"No one looks at the money supply anymore. But I believe the M2 measure is a useful signal of transactions demand in the economy." - Lawrence Kudlow
Weekly Monetary Report
Mon 15 May 2000 0140Z
U.S. Money Supply
That short-term rates will move higher than many expect is a circumstance that's been announced in several prior weekly reports, and as early as last Autumn. The growth rate of the money supply since the last Fed tightening has been primary among my reasons for believing such was, and still is, the case.
Growth in the M2 aggregate for the latest report period slowed to 5.7% y/y from the 6.1% y/y gain in the previous report. No trend is evident. However, the opportunity costs of holding deposits will be a factor that should reduce the money supply by some amount going forward.
It's not unusual for growth in the monetary aggregates to continue, albeit at a lesser rate, while the Federal Reserve tightens its policy conduct. It is, in fact, a feature of all prior tightening cycles during Mr. Greenspan's tenure. Importantly, what is also characteristic of the prior cycles is an M2 growth rate that registers beneath the upper limit of the Fed's provisional 1-5 percent range.
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Characteristics of Recent Federal Reserve Tightening Cycles
S&P 500 Percent +/- Monthly Basis
Cycle Period M2 Y/Y Growth Cycle Low Cycle End
1987 9.5% to 4.8% - 8% - 8%
Interlude 5.2% -10%
1988-89 6.0% to 3.0% -20% 15%
1994-95 2.0% to 0.4% - 3% 5%
1999-00 7.8% to ... 18% ...
The first two tightening cycles are essentially one in the same. A brief interlude was instated during October of the first cycle period.
Notice the comparatively slow M2 growth during the 1994-95 period. A situation corrected at the end of that stanza and coincident to Mr. Rubin's appointment as U.S. Treasury Secretary.
Growth rates for both M2 and M3 did appear to accelerate recently. But, as warned in prior reviews, interpreting monetary aggregates during the annual tax period is difficult. This is particularly true when high year-end capital gains have been incurred. The gains typically result in large April tax payments that cause M2 to swell above the normally expected tax-related buildups in liquid accounts. The surge normally reverses as payments are processed and credited to the U.S. Treasury account which is not included in the monetary aggregates.
Latest M3 y/y growth is reported at 8.3 percent. Federal Reserve researchers tell us strong M3 growth, coupled with a steady advancement in the narrower aggregates, can often be explained by heavy demand for commercial and industrial loans. Banks often finance the C&I loans by issuing large-dollar-value certificates of deposit, which are counted in M3 but not in M2. Growth in C&I loans is currently more than 10 percent.
They'd better be careful.
By the way, if you haven't guessed by now, and regardless of the Fed's official rhetoric, the FOMC is targeting the stock market. That they've shot poorly is not so much an indication of their marksmanship as it is their fear of hitting a critical area. After all, the target is quite large. Too, their choice of caliber to this point has been for one quite small.
federalreserve.gov
Additionally, should the Fed, by virtue of its various policy actions, move monetary growth to within its pre-established growth range -- a region that hasn't been visited by M2 since mid-1997 and by M3 since 1995, I'd expect the worst is still ahead for U.S. share prices that advanced on a burst of money and credit that began in 1995 and have been supported by an on-off credit subsidy since the Summer of 1998.
A review of the down-trend in broad money ( M3 ) growth entering 1999, and the only drop in M3 growth since 1995, coupled with the coinciding failure of many equity shares to muster a gain last year, displays what a distinct possibility exists for a failure in the U.S. share market should the Fed take decisive action to slow the economy to what they deem an acceptable rate of growth.
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Fed Open Market Activity
May 01 Week
Day Action Amount Duration
Mon add $12.7b 3-day
Tue add $5.60b overnight
Wed add $9.99b overnight
Thu add $3.01b overnight
Fri none
May 08 Week
Day Action Amount Duration
Mon add $12.2b overnight
Mon add $2.1b 28-day
Tue add $8.0b 2-day
Wed none
Thu add $5.0b overnight
Thu add $2.0b 28-day
Thu add $0.5b permanent
Fri add $4.0b 6-day
NR = not recorded
Comments: Nice work by the open market desk.
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Coupon Passes
In 1999, the Fed's outright purchasing of domestic securities expanded by a record $44 billion, surpassing the previous record of $41 billion set in 1997. The $30 billion in coupon passes conducted during the first six months of 1999 was also a record amount for a calendar half-year. Thus far, in 2000, the Fed has conducted $7.042 billion in open market purchases and the Treasury $7.00 billion in debt buy-backs. With more buy-backs scheduled by Treasury for the third and fourth weeks in May, June and July, we will have, essentially, a new calendar-half record for permanent reserve injections. Certainly not an anti-inflationary strategy.
There is no other way I, myself, prefer to account for the Treasury's activity than from the perspective of system effect. Mr. Summers himself used the word "coupon pass" when describing in February the market influence of the buy-backs.
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Bank Credit
Seems we have the smaller banks making hay while the sun shines, upping their share of commercial and industrial loans prior to higher rates.
The investment category shows larger dollar amounts in trading accounts but less in the investment accounts.
Recall that last year the commercial banks made a heavy increase in their purchasing of U.S. equity shares during price declines. In less than three months last Summer the banking collective more than doubled what it has added to the non-USG securities sub-account in the first four months of this year.
The category total for bank loans used to purchase securities ( hedge funds, et al ) has decreased by more than 30%, or $28 billion, since the March 8th report.
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The GSE Saga
In Chicago last week, U.S. Senator Phil Gramm went out of his way to praise the work of Rep. Baker who has drafted legislation to overhaul GSE regulation. Gramm was quoted last week as saying, "He is a very serious member ... who may be chairman of the Banking Committee one day." Also that he takes Baker's bill "seriously."
Congressman Baker, was reported by several sources recently, saying he believes House passage of the legislation this year would be an ambitious schedule. Meanwhile, at a conference last week in San Diego, Fannie Mae officials called openly for attendees to put pressure on their legislators to scuttle Congressman Baker's bill.
But, let's not be unduely swayed by any accusatory language emanating from within the GSE ranks. It is an agency that was once insolvent. Should market conditions worsen substantially, Americans might be looking at a sizeable second mortgage of which they have little or no knowledge.
Recall, too, that interest on agency debt, unlike that of other corporate debt, is subject only to federal taxation. Corporate debt interest is taxed at the state, local and federal level. Legislation could change this feature. A fact, I would hazard to guess, does not set well with those who favor the GSE's side of the issues.
Though there is no argument from any corner over what a necessary function the GSE's provide for the economy, according to the Congressional Budget Office, Fannie and Freddie pass only part of what subsidies they receive on to home buyers with the remainder of the credit enhancement subsidy pocketed by private shareholders, the corporations' executives and lobbyists. For every $2 delivered to home buyers, one consumer agency states Fannie and Freddie take $l of the subsidy for themselves. Studies conducted by Treasury, CBO, and GAO over the past ten years concluded also that the GSE's retain a significant amount of their federal subsidy.
The Mae's are not alone among GSE's whose operating practices are being scrutinized. The Federal Home Loan Bank System has been under fire from the Treasury Department.
The FHLB System has used its ability as a GSE to borrow cheaply and engage in arbitrage by making investments in non-housing related investments. However, the arbitrage record-holder among the GSEs is Farmer Mac with a herculean effort at garnering over $1 billion of investments unrelated to its mission.
I believe it's beyond question that some sort of reform is necessary.
In 1999, as the national debt was reduced by $140 billion, Fannie Mae, Freddie Mac and the Federal Home Loan Banks increased their debt by $309 billion, making taxpayers responsible for a net increase of $169 billion in debt. Though not a present fiscal burden, it presents a risk to the public that is quite large.
The American Enterprise Institute has scheduled a day long seminar on GSEs for May 23, saying, "change is inevitable; it's only a matter of time." Congressman Baker will speak, Treasury will be there, a Freddie Mac official, the Federal Reserve, but not Fannie Mae. One very recent study from AEI concluded that uncontrolled growth at Fannie Mae and Freddie Mac poses a threat of another expensive taxpayer-financed bailout.
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Money Around the World
I'd like to make Money Around the World a permanent feature here, but the database now being constructed should probably be completed prior to doing so. For now, just a couple of instances.
Euro zone M3 grew at 6.5% year-over-year in March, up from 6.1% in February and well above expectations. Private sector credit growth rose to 10.9% y/y in March from 10.4% the month before. The ECB has cited strong money supply and private credit growth for its recent series of rate hikes. In Malaysia, the annual rate of M1 growth increased to 28.2% in March but a weak credit multiplier has dampened broad money supply growth.
I suspect it's much the same story elsewhere. Except Switzerland, of course.
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Finally, I don't intend ending each report with a quote. It appears pretentious, and a bit too high-minded for me. It's only that while verifying certain circumstances I happen upon one or two interesting statements. Many of you will no doubt recognize the celebrity source of the following one.
"No one looks at the money supply anymore. But I believe the M2 measure is a useful signal of transactions demand in the economy." - Lawrence Kudlow
See you next week.
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