Are We Measuring the Wrong Money Supply … Again?

Posted on June 12, 2012

Back in 2008 we wrote that the U. S. was facing a serious credit squeeze in part because we had failed to take into account some important structural changes in the credit markets: i.e. the rapid growth and subsequent collapse of the Shadow Banking system. Since then the Fed and the Treasury have spent enormous resources addressing the impact of that collapse through the purchase of assets from financial institutions, the nationalization of Fannie and Freddie and numerous other actions to prop up the housing market in hopes of repairing shrunken balance sheets throughout the economy.

We may be suffering from a different, but equally portentous, issue today arising from another misreading of what the term money really means. In response to our recent article on Fed tightening since the fall of 2011, John Lounsbury, Managing Editor of econintersect.com, made a very astute observation:

You do not mention it in your article but is it possible that the Fed has not been taking a sufficiently global view and has insufficiently reacted to a recessing Europe and a rapidly slowing Asia? India just dropped to a GDP growth rate below anything seen during the Great Financial Crisis. The manufacturing numbers in China have been flirting with contraction for several months. If the Fed reacts to these factors after they have gained a solid foothold, doesn’t that likely increase the magnitude of the yo-yo swings?

The U.S. dollar is without question the world’s reserve currency and the current problems of the Euro have only served to cement that position. Given the global demand for $100 bills, in many parts of the globe the dollar is not only the reserve currency, but the defacto physical currency as well. Yet we continue to look at money as a national, or in the case of the Euro, regional … read the rest

Did Fed Tightening Help Bring About The Current Market Downturn?

Posted on June 6, 2012

Bill Clinton often gets credit for the insight that the economy would drive the 1992 election, leading him to victory over George Bush. Actually it’s his acerbic sidekick James Carville who deserves the credit for that famous one-liner “It’s the economy stupid”.

Without a doubt, the economy played a major role in President Obama’s victory in 2008 as well. Now we’re in another election year and there is universal agreement that the economy is likely to drive the outcome in 2012. While most commentators are focused on whether QE3 is in the cards, we have a different slant on the current downturn. We suspect that the Fed has, possibly inadvertently, played a major role in bringing about this contraction, just as it did in triggering the crash in 2008. We’re also concerned that election year political pressure, driven by the economic slowdown, will force the Fed into a response with serious long term inflationary implications.

I’m an unabashed monetarist. Over long cycles money supply growth or the lack of it drives both economic activity and price levels. I understand that this is a simplistic view, that the collapse of velocity has changed the meaning of money growth, that the increased investor appetite for liquidity has skewed the numbers, etc. Simplistic or not, changes in the rate of growth of the money supply often prove, after appropriate lags, to be a great predictor of the future course of the financial markets and, to a lesser extent, the economy. So what are they saying now with the election less than six months off?

Every week the St. Louis Fed publishes a twenty-four page pamphlet called U. S. Financial Data, which provides a great snapshot view of monetary trends. Preceding the fall 2008 financial crash, in spring 2008 the Fed had pumped significant liquidity in the system … read the rest

January Video Newsletter

Posted on January 26, 2012

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Will Business Owners Hit the Bid in 2012?

Posted on January 24, 2012

Over the years one of the best indicators of M&A activity has been what I call the Free Lunch Index. I live in Memphis, normally not a hotbed of middle market M&A activity.  That’s why my practice is national in scope.  When banks or private equity groups do come to town looking for deals, I often get a call for lunch, breakfast or coffee.

Since the crash in 2008 it’s been fairly lonely out here and I pretty much buy my own lunches. Starting this month, however, I’ve seen a marked pickup in calls and lunch invitations.  The word appears to be out among both the private equity groups and the financial institutions that now is the time to get back into the market and they’re actually spending money to look for deals.

Our experience at Focus indicates that business sale interest has increased strongly since yearend. Apparently we are not alone.  Cyprium Partners, a leading mezzanine financing specialist, recently completed a survey of 175 investment-banking firms throughout the U. S.  Among their findings, 44% of respondents reported more assignments signed or in the market than at a comparable time in 2010.  56% reported that new business pitches were up and less than 10% of the firms reported lower activity.  Bottom line the M&A business is improving and that’s consistent with our belief that the overall economy will surprise to the upside.

It’s no secret that the U. S. private equity industry has been in a depression over the past three years.

Source: Pitchbook

Private equity deal flow showed great promise this time last year, but fell precipitously by the end of 2011.  Interestingly, according to Capital IQ, global aggregate annual deal flow in terms of number of transactions has been far more stable while dollar values have fluctuated widely.

Year                          # of  … read the rest

Is 2012 More Like 1972 Than 1992?

Posted on January 23, 2012

Newt Gingrich and Bill Clinton are quick to remind us that twenty years ago they lifted America from the depths of recession, initiating an unprecedented period of prosperity, jobs growth and balanced budgets. Sounds nice, but what if the America of today bears a closer relationship to 1972 than 1992?

In January 1972 America was a bit over a year past the recession of 1969-1970. We had spent much of the prior decade mired in increasingly unpopular wars that had placed a huge drain on the nation’s financial resources and we were headed toward a messy exit from our Asian adventure. The Democratic Party was so ideologically divided that it was preparing to nominate George McGovern as its presidential candidate and thus give a resounding second term victory to Richard Nixon. After hitting an all time high of just under 1000 in 1968, the Dow Jones Industrials had experienced a sharp drop during 1969-1970 recession, but had since rallied back to near its highs and was poised to continue to rise into the election season.

Source: Capital IQ

On the monetary front the U. S. had been engaged in a period of what we would now call quantitative easing, funding debts incurred in the Vietnam War through the printing of new money. M2 had grown 12% in 1971 and was poised to grow another 12% in 1972. As a result the U. S. was running a then unheard of balance of payments deficit and had been forced off the gold standard in August of 1971.

Subsequent events certainly did not turn out well for the U. S. While inflation remained comparatively mild in 1972 at 3.7% for the year, the rate of price growth jumped to 6% by the end of 1973 and 11% in 1974. The ensuing recession of 1973-1975 was comparable in … read the rest

Could 2012 Surprise to the Upside?

Posted on January 22, 2012

In January we are trained to predict the likely course of the coming year and more often than not we get it wrong. This year virtually everyone has had the same prediction: “We’ll muddle along at around 2.5% growth unless something really bad happens and then all bets are off.” The outliers tend to focus on the possibility that we are heading for a recession based in part on the negative call from the Economic Cycle Research Institute (ECRI). Yet some of the economic data is not cooperating with the doomsayers and our observations in the real world are that business for many of our clients is not all that bad and is in fact improving.

What if the pessimists are wrong and 2012 turns out to be a far more positive year for the economy than many are predicting? While the jury is still out, the data continues to improve in terms of employment and consumer spending.

Credit to Hale Stewart who recently published this and a number of other charts supportive of a positive economic case on Seeking Alpha. What’s the chance he could turn out to be right? Ignoring for the moment all the could go wrongs, what’s the case for a far stronger 2012 than is currently being predicted?

1. Everyone wants things to get better. This is not trivial. After four years of depression, everyone longs for the good old days. 2012 is predicted to be the best year since 2007 for the travel industry. What happens if Americans who have been accumulating dry powder for the past four years suddenly loosen their purse strings?

2. The Fed is committed to a massive and continuing program of monetizing the massive deficits the federal government continues to run. As we wrote recently, this has created a huge overhang of … read the rest

Is QE3 Already Underway?

Posted on January 17, 2012

Much ink is being spilled on when/if the Fed will move to the next iteration of its quantitative easing program. That’s the wrong question. The Fed and the world’s other major monetary authorities have effectively been captured by national treasuries running historically high budgetary deficits and their chief function has become the funding of governmental expenditures that cannot or will not be funded through taxes. Continued pressure to monetize the debt is a foregone conclusion so long as the deficits continue at their current levels.

A year ago we explored Chairman Bernanke’s position that “QE II (the purchase of long term Treasury Bonds by the Federal Reserve) is not inflationary and has not created an explosion of the money supply.”

How could it be the case that rapid monetary expansion could be accomplished without an inflationary impact? Keynes, though much maligned and misused, provided a clear explanation for this one with his description of a “liquidity trap”. In normal credit environments new reserves added to the banking system are magically multiple through the working of fractional banking, creating a significant multiplier effect on business activity throughout the economy.

In a liquidity trap this no longer works; reserves just sit at the banks and the money multiplier sinks. That’s where we are today as recently outlined by Paul McCulley, Chairman of the Society of Fellows of the Global Interdependence Center and former PIMCO trader, in a recent CNBC interview. As a result the Fed has been able to create in excess of $1.5 Trillion of excess bank reserves since the 2008 crash


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Looked at globally, the trend is even more dramatic.


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Source: Zero Hedge

The size of the combined Federal Reserve, European Central Bank and Bank of Japan balance sheets has grown from a historical norm of … read the rest

Are Derivatives Accounting Rules Helping the Big Banks Overstate Their Earnings?

Posted on November 21, 2011

Profits do not mean the same thing for the major banks as they do for ordinary businesses.  If you manufacture or distribute widgets, calculating your profit on a sale is pretty straightforward.  What did it cost to acquire or make the widget? What did you sell it for?  The difference is profit.  For a broker/dealer it works pretty much the same way.  What did the bond cost me?  What commissions did I pay?  The difference is profit.

Now consider the case of the major money center banks.  Thanks to the repeal of Glass Steagall they are in the position to act not only as a broker dealer, but also as a principal, holding the financial instruments they create in their long-term investment book.  During the heyday of the mortgage securitization boom, this permitted the banks to package bundles of mortgages into mortgage-backed securities (MBS), booking a hefty spread in the process.  The MBSs could then be repackaged as collateralized debt obligations (CDO) and the CDOs could then be re-repackaged an infinite number of times as synthetic CDOs thanks to the magic of credit default swaps.

At each step of the process the bank earned a hefty origination spread, the investment bankers, brokers, lawyers and a myriad of consultants and rating agencies made their commissions and fees and everyone was happy, at least as long as the securities could be pawned off to some Norwegian village north of the Artic Circle.  At some point the music stopped and the Norwegians went back to hunting reindeer, but not so the bankers.

Thanks to the repeal of Glass Steagall the banks were able to find new customers for the convoluted structures their well-oiled machines were churning out by the hundreds: they held them on their own books.  By booking the securities at “retail” this process enabled the … read the rest

Just What is Quantitative Easing About Anyway?

Posted on January 1, 2011

Quantitative Easing 2

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It has become quite fashionable for commentators and blaring TV ads to assume that the United States is rapidly printing money, which will inevitably lead to hyperinflation and a debasement of the dollar as a global currency.  All you have to do is look at the increasingly volatile (some might say speculative) chart of gold prices over the last decade and particularly over the past several years to see that many investors have bet with their bank accounts that this will be the case.

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I will admit to an inclination to being as susceptible as the next person to the suspicion that the western world is in for some significant inflation looking forward.  Yet this belief must be based, not on demonstrable proof, but on an innate faith that politicians will invariably do the wrong thing, given the choice.  In a December 5 interview on 60 Minutes, Chairman Bernanke of the Federal Reserve, conducted in my opinion the most candid discussion ever to slip from the lips of a Fed Chairman.  He made a very forceful case that, far from inflating the currency, the Fed is fighting a very real risk that the U. S. could fall into a serious deflation.  Without equivocation Bernanke indicated that QE II (the purchase of long term Treasury Bonds by the Federal Reserve) is not inflationary and has not created an explosion of the money supply.  He went on to say that, were inflation to rear its ugly head, the Fed could raise interest rates “in fifteen minutes” if necessary.

So what are the facts for Mr. Bernanke’s case?  First, the Money Supply as measured by M2 (currency plus bank demand and time deposits excluding large CDs) is not growing very fast

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After a brief period of rapid growth … read the rest

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