As it turns out while media talking heads were ranting about how the Fed was running their printing presses overtime to push up money supply the facts were very different. M1 has actually declined since the middle of December, 2008. During the same six month period M2 has only risen by a little less than 3%.

For some reason that I can’t explain most financial, economic and media experts don’t bother to read the Federal Reserve’s weekly money supply data before writing authoritative articles or spouting off on TV about money supply and its implications.

Of course, M3 followers argue that M1 and M2 are bad money supply indicators because they are too narrow and that only M3 should be used to measure the growth in money supply. Unfortunately, the Fed stopped publishing M3 a few years ago (because they said it was irrelevant) which started a club of M3 conspiracy theorists, i.e., people that believe the Fed stopped publishing M3 as part of a conspiracy to hide irresponsible monetary policy.

However, even without M3 being specifically published we know that broader measures of money supply, like M3, haven’t materially risen in 2009.

M3 followers can get a very rough idea of what M3 would have been, if it were published, by looking at the Federal Reserve quarterly Flow of Funds Accounts of the United States which was distributed yesterday. As it turns out, total net borrowing of the United States (private and public) dropped approximately $255 billion in the first quarter and other indicators of M3 fell or are about flat (on a net basis). The Flow of Funds Accounts data is inconsistent with a large rise in M3 (or a large rise in any money supply measure). By the way, this data supports Brad Setser’s theory that the fall in private borrowing is more than offsetting the rise in government borrowing and therefore, at least for the time being, financing the deficit isn’t a problem.

And, I have a suggestion for the M3 conspiracy theorists; get a life. Worrying about a Federal Reserve conspiracy isn’t worth your time and effort.

Set forth below is a chart that was compiled from weekly Federal Reserve data that illustrates money supply growth, seasonally adjusted, since the week ending December 15, 2008. The data suggests that the Fed is hardly “out of control” or a drunken sailor.

To those readers who want to flame me for not accusing Bernanke & Company of ruining the economy because of the growth in the Fed’s balance sheet, just hang in there. You will get your chance soon enough. Over the weekend I am going to write about the “irresponsible” expansion of the Federal Reserve balance sheet (or maybe why it wasn’t irresponsible at all).

-Mark Sunshine

Disclosure: This article is taken from the website Sunshine Notes with the permission of the original author. All questions regarding disclosure should be referred to the original author.

Since I wrote my article Paul Krugman wrote an article citing research done by Brad Setser that supports my thesis. Setser’s analysis predates my article and is really high quality work.

I am certain that Krugman didn’t have any idea what I wrote when he published his article but, just the same, Krugman’s subsequent writing is a helpful addendum to my “why not to worry about the debt tsunami” theme.

Basically, according to the analytical work done by Setser, the amount of public borrowing is being offset by a fall off in private borrowing. Less private borrowing is another way of saying that the savings rate has risen. Below is a graph from Setser’s article illustrating how the rise in government borrowing is more or less being offset by a drop in private borrowing.

Krugman concludes “We’re actually borrowing less from foreigners than we were before.”

Setser, on the other hand, worries that “…the challenge…will be to bring down the government’s borrowing as private borrowing resumes.”

-Mark Sunshine

Disclosure: This article is taken from the website Sunshine Notes with the permission of the original author. All questions regarding disclosure should be referred to the original author.

While interest rates are likely to rise for both long maturity Treasury notes and bonds and agency guaranteed residential mortgage debt, rising rates are not because of a lack of investment demand or failing confidence in the U.S. Government. Instead, as I have written for months, the all-in cost of capital for most domestic institutional investors is higher than the net yield on Treasury and agency guaranteed mortgage debt. The inability of domestic institutions to earn a profit at current interest rates isn’t the same thing as a lack of desire, capacity or confidence.

But of course yields are too low for private market investors to make money. After all, since December the Federal Reserve has been executing a program of open market purchases of Treasury and agency guaranteed mortgage debt designed to drive interest rates below market clearing yields. So, it shouldn’t be a surprise that among private investors there is an upward interest rate drift that can only be offset with more aggressive Federal Reserve intervention.

Private institutions can’t make money buying Treasury and agency guaranteed mortgage debt because the operating expenses of most institutions are very close to the investment yield on the Treasury and agency guaranteed mortgage debt. Unless the Federal Reserve is somehow able to magically force operating expenses of domestic institutions downward, market clearing yields are going to rise. At higher interest rates the private market won’t have any trouble absorbing the forward calendar of debt issuance.

To understand whether or not the volume of newly issued debt will swamp investor demand each type of debt needs to be broken down and analyzed individually and compared to sources of investment liquidity.

Residential Mortgage Debt

The amount of new mortgage debt isn’t a problem because basically there is no net new mortgage debt being created. There are two ways to create new mortgage debt; (i) refinance existing mortgage debt and (ii) finance home sales.

Refinancings, by definition, result in a repayment of old mortgage debt held by investors. For every dollar of refinanced mortgage debt that is issued there is a dollar of old mortgage debt that is retired. As a result, old mortgage debt investors receive cash that they recycle into newly created mortgage debt (or other investments like Treasury securities).

Mortgage debt created by home sales falls into two categories: new home sales and sales of existing homes.

The proceeds from purchase money mortgage debt created from sales of existing homes generally are used to pay off mortgage debt of the selling home owners. So, mortgage debt created through existing home sales is like refinancing debt, generally it doesn’t create net new mortgage debt.

If for some reason the debt tsunami worriers are agonizing about increased mortgage debt created from new home sales that should be the least of their concerns. If new home sales weren’t stuck in the mud there wouldn’t be a credit crisis or a deep recession which are the underlying causes of the debt tsunami. The United States should only have the problem that new home sales are so high it isn’t clear how they are going to be financed.

Treasury Debt

There is plenty of demand for long term Treasury notes and bonds, just not at current interest rates. The natural buyers for Treasury debt are domestic banks, thrifts and insurance companies. These institutions have more than $1 trillion of excess liquidity which continues to grow every day. The pool of domestic cash sitting on the side lines gets bigger every day because of a combination of increased U.S. savings and accommodative Federal Reserve policy.

 However, domestic financial institutions are sitting on the sidelines and not buying. The problem is that domestic financial institutions know that they can’t make money buying Treasury securities at current interest rates and no matter how much they would like to own long term Treasury notes and bonds they can’t invest.

When interest rates on long term Treasury debt rises above 5% domestic institutions will start to be large scale buyers. These institutions will start to make a reasonable profit without taking on unreasonable risk or leverage from purchasing long term Treasury notes and bonds.

Debt tsunami worriers need to pick something else to anguish about, at least for a while. Obviously, the current deficits can’t last forever but they aren’t in danger of swamping the economy for a long time. And, interest rates are inevitably going to rise but then again long term interest rates aren’t being set by the marketplace. Rising interest rates aren’t a source of worry but rather the beginning of the end of the great recession.

Please stay tuned for Part II of Don’t Worry About the Debt Tsunami coming shortly.

-Mark Sunshine

Disclosure: This article is taken from the website Sunshine Notes with the permission of the original author. All questions regarding disclosure should be referred to the original author.

It seems that every piece of information currently being released carries with it the claim that “this decline was less than expected” or ‘the decline was smaller than the last information released.” These are taken as signs of hope.

Even the results of the Treasury’s “stress tests” on the banks are accompanied by the assessment that the major banks that have just been examined are better off than was thought. Therefore, the banking system is not in as bad a condition as feared, and, stock prices can now continue moving upwards.

Fed Chairman Bernanke is still the leading spokesperson and “cheer-leader” in the administration and he stated this week that the economy will begin to expand later this year. So we must be at or near the bottom if the administration thinks so. Right?

We still have the nay-sayers out there claiming that things remain in terribly bad shape. Nicolas Taleb, of Black Swan fame, is saying that the economic situation is worse than it was in the 1930s because world markets are much more integrated now than it was then. And, Nouriel Roubini continues to sound alarms about how bad things could get. Part of his argument rests on the fact that the worst case scenario used in the Treasury’s “stress test” is out-of-date due to the recently released estimates issued by the International Monetary Fund that financial sector losses have doubled in the last six months. Yet are their claims sounding awfully shrill these days amidst the hope others are seeing?

Where are we?

To me, the uncertainties still outweigh any real sense of which direction the economy might take. I would tend to lean on the side that we have not seen the bottom yet, but what odds would I place on this possibility? Maybe I would give odds of 2-to-1 that the economy still will decline further. Maybe they should be 3-to-1. Maybe they should be 3-to-2. Somewhere in there.

First off, I am not convinced that the banks are coming out-of-the woods yet. Even if they are able to obtain more capital, I don’t see their lending picking up in any major way. Personal and business bankruptcies are still on the rise and there are still several major “black clouds” on the horizon that threaten that the storm that has hit bank balance sheets is not over. There are still large companies that are going out-of-business on a regular basis, in retail, in commercial real estate, in some areas of manufacturing, and we are waiting for the full ramifications of the collapses in the auto industry. Car dealerships are being closed, parts supply companies are on the edge, and the spread of these closures are affecting many other organizations and geographic regions. If unemployment is going to continue to rise, since it is a lagging economic indicator, then there still are houses that are going to need to be sold if not foreclosed upon and some credit card debt and auto loans that will need repayment.

And, speaking of cars. Last time I looked the price of a barrel of oil was approaching $60. Where is the price of oil going? And, the price of other commodities? The Financial Times has had several articles recently about why the price of commodities, including oil, might be going higher if a trough or bottom has been reached. What would higher commodity prices do to any recovery?

Then there is the level of interest rates. The government held an auction today for $14 billion of 30-year Treasury securities. The result? The yield of the new issue came out at 4.288% higher than the expected 4.192%. This caused a decline in bond prices with the 10-year Treasury note trading around 3.30% up from 3.14% late last week which was above the 3.00% level, reached earlier last week a level that had not been crossed since November 24, 2008.

How high are these interest rates going to go and what impact will these higher rates have on mortgage rates and corporate rates? We are already seeing spreads between Treasuries and corporates reach levels since last October and November. And the interest rate spreads on lesser credits have also been increasing. And, there is still much more Treasury debt to come.

Furthermore, the economic structure of the United States (and the world) has changed. The manufacturing base is going to be different in upcoming years and everything is going to be more connected technologically than before. And, what if the personal savings rate in the United States reverts back to 8% or so as it was before 1992? We are not going to be able to force employment, human or otherwise, back into the same industrial and financial structure with the same employment intensity as existed before this economic collapse.

I am not intentionally trying to stay on the “dark side”. It would be great if things were bottoming out and the economy were about to start on an upward path once again. But, there still seem to be too many “unknowns” out there, unknowns that relate to serious problems, for us to get our hopes up too high at this point. Managements must still re-focus their businesses and must deleverage their balance sheets. Boards of Directors still must make sure they have the right executives in the right places, and if the Boards don’t do this then the shareholders must become more aggressive. Many executives that managed in the pre-2007 period, I believe, are not the executives to lead our companies in the post-2009 period.

Are we at a tipping point? Are we at or near the bottom of the downturn?

The most important questions are still going unanswered: even with the results of the Treasury stress tests. Will a major bank fail? How many regional banks might fail? So far there have been 32 bank failures this year, up from 25 last year and 8 the year before. How will a General Motors bankruptcy impact the economy? What other possibilities are out there?

Other company failures? Bloomberg reports today “Moody’s is forecasting the default rate among high-yield companies globally to soar to 14.8 percent by year-end from 8.3percent in April as companies that financed a record amount of high-yield, high-risk debt leading up to the credit crisis struggle to refinance.”

And, I haven’t mentioned the debt overload that exists throughout the country. The list goes on.

It seems to me that what we are seeing a lot of these days is wishful thinking. I really haven’t seen anything yet that one could argue was a “hard” fact pointing to a bottom of the downturn. I really don’t think we are going to see any “hard” facts in the near future, so the stock market and other areas of the economy will just to continue to live off of wishful thinking. This is a situation made for traders. Uncertainty creates volatility and traders feast off of volatility. I guess it is good to know that at least some people profit from this environment.

- John Mason

Disclosure: This article was taken from Mase: Economics and Finance with the permission of the original author.  All disclosure questions should be refferred to the original author.