-year Treasuries enjoyed their strongest gain in 16 months, with yields sinking 17 basis points during today's session. Five-year yields sank 18 basis points and 10-year yields 14 basis points. For the week, 2-year yields dropped 18 basis points to 1.86%, 5-year yields declined 16 basis points to 3.20%, and 10-year yields dropped 12 basis points to 4.22%. The long-bond saw its yield dip 8 basis points to 5.21%. Mortgage-backed yields remain volatile. For the week, benchmark Fannie Mae mortgage-backed yields sank 20 basis points. The spread on Fannie’s 4 3/8 2013 note was unchanged at 37, and the spread on Freddie’s 4 ½ 2013 note was unchanged at 36. The 10-year dollar swap spread declined 1 to 39.25. Corporate debt spread indexes generally moved to the lowest level since just before the Russian collapse in August 1998, although corporates lost some ground with today’s Treasuries melt-up. The implied yield on December 2004 Eurodollars sank 27.5 basis points today to 2.35%. It was a huge week for debt issuance, with almost $20 billion sold. Investment grade issuers included Alcan $2.25 billion (up from $1.0 billion), US Bank $2.0 billion, Household International $1.5 billion (up from $1 billion), Nationwide Building $1.25 billion, Swedish Export Credit $1 billion, CIT Group $750 million, Toyota Motor Credit $750 million, RBS Capital Trust $650 million, JPMorganChase $500 million, Georgia Pacific $500 million, HBOS Treasury Services $500 million, ASIF Global Finance $500 million, Istar Financial $500 million, US Cellular $444 million, Virginia Electric & Power $430 million, GE Capital $400 million, Unionbank of California $400 million, Commerce Group $300 million, TXU Australia $300 million, Clear Channel $270 million, Hanover Compressor $262 million, Duke Energy $250 million, Plains All America Pipeline $250 million, Precision Castparts $200 million, Camden Property Trust $200 million, RPM International $200 million, Massmutual Global Funding $200 million, Northern Illinois Gas $150 million, Wisconsin Gas $125 million, Northern Trust $100 million, 21st Century Industries $100 million, and Niagara Mohawk Power $90 million. At $324.7 million, junk bond funds enjoyed another week of modest inflows (from AMG). Junk Issuance: Petrobras International $750 million, Huntsman LLC $455 million, Continental Airlines $415 million, Six Flags $325 million, Crown Castle $300 million, Unibanco Cayman $200 million, Insight Capital $130 million, Sweetheart Cup $95 million, and Atrium $50 million. Converts issued: Genzyme $600 million, Fairmont Hotels $270 million, Dominion Resources $200 million, Concord Communications $75 million, and Input/Output $50 million. Dollar watch: The dollar index declined better than 1% this week to the lowest level since January 1997. Dollar weakness was noticeably broad-based. The Euro rose to a new record. The Australian dollar rose above 73 to the U.S. dollar for the first time since October 1997, enjoying 14 straight weekly gains against the greenback. Today, the dollar closed at the lowest level against the yen since November 2000. Chile’s peso gained almost 3% this week to a 30-month high, with only a handful of global currencies losing value against our faltering currency this week. Commodity Watch: December 4 – Wall Street Journal: “The oil minister of Saudi Arabia suggested that OPEC will aim to keep oil prices high to compensate for a weak dollar, in a sign the cartel is considering ending its system of price targets that has helped maintain stability in world oil markets in recent years. Since 2000, the Organization of Petroleum Exporting Countries has pledged to vary its production levels to keep oil prices between $22 and $28 a barrel. Now OPEC officials, who are meeting here today, appear to have given up defending the upper end of the price caps to capitalize on a wave of strong demand in the U.S. and China. ‘We are not going to do something about high prices,’ one senior OPEC official said.” As a store of value against the sinking dollar, Gold today reached its highest price since February 1996. Recent fears of escalating trade tensions have been allayed for now by the Administration’s repeal of steel tariffs. The CRB index jumped 3% this week to the highest level since May 1996. Cold weather and inventory concerns were behind this week’s almost 25% surge in spot natural gas prices. With energy prices rising, the Goldman Sachs Commodity Index (GSCI) jumped almost 4% this week. Copper enjoyed its best weekly rise in two years, with prices up 6% to a new 6-year high (up 38% y-t-d). December 5 – Bloomberg: “Gold may top $450 an ounce -- a level it hasn’t reached since 1988 -- within a year as a falling U.S. dollar and concern about the U.S. budget and trade deficits boost the metal’s attractiveness for investors seeking a haven, Goldman Sachs… said.” Global Reflation Watch: The Bank of Japan increased foreign exchange reserves by another $18.3 billion during November to $623.8 billion. Year-to-date, foreign reserves are up $172.3 billion, or 42% annualized. Japanese foreign reserves increased $63.7 billion during all of 2002. Taiwan’s central bank foreign reserves increased $6.2 billion during November to $202.8 billion, with reserves expanding at a 28% rate through the first 11 months of 2003. South Korea increased its foreign reserve position by $6.0 billion during November to $150.3 billion, expanding reserves at a 26% growth rate so far this year. December 5 – Bloomberg: “Japan’s index of leading economic indicators was above 50 percent in October for the sixth month, signaling the world’s second-biggest economy will extend its longest economic expansion since 1997. The index, which measures job offers, consumer confidence and other indicators of economic activity in three to six months, rose to 88.9 percent from 66.7 percent… A reading above 50 percent signals an economic expansion. Today’s reading was the highest since February 2000…” December 1 – Bloomberg: “Deputy Governor Toshiro Muto said the Bank of Japan may pump more cash into the economy to help it recover, Nihon Keizai Newspaper reported, citing Muto. ‘It won’t be odd for the central bank to take a policy action’ during a recovery, Muto, one of two deputy governors and a member of the policy board, said in an interview. ‘Even if the economy moves in a better direction than the board expects, it doesn’t necessarily mean we don’t have to do anything.’ …In October, the board unexpectedly decided to pump extra cash into the economy on the same day that it raised its monthly evaluation of the economy. Muto said Japan’s deflation is continuing and that he sees some ‘fragility’ in the current economic recovery…” December 4 – Bloomberg: “Japanese companies are optimistic about the world’s second-largest economy for the first time in almost three years as rising overseas demand for their cars, computer chips and flat-panel screens swells profits. Business confidence rose to plus 5.6 points this quarter from minus 5.2 points in the third, a Ministry of Finance survey showed in Tokyo. A positive number means most companies with at least 1 billion yen ($9.2 million) of capital are optimistic. Companies forecast a higher reading for next quarter.” December 4 – Far Eastern Economic Review: “Although still intervening heavily in the foreign-exchange market, in the last few months China has radically scaled back its purchases of United States bonds. In September, Chinese institutions were actually net sellers of U.S. government and agency debt by $2.8 billion, even though foreign reserves rose by $19 billion. Now, economists and market strategists are beginning to wonder what Beijing is doing with all the dollars it is buying. Chinese state media provided a partial answer in early December, reporting that Beijing plans to build up a 90-day, 50-million-tonne strategic oil reserve. At current crude prices of around $30 a barrel, that will cost China $10 billion. Bankers and brokers in Hong Kong predict further large purchases of strategic materials, together with the possible acquisition of equity stakes in overseas suppliers over the coming year. If pursued, China’s diversification away from U.S. government bonds will be bad news for Washington, which has relied heavily on China’s debt purchases to fund its fiscal and current-account deficits. In Asia, some economists even say Washington had it coming, suggesting that the switch is subtle retaliation for current U.S. trade pressures on Beijing.” December 5 – Bloomberg: “JP Morgan Chase raised its growth forecast for the Indian economy to 8 percent in the year ending March 31 from 7 percent… JP Morgan Chase predicts the economy will grow at 6 percent in the year to March 2005.” December 5 – Bloomberg: “German industrial production rose 2.4 percent in October, almost twice as much as economists had forecast, the sixth report this week to suggest growth in Europe’s biggest economy is picking up.” December 1 – Bloomberg: “South Korean exports rose 23 percent in November, widening the trade surplus to the highest in almost five years, because of higher overseas demand for the nation’s cars, semiconductors and other goods. Exports rose to $18.62 billion from a year earlier, and imports gained 13 percent to $15.76 billion. The trade surplus widened to $2.86 billion, the highest in 59 months… South Korea joins Asian economies from Japan to India that are benefiting from faster global growth.” December 3 – Reserve Bank of New Zealand: “The Reserve Bank has decided to leave the Official Cash Rate unchanged at 5.0 percent. However, in saying that, small increases in the OCR may be required over the year ahead to ensure that inflation remains comfortably within the target range over the medium term. New Zealand’s economy has continued to perform well in 2003, although growth has been seated in the domestic economy rather than the export sector, where earnings are under pressure from the rising NZ dollar. New Zealand’s current account deficit is again building and some key asset prices appear to be moving beyond their sustainable level. The strong activity, especially in housing and construction, spurred by rapid population growth and high consumer confidence, has produced quite intense inflation pressures in parts of the domestic economy. Despite the domestic inflation pressures, CPI inflation has fallen over the past year largely due to falling import prices.” The astute Reserve Bank of New Zealand should be commended for incorporating the concept of “inflation pressures” as distinguished from and paramount to “CPI inflation.” Consumer price inflation is but one of many Inflationary Manifestations, including rising asset prices, current account deficits, over/mal investment, over-consumption, myriad spending distortions and speculative excess. Moreover, and certainly the case today worldwide, consumer price inflation may be a relatively insignificant Manifestation of contemporary Credit Inflation. December 1 – MarketNews: “The euro is strong by default, since ‘nobody wants to buy the dollar anymore and people tend to avoid it as a transaction currency,’ said (Eisuke) Sakakibara, (“Mr. Yen”) now professor at the Keio university in Tokyo. ‘Only the (central) Bank of China and the Bank of Japan are buying U.S. government bonds.’ Despite the lagging recovery in the eurozone and the need for structural reforms, investors are buying the euro since there is no other option, he explained. ‘After the U.S. presidential election, nobody knows which way the American economy will go,’ he said. ‘Thus we could have a euro at $1.20 for some time!’” Domestic Credit Inflation Watch: December 4 – Bloomberg: “Bush administration efforts to tighten controls on Fannie Mae and Freddie Mac won’t impede the housing industry or the ability of the largest U.S. home mortgage financiers to provide funding for American home buyers, a housing official said. ‘We are not intending to change their role in the housing market and we are not intending by any stretch of the imagination to weaken the housing market,’ said John Weicher, assistant secretary of the Housing and Urban Development Department. ‘No president running for reelection wants to weaken a significant part of the economy just in time for the election.’” December 5 – Bloomberg: “Poor federal supervision of Fannie Mae and Freddie Mac, the two largest sources of U.S. mortgage financing, is ‘getting worse,’ said Wayne Abernathy, assistant Treasury secretary for financial institutions… What will drive the solution is the fact that the problem isn’t going away,’ Abernathy said after a speech in Washington to the Consumer Federation of America. ‘This is an issue that is being driven by the problem, and the problem isn’t getting any better -- if anything, it’s getting worse.” December 2 – Bloomberg: “Sales of high yield, high risk debt have almost doubled to $112 billion this year from 2002, as low interest rates drive investors to seek out higher yields, Standard & Poor’s said. Issuance may remain strong next year, according to the credit rating company… Yield spreads of the non-investment grade debt have fallen by 53 percent, to 477 basis points from a high of 1,011 basis points in October 2002.” December 2 – Bloomberg: “Tyson Foods Inc., the biggest U.S. beef processor, has raised prices on wholesale beef. Marriott International Inc. is boosting room rates. Honda Motor Co. is charging 9.5 percent more on its Acura TL luxury performance sedan than a year ago. The U.S. is moving ‘from reflation to inflation,’ said David Malpass, chief global economist of Bear, Stearns & Co., who predicts the Federal Reserve will have to raise interest rates as early as March to prevent a surge in inflation beyond the consumer price index’s 2 percent rise for the year ended in October.” December 2 – Bloomberg: “Wealthy Americans are putting more assets into hedge funds and real estate, and pulling their money from mutual funds, to get higher returns, a survey by Chicago-based consultant Spectrem Group found. American households with at least $5 million to invest now have 6 percent of their investments in mutual funds compared with 11 percent two years ago, the survey of 300 respondents found. Hedge funds are owned by 15 percent, up from 6 percent in 2001, while real estate is owned by 74 percent. ‘They’re reacting to three years of a (declining) market,’ Spectrem President George Walper said… ‘They’re more sophisticated with regard to the hedge fund world and interest rates have been so low that they’ve been able to leverage their investments in real estate significantly.’” December 1 - Dow Jones (Christine Richard): “Changes in global capital flows, rules-based investing and higher balance sheet leverage have increased the risk of investing in corporate bonds, but these risks are being vastly underestimated by investors, according to recent research published by PIMCO… Key among those risks is the $500 billion U.S. current account deficit which is being offset by foreign investors lending $2 billion a day to U.S. borrowers, PIMCO managing director Chris Dialynas wrote… The stakes are high not only for corporate bond investors as ‘lofty valuations leave little room for error’ but for the financial system… ‘U.S. corporations dependent upon foreign investors have jeopardized the post-World War II U.S. financial system.’ The report also said that the Federal Reserve bailed out the corporate bond market in October 2002. ‘Chairman [Alan] Greenspan had indicated that spreads were a policy variable and Governor [Ben] Bernanke opened the door to direct credit insurance from the Fed…’ ‘The bank’s participation was outright and in structured form. Clearly, the Fed invoked a too big to fail doctrine toward the corporate bond market at large.’ PIMCO also put the blame for the $3.5 trillion current account deficit at the feet of the Federal Reserve, calling it the result of ‘massive misallocation of global capital.’ That misallocation resulted from Fed policy aimed at protecting the markets against the potential negative impact of such events as the 1987 stock market crash, the savings and loan crisis, the Asian crisis, the bailout of Long Term Capital Management, Y2K risks, the NASDAQ crash of 2000, the Sept. 11 terrorist attacks and last fall’s deflation fears… He also called for ‘an immediate 30-40% decline in the U.S. dollar and/or tariffs and consumption taxes on foreign goods’ to create a better balance in global trade.” Economy Watch: November auto sales were a stronger-than-expected 16.8 units annualized, up from October’s 15.6 million unit pace. Toyota enjoyed its best November ever, with sales up 12.8% y-o-y. Lexus sales were up 40% from November 2002. It was also a record November for BMW, as y-o-y sales increased 6.4%. There were 24,721 bankruptcy filings during the holiday week, up slightly from the comparable week one year ago. Year-to-date filings are running up 6.0%. October Consumer Credit increased only $941 million, although September’s big gain was revised almost $2 billion higher to $17.0 billion. Freddie Mac posted 30-year fixed mortgage rates rose 13 basis points last week to 6.02%. Fifteen-year fixed rates increased 14 basis points to 5.36%. One-year adjustable-rate mortgages could be had at 3.77%, unchanged for the week. The Mortgage Bankers Association Purchase application index dipped moderately but remains at a strong level. Purchase applications were up 15% from the year ago level, with dollar volume up 33.0%. The average Purchase mortgage was for $205,400, with the average adjustable-rate mortgage at $286,400. October Construction Spending was up a better-than-expected 0.9% from September to a record $922 billion annualized. Year-over-year, Construction Spending was up 7.0% (strongest y-o-y gain since October 2000). Residential spending was up 12.5% from October 2000. With year-over-year gains of 28.9% in Healthcare and 14.5% in Education, Public sector Construction Spending was up 6.6% from October 2002. The F.W. Dodge Construction Activity Index jumped 4 points to a record during October. Non-residential construction surged during the month, pushing the overall index to a level 10% above one year ago. As was widely reported, the ISM Manufacturing Purchasing Management index jumped almost 6 points during November to 62.8. This was up 12.3 points from November 2002 to the highest reading since December 1983. Also the highest since the last month of 1983, New Orders surged 9.4 points to 73.7. This was up 21.3 points from one year earlier. Production rose 5.7 points to 68.3, while Imports rose to a record 62.4. Declining slightly, Exports remained at a strong 57.9. Prices Paid jumped 5.5 points to 64. This compares to the year ago 55.7 and November 2001’s 32.0. Total Bank Assets increased $29.8 billion. Securities holdings declined $3.3 billion and Loans & Leases dipped $1.3 billion. Commercial & Industrial loans gained $5 billion, while Real Estate loans dipped $4.8 billion. Consumer loans declined $3.0 billion and Security loans dipped $2.7 billion. Elsewhere, Commercial Paper sank $19.2 billion last week to $1.298 Trillion. Non-financial CP declined $10.7 billion and Financial CP decreased $8.5 billion. Broad money supply (M3) declined $19 billion for the week ended November 24. Demand and Checkable Deposits dipped $0.9 billion and Savings Deposits sunk $23.2 billion. Small Denominated Deposits dipped $1.4 billion. Retail Money Fund deposits declined $2.7 billion, while Institutional Money Fund deposits added $9.3 billion. Large Denominated Deposits declined $2.9 billion. Repurchase Agreements were about unchanged and Eurodollar deposits added $2.2 billion. Confirming that the GSEs have geared up to hawk debt to the yield-chasing public (with clear implications for the contracting money supply “debate”), comes an article yesterday from Dow Jones’ ace journalist Christine Richard: “As fears of rising interest rates continue to mount, retail investors have been buying step-up bonds issued by government sponsored enterprises, such as Freddie Mac and Fannie Mae… (LaSalle Broker Dealer Services managing director) Kelly estimates Fannie Mae, Freddie Mae and the Federal Home Loan Banks have sold around $25 billion to $30 billion in retail debt this year and about 40% of that debt contains step-up provisions. ‘Demand has picked up recently for step-ups as the result of expectations in the market about the future path of rates’ said Itai Benosh, director of debt product management at Freddie Mac.” Foreign (Custody) Holdings of U.S., Agency debt held by the Fed increased $8.4 billion. Custody holdings were up $35.0 billion over three weeks. For all of 2001, custody holdings increased about $40 billion. Inflationary Manifestations and the Farm Sector: U.S. Department of Agriculture: “The preliminary All Farm Products Index of Prices Received by Farmers in November is 117… 4 points (3.5 percent) above the October Index. Both the Livestock and Products Index and the All Crops Index were higher in November. Producers received higher commodity prices for cattle, corn, soybeans, and wheat. Lower prices were received for cotton, hogs, and milk. The seasonal change in the mix of commodities farmers sell, based on the past 3-year average, also affects the overall index. Increased average marketings of all milk, cotton, cattle, and cottonseed offset decreased marketings of peanuts, soybeans, sunflowers, and potatoes. This preliminary All Farm Products Index is up 20 points (20.6 percent) from November 2002. The Food Commodities Index increased 5 points (4.3 percent) above last month to 121, and is 25 points (26.0 percent) above November 2002. This index value is the highest since records began in 1975. “ December 4 – Bloomberg: “U.S. farm income will reach a record $65 billion in 2003, a third higher than last year, driven by stronger export sales and almost $20 billion in government subsidies, U.S. Agriculture Secretary Ann Veneman said… Veneman’s remarks came as a delegation of China’s grain buyers is expected to visit Chicago later this month, raising expectations of more sales to the biggest buyer of U.S. soybeans. Soybean futures have surged 36 percent from a year ago partly on strong export sales, particularly to China. Orders for U.S. soybeans, corn, wheat and cotton from overseas buyers are all running well ahead of the pace of a year ago, the USDA said in a report earlier today. Orders for corn, the largest U.S. crop, are up 26 percent in the marketing year that began Sept. 1 while soybean orders are up 20 percent. Wheat orders in the marketing season that began June 1 are up 28 percent. Cotton orders in the season that started Aug. 1 are up 38 percent, the report showed.” December 1 - Wall Street Journal (Scott Kilman and Daniel Machalaba): “In a harbinger of potential snags across the U.S. economy, a sudden boom in the farm sector has combined with shortages of railcars and crews to delay freight trains and lead to higher delivery costs for farmers across the country. The demand for grain-hauling equipment is hot because the Farm Belt is humming after five years of recession. Grain prices are profitable for farmers in large part because corn and wheat exports have soared 24% since Sept. 1, a reflection of poor harvests this year in Europe and elsewhere. But there is a catch: Failure to deliver their goods is cutting into the potential profits. That is because years of cost-cutting on both personnel and equipment have left railroads short-handed, forcing them to scramble to deal with the unexpected surge in both the agriculture sector and the economy in general… Even when the train shortage ends, some costs will remain higher. Burlington Northern plans to raise its basic rate for hauling corn from the Northern Plains to points in the Pacific Northwest by 8%... Canadian Pacific says it is raising its rate for similar service by 8% to 10%.” The Journal titled Kilman and Machalaba’s excellent article “Railroad Logjams Threaten Boom in the Farm Belt.” I would have argued (and lost) for the headline “Powerful Inflationary Manifestations Hit the Farm Belt.” All the same, the article captured the essence of the new strains of unfolding inflationary pressures now taking hold. It also helps to explain the precipitous upturn in the manufacturing sector. Importantly, the demise of King Dollar has set in motion a major devaluation of the world’s reserve currency. Accordingly, things priced globally in dollars are experiencing a major inflationary revaluation. Crude oil, gold, platinum, copper, soybeans, and commodities generally have all experienced significant price inflation. Buyers and sellers of such assets are forced to make major adjustments. At the same time, runaway global dollar liquidity provides extraordinary purchasing power for buying (especially by China!), investing and speculating. Domestically, an over-liquefied Credit system and under-priced finance provide incredibly attractive means to profit from the unfolding agriculture and commodities boom. This newfound inflationary bias is today inciting the type of response one would expect from an overheated system: the forces of borrowing, investing/spending, and speculating have been unleashed; boom and bust dynamics, once again, have been nurtured and set on their merry way. Exuberance throughout the financial sphere feeds on exuberance in the real economy and vice versa. I especially appreciated Kilman and Machalaba’s article, as it captured the dynamics of a sector of the economy that has been suddenly and radically transformed by evolving inflationary forces. After years of stagnation – with previous King Dollar inflation manifestations prominent in the equity market and financial assets generally, technology, telecom and housing, much to the expense of other sectors – the farm sector is abruptly engulfed by a virile boom. Having suffered for so long, the agriculture industry today struggles to cope with its newfound prosperity. The booming Farm Belt is also one more example of the acutely imbalanced “stop and go” U.S. economy, as well as providing unmistakable evidence of mounting systemic inflationary pressures. And while the consensus fixates on monthly CPI data to measure the inflationary impact of the weaker dollar, this misses the crucial point. The key analysis is that surging prices for many things – especially those in previously stagnant sectors - are now in the process of fueling a self-reinforcing borrowing and spending boom. Systemic Credit excess is sustained. The bottom line is that for years our dysfunctional financial system has thrown endless finance at housing, new technologies and consumption, with meager investment in the farm and industrial sectors. Now even the laggards are on an inflationary adrenalin rush. While the WSJ article focused on the farm sector, it carried the warning, “The delays are sparking fears that bottlenecks might also arise in other sectors of the U.S. economy as they also get busier.” As long as the Credit spigot runs wide open, you can count it. From the article: “The condition of the nation’s rail fleet has deteriorated in recent years, particularly so with grain-hauling equipment. According to Steve McClure, president of the rail-leasing unit of CIT Group, 68% of railroad-owned grain cars are more than 20 years old.” A grain elevator general manager was quoted: “I’ve been in the grain business 25 years, and this is the worst delay I’ve ever seen.” “...railroads are scrambling to hire more crews and secure more locomotives.” CSX is experiencing its worst delays since 1999. “Burlington Northern…was caught off-guard by the record U.S. corn harvest and a bumper wheat crop. It had allowed its fleet of grain-hopper cars to shrink 24% over the past five years… Grain cars are now in such short supply that (the company) has temporarily stopped guaranteeing when it will deliver any more to customers.” “In addition, the railroad industry is short of skilled workers.” “The farm sector’s demand for trains this autumn is particularly strong, thanks in part to the need to move soybeans to ports for export to China, which is buying U.S. soybeans at a record pace for this time of year. The domestic appetite for grain is strong, too. A rebound in the consumer demand for beef is lifting cattle prices to record highs, spurring the feedlots that fatten them on grain to expand their operations. Much of the grain they use moves by rail. ‘It is increasing costs all across the system,’ says Kimberly Vachal, a research fellow at the Upper Great Plains Transportation Institute… Grain industry officials say the logjams are the worst since 1997… Transportation is a big part of the cost of making food, so the train shortage will help keep upward pressure on food prices already being pushed higher by rising cattle and crop prices… For instance, the charge for leasing one grain-hopper car for one month has doubled over the past six months to about $300.” And there are indications that ports throughout the country are struggling to keep up with traffic. Well, at this point it is reasonable to posit that the agricultural sector has joined healthcare, education, energy, financial services, and housing as key sectors demonstrating strong inflationary biases. The transportation industry has been caught flatfooted by the inflationary surge, and we will have to wait to see if similar dynamics are at play more broadly throughout manufacturing. Especially considering the current ultra-easy Credit environment, we should expect a substantial borrowing and spending boom encompassing the “farm belt.” Farm income is already surging, and I would expect one heck of a land boom. The rail, trucking and international shipping industries will scamper to attain finance and upgrade their systems. The beleaguered manufacturing sector now appears well on its way toward getting fully revved up, joining the energy, housing and services sectors. It is difficult to envision how this inflationary boom can run smoothly for a sector so atrophied after years of neglect. But, then again, these are precisely inflation dynamics a work. There is much more involved than money supply. And, importantly, we will witness yet another example of how Credit inflation begets heightened Credit excess and only greater inflation. Who knows, this Post-King Dollar Inflationary Manifestation may even make its way to the Consumer Price Index. But that’s actually beside the point. We definitely have a ringside seat at a tenacious and historic affliction of an out of control Credit system and boom and bust dynamics. As such, today was another fascinating day in the markets. The Credit market again demonstrated its strong inflationary bias, basically relapsing into histrionic melt-up on the news of weaker-than-expected job growth. Things have regressed to the point of this having become one big bet on the Fed. Meanwhile, the speculative marketplace is understandably confident that our biased central bankers will be more than happy to use tepid job growth as an excuse for sustaining 1% short rates. Then there is the massive and destabilizing derivatives and hedging monster waiting to accentuate market moves either way. But with the GSEs and their liquidity operations there to insure that rates don’t move much higher, as well as the leveraged speculators keen to play the spread game, the market bias remains for aggressive financial sector expansion, liquidity and Credit excess, and for artificially low rates. And with foreign central banks unabashed buyers, a weaker dollar is ironically an additional factor fostering lower market yields. Yet - and as I have rambled on about repeatedly - the dollar is in desperate need of some serious liquidity and Credit restraint. It receives the exact opposite. And the longer the requisite moderation is postponed, the greater the number and degree of (self-reinforcing) inflationary manifestations that take hold; the greater the amount of dollar claims inflation; the greater the dollar liquidity available to seek non-dollar things; the greater dollar selling pressure; and the greater the out-performance of non-dollar asset classes. Today’s unprecedented derivatives overhang and the truly massive global speculator community transform these risky dynamics into something incomprehensible but absolutely dangerous. And I certainly saw nothing this week that would encourage me to back away from the view that a serious dollar “problem” has arrived and won’t be leaving anytime soon. It is almost as if the light bulb has gone off; a scurry has commenced with the intention of protecting wealth against what is being increasingly recognized as a permanent and ongoing devaluation of dollar value. |
Wednesday, September 3, 2014
12/05/2003 Inflationary Manifestations Hit the Farm Belt *
12/03/2003 Pertinent Monetary Economics from Ralph G. Hawtrey *
Global markets (currencies, commodities, interest-rates, equities) remain extraordinarily unsettled. As for the rejuvenated U.S. equities Bubble, The Dow and S&P500 gained less than 1%. The Transports added 2%, increasing 2004 gains to 24%. The Morgan Stanley Cyclical index was unchanged, while the highflying Utilities dropped 4%. The Morgan Stanley Consumer index added 1%. The broader market was strong, with the small cap Russell 2000 gaining 2% (up 15% y-t-d) and the S&P400 Mid-cap index adding 1% (up 12% y-t-d). The technology rally continues, with the NASDAQ100 up 2% (2004 gain of 10%) and Morgan Stanley High Tech index gaining 3%. The Semiconductors rose 3%. The Street.com Internet Index rose 4% (up 35% y-t-d), and the NASDAQ Telecom index added 2%. The Biotechs gained 2%. Financial stocks were mixed. The Securities Broker/Dealers were up 1.5%, while the Banks were about unchanged. Although bullion rose $3.95 to $455.90, the HUI Gold index dropped 7%.
With Treasury yields whipping about violently, bond traders must be pulling their hair out. Today’s huge rally helped re-steepen the yield curve. For the week, 2-year Treasury yields declined 10 basis points to 2.92%. Five-year Treasury rates dipped 3 basis points to 3.60%. At the same time, ten-year Treasury yields rose 2 basis points at 4.25%. Long-bond yields ended the week at 4.93%, up 4 basis points for the week. Benchmark Fannie Mae MBS yields added one basis point. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note was unchanged at 39, and the spread on Freddie’s 5% 2014 note narrowed one to 34. The 10-year dollar swap spread was up 1.75 to 41.0. Corporate bond spreads were generally little changed. The implied yield on 3-month January Eurodollars rose 5.5 basis points to 2.825%.
Corporate debt issuance jumped to a strong $18.3 billion (from Bloomberg). Investment grade issuers included News America $1.75 billion, Clorox $1.65 billion, World Savings $1.3 billion, Ford Motor Credit $1.25 billion, Citigroup $1.0 billion, Key Bank $750 million, Chesapeake Energy $600 million, PNC Bank $500 million, First Tennessee Bank $400 million, Suntrust Bank $350 million, Enbridge Energy $300 million, and Huntington National $250 million.
Junk bond funds saw outflows of $186.4 million (from AMG). Issuers included CCO Holdings $550 million, SBA Communications $250 million, WDAC Subsidiary $200 million, and MAAX Holdings $170 million.
Convert issuers included Universal City $450 million, Scientific Games $250 million, American Equity $250 million, OMI Corp. $225 million, American Equity $175 million, Synaptics $100 million, and Cray Inc. $65 million.
December 1 – MarketNews: “The Chicago Board of Trade…experienced its highest monthly volume ever in November, with turnover for the month increasing 58% from the prior year to 59,467,507 contracts amid a surge in financial futures and options trading. Month-over-month volume was up 24.3%, the exchange said. Trading in the exchange's franchise Treasury futures and options was up 26% from a month ago and up 67.8% from year-ago figures with a total of 49,911,971 financial contracts traded.”
Heavy foreign dollar debt issuance included Venezuela $1.5 billion, Republic of Brazil $1.25 billion, Swedish Export Credit $1.0 billion, Banco Santander $700 million, Royal Bank of Scotland $675 million, Yara International $500 million, Fairfax Financial Holdings $470 million, and Woori Bank $300 million.
Japanese 10-year JGB yields were unchanged at 1.44%. Brazilian benchmark bond yields rose 3 basis points to 8.21%. Mexican govt. yields ended the week at 5.28%, up 5 basis points for the week. Russian 10-year dollar Eurobond yields were unchanged at 5.89%.
Freddie Mac posted 30-year fixed mortgage rates jumped 9 basis points this week to 5.81%. Fifteen-year fixed mortgage rates were 8 basis points higher at 5.23%. One-year adjustable-rate mortgages could be had at 4.19%, down 8 basis points. The Mortgage Bankers Association Purchase application index was about unchanged for the week. Purchase applications were up about 5% from one year ago, with dollar volume up 15%. Refi applications sank 12.3% during the week. The average new Purchase mortgage declined to $225,500, and the average ARM dropped to $304,800. ARMs declined to 32.3% of total applications.
Broad money supply (M3) expanded $7.1 billion (week of November 22). Year-to-date (47 weeks), broad money is up $480.2 billion, or 6.0% annualized. For the week, Currency increased $0.6 billion. Demand & Checkable Deposits jumped $23.6 billion. Savings Deposits declined $18.0 billion, with a year-to-date gain of $339 billion (11.7% annualized). Small Denominated Deposits dipped $0.4 billion. Retail Money Fund deposits added $2.7 billion, while Institutional Money Fund deposits dipped $1.2 billion. Large Denominated Deposits rose $7.9 billion. Repurchase Agreements declined $6.7 billion, and Eurodollar deposits fell $1.3 billion.
Bank Credit surged $46.5 billion for the week of November 24 to $6.781 Trillion. Bank Credit has expanded $506.9 billion during the first 47 weeks of the year, or 8.9% annualized. For the week, Securities holdings jumped $23.6 billion, and Loans & Leases rose $22.9 billion. Commercial & Industrial loans gained $6.3 billion, while Real Estate loans dipped $2.9 billion. Real Estate loans are up $286 billion y-t-d, or 14.2% annualized. Consumer loans were about unchanged for the week, while Securities loans jumped $14.2 billion. Other loans expanded $5.7 billion. Elsewhere, Total Commercial Paper rose $4.4 billion ($24.3bn in 3 weeks) to $1.393 Trillion. Financial CP added $5.1 billion to $1.259 Trillion ($25.4bn in 3 weeks), expanding at a 9.2% rate so far this year. Non-financial CP dipped $0.7 billion (up 25.8% annualized y-t-d) to $133.7 billion. Year-to-date, Total CP is up $124.3 billion, or 10.6% annualized.
Fed Foreign “Custody” Holdings of Treasury, Agency Debt rose $5.9 billion to $1.323 Trillion. Year-to-date, Custody Holdings are up $255.9 billion, or 26% annualized. Federal Reserve Credit jumped $5.7 billion for the week to $785.5 billion, with y-t-d gains of $38.9 billion (5.7% annualized). Fed Credit has surged $20.6 billion over the past eight weeks.
This week’s ABS issuance came to about $7 billion (from JPMorgan). Total year-to-date issuance of $591.9 billion is 37% ahead of comparable 2003. 2004 home equity ABS issuance of $383.5 billion is running 82% ahead of last year’s record pace.
Currency Watch:
Today’s bludgeoning put the dollar index down 1% for the week and below 81 for the first time since May 1995. The Euro ended today’s session at a record 134.54. The Iceland krona gained almost 5% this week, the British pound 2.65%, Polish zloty 2.2%, and Hungarian forint 2.0%. The Argentine peso declined almost 1%, with small losses suffered by the Canadian and Australian dollars.
Commodities Watch:
November 30 – Bloomberg (Hector Forster): “Japan, the world’s largest consumer of crude oil after the U.S. and China, said oil imports rose for a fourth consecutive month in October, gaining 14.3 percent from a year earlier… Japan imports more than 99 percent of its oil, according to the ministry.”
I wouldn’t much want to be an energy trader either. January Crude Oil sank $6.90 this week to $42.54. The Goldman Sachs Commodities index dropped 11.6% for the week, reducing year-to-date gains to 18.6%. The CRB index declined 2.3%, with 2004 gains of 11.4%.
China Watch:
December 3 – Bloomberg (Xiao Yu): “China faces a bigger influx of foreign currencies as investors bet the government will let the yuan appreciate, the state-run Xinhua News Agency said, without disclosing specific amounts.”
November 29 – Bloomberg (Simon Casey): “China, the world’s largest steel producer, will import 37 percent more iron ore this year than in 2003 as mills boost output to meet domestic demand, Macquarie Bank said. Chinese iron imports will rise to 203 million metric tons from 148 million tons last year… The nation’s steel output will jump 23 percent this year to 270 million tons.”
December 3 – Bloomberg (Allen T. Cheng): “China’s technology exports in the first 10 months rose about 52 percent to $128.3 billion from a year earlier, said Shan Qingjiang, deputy director general at the Ministry of Commerce’s technology division. For the full year, technology exports will probably climb 41.2 percent to $160 billion…”
December 2 – Bloomberg (Allen T. Cheng): “China’s economy generated 8.4 million jobs in the first 10 months, achieving the target set by the government, China Central Television reported.”
November 30 – Bloomberg (Allen T. Cheng): “Chinese consumers are the most optimistic in the world, with 78 percent expecting the economy to improve in the coming year, according to a survey by market researcher AC Nielsen. China was followed by India, where 77 percent of consumers said they expect an improvement and Indonesia with 76 percent, said New York-based Nielsen, which interviewed 14,134 people in 28 markets…”
December 2 – Bloomberg (Joshua Fellman): “Hong Kong real estate sales, mainly of apartments, more than doubled in November, rising for a 14th month as property prices and transactions increased in the city because of an economic rebound. Sales of building units, which also include factory and office space, jumped to HK$44.51 billion ($5.73 billion) last month… Transactions rose 42 percent to 13,690.”
Asia Inflationary Boom Watch:
December 1 – Bloomberg (Seyoon Kim): “South Korean export growth picked up in November for the first time in six months, with shipments reaching a record $23.3 billion as manufacturers sold more cars and cell phones abroad. Overseas sales rose 28 percent from a year earlier after climbing a revised 20 percent in October…”
December 2 – Bloomberg (Seyoon Kim): “South Korea’s foreign-exchange reserves rose $14.2 billion in November, the biggest-ever monthly gain, as the central bank bought U.S. dollars to stem the won’s appreciation. The reserves, the fourth largest in the world, reached a record $192.6 billion at the end of last month, the Bank of Korea said…”
December 3 – Bloomberg (Theresa Tang): “Taiwan’s foreign-currency reserves, the third-highest in the world, rose in November to a record $239 billion, boosted by net foreign capital inflows and an appreciation of the euro and Japanese yen. The reserves, which trail those of Japan and China, rose for a 41st month from $235 billion in October…”
December 1 – Bloomberg (Shanthy Nambiar and Aloysius Unditu): “Indonesian exports surged 46 percent in October, more than expected, on rising oil prices and demand for palm oil, nickel and coal in China and India. Exports rose to $7.27 billion from a year earlier…”
November 30 – Bloomberg (Grace Nirang and Wahyudi Soeriaatmadja): “Indonesia plans to raise prices of gasoline, diesel and other fuels by as much as 40 percent next year, and cut subsidies to help narrow the country’s budget deficit, government ministers said.”
November 30 – Bloomberg (Kate Mayberry): “Malaysia’s broadest measure of money in circulation expanded in October at its fastest pace since June as banks extended more loans to consumers and companies. M3, the most closely watched measure of money supply, rose 10.7 percent in October from a year earlier…”
December 1 – Bloomberg (Khoo Hsu Chuang): “Malaysia’s economic growth may exceed a government forecast of 7 percent expansion this year, Second Finance Minister Nor Mohamed Yakcop said. ‘I’m confident of getting more than 7 percent growth. Private consumption is the engine of growth; we are in for a good patch of two years.’”
November 29 – Bloomberg (Francisco Alcuaz Jr.): “The Philippines raised its economic growth forecast for this year to more than 6 percent, the fastest in more than a decade…”
December 3 – Bloomberg (Francisco Alcuaz Jr.): “Philippine export growth picked up in October as electronics makers sold more disk drives and computer chips to Japanese factories. Overseas sales rose 12 percent from a year earlier to $3.75 billion after increasing 8.4 percent in September…”
Global Reflation Watch:
December 3 – Bloomberg (Lily Nonomiya): “Japanese companies increased capital spending more than expected in the three months ended Sept. 30, prompting economists to predict the government will raise its estimate for growth in the world’s second-largest economy. Capital spending, including investment in software, rose 14.4 percent from a year earlier…”
November 30 – MarketNews Intl.: “Home construction in France remained buoyant in October, as three-month housing starts posted a 21.8% rise on the year, while permits for the same period were up 21.4%, according to non-seasonally adjusted data released Tuesday by the Construction Ministry.”
December 2 – Bloomberg (Todd Prince): “Russia’s foreign currency and gold reserves rose for a 14th-straight week to a record $117.1 billion, nearing the country’s total foreign debt. The central bank said the reserves rose $3.2 billion in the week ending Nov. 26… Russia’s foreign currency and gold reserves are surging as the central bank buys dollars being brought into the country by oil and gas exporters…”
December 1 – Bloomberg (Ben Holland): “Turkish exports climbed 45 percent in November from the same month last year, the fastest pace of growth this year… The country had exports of $5.8 billion in November… Exports in the 12 months through Nov. 30 climbed 35 percent to $62 billion…”
November 30 – Bloomberg (Vernon Wessels and Mike Cohen): “South Africa’s economy expanded an annualized 5.6 percent in the third quarter, the fastest pace since 1996 and more than economists expected, as the lowest interest rates for two decades boosted demand.”
November 29 – Bloomberg (Heather Walsh): “Latin American economies will grow more than 5 percent this year, faster than previously forecast, driven by demand for commodities and low financing costs, the World Bank’s chief economist for Latin America said.”
December 1 – Bloomberg (Guillermo Parra-Bernal): “Brazil’s economic growth quickened to its fastest pace in eight years in the third quarter as lower interest rates boosted demand at home and exports of soybeans and cars surged. Gross domestic product grew 6.1 percent in the July-through-September period from a year ago after expanding 5.6 percent in the second quarter…”
December 2 – Bloomberg (Daniel Helft and Andrew J. Barden): “Argentine central bank President Martin Redrado said the country’s monetary supply will expand as much as 15 percent in 2005, without stoking inflation and keeping the exchange rate stable.”
Dollar Consternation Watch:
November 29 – UPI: “China Premier Wen Jiabao launched an indirect attack on the U.S. failure to halt the dollar slide while vowing not to revalue the yuan under pressure. In the strongest sign yet of Beijing’s concern at the weakening dollar, Wen questioned the American government’s management of its currency, The South China Morning Post reported... ‘China is a responsible country. We have ensured that the exchange rate of the renminbi remained stable during the 1997 Asian financial turmoil and, by doing so, contributed to the resolution of the crisis,’ Wen said…‘Today, we have to ask a question. The US dollar is depreciating and there is no attempt to manage it. What is the reason for this? Shouldn’t the relevant parties take measures?’ Wen described the revaluation of yuan as a major economic issue that should not be carried out under pressure, pointing that change in the exchange rate required certain conditions. ‘The most important is to have a stable macroeconomic environment, a healthy and complete market mechanism and a healthy financial system.’”
California Bubble Watch:
December 3 – San Francisco Chronicle: “Bay Area home prices are increasingly outstripping incomes, making it less likely that nurses, teachers and firefighters can purchase properties here than in other major metropolitan areas… A quarterly analysis by the California Association of Realtors found Bay Area household incomes are $82,910 short of being able to afford a median-priced home… a Bay Area buyer now needs an income of $151,338 to afford a typical home…”
Bubble Economy Watch:
December 2 – The Wall Street Journal (Ann Davis): “Wall Street firms that are best positioned to take advantage of the bull market in commodities trading, and those that continue to post strong bond-trading gains, are poised to pay bankers much higher year-end bonuses than peers, according to a report by Deutsche Bank AG. Reflecting more-generous bonuses, Goldman Sachs Group Inc.’s total compensation expense is expected to rise an outsized 37% over last year’s, according to Deutsche Bank’s brokerage industry analyst, Richard Strauss. Morgan Stanley and Lehman Brothers Holdings Inc. are expected to post compensation increases of 25% and 30%, respectively.”
December 1 – Bloomberg (Jeff Green): “Thor Industries Inc. Chief Executive Wade Thompson, whose company is the world’s largest maker of motor homes and travel trailers, expects the industry's shipments to rise in 2005 for the fourth straight year… Thompson and chief executives of three rivals said they plan to hire more workers and Thor, Fleetwood Enterprises Inc., Winnebago Industries Inc. and other recreational-vehicle makers expect shipments to rise 14 percent this year to 364,900 units, the best since 1978…”
Mortgage Finance Bubble Watch:
December 2 – Bloomberg (Al Yoon): “Freddie Mac, the second-biggest provider of financing for U.S. residential mortgages, said investors in Asia purchased a record 40 percent of its $3 billion five-year reference note sale. Foreign investors accounted for 48 percent of the notes, which pay an interest rate of 4 percent and were priced to yield 30.5 basis points more than the U.S. Treasury's five-year note…”
December 1 – Bloomberg (Kathleen M. Howley): “U.S. home prices increased at the fastest pace in 25 years during the third quarter, led by Nevada and California, as the economy improved and low mortgage rates made financing more affordable. Prices across the nation rose an average of 13 percent from a year earlier, surpassing the second quarter’s 9.8 percent pace, according to a report from the Washington-based Office of Federal Housing Enterprise Oversight, or Ofheo. It was the biggest increase since 13.1 percent in 1979's third quarter.”
In CaseYou Missed it on CNBC - Watch:
December 1 – Dow Jones: “The amount of trash produced by U.S. consumers serves as an indicator of the domestic economy’s health, said Michael Hoffman, deputy director of research at Friedman Billings Ramsey. ‘I think we’re in a healthy environment,’ Hoffman said Wednesday on CNBC, referring to economic conditions. Hoffman said the volume of trash has been increasing recently in step with observations that the U.S. economy is in a recovery.”
Pertinent Monetary Economics from Ralph G. Hawtrey
Recent comments from the eminent Stephen Roach: “The asset economy does not just have its origins in America. It is very much a by-product of support from global investors and policy makers. One of the outgrowths of an increasingly asset-dependent economy is a shortfall in income-based national saving. America has taken this shortfall to an unprecedented extreme. The net national saving rate -- the combined saving of consumers, businesses, and the government sector after deducting for the depreciation of worn-out capacity -- fell to a record low in the 1-2% range in 2003-04. Lacking in domestic saving, America has had to import foreign saving from abroad -- and run massive current account deficits to attract that capital.”
I have to this time take exception with Mr. Roach’s analytical approach. The “origins” of our “asset economy” are surely not only here at home, but they reside in the bowels of Washington and Wall Street. And I would argue that the key issue today is not a lack of “savings” or our massive current account deficits. These are only symptoms of the massive Credit Inflation that has ridden roughshod through our Credit system and economy and that now destabilize the world. And I’m no fan of the language “attract capital” or “import foreign saving” in this context. Foreign financial flows are merely the “recycling” of dollar balances – created in gross excess by our financial sector and federal government - into U.S. securities. Foreign central banks can be faulted for being complicit with respect to their dollar purchases. But if they don’t buy who will? And are we really going to continue to castigate the lender – the buyer of last resort for our debt? There should be no confusion surrounding the lack of central bank enthusiasm for intervening in the markets on our behalf.
I guess we can refer to foreign “savings” or “capital,” yet the fact of the matter is that foreigners are accumulating our IOUs – no more, no less. We consume and import too much. There is nothing gained by using language that muddles the issue; no one is forcing us to issue trillions of IOUs or to stock our stores and homes full with imported goods. There is, as well, no way for export growth to balance our trade deficit. Furthermore, foreign central banks are only inflating Credit, not creating or allocating savings and “capital.” The bottom line remains that we are in the midst of history’s greatest inflation, and I do believe there are clear analytical advantages to disentangling a very complex environment down to the key issues of Credit Inflation, Inflationary Processes and Speculative Finance.
I also read these days much commentary regarding the American consumer. Some believe the spendthrift American household sector (along with abstemious Asian and European consumers!) is to blame for the current account deficit and weak dollar. And very bright minds aver that consumer debt provides today’s “weak link” for both fragile domestic and global economic systems. While such a viewpoint is justifiable, I nonetheless believe it misdirects emphasis away from what should be the paramount issue. If our quest is to identify the true source of increasingly destabilizing Monetary Disorder, look to Wall Street and not Main Street; look at home and not abroad; look in the mirror instead of throwing stones at our neighbors (especially when they hold our mortgages). And the poor unsuspecting American consumer is reacting as one would expect considering the extraordinary inflation in the value of their assets: they are merrily enjoying the fruits of their non-labor, while scampering to buy more inflating assets.
The Paramount Issue - the “origins” – The Core – The Epicenter of the U.S. Credit Bubble lies in financial sector leveraging and securities speculation. Not surprisingly, this subject matter is taboo for most economists. But I will (again) strongly argue that the leveraging of marketable securities has been and continues as the instrumental source of Credit inflation – the commanding source of system liquidity, purchasing power, income growth and corporate cash flow. This mechanism of speculative leveraging - at the direction of the Greenspan Fed and Wall Street - artificially lowered interest rates, created the perception of an unlimited supply of finance and liquidity, and sustained ultra-low rates when fundamentals dictated that they should move significantly higher. The collapse in rates has stoked housing, equities and, increasingly, broad-based asset inflation. This has nurtured an inflationary boom of consumer borrowing and spending excess, not to mention rather ferocious “animal speculative spirits.” The consumer sector has responded vigorously to The Source – the ballooning financial sector.
When it comes to cogent analyses of Credit, inflation, and the prominent role of speculative trading in Inflationary Processes, I am happy to return to the work of one of my favorite “monetary” economists, Ralph G. Hawtrey (1879-1975). The focus of Mr. Hawtrey’s analysis of the “Trade Cycle” was the instrumental monetary role played by traders and merchants borrowing to increase the inventory of goods and commodities. Like few contemporary economists, he was keen to Credit, Credit inflation, and marketplace speculative dynamics. It’s a good week to ponder the wisdom of Mr. Hawtrey.
Recognizing the prominence that asset markets today have with respect to credit, liquidity, and income – when reading Hawtrey’s “traders,” “merchants,” “production” and “goods” think in terms of contemporary systems commanded by asset-based lending and securities markets. Today’s traders leverage bonds and merchants inventory and hock securities!
From Ralph Hawtrey:
“An expansion of credit is similarly started through the sensitiveness of merchants to the rate of interest. Merchants are tempted by cheap money to hasten their purchases. It is obvious that much depends upon the psychology of the merchants and other traders, and particularly on their expectations as to the course of markets. One who expects demand to grow will hasten to buy… When prices are rising, the holding of goods in stock is itself profitable; when prices are falling, the holding of goods in stock is a source of loss. When prices are rising, a very high rate of interest may fail to deter merchants from borrowing; when they are falling, an apparently low rate of interest may fail to tempt them… Each state of expectation tends to bring about its own fulfillment. The optimists borrow freely, and the spending power thus created brings about the rise of prices they hope for; the pessimists refrain from borrowing and the shortage of spending power brings about the fall of prices they fear. It is only at the turning-points, when the banks check borrowing, or succeed in reviving it, that the optimists and pessimists are respectively mistaken… Traders’ expectations, whether erroneous or correct, form one element in the problem of the regulation of credit… The inherent instability of credit, which becomes apparent in the vicious circle of expansion and the vicious circle of contraction, is due to the mutual relations of these three factors. Optimism encourages borrowing, borrowing accelerates sales, and sales accentuate optimism. Pessimism discourages borrowing, and the consequent decline in sales intensifies pessimism.” (R.G. Hawtrey, The Trade Cycle, Readings in Business Cycle Theory, p. 346).
“The consumers’ purchasing power is…largely supplied out of the credits which the traders borrow from the banks... The supply of purchasing power is thus regulated by the transactions which require to be financed.” Currency and Credit (C&C), 1919, p. 10
“Apart from this shuffling of debts, all the credit created is created for the purpose of being paid away in the form of profits, wages, salaries, interest, rents – in fact, to provide the incomes of all who contribute, by their services or their property, to the process of production, production being taken in the widest sense to include whatever produces value. It is for the expenses of production, in this wide sense, that people borrow, and it is of these payments that the expenses of production consist. So we reach the conclusion that an acceleration or retardation of the creation of credit means an equal increase or decrease in people’s income.” C&C p. 40
“Self interest prompts both the enterprising trader ever to borrow more, and the enterprising banker ever to lend more, for to each the increase in his credit operations means an increase in his business… The general rise of prices will involve a proportional increase of borrowing to finance a given output of goods, over and above the increase necessitated by the increase in output. This increase of borrowing, meaning an increase in the volume of credit, will further stimulate trade. Where will this process end? …The indefinite expansion of credit seems to be in the immediate interest of merchants and bankers alike. The continuous and progressive rise of prices makes it profitable to hold goods in stock, and the rate of interest which the merchant who holds such goods is prepared to pay is correspondingly high. The credit created…becomes purchasing power in the hands of the people engaged…; the greater the amount of credit created, the greater will be the amount of purchasing power and the better the market for the sale of all kinds of goods. The better the market the greater the demand for credit. Thus an increase in the supply of credit itself stimulates the demand for credit… Either the expansion or the contraction of credit may therefore proceed absolutely without limit, and the corresponding fall or rise in the value of the monetary unit would therefore also proceed without limit. In each case all standard of value will be completely lost.” C&C, pp. 12/13
“Inflation means a too free creation of credit.” C&C p. 365
“We shall find that the expansive tendencies of credit are in perpetual conflict with the maintenance of a fixed standard of value…” C&C p. 16
“The danger arises from the undue increase in credits; the remedy is to be found only in the curtailment of credits. The grant of credit rests in a banker’s absolute discretion.” C&C p. 23
“Difficulties in enforcing the control of credit occurred at the climax of trade activity, but that was chiefly on account of the heavy commitments which involved traders in further borrowing on any terms.” The Trade Cycle p. 348
“The existence of any large class of traders, whether they be bankers, underwriters, finance companies, or any others, with long-period assets and short-period debts, is always a source of danger.” C&C p. 195
“Traders borrow to purchase and hold stocks of goods or securities, and bankers encourage them to increase these stocks, and so to increase their borrowing, by lowering the rate of interest… As prices rise, the quantity of credit needed to finance a given consignment of goods increases in proportion, and the creation of credit is still further accelerated.” C&C p. 43
“The only effective method of controlling the issues of paper money is to control the creation of credit, for the demand for legal tender money for circulation is consequential upon the supply of credit. Hence the need for a central bank of issue. Inevitably a central bank with a monopoly of a legal tender note issue must be subject to carefully devised legal or at any rate administrative restraints…The actual limitations imposed on this right must be so devised as to guard the community against the various disorders which may arise from an imperfect standard of value or medium of payment.” C&C p. 52
“…inflationism, that insidious financial vice, which seems so attractive, but overindulgence in which may enfeeble or wreck the system.” C&C p. 365
“It is one of the advantages of the standpoint which we have adopted, treating credit as the primary means of payment and money as subsidiary, that it brings out the causes and the nature of these cyclical movements with special clearness. And I think it enables us to trace the instability of credit, not so much to the banker as to the merchant and the promoter.” C&C p. 377
“We have treated money as subsidiary to credit. In a highly-developed system of deposit banking, such as that of England or the United States, the justification for this is obvious. Purchasing power is created and extinguished in the form of credit.” C&C p. 380
“When it comes to practical consequences, all that debtor and creditor ask is that they may know how they stand, that they may be secured against arbitrary or incalculable variations in the value of the monetary unit… the danger is that the unit may wander far beyond these limits. Beset by the tendency of credit towards inflation, it is always liable to fall away from whatever standard may be adopted. Unless a return to the standard is regarded as an unequivocal obligation, there is no limit to the possible depreciation. The unit may follow in the well-trodden path of the assignats, the continental currency, the Austrian paper florin, the rouble. A return to a standard once lost is a painful and laborious journey… As Cobden once said of the greenbacks, after the debauch comes the headache. It is the inherent instability of credit that is perpetually involving the world in credit expansions… We traced the instability of credit to its source… We found that the initiative in production rests with the merchant and the promoter, the dealer in commodities, and the dealer in capital issues.” C&C p. 375/76
To wrap this up, the dollar “monetary unit” is in free-fall and our Creditors are being punished. “All that debtor and creditor ask is that they may know how they stand, that they may be secured against arbitrary or incalculable variations in the value of the monetary unit.” We are witnessing a truly extraordinary development, the loss of confidence in the world’s main reserve currency. And surely the consensus will stick with the story that a weaker dollar is no real problem, and this fallacy may survive a little longer. After all, at this point it’s Bubble Business as Usual for the U.S. Credit System. The falling dollar lends support to the blow-off stage of Credit Bubble excess. Heightened inflationary pressures at home (including equity prices!) augment Credit excess, while rising prices of commodities and non-dollar things – along with incredible liquidity excess throughout Asia and global “developing” financial markets - exacerbate Credit profligacy globally. But that’s precisely why they’re called “blow-offs,” and this one’s for the history books.
But financial folly is mercilessly sowing the seeds… The Source – the highly leveraged U.S. Credit system – is now acutely vulnerable to higher rates. And I do believe it has reached a point where low rates are self-defeating - only exacerbating Monetary Disorder and a dollar crash. And the problem is that it will take significantly higher rates today to suppress inflationary forces and support the dollar than it would have last year or even last month. Dollar confidence has faltered not coincidently as inflationary pressures have broadened and mounted.
When rising rates commence the de-leveraging process, the illusion of endless liquidity will be challenged. Levitated asset prices from U.S. stocks and bonds, to emerging securities, to California homes will be immediately vulnerable. In this regard, it is worth noting that the initial signs of systemic stress have appeared: speculative bond market profits have largely disappeared, interest rate markets have turned treacherous, and the yield curve is lurching about. The leveraged players will see few good alternatives other than battening down the hatches. And derivative players - reeling from chaotic trading in currency, energy, commodity, equity, and interest-rate markets – will be increasingly skittish and risk-averse. Rising risk aversion in an unwieldy Bubble environment signals we are not many steps away from Acute Financial Fragility. But, as Mr. Hawtrey recognized many years ago, “There is an inherent tendency on the part of traders to borrow more and more and of bankers to lend more and more.” (C&C p. 30)
With Treasury yields whipping about violently, bond traders must be pulling their hair out. Today’s huge rally helped re-steepen the yield curve. For the week, 2-year Treasury yields declined 10 basis points to 2.92%. Five-year Treasury rates dipped 3 basis points to 3.60%. At the same time, ten-year Treasury yields rose 2 basis points at 4.25%. Long-bond yields ended the week at 4.93%, up 4 basis points for the week. Benchmark Fannie Mae MBS yields added one basis point. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note was unchanged at 39, and the spread on Freddie’s 5% 2014 note narrowed one to 34. The 10-year dollar swap spread was up 1.75 to 41.0. Corporate bond spreads were generally little changed. The implied yield on 3-month January Eurodollars rose 5.5 basis points to 2.825%.
Corporate debt issuance jumped to a strong $18.3 billion (from Bloomberg). Investment grade issuers included News America $1.75 billion, Clorox $1.65 billion, World Savings $1.3 billion, Ford Motor Credit $1.25 billion, Citigroup $1.0 billion, Key Bank $750 million, Chesapeake Energy $600 million, PNC Bank $500 million, First Tennessee Bank $400 million, Suntrust Bank $350 million, Enbridge Energy $300 million, and Huntington National $250 million.
Junk bond funds saw outflows of $186.4 million (from AMG). Issuers included CCO Holdings $550 million, SBA Communications $250 million, WDAC Subsidiary $200 million, and MAAX Holdings $170 million.
Convert issuers included Universal City $450 million, Scientific Games $250 million, American Equity $250 million, OMI Corp. $225 million, American Equity $175 million, Synaptics $100 million, and Cray Inc. $65 million.
December 1 – MarketNews: “The Chicago Board of Trade…experienced its highest monthly volume ever in November, with turnover for the month increasing 58% from the prior year to 59,467,507 contracts amid a surge in financial futures and options trading. Month-over-month volume was up 24.3%, the exchange said. Trading in the exchange's franchise Treasury futures and options was up 26% from a month ago and up 67.8% from year-ago figures with a total of 49,911,971 financial contracts traded.”
Heavy foreign dollar debt issuance included Venezuela $1.5 billion, Republic of Brazil $1.25 billion, Swedish Export Credit $1.0 billion, Banco Santander $700 million, Royal Bank of Scotland $675 million, Yara International $500 million, Fairfax Financial Holdings $470 million, and Woori Bank $300 million.
Japanese 10-year JGB yields were unchanged at 1.44%. Brazilian benchmark bond yields rose 3 basis points to 8.21%. Mexican govt. yields ended the week at 5.28%, up 5 basis points for the week. Russian 10-year dollar Eurobond yields were unchanged at 5.89%.
Freddie Mac posted 30-year fixed mortgage rates jumped 9 basis points this week to 5.81%. Fifteen-year fixed mortgage rates were 8 basis points higher at 5.23%. One-year adjustable-rate mortgages could be had at 4.19%, down 8 basis points. The Mortgage Bankers Association Purchase application index was about unchanged for the week. Purchase applications were up about 5% from one year ago, with dollar volume up 15%. Refi applications sank 12.3% during the week. The average new Purchase mortgage declined to $225,500, and the average ARM dropped to $304,800. ARMs declined to 32.3% of total applications.
Broad money supply (M3) expanded $7.1 billion (week of November 22). Year-to-date (47 weeks), broad money is up $480.2 billion, or 6.0% annualized. For the week, Currency increased $0.6 billion. Demand & Checkable Deposits jumped $23.6 billion. Savings Deposits declined $18.0 billion, with a year-to-date gain of $339 billion (11.7% annualized). Small Denominated Deposits dipped $0.4 billion. Retail Money Fund deposits added $2.7 billion, while Institutional Money Fund deposits dipped $1.2 billion. Large Denominated Deposits rose $7.9 billion. Repurchase Agreements declined $6.7 billion, and Eurodollar deposits fell $1.3 billion.
Bank Credit surged $46.5 billion for the week of November 24 to $6.781 Trillion. Bank Credit has expanded $506.9 billion during the first 47 weeks of the year, or 8.9% annualized. For the week, Securities holdings jumped $23.6 billion, and Loans & Leases rose $22.9 billion. Commercial & Industrial loans gained $6.3 billion, while Real Estate loans dipped $2.9 billion. Real Estate loans are up $286 billion y-t-d, or 14.2% annualized. Consumer loans were about unchanged for the week, while Securities loans jumped $14.2 billion. Other loans expanded $5.7 billion. Elsewhere, Total Commercial Paper rose $4.4 billion ($24.3bn in 3 weeks) to $1.393 Trillion. Financial CP added $5.1 billion to $1.259 Trillion ($25.4bn in 3 weeks), expanding at a 9.2% rate so far this year. Non-financial CP dipped $0.7 billion (up 25.8% annualized y-t-d) to $133.7 billion. Year-to-date, Total CP is up $124.3 billion, or 10.6% annualized.
Fed Foreign “Custody” Holdings of Treasury, Agency Debt rose $5.9 billion to $1.323 Trillion. Year-to-date, Custody Holdings are up $255.9 billion, or 26% annualized. Federal Reserve Credit jumped $5.7 billion for the week to $785.5 billion, with y-t-d gains of $38.9 billion (5.7% annualized). Fed Credit has surged $20.6 billion over the past eight weeks.
This week’s ABS issuance came to about $7 billion (from JPMorgan). Total year-to-date issuance of $591.9 billion is 37% ahead of comparable 2003. 2004 home equity ABS issuance of $383.5 billion is running 82% ahead of last year’s record pace.
Currency Watch:
Today’s bludgeoning put the dollar index down 1% for the week and below 81 for the first time since May 1995. The Euro ended today’s session at a record 134.54. The Iceland krona gained almost 5% this week, the British pound 2.65%, Polish zloty 2.2%, and Hungarian forint 2.0%. The Argentine peso declined almost 1%, with small losses suffered by the Canadian and Australian dollars.
Commodities Watch:
November 30 – Bloomberg (Hector Forster): “Japan, the world’s largest consumer of crude oil after the U.S. and China, said oil imports rose for a fourth consecutive month in October, gaining 14.3 percent from a year earlier… Japan imports more than 99 percent of its oil, according to the ministry.”
I wouldn’t much want to be an energy trader either. January Crude Oil sank $6.90 this week to $42.54. The Goldman Sachs Commodities index dropped 11.6% for the week, reducing year-to-date gains to 18.6%. The CRB index declined 2.3%, with 2004 gains of 11.4%.
China Watch:
December 3 – Bloomberg (Xiao Yu): “China faces a bigger influx of foreign currencies as investors bet the government will let the yuan appreciate, the state-run Xinhua News Agency said, without disclosing specific amounts.”
November 29 – Bloomberg (Simon Casey): “China, the world’s largest steel producer, will import 37 percent more iron ore this year than in 2003 as mills boost output to meet domestic demand, Macquarie Bank said. Chinese iron imports will rise to 203 million metric tons from 148 million tons last year… The nation’s steel output will jump 23 percent this year to 270 million tons.”
December 3 – Bloomberg (Allen T. Cheng): “China’s technology exports in the first 10 months rose about 52 percent to $128.3 billion from a year earlier, said Shan Qingjiang, deputy director general at the Ministry of Commerce’s technology division. For the full year, technology exports will probably climb 41.2 percent to $160 billion…”
December 2 – Bloomberg (Allen T. Cheng): “China’s economy generated 8.4 million jobs in the first 10 months, achieving the target set by the government, China Central Television reported.”
November 30 – Bloomberg (Allen T. Cheng): “Chinese consumers are the most optimistic in the world, with 78 percent expecting the economy to improve in the coming year, according to a survey by market researcher AC Nielsen. China was followed by India, where 77 percent of consumers said they expect an improvement and Indonesia with 76 percent, said New York-based Nielsen, which interviewed 14,134 people in 28 markets…”
December 2 – Bloomberg (Joshua Fellman): “Hong Kong real estate sales, mainly of apartments, more than doubled in November, rising for a 14th month as property prices and transactions increased in the city because of an economic rebound. Sales of building units, which also include factory and office space, jumped to HK$44.51 billion ($5.73 billion) last month… Transactions rose 42 percent to 13,690.”
Asia Inflationary Boom Watch:
December 1 – Bloomberg (Seyoon Kim): “South Korean export growth picked up in November for the first time in six months, with shipments reaching a record $23.3 billion as manufacturers sold more cars and cell phones abroad. Overseas sales rose 28 percent from a year earlier after climbing a revised 20 percent in October…”
December 2 – Bloomberg (Seyoon Kim): “South Korea’s foreign-exchange reserves rose $14.2 billion in November, the biggest-ever monthly gain, as the central bank bought U.S. dollars to stem the won’s appreciation. The reserves, the fourth largest in the world, reached a record $192.6 billion at the end of last month, the Bank of Korea said…”
December 3 – Bloomberg (Theresa Tang): “Taiwan’s foreign-currency reserves, the third-highest in the world, rose in November to a record $239 billion, boosted by net foreign capital inflows and an appreciation of the euro and Japanese yen. The reserves, which trail those of Japan and China, rose for a 41st month from $235 billion in October…”
December 1 – Bloomberg (Shanthy Nambiar and Aloysius Unditu): “Indonesian exports surged 46 percent in October, more than expected, on rising oil prices and demand for palm oil, nickel and coal in China and India. Exports rose to $7.27 billion from a year earlier…”
November 30 – Bloomberg (Grace Nirang and Wahyudi Soeriaatmadja): “Indonesia plans to raise prices of gasoline, diesel and other fuels by as much as 40 percent next year, and cut subsidies to help narrow the country’s budget deficit, government ministers said.”
November 30 – Bloomberg (Kate Mayberry): “Malaysia’s broadest measure of money in circulation expanded in October at its fastest pace since June as banks extended more loans to consumers and companies. M3, the most closely watched measure of money supply, rose 10.7 percent in October from a year earlier…”
December 1 – Bloomberg (Khoo Hsu Chuang): “Malaysia’s economic growth may exceed a government forecast of 7 percent expansion this year, Second Finance Minister Nor Mohamed Yakcop said. ‘I’m confident of getting more than 7 percent growth. Private consumption is the engine of growth; we are in for a good patch of two years.’”
November 29 – Bloomberg (Francisco Alcuaz Jr.): “The Philippines raised its economic growth forecast for this year to more than 6 percent, the fastest in more than a decade…”
December 3 – Bloomberg (Francisco Alcuaz Jr.): “Philippine export growth picked up in October as electronics makers sold more disk drives and computer chips to Japanese factories. Overseas sales rose 12 percent from a year earlier to $3.75 billion after increasing 8.4 percent in September…”
Global Reflation Watch:
December 3 – Bloomberg (Lily Nonomiya): “Japanese companies increased capital spending more than expected in the three months ended Sept. 30, prompting economists to predict the government will raise its estimate for growth in the world’s second-largest economy. Capital spending, including investment in software, rose 14.4 percent from a year earlier…”
November 30 – MarketNews Intl.: “Home construction in France remained buoyant in October, as three-month housing starts posted a 21.8% rise on the year, while permits for the same period were up 21.4%, according to non-seasonally adjusted data released Tuesday by the Construction Ministry.”
December 2 – Bloomberg (Todd Prince): “Russia’s foreign currency and gold reserves rose for a 14th-straight week to a record $117.1 billion, nearing the country’s total foreign debt. The central bank said the reserves rose $3.2 billion in the week ending Nov. 26… Russia’s foreign currency and gold reserves are surging as the central bank buys dollars being brought into the country by oil and gas exporters…”
December 1 – Bloomberg (Ben Holland): “Turkish exports climbed 45 percent in November from the same month last year, the fastest pace of growth this year… The country had exports of $5.8 billion in November… Exports in the 12 months through Nov. 30 climbed 35 percent to $62 billion…”
November 30 – Bloomberg (Vernon Wessels and Mike Cohen): “South Africa’s economy expanded an annualized 5.6 percent in the third quarter, the fastest pace since 1996 and more than economists expected, as the lowest interest rates for two decades boosted demand.”
November 29 – Bloomberg (Heather Walsh): “Latin American economies will grow more than 5 percent this year, faster than previously forecast, driven by demand for commodities and low financing costs, the World Bank’s chief economist for Latin America said.”
December 1 – Bloomberg (Guillermo Parra-Bernal): “Brazil’s economic growth quickened to its fastest pace in eight years in the third quarter as lower interest rates boosted demand at home and exports of soybeans and cars surged. Gross domestic product grew 6.1 percent in the July-through-September period from a year ago after expanding 5.6 percent in the second quarter…”
December 2 – Bloomberg (Daniel Helft and Andrew J. Barden): “Argentine central bank President Martin Redrado said the country’s monetary supply will expand as much as 15 percent in 2005, without stoking inflation and keeping the exchange rate stable.”
Dollar Consternation Watch:
November 29 – UPI: “China Premier Wen Jiabao launched an indirect attack on the U.S. failure to halt the dollar slide while vowing not to revalue the yuan under pressure. In the strongest sign yet of Beijing’s concern at the weakening dollar, Wen questioned the American government’s management of its currency, The South China Morning Post reported... ‘China is a responsible country. We have ensured that the exchange rate of the renminbi remained stable during the 1997 Asian financial turmoil and, by doing so, contributed to the resolution of the crisis,’ Wen said…‘Today, we have to ask a question. The US dollar is depreciating and there is no attempt to manage it. What is the reason for this? Shouldn’t the relevant parties take measures?’ Wen described the revaluation of yuan as a major economic issue that should not be carried out under pressure, pointing that change in the exchange rate required certain conditions. ‘The most important is to have a stable macroeconomic environment, a healthy and complete market mechanism and a healthy financial system.’”
California Bubble Watch:
December 3 – San Francisco Chronicle: “Bay Area home prices are increasingly outstripping incomes, making it less likely that nurses, teachers and firefighters can purchase properties here than in other major metropolitan areas… A quarterly analysis by the California Association of Realtors found Bay Area household incomes are $82,910 short of being able to afford a median-priced home… a Bay Area buyer now needs an income of $151,338 to afford a typical home…”
Bubble Economy Watch:
December 2 – The Wall Street Journal (Ann Davis): “Wall Street firms that are best positioned to take advantage of the bull market in commodities trading, and those that continue to post strong bond-trading gains, are poised to pay bankers much higher year-end bonuses than peers, according to a report by Deutsche Bank AG. Reflecting more-generous bonuses, Goldman Sachs Group Inc.’s total compensation expense is expected to rise an outsized 37% over last year’s, according to Deutsche Bank’s brokerage industry analyst, Richard Strauss. Morgan Stanley and Lehman Brothers Holdings Inc. are expected to post compensation increases of 25% and 30%, respectively.”
December 1 – Bloomberg (Jeff Green): “Thor Industries Inc. Chief Executive Wade Thompson, whose company is the world’s largest maker of motor homes and travel trailers, expects the industry's shipments to rise in 2005 for the fourth straight year… Thompson and chief executives of three rivals said they plan to hire more workers and Thor, Fleetwood Enterprises Inc., Winnebago Industries Inc. and other recreational-vehicle makers expect shipments to rise 14 percent this year to 364,900 units, the best since 1978…”
Mortgage Finance Bubble Watch:
December 2 – Bloomberg (Al Yoon): “Freddie Mac, the second-biggest provider of financing for U.S. residential mortgages, said investors in Asia purchased a record 40 percent of its $3 billion five-year reference note sale. Foreign investors accounted for 48 percent of the notes, which pay an interest rate of 4 percent and were priced to yield 30.5 basis points more than the U.S. Treasury's five-year note…”
December 1 – Bloomberg (Kathleen M. Howley): “U.S. home prices increased at the fastest pace in 25 years during the third quarter, led by Nevada and California, as the economy improved and low mortgage rates made financing more affordable. Prices across the nation rose an average of 13 percent from a year earlier, surpassing the second quarter’s 9.8 percent pace, according to a report from the Washington-based Office of Federal Housing Enterprise Oversight, or Ofheo. It was the biggest increase since 13.1 percent in 1979's third quarter.”
In CaseYou Missed it on CNBC - Watch:
December 1 – Dow Jones: “The amount of trash produced by U.S. consumers serves as an indicator of the domestic economy’s health, said Michael Hoffman, deputy director of research at Friedman Billings Ramsey. ‘I think we’re in a healthy environment,’ Hoffman said Wednesday on CNBC, referring to economic conditions. Hoffman said the volume of trash has been increasing recently in step with observations that the U.S. economy is in a recovery.”
Pertinent Monetary Economics from Ralph G. Hawtrey
Recent comments from the eminent Stephen Roach: “The asset economy does not just have its origins in America. It is very much a by-product of support from global investors and policy makers. One of the outgrowths of an increasingly asset-dependent economy is a shortfall in income-based national saving. America has taken this shortfall to an unprecedented extreme. The net national saving rate -- the combined saving of consumers, businesses, and the government sector after deducting for the depreciation of worn-out capacity -- fell to a record low in the 1-2% range in 2003-04. Lacking in domestic saving, America has had to import foreign saving from abroad -- and run massive current account deficits to attract that capital.”
I have to this time take exception with Mr. Roach’s analytical approach. The “origins” of our “asset economy” are surely not only here at home, but they reside in the bowels of Washington and Wall Street. And I would argue that the key issue today is not a lack of “savings” or our massive current account deficits. These are only symptoms of the massive Credit Inflation that has ridden roughshod through our Credit system and economy and that now destabilize the world. And I’m no fan of the language “attract capital” or “import foreign saving” in this context. Foreign financial flows are merely the “recycling” of dollar balances – created in gross excess by our financial sector and federal government - into U.S. securities. Foreign central banks can be faulted for being complicit with respect to their dollar purchases. But if they don’t buy who will? And are we really going to continue to castigate the lender – the buyer of last resort for our debt? There should be no confusion surrounding the lack of central bank enthusiasm for intervening in the markets on our behalf.
I guess we can refer to foreign “savings” or “capital,” yet the fact of the matter is that foreigners are accumulating our IOUs – no more, no less. We consume and import too much. There is nothing gained by using language that muddles the issue; no one is forcing us to issue trillions of IOUs or to stock our stores and homes full with imported goods. There is, as well, no way for export growth to balance our trade deficit. Furthermore, foreign central banks are only inflating Credit, not creating or allocating savings and “capital.” The bottom line remains that we are in the midst of history’s greatest inflation, and I do believe there are clear analytical advantages to disentangling a very complex environment down to the key issues of Credit Inflation, Inflationary Processes and Speculative Finance.
I also read these days much commentary regarding the American consumer. Some believe the spendthrift American household sector (along with abstemious Asian and European consumers!) is to blame for the current account deficit and weak dollar. And very bright minds aver that consumer debt provides today’s “weak link” for both fragile domestic and global economic systems. While such a viewpoint is justifiable, I nonetheless believe it misdirects emphasis away from what should be the paramount issue. If our quest is to identify the true source of increasingly destabilizing Monetary Disorder, look to Wall Street and not Main Street; look at home and not abroad; look in the mirror instead of throwing stones at our neighbors (especially when they hold our mortgages). And the poor unsuspecting American consumer is reacting as one would expect considering the extraordinary inflation in the value of their assets: they are merrily enjoying the fruits of their non-labor, while scampering to buy more inflating assets.
The Paramount Issue - the “origins” – The Core – The Epicenter of the U.S. Credit Bubble lies in financial sector leveraging and securities speculation. Not surprisingly, this subject matter is taboo for most economists. But I will (again) strongly argue that the leveraging of marketable securities has been and continues as the instrumental source of Credit inflation – the commanding source of system liquidity, purchasing power, income growth and corporate cash flow. This mechanism of speculative leveraging - at the direction of the Greenspan Fed and Wall Street - artificially lowered interest rates, created the perception of an unlimited supply of finance and liquidity, and sustained ultra-low rates when fundamentals dictated that they should move significantly higher. The collapse in rates has stoked housing, equities and, increasingly, broad-based asset inflation. This has nurtured an inflationary boom of consumer borrowing and spending excess, not to mention rather ferocious “animal speculative spirits.” The consumer sector has responded vigorously to The Source – the ballooning financial sector.
When it comes to cogent analyses of Credit, inflation, and the prominent role of speculative trading in Inflationary Processes, I am happy to return to the work of one of my favorite “monetary” economists, Ralph G. Hawtrey (1879-1975). The focus of Mr. Hawtrey’s analysis of the “Trade Cycle” was the instrumental monetary role played by traders and merchants borrowing to increase the inventory of goods and commodities. Like few contemporary economists, he was keen to Credit, Credit inflation, and marketplace speculative dynamics. It’s a good week to ponder the wisdom of Mr. Hawtrey.
Recognizing the prominence that asset markets today have with respect to credit, liquidity, and income – when reading Hawtrey’s “traders,” “merchants,” “production” and “goods” think in terms of contemporary systems commanded by asset-based lending and securities markets. Today’s traders leverage bonds and merchants inventory and hock securities!
From Ralph Hawtrey:
“An expansion of credit is similarly started through the sensitiveness of merchants to the rate of interest. Merchants are tempted by cheap money to hasten their purchases. It is obvious that much depends upon the psychology of the merchants and other traders, and particularly on their expectations as to the course of markets. One who expects demand to grow will hasten to buy… When prices are rising, the holding of goods in stock is itself profitable; when prices are falling, the holding of goods in stock is a source of loss. When prices are rising, a very high rate of interest may fail to deter merchants from borrowing; when they are falling, an apparently low rate of interest may fail to tempt them… Each state of expectation tends to bring about its own fulfillment. The optimists borrow freely, and the spending power thus created brings about the rise of prices they hope for; the pessimists refrain from borrowing and the shortage of spending power brings about the fall of prices they fear. It is only at the turning-points, when the banks check borrowing, or succeed in reviving it, that the optimists and pessimists are respectively mistaken… Traders’ expectations, whether erroneous or correct, form one element in the problem of the regulation of credit… The inherent instability of credit, which becomes apparent in the vicious circle of expansion and the vicious circle of contraction, is due to the mutual relations of these three factors. Optimism encourages borrowing, borrowing accelerates sales, and sales accentuate optimism. Pessimism discourages borrowing, and the consequent decline in sales intensifies pessimism.” (R.G. Hawtrey, The Trade Cycle, Readings in Business Cycle Theory, p. 346).
“The consumers’ purchasing power is…largely supplied out of the credits which the traders borrow from the banks... The supply of purchasing power is thus regulated by the transactions which require to be financed.” Currency and Credit (C&C), 1919, p. 10
“Apart from this shuffling of debts, all the credit created is created for the purpose of being paid away in the form of profits, wages, salaries, interest, rents – in fact, to provide the incomes of all who contribute, by their services or their property, to the process of production, production being taken in the widest sense to include whatever produces value. It is for the expenses of production, in this wide sense, that people borrow, and it is of these payments that the expenses of production consist. So we reach the conclusion that an acceleration or retardation of the creation of credit means an equal increase or decrease in people’s income.” C&C p. 40
“Self interest prompts both the enterprising trader ever to borrow more, and the enterprising banker ever to lend more, for to each the increase in his credit operations means an increase in his business… The general rise of prices will involve a proportional increase of borrowing to finance a given output of goods, over and above the increase necessitated by the increase in output. This increase of borrowing, meaning an increase in the volume of credit, will further stimulate trade. Where will this process end? …The indefinite expansion of credit seems to be in the immediate interest of merchants and bankers alike. The continuous and progressive rise of prices makes it profitable to hold goods in stock, and the rate of interest which the merchant who holds such goods is prepared to pay is correspondingly high. The credit created…becomes purchasing power in the hands of the people engaged…; the greater the amount of credit created, the greater will be the amount of purchasing power and the better the market for the sale of all kinds of goods. The better the market the greater the demand for credit. Thus an increase in the supply of credit itself stimulates the demand for credit… Either the expansion or the contraction of credit may therefore proceed absolutely without limit, and the corresponding fall or rise in the value of the monetary unit would therefore also proceed without limit. In each case all standard of value will be completely lost.” C&C, pp. 12/13
“Inflation means a too free creation of credit.” C&C p. 365
“We shall find that the expansive tendencies of credit are in perpetual conflict with the maintenance of a fixed standard of value…” C&C p. 16
“The danger arises from the undue increase in credits; the remedy is to be found only in the curtailment of credits. The grant of credit rests in a banker’s absolute discretion.” C&C p. 23
“Difficulties in enforcing the control of credit occurred at the climax of trade activity, but that was chiefly on account of the heavy commitments which involved traders in further borrowing on any terms.” The Trade Cycle p. 348
“The existence of any large class of traders, whether they be bankers, underwriters, finance companies, or any others, with long-period assets and short-period debts, is always a source of danger.” C&C p. 195
“Traders borrow to purchase and hold stocks of goods or securities, and bankers encourage them to increase these stocks, and so to increase their borrowing, by lowering the rate of interest… As prices rise, the quantity of credit needed to finance a given consignment of goods increases in proportion, and the creation of credit is still further accelerated.” C&C p. 43
“The only effective method of controlling the issues of paper money is to control the creation of credit, for the demand for legal tender money for circulation is consequential upon the supply of credit. Hence the need for a central bank of issue. Inevitably a central bank with a monopoly of a legal tender note issue must be subject to carefully devised legal or at any rate administrative restraints…The actual limitations imposed on this right must be so devised as to guard the community against the various disorders which may arise from an imperfect standard of value or medium of payment.” C&C p. 52
“…inflationism, that insidious financial vice, which seems so attractive, but overindulgence in which may enfeeble or wreck the system.” C&C p. 365
“It is one of the advantages of the standpoint which we have adopted, treating credit as the primary means of payment and money as subsidiary, that it brings out the causes and the nature of these cyclical movements with special clearness. And I think it enables us to trace the instability of credit, not so much to the banker as to the merchant and the promoter.” C&C p. 377
“We have treated money as subsidiary to credit. In a highly-developed system of deposit banking, such as that of England or the United States, the justification for this is obvious. Purchasing power is created and extinguished in the form of credit.” C&C p. 380
“When it comes to practical consequences, all that debtor and creditor ask is that they may know how they stand, that they may be secured against arbitrary or incalculable variations in the value of the monetary unit… the danger is that the unit may wander far beyond these limits. Beset by the tendency of credit towards inflation, it is always liable to fall away from whatever standard may be adopted. Unless a return to the standard is regarded as an unequivocal obligation, there is no limit to the possible depreciation. The unit may follow in the well-trodden path of the assignats, the continental currency, the Austrian paper florin, the rouble. A return to a standard once lost is a painful and laborious journey… As Cobden once said of the greenbacks, after the debauch comes the headache. It is the inherent instability of credit that is perpetually involving the world in credit expansions… We traced the instability of credit to its source… We found that the initiative in production rests with the merchant and the promoter, the dealer in commodities, and the dealer in capital issues.” C&C p. 375/76
To wrap this up, the dollar “monetary unit” is in free-fall and our Creditors are being punished. “All that debtor and creditor ask is that they may know how they stand, that they may be secured against arbitrary or incalculable variations in the value of the monetary unit.” We are witnessing a truly extraordinary development, the loss of confidence in the world’s main reserve currency. And surely the consensus will stick with the story that a weaker dollar is no real problem, and this fallacy may survive a little longer. After all, at this point it’s Bubble Business as Usual for the U.S. Credit System. The falling dollar lends support to the blow-off stage of Credit Bubble excess. Heightened inflationary pressures at home (including equity prices!) augment Credit excess, while rising prices of commodities and non-dollar things – along with incredible liquidity excess throughout Asia and global “developing” financial markets - exacerbate Credit profligacy globally. But that’s precisely why they’re called “blow-offs,” and this one’s for the history books.
But financial folly is mercilessly sowing the seeds… The Source – the highly leveraged U.S. Credit system – is now acutely vulnerable to higher rates. And I do believe it has reached a point where low rates are self-defeating - only exacerbating Monetary Disorder and a dollar crash. And the problem is that it will take significantly higher rates today to suppress inflationary forces and support the dollar than it would have last year or even last month. Dollar confidence has faltered not coincidently as inflationary pressures have broadened and mounted.
When rising rates commence the de-leveraging process, the illusion of endless liquidity will be challenged. Levitated asset prices from U.S. stocks and bonds, to emerging securities, to California homes will be immediately vulnerable. In this regard, it is worth noting that the initial signs of systemic stress have appeared: speculative bond market profits have largely disappeared, interest rate markets have turned treacherous, and the yield curve is lurching about. The leveraged players will see few good alternatives other than battening down the hatches. And derivative players - reeling from chaotic trading in currency, energy, commodity, equity, and interest-rate markets – will be increasingly skittish and risk-averse. Rising risk aversion in an unwieldy Bubble environment signals we are not many steps away from Acute Financial Fragility. But, as Mr. Hawtrey recognized many years ago, “There is an inherent tendency on the part of traders to borrow more and more and of bankers to lend more and more.” (C&C p. 30)
11/28/2003 Compounding the Problem *
This is an abbreviated Bulletin.
The liquidity and speculation-driven U.S. stock market came to life again. For the week, the Dow and S&P500 added about 2%. The Utilities and Morgan Stanley Consumer indices also gained about 2%. Economically sensitive issues outperformed, with the Transports gaining 3% and the Morgan Stanley Cyclical index increasing 4% (up 38% y-t-d). The S&P Homebuilding index jumped 5% this week, increasing y-t-d gains to 98%. The S&P Retail Stores index added 3% this week, with 2003 gains of 44%. The broader market caught fire. The small cap Russell 2000 jumped almost 4%, increasing year-to-date gains to 43%. The S&P400 Mid-cap’s 3.5% rise increased 2003 gains to 32%. The NASDAQ100 added almost 4% and Morgan Stanley High Tech almost 5%, with respective y-t-d gains of 45% and 61%. The Semiconductors and The Street.com Internet index indices gained 5%, increasing 2003 gains to 83% and 71%. The NASDAQ Telecom index’s 4% rise increased y-t-d gains to 59%. The Biotechs gained 3% (up 36% y-t-d). Financial stocks rose as well, with the Broker/Dealers adding 3% (up 51% y-t-d) and the Banks 2% (up 26% y-t-d).
Curiously, the bond market was caught flat-footed by this week’s strong economic data (paying too much attention to a bungling Federal Reserve!). For the week, 2-year Treasury yields jumped 17 basis points to 1.99%. Five-year Treasury yields surged 21 basis points to 3.36%, with 10-year yields up 17 basis points to 4.33%. The long-bond saw its yield increase 11 basis points to 5.13%. Benchmark Fannie Mae mortgage-backed yields jumped 19 basis points. The spread on Fannie’s 4 3/8 2013 note widened 3 to 39, while the spread on Freddie’s 4 ½% 2013 note widened 4 to 38. The 10-year dollar swap spread was unchanged at 39.25. Corporate spreads generally narrowed, with junk debt spreads narrowing meaningfully. A Merrill Lynch index of corporate spreads moved to the narrowest margin since 1999. The implied yield on December 2004 Eurodollars rose 29 basis points to 2.62%.
Demand encouraged unusually strong debt issuance for a Thanksgiving week. GE Capital raised $1 billion (up from $750 million), United Healthcare $500 million, Suncor Energy $500 million, PSEG Power $300 million, Penn National $200 million, Consolidated Natural Gas $200 million, and Chevy Chase Bank $175 million.
Junk funds enjoyed inflows of $425 million. Issuers included Jostens $247 million, General Nutrition $215 million, Embratel $200 million, and Stena AB $175 million.
Converts issued: Ciber $150 million and Lion’s Gate $50 million.
Dollar Watch:
Monday’s abrupt dollar surge quickly faded, with the dollar index trading today at the lowest level since January 1997. It is especially alarming that the dollar traded so poorly in the face of strong economic data. Three straight losing weeks has the dollar at a record low against the euro. The British pound gained 1% this week and today closed at the highest level against the dollar since those dark October 1998 days of the LTCM crisis. Commodity currencies continue to perform well, with the South African rand gaining about 2% this week. The Australian dollar rose against the greenback for the 13th straight week. The Canadian dollar traded to a new 10-year high this week.
Commodities Watch:
Various commodity markets have turned stunningly volatile. The CRB index reversed early weakness to end the week about unchanged. Gold traded above $400 this week, before ending the week up $2.10 to $398.15. Heightened trade frictions with China have commodity traders on edge.
November 27 – Bloomberg: “China Steel Corp., Taiwan’s biggest steelmaker, said it plans to raise domestic prices for the first quarter to reflect higher global prices and rising raw material and transportation costs as the global economy recovers… Economic expansion in the U.S., Japan and Europe and China’s growing demand are pushing up prices. China steel demand has caused a shortage of almost all products and spurred an increase in prices, driving up costs of raw materials such as coal, metals, scrap steel and steel slabs, China Steel said in a statement.”
Global Reflation Watch:
November 27 – Bloomberg: “Money supply growth in the dozen-nation euro region accelerated in October, suggesting the European Central Bank may become more concerned about the inflation outlook as the economy recovers. M3 grew at an annual pace of 8 percent last month after a revised 7.6 percent in September, the ECB said in a conference call. The central bank says M3 above 4.5 percent risks fueling inflation.”
November 28 – MarketNews: “The European Commission’s Business Climate Indicator (BCI) rose in November to +0.02, the fourth monthly rise in a row and the first positive reading in two and one-half years, according to data released Friday by the EU Commission.”
November 27 – Bloomberg: “Manufacturers in France, Europe’s third-largest economy, were at their most confident in 11 months in November as demand for exports boosted order books. An index based on a survey of about 2,500 companies rose to 100 from 95 in October, Paris-based statistics office Insee said. Economists had expected a reading of 97… French manufacturers are mirroring improving sentiment in Belgium, Germany and Italy. The Munich-based Ifo institute’s German business confidence indicator climbed to a 33-month high this month…”
November 28 – Bloomberg: “Swiss leading economic indicators rose to the highest in more than 2 1/2 years in October, indicating the economy is about to accelerate after emerging from its longest recession in more than a decade.”
November 28 – Bloomberg: “Japanese consumer prices rose 0.1 percent in October, increasing for the first time since April 1998 because of higher taxes and more costly rice.” (From the 25th) “Sales at Japanese department stores and supermarkets rose in October for the first time in more than a year…”
November 27 – Bloomberg: “The number and value of mortgage loans approved in October rose to a record, the British Bankers’ Association said, suggesting the pace of consumer borrowing, which helped prompt an increase in interest rates this month, isn’t slowing.”
November 28 – Bloomberg: “Irish mortgage lending accelerated in October, as the lowest interest rates in decades spurred more people to buy property, Ireland’s central bank said. The value of outstanding mortgage loans rose 24.8 percent to 51.75 billion euros ($62 billion) in October from a year earlier…”
November 24 – Bloomberg: “Taiwan’s export orders rose to a record in October, climbing as overseas consumers buy more of the island’s laptop computers, flat-panel displays and cell phones. Orders -- indicative of shipments in one to three months -- rose 19.9 percent from a year earlier…” “Taiwan’s money supply grew last month at the fastest pace in two years…”
November 25 – Bloomberg: “Hong Kong’s exports grew in October at their fastest pace in four months as its ports handled more components en route to factories in China and Chinese-made cell phones, clothes and fridges bound for the U.S., Japan and Europe. Exports rose 9.4 percent from a year earlier…”
November 27 – Bloomberg: “Thailand’s economy grew more than 6 percent from a year earlier in the third quarter, led by gains in exports and consumer spending, a senior government official said.”
November 26 – Bloomberg: “Singapore’s manufacturing rose in October at its fastest pace this year… Manufacturing, which accounts for a quarter of the economy, rose 19.3 percent from a year earlier after gaining a revised 6.2 percent in September…”
November 24 – Bloomberg: “India’s economy is expected to grow at an ‘explosive’ pace as the government sells assets, allows more overseas investments and boosts infrastructure, encouraging consumers to spend more, Finance Minister Jaswant Singh said. ‘India’s economy is fast approaching the point of criticality and, when it does, growth would be explosive,’ Singh told businessmen in New Delhi yesterday. ‘The fundamentals in reality have not been better in the last 52 years.’”
November 28 – Bloomberg: “New Zealand house prices rose for a ninth straight quarter in the three months ended Sept. 30… The national house price index provisionally rose 17 percent in the third quarter from the year-earlier quarter…”
November 24 – Bloomberg: “Mexico’s exports climbed in October to their highest in three years on rising foreign demand for manufactured goods, helping narrow the country's trade deficit…”
Domestic Credit Inflation Watch:
Despite its interminable accounting woes, Freddie Mac posted strong growth during October. Freddie’s Book of Business jumped $38.0 billion for the month, a 33.8% annualized growth rate, to $1.387 Trillion. Over three months, the company’s Book of Business surged $96.0 billion, or 29.8% annualized. Freddie’s Retained Portfolio expanded at a 27% annualized rate during the month to $655.5 billion. Over the past three months, the company’s Retained Portfolio jumped $60.3 billion, or 40.5% annualized. Freddie and Fannie’s combined Retained Portfolios increased an unprecedented $169.3 billion over four months (the onset of near Credit market dislocation in July through October), or 36.3% annualized. It is not often in financial history that a $1.5 Trillion portfolio expands at such a pace. Over the past 12 months, Freddie and Fannie’s Retained Portfolios have increased $280 billion, or almost 22%. For comparison, total Federal Reserve Assets are up about $25 billion so far this year to $758 billion.
October Existing Home Sales slowed moderately from September’s extraordinary pace. At a seasonally adjusted annualized 6.35 million units, year-over-year sales were up 12.8%. And with Average Prices (mean) up 8.4% y-o-y, Calculated Transaction Value (CTV) was up a noteworthy 22.2% from October 2002 to $1.39 Trillion. New Homes sales also moderated from September, although the 1.105 million unit pace was up 10.0% from 12 months earlier (5th highest level on record). And with Average Prices up 8.2%, New Homes CTV was up 18.9% y-o-y to $276.5 Trillion. Combined October New and Existing Home Sales were up 12.4% y-o-y to an annualized 7.455 million pace. Combined CTV was up almost 22% y-o-y to $1.67 Trillion. Combined CTV was up 47% over two years and 97% over six years, providing what should be irrefutable evidence of an historic mortgage finance Bubble.
Freddie Mac posted 30-year fixed mortgage rates increased 6 basis points this week to 5.89% (but down from the year ago 6.13%). Fifteen-year adjustable mortgage rates increased 5 basis points to 5.22%. One-year adjustable mortgage rates increased 5 basis points to 3.77% (down from the year ago 4.19%). The Mortgage Bankers Association application index came to life, although we must be mindful of holiday-week distortions. For the week, Refi Applications surged 42% to the highest reading in 7 weeks. Purchase Applications jumped 15% to a near record, with a 2-week gain of almost 23%. Purchase Applications were up 32% from the year ago level, with dollar volume up 49%.
Interestingly, October was a huge month for the ports of Los Angeles and Long Beach. Combined inbound containers jumped 9% from September to 595,726, a new record (up 43% from strike-impacted October 2002). Combined Outbound containers surged 19% from September to the strongest level in five months. October saw a total of 333,429 empty outbound containers, a new record and 56% of the month’s total inbound containers.
November 25 - Dow Jones (Christine Richard): “Large cash-back payments and other incentives have been driving auto sales in the U.S. in recent years, but besides shifting cars out of the showrooms, these deals are also creating riskier auto loans. That’s because incentives aren’t just being used to discount the price of vehicles. Often, they provide a way to bail customers out of old auto loans, freeing them up to finance new purchases. ‘Dealers are very creative,’ said Bob Kurilko, vice president of marketing at Edmunds.com, which provides research and information on buying vehicles. ‘They do what they have to do to get the deal done.’ Sometimes that means giving a hand to buyers who owe more on their current auto loan than the auto’s trade-in value - otherwise known as being ‘underwater’ on a loan. It’s a surprisingly common problem. According to the latest data from Edmunds, during August, 29% of all trade-ins in the U.S. were underwater, with the average shortfall between the loan amount and the trade-in value standing at $3,700. That’s up from August 2002, when 26% of trade-ins were underwater by an average of $3,280… In California, Texas and Alabama, 40% of all trade-ins were underwater in August. In California, the average shortfall on trade-ins was $4,700, said Kurilko.”
Broad money supply (M3) added $3.1 billion this week. Demand and Checkable Deposits declined $6.3 billion, while Savings Deposits added $8.9 billion. Small Denominated Deposits declined $1.6 billion, while Retail Money Fund Deposits inched up $0.1 billion. Institutional Money Fund Deposits dropped $12.4 billion (down $29.5 billion over two weeks). Large Denominated Deposits added $6.4 billion. Repurchase Agreements increased $9.4 billion, while Eurodollars declined $2.3 billion.
“Foreign (custody) holdings of U.S. Debt,” Agencies jumped another $14.4 billion to $1.03 Trillion. Custody (the Fed’s holdings for foreign accounts) Holdings were up $26.3 billion over the past two weeks. And since the end of July (17 weeks), Custody Holdings have surged an unprecedented $96.8 billion, or 32% annualized.
After last week’s $82.8 billion jump, Total Bank Assets declined $50.3 billion for the week ended November 19. Yet, Bank Credit (loans and securities holdings) increased $13.1 billion, with a three-week gain of $50.7 billion! For the week, Securities holdings jumped $15.2 billion, while Loans and Leases dipped $2.2 billion. Commercial and Industrial loans declined $0.9 billion and Real Estate loans dropped $11.7 billion. Consumer loans added $2.5 billion ($34.4 billion over four weeks) and Security loans jumped $14.5 billion ($18.6 billion in two weeks). Elsewhere, Commercial Paper (CP) increased $3.1 billion, with Non-financial CP up $0.6 billion and Financial CP up $2.5 billion.
Bond players’ confidence that the economy was slowing to a more moderate pace was rattled this week. October Durable Goods Orders were up 3.3% (estimates of 0.7%), the strongest gain since February 2002. Total New Orders were up 10.5% y-o-y, with Ex-defense up 7.6%. Conference Board Consumer Confidence jumped 10 points in October to the highest level since February 2002. The Current Situation index has surged 20 points in two months to the strongest reading in 14 months. The ABC News/Money magazine weekly measure of consumer confidence jumped to the strongest reading since September 2002. Initial Jobless Claims declined to the lowest level since January 2001.
The Chicago Purchasing Managers’ index surged 9.1 points (largest gain in 20 years) to 69, the highest level since February 1995. New Orders jumped 14.1 points to 73.3, the strongest reading since May 1994. Backlog jumped 12.3 points to 59.6, the highest since November 1999. Prices Paid gained 5.8 points to 67.3, the highest since July 2000. The Milwaukee Purchasers index jumped 11 points to a record 66. The Cincinnati Purchasing Managers index rose to the highest level since February.
Dollar “Problem” Watch:
November 28 – Bloomberg: “Japan sold its currency in November for a ninth month this year, according to the Ministry of Finance, trying to stem gains that threaten the nation’s exports and may slow economic growth. The Bank of Japan sold 1.6 trillion yen ($14.6 billion) from Oct. 30 to Nov. 26… It also sold currency last week after the yen strengthened to a three-year high of 107.55 per dollar… The sales totaled about 1 trillion yen… ‘We know the BOJ’s been around this month,’ said Shohgo Nagaya, foreign exchange manager in Tokyo at Nomura Trust & Banking Co., ‘All they can do is limit the yen’s gains.’”
This afternoon from Bloomberg: “There was speculation yesterday that Warren Buffett and George Soros are building ‘short’ positions against the dollar, as the British pound remained near a five-year high against the U.S. currency, the Independent reported, citing a hedge fund manager who asked not to be named.”
And Wednesday from Bloomberg, quoting ECB council member Ernst Welteke: “On the impact if the euro climbed to $1.20 or $1.25: ‘At some stage companies that export to the dollar region can of course reach a pain threshold. But only a seventh of German exports go to this region. ‘A lot of companies say that we have hedged ourselves for the time being through swaps. At the moment, the euro’s exchange rate is moving in a neutral range. An abrupt drop in the dollar could of course have consequences for the global economy and therefore for us as well. I don’t think that will happen.’”
These three anecdotes – “all they can do is limit the yen’s gains” BOJ dollar purchases; talk of speculative dollar sales by Soros and Buffett; and Welteke noting that German companies “have hedged” – go right to the heart of what I believe is an unfolding dollar “problem.” First of all, aggressive foreign central bank dollar purchases have clearly lost their forcefulness. Ballooning Asian central bank and U.S. “custody” holdings are today barely managing an orderly dollar decline. And with the ECB (as opposed to the BOJ) not aggressively accumulating dollars, euro sellers are finding it increasingly difficult to find buyers. This is precisely the type of environment that captivates the expansive global speculator community.
Speculative dynamics today find progressively emboldened sellers and discouraged buyers. Things have recently taken a turn for the worst, with this week’s strong data and today’s rising bond yields offering little in the way of dollar support. Such circumstances should have market participants contemplating the unprecedented derivative hedging positions that have and continue to accumulate. Recall the surge in derivative activity during the first half of the year. Dollar hedging has quite likely only escalated over the past few months. Surely, German, Japanese and other exposed manufactures have hedged dollar exposure. And, certainly, scores of global speculators and investors have incorporated more aggressive hedging strategies against their ballooning dollar holdings. But who is on the other side of these trades? Is the market to hedge dollar exposure tenable? I have serous reservations.
There is no doubt in my mind that dynamic hedging strategies play the dominant role in contemporary derivatives markets. Sellers of derivative protection incorporate “sophisticated” computer models that are basically trend-following systems “hedging” (buying rising and selling declining markets) exposure on market insurance written. Instead of learning from the 1987 portfolio insurance fiasco, the Greenspan Fed has been the staunchest supporter of the mushrooming derivative markets. But from analyzing the Mexican, SE Asian, Russian, and Argentina currency collapses, we have absolutely no doubt that the combination of runaway Credit excess, rampant global speculative financial flows, and aggressive (speculative) derivative hedging operations create over time acute currency and financial system fragility.
It would appear to me that we are now quickly approaching a critical point where heightened speculative and dynamic hedging-related selling could overwhelm apprehensive global central bankers. That the U.S. stock market at this time seemingly couldn’t care less about the unfolding dollar “problem” is curious. But, then again, the unfolding Mexican, Asian, and Russian meltdowns almost had to hit the U.S. market on its head before there was recognition.
I remember clearly how U.S. financial stocks rallied to new highs in late July 1998, with the Russian and LTCM collapses only weeks away. This, however, is only one of many curious examples of surging markets determined to ignore the inevitable. But, then again, excessive liquidity creation in the face of heightened systemic stress is a most-important dynamic of contemporary (unrestrained) finance. Looking at GSE and foreign central bank balance sheets, both domestic and international liquidity operations over the past four months have gone to new extremes. Accordingly, speculative excess, both domestic and international, has gone to new liquidity-driven extremes. Greater dollar liquidity is only Compounding The Problem. And when the next crisis does arrive, the old “fixes” won’t get the job done.
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