With your host Hank Cunningham
November 3, 2006
Money is cheap
12:04 EST Thursday, Nov 02, 2006
Hard as it is to believe today, there was a time in the bond market when the thing that mattered the most, the single economic indicator that dismal scientists and traders obsessed over, the one that sparked volatility in bond prices, was money supply.
It was a simpler time, of course. Junk bonds hadn't been invented yet, nor had hedge funds, credit default swaps, bullion exchange-traded funds or weather derivatives. Most of the time, bonds wallowed around in a comfortable trading range, punctuated by the occasional knee-jerk on the release of the U.S. Federal Reserve Board's money supply numbers? "Oh, my gosh, M3 is up 0.5 per cent! Sell everything!"
Nowadays, well, I can't remember the last time I paid any attention to the money supply data, and nobody else seems very concerned about it either. Maybe we should be.
Money is cheap. True, overnight interest rates have risen, but money is still way cheap.
Global markets are up to their knees in excess liquidity. Interest rates are still low ? in Japan, the overnight rate is a mere 0.25 per cent. According to a story on Bloomberg this week, in the Eurozone economies, money supply grew in September at an annual rate of 8.5 per cent. In the top global economies, it's grown at an annual rate of 7.5 per cent this year. That's down from 9 per cent last year, but still very high.
I mentioned this in passing while chatting with someone on a bond desk this week. "Gee, Harry, not that there's anything wrong with that, but you're not one of those monetarists, are you?"
Well, I do think that Milton Friedman was right when he said that most of the time inflation is caused by increases in the money supply, so I guess that does make me a monetarist, as unfashionable as that may be these days.
Anyway, the point is that central banks may have the rate-hike controls on cruise-a-matic at the moment, but they've got to be concerned about all this global excess liquidity, and sooner or later, they're going to have to start raising interest rates again. Yet the bond market, which has been rallying smartly of late, is already pricing in its anticipation of 75 basis points of rate cuts next year. The theory seems to be that that all the excess cash is just chasing financial instruments and not driving up consumer prices, so while there may be asset-price inflation that causes a financial bubble or two, consumer and producer price inflation is fairly benign. Don't worry, be happy.
All that cash, though, is looking for a home, and with most Western economies slowing or growing at anemic rates, money has to go a little further out the risk spectrum to find the kinds of returns it has grown to expect. In a crude, laissez-faire sort of way, this may be a good thing: a lot of the excess cash will get pumped into dodgy investments and will get vaporized when the next bubble bursts, thereby helping to restore equilibrium ? as long as central bankers don't pump even more liquidity in as the bubble bursts to ensure a soft landing, as they are so wont to do.
Speaking of flaky investments, this month, Industrial & Commercial Bank of China Ltd. raised $19.1-billion (U.S.) in the world's biggest initial public offering. There were more than $500-billion worth of orders for the IPO. Did I say this was a mainland Chinese bank? I'm all for investing in companies that make the stuff that China needs to buy, the stuff that, as Dennis Gartman says, "hurts if you drop it on your foot." But buying shares in a Chinese Bank, well, dudes, that's a little too sporty for me. Two words: non-performing loans - and plenty of them.
Even scarier, they could have sold half a trillion dollars worth of the stock. That's a very lemming-like number. There's so much cash around that half a trillion dollars of it can slosh over to pour into a Chinese bank IPO? What are they thinking? For half a trillion, you could buy Citibank - twice. As the Modern Lovers once sang, "Where's their financial adviser? Somebody should take him by the hand."
Besides nebulous investments, the other place all that excess cash tends to accumulate is in the hands of investment banks and dealers, who think up and sell all those clever investment vehicles in the first place.
It's Halloween as I write this, and my street is overrun by hordes of kids clutching big bags full of loot. It's also the end of the fiscal year for the big domestic banks, when they add up all the numbers and decide how big everybody's bonus is going to be.
I was reading about how fat the bonus cheques will be in London's financial district this year. It looks like the City of London is also going to be overrun by hordes of kids clutching big bags of loot. Naturally, when vast tidal flows of cash slosh around the globe, some of it is going be siphoned off by the financial engineers who run the pipeline. According to Bloomberg, the London dealer bonus pool this year will be ?8.8-billion. That's $16.7-billion (U.S.), or a little more than the annual gross domestic product of Iceland. It's also up a hefty 18 per cent from last year. Bloomberg says there will be 4,200 people in London who will receive bonuses of more than ?1-million this year, up from a mere 3,000 of them last year. That's some serious Jack. No wonder it costs an arm and a leg to live in London.
Sr. Market Analyst,
36 Green Meadow Crescent,
Richmond Hill, Ontario,