ALERT - September 22, 2008

JOHN WILLIAMS’ SHADOW GOVERNMENT STATISTICS

A L E R T

September 22, 2008

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Government Actions Will Spike Money Supply

Highly Unlikely That the Financial Storm Has Passed

 Recession Was Well Underway Before the Housing/Mortgage Crisis Broke

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PLEASE NOTE: As of this Alert, posted Monday morning (September 22nd), pending legislation on a financial-system rescue package is far from being finalized, while the system remains in a state of flux and Treasury and Federal Reserve reactions remains fluid. The markets appear lulled, at least temporarily. The full SGS newsletter will follow soon, but given likely continued rapid evolution of the systemic solvency crisis and government response to same, any issues that need to be addressed in update will be covered in further Alerts. My general outlook is unchanged.
– Best wishes to all, John Williams

They Will Do Anything to Keep the System from Collapse

In response to a mounting run on the U.S. financial system and high risk of a systemic implosion, the U.S. Treasury and Federal Reserve put forth a plan to purchase up to $700 billion in illiquid assets from U.S. and foreign financial institutions that have "significant operations" in the United States. Congressional authorization of this plan (including a boost in the federal debt ceiling from $10.6 trillion to $11.3 trillion) purportedly is likely by the end of this week. Nothing is certain, though, given ongoing instability in the markets and system. Further, it is not clear that $700 billion is adequate, or that the Congress will allow this package without oversight, as requested by the Treasury. The actions taken and promised will increase money supply growth and ultimately add upside pressure to inflation.

A stock market crash by itself does not implode money supply and trigger deflation any more than a stock market boom expands money growth and triggers inflation. It is the loss or creation of money in the monetary aggregate accounts that alters money growth. Deposits wiped out by failed banks, or cash taken out of banks and put under a mattress contract the money supply. It is in such areas that the various systemic-supportive actions by the Fed and the Treasury have been aimed (such as the guaranty program to back money market funds), in addition to efforts to prop the equity market (such as banning short selling of certain financial stocks). Other efforts, such as the bailout and takeover of AIG and the proposed $700 billion package, will have the effect of increasing money, as discussed below.  

One can hope that the legislative package being developed by the Administration and Congress will restore calm and confidence to the U.S. financial markets and financial system, but actions taken by the Fed and Treasury, Sunday night, suggest that circumstances remain far from stabilized. The Treasury expanded its guaranty of money market funds, but only on those existing as of Friday. Reportedly, the time limit was imposed to destroy the incentive for bank depositors to transfer bank deposits (protected by more-limited FDIC coverage) to the now better-insured funds. Presumably, if forced by increasing bank runs, a Federal guaranty on all bank deposits (irrespective of size) could be next. Last night, the Fed allowed investment banks Goldman Sachs and Morgan Stanley to become bank holding companies, in an effort to enhance their funding abilities.

It is worth noting that the prior weekend’s implicit message from the Fed and Treasury on Lehman’s collapse — that there were no institutions too large to fail — might have helped to trigger or at least to exacerbate the systemic panic that reached a near-term crescendo during the ensuing week.   That said, beyond spending or promising whatever money the Treasury and the Fed need to create, in order to prop the system, much continues to go on beyond the scenes, including extraordinary arm-twisting ("encouraged" takeovers), market and likely data interventions/manipulations, etc.  These sub rosa crosscurrents and interventions leave short-term market conditions extraordinarily unpredictable, dangerous and volatile.

Inflation Implications. The two most frequent questions I have been getting from readers over the last several days: (1) How do the government’s actions impact money supply? (2) Does the current circumstance accelerate my hyperinflation outlook?

Money Supply Boosts.  As discussed in the prior Alert (September 17th), the Fed and the Treasury created new money to handle the AIG circumstance. Whether a check is written by the Treasury or funded by the Fed, the new cash supplied to AIG likely will go initially into a demand deposit, a component of M1, and initially enjoy the multiplicative effect of the fractional reserve system, adding directly to broad money growth. 

Separately, a bank with an impaired balance sheet also has an impaired ability to lend money. To the extent the $700 billion being designated to buy illiquid assets from financial institutions may help to stabilizebalance sheets, aided banks presumably will resume lending money in a more-normal fashion. Freeing up lending is Treasury Secretary Paulson’s expressed reason for putting forth the finance package, and the renewed bank lending will expand money growth in a very traditional manner.

The weekly money supply numbers likely will show some unusual patterns, as the current weeks get reported. Broad money supply, as reflected in the SGS ongoing M3 measure, which showed still highly-inflationary annual growth of roughly 14% in August, could soften to perhaps a 13% annual pace in September, but that annual growth rate likely will be surging anew come October reporting.

Hyperinflation Outlook Remains. In saving the system, the cost to the American public from this effort — aside from rapidly expanding federal debt — is inflation. My outlook for double-digit inflation, as reported by the government, remains in place for early 2009. The broad timeframe of 2010 to 2018 suggested for the hyperinflation discussed in the April 8th Special Report, certainly has not been pushed back in time by current events, but the final shape of the systemic bailout still is fluid. The more the government spends, the sooner the hyperinflation is likely to hit. 

Key to the timing of the hyperinflation remains the U.S. dollar and the ongoing willingness of foreign institutions to hold it and dollar-denominated assets. At such time as massive dollar selling kicks in and dumping of dollar-denominated assets starts to overwhelm the Fed, the hyperinflation timing would begin to firm and move closer in time.

General Outlook Is Unchanged. It is not likely that the systemic solvency crisis is behind us, and it is too late to prevent a recession. The inflationary recession was well underway before the housing/ mortgage crisis, and little can be done to stimulate economic activity, to contain inflation or to provide a long-term prop to equity values. The government, however, does have the ability to support depositor safety, to prevent a collapse of the related financial services industry and to prevent a deflation in the prices of goods and services. Indeed, the cost of systemic salvation is price inflation.   

[The following is repeated from the April 17th Alert.] The various markets are about as volatile and dangerous as they can get. With extraordinary crosscurrents from the solvency crisis and various governmental and global central bank interventions in the markets and marketplace, volatility likely will continue, sometimes in directions that may seem irrational. The gold and currency markets, in particular, remain subject to jawboning and both covert and overt central bank intervention, aimed at discouraging investors from seeking safety in gold our outside the greenback. 

All factors considered, the broad outlook remains the same: further intensification of the inflationary recession and a continued deepening systemic and banking solvency crisis.  Growing market recognition of these issues and mounting global political tensions have intensified the risks for continued unstable market conditions, markedly.

Over the near-term, negative major market displacements should follow or be accompanied by intense, broad selling of the U.S. dollar, which may be beginning anew.  An eventual, increasing flight-to-safety outside of the U.S. dollar also should include flight-to-safety into gold.  Despite continuing softness in oil prices, current levels (anything above $90 per barrel) remain highly inflationary. Over the longer term, U.S. equities, bonds and the greenback should suffer terribly, while gold and silver prices should boom.

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