PLEASE NOTE: The SGS-Ongoing M3, SGS-Financial-Weighted Dollar and SGS-Alternate GDP all have been updated through February, or for the latest reporting, and are available on the Alternate Data Series tab at www.shadowstats.com.  
     Due to a sense elevated risk of systemic instability, today’s publication is an Alert. That and a bad cold have pushed the posting of the February SGS newsletter to next Monday, March 10th. Accordingly, the newsletter will include analysis of the February payroll and unemployment data. The Hyperinflation Special Issue will follow very shortly thereafter.
     — Best wishes to all, John Williams

Risks Mount of Non-Traditional Federal Reserve/Treasury Actions

With roughly 18 to 20 of 29 days of reporting in place, the monthly-average annual growth in the SGS-Ongoing M3 for February likely will top 16.7%, setting an all-time high monthly growth rate for the M3 series (the Federal Reserve’s calculation of the broad money measure dates back to January 1959). The prior annual-growth record was 16.4% in June 1971, and the inflation from excessive money growth at the time was a key factor pressuring the U.S. dollar and leading up to President Nixon’s closing the gold window and imposing wage and price controls in August of that year. The current surge in broad money supply growth has equally ominous implications for monetary inflation and dollar pressures during the next nine to 12 months.

The February 2008 estimate of 16.7% annual M3 growth is up sharply from 15.5% in January and 15.1% in December. The narrower M2 annual growth measure likely will top 6.7% in February, up from 5.8% in January and 5.9% in December. The recent rapid growth in broad money coincides with the U.S. central bank’s establishment and expansion of its temporary auction facility (TAF) at the discount window, which was designed to relieve liquidity strains in a solvency-impaired banking system.

The February 2008 M3 estimate will be updated over the weekend on the Alternate Data Series tab at www.shadowstats.com, following the Fed’s Friday afternoon statistical releases.

Signs of Deepening Instabilities and a Caution. When President Nixon floated the dollar in 1973, I was forced to become a day-to-day currency trader in a family business that imported chain saws from West Germany for distribution in the United States. Our product was denominated in Deutschemark, and my previous instincts had worked well in calling for dollar devaluations with enough of a warning to hedge our exposures. Over the several years that followed, I found that my instincts in assessing what was going on in the realm of the currencies and related activities by the affected governments served me well in minimizing potential damage to our business from the general decline in the value of the U.S. dollar. They also worked well in my timing and calling for the 1987 stock market crash.

My instincts also have been wrong a number of times, usually in the direction of being overly cautious. I am referring here to gut instinct, where a large variety of factors — often subtle — come into play, get weighed in judgment and result in a heads up that certain things are at an elevated risk of happening. In play at present are the recent movements in key currencies such as the yen and Swiss franc to relative extremes; growing market recognition of the U.S. economy in deepening recession; U.S. inflation and oil and food prices rising sharply; gold pushing $1,000 per troy ounce.

In combination, these factors all are pushing limits never faced before by the Fed. In conjunction with the banking system’s solvency crisis, the market and economic circumstances have the broad financial system facing its greatest risks of instability or outright collapse in modern times.

Rarely do I get into my instincts in the newsletter but mention them now only because they are telling me that something major could be afoot. Given news of the last day or so, there appears to be a somewhat elevated risk of a surprise action by the authorities, and/or in a large downside break in the currency and equity markets. The potential non-traditional government actions discussed at the end of this section are not predictions, just a heads up as to the type of actions that could be considered.

 I have been contending and still contend that the Federal Reserve will spend every dollar it needs to create in order to prevent the financial system from collapsing. A systemic failure is not an option for the Fed, and any needed bailouts will not be limited to large banks, but also will include related establishments such as the credit insurers. Fed Chairman Ben Bernanke has expressed the desire and has the wherewithal and the ability to prevent a systemic collapse, although much of the salvage operation may be covert. Not to do so would promise a deflationary great depression.

Unfortunately, however, the eventual result of the great bailout will be a hyperinflationary great depression, as discussed in the a three-part hyperinflation series beginning in the December 2006 SGS (see Archives tab at www.shadowstats.com) and as will be updated in the pending Hyperinflation Special Issue.

That said, a headline such as, "Gulf investors may not save Citigroup, Dubai executive says [Dow Jones, March 4, 2008]," suggests all is not going as planned in the systemic bailout. While such stories likely are just part of ongoing negotiations, one would expect that the Fed will make sure that Citigroup does not "fail." A major bank failure is not an option for the Fed; it has intervened in the past with troubled major banks, sometimes with forced mergers or acquisitions. Multiple major banks in trouble could force consideration of non-traditional options.

Also, before Congress yesterday, Chairman Bernanke suggested that banks reduce the principal due on defaulted or troubled mortgages so that homeowners would have positive equity in their properties. Bernanke has to know that such is a near-impossibility for mortgages bundled into structured securities, and that suggests he may have something else in mind for the system.

While there no longer is a gold window to be closed, and where the Fed already has pushed beyond its standard options, non-traditional approaches could be under consideration. A couple of years back, Mr. Bernanke noted that the Fed was free to buy up any securities it wanted to in order to provide liquidity to the system. Such could range from equities to troubled mortgage-backed securities. In other places and other times (sometimes in the United States) actions ranging from nationalization of a banking system; to wage and price controls; to capital controls that restrict non-commercial transference of currency from a country, inhibiting flight from the domestic currency; to other options involving more-direct government control of the financial system have been used in efforts to stabilize banks, inflation or currencies.

While all of these concepts generally are bad ideas, and any form of price or capital-flow controls would lead to major financial-market or market-place disruptions, you might want to consider the potential impact on your circumstances if the government decided to make life more difficult for those tempted to raise prices or to move capital outside the United States. While such controls might seem unlikely at present, we are in an election year, and if oil prices keep rising, cries of price gouging at the gas pump will not be far behind. Politicians might respond. Again, these thoughts are just cautions, not formal forecasts of government actions to come.  

Beyond direct market interventions, jawboning, overt and covert bailout operations, and any short-lived gyrations these factors cause in the markets, the general outlook for the months ahead remains for heavy selling of the U.S. dollar, heavy buying of gold, a severe bear market in equities, and a sharp rise in long-term interest rates at such time as flight from the dollar becomes a flight to safety outside the dollar.

Pending February Employment Report. Market expectations appear to be for roughly a 25,000 jobs gain in the February payroll report on Friday (March 7th). Based on underlying economic activity, a month-to-month contraction would be more realistic, with the household survey showing a rebound in the unemployment rate. Nonetheless, given the political season and ongoing financial market distress, an upside revision in January jobs (currently a monthly loss of 17,000), so as to show positive month-to-month change, remains a fair bet. February reporting simply will be brought in as desired by the Administration and/or Fed.

Full updates on recent economic reporting will follow in the February SGS newsletter.