Everything's Pointing Up Except Money Supply: Caroline Baum
Dec. 19 (Bloomberg) -- For the first time in four years, the holiday season in the U.S. is coinciding with good news on the economy.
Housing is still booming, inflation is still low, the consumer is still spending and manufacturing is revving up. The most recent evidence of a renaissance in factory activity was Tuesday's report on industrial production and yesterday's survey of manufacturing activity in the Philadelphia area.
Output at the nation's factories, mines and utilities rose 0.9 percent in November. Manufacturing production increased by 0.9 percent as well, the biggest increase for both series in four years. Output of business equipment rose at a 9.7 percent three- month annualized rate, a pace last seen in the middle of 2000 before capital spending took a nosedive.
The Federal Reserve Bank of Philadelphia's Business Outlook Survey rose to a 10-year high of 32.1 in December. Big gains were registered across the board, including a leap in the indexes of new orders and employment to a 30- and 20-year high, respectively. (A diffusion index reading is not indicative of the level of activity.)
No wonder business leaders are increasingly optimistic, as chronicled in two surveys on Wednesday. The Business Roundtable's survey of chief executive officers showed a big jump in expectations about the economic outlook in the next six months, with CEOs expecting strong sales and capital spending. The index rose more than 20 points to 89.6.
Money Cult
Meanwhile, year-end found chief financial officers more optimistic than at any time in the seven-year history of the survey, according to Duke University's Fuqua School of Business. Sixty-three percent of the CFOs surveyed said their companies plan to increase capital spending next year by an average of 5 percent. Two-thirds of the companies plan to hire, ``up sharply from six months ago, when no employment growth was expected,'' according to the survey.
The growing optimism among businesses is evident in rising orders, output and spending on equipment and software and in falling claims for unemployment insurance.
Leading economic indicators continue to flash a green light -- with the exception of one that's been wholly discredited and is widely ignored: money. Money growth has a relationship to spending; inflation is still a monetary phenomenon.
For members of the cult who think money matters, the M2 money supply -- which includes currency, demand and savings deposits, and retail money market funds -- has been declining since the middle of August. On a 13-week annualized basis, M2 has slowed from a 14 percent growth rate, its recent peak in early July, to a 5 percent rate of decline in early December.
Refi Distortion
The most credible explanation for the decline is the reduction in mortgage refinancing activity. When a homeowner refinances his mortgage, the proceeds are returned to the holder of the mortgage-backed security -- with a lag. The funds used to pay off the old loan typically go into an escrow account that is held in either a demand or a savings deposit and is hence counted as part of M2.
Once a month the funds are distributed to Fannie Mae, Ginnie Mae and Freddie Mac, which return them to the MBS holder.
``A decline in mortgage refinancing reduces these liquid deposits,'' the Federal Reserve Bank of Cleveland research staff says in its monthly Economic Trends publication.
Pattern Identification
Refinancing activity has plummeted in the last few months. According to the Mortgage Bankers Association, an index of applications for refinancing stood at 2072.9 in the week ended Dec. 12, down 79 percent in the past six months. Based on the mortgage-backed securities outstanding, settlements on those applications peaked over the summer quarter.
There's an observable pattern of a surge in refinancing activity, triggered by declines in long-term interest rates, and money growth, says Joe Carson, head of global economic research at Alliance Capital Management.
``Two to three months after a peak in refinancing, money growth comes to a standstill for about a two-month period,'' Carson says. The current slowdown, already into its fourth month, ``is more protracted than in the past,'' he says.
An observation of a phenomenon is one thing. A meaningful assessment of it is another.
To the extent that the money supply portends future spending, funds held in escrow by a bank are not a leading indicator of anything except the moneys going to the MBS holder.
Temporary Effect
The distortions to the money stock from mortgage refinancing aren't a one-way street. The surge in refinancing activity earlier in the year artificially inflated the growth in the money supply just as the drop-off is artificially depressing it now.
These effects should be temporary. They shouldn't have much impact on spending and the economic outlook if the analysis is correct. On a year-over-year basis, M2 was up 5.1 percent in November from the same month a year ago, down from 8.3 percent in August.
``It would take a huge collapse in money to negate the huge liquidity creation'' over the past few years, Carson says.
If it happens, it would be the one dark cloud on a brightening horizon.
Last Updated: December 19, 2003 00:06 EST |
