Financial Sense Archive | About | Newshour | Metals | Storm Watch | Authors | Resources



THE FEDERAL RESERVE: THE STOCK
MARKET'S FAIRY GODMOTHER
by Stephen Tetreault
February 22, 2006

The Federal Reserve along with Global Central Banks is going to keep pumping in Liquidity until the banking systems implodes from sheer overweight!

The Federal Reserve continues to pump huge amounts of liquidity into a system (in the first 7-8 weeks of the new year they have added a staggering $9.51-billion to the permanent money supply alone) that they claim to be the underdogs for fighting inflation is this proverbial over-heating inflationary environment; this practice flies in the face of logic.

Note the Federal Reserve defines inflation as:

Federal Reserve is moving into a Cloud of Secrecy

Now here is a situation that bears some reflection and pondering as the potential ramifications will be huge. As many of you are aware (through my various writings), the FED released a new policy statement that has gone mostly unnoticed and almost completely unreported by those bubbleheads on bubblevision.

In a nut shell the FED stated that they will cease publication of the M3 monetary aggregate; they will also cease publishing large-denomination time deposits, repurchase agreements (Repo�s). And I believe that the implications and ramifications of this rather manipulative stance is enormous and will have far reaching effects. Please let me explain my major concerns with this. It's important to understand folks that the FED�s M3 report is the broadest measure of the supply of money in the economy. For those that have forgotten economics 101; the total supply of money in circulation in a given country's economy at a given time.

To an economist the money supply is considered an important instrument for controlling inflation by those of us economists who subscribe to sensible processes know that growth in money supply will only lead to inflation if money demand is stable. In order to control the money supply, the FED has to decide which particular measure of the money supply to target. The broader the targeted measure, the more difficult it will be for them to control that particular object. It is important to note that the M3 has literally more than doubled in just about 7-8-years; basically there are more than twice as many dollars out there now, far out pacing even the pro forma growth of the economy.

Now why is this a major issue in my mind, well lets look at a simple definition of inflation: It's a persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services. Basically it alludes to the fact that more dollars are chasing fewer goods which leads to the production of significant price inflation which is a symptom of monetary inflation **created by the very department of oversight, that was created to combat price inflation** and oxymoron. And this doesn't even address the fact that price inflation is significantly under-reported by a staggering degree (a story for another day). So you ask what the heck the big deal Steve is. Who cares that the FED isn't going to report on those data points/numbers anymore besides you; stop being so anal you have told me.

Well let me give you an analogy to ponder: let's imagine that the federal government starts to only report the ongoing deficits, but no longer reports the total of the federal debt. For comparison the pro forma federal deficit last year came in around $320 Billion; but the federal debt ran up by a staggering $555 Billion last year�.so can you see the paradox�Now I bet that some of you are asking, how can that be�.how could the total debt increase more than the deficit? Well that is quite easy as they use fuzzy math and accounting tricks that amounts to lying to the public, those folks who they serve (or do they). Our government is just like major corporations utilizing what are classified as off-budget items that don't become reportable in the overall deficit numbers. So basically folks to me (someone who need the predictive data to factor a directional bias of the economy and markets) that's why the M-3 data is so important, because it includes items that aren't reported in the M1 and M2 that have a direct bearing on inflation and our overall economic health.

Another major concern for me, folks, is that the FED will no longer be reporting Eurodollars and repurchase agreements. Eurodollars are U.S. dollar-denominated deposits at banks outside of our borders and the Eurodollar market is relatively free of regulation, and as such banks can operate on narrower margins than their counterparts in the United States. As a result, the Eurodollar market has expanded largely as a way of circumventing regulatory costs (something that you will never hear on bubblevision). For those who are not aware there are more Eurodollars out in circulation than there are dollars. To stop counting Eurodollars by the FED is to stop counting an enormous percentage of dollar-denominated assets in the world, and I very concerned about this situation.

Next and even more importantly, is their desire to end of reporting of repurchase agreements. For those of you who do not remember a repurchase agreement (repo), is when the FED buys government securities from a dealer who agrees to buy them back, typically within 1-14; (a reverse repo is just the opposite; however lately I'm hard pressed to find any). Now when you realize that the Federal Reserve, can print dollars when ever they want, is quite often manipulating the bond market on short term basis; and they are increasing their manipulation in a steadily increasing basis to the point that they have now become a dominant force in bond market activities. Remember Federal Reserve Commander Helicopter Bernanke, issued comments on how to combat inflation/deflation. Remember folks that our dollars have value only to the extent that they are strictly limited in supply; and we are aware that the Fed's printing press allows it to produce as many greenbacks as it wishes. By increasing the number of dollars in circulation, or even by credibly threatening to do so, the Fed can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.

What are they doing this�.I believe the Federal Reserve realizes that they need to hyper-inflate the money supply, as if they fail to do so they could be responsible for exploding the huge housing bubble that they have created. With record debt levels in this country, consumers will no doubt start to be feeling a choking effect by the rise in interest rates; and this will certainly act as a major drag on the economy. The FED new chief attempted to explain away the �conundrum� of sustained low long-term interest rates by the so called �global savings glut� by foreigners� and their willingness to buy our assets, and debt as (China and OPEC) are awash in liquidity/dollars. What is extremely alarming to me and (and of course the new fed Chief ignored the questions and contagions surrounding these facts) is that to support our huge spending habits; the ballooning twin-deficits (federal deficit and enormous trade deficit) we are now borrowing roughly 70% of the entire world's savings�.this pace of ballooning debt-load is extremely unsustainable and it holds us hostage to others; those very nations that are not our allies or friends. The question remains how much longer will they continue loaning us money to support out euphoric spending habits�.As we continue to see our society crumble (just my opinion) as we continue too export our jobs to China/India and abroad while they loan us money (to keep our huge spending appetites satisfied, while we consume their cheap exports; we dig our own societal demise deeper and deeper.. It has been these loans�their buying of our debt which has resulted in keeping long-term interest rates artificially low.

Many Working class Americans are moving toward extinction

Despite what you hear day in and day out on the financial media and the hype that we constantly hear from the Bush administration America's once mighty and highly regarded industrial machine is struggling for its very survival as the premier leadership nation. And unfortunately for many Americans (those the current administration neglects and has cast a blind eye toward) those I call the �working class� are heading toward extinction. And before a number of you write me and tell me that all the data points to a rosy picture please hear me out first. I believe that the combination of inadequate and sub par job creation (the elimination of high-quality and benefited jobs, and their subsequent replacement with sub par and uniquely inferior jobs with minimal to no benefits) during the past 6-years and the fact that real wages are slipping downward (stagnate at best) will no doubt place extraordinary contagion/pressure on the actual wage income-generating capacity of Americans. And when coupled with the facts that Americans are the world's most veracious consumers of the world's resources. Now you may already be thinking, I am just a doomsayer; or acting like that proverbial childhood character called �chicken little� I assure you that I'm not. Now of course, folks if you take your cue from the current administration or the hyping Wall Street media machines, the verdict will be nearly unanimous; all is fine on the employment front; and as you are aware I believe this is so very far from the actual truth that is being buried and totally manipulated by the financial media and the various reporting agencies.

Let's do a little bit of reflecting on the current state of affairs: Our economy has just completed the 50th month of an so-called expansion that began in November 2001 (if we are to believe the pro forma data and reports, but let's do so for this analysis). Normally when reflecting on the past four longer term cycles (1961, 1976, 1982, and 1991) job growth was cruising ahead by an average of 210,000 per month. And during those cycles both the economy and employment markets were considerably smaller than is the case today; so we need to adjust for the scale effect, and when we do so the 210,000 cyclical norm from those pervious cycles would translate into about 330,000 jobs per month in today's economy. And if you have been watching the reports we have seen nothing remotely close to that average; and when we utilize that benchmark the latest four-month average running average of 114,000 on the jobs creation front looks all the more pathetic.

How soon we forget the rhetoric that we heard during the first two years of this so called expansion was referred to as the infamous �jobless recovery.� And we heard that hype months/quarters. Now I will admit that the pace of hiring has picked up somewhat in the last two years, the quality of those jobs being created to replace those that were either destroyed, outsourced or moved abroad growth has been lackluster at best when compared with any expansions during the past 60 years. Unfortunately, for the majority of the working class Americans, this lackluster and quality-jobless recovery has also been what I unfortunately refer to as a �wage-less recovery� characterized by an extraordinary slippage in real wages.

This combination of a relatively quality/jobless and wage-less recovery will start to accelerate their contagious pressures on American households. This shows up loud and clear in the compensation component of the personal income data. This is the broadest measure of labor income paid out by the private sector including not only wages and salaries but also social security, healthcare, pensions, insurance, and other benefits paid to Americans. During the past quarter private sector compensation accounted for 66-68% of total disposable personal income in the US by far, the major engine of the internal income-generating capacity of our economy. During the past 50 months of the current economic expansion, private sector labor compensation has risen only 10.8% in real dollar terms far short of the 20% average gains from the comparable periods of the past five expansions. Had this gauge of income followed a similar trend/trajectory path similar to that of previous cycles, the numbers would reflect that real compensation would have risen by $330-338 billion higher than we have seen so far. In a nut shell folks this jobless and wage-less employment market has left most hard working American strapped tightly, more tightly than most realize.

The current administration is running their hype machine at full steam�and their pro forma numbers are masking the real and �well-known� disparities in the income distribution matrixes by obscuring the distinction between quality and sub-par job creation. Bush continues to pump the one liner�as he boats of the creation of 2.4 million jobs by his great economic prowess and insight�.well what he fails to state is that 45% of those jobs created were concentrated at the low end of the job spectrum, and when compared to the jobs they replaced they fell extremely short. The administration has also very successfully masked (a great accounting and pro forma reporting job) that approximately 24% of the recent jobs being created over the past 12 months was attributed by the financial services and the bubble-driven construction and real estate industries not what we could refer to as a stable source of quality job creation.

Well you are probably asking yourself, why is this a problem? Let me explain and extrapolate a few more premises and ramifications of these underlying contagions as the implications of these contagions/developments will be very profound in my opinion. Now as I have stated above; working class Americans have been lacking real income support, and as a result of their addictions. as I have stated before Americans are living on borrowed time/money�.we will soon be called the "Plastic-Credit Card Nation� as the overall consequences of the growing consumer addiction to credit is a deadly witched brew. I have used that analogy that the average consumer is like a junkie (and the pushers are the banks seeking profits at all costs and the Federal Reserve, Current Administration along with Credit Card companies and various hypsters that promote the proverbial buy now/pay-later mentality) and this contagion could be staggering for the economy�the problem can be directly tied into the fact that credit cards have become the new "food stamp program" almost akin to a "lower-class entitlement" rather than an earned privilege.

I believe that the majority of the increases seen this year to our economy and especially to the stock market has been the direct result of several processes (the one-time-event, �repatriation of almost 400-billion� in back taxes that corporations were keeping in off shore accounts to avoid payments to our government). Large corporate tax breaks that the Bush administrations desires to make permanent. Huge increases to the monetary flows, liquidity infusions from the Federal Reserve. And the majority of the positive fuels utilized to boost the economy have been powered once again by homeowners using their homes as a proverbial ATM machine where they have been extracting pent up equity from their homes. And they have been doing so at a break neck pace. Now we better pray that when this housing boom/bubble a start to deflate it does so in a very slow manner as any significant downturn in the housing market will act like a fast moving consuming cancer.

The main contagion that our economy will face is the eraser of a huge �inflated line� of liquidity being utilized to help keep sustained this so called economic boom. When coupled with the contagion of increased interest rates (affecting variable mortgage rates); the overall drag on the economy could be staggering. As it will most likely start a cascading effect resulting in a possible dramatic shift and retracement in consumer discretionary spending; which will act as a major drag to our overall economy; as their current delusional euphoric spending state (mostly on borrowed monies) will end very nastily. As the spending-addicted consumer has turned toward what I refer to as an �ATM� equity extraction from asset holdings in order to support their habit.

I believe that there is good reason to believe that both the property and consumer bubbles as I have outlined them in my writings will burst in the not-so-distant future. If they do (and I believe they will, there is a realistic possibility that our country will suffer a series of recessionary relapses over the next several years. Yet denial of any potential bubble-deflation or bursting remains deeply routed in mainstream economics and especially in bubblevision. But then again they were all dead wrong when the Nasdog was heading toward 5,000; as then few in the financial world wanted to believe that that economic expansion was being built on a very shaky foundation.

The evidence for me folks that support of a housing bubble is very compelling. The 25-28% increase in inflation-adjusted housing prices since 1997 represents the sharpest five-year increase since 1945 (the post war period). This surge is also three times the increase in real housing rents over this same period. (This divergence of housing prices and rents, which usually move in tandem, is one measure of the excessive speculative element surrounding the housing market.) As we have seen as property values rise, financially overly-stretched consumers have been very quick to extract equity from their homes (many needed the equity to sustain their current lifestyles), by taking advantage of historically low interest rates to refinance their properties. What also disturbs me is that so many folks have stripped away the equity from their homes (that would have been used for their retirements) and they utilized it to buy cars (especially SUV�s), furniture, appliances and other luxury goods (depreciating assets). And as such the ever-expanding housing bubble has become central to the culture of excess (those caught up in the compelling drug �consumer euphoric ecstasy� of acquiring things) that has been the primary driver of our economic rebound during the past several years. Hence I believe that the consumer-spending bubble (which I believe to be 6-9 times exponentially greater than the Nasdog bubble) will undoubtedly be the last to fizzle or worse yet pop. Our culture is tremendously short on the proverbial savings front and we are excessively long on all kinds of debt, and when coupled with an aging population we must begin to come to grips with the looming realities of retirement. And we must do so in an era of defined contribution pension plans whose performance has been battered by a devastating bear market in equities, and whose caretakers are increasingly moving towards their elimination. We must come to the realization that the great American consumption trends (where we consume the greatest portion of the worlds resources and goods) will eventually implode.

How long can the hosing euphoria last? Estate agents, builders, lenders, and most economists have all insisted that there is no house-price asset bubble (remember that they all said that about the stock markets in 1999/2000). Rising house prices, they argue, are fully justified by low interest rates, rising real incomes (here is a major farce), growing populations and a fixed supply of land. Now doesn't this sound a little like the �wall of money� argument used to defend inflated stock prices in 1998-2000�They argued then that Prices had to rise, because the number of shares in which pension funds could invest their new found billions was limited. Therein investors mistakenly were led to believe that the traditional link between share prices and profits no longer mattered. I believe that so many home-owners now are making a very similar mistake and are being led down a prime rose path. We have seen before that swings in property prices can have a huge impact on overall economic growth. Since the great IT/Internet and stock market bubble bursting in 2000-2001, rising property prices and equity extraction from these homes around the globe have helped to prop up and place a proverbial floor under the world's economies. Rising house prices and equity extraction have boosted consumer spending by making people feel wealthier, offsetting the effect of falling share stock prices and weakening real-wage growth. Consumers have been able to borrow against the inflated values of their homes, turning capital gains into cash which they have for the most unfortunately spent on diminishing assets.

Now for the contagions to this bubble; just as rising housing prices helped to boost consumer spending and the economy, falling housing prices will cause significant economic pain. In my analysis of a number of earlier housing bubbles, I found that output losses after housing price peak and burst have on average been 2-3 times greater than those after stock market crashes. I have found that there are three primary reasons why a housing price decline (bubble bursting) causes more harm than a stock market bubble-bursting. First, house prices have a bigger wealth effect on consumer spending, largely because more people own their homes than own shares of stocks; especially on a global scale. Secondly, folks are much more likely to borrow (many borrow excessively) to buy a home than to buy stocks or to make investments. Third, a significant decline in property prices will leaves many households with homes worth far less than the amount they have borrowed, so housing bubbles when deflating or worse yet if they burst have a significantly greater effect on the banking sectors, which are typically heavily exposed to the real estate markets. Falling house prices lead to an increase in banks' non-performing loans, and as their collateral shrinks, so does their capacity to lend hence one reason why the Federal Reserve has been pumping in excessive amounts of liquidity these past few years. I have forecasted that within the next year (maybe 2-at best) these bubbles are likely to start to deflate (hopefully not rapidly; again most likely why central banks around the world are pumping in huge amounts of liquidity in an attempt to slow the contagions before they hit us hard like a run-away Mack-truck), will lead to cascading drop in average real house prices of 15-25% in America and possible 30% or more elsewhere over the next few years, which is in line with the mean-average price declines experienced during past housing-market declines. This time, however, with pro forma inflation significantly lower, house prices will most likely fall more rapidly in money terms than they did in the past. And as such significant numbers of home-owners may be left with homes worth far less than their current mortgages especially as the proportion of owners with mortgages exceeding 85% of the value of their homes is dramatically higher now than it was in the previous housing market down-turns. There are already signs in some major cities, Boston, New York, San Francisco, that the housing market is cooling fast, but estate agents are still insist that prices are unlikely to fall by much�.sound familiar, I can remember the horde of stock-brokers telling investors the same thing for many months/years.

Americans are living with Alice in �Wonderland�

Our nation is in the midst of a major economic boom if you believe all the hype on bubblevision. Meanwhile our twin deficits are ballooning; we're running a current budget deficit of very roughly $475-520 billion (depending on the figures used). And a whopping current account gap, which has been growing sharply over the past few years. Most of the deficits that we are running folks are essentially being supported by the Chinese and Japanese and by the world's major oil-cartels (several of which are terror states�.those who are the main culprits in the war against terror). Foreigners have run up a staggering trade surplus with us approximating $740-760 billion a year, and it’s quickly approaching a trillion dollars. That is, we're buying cheap goods from the rest of the world about � of a trillion dollars more each year than we're selling to the rest of the world (and this pattern can not continue or it will be the ruin of our economy). As you are an aware folk from my past writings the difference between the gaps is made up by foreigners (Chinese, OPEC and Japan) lending us money (imagine the greatest nation on this planet now the greatest debtor nation) by acquiring our assets, especially our bonds (hence why we still have depressed rates. At this point in time we owes the rest of the world at least $3.7 trillion more than they owe us, and the sum is growing rapidly day by day. In this so called time of prosperity, our savings rate is in at an historic low (in negative territory), roughly (-1.7%) percent of total consumer earnings the lowest it has been since the Great Depression. And it getting worse; as total consumer spending last year was roughly a whopping $8.5 trillion. Of this amount approximately $895 billion came from home refinancing in other words, they have continued to extract pent up value from their homes that they should have left for their retirement years. In essence we're only able to sustain these euphoric spending levels to keep the economy trending along by going deeply into debt to foreigners, and mortgage lenders and unfortunately our children, the future taxpayers.

To make matters even worse staring in a few years the majority of the baby boomers will start to retire and become eligible for social security and Medicare and by my calculations will be bankrupt in about 11-16 years and possible sooner if the current path of eliminating revenues (By giving extra tax breaks for the most wealthy, and corporations to facilitate out sourcing our very way of life). What is even more amazing to me is that in the face of these extreme imbalances and looming cancerous uncertainties, you would expect our government to be stressing the importance of Americans to start intensive saving like crazy to prepare for the future and the contagions that are growing and looming ahead. But instead, the Bush administration is taking us ever deeper into debt; and is completely down-playing the threats.

Remember, as I have stated many times before in my writings the Baby Boomers are the single largest part of the population (even on a global basis). But by the census estimation they total about 80-82 million men and women within our country. They will need staggering sums to maintain their current standard of living after they reach retirement years, especially with the current stream of pensions that have long promised defined benefits collapsing all around us as large firms race to eliminate their duty and long held promises to those about to retire. And without understating this cancerous huge crisis the Baby Boomers are pathetically unprepared for their future. According to what I have read the average savings for � of the baby boomer households is less than $55,000, not including the slipping equity in their homes�and the other � of the baby boomers have little to no savings and will be reliant on Social Security and Medicare for full sustenance, hence this is a resounding RED Flag.

© 2006 Stephen Tetreault
Editorial Archive

Contact Information
Stephen Tetreault
T-Waves
Southern Maine, USA
Email | Website

Contact Us | Copyright | Terms of Use | Privacy Policy | Site Map | Financial Sense Site

© 1997-2011 Financial Sense® All Rights Reserved.

The opinions of the contributors to Financial Sense® do not necessarily reflect those of Financial Sense, its staff, or its parent company.