Friday, February 13, 2009
Happy Friday the 13th
Of all days, Obama's stimulus bill passed Congress this night. I'll post details of the bill with commentary next week when Obama signs it in to law.
Wednesday, February 11, 2009
Welcome to Banking Hell
Today, the CEOs of the major banks arrived in Washington, D.C. on Amtrak to testify before Congress they are sorry about past malfeasance and really are trying to lend out money to get the economy rolling—which I doubt anyone believed.
Here's the situation: there is $330B in TARP bailout money left, there is about $850B of newly created base money sitting in bank reserves they could fall back on, an unknowable but estimated $2-3T of toxic assets, and a taxpaying public growing more outraged by further bailout money for the financial industry. So, that's nearly $1-2T or so of vaporized wealth that banks somehow need to wiggle out of. And that's just for mortgages.
I had no doubt the original TARP would breeze through Congress. Now, finally, things may be getting interesting.
Here's the situation: there is $330B in TARP bailout money left, there is about $850B of newly created base money sitting in bank reserves they could fall back on, an unknowable but estimated $2-3T of toxic assets, and a taxpaying public growing more outraged by further bailout money for the financial industry. So, that's nearly $1-2T or so of vaporized wealth that banks somehow need to wiggle out of. And that's just for mortgages.
I had no doubt the original TARP would breeze through Congress. Now, finally, things may be getting interesting.
Tuesday, February 10, 2009
Geithner reveals... nothing?
News of late has been dragging its feet—being anticipated days and weeks ahead of its actual coming. This is a good thing when it comes to government spending—after all it seems sensible that bailout packages in the hundreds of billions should receive a healthy congressional debate rather than steamrolling it through based on fear tactics. So thumbs up to senate republicans for offering some minority opposition to Obama's stimulus proposal, a luxury democrats rarely saw from their representatives during the Bush administration.
As with the stimulus package, we've been awaiting a statement by new Secretary of the Treasury Timothy Geithner around continued bailouts of the banking industry. So far he has been non-commital around action—but talking trillions of dollars for expenses. Most famously has been proposed the "bad bank," where toxic assets can be taken off bank's balance sheets and backed by a taxpayer driven federal program.
As of his statement today, he remains diffuse, and was explicitly criticized by a Congressional hearing over that, and the DJIA trended down sharply in response. Whatever it is, he still has $320B of TARP money to work with, for now.
The fact he is calling for the use of private capital in all of this, for this "bad bank," which obviously isn't going to happen unless it is fully guaranteed, strikes me as almost a delay tactic.
As with the stimulus package, we've been awaiting a statement by new Secretary of the Treasury Timothy Geithner around continued bailouts of the banking industry. So far he has been non-commital around action—but talking trillions of dollars for expenses. Most famously has been proposed the "bad bank," where toxic assets can be taken off bank's balance sheets and backed by a taxpayer driven federal program.
As of his statement today, he remains diffuse, and was explicitly criticized by a Congressional hearing over that, and the DJIA trended down sharply in response. Whatever it is, he still has $320B of TARP money to work with, for now.
The fact he is calling for the use of private capital in all of this, for this "bad bank," which obviously isn't going to happen unless it is fully guaranteed, strikes me as almost a delay tactic.
Saturday, February 7, 2009
Bank Reserves and Inflation
Per Fed data, nearly $1T has been added to base money in the last 4 months. If all of it were lent out by recipient banks, it could expand upwards of $10T (at 10% fractional reserve), nearly doubling the overall money supply. But as we know, banks have hardly been lending their bailout money… thankfully, because it was excessive credit that got us in to this mess.
During the period of base money expansion, starting last September, prices have remained at best the same for most common everyday goods, and have been dropping for things like gas, houses, and most investments. Even retail prices have been dropping with more and more on-sale items to be found. The money added to bank reserves almost exactly matches the base money expansion. So the question becomes, how inflationary would be increasing bank reserves if the reserves are just sitting there?
Let’s start by examining the deflationary forces that prompted recent increases in base money. Say a $500,000 house in the outskirts of Stockton two years ago now goes for $200,000. That’s a decline in wealth by $300,000. Now, as much as people who hold legal title to the house like to believe they are homeowners, the truth is, until the mortgage is paid off, it is owned by the bank—and in this situation, one does well to take full advantage of that and mail the bank their keys if there were little equity in the place. The bank will recover what it can, about $200k at auction, and be stuck with a $300k deficit, minus any equity there might have been.
Now the original $500k loan added to the money supply via fractional reserve credit is still out in circulation (sitting in the sellers bank account unless they spent it, in which case the money is wherever it is in a line of transactions). If the Fed or Treasury department decides to keep the troubled bank afloat and grants them $300k in base money for their loss, is that $300k worth of money expansion? The rescue of the loan can be viewed as a deposit of new currency from the Fed. Which is inflationary.
But what price increases there were during a credit happy environment are now stressed with credit contraction, and not sufficiently compensated by base money expansion. So while inflationists are right that we have a lot of inflation in base money, we have greater contractions in credit, and general price declines.
Whether inflationary forces outweigh deflationary ones, or vice versa, the proof is in the pricing: the dollar now buys more houses, gas, stocks, and a slew of retail items than it once did. There is a broad contraction of investment wealth, and only the banks (and AIG and automakers) are being rescued. Deflationary forces are prevailing over inflationary ones, and I see no reason to anticipate a quick turnaround.
If this deflationary course reverses I’ll be the first to report on it.
During the period of base money expansion, starting last September, prices have remained at best the same for most common everyday goods, and have been dropping for things like gas, houses, and most investments. Even retail prices have been dropping with more and more on-sale items to be found. The money added to bank reserves almost exactly matches the base money expansion. So the question becomes, how inflationary would be increasing bank reserves if the reserves are just sitting there?
Let’s start by examining the deflationary forces that prompted recent increases in base money. Say a $500,000 house in the outskirts of Stockton two years ago now goes for $200,000. That’s a decline in wealth by $300,000. Now, as much as people who hold legal title to the house like to believe they are homeowners, the truth is, until the mortgage is paid off, it is owned by the bank—and in this situation, one does well to take full advantage of that and mail the bank their keys if there were little equity in the place. The bank will recover what it can, about $200k at auction, and be stuck with a $300k deficit, minus any equity there might have been.
Now the original $500k loan added to the money supply via fractional reserve credit is still out in circulation (sitting in the sellers bank account unless they spent it, in which case the money is wherever it is in a line of transactions). If the Fed or Treasury department decides to keep the troubled bank afloat and grants them $300k in base money for their loss, is that $300k worth of money expansion? The rescue of the loan can be viewed as a deposit of new currency from the Fed. Which is inflationary.
But what price increases there were during a credit happy environment are now stressed with credit contraction, and not sufficiently compensated by base money expansion. So while inflationists are right that we have a lot of inflation in base money, we have greater contractions in credit, and general price declines.
Whether inflationary forces outweigh deflationary ones, or vice versa, the proof is in the pricing: the dollar now buys more houses, gas, stocks, and a slew of retail items than it once did. There is a broad contraction of investment wealth, and only the banks (and AIG and automakers) are being rescued. Deflationary forces are prevailing over inflationary ones, and I see no reason to anticipate a quick turnaround.
If this deflationary course reverses I’ll be the first to report on it.
Sunday, February 1, 2009
Metrics: Cash, Credit, and Prices
The "cash-inventory equivalency," proposed before, states: money supply (MS)—or the sum of printed cash (P) and outstanding credit (C)—exactly equals the value of the inventory (I) of all things for sale (e.g. MS = I; or P + C = I).
Where there are discrepancies in this equation, where things for sale are overpriced or underpriced, it reflects an error of pricing, relative to the desire society has for a given item. Since errors of pricing reflect inefficiencies for the seller, prices will tend to self-adjust over time to conform to this equivalency. From the cash-inventory equivalency, one can derive a value for cash that reflects its purchasing power at home, independent of how it sizes up against foreign currencies. Also, equilibrium and disequilibrium prices can be conceptualized.
But this equation is an assumption. I have argued that if the sum of all prices is greatly lower than money supply, then sales velocity increases and sellers adjust by increasing prices; or if prices greatly exceed money supply, then sales will slow, and sellers have to cut prices such that sales keep up with productive capacity. In either of these extreme cases the direction of price correction goes toward the cash-inventory equivalency, but does it exactly equal it? That I cannot say for sure.
Even if money supply and inventory were not exactly equal but exactly proportional and related by a constant, then cash value and price disequilibrium would still hold valid, but with the constant factored in. But if money supply and prices are generally proportional and not exactly proportional, then no headway has been made since the quantity theory of money, which has been around for centuries.
Now, the cash-inventory equivalency (P + C = I) could be demonstrated if each variable were measurable and could be followed over time; and especially opportune would be a setting where the relative proportion of credit to printed currency is in flux as it is now. This post will offer some initial thoughts on the measurement of these variables.
1. Cash (P) is the easiest to measure. There are two approaches I have, both of which yield around the same answer: you have M1-currency which is the amount of cash that was run off at the presses; either that you can subtract bank reserves from base money supply—all of these numbers are published regularly by the Fed. Interestingly, while base money and bank reserves have been skyrocketing, M1 has risen slightly. The Fed isn’t really “printing” all that much. Base money expansion is just ineffable eMoney which gives the banks some leeway for making loans in the current credit environment; or more importantly, it will allow them to withstand the implosion of Alt-A (stated income) loans, commercial real estate, and credit cards, particularly as the effect of recent job losses snowballs through the economy. Currently, there is about $800B cash in circulation.
2. As for measuring credit (C), to the degree that the money originated by fractional reserve lending is redeposited by sellers back in to banks, and I think that is a pretty reliable assumption, then deposits are a reasonably good estimate of credit. Until March 2006, we used to have that information when M3 was published by the Fed. Subtract M1-currency from M3 and you have outstanding credit in dollars. So now there is M2 and MZM which do not factor in large CDs or deposits with a maturity date. M3 was becoming increasingly disproportionate to M2 right before the Fed stopped publishing it, so it’s essential data in measuring credit.
So all we have are M2 and MZM, which are around $8-9 trillion dollars. Subtract cash and we have close to $7 trillion outstanding credit in the system (I am using broad approximations with wide error margins for now and will refine over time). While the financial industry is crashing and burning, we don’t see declines in M2. Part of this may be due to bailout efforts delaying the pain, particularly in protecting the balance sheets of the banks. Defaulted credit does not hit personal deposits; it hits the reserves of banks, and that is where the bailout money and base money expansion has been going.
3. As far as prices (I) go, thus far I’ve been following trends. I watch several indices: DJIA for the health of businesses; Case Shiller for house prices; Reuters-CBH commodities index; spot oil; the CPI for everyday expenses; GDP; and gold. Trends in these indices can be eyeballed as indications of general price trends.
So far, I have a decent measurement of cash, a broad and inaccurate underestimation of credit, and broad indices of general price movements, but nothing that could be considered “the sum of all things for sale.” The first step in demonstrating the cash inventory equivalency would be to refine measurements of credit and pricing trends to determine whether money supply and inventory could be regarded as exactly proportionate or not.
Where there are discrepancies in this equation, where things for sale are overpriced or underpriced, it reflects an error of pricing, relative to the desire society has for a given item. Since errors of pricing reflect inefficiencies for the seller, prices will tend to self-adjust over time to conform to this equivalency. From the cash-inventory equivalency, one can derive a value for cash that reflects its purchasing power at home, independent of how it sizes up against foreign currencies. Also, equilibrium and disequilibrium prices can be conceptualized.
But this equation is an assumption. I have argued that if the sum of all prices is greatly lower than money supply, then sales velocity increases and sellers adjust by increasing prices; or if prices greatly exceed money supply, then sales will slow, and sellers have to cut prices such that sales keep up with productive capacity. In either of these extreme cases the direction of price correction goes toward the cash-inventory equivalency, but does it exactly equal it? That I cannot say for sure.
Even if money supply and inventory were not exactly equal but exactly proportional and related by a constant, then cash value and price disequilibrium would still hold valid, but with the constant factored in. But if money supply and prices are generally proportional and not exactly proportional, then no headway has been made since the quantity theory of money, which has been around for centuries.
Now, the cash-inventory equivalency (P + C = I) could be demonstrated if each variable were measurable and could be followed over time; and especially opportune would be a setting where the relative proportion of credit to printed currency is in flux as it is now. This post will offer some initial thoughts on the measurement of these variables.
1. Cash (P) is the easiest to measure. There are two approaches I have, both of which yield around the same answer: you have M1-currency which is the amount of cash that was run off at the presses; either that you can subtract bank reserves from base money supply—all of these numbers are published regularly by the Fed. Interestingly, while base money and bank reserves have been skyrocketing, M1 has risen slightly. The Fed isn’t really “printing” all that much. Base money expansion is just ineffable eMoney which gives the banks some leeway for making loans in the current credit environment; or more importantly, it will allow them to withstand the implosion of Alt-A (stated income) loans, commercial real estate, and credit cards, particularly as the effect of recent job losses snowballs through the economy. Currently, there is about $800B cash in circulation.
2. As for measuring credit (C), to the degree that the money originated by fractional reserve lending is redeposited by sellers back in to banks, and I think that is a pretty reliable assumption, then deposits are a reasonably good estimate of credit. Until March 2006, we used to have that information when M3 was published by the Fed. Subtract M1-currency from M3 and you have outstanding credit in dollars. So now there is M2 and MZM which do not factor in large CDs or deposits with a maturity date. M3 was becoming increasingly disproportionate to M2 right before the Fed stopped publishing it, so it’s essential data in measuring credit.
So all we have are M2 and MZM, which are around $8-9 trillion dollars. Subtract cash and we have close to $7 trillion outstanding credit in the system (I am using broad approximations with wide error margins for now and will refine over time). While the financial industry is crashing and burning, we don’t see declines in M2. Part of this may be due to bailout efforts delaying the pain, particularly in protecting the balance sheets of the banks. Defaulted credit does not hit personal deposits; it hits the reserves of banks, and that is where the bailout money and base money expansion has been going.
3. As far as prices (I) go, thus far I’ve been following trends. I watch several indices: DJIA for the health of businesses; Case Shiller for house prices; Reuters-CBH commodities index; spot oil; the CPI for everyday expenses; GDP; and gold. Trends in these indices can be eyeballed as indications of general price trends.
So far, I have a decent measurement of cash, a broad and inaccurate underestimation of credit, and broad indices of general price movements, but nothing that could be considered “the sum of all things for sale.” The first step in demonstrating the cash inventory equivalency would be to refine measurements of credit and pricing trends to determine whether money supply and inventory could be regarded as exactly proportionate or not.
Wednesday, January 28, 2009
Government Housing
We now have word that the Fed finally has actual mortgages on its books. This has been spoken of for awhile, and has been a major part of the bailout planning, but in practice there seems to be resistance by the Fed and Treasury Department to accepting mortgages on their balance sheets. Nobody wants toxic mortgages.
But here it is now; mortgages from Bear Stearns and AIG are carried by the Fed. How an investment bank and insurance company came to service home loans I have no idea, but there you go. As I've anticipated before, the government will be more generous than private industry when it comes to loan modification.
In other news, today was another Fed Open Market Committee meeting. They cut interest rates to zero last time, and so until they start raising rates again, there isn't much to report. Expect quantitative easing soon.
But here it is now; mortgages from Bear Stearns and AIG are carried by the Fed. How an investment bank and insurance company came to service home loans I have no idea, but there you go. As I've anticipated before, the government will be more generous than private industry when it comes to loan modification.
In other news, today was another Fed Open Market Committee meeting. They cut interest rates to zero last time, and so until they start raising rates again, there isn't much to report. Expect quantitative easing soon.
Monday, January 26, 2009
The Depression has Arrived
In the wake of a bad holiday season, the news is more and more punctuated with job cuts by the thousands, first from the financial industry, and now from retail and tech powerhouses—Microsoft, Intel, and Sprint Nextel come to mind. The California jobless rate has crept above 9%. For those who don't quite make the statistics, there is increasing competition, less negotiating power, and one has to be a lot more adaptable to find work.
No longer can this be brushed off as a lackluster financial climate. The toll of suffering has started, and probably is going to be prolonged, and this is probably just the beginning.
Now, I do wish that house prices would fall to historic levels relative to income so I can afford to buy one. But I don't care about the prices of stocks and bonds—and commodities only to the degree that it affects prices I pay for food and gas. Though I've postulated a model which anticipates general economic stress in the face of a failing credit industry, I didn't want it to be like this.
UPDATE [1/29/09]: Unemployment claims have set a record this month with new filings at 588,000 and total at 4,776,000. In 1982, numbers were nearly this high, however it doesn't fully reflect the tightness of the work climate—as future indicators show no end to budget cuts and profit downgrades. [4/16/09]: This link from Slate goes to a map of the U.S. that shows job gains losses per county from Jan '07 to Feb '09. Just hit the play button and you will see a striking downtrend in jobs beginning at the end of 2008.
No longer can this be brushed off as a lackluster financial climate. The toll of suffering has started, and probably is going to be prolonged, and this is probably just the beginning.
Now, I do wish that house prices would fall to historic levels relative to income so I can afford to buy one. But I don't care about the prices of stocks and bonds—and commodities only to the degree that it affects prices I pay for food and gas. Though I've postulated a model which anticipates general economic stress in the face of a failing credit industry, I didn't want it to be like this.
UPDATE [1/29/09]: Unemployment claims have set a record this month with new filings at 588,000 and total at 4,776,000. In 1982, numbers were nearly this high, however it doesn't fully reflect the tightness of the work climate—as future indicators show no end to budget cuts and profit downgrades. [4/16/09]: This link from Slate goes to a map of the U.S. that shows job gains losses per county from Jan '07 to Feb '09. Just hit the play button and you will see a striking downtrend in jobs beginning at the end of 2008.
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