One Last Comment on M3

We started beating the M3 drum back in November 2005. It seemed to us — on the basis of the rapid increase in M3 versus M2 alone — it was a worthwhile stat to keep around, and we could not understand why the Fed was so intent on cancelling M3 reporting. These perspectives were dismissed by some as paranoia.

You can imagine how pleasantly surprised we were when Raymond James’ Jeff Saut addressed that very issue this morning:

"Yet, we just don’t “get it” because as the Fed has
been raising interest rates, it has simultaneously been talking rates down by
commenting on how “contained” inflation remains. Surprisingly, concurrent with
the Fed’s financial tightening has been Mr. Bernanke’s “printing press” gone
wild with roughly $1.5 trillion additional dollars per year being added to the
country’s money supply, at least at the last M3 reading. And that caused one
savvy seer to exclaim, “Can you spell liquidity?!” Liquidity indeed, for as Ed
Hyman aptly notes, “U.S. Federal outlays in the 4Q increased to a remarkable
$2.7 trillion. That’s 21% of GDP and increasing at a 30% annual rate.”

Suspiciously, however, one month ago those M3, broad-based, money supply figures
ceased to be reported because they allegedly added little additional value to
the M2 figures. Hereto “we just don’t get it” because M3 contained the amount of
repo activity in the banking system while the M2 report does not. Repos, ladies
and gentlemen, is short for repurchase agreements, which are contracts for the
sale and future repurchase of a financial asset. Most often repos are used with
Treasury securities. We think repo activity is pretty important since it shows
the amount of “financial leverage” the Federal Reserve is attempting to
introduce into the banking and brokerage system. Indeed, we just don’t “get

Nevertheless, in this business what you see is what you get, which reminds us
of that old Annapolis “saw” – you can’t change the wind, but you can always
adjust the sails! And currently the “winds” are blowing interest rates higher.
Where this rate-rise will end is unknowable. Even the Fed has hinted that it
doesn’t know by commenting that things are “data dependent.” However, consider
this – When was the last time the Federal Reserve stopped raising interest rates
with many of the equity markets at (or near) all-time highs, base and precious
metals at multi-decade highs, oil within “spitting distance” of record highs,
and retail sales (despite a late Easter), as well as the housing figures,
stubbornly perky? Furthermore, the recent unemployment rate was at a four-year
low (4.7%), while the first quarter’s employment figures showed the strongest
non-farm payroll growth in six years. Historically, rising employment growth has
tended to lead to rising wage pressures. As the good folks at the GaveKal
organization opine, “Once again, we find ourselves asking the question, can the
Fed really stop at 5% in this environment?”

In addition to these questions, we would suggest that forgetting the
laughable “core” inflation figures (ex-food/energy), annualizing last month’s
headline CPI figure of +0.7% (core was +0.2%) yields an inflationary ramp-rate
of 8.4% (0.7% x 12). While clearly one month does not make a trend, even if we
use this week’s estimated headline CPI number of +0.4% (-0.2%E core), and
average it with last month’s (0.7% + 0.4% / 2 x 12 = 6.6%), we get an annualized
inflation rate of 6.6%. The potential inference from this is that despite the
Fed’s “tightening campaign” with Fed Funds at 4.75%, overlaid with a 6%+
inflation rate, we could still be in a negative “real” interest rate
environment. Given the possibility of still “free money” (aka negative real
rates), no wonder speculation remains rampant in the various markets."

What more can we add to that?


The 5% Solution
Jeffrey Saut
Investment Strategy

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What's been said:

Discussions found on the web:
  1. EKC commented on Apr 17

    My theory as to why FED will not stop raising is to get households to save by shifting consumption dollars to checking account dollars.

    Seems rational. Any counterthoughts?

  2. Jordan commented on Apr 17

    Real interest rates are going to be negative for a long time. With debt growing out of control, there is just too much risk with rates at 6% or 7%. The fed is trying to manage inflation expectations and not inflation itself. We should start getting helicopter money in the next few years.

  3. B commented on Apr 17

    I still believe the Fed is speaking out of both sides of their mouth. Flooding the money supply while raising rates. Keep the dollar out of crisis with higher rates while flooding the money supply to keep the economy going? Is it different this time as it pertains to Fed action? A dual mandate of difficult proportions that is causing an inflationary mess? We’re looking more and more likely the 70s. Time to break out the bell bottom jeans?

    Determining “why” equity markets crater is a crap shoot. Nearly everyone predicting a market correction was predicting the markets would crater because the consumer was out of cash, debt was at an all time high and, of course, it was the four year cycle.

    Well, it appears the only one to hold true at this point is the four year cycle. Not that the consumer won’t quit spending if the signs of a recession are there. But, how can one refuse to believe government reported statistics when it comes to inflation but pound their fist on the table that other government statistics such as consumer debt are indeed accurate? It’s called selective reasoning to support a biased position.

    The facts are undoubtedly much different. The world economy seems to be on the verge of overheating, yield inversion between the short and ten year rates never really happened, we very well could get the Goldman superspike in assets people laughed off (I think we’re already seeing it in metals, precious and industrial), wage inflation will likely show up in the numbers because people don’t really understand this supposed labor arbitrage, inflation appears to be one hell of a mess, the housing bubble argument was flamed by the media and consumer debt is likely misdiagnosed because of the high home ownership numbers. As I blow till I’m blue in the face, consumer credit debt is no higher than 1980 and is lower than 2000. So, does some other unspoken mess hold the key? Or is it still the global asset boom that will bust? You simply cannot buy the global home building bubble while discounting the global metals bubble. What else are they doing with all of that copper? They are frick and frack.

    It still could and likely will go to hell in a handbasket short term but for reasons other than nearly anyone predicted. That includes the argument that there is a housing bubble. We will only have a housing bubble when inflation abates, the economy craters and/or long rates explode. Right now, all we have is condo overbuilding and a media induced panic that has stalled single family home sales while builders continue to build at a maddening rate. What will the mess be?

  4. vfoster commented on Apr 17

    raja’s thesis has been discussed on this board before. they are right about the Fed ceasing rate hikes with commodities at their highs.. if Beranke quits at 5%, gold and oil will spike even further, the dollar will puke and the bond market will take over for the Fed (the mkt has been telling us what will happen)…

    if the bond market has to take over, Bernanke will become irrelevant before he gets started and it will be very difficult to regain any confidence in the bond and fx markets. stocks will be completely held hostage by those much larger markets..

    the irony is that the economy and earnings are slowing and Bernanke knows that, unfortunately there was so much stimulus pumped in there is still excess liquidity despite all the rates hikes (and due to the continued expansion of the money supply).. Bernanke is staring at the nightmare of stagflation..

  5. fred c. dobbs commented on Apr 17

    Take off the tinfoil hat, Barry. You look ridiculous.

    Yes, commodity prices are rising. Why? Because the global economy is DEMANDING lots of oil, steel, chemicals, plastics, etc. Why should the Fed get in the way of markets adjusting to a new supply/demand curve?

    For an intelligent discusssion of inflation, check out David Altig’s blog:

    Finally: Anyone who wants the M3 data can still get it by driving out to Area 51! Tell Ernest at the Esso Station in Henderson that I said Howdy!!!

  6. JFG commented on Apr 17

    “Finally: Anyone who wants the M3 data can still get it by driving out to Area 51! Tell Ernest at the Esso Station in Henderson that I said Howdy!!!”

    cute, and witty. instead of childish nonsense, perhaps you can enlighten us as to the reason why the M3 data were discontinued? if they are as trivial as you imply, then why the change in policy – why bother?

  7. B commented on Apr 17

    I can’t put all of my supporting information on here but I can assure you the metals and oil boom are not because of end user demand. Not one iota. It is nearly 100% correlated to investment demand. If oil, iron ore and copper were a result of global demand, specifically from China and India, why did they just start going up when rates hit 1%? And why has this cycle repeated time and again after blow off equity markets followed by low interest rates? These stocks and commodiies were pigs when China was growing at a faster pace and were in the midst of their build out. They’ll be pigs again.

    As far as the Fed and M3, I actually heard it costs quite a tidy sum to collect and report M3. Want to read something less cynical on M3?

    One of the things the reader’s attention is drawn to in the promotional is the steady long-term decline in the Monetary Base statistic released by the Federal Reserve banks. The reader is told that the last time such a pronounced drop occurred in this monetary measure, it preceded the infamous stock market crash of 1987. Therefore, concludes the advisory, the U.S. stock market is nearing another “historic” crash. Two years have gone by since I first received this flier and we still haven’t witnessed a “historic crash.” To the contrary, many major stock indices made new all-time highs this year.

    Why hasn’t the Monetary Base figure been of any value in recent years, vis a vis, the 1980s when it was a much more widely followed and authoritative statistic? Is it because the transition to our current credit-based economy is no longer as reliant on the so-called monetary “base” itself? Whatever the reason, for all intents and purposes the Monetary Base number is a relic of a bygone era and simply no longer holds the same significance as it did in former decades.

    I mention this by way of introduction because I believe we’ve arrived at yet another transitional point along the monetary policy time line. Another widely followed and much ballyhooed Fed statistic, namely the M3 money supply figure, will evidently no longer be published by the Fed for public dissemination beginning in March 2006. This announcement that M3 will soon no longer be available to the public has caused no end of shock and outrage in some financial circles (especially among the Internet gold bug community, who see it as a conspiracy or suppression to keep the public in the dark concerning monetary policy and to allow the Fed banks to work their deeds with less transparency).

    Admittedly, this move toward less transparency in the release of the M3 money supply figure is suspicious in and of itself. This is particularly true when one considers the great emphasis the banking establishment lays upon the need for increased transparency among public institutions and private citizens. But philosophical considerations aside, I’ve concluded that it really doesn’t matter whether the Fed releases the M3 numbers or not because it no longer really matters.

    How much of an influence do the monetary aggregates have on the all-important U.S. financial markets – and by extension to the general economy – when taking into consideration that we’ve increasingly being merged into an expansive global economy? A global economy, for that matter, that depends on flows of funds across international boundaries and that can be commanded through any number of complex financial techniques. As an article in a 1989 journal of Business Economics expressed, “The monetary aggregates no longer serve the same dominant role as a guide to [Fed monetary] policy that they had in the earlier part of the 1980s”.

    There was a time when domestic monetary policy was the paramount consideration. But today the financial system of the U.S. is regulated in large part through the securities market and related endeavors (including Federal Reserve securities lending and various open market operations), global currency exchanges, and plain and simple flow of funds manipulations.

    In fact, to a very large extent the stock exchanges have taken precedence over almost all other considerations when it comes to the regulation of the nation’s economic health. The equities market is in the final analysis not only a barometer of the economy but is in fact the great stimulus thereof. As the great historian and cycle expert Oswald Spengler wrote in his book, The Hour of Decision, “Productive economy is in the last resort nothing but the will-less object of stock exchange maneuvers. It was only the rise of the share system to domination that enabled the stock exchange (formerly a mere aid to economy) to assume the decisive control of economic life.”

    The July 11, 2005 cover story of Business Week magazine observes that the growing financial clout of Asian economies has become a major factor in the economies of developed nations such as the U.S. “Too Much Money: The surprising consequences of a global savings glut” is the title of this important article by Rich Miller. This phenomenon of global liquidity, with mountains of cash in the hands of developing economies not to mention multinational corporations is now a prime consideration to any discussion of money supply and monetary policy in the U.S. and has supplanted a narrow focus on M3 as the baseline consideration for monetary policy.

    The name of the game in keeping the U.S. economy healthy has become one of sophisticated financial market maneuvering for the purpose of attracting “hot inflows” of foreign funds to keep the system buoyant. Much more could be said about this “new wave” in money supply analysis. This much will suffice, however, as additional commentary will be reserved for later.

    -Clif Droke

  8. Idaho_Spud commented on Apr 17

    Personally I agree with *this* point of view – it simultaneiously explains Greenspan’s ‘conundrum’ and invalidates Bernanke’s ‘savings glut’ theory.

    “…Despite Fed rhetoric, the lifting of dollar interest rates has more to do with preventing foreign central banks from selling dollar-denominated assets, such as US Treasuries, than with fighting inflation. In a debt-driven economy, high interest rates are themselves inflationary. Raising interest rates to fight inflation could become the monetary dog chasing its own interest-rate tail, with rising rates adding to rising inflation, which then requires more interest-rate hikes. Still, interest-rate policy is a double edged sword: it keeps funds from leaving the debt bubble, but it can also puncture the debt bubble by making the servicing of debt prohibitively expensive.

    To prevent this last adverse effect, the Fed adds to the money supply, creating an unnatural condition of abundant liquidity with rising short-term interest rates, resulting in a narrowing of interest spread between short-term and long-term debts, a leading indication for inevitable recession down the road. The problem of adding to the money supply is what John Maynard Keynes called the liquidity trap, that is, an absolute preference for liquidity even at near-zero interest-rate levels. Keynes argued that either a liquidity trap or interest-insensitive investment draft could render monetary expansion ineffective in a recession. It is what is popularly called pushing on a credit string, where ample money cannot find creditworthy willing borrowers. Much of the new low-cost money tends to go to refinancing existing debt taken out at previously higher interest rates. Rising short-term interest rates, particularly at a measured pace, would not remove the liquidity trap while long-term rates stay flat because of excess liquidity.”…

  9. todd commented on Apr 18

    The question is, can you actually slow down a runaway economy, or will it boom and bust? The market left to it’s natural tendencies will boom and bust.

    Central bankers can try to soften the edges by artifically setting short term rates. However Greenspan’s move to 1% was far too much, and the current rate hikes are going WAY too slow.

    Long bonds finally woke up and the market is resorting back to its natural tendencies. Look for panic selling on the long bond, panic buying of gold, a big equities correction and a big oil correction as the world economy slows.

    All the ingredients for a financial storm are in the mix, and the oven is heating up.

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