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30nov09 Wilmot Shadows 2parte Cs

30nov09 Wilmot Shadows 2parte Cs

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01/11/2013

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ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ARE IN THE DISCLOSURE APPENDIX. FOR OTHERIMPORTANT DISCLOSURES, PLEASE REFER TOhttps://firesearchdisclosure.credit-suisse.com.
Market Focus
 
Global Strategy
Long Shadows: The Sequel
There can be no doubt that besides the regular types of the circulating medium….there exist still other forms of media of exchange which occasionally or  permanently do the service of money.Now while for certain practical purposes we are accustomed to distinguish theseforms of media of exchange from money proper as being mere substitutes for money, it is clear that, other things equal, any increase or decrease of thesemoney substitutes will have exactly the same effects as an increase or decrease of the quantity of money proper…
”.Friedrich Hayek, Prices and Production 1931 - 1935.We update our estimates and analysis of the “shadow money stock” in the US.Direct bank lending only accounts for about half of total private credit, whichmeans that incorporating shadow money and credit into traditional analysis isabsolutely essential in assessing inflation and deflation risks.We draw four main conclusions:First, there is absolutely NO evidence that the unprecedented increase in publicdeficits and the Fed’s balance sheet has yet created an inflationary overhang of excess liquidity. The effective money stock (M2 plus shadow money) hasgrown only 2.5% p.a. since February 2007.Second, restoring funding liquidity to the financial system was the right thing todo, and has almost certainly prevented a deflationary disaster.Third, just as the devastating wholesale funding run on the shadow bankingsystem prefigured a collapse in commercial bank willingness to lend, it is nowleading the way in restoring credit availability to markets and the economy.Effective money growth has accelerated in the last six months.Fourth, huge volatility in the oil price over the past 18 months has led to muchlarger swings in the effective money stock measured in real terms. Equityprices and production have mirrored those swings quite closely. Going forward,we expect somewhat slower real growth in effective money.
Special Note
: on Tuesday 1
st
December, Jonathan Wilmot will be a guest editor on FT Alphaville, the opinion and news blog of the Financial Times. Our postswill appear simultaneously on theglobal strategy blogpage.30 November 2009
Fixed Income Research
http://www.credit-suisse.com/researchandanalytics
Contributors
Jonathan Wilmot+44 20 7888 3807 jonathan.wilmot@credit-suisse.comJames Sweeney+1 212 538 4648 james.sweeney@credit-suisse.comMatthias Klein+1 212 325 1790matthias.klein@credit-suisse.comAimi Plant+44 20 7888 7054aimi.plant@credit-suisse.comWenzhe Zhao+44 20 7883 8189wenzhe.zhao@credit-suisse.com
 
30 November 2009Market Focus
 
2
 
The Dark Side of the Moon
In May, we showed that a rising public debt and a bigger Fed balance sheet weresubstituting for a collapse in private debt, lending, and leverage. We presented aframework for quantifying this and estimated that the huge expansion of the monetarybase and of public debt (public shadow money) had merely offset a sharp contraction of private shadow money.This broad conclusion remains true today: our measure of the US effective money stock,which includes bank deposits (M2) plus public and private shadow money, is up 6.8%since Q1 2007, just before the financial crisis began. For comparison, nominal GDP hasrisen 3.4% over the same period (Exhibits 1 & 2 below). All of this modest excess growthof money reflects the 3.7% growth in effective money since April.Restoring funding liquidity has allowed private shadow money to rebound by about $1trillion over the past six months. (Recall that it plunged some $3.6 trillion during the crisis.)Public shadow money is up just $150bn since April, after soaring $3 trillion in the crisis.Further credit healing should allow public shadow money growth to slow further, or evencontract as the private balance sheet begins to function again.
If we are correct, extreme opinions about both inflation and deflation are simply notsupported by the facts, and stem from not understanding how the modern financialsystem really works, and so looking at incomplete measures of money and credit.
The error involves too much focus on commercial bank assets and deposits, which nolonger dominate either credit flows or liquid, money like assets. Like the dark side of themoon, shadow money is hard to see. But just because we can’t always see it does notmean we should ignore it.No scientist would make such an elementary error as ignoring the gravitational pull of invisible things, and nor should participants in financial markets. Unfortunately, a greatdeal of bad analysis and potentially bad investment decisions are currently flowing frommaking exactly this kind of mistake.Understanding what is happening to shadow money and credit is therefore of profoundimportance to us all.
Exhibit 1: Total Effective Money Stock and Nominal GDP
100001500020000250003000035000Feb-07Jul-08Nov-08Apr-09Oct-091.71.751.81.851.91.9522.052.12.15
Effective MoneyNominal GDPRatio of Effective Money to Nominal GDP
$ Bn
 
Source: Credit Suisse
 
30 November 2009Market Focus
 
3
 
Fixing a Deflationary Hole
Last spring, we described the collapse of private shadow money, which includes non-agency RMBS, CMBS, investment grade corporate bonds, high yield bonds, and other ABS. We calculated shadow money for each type of debt by multiplying an estimate of thecurrent market value by one minus the prevailing repo market haircut.For example, we calculated that the outstanding investment grade bond stock had amarket value of $5811bn and a median repo haircut of 25%, so it represented shadowmoney of $4359bn ($5811 * (1 – 25%)).
Exhibit 2:US Effective Money (Public versus Private)
Billion $
1000011000120001300014000150001600017000Feb-07Jul-08Nov-08Apr-09Oct-09Private Effective Money = Inside Money + Private Fundable DebtPublic Effective Money = Outside Money + Government-backed Debt
 
Source: Credit Suisse
Exhibit 3: Cumulative Change in Money Stocks
Trillion $
-5-4-3-2-1012345Feb-07Jul-08Nov-08Apr-09Oct-09Public Effective MoneyInside Money (Bank Deposits minus Reserves)Private Shadow Money
 
Source: Credit Suisse
Private shadow money fell from $9.5tr to $5.9tr between early 2007 and last April. Howbig was this $3.6tr fall? Colossal: roughly 40% of the broad M2 money stock, which isaround $8.4tr, and nearly 15% of the effective money stock. And initially at least bigger than the public sector response, leading to a slight fall in effective money.

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