Outside the Box

Hoisington Investment Management-Quarterly Review and Outlook, First Quarter 2013

April 23, 2013

Lacy Hunt and Van Hoisington launch into their first-quarter "Review and Outlook," this week's Outside the Box, with a statement that some may find eye-opening: "The Federal Reserve (Fed) is not, and has not been, 'printing money'…" But given the facts of life about how money is really created (and destroyed), they are of course right: it's all about the acceleration – or deceleration – in the M2 money supply.

But there are deeper currents here. For, as Van and Lacy say, "A review of post-war economic history would lead to a logical assumption that the money supply (M2) would respond upward to [the Fed's] massive infusion of reserves into the banking system. And yet, the Fed's 3.5x expansion of the monetary base over the past five years has only grown M2 by 35%, and year-over-year growth through March, 2013, was less than 7%. "In other words," say our authors, "there is no evidence that the massive security purchases by the Fed have resulted in a sustained acceleration in monetary growth; nor is there evidence that economic conditions have improved."

So what is wrong with this picture? Well, it turns out that not only can the Fed not control the money supply, it can't control the velocity of money either. And that means the Fed can't create rising aggregate demand. As in, Ben's shooting blanks.

To help us get our heads around this fundamental realization, Van and Lacy lead us deeper into the gooey cytoplasm of Federal Reserve genetics; but the bottom line, as Prof. Irving Fisher taught us, is that GDP = MV. That is, nominal GDP equals money times its turnover (velocity). And don't look now, but velocity is the lowest it's been in six decades.

The upshot (downshot?) is that the decade just past saw a growth rate worse than any in US history, except the 1930s. We already knew that, but it's good to have estimable gentlemen like Messrs. Hunt and Hoisington bring us the numbers and solid analysis to back up the surprising statements we find ourselves forced to make about this oh-so-Muddle Through Economy.

Hoisington Investment Management Company (www.Hoisingtonmgt.com) is a registered investment advisor specializing in fixed-income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $5 billion under management and is the sub-adviser of the Wasatch-Hoisington U.S. Treasury Fund (WHOSX).

I am back in Dallas for a week and getting ready for my conference next week, preparing a brand-new presentation, working on books, looking through architectural plans, spending time with family, dealing with endless minutiae, and  all the while trying to stay caught up with my reading. Life seems so much busier than a decade or so ago when I had seven kids at home and a growing business, was deeply involved in politics, and was limited to old-fashioned publications on paper as the sources for my research. I am not complaining, mind you, as I am having a marvelous time; I just wonder how I would have done back then what I do now.,

I am really looking forward to my conference next week. This will be our (Altegris and my) 10th conference. From the beginning I have always invited speakers I wanted to hear and who would challenge my thinking. This is about our best line-up ever, and I really would put it up against the roster of any conference anywhere. Most conferences  have a few “headliners” and then other speakers, many of whom pay to sponsor and speak.  We have nothing but headliners. My only regret is that we could not go for a couple more days and bring in a few more names.

I know some people look at our line-up of speakers and see mostly bears, but I think the attendees are in for a surprise. I am looking at PowerPoints and letters from the presenters, and the large majority of them are finding places to put capital to work.  This dynamic is going to make for some lively debates at the conference.  You can learn more at www.altegris.com/sic .

Two final thoughts. Given how much I travel it may be self-serving, but I find it inexcusable that the FAA would blame “sequestration” on the cutback in air-traffic controllers, etc. In a federal budget that large, they could find a few dollars to keep things rolling. That Congress would allow this without requiring prioritization funds is just one example – out of thousands – of the executive branch saying, “See, if you don’t give us money we will just inconvenience you,” all the while funding programs that we could well do without They might also take a look at cutting and rearranging budgets, as any normal business would do, to make sure that the important work for their customers gets done.

And finally, I have to apologize to my British friends. I am appalled that the current administration did not send a few officials to the funeral of Dame Margaret Thatcher. So much has been written about her that there is little I can add. I understand that some in the current administration might not agree with her policies, but an official acknowledgement of the “special relationship” that exists between Britain and the US would have seemed to require the presence of a representative from our government. That none were dispatched causes me to feel great shame for our country. Is this the way we treat our friends? It speaks volumes.

Have a great week. And are you paying attention to Italy? It seems that whom the gods would drive mad they first send to Italy to study politics.

Your needing to go back to Tuscany analyst,

John Mauldin, Editor
Outside the Box

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Hoisington Investment Management – Quarterly Review and Outlook, First Quarter 2013

Printing Money

“The Federal Reserve is printing money”. No statement could be less truthful. The Federal Reserve (Fed) is not, and has not been, “printing money” as defined as an acceleration in M2 or money supply. Just check the facts. For the first quarter of 2013 the Fed purchased $277.5 billion in securities (net) as their security portfolio expanded from $2.660…

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John B. Robb

May 3, 2013, 1:14 p.m.

The paragraph headed “No Inflation” is full of non-sequitors and unsupported assertions masquerading as arguments.

“Some inflationists point to the vast pool of reserves and conclude that if borrowing and lending begin to accelerate, money will surge, and so will nominal GDP, but this argument is invalid. First, the money multiplier could continue to contract…”, but they just defined the money multiplier as the ratio between the aggregate amount of lending (“bank deposit expansion”) and the monetary base, so even if the monetary base remains frozen at its current high level, the money multiplier has to expand.

Next, it is asserted that the money multiplier in on a contraction course and suggested that it would continue on this course (at least for some time) even given a resurgence in lending, but this collapses the distinction between further lending to sustain consumption and/or to keep the debt pyramin afloat, and lending for “productive” purposes, i.e. investment.  Admittedly, the money multiplier (and also velocity) would probably continue to fall in the absence of the latter type of lending, but the most of inflationists whose views Hoisington is challenging here, are talking about a true sustainable recovery scenario, in which the latter kind of lending predominates.  At best Hoisington is advancing a straw man argument.

“Even if, contrary to the latest data, the money multiplier were to stabilize, an extended period would still transpire before any meaningful change in economic conditions.”  This is what the Fed appears to believe, but it’s not just that no data is provided in support of this assertion.  It’s hard to see what kind of historical data the authors could cite that would be convincing, since they acknowledge that our present situation is in many ways unprecedented, and indeed, history never repeats because there are always new (and often hidden) factors at work.  One vital but generally unacknowledged factor is the expectations of market makers, policy makers, and of the man in the street.  The consensus of the market makers at present is that we are already on the path to a sustainable recovery, and this is what the policy makers claim too.  Consequently, if they are right, the market, which always front runs events (when it is right) is already poised and primed to jump on and intensify any signs of accelerating growth.  Meanwhile, the man in the street well knows that inflation is running much higher that the Fed’s and the economists’ numbers of 2% or less, which is why the man in the street (especially in foreign countries where citizens haven’t been brainwashed to believe that the government knows what it is doing) is accumulating gold.  Thus, despite the fact that the blinkered Fed economists, believing their own heavily doctored CPI and other inflation measures, believes that inflationary expectations are “well-anchored”, but history shows that the Fed has almost always been way behind the curve in recognizing changes in inflationary expectations.

And speaking of policy makers, the Hoisington analysis entirely overlooks another factor that I expect to come further to the fore as we continue to wallow in stagflation.  Hyper-Keynesians like Krugman, and all his market maker cheerleaders, are going to be calling for a ramping up in the distribution of US Treasury-printed, Fed-purchased monopoly money, to increase consumption and generate inflation, and if they do enough of this it will inevitably impact price inflation - in fact what the Fed has been doing all along is already having this effect by supporting high consumer energy prices, high medical and medical insurance costs, and higher-than-otherwise housing prices.

In the next paragraph, Hoisington does identify two legitimate deflationary factors which should continue operate to retard runaway inflation: continued globalization, and high debt levels.  But as both the world and domestic political situations continue to deteriorate, I expect that resurgent nationalism and scapegoating of foreigners will lead to increase trade wars and shooting wars, and that countries with too much debt (most countries) will indeed engage in a “race to the bottom” in depreciating their currencies (which is inflationary, and even hyper-inflationary, not deflationary, as Hoisington later claims), or simply default on their sovereign debt, which is the time-tested traditional method of shedding debt.  The world financial authorities are doing their best to engineer controlled defaults, by which Hoisington’s preferred policy of robbing savers to bail out irresponsible debtors, will keep the financial con game going as long as possible, so that the utmost can be squeezed out of those savers before the whole Ponzi scheme collapses, but the whole scheme, considered the aggregate of world capital is way too big for all the central banks, even acting in concert, to control, and at some unpredictable point worldwide hyperinflationary collapse becomes imminent inevitable.

Ronald Nimmo

April 28, 2013, 7:50 a.m.

“The financial and other markets do not seem to reflect this reality of subdued growth. Stock prices are high, or at least back to levels reached more than a decade ago, and bond yields contain a significant inflationary expectations premium.”
  My answer to this quote by Hunt and Hoisington is that the market loves a slow-growth, low interest rate environment. That way the present value of corporations steadily increases by virtue of this formula:

As long as earnings can slowly increase the equation PV = FV/ (1 + r)^n.  will keep the stock market rising. PV= Present Value, FV = Future Value (future cash flow), r = annual interest rate, n= number of years of compounding. The ^ symbol is used on non-mathematical keyboards to indicate an exponent. “x^2” means “x squared”. This formula is the reverse of the compound interest formula and is thus derived from it.
  If interest rates are low, the value of r is less,  FV is being divided by a smaller number, and thus the formula’s quotient yields a higher value for PV, which is the discounted Present Value of stocks (what they are selling for now). This is closely related to the idea that in a zero interest rate environment, there is no sacrifice of interest required to invest in stocks (there is no low risk, interest yielding alternative to stocks). If earnings decline, the FV part of the formula will decrease and thus the quotient PV will diminish for that reason. If interest rates increase, the formula quotient PV will fall because FV is being divided by a larger number . That is why I say that a slow growth economy with gradually rising earnings and very low interest rates will cause the bull market to resume after the correction completes. If any of these factors changes significantly, the correction could easily develop into a bear market.

By the way, I agree with John that Britain deserves an apology from Americans for not sending at least one rep to Margaret Thatcher’s funeral. She wasn’t just any old politician, but a courageous and honest one.

Ronald Nimmo

April 28, 2013, 6:58 a.m.

The Hunt/Hoisington articles are always rich in economic tutorials for the non-professionally trained in the field. However, I still felt that I did not fully understand the exact difference between an increase in the money supply and an increase in velocity. When money is lent and borrowed, it seems that that is a form of increase in velocity, but it is defined to be only an increase in M2 money supply, but not velocity. What specific actions must occur to turn this lending and borrowing into velocity?
  In John’s column of last week there was prominent discussion of a flaw found in the following research work of Rogers and Reinhardt by an economics graduate student at the U of M @Amherst:

“4) In Debt Overhangs: Past and Present - Post 1800 Episodes Characterized by Public Debt to GDP Levels Exceeding 90% for At Least Five Years, Carmen M. Reinhart, Vincent R. Reinhart and Kenneth S. Rogoff confirm that public debt overhang episodes are associated with growth over one percent lower than during other periods, and such episodes lasted an average of 23 years.”

There was no reference in the Hunt and Hoisington article about this discrepancy. It presented the R & R 2012 paper as unquestioned and unchallenged. What gives with that?


April 26, 2013, 3:03 p.m.

Re: the first of John’s “Two final thoughts” I guess I’m bemused that someone like John is apparently so uninformed about how Federal obligation authority works. The FAA, constrained by Federal law in general and specifically by the “sequestration” law passed by our thoughtless Congress, can NOT just move money around to cover whatever John thinks is important. That’s why Congress is passing a law today to fix the FAA controller problem. Does the Executive Branch have some discretion - yes. Total discretion - hardly. Isn’t that the way we really want it? Unintended consequences!


April 25, 2013, 10:05 a.m.

I don’t agree with John apologizing to his British friends. No need for it. Your apologies and sorry will only deepen the cut!
It’s not Reagan’s or George H.W Bush’ administartion here. We are talking of different times. Move on!
Even Cameron didn’t pay much heed.
The shame comes when we criticize our own administration, who ever is running it. We did it the last time and we are doing it now. Did it change anything?
But do we need to change in order to see the change? Yeah.


April 24, 2013, 7:26 p.m.

What is the matter with your readers? They do not seem to understand what is happening…..

Carl Bechgaard

April 24, 2013, 4:59 p.m.

I disagree with Geoffrey Henny’s comment. To know about John’s travels and the people he meets provides an understanding of the broad background for his writings. Incidentally, I find that comments about other people being motivated by insecurity are often made by people who are themselves affected by this condition.

Barry Rose

April 24, 2013, 3:03 p.m.

I get that the data shows that the Fed isn’t printing money, but the data appears to be in contrast with the evidence.  In 2012 there were multiple articles on Fed “currency swaps”, where their balance sheet increased after the swap. It’s a great deal: the Fed “prints money”, the ECB “prints money”, they swap currencies and smoke a cigarette. If you are swapping asset value for asset value, isn’t that a break-even proposition? How would your balance sheet grow by leaps & bounds? The Fed has purchased the vast majority of the Treasuries issued this year. Where does that money come from?  I’m sorry, but I find it hard to believe that the Fed’s balance sheet can increase $3 trillion without the aid of a printing press.

Robert Hardcastle

April 24, 2013, 7:07 a.m.

Still defending the government debt ratio to GDP indirectly through the Hoisington letter despite that it has been debunked.  Sorry, the earth isn’t flat. However, the letter points out the real problem of private debt.  You and many others identified it at the beginning of the crisis and virtually no real attempts have been made to reduce it except on an individual sink or swim basis. This is where national policy should be directed.  Once the albatross of private debt is reduced, then the economy will expand due to higher disposable income which will increase government revenues thereby reducing the debt load.


April 24, 2013, 7:01 a.m.

They are right, on balance the FED is not adding to money supply but they are changing its character substantially. The FED are printing money with QE, but this effort is negated by the repressive/contractionary/tight policy zero nominal rates and negative real yields. It would seem to me that many things control the velocity of money in a system, but it is relatively trivial to demonstrate that low nominal rates and low or negative real yields are very distructive to the circulation of money in any system (I learned this in the 1990s while working in Japan). So I would argue that the FED, though they may not have much directcontrol, can massively influence the velocity of money, and they are presently conducting a push-me(QE) pull-you(Rates) policy approach (which frankly, is nuts). As the authors rightly note, the change in the make-up of M2 has shifted money in the system away from productive sources into unproductive reserves. This can and will only make the entire situation worse… and therefore, inflation is not a certainty at all… Thanks for posting John.

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