Monday, October 19, 2009


The week has started with a bit of a bang, as the Barron's cover story arguing for a Fed rate hike sent equity longs and dollar shorts scurrying for cover. Well, for a couple of hours at least; after the initial flurry, both equities and non-dollar currencies saw solid demand and are, at the time of writing, solidly up on the day.

The Barron's article contrasts starkly with views expressed in the weekend press by Adam Posen, newest member of the BOE MPC (and, as it so happens, a former colleague of one Benjamin S. Bernanke) arguing if favour of more, not less, QE.

We are now entering treacherous waters for monetary authorities in highly-leveraged economies. Given the decade(s)-long dependence on the credit mechanism to spur economic growth, the financial crisis has brought about a precipitous decline in the velocity of money- i.e., how much economic activity is generated per unit of money supply. Bloomberg helpfully calculates a velocity indicator; as you can see, while recent fall has been steep, velocity never really recovered from the heady days of the 90's productivity boom (and..err....internet bubble.)
If the average or median citizen feels like they never really participated in the Noughties recovery, this is perhaps an indication of why. Q3 data, to be released towards the end of next week, will probably show a very modest uptick in velocity (presuming a small positive growth reading for nominal GDP in a quarter when M2 was broadly stable.)

Given the damage inflicted on Main Street by this recession, the Fed will almost certainly want to see what looks to be a sustained uptick in the "economic" velocity of money before meaningfully tightening the taps; after all, we know that Big Ben is a student of the Depression and of the policy mistakes that occured in the 30's.

So what's the problem? Well, the challenge for the Federales is that there are some areas where velocity has picked up- namely, financial markets. Macro Man constructed a rough and ready "financial velocity" index, which is the ratio of an index of financial markets (the SPX, 10 year Treasury futures, EUR/USD, gold, and oil, all equally weighted) to M2. As you can see, after a calamitous decline in the teeth of the crisis, over the last couple of quarters financial velocity has picked up nicely.
So herein lies the problem; the vast bulk of the veritable Everest of Fed liquidity provisions seems to have found its way onto Wall Street, not Main Street. Not that you didn't know this, of course; however, it seems close to inevitable that there will be a significant backlash against, ahem, "well-connected" banks that have benefited disproportionately from the Fed's largesse.

Now, the Fed might say that "that's a problem for the Administration, not for us." OK, fine. But the question still remains; does the Fed shape policy to goose economic velocity higher (in which case lower for longer will be the outcome), or does it at long last address asset prices ('twould be troubling to see financial velocity start exceeding the 2002-2006 trend.)

There really isn't an obvious answer. It seems clear, however, that the government (and not just in the US, mind you) will wish to align the fortunes of Wall Street and Main Street more closely. Indeed, during the first six years or so of the Noughties, economic and financial velocity were relatively well-correlated...
...only to diverge sharply since 2007.
Re-aligning the two would appear to be a task well outside the scope of monetary policy; small wonder, then, that pockets of policymakers the world over are expressing considerable zeal for financial regulation.

And where does that leave the Fed? Fervently praying that economic velocity picks up so that their job becomes a bit easier!


Anonymous said...

macro man, as a macro dude, do you think credit based consumption should be included in gdp numbers since it is in theory offset by the drag of future debt repayments?

Nemo Incognito said...

The seemingly logical step of repealing Glass-Steagal to ensure the "utility that lends money" group is clearly delineated from the "pretty much a hedge fund" group appears to be out of the question. It would go a long way to ensuring that government largesse does not end up in all the wrong places. If we'd had that plus derivative clearing houses things would have been bad but not systematically bad.

Anonymous said...

So finance is back rolling like this was January 06. I have a my own proprietary consumer purchasing power index which states residential RE is down 40-50% from that date.

Do you have any practical ideas how popular disapproval of 150 billion of bonuses may manifest itself? Does anyone still include political risk in their models, or is that now written off by liquidity?


Nemo Incognito said...

I said this a while ago but when the taxpayer revolt starts the next leg down starts. The reason being that given that Timmy G has been bribed/cajoled/pushed to not do anything about the obvious problem of determining who and who isn't too big to fail he is going to have to do something very fast and probably quite sloppily once GS bonuses get paid and the public gets up in arms. The panicked reaction of Obama at a significant loss in approval ratings is likely to seriously scare the crap out of the market, though if he puts up taxes enough it might give the dollar a boost.

But What do I Know? said...

Interesting that you connect the Fed and prayer. Given the former's totemistic reliance on the belief that setting the "correct" level of short-term interest rates will keep our world safe and prosperous and the increasing public persona of its high priest--chairman, I'm surprised that they don't build some kind of temple.

And of course, the recession will go away if we all just believe enough. . .

Macro Man said...

Anon @ 10.15, sure it should be included, as should the resultant collapse in growth when the wheels fall off.

Credit, when taken in moderation, can be a good thing; these financial Luddites who pooh-pooh fractional reserve banking as somehow evil or criminal don't seem able to specify which link in the chain is "wrong", not what the alternative should be (other than sticking your money in the Bank of Sealy Posturepedic.)

Obviously, when taken to excess credit is, like most medicine, a dangerous thing...hence the need for a decent regulatory framework that allows for a dose of common sense.

F&S said...

" these financial Luddites who pooh-pooh fractional reserve banking as somehow evil or criminal don't seem able to specify which link in the chain is "wrong", not what the alternative should be "

The link of the chain that is wrong is the fact that "systemically" important institutions can force the Central Bank to exchange their "private money" (for instance deposits in a Citibank current account) into legal tender Central Bank money.

The alternative is a system where banks or leveraged entities like GE or your hedge fund should fund their assets with liabilities that are longer in maturity. The only entity with the ability to borrow short term and lend long term would the Central Bank (and by extension, the government).

Anonymous said...

MM moderation is not something man knows well. Sure credit is a good thing for investment's sake, and providing those with savings with fixed income producing assets (as opposed to rent based assets...). But GDP is the yardstick of economic progress as cited by politicians and technocrat central bankers alike and does not differentiate between GDP growth based on productivity increases and unsustainable GDP growth based on consumer leveraging. The latter leads to long term instability but short term political success so clearly poses great moral hazard to politicians and central bankers alike.

Steve said...

This site has a nice little interactive chart of M2 velocity going back to 1959. It shows that velocity has returned to the "speed" prevalent during the '60s-'80s:

Nemo Incognito said...

Very snappy Steve

Steve said...

I also played with MM's BBG reference chart and could get the data back to '59. The link tho allows you to highlight recessions, a nice little overlay, along with a few other bells n whistles.

Macro Man said...

F&P, no, the other alternative is to place sensible leverage/size limits on individual banks and restrict their ability to engage in off balance sheet shenanigans.

Forcing the private sector to run exclusively long-term liabilities would, for example, seriously crimp modern inventory management techniques, and lead to the sort of Soviet-style allocation of resources that we have recently enjoyed here in the UK.


Anonymous said...

I think the problem is the LOLR; we should get rid of the CBs. I think more frequent but smaller scale bank failures is a small price compared to quite frankly the utter mother we are sitting on right now.

Regulation just doesn't work; the market simply finds loopholes to exploit.

Classic example is concentrated real money buying of systemically important bank wholesale term debt. The reason? Because they won;t be allowed to fail. This attitude was very prevalent after 1998, and was proved correct.

Anyway, back to the macro. A chimp could tell you big government is utterly unsustainable for most of the G7.

So, price indices will keep surprising to the upside for the next month or two.

But then I look at UK net lending secured on dwellings...and it is stuck at a very low level....

Equally I look at the stock market and volume sponsorhip MA is still dropping...

It all comes back to a huge inflation of financial assets...totally disconnected from reality. How can anyone justify these levels for risky assets?

Of note, UK retail broker Hargreaves Lansdowne turned bullish on the broad market at the weekend. Another contrary indicator.

leftback said...

The Fed will stand pat because they have access to the real time economic data and they know it will be a grim winter. LB does believe that the scalpels are out and that there will be at least some cosmetic surgery coming for the TBTF institutions.

In other news, perp walks are back in a big way in NY, and Icahn is lending to CIT, so we will probably have a full scale trash rally again today.

BTW, MM, if anyone mentions BEACH BALLS, LB's calm reserve will be replaced by a violent outburst.....

Anonymous said...

"Credit, when taken in moderation, can be a good thing; these financial Luddites who pooh-pooh fractional reserve banking as somehow evil or criminal don't seem able to specify which link in the chain is "wrong", "

This is plausible assuming that we live in a rational world. Give me a few examples in history where credit was taken in moderation for an extended period of time and that was not later on influenced by political and speculative powers.

Macro Man said...

Postwar Germany.

Nemo Incognito said...


Postwar Japan too, perhaps?

Macro Man said... Japan, maybe.

Judy said...

The air up there is really quite thin, wonder if that will choke off velocity?

Professional Gringo said...

You lads might want to take a look see at this:


Anonymous said...

Postwar Germany a product of credit growth? Very debatable.

Postbubble Japan? No growth whatsoever in Japanese economy despite "sensible" credit growth.

Crisis Management said...

(???) Post-war Germany was Bretton Woods, which of course "exploded" as Trichet likes to say. As Anon/2:15 alluded to, the problem isn't fractional reserve banking per se, it's the central banking system.

A CB is basically a central planning agency, nothing more. Financial bubbles could never grow as big as they have without the CB system.

Macro Man said...

Anon, I cited Germany since the war as an example of a country that has not been dependent on credit growth. The aversion to borrowing that exists among German consumers to this very day is, I believe, a support for this claim.

As for post-bubble Japan, I think that it is a useful signal that those who support essentially no credit growth from here might want to be careful what they wish for.

CM, I don't believe that central banking is necessarily reponsible for the world's financial ills. After all, bubbles and boom/bust were de rigeur in the 19th century America before the advent of the Federal Reserve in the US.

To me, the real failure was that of allowing leverage to grow unchecked, widespread fraud to occur unchecked, and an opaque web of OTC contracts to grow unchecked....all based on the implicit assumption that the CB would act as LOLR.

Splitting banks into "lenders" and "punters", enforcing leverage limits, putting the web of OTC credit contracts into a clearinghouse or exchange are all part of the solution.

So, too, is common sense (which is, admittedly, almost universally lacking in the regulatory sector), so that when banks exploit loopholes, those loopholes are swiftly closed.

Somehow, I don't think that a 20 year old kid from, you guessed it, Goldman is the right guy for the job. And so, alas, the drumbeat of cronyism and regulatory failure marches on....

Macro Man said...

Sorry, I did the kid a disservice. He's 29.

Steve said...

MM I would add to your list of financial ills the SIVs and ludicrous practice of auctioning illiquid turds to be as some sort of money market instrument. This nonsense could have and should have been verboten.

And then doing away with mark to market? Ugh.

Crisis Management said...

Precisely my point, in the 19th century we had regular booms and busts. Only under the Fed have we had a Great Depression.

Basically your prescription was tried last time around, Glass-Steagall, Truth in Securities Act, &c, so why didn't it work?

Anonymous said...

CM, if the 19th century had no Great Depression, twas only because no one called 'em that. The Panics of 37 and 73 would certainly qualify, for example.

As for Glass SteagallN its repeal set the stage for what we have just been thru. LTCM was a warning sign re: OTC derivs, but in an eerie foreshadowing was most useful as a subsidy for GS. The Fed's failure to increase margin requirements in the dotcom bubble was just that, a failure.

I am no great fan of regulation and interventionism for the sake of it, but there is a place for them in cases of market failure such as what we have observed.

- MM (blackberry)

Anonymous said...

Steve, you are correct about the US money funds buying ABS that was illiquid. I would also add that the biggest problem was the money funds bought waaaay too much of it as a % of AUM. They all worried about credit risk but they should be concerned with liquidity risk (as they area a LIQUIDITY fund). And the other problem was they bought $hite for an extra bp for 2004 onwards! They were heavy buyers of the MM tranches of the KKR deals in 2006, MM tranches of ABS CDOs, MM tranches of newer SIVs (trash) and reduced their buying as a % of AUM of the legacy SIVs (a lot less trash) from 2004 onwards.

It struck me that most of these money funds are staffed by absolute idiots.

The entire MM fund industry in the US makes no sense. Thankfully with ZIRP it is going the way of the dodo.

I still laugh about the bull$hit Blackrock brought out in 2005 ("enhanced cash", "short term bond fund") etc....

Crisis Management said...

Yes, I agree re: regulation and intervention. Ironic that you cite 1837, there too the blame lies with the central bank. With 1873, important to remember that 3% of the population died in the civil war, not strictly a monetary phenomenon as the 1930's was.

Macro Man said...

CM, so what's your excuse for the panic of 1893? In a way, it combined the caused of the '37 panic (a Federal hard currency policy...funny you should blame the 2nd BOTUS when Jackson hamstrung it) and the panic of '73 (rampant railroad speculation.) What about the panic of 1907, which led to the Federal Reserve Act? Tulipmania? While the Federales were certainly culpable in the bubbles of the last decade, to suggest that bubbles are exclusively the product of central banks seems to me to be wide of the mark.

Crisis Management said...

Tulipmania is the classic gotcha argument for CB advocates. Along with the South Sea bubble, it's a perfect example of completely isolated and contained speculation. Nobody starved to death on account of astronomical tulip prices.

I view the demonetization of silver as the precursor to 1893 and 1907; a pure gold standard is obviously too rigid. I realize that it's easier to go with the consensus that we need CB's than to challenge it.

PPM said...

History is useful at helping shape our future expectations, but it isn't prescriptive i.e. history doesn't repeat itself. The biggest difference between now, and way back when is the more advanced state of financial technology, primarily in the form of securitization. It is complicated stuff, and most people who I run into don't (in my opinion) give it sufficient attribution for blowing the credit bubble. Securitization allowed banks to make mortgages, HELOCs, car loans, credit card loans and every other time of consumer lending product to the public, with very, very favourable capital consequences. Instead of 8% capital retention, they had to retain only basis points (not sure of the exact amount). Exploiting the loophole created by securitization allowed multiples of prior levels of private sector credit creation. It was fractional banking on steriods.

Securitization was also a highly efficient way to get cash into the hands of consumers, since the types of diversified asset pools backed by consumer products were those easiest to securitize. We have to understand that this mechanism was not present in past credit crises, and try to understand how the outcomes in the present case will differ from historical. In particular, the type of monetary easing embarked upon by the central banks is not an efficient way to get cash into the hands of consumers. It puts cash in the hands of financial intermediaries who lack the willingness and infrastructure, absent securitization, to allocate it down to consumers. Accordingly, increasing money supply to intermediaries when the allocation mechanism (securitization) is broken, leaves them with no other place to put it, other than risk assets.

I'm sure that this partially explains the velocity phenomenon discussed in today's post.

Macro Man said...

PPM, I think it's not so much that they lack the mechanism (OK, GS lacks the mechanism) as that those banks with any risk appetite find that they can generate much better risk adjusted returns (with more leverage) in securities markets than through orthodox loans.

But for sure, securitization a) allowed the system to pump itself up, and b) led to an appalling decline in lending standards to disintermediating lenders and borrowers . Hence, the "market failure" and the need for a robust regulatory framework

Crisis Management said...

PPM, Eccl. 1:9 "What has been is what will be, and what has been done is what will be done; there is nothing new under the sun."

Private financial intermediation is being slowly replaced with government intermediation. In Cuba the worker pays the state a fixed 10% of his wages for rent.

Not so dissimilar to government rewriting mortgages and giving out 3% down loans. The bureaucrats are trying whatever they can to get the securitization machine back online, this time under their direct control.

fajensen said...

these financial Luddites who pooh-pooh fractional reserve banking as somehow evil or criminal don't seem able to specify which link in the chain is "wrong",

The Exponential Bit -

Things looks Ok at the bottom but, as one moves up the curve and it goes vertical, the system gain approaches infinity and any action at all will slam the output into the rails.

This is why enough trillions will move to change the price of the USD based on an article in a magazine referring some hearsay about what the FED will maybe do to interest rates .... the system is so far up the curve it is running on noise. Should the FED actually touch rates - Blammo!!

RebelEconomist said...

Re Posen/Bernanke, one wonders what the point of central bank independence is when governments can appoint policy board members who operate "as if" they are lackeys.

By the way, another thing Posen has in common with Bernanke is they both look like they have their head on upside down.

Stephen Kirchner said...

A better way to think about velocity is in terms of its inverse, or money demand. Money demand is typically viewed as some function of nominal GDP, an interest rate (the opportunity cost of holding money balances) and financial technology. The latter usually goes unmodelled, but conceptually at least, we can distinguish between permanent and temporary changes in financial technology. Permanent changes in financial technology are probably the main driver of long-run trends in velocity. Velocity trends lower in the early stages of economic development, as money facilitates a growing division of labour, before declining again as new forms of financial instrument take over some of the functions previously performed by money, giving rise to a classic U-shape.

Short-run changes in money demand are likely to reflect temporary changes in financial technology or financial shocks, as well as cyclical variations in nominal GDP and interest rates. From the foregoing, it should be apparent that short-term movements in velocity are unlikely to tell us anything we don’t already know about current and prospective business cycle conditions.

Anonymous said...

The system needed some serious haircuts administered. None were. Instead we have a maniac, running Fed, running its BS through and levering the Treasuries` investments up to the moon for the sole purpose of hiding the fraud perpetrated in the recent past - behind the lake of “liquidity”, leaking into excess reserves - turned “assets”, interest rates calm and 401ks pump. Not -mind you- leaking into anything, disturbing the backed by nothing securities` cash flow.

So it is not that there is complete stupidity behind this destruction in progress.

Then we have lenders being mopped up one by one by the deposit insurance maniacs for the sake of the punters, again, whose bonds they back against own charter into deficits that supposedly hedge ALL deposits - that now flow onto punters exclusive “daily day care” studio.

So velocity is not a problem. That velocity was The solution.

As for the turd clearing house - courts were the ONLY option and fraud the only theme. Not by virtue or for ethics` sake but for the numbers! Thankfully, the Europeans went all in too, were then bribed a bit too on the counter party status plus have now no political brain cell left - to finally default on the entire pile of turds they find themselves sitting upon and thus end this farce.

Then we’ve just had our special drawing obligations revalued onto 1:10.

The real failure is that the same guys that merged lenders and punters into banks and then levered them up to the moon for “all the turds that came out” sake - are in fact in charge.


And the condition is hence such - we must now all protect the stinky Ass that turds are dropping from.

For this obviously is the greatest achievement of mankind.

F&S said...

"Forcing the private sector to run exclusively long-term liabilities would, for example, seriously crimp modern inventory management techniques, and lead to the sort of Soviet-style allocation of resources that we have recently enjoyed here in the UK."

Permanent financing of inventory is working capital that should be financed with long term liabilities such as long bonds or equity.Cyclical financing of inventory should be financed with debt that has a duration higher or equal than that of the cycle (for instance, one year for a toy maker).

You can find this principle already stated in the wealth of nations II.2.64

I don't see how maturity matching has anything to do with modern inventory management techniques (which are essentially automatically linking the inventory management system of companies along the production chain, together with tight logistics integration), nor with soviet economies. Please explain.

Anonymous said...

Hence, the "market failure" and the need for a robust regulatory framework

I believe that forcing the perps to eat their losses would be much more effective!

Forex Info USA said...

Anon @11.40 has it right on:
"The real failure is that the same guys that merged lenders and punters into banks and then levered them up to the moon for “all the turds that came out” sake - are in fact in charge.


I agree. The same people are again in charge.

What we have seen recently, with the DOW back up to 10,000 is a bear market rally. Not a recovery.