Stuff about finance & investing

The Multiplication of Money - John Mauldin's Weekly E-Letter
Send to a Friend | Print Article | View as PDF | Permissions/Reprints
Thoughts from the Frontline Weekly Newsletter
The Multiplication of Money
by John Mauldin
February 26, 2010
 Visit John's Home Page


 

/***/

So Where's the Inflation?

Now for a series of graphs. First, let's look at the Adjusted Monetary Base (or M0). This is the one monetary aggregate that the Federal Reserve actually controls. Notice that it exploded in the middle of 2008, as the Fed started quantitative easing and pushed rates to zero. They were desperate to try and thaw out the credit markets that had frozen.

image001

That in turn caused M1 to increase.

image002

But the broader measure on money that is M2 rose into 2009 and has then gone sideways. Normally the stimulus of such raw money growth in M0 would have M2 exploding upward, as you get a money multiplier effect.

image003

We all know that a US bank can lend out about nine times the deposits it has on hand. When the Fed puts money into the system, it can be multiplied rather quickly if banks choose to lend. This is called the money multiplier.

"Restated, increases in central bank money may not result in commercial bank money because the money is not required to be lent out – it may instead result in a growth of unlent reserves (excess reserves). This situation is referred to as 'pushing on a string': withdrawal of central bank money compels commercial banks to curtail lending (one can pull money via this mechanism), but input of central bank money does not compel commercial banks to lend (one cannot push via this mechanism)." (Wikipedia)

This described growth in excess reserves has indeed occurred in the financial crisis of 2007–2010, with US bank excess reserves growing over 500-fold, from under $2 billion in August 2008 to over $1,000 billion recently. Look at the chart below. This is what has all the gold bugs salivating. Where else has this happened without hyperinflation?

image004

Now let's turn to our old friend Paul Samuelson and his textbook that we all read in Econ 101 to learn about the money multiplier:

"By increasing the volume of their government securities and loans and by lowering Member Bank legal reserve requirements, the Reserve Banks can encourage an increase in the supply of money and bank deposits. They can encourage but, without taking drastic action, they cannot compel. For in the middle of a deep depression just when we want Reserve policy to be most effective, the Member Banks are likely to be timid about buying new investments or making loans. If the Reserve authorities buy government bonds in the open market and thereby swell bank reserves, the banks will not put these funds to work but will simply hold reserves. Result: no 5 for 1, 'no nothing,' simply a substitution on the bank's balance sheet of idle cash for old government bonds."

–(Samuelson 1948, pp. 353–354)

And that is what has happened. And all those mortgage bonds and other assets the Federal Reserve has purchased? They have been put right back into the Fed by the banks. There has been no money multiplier. In fact, the money multiplier, as measured by the ratio of MO to M1 growth is at its lowest level ever. Look at the graph below:

image005

What this graph shows, astonishingly, is that a dollar added to the monetary base now has a NEGATIVE multiplier effect. Without showing yet another chart, bank lending has fallen percentagewise the most in 67 years. The actual amount of bank loans is falling each and every quarter, with no signs of a bottom. Consumers are reducing their debt and leverage. Bank loans are being written off at staggering rates. Over 700 banks (I think that is the figure I saw) are officially on watch by the FDIC, with more banks being closed each week.

There is at least $300-400 billion in losses on commercial real estate waiting to be written down. Housing foreclosures are rising and hundreds of billions have yet to be written off. As more families fall into unemployment or underemployment, there will be more writedowns. Is it any wonder that banks are having to shore up their balance sheets and make fewer loans?

With capacity utilization just off all-time lows, why should we expect businesses to borrow to increase capacity? Inventory levels are much lower than two years ago. Businesses no longer need to finance as much inventory. They simply need less.

Dennis Gartman writes:

"Effectively the Fed had become a cash machine rather than a monetary expansion machine. At the end of last year, the multiplier had actually fallen to less than 1.0 and the trend remains downward. If anyone had told us five years ago that the money multiplier would be down to 1.0 we would have laughed. The laugh, however, would have been upon us, for it is there and it is still falling. Hard it shall be to sponsor strong economic growth when no one really wants to take a loan or when few banks want to make a loan. The "game" of banking has been turned upon its head, and the strength of the economy suffers while inflationary pressures (at least for now) remain virtually non-existent."

Next week (or within a few weeks) we will review the velocity of money, as the normal, accustomed relationships about money supply and inflation are proving to be wrong. We live in extraordinary times. We are coming to the End Game of the debt supercycle that has lasted for 70 years. Everything is changing in front of our eyes. It compels us to understand the basics of how economies function, and what is both different and not different about the times we are in.

/***/

Headline of the Day: “Lending Falls at Epic Pace”

via The Big Picture by Barry Ritholtz on 2/23/10

How can you not love that hedder?

It sums up everything in the article in a tidy little package, and delivers it with style and grace. (Plus, its the second time today I have gotten to use the word epic!)

Here is the Journal’s version (pub date FEB 24, 2010):

“U.S. banks posted their sharpest decline in lending since 1942 at the end of last year, suggesting that the industry’s continued slide is making it harder for the economy to recover.

While top-tier banks are recovering at a faster clip, the rest of the industry is still suffering, according to a quarterly report from the Federal Deposit Insurance Corp. Banks fighting for survival, especially those plagued by losses on commercial real estate, are less willing to extend loans, siphoning credit from businesses and consumers.

Besides registering their biggest full-year decline in total loans outstanding in 67 years, U.S. banks set a number of grim milestones. According to the FDIC, the number of U.S. banks at risk of failing hit a 16-year high at 702. More than 5% of all loans were at least three months past due, the highest level recorded in the 26 years the data have been collected. And the problems are expected to last through 2010.”

That is epic!

>

Click for Interactive Graph on Bank Failures

Courtesy of WSJ

>

Source:
Lending Falls at Epic Pace
MICHAEL R. CRITTENDEN And MARSHALL ECKBLAD
WSJ, FEBRUARY 24, 2010
http://online.wsj.com/article/SB10001424052748704188104575083332005461558.html

Mergers in the fertiliser industry: A growth business | The Economist

Mergers in the fertiliser industry

A growth business

Feeding the world has become a mouth-watering opportunity

Feb 18th 2010 | From The Economist print edition

Corbis Potash makes the world grow round

FOR thousands of years farmers would try to ensure a decent harvest with exhortations to various deities. The weather may still be in the lap of the gods but the fecundity of the soil can now be improved by more down-to-earth means. The run-up in the price of fertiliser, which reached a peak along with most agricultural commodities in 2008, gave a taste of the money to be made by feeding the world. A recent flurry of takeovers suggests that fertiliser companies see the subsequent drop in prices as a buying opportunity before the next ascent begins.

The biggest deal so far this year was unveiled on February 15th. Yara, a Norwegian fertiliser-maker, agreed to pay $4.1 billion for Terra, an American company. The deal will extend Yara’s lead as the world’s biggest maker of nitrogen-based fertiliser. Vale, a huge Brazilian mining company, has put up $4.8 billion for two recent purchases. These will boost its phosphate- and potash-based fertiliser businesses, which serve Brazil’s vast and growing agricultural sector.

BHP Billiton, the world’s biggest mining company, has also added bulk to its potash operations. In January it paid $320m for Athabasca Potash, a Canadian business situated near a mine it owns in Saskatchewan. In a decade the combined sites could churn out 8m tonnes of potash annually, twice the output of the world’s largest mine and equivalent to a just under a sixth of global consumption. Such is the allure of potash that rumours last year suggested that Vale or BHP might bid for a big global fertiliser company such as America’s Mosaic or PCS of Canada.

The explanation for all this is undoubtedly the open maw and changing dietary habits of the world’s fast-expanding population. It is expected to grow by around a third by 2050 to over 9 billion people, who will all need to be fed. Moreover, as people grow more prosperous they eat more meat, which will require even more crops to provide feed for livestock.

China’s demand for fertiliser is expected to be particularly buoyant as a result of its huge population and the poor quality of its arable land. China is largely self-sufficient in nitrogen fertilisers. But the country is already a big importer of phosphates and especially potash. It consumes around a quarter of the 50m tonnes of potash produced in the world each year. By some estimates China alone might use 26m tonnes a year within a decade and a half.

There are other factors at work besides the world’s population pressures. The prices of fertilisers are recovering more slowly than those of other commodities, making fertiliser companies relatively cheap. That is especially true if the buyer is a mining firm, earning near-record prices once more for its ore. Big mining companies are also interested in phosphates and potash because they are generally extracted from the sort of huge mines that are their bread and butter.

The Yara deal is partly a response to lower prices for natural gas in America. Energy accounts for about three-quarters of the cost of producing nitrogen fertilisers, so cheaper gas and proximity to America’s many farmers make Terra an attractive buy. The gods, it seems, are smiling on the fertiliser-makers.

via economist.com

Nokia pulls the plug on wireless payment handset • The Register

Nokia has scrapped its third NFC handset, the 6216, which never got launched despite being scheduled for last year and despite China Unicom's plans for an NFC launch.

The 6216 would have been Nokia's third NFC handset, but the first to have handed control of the payment system to the operator's SIM through the Single Wire Protocol (SWP): exactly the architecture that China Unicom will be deploying in the next six months, as NFC World reports.

"We felt the quality of the consumer experience was not what it needed to be," Nokia told NFC World when asked about the cancellation of the 6216, before confirming that the company was still committed to the idea, just not the architecture that gives operators control.

Near Field Communications (NFC) is a system that allows a phone handset to be used as a proximity-payment system, waved near a reader for small-value transactions such as public transport for example. Those compliant with the NFC Forum's specification can operate through induced power (so work on a battery-dead phone) and are compatible with existing ticketing systems such as London's Oyster card.

But wireless communications are only half the story - such a system also needs a safe place to store the current balance and the various certificates necessary to secure the system. The obvious place for that is inside the SIM, and operators lobbied hard for the SWP standard which would connect a SIM-based NFC system to the outside world, but despite being a standard for more than two years SWP-compatible handsets still don't exist in significant numbers.

Companies like Nokia would much rather see the secure module embedded in the phone, tying the user to the handset rather than the SIM, and operators haven't provided any discouragement.

So the 6216 would have been a significant handset, if it had been launched, which Nokia has now admitted won't happen.

Which is a shame as China Unicom has announced it will be launching an NFC-Forum-compatible service, based on SWP, later this year. That's going to have to compete with China Mobile's, incompatible, RF SIM system, but as China's second network operator Unicom still has more than 125 million subscribers - enough, one might think, to make Nokia think again about the 6216. �

via theregister.co.uk

How Much Are We Subsizidizing Banks (beyond TARP) ?

via The Big Picture by Barry Ritholtz on 2/20/10

Dean Baker of the Center for Economic Policy Research looked beyond the TARP to see how much Uncle Sam is subsizidizing the banks considered “too big to fail” — beyond TARP. Call it the Value of the “Too Big to Fail” Big Bank Subsidy.

His conclusions?

-The spread between big banks’ (1.15%) and smaller banks’ (1.93%) cost of funds is 0.78%:
-The annual boost to profits of 18 biggest banks from that funds-cost advantage: $33 billion;
-Pre-2008 spread in big and small banks’ funds-cost: 0.49%:
-Part of big banks’ profits from rate “subsidy” (1H09): 48%:

To give this some context, Dean compares it to the Temporary Assistance for Needy Families (TANF) and to US Foreign Aid Spending. Not including TARP, the “TBTF bank subsidy” was more than twice as large as the TANF grant for 2009; the bank subsidy is almost 20 percent larger than spending on foreign aid.

Here is something to think about: Even after the TARP has been fully paid back, the US Government is STILL bailing out TBTF banks more than we are giving bailouts to US families with hungry kids, and more than all of our overseas aid . . .

>

Sources:
Value of the “Too Big to Fail” Big Bank Subsidy.
DEAN BAKER AND TRAVIS MCARTHUR
Center for Economic and Policy Research, September 202009

The Big Bank Theory
How government helps financial giants get richer
Dean Baker
Boston Review, JANUARY/FEBRUARY 2010
http://bostonreview.net/BR35.1/baker.php

Job-Creation Cacophony
BILL ALPERT
BARRONS  FEBRUARY 22, 2010
http://online.barrons.com/article/review.html

See also:
The Cost of Saving These Whales
GRETCHEN MORGENSON
NYT, October 3, 2009
http://www.nytimes.com/2009/10/04/business/economy/04gret.html

FT.com / Capital Markets - Jitters over China’s waning taste for T-bills

Jitters over China%u2019s waning taste for T-bills

By Robert Cookson and Michael Mackenzie

Published: February 18 2010 18:16 | Last updated: February 18 2010 19:02

If there is one thing that gets investors twitchy, it is the fear that China is losing its appetite for US government bonds.

securities thumb

As the biggest and most liquid pool of assets in the world, the US Treasury market lies at the heart of the global financial system and allows the American government to finance its trillion-dollar budget deficits. Until recently, China has been the largest foreign official holder of US debt.

That is why the latest release of Treasury International Capital (Tic) data, showing that China%u2019s holdings of Treasuries fell by a record amount in December, has caused something of a stir.

China%u2019s holdings fell by $34.2bn to $755.4bn from the previous month, prompting renewed jitters that the country was diversifying from Treasuries over fears about their future value.

China%u2019s holdings have fallen from a peak of $801.5bn in May 2009, and the data come at a time of heightened political friction between Beijing and Washington over issues such as Barack Obama%u2019s meeting with the Dalai Lama, US weapons sales to Taiwan, and pressure on China to revalue the renminbi.

%u201CThese developments require monitoring because they could cause China to become even less enthusiastic buyers of US Treasuries,%u201D says Yasunari Ueno, chief economist at Mizuho Securities in Tokyo. %u201CA key issue now is how China will act in 2010 in light of the deteriorating bilateral relationship with the US.%u201D

China may have indeed started to rebalance its foreign reserve portfolio from US Treasuries, he says, having piled into the asset class after the collapse of Lehman Brothers in September 2008. But most analysts, including Mr Ueno, believe the December dip in China%u2019s holdings of US Treasuries more likely has more mundane explanations. They also caution against reading too much into the Tic data, which is prone to big monthly swings and is subject to so-called transactional bias.

Tic data is further clouded as the true holdings of Asian central banks such as the People%u2019s Bank of China are obscured by their use of custodians in big financial centres offshore.

Dealers believe China may have made significant purchases in the past year through Hong Kong and London. Treasury holdings by Hong Kong rose to $152.9bn in December %u2013 up from $77.2bn in Dec 2008.

Meanwhile, UK holdings of Treasuries have also surged, reaching $302.5bn in December, from $230.1bn in October.

In terms of China%u2019s portfolio of Treasuries in the Tic report, the December data show a further big reduction in holdings of short-dated bills and buying of longer-dated coupon debt. China%u2019s T-bill holdings dropped by $38.8bn in December while its holdings of notes rose by $4.6bn.

Rather than selling any of its holdings, China appears to have let the bills mature and then used some of the proceeds to buy longer-dated coupons, analysts say. Extending its purchases along the yield curve is, partly, a sign of China%u2019s confidence in the US government%u2019s ability to service its debt. The Tic data show that China has not diversified into US equities or corporate bonds.

During the financial crisis, China built up holdings of short-dated T-bills from $14bn in mid-2008 to $210bn by May 2009 and they are now back around $70bn.

%u201CThe latest data is consistent with them shrinking the T-bill mountain rapidly, although there is more to come, as the likely underlying desirable holdings of T-bills is probably nearer $20bn,%u201D says Alan Ruskin, strategist at RBS Securities.

%u201CChina is simply fine tuning its portfolio and as US banks and consumers continue deleveraging, there will be enough domestic demand to buy Treasuries,%u201D says John Brady, senior vice-president of global interest rates at MF Global.

Mr Ueno says the most probable cause of China%u2019s decline in Treasury purchases, is simply that the country%u2019s foreign reserves grew at a slower pace in December. Julian Jessop, economist at Capital Economics, predicts that December%u2019s Tic data represent a brief pause before China%u2019s purchases of Treasuries resume.

And even if China is shifting out of US Treasuries, it would not necessarily cause trouble in the market as long as other buyers step into the breach. Indeed, US Treasury yields remain well inside last summer%u2019s peaks as other countries have stepped up their buying.

Significantly, Japan overtook China as the biggest foreign holder of US Treasuries in December, and its monthly purchases have been consistently rising since May. The country, which is seen as having a more stable relationship with the US, held $768.8bn of Treasuries in December, an increase of $142.8bn from the previous year. Analysts see little rationale for China to reduce its Treasury holdings dramatically, given that such a move would be likely to have severe consequences for Beijing.

If Chinese demand for Treasuries disappeared and it started selling, US interest rates would rise, analysts say. This could throttle a US economic recovery, damage Chinese exports, and also reduce the value of China%u2019s existing vast holdings of Treasuries as yields rose and prices fell, damaging a key plank of its currency reserves.

Moreover, China%u2019s currency link with the US dollar entails there is a limit to how far they can diversify their foreign reserves.

%u201CSo long as China%u2019s currency is pegged to the US dollar, they will need to recycle their trade surplus dollars back into US assets,%u201D says Gerald Lucas, senior investment adviser at Deutsche Bank.

Which is yet another reason why Tic data is being closely watched. If the latest numbers mark the beginnings of a diversification by China away from US Treasuries and other dollar assets, a widely speculated rise in the value of the renminbi against the dollar is on the cards.

Copyright The Financial Times Limited 2010. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.

via ft.com