The reach of the bailing bucket
By Daniel M. Ryan
Like many commentators, I was surprised at the House's rejection of the original bailout package: public anger, and the consequent vote-down, seemed to come out of nowhere. The modified, considerably earmarked bailout package is now out of the hands of the President and is now law. Now that the Treasury will have the funds, where does the economy go from here?
Still A Bear Market…For Now
Surprisingly, if the prior odds on U.S. bailouts are considered. Ever since 1982, a rescue package has tended to kick-start a new bull market in U.S. stocks or reinforce one already in progress. Despite these prior odds, all three U.S. averages closed down on Friday's close after strong gains in the morning. Although the drop was initially attributed to worry over the bad payroll data and other associated bad figures, the timing of Friday's drop suggests that little confidence in the bailout was the cause. This report quotes a trader as saying the Friday afternoon drop was a sell-on-news event, even if that same report also points to some skepticism about the bailout's efficacy. Although this comparison's validity will become apparent this coming week, Friday's market action indicates that it ain't another 1982.
In other words, there's no current sign that the current bear market isn't over. The S&P 500 closed at a level slightly below the one it reached after Monday's post-rejection panic. This close puts its decline from October 2007's high at about equal to the average drop for an average bear market. (I saw this factoid on CNBC's "rejection special" on Monday night, and extended it to the end of the trading week.) My January call on the current bear market has held up, even if my parallel "no recession" call is still debatable.
A large part of the reason why the market received the passage news with such skepticism is that the bailout isn't being compared to previous rescue efforts by the D.C crew. It's being compared to the Japanese rescue attempts, which led to a Nikkei and economy that have gone basically nowhere for the past fifteen years, and the Swedish bailout of 1992. Shifting from a national category to an international one makes a kind of sense, because of the current credit crisis' unprecedented magnitude and the fear that the Fed's now pushing on a string. The Federal Reserve had expanded the monetary base at a phenomenal rate even before the original bailout bill was rejected.
Nonetheless, the M2 money supply isn't growing all that much. The most recent Fed report on it shows that annualized M2 growth has been a tepid 1.4% from May to August…although the annualized 13-week rate of growth, from June 23rd to September 24th (preliminary), is a more buoyant 2.4%. The big grower amongst the Fed-reported Ms has been M1: 6.9% annualized growth from May to August, and 8.8% annualized over the last thirteen weeks. No wonder the general public is buying so much precious metal: M1 is the series that most closely matches street-level money.
The tepidity of M2 growth squares with the huge jump-up in excess reserves, which has naturally encouraged fears that the Fed is pushing on a string. According to the most recent Fed report on aggregate reserves, the excess in this department has shot up from $2.256 billion to a figure of $68.771 billion. Normally, the percentage of excess reserves is negligible compared to the overall monetary base. According to Sept. 24th's preliminary figure, though, excess reserves were 7.5% of total reserves as of last week. Subtracting the Sept. 10th - 24th jump in excess reserves from the Sept. 24th monetary-base figure leaves a reserve count that's almost unchanged. This bottlenecking does make comparisons to Japan's post-bubble economy credible.
On the other hand, the mountain of excess reserves may prove to be a molehill. As the 25-year St. Louis Fed graph of the monetary base's changes indicates, big spurts in the monetary base are usually followed by big drops. The current huge excess-reserve build-up could have as homely a cause as bankers deciding that the current spurt isn't durable enough to base a spurt of new loans on. They probably won't until the Fed either reduces the monetary base or, over the course of the next few months, leaves it be. Like many of us, today's bank executives base their decisions on their experiences in similar circumstances. The ones similar to now are followed by the Fed draining reserves within a few months after hurriedly shoving them in.
But What Of The Economy?
I'm inclined to go with the current consensus right now: there will be a United States recession, which will be apparent by the release of 2Q 2009's GDP figures. (This call gives me three upcoming quarters to get two consecutive negative ones.) Although the stock market has had some false positives when it comes to recession prediction, the current drop has been large enough for it to have discounted a real one.
On the other hand, the frenetic growth in the monetary base is a reliable signal that a recession is either not going to come or is about to end. 1999's ramp-up corresponds with the former, and late 2001's corresponds with the latter. Putting it all together suggests that a late 2008 or early 2009 recession is going to be mild and shaken off relatively quickly: the recently-predicted two-year grinder will not show up. Once the fall of 2009 approaches, it will indeed be apparent that late 2008 is not another 1982.