The Fed versus Fear: A Status Report on the Economy

As I have noted in recent posts, any growth in the economy appears to be coming out of the consumer sector, with growth in revenues from live concert appearances and the astounding $805 million in payroll going to four New York Yankee players.

This strength in parts of the consumer sector, in an overall weak economy , falls in line with Austrian Business Cycle Theory. During a readjustment period in the economy, according to ABCT, the consumer-savings ratio readjusts itself to show greater strength in consumption versus savings (which would be reflected in capital goods purchases). But, how does this square with the likelihood that on January 8 when retailers report their sales for the month of December, they are likely to show a decline in sales in total of around 1 to 2%?

It squares because of other factors that occur during a readjustment period, in particular, the fear which leads many to hold on to cash. The spectacular growth in M1 is an indicator of just how much fear there is in the economy, as it has grown in recent months in excess of 30%. The desire to hold larger cash balances (as indicated by the growth in M1)in many ways has the same impact as a decrease in the money supply would have. A general deflation of prices occurs, which ultimately results in a lower overall price level. So what does this have to do with ABCT and the consumption-savings ratio. It means that if there is a strong demand to hold cash balances, which puts downward pressure on all prices, even if some consumer prices are falling, the consumption-savings ratio can still be readjusting in favor of consumption versus capital. It just means that even less spending is occurring in the capital goods sector and that prices are falling by larger amounts in the capital goods sector. And this is what is occurring, the prices of real estate and autos, for example, are dropping by much larger amounts than products in retail stores. This is also why we see dramatic declines in total sales in the housing and auto markets dropping by much larger amounts than the sales declines at retail stores. With this condition, the consumption-savings ratio is adjusting in favor of consumption.

All this being said, over the last two months the Fed as been increasing money supply (measured by M2 nsa) at double digit rates, which will again at some point push the consumption savings ratio in favor of savings (capital goods purchases).

Right now it is a battle between fear by the general public, which is holding on to additional cash, versus the Fed and its pumping of money. The Fed will eventually win this battle. It will mean a "recovery" (a movement towards the capital goods sector, i.e. the stock market, autos etc.) and overall climbing inflation, including that of consumer prices.

Although exact timing is always difficult, the recovery will occur much sooner than most expect. Certainly a lot sooner than those who are forecasting a decline in the economy that will last well into 2010. Indeed, any surprises in the economy will be on the upside. In the stock market, for example, we could very easily start with strong, very strong upside action immediately after January 1. Longer term, the Fed's mad money printing will result in record lows for the dollar, higher interest rates and very strong price inflation.

Mortgage Rates Fall on Fannie, Freddie Rescue

Mortgage rates are down 35 basis points today on news of a Treasury-led bailout of mortgage giants Fannie and Freddie Mac.

In trading today, the national average on a conforming 30-year fixed mortgage dropped to about 6.20% from last week's 6.55%, according to BankRate.

On The Road To Depression

In the most recent example of the Fed watching the wrong numbers, directors at the Federal Reserve Banks of Kansas City, Dallas and Chicago sought quarter percentage-point hikes in the discount rate before an Aug. 5 policy meeting to keep inflation at bay, Fed documents released yesterday showed.

Current price inflation is the result of money printing over recent years. It has zero to do with Federal Reserve policy over the last three to six months. It takes a long time, often years, for Fed policy to be reflected in consumer price inflation.

At present, interest rates appear to be ABOVE real rates, since, as we have pointed, out before, money supply growth has slowed to a trickle. Any further hike in rates will simply tighten credit in the economy further and plunge the economy into a Category 5 recession/depression.

Crashing Money Supply Numbers Signal Depression

It is now clear that Ben Bernanke has no clue as to how to control the money supply.

We have been commenting in recent weeks regarding the slowdown in money supply. It has been growing at approximately 2.5% (M2SA) over the last three months on an annualized basis, earlier this year it was growing at double digit rates. This is a dramatic downturn. The numbers out yesterday show no end to the money growth slowdown, in fact, three month annualized growth (M2SA) has dipped further to 2.2.%.

While there is a lot to be said for a no growth money supply that results in a recession to clear the system, the Fed doesn't believe this and neither does Bernanke. They are eternal money pumpers, who consistently want to prop up the economy and never have a recession. Thus, it is truly bizarre that they would allow money growth to collapse. They simply have their eye on the wrong ball. They are watching the Fed Funds rate and believe they are providing huge amounts of liquidity to the system because of the 2.0% Fed Funds target. But the fact that money supply at this target rate is not climbing suggests that the real interest rates must be lower.

Indeed, the actions of M1 suggest this is exactly the case. Since what is climbing is M1. Three month annualized M1SA is growing at 5.8%. And what is exploding is demand deposit money (a part of M1). Three month annualized demand deposits are growing at 9.5%. This suggests there is huge fear in the system, and depositors prefer keeping their money in demand deposits as opposed to M2 components such as saving accounts and retail money market funds, which are displaying no growth. Clearly, this situation tells you that depositors prefer what they perceive is safety over yield.

Only a much lower interest rate would reverse the current situation, or perhaps non-sterilized loans and purchases of bank collateral provided by those using the Term Auction Facility. If this isn't done soon then the economy and stock market will worsen by leaps and bounds, including a major eye opening stock market crash.

Rates On 30 Year Mortgages Up Sharply

The average contract interest rate for 30-year fixed-rate mortgages increased to 6.59% from 6.22%, according to the Mortgage Bankers Association.

The average contract interest rate for one-year ARMs remained unchanged at 7.16%.

Fed's Yellen Sees Signs of Recovery, But Conditons Not Normal

Always keep an eye out for comments from San Francisco Fed President Janet Yellen. She never rocks the boat and always tows the line. If you want to really know what Bernanke is thinking, Yellen will channel his thoughts.

This morning she spoke at an Asian banking conference in San Francisco and said that:

While there have been glimmers of hope that strains in our markets may be easing, conditions are still not normal...

Translation: The Fed is in no hurry to battle inflation and raise rates aggressively.