ONLY THE SHADOW KNOWS!

"Who knows what evil lurks in the hearts of men? Only the Shadow Knows!"

My brother-in-law and I like to reminisce about old TV and radio shows. The above line was the intro to the radio show "The Detective" which came to be called "The Shadow" soon after it went on the air in 1930. The show was popular and played on until 1954.

Marconi invented wireless radio in 1895. His first signal went one and a half miles. Do you suppose he would be surprised to see folks walking around talking on cell phones? I digress.

Anyway, I can barely remember hearing the announcer’s deep voice saying, "Who knows what evil lurks in the hearts of men? The Shadow knows!” In the early 70's, at least one station played re-runs. Do you remember William Boyd? How about Hop-a-long Cassidy (trick question), Jingles or Howdy Doody Time? I am showing my age.

The Shadow was very good at picking up on tiny clues that helped him beat The Black Master or the Red Menace. The Shadow would have noticed the bank advertisements in this morning’s paper.

Why would Wachovia and CCB bank offer to pay more interest on 5 year deposits than the US Government will pay on ten year US Government Bonds? The Shadow would have dug as deep as necessary to find the answer? He would not have had the benefit of the mid to late 1970's so we have the advantage. On the other hand the Shadow knew about disintermediation from his life during the depression.

Disintermediation is the process of folks drawing money out of banks and investing it directly in government bonds. When the demand for money is low the federal government is willing to lend money to the banks at very low rates. Depositors get higher yields than offered by the government. When the demand for money is high, the US Government and banks are in effect in competition with one another to take in "deposits". Is the demand for money high or low?

The Federal Reserve for the past several years has offered to lend money at a negative real interest rate! In other words, the FOMC has offered a federal funds rate that is less than the inflation rate; but, there is a "correction" in progress. The Fed does not want to spook the markets so it is making gradual moves. For six consecutive months, the Fed has raised the Fed Funds Rate by one quarter of one percent. The money rate offered by the Fed has risen from 1% to 2.5%. Has the Fed raised rates enough?

The $64,000 question! Maybe only the Shadow Knows?

After a recession, economies go through a recovery and then an expansion. The US economy has moved through the recovery and selected industries are now in an expansion. For an industry to expand, it must have capital. Companies that are flush with bank deposits, expand by drawing down on these deposits. However, in a strong economy, companies sooner or later issue new stock or borrow money. Banks are required by law to have deposits to back-up a certain portion of all loans on the books. Banks have had no trouble maintaining a healthy ratio of deposits to loans for the past several years. Banks have been able to pay 1% or so and scared investors have left large amounts on deposit.

In the late 70's, I noticed the same situation. The banks took out large advertisements offering high rates for 5 years. It looked a little silly at the time. After all, in several years prior, banks took in deposits at low rates to buy US Bonds at higher rates. Why would they pay more than the Government Bonds?

The banks see deposit draw downs and loan demand coming long before the average investor. The high rates customers secured on long term CD's in 1977 and 1978 turned out to be low paying CD's. Rates were headed up and the banks knew it before the general population.

Disintermediation can be extremely risky for banks. Therefore, they try to get ahead of the curve. Banks hate to pay out unnecessary interest but would rather lock-in higher rates now than to scramble for deposits when a bank examiner is checking the books.

Greenspan testified today before congress. I did not see most of the testimony but I did catch a couple of important points about social security. One is that the short fall of about 11 Trillion Dollars needs to be made up under the current plan and under the private account plan. The cash to the system is the same. The alarmist view that trillions will need to be borrowed under the Bush plan is a lot of hooey. The second point is that he likes my favorite way to make up the 11 Trillion. It is a simple way and it is as fair as one can make it.

All that needs to be done is to index the starting benefits to the price index rather than to the wage index. This way, those who are currently drawing benefits will see no change. Those who start drawing in the future will get the promised starting amount and they will see increases in their subsequent checks that are in line with inflation.

The Shadow has checked the bank deposit offerings and he knows that the economy must be strong. He knows that company profits have been going up and must be projected by the business management to be going up even more. He knows that banks are preparing to lend money to companies at higher interest rates. He knows that the social security problem is not such a difficult problem to solve. The Shadow knows that conditions are ripe for accumulating wealth. Does ONLY THE SHADOW KNOW?