Don Hays / Mr. Moto hit Reuters Wire
By Pierre Belec
NEW YORK (Reuters) - Here's a little secret: Federal Reserve Chairman Alan Greenspan may not be as hard to figure out as most people think.
If you want to know what's on his mind, follow the nation's money supply, a simple map that doesn't require much inside knowledge. It's a focus of the Fed's thinking and often provides a clue that the central bank may be seeing something nasty down the road that could disrupt Wall Street.
Greenspan has had a terrific record of rescuing financial markets from their own excesses.
Whenever he has sighted a problem on his radar screen that could slam the global economy, Greenspan has turned on the Fed's great money machine, pumping up what is known as the money supply, says Don Hays, president of The Hays Advisory Group, an investment consulting firm.
Indeed, since 1987 the Fed chief has been quick in heading off financial or economic events that could have put a stress on the global economy.
Hays, a veteran Wall Streeter, has an eye trained on spotting when the Fed is jittery. And over the past 13 years, there's been a mess of things that could have fouled up things.
``The first sign is peripheral evidence of some strains in the world market and it's initially reflected in the yield spread in the U.S. bond market,'' he said. ``But you'll never know all of the truth until the storm has passed and the facts are in.''
The central bank's biggest fear is that a scramble by investors out of stocks could have a distorted impact on the market. For that reason, it has been swift in manipulating the money supply and/or interest rates to head off a market panic.
FED IS AGAIN PUMPING UP THE CASH MACHINE
The latest evidence suggests the Fed is again playing with the money supply. The Fed's own numbers show that it has unexpectedly been injecting more cash into the nation's economy over the past eight weeks.
The $64,000 question: What has crept up on Greenspan's radar screen?
Hays suspects that Greenspan may be doing some risk management. Just a week ago, the closely watched M2 -- a measure of savings and small time deposits, overnight repos at commercial banks, and noninstitutional money market accounts -- jumped $6.5 billion from a week earlier and it was up another 3.7 billion this past week, which would put the money supply's growth at more than 10 percent on an annualized basis.
``I'm just watching the indicators and what they are saying is that it may be time to be more careful,'' he said.
The M2 is rising just as the central bank has raised rates six times between June 1999 and May this year to slow the economy's growth.
THE FED RESPONDS WHEN MORE CASH IS NEEDED
The central bank this spring boosted the money supply twice to contain what it saw as possible sources of stress to the global market, experts say.
The M2 spiked up in March following the shutdown of the high-profile hedge fund Tiger Management, whose assets plunged to $6.5 billion from $22 billion in 18 months.
Julian Robertson, chief executive of Tiger Management, killed off all six Tiger funds, saying he was getting out of the market because Wall Street was ignoring traditional valuations, specifically the high-flying technology stocks.
The central bankers acted because of concern that if banks got frightened and made it tougher for the other hedge funds to borrow money, it might force the funds to panic and dump the stocks that they held, thereby triggering a domino effect throughout the stock market.
Weeks later, Greenspan again raised the money supply, this time to head off fallout from the restructuring of the world's largest hedge fund, Quantum Fund, controlled by the Soros Group.
George Soros, the big U.S. speculator, overhauled his flagship Quantum Fund after it got slammed in the spring by a sell-off in technology stocks. That tech wreck wiped out more than 30 percent from the Nasdaq composite index.
OTHER FED RESCUES
Last year, the Fed flooded the economy with a record amount of cash for fear that the Y2K computer bug would be an economy-killer.
Fast-rewind back to two years ago. The money supply jumped sharply in September 1998 when Long-Term Capital Management, a hedge fund worth billions, threatened to crash and burn as Russia defaulted on its debt and the Asian economic crisis deepened.
When Long-Term Capital imploded, its tentacles were embedded in so many other financial sectors that New York Fed President William McDonough warned that markets could freeze up if the fund was forced to liquidate.
During the 1987 market crash, Greenspan reassured Wall Street that the liquidity machine was in overdrive to prevent a panic. His soothing comments sent stocks racing back as fast as they had fallen.
In late 1980s and early 1990s, the Fed head came forward to bail out the savings and loans mess by freeing up the money supply.
PLAYING WITH FIRE?
Massaging the money supply to artificially stimulate Wall Street can be dangerous because whatever cash that is not absorbed by the economy will eventually find its way to the stock market, encouraging speculators to buy stocks on margin, Wall Street lingo for playing the market with borrowed money.
The Web site www.piraz.com/wmre.htm, written by a market-savvy guy who identifies himself only as Mr. Moto, notes in a weekly monetary report that there is a close relationship between a jump in the money supply and a spike in demand for money used to buy stocks on margin.
``Regardless of claims to the contrary, it's patently obvious the Federal Reserve is fueling stock market rallies via large temporary funding programs,'' he said. ``The Fed would of course claim they are only responding to demand, yet they should be questioned why the demand is so periodically heavy.''
The latest numbers support Mr. Moto's belief about a link between a jump in the M2 and higher margin debt.
On Wednesday, the New York Stock Exchange said margin debt, which had been decreasing steadily since setting a record high of $278.53 billion in March, rose in August -- to $247.56 billion from $244.97 billion in July.
RISK OF TRADING ON MARGINS
The downside of trading on margin is that it magnifies the risk of investors' losses when the market turns downward.
The current 50 percent minimum on margin loans, which the Fed has maintained since 1974, allows investors to plop down only half of the purchase price for a stock -- giving them twice the buying power.
But the investors will immediately owe more money if the market takes a tumble and they can lose more than they originally had. Such was the case during the 1987 stock market crash and again this spring when the Internet stocks lost more than 50 percent of their value.
``People who had bought on margins extended themselves because they really believed that the market could do nothing but go up,'' said John Geraghty at North American Equities Services.
``And when the market made a big correction, they found themselves over-extended. And in fact that over-extension situation contributed to the depth of the correction as people were forced to liquidate 'good' stocks for the speculative ones like the dot-coms.''
For more information, go to the Web site of the Federal Reserve Bank of St. Louis -- www.stls.frb.org/docs/publications/usfd/usfd.pdf
( Questions or comments can be addressed to Pierre(at)Reuters ).
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