Government/Fed Will Accept Any Cost to Save System

"The Treasury Department will propose on Monday that Congress give the Federal Reserve broad new authority to oversee financial market stability, in effect allowing it to send SWAT teams into any corner of the industry or any institution that might pose a risk to the overall system [New York Times¸ March 29, 2008]." As noted in my various writings over time, however, the Fed already has had and has used such powers in recent decades to save the system, and it has been using same — both overtly and covertly — in the current crisis.

Separately, the Treasury’s proposal "carefully avoids a call for tighter regulation," including actions that could "reduce the power of the Securities and Exchange Commission." The purported pending action not only outlines a formalization of the systemic bailout process but also appears to soften certain regulatory controls and oversights that otherwise might throw up inconvenient warning signals of problems, encouraging the camouflage of mortal flaws already in place in the system.

The U.S. Treasury, in its pending announcement, and the Federal Reserve, in its actions to date, effectively are broadcasting that they will accept any cost in terms of money creation and loss of regulatory integrity in order to save the domestic financial system. The alternative of an imploded financial system, with the resulting disruption to, and chaos in the citizenry’s daily living; the resulting collapse in normal business activity; and resulting social and political upheaval; are unthinkable to the powers that be. Unfortunately, their cures will be just as destructive, if not more so, in the slightly longer term. The government only is buying some time, which has been traditional practice. Yet, as will be explored in the SGS Hyperinflation Special Report due out this week, the current actions taken to stabilize the financial system have set a course for a debilitating inflation, which eventually will feed upon the U.S. government’s effective long-term insolvency and generate a hyperinflationary depression.

Some have raised the issue of moral hazard, with the government’s current actions saving financial institutions from their own bad investment decisions. Lack of a "moral hazard" consideration, though, has been the norm for decades, whenever large banks were at risk. What could be expected from a system where the Fed Chairman is also the madam of the house of ill-repute? Wall Street and most senior politicians have profited heavily from the questionable, but once highly-touted business/investing practices that now have turned sour. Many among the investing public ignored common sense and fed off the related mania hyped by some in the financial media. Some regulators turned a blind eye to obvious problems. As a result, few in officialdom are in an untainted position to offer honest lectures on the virtues of virginity to the bailers or to the crowd being bailed out, and neither the Fed nor the government can afford to become principled at this late date.

Money Supply M3 Growth Continues Rising, Monetary Base Surges At Annualized 20% Pace. With 17 to 19 days of reporting in on the 31 days of March, if the reported M3 components were to hold unchanged for the balance of the month, the SGS-Ongoing M3 monthly-average for March would show annual growth of 17.1%, versus the record growth level of 16.9% seen in February. The growth rate will be higher if the weekly data continue to surge. On a similar basis, annual M2 growth would stand at 7.2%, up from 6.9% in February. The increasing signs of accelerating money growth remain coincident with the Fed’s increasing re-liquefaction of illiquid assets held within the financial system.

For those arguing that the system faces deflation because of no growth or a decline in the monetary base (bank reserves plus currency in circulation), the latest numbers could be disconcerting. For the two weeks ended March 26th, the seasonally-adjusted monetary base rose at an annualized rate of 20.1% from the prior two weeks. The broadest measure M3, however, not the narrowest one, remains the better indicator of looming inflation activity.  

Home Sales Data Cautions. With the March consumer confidence numbers plunging ever deeper into recession territory (Conference Board down 15.6% for the month, down 40.3% year-to-year; University of Michigan down 1.8% for the month, down 21.4% year-to-year), it was not unusual also to see weak homes sales data. February existing and new home sales both fell year-to-year, by 23.8% (versus a 22.0% drop in January) and by 29.8% (versus a revised 29.8% [was 33.9%] drop in January), respectively. It thus was somewhat surprising to see the press hyperventilating over a statistically meaningless 2.9% monthly increase in existing home sales. Problems with significance of the month-to-month sales volume reports and with the meaning of the home sales prices, are addressed below.

The home sales data (both series) are highly volatile and subject to massive revisions on a monthly basis. The seasonal-adjustment process does little to improve overall reporting quality. Accordingly, the month-to-month data are worthless. It is more useful to look at the broad series in terms of year-to-year changes, which, although also volatile, tend to tell a more consistent story. At present, annual growth for these series remains deep in recession territory.

The unusual existing home sales press triggered some questions from subscribers as to whether the existing home sales included rising home foreclosures, and if so, would that distort the picture of regular home sales and sales price activity being reported.

The National Association of Realtors (NAR) generates the report in question and NAR’s sampling would pick up some foreclosures that involved listings with realtors, but not those that were run just as sheriff’s sales. The NAR has no idea as to the proportion of foreclosures in its numbers, but believes the number to be "small."

So the answer to subscribers’ questions is yes, there are some (not all) foreclosures in the numbers, and while those contracts distort results, the level of distortion is not known at this time.

More importantly, there is a large problem as to the use and meaning of sales price data published with both the new and existing sales reports. The reported prices reflect only the mix of those homes that are selling, not the reported sales prices of a constant piece of real estate priced to varying market conditions. If low-priced homes are selling more easily than high priced ones, and such were the reverse of the year before, then a decline in the year-to-year average price would reflect shifting market mix, not the relative drop in the price of the same piece of real estate in the same market, year-to-year.

Durable Goods Continue to Signal Recession. In other reporting, seasonally-adjusted February new orders for durable goods fell by 1.7% (down 1.0% net of revisions) following a revised 4.7% (previously 5.3%) drop in January’s orders. Year-to-year change in February orders was up 4.3%, slightly stronger than official CPI, but still leaving the six-month moving average of this highly volatile series well under water, net of price increases.

The "final" estimate revision to annualized real (inflation-adjusted) fourth-quarter GDP held at 0.6%, with annual growth at 2.5%, which looks on the surface like nothing more than statistical noise against the same numbers in the "advance" and "preliminary" estimates. Games played with inflation numbers that kept the "final" growth estimate from falling to 0.3% or less will be discussed in the upcoming newsletter.

Week Ahead. The big report in the week ahead is Friday’s (April 7th) employment report. Market expectations are for declining payrolls and a rising unemployment rate, and both expectations are reasonable as to direction. Given that the markets are not recognizing the full depth of the current downturn, worse than expected results would be likely if the reporting were honest. In the current environment, however, there are efforts to sell concepts such as "an economic recovery is underway" and "the solvency crisis is over." If the data suddenly turn rosy, the long arm of Fed/Treasury intervention in the markets most likely will be responsible for the misreporting.   

The various economic data will be reported on more fully in the upcoming mid-April newsletter.

__________

Continuing market turmoil, central-bank/government intervention and systemic shocks remain within the general outlook, which is unchanged.

Publication of the Hyperinflation Special Issue should be in the week ahead.

Flash Updates and Alerts will be posted as needed, with the next expected Flash Update due to follow the employment report on Friday, April 7th. The next regular newsletter is targeted for mid-April.