The Growth Economy

By Chris Puplava, January 26, 2006

You've heard it said that "money makes the world go around." Just looking at components of our economy and government will support this: growth in the money supply, growth in housing prices, growth in the trade deficit, growth in the budget deficit, and growth in Social Security and Medicare liabilities. Low interest rates and the readily available credit and an incredible expansion in money supply (M3) have driven the growth (financial, not true growth) over the past few years.

The rapid growth in the money supply has been on a tear since 1997. The M3 money supply is up 50% since 2000 and has doubled since 1997. Prior to 1997 it took fourteen years for the money supply to double, but only requiring nine years since 1997.

Source: Economagic.com

In December over $145 billion in new money has been created and if that rate was continued, M3 would double in 4 years! Maybe the fact that the printing presses have been running at full speed and are even accelerating is the cause for the discontinuation of the M3 data by the Federal Reserve. The growth in the money supply has ushered in liquidity into the economy and markets. If you want proof, look at the charts below! (Source: Dismal Scientist)

The constant money pump has led to an increase in consumer credit to perilous levels, which then flooded into the housing market and into consumer goods as seen by the trade deficit. Things over the past few years have been bright. Since the October lows of 2002, the S&P is up over 50% since the October lows, the Dow is up over 36%, and the NASDAQ is up over 86%. Housing prices have also been soaring over the past few years providing a virtual ATM with home refinancing and the home owner pumping that money back into the economy and inflation has been mild, if you believe the statistics and backing out food and energy of course. So yes, things have looked bright over the past years. What would happen if a housing slow down occurred and how much of the housing boom has propelled GDP? Chris Isidore, CNNMoney.com senior writer, explored how much of GDP is related to mortgage equity withdrawal (MEW) as he calls it, in his article, "GDP Growth: With and Without Mortgage Extraction."

As can be seen from the graph above, MEW makes up the bulk of the GDP and has been slowing as of late and any further slowing would have disastrous consequences on GDP and the economy.

I'd like to insert a quote below from Jens O. Parsson's book, "Dying of Money: Lessons of the Great German & American Inflations." Here is a perfect illustration of the inflation cycle and its signs and ramifications:

"Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and ineffectiveness of all traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation."

There is a concept in finances known as mean reversion, where some quantity that is measured will have an average (normal value) and will deviate from this on the low and high side over time, but will ultimately revert back to the norm/average over time when over or under extended. Stocks are seen to do this with their moving averages from a technical stand point. Companies exhibit this behavior as well with their earnings cycle as seen by the stock price and the company�s earnings (PE ratio). Think of mean reversion like a rubber band that gets stretched too much--the more energy is put into stretching it, the more energy that will be unwound like a spring once the force stretching it is removed. The effects of easy credit and the constant printing of the money press is causing the current economic and market conditions to stretch to dangerous levels, and the more that it is stretched, the more pain that will be felt in its unwinding.

I believe we are possibly already seeing some of this unwinding. Looking at the existing homes sales chart above, a possible top may already have been placed over summer of 2005. Bankruptcies in the United States have spiked (see chart below) and 2005 was relatively flat for the broad indexes until November with the notorious end-of-the year momentum rally driven by bonus seeking fund managers.

Source: Dismal Scientist

In yesterday's wrap up Ike Iossif referenced an article titled, "Wall Street Bonuses Hit Record $21.5 Billion." The previous record of $19.5 billion was set in 2000 at the peak of the market. The average bonus was $125,500, also a record. In comment on the lousy performance of the market and the aid of fund managers in November, I'd like to insert below Peter Navarro's Financial Sense Online guest editorial article, "Bully, We Hardly Knew Ya."

"Here's the way I see it: We had a lousy 2005 right up until November when we got the obligatory end-of-the year momentum rally fueled by desperate fund managers. Once enough of them put up semi-respectable numbers, they pulled their dough off the table until the New Year - which killed the Santa Clause rally. The pent-up demand and cash piling up on the sidelines as these money managers swilled eggnog then fueled another wave of 2006 buying - again driven not by economic fundamentals but rather by technical momentum considerations. However, once the momentum wore off, traders raced for the exits - and the markets gave away most or all of their gains."

"The bottom line: more than a few traders got left standing and bleeding in this game of musical chairs. Expect the numbers of walking wounded to swell in fits and starts over the next few months as the fantasy of robust economic growth driven by increased corporate spending and an only moderating consumer sector is bowled over by the reality of Fed rate hikes, oil price shocks, the closed gate on the home refi ATM, stagnant income, left week crazies in Bolivia and Venezuela, gangsters in Nigeria, right wing nuts in Iran, and a budding power vacuum in Israel."

Any weakening in the economy will cause concern for the Fed that the rubber band "Growth Economy" may be extended as far as it may go and cause them to print more money to support the markets and the economy, and usher in the later part of the inflation cycle where everyone pays and no one benefits. This is my feeling why M3 will be discontinued. The Fed wants to support the market with a flood in liquidity (M3) and doesn't want anyone to think the market support is superficial, but actual strengthening of the economy.

Today's Markets

The broad indexes finished slightly lower today due to concerns over more weak earnings announcements may be pointing to a slowdown in corporate profits, and a decline in existing home sales further contributed to a poor investor sentiment.

Source: Econoday

Existing home sales fell a sharp 5.7% in December to a lower-than-expected annual rate of 6.60 million, with the consensus estimated at 6.90 million. The biggest source for the drop in sales came from single-family homes, which dropped 6.8%, while on the positive side, condos rose 1.6%. Sales fell the sharpest in the West and South and were strongest in the Northeast where they were unchanged. Supporting the weakening housing market was a drop in the median sales price, falling 1.9% lower to $211,000.

Source: Econoday

The Dow closed at 10,709.74, down 2.48 points, with the NASDAQ and S&P 500 also closing down at 2,260.65 (down 4.60 points) and 1,264.68 (down 2.18 points) respectively. The 10-year bond yield rose 0.09 to close at 4.479%. February crude was up $1.45 (2.12%) to close at $67.25 a barrel while February natural gas fell 0.19 per million btu, closing at $8.46, down 2.2%. Gold spot prices rose $5.1 an ounce to finish at $562.8, with silver spot prices also posting a gain of $0.28 an ounce to close at $9.47, up 3.05%.

Sector Summary

Description	Last Price	Price Change	Today's % Price Change	Week To Date % Price Change	1 Month % Price Change
Basic Materials	1,419,051	17,530	1.3%	3.8%	8.2%
Capital Goods	721,523	-3,742	-0.5%	1.2%	2.9%
Conglomerates	799,243	-919	-0.1%	-0.1%	-3.5%
Consumer Cyclical	833,824	-3,824	-0.5%	2.0%	2.0%
Consumer/Non-Cyclical	1,334,277	2,441	0.2%	0.8%	-0.1%
Energy	2,840,855	-42,276	-1.5%	-0.7%	8.4%
Financial	5,007,557	14,648	0.3%	1.3%	-0.1%
Healthcare	2,347,651	1,359	0.1%	0.1%	0.3%
Services	4,586,077	3,799	0.1%	1.0%	0.8%
Technology	3,221,584	4,324	0.1%	1.1%	1.2%
Transportation	408,316	2,311	0.6%	3.1%	1.6%
Utilities	950,484	-7,817	-0.8%	0.1%	4.2%

Have a pleasant weekend,

Chris Puplava

© 2006 Chris Puplava

Contact Information

Christopher M. Puplava
PFS Group
PO Box 503147
San Diego, CA 92150-3147
(888) 486-3939 Toll Free
(858) 487-3939 Tel
(858) 487-3969 Fax
Email