On Monetary Inflation and M3

From a chatboard frequented on the occasional break from the kitchen.

Q. A Question for the Inflationists

"The government no longer tracks M3 because of its expense to generate (yeah, right) but private groups still do and it has basically fallen since the stock market entered its bear market a couple of years back. So by definition, do we have inflation or deflation? Gold driven to new highs could be more about gold fever than real inflation."

I usually try to avoid conversations that start this way, with a label and a challenge, since it generally implies an exchange of what are more like religious beliefs, from the opposing 'isms.' As an monetary agnostic, I am usually in the middle of two groups with ardently held beliefs, and a range of impassioned arguments, good and bad. But knowing the person who asked it, I think it is a sincere question, and so here is my answer, for what it is worth.

Within a relatively pure fiat currency system the conditions of inflation and deflation, and the broad range in between, are largely the result policy and fiscal decisions, constrained for the most part only by the acceptability of the bond and the dollar and the tolerance of the people.

Regarding M3, it is the eurodollar component that is primarily missing, and Williams and my friend Bart estimate it. I have discussed the difficulty of that and their specific methods with them. I estimate the eurodollar s well, from the BIS and TIC reports, for another reason. It is my measure of dollar demand from overseas, the sole cause of the last dollar rally that was sustained, the eurodollar short squeeze. But one can look at MZM or M2 and see the same trends essentially. Money Supply: A Primer

Money supply alone is not the sufficient to measure monetary inflation or deflation. That is like asking if someone is overweight, if they weigh XX pounds, without specifying their height. Are they four feet or six feet tall? One meter or two meters? It obviously matters.

The measure of monetary inflation is by definition money supply in relation to something else. If nothing else, to population growth or decline, one might imagine, even if one cannot measure economic vitality, or stagnation. As an aside, it is a curious fact of history that the Plagues decimated the people of Europe, but hard wealth and the land remained. So the survivors were richer per capita, helping to create the relief and ebullience that sparked the Renaissance.

Money supply is relative to demand, and potential money supply to potential demand. Even though money supply may not be growing, demand may be contracting faster than it is not growing. If one looks at GDP, and the Velocity of Money which is nothing more than GDP divided by some nominal measure of defined money, domestic demand is slack. And from non-domestic sources, demand for the dollar reserve currency is weaker than in years past.

But there is a funny thing about potential money supply. It can grow quietly in assets, stored in investments and other less repositories of value, and then spring into action relatively more quickly, when wealth is converted to money, the medium of exchange.

Money as the medium of exchange, the note of zero duration, is a very imperfect store of wealth, when real short term rates of return are negative. So the market does not value it, except perhaps for the daily needs, diminished, and a safe haven from unknown risk, and a refuge from bonds of longer duration whose returns may be even worse.

Monetary inflation is deceptively simple, and immensely more complicated than the average person can allow, and the pundit will admit.

Credit is not money. Debt is not money. They are methods of creation of money, of financing the money used in an enterprise.

Money is the exchange, wealth in action, the others potential for transactions. Money bridges the gap between stores of supply and stores of wealth. Money moves, and goods and wealth are exchanged, and then stored again. Money supply is a snapshot of a dynamic process.

Credit/debt destruction are the preoccupation for the deflationary camp. Yes, they are important sources for the creation of money, over which the central bank exercises a remarkable degree of control, despite their occasional and highly disingenuous denials. As credit is destroyed, by writeoffs for example, potential sources of money are negated. But the real question is, what other mechanism for the creation of money remain, perhaps methods that have not been recently used, because they did not need to be used.

One very fine example of this is the method by which the Bernanke Fed expanded its monetary base, to a degree not seen since 1933. The monetary base is high powered money, because it is supposed to represent a pure financial asset, zero risk. Certainly more leveragable than a collaterized debt obligations. The Fed's balance sheet, and the Treasury's ability to issue sovereign debt based on that balance sheet, are the sorcerer's stone. Touch even the most toxic assets with them, as most recently seen in the case of AIG and Goldman Sachs, and they are now worth 100 cents on the dollar.

Debt/credit are one means of financing the enterprise. There is also equity. But a wise person will look at the organically generated flows of wealth in valuing the shares. Are you consuming more than you are creating? What are the future prospects for this flow of wealth? If there is no prospect of net positive wealth creation, then you are living on borrowed time, in a castle of sand, no matter how good the accounting tricks you are using to hide it from the shareholders.

One might look an an unconnected car battery and say, 'oh look it is benign.' But grab hold of each of its terminals with your bare hands while grounded, and see what happens then. And gold is in part measuring that potential, for the Fed and the monetary base and a resurgent economy to generate monetary expansion. There are lags of years involved in the process.

And this is the nature of Bernanke's challenge. He must at some point allow the economy greater access to his excess monetary reserves, and the swollen monetary base, but try to prevent the dollar and the bond from igniting. And gold is where the prudent seek at least a partial refuge while the central bankers conduct their experiments.

Is gold a bubble? It is said to be so by those who wish you to extend your willing hands, and grasp the poles of their mad experiment, without reserve, to help them measure the effect. And, of course, by those who merely to stand by and watch, and plan for their own per capita increase in wealth if you are subsequently reduced to toast.

"The conscious and intelligent manipulation of the organized habits and opinions of the masses is an important element in democratic society. Those who manipulate this unseen mechanism of society constitute an invisible government which is the true ruling power of our country." Edward Bernays, Propaganda, P.37

It's about confidence, isn't it? And perception, and custom, as in habit. The acceptability of the dollar and the bond by the world is the limiting factor on the ability of the Fed and Treasury to create money, managing its supply, by whatever means direct and indirect, by action or allowance, in a fiat currency.

Is Blackrock Buying the US Equity Market?

One might conjecture from this enormous number of 13G filings noted below that Blackrock has taken what appears to be new 5+% stakes in over 1,800 US equities.

"We counted over 1,800 13Gs that Blackrock dumped on Friday...For those less familiar with the 13G...it’s a requirement when ownership exceeds 5% of the outstanding shares...these filings represented new positions for Blackrock since we only counted 11 amended 13Gs, which in itself seems very surprising, given the long list of stocks."

Holy guacamole!

Perhaps this is an error, or a misreading of the data. Someone 'fat-fingered' the Edgar filing button.

We are incredulous that a private investment firm, no matter how well connected, could have taken 5+% positions in most of the NY listed equity market so quickly. Driven madly bullish, with enormously deep pockets, and an abiding faith in their ability to defy the odds? Facilitating the hostile takeover of the rest of US real economy by a cabal of bonus taking Bonapartes? Starting a new Blackrock 1800 index fund from the bottom up, build it and they will come? LOL

Certainly the SEC will inquire as to their intentions, which is the purpose of such filings, and an explanation to the investment public will be forthcoming.

We suggested the other day that Blackrock and the NY Fed might turn out to be Obama's Halliburton and KBR - private contractors fulfilling administration policy. NY Fed Conspired to Hide Details of AIG There are repeated rumours of an invisible hand in several markets, as an arm of Washington. But this is a bit much.

The Robert Rubin Rule of Financial Crisis Management was stated in the mid 1990's. It held that buying SP futures to prop the stock market was cheaper than trying to clean up the mess after a stock market panic. But this was not about actually buying the market; it was about using price to manage perception, in the manner recommended by Edward Bernays.

The problem with this doctrine, of course, is that it requires larger and more pervasive interventions to maintain the illusion, unless the underlying conditions that set the primary market trend are changed. Rather like creating a short term euphoria by treating a patient with pain killers, to the point of harmful addiction, without addressing the underlying condition.

But buying over 5 percent positions in 1,800 listed equities? That is not your father's market rigging, and certainly a step above buying the SP futures contracts. Clumsy and heavy-handed to say the least.

Skeptically waiting, we are keen to see the clarification, legitimate investment or data error. Regardless of the punter, it's a hell of a bet if that is what it is.

Postscript with tongue still in cheek: As I suspected they are rebranding their ETF's purchased from Barclay's. Impressive amount of stock behind it. Still a hell of a bet, just risk spread more widely. They are just taking the management fees, the public is putting up the capital. LOL


footnoted.org
Blackrock’s massive Friday afternoon dump…
By Michelle Leder
February 1, 2010 at 9:30 am

As we monitored filings on Friday afternoon, we wondered why EDGAR seemed unusually sluggish. But it wasn’t until late Friday that we realized why: Blackrock (BLK) had done a massive document dump on Friday afternoon of 13G filings related to its acquisition of Barclay’s Global Investors.

We counted over 1,800 13Gs that Blackrock dumped on Friday, which explains why EDGAR might have been a tad bit pokey. The stream started at just after 2 p.m. est and didn’t let up until just after 4:30, when the last one, which reported a 6.5% stake in Vodafone came in.

For those less familiar with the 13G, since we don’t often write about these filings, it’s a requirement when ownership exceeds 5% of the outstanding shares. With few rare exceptions, these filings represented new positions for Blackrock since we only counted 11 amended 13Gs, which in itself seems very surprising, given the long list of stocks.

Though it’s hard to tell from the SEC’s EDGAR database the names of those 1,800-plus companies without clicking on each filing (and who has time to click on 1,800 of them?), it’s a bit easier in 10KWizard (now known as Morningstar Document Research). And, indeed, there’s a lot of household names on the list including some big names in tech like Apple (AAPL), AOL (AOL), Google (GOOG), Yahoo (YHOO) — several of which Dow Jones picked up on on Friday afternoon. But there’s a lot more names on the list too, including United Technologies (UTX), Toll Brothers (TOL), and even footnoted frequent flyer Martha Stewart Omnimedia (MSO) where Blackrock disclosed a stake of just over 7%.

Actually, a far more interesting project might be trying to figure out who wasn’t on the list since with 1,800-plus filings, just about any company over even a relatively modest market cap — Martha Stewart’s is currently around $240 million — seems to have made the cut.

Equal Protection (From the Zombie Banks)

"...the AIG bailout, a hideous political contrivance that ranks with the great acts of political corruption and thievery in the history of the United States."

Remarkable that in light of the massive failure of the Executive and Legislative Branches of the United States Corporatocracy to protect and defend the public from the outrages being committed by the FIRE sector, the Judicial Branch is providing a haven for the rights of the people under the Constitution.

Can this be due to the fact that federal judges do not require huge campaign contributions, which Wall Street doles out like a foreign power to the craven denizens of Foggy Bottom?

Indeed. The clauses that designate the Credit Default Swaps as super senior to nearly everything else (Some animals are more equal than others clauses) are being struck down by bankruptcy courts. The banks do not take precedent in the hearts and minds of everyone, despite assertions by Timmy and Hank to the contrary.

This is an old financiers trick in the equity world of venture capital, the Sand Hill Road clause, long used to strip the holders of common shares of their slice of the pie in the evolution of startups. The CDS and CDO variation took the gambit a step too far, stepping on the rights of the bond holders, and the courts are nullifying it. Good for them.

Wall Street does not always come first, when honest public servants uphold their oaths to protect and defend the Constitution against those confiscating the wealth of the people.

Do what thou wilt shall be the whole of the Law is the guide of those doing their darker god's work. In the short term it makes them strong, because they deny themselves nothing: no trick or falsehood, no claim or deceit, no act of betrayal or sympathetic ploy. They simply have no shame.

But there is also no honour among thieves, only greed and fear. The best part of honour is the love of something greater than ourselves. And so the bonds of their coalition are weak. Greed and self-interest will be unable to sustain the partnership of government and the Banks when the tide turns-- in the end only the fear remains.

And will Timmy whimper when the zombies turn on him?


Institutional Risk Analyst
Zombie Update: Loan Repurchases and REO Anyone?
February 2, 2010

...Our friends at HousingWire report that a federal bankruptcy judge in New York sitting on the Lehman Brothers bankruptcy, has voided the seniority claims of holders of various qualified investment contracts, ruling that their ipso facto clauses which subordinated other claims to their own were "null and void in bankruptcy." This is an important victory for fans of equal protection and due process, and a big setback for the OTC derivative dealer banks which exert considerable influence at the Fed and OCC.

We have always held the view that the attempts by the large dealer banks, ISDA and regulators to carve out a special, privileged place in the law for OTC derivatives contracts in the event of default is inherently unfair and is doomed to failure, or at least would be challenged, on Constitutional grounds. This case and others make that challenge and review process a reality and also leaves much of the world of complex structured finance in a shambles when it comes to the legal reality of counterparty risk.

Indeed, the same legal art that gave the swap counterparties in this latest case the impression that they were senior to the other creditors of the bankruptcy estate was used by former Treasury Secretary Hank Paulson and his successor, Timothy Geithner, to justify the rescue of American International Group. The very same type of investment contracts that Secretary Paulson and Secretary Geithner swore under oath, over and over again, just had to be paid at par in the case if AIG were just set aside by New York Bankruptcy Judge James Peck.

And notice that the world has not ended when the holders of OTC contracts are treated like everyone else. Indeed, Judge Peck has made a number of rulings over the past two years re-leveling the playing field between holders of OTC contracts and other claims against the Lehman bankruptcy estate. As we have noted before, the admirable conduct of the Lehman Brothers bankruptcy case by Judge Peck and US Bankruptcy Trustee Harvey Miller is the starkest condemnation possible of the AIG bailout, a hideous political contrivance that ranks with the great acts of political corruption and thievery in the history of the United States.

The question of the enforceability of the documentation in a complex structured securitization involving OTC swaps is not just a matter of debate in the AIG case. Across the US and around the world, investors and trustees are grappling with this same issue. The result is litigation by bond trustees against bond issuers as well as claims by guarantors such as MBIA (MBI) and the housing GSEs, including the Federal Home Loan Banks, against sponsor banks. Many of these claims regarding derivatives are being made in the context of claims for the repurchase of defaulted residential and commercial loans.

The wave of loan repurchase demands on securitization sponsors is the next area of fun in the zombie dance party, namely the part where different zombies start to eat one another. The GSE's are going to tear 50-100bp easy out of the flesh of the banking industry in the form of loan returns on trillions of dollars in exposure, this as charge-offs on the several trillion in residential exposure covered by the GSEs heads north of 5%. The damage here is in the hundreds of billions and lands in particular on the larger zombie banks, especially Bank of America (BAC) and Wells Fargo (WFC).

To put the growing combat in the loan repurchase channel into perspective, keen analysts will already know that a new item has appeared in the disclosure for non-interest income by many larger banks that have been active in the securitization markets. In the case of WFC in Q4 2009, gross income of $1.2 billion in mortgage loan originations was net of $316 million in loss reserves for loan repurchases. Imagine if we add a zero to the loss allocation, then another, and you get to the worst-case exposure on OBS loan repurchases.

Watch this heretofore obscure part of the mortgage banking business become downright material in coming quarters as a race of sorts develops between banks that want to restart the securitization markets and those that are being dragged under water by the weight of legacy liabilities. Notice, for instance, that in the MBI litigation against Countrywide Financial et al, MBIA Insurance Corporation v. Countrywide Home Loans, Inc. et al. that now includes BAC explicitly.

The action "arises out of the alleged fraudulent acts and breaches of contract of Countrywide in connection with fifteen securitizations of pools of residential second-lien mortgages" Take particular care to savor the fact that these are second lien pools and that, where defaults have occurred on the primary mortgage, loss severities on the seconds will tend to be 100%. Or the cost could be more than par if you count the cost of remediation and recovery efforts.

With private issuers trying to find a workable formulation for new securitizations, the mounting litigation in the secondary market for structured deals comes at a bad time for efforts to revive the patient and confirms our worry that there is a lot of tough work ahead in the loss mitigation channel. More, we worry that the level of claims and defaults now visible in the US markets is just a taste of the high tide we could see in 2010-2011, especially as and when interest rates start to rise even modestly. Did somebody say "interest rates?"

Weekly Gold Chart

The Bulls are bouncing it off support, but they do not yet have control of price.