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The Evolution to an All-encompassing Credit Bubble

Strong economic news had mixed impact on the speculative U.S. stock market. For the week, the Dow and S&P500 were about unchanged. The Utilities declined 1% and the Morgan Stanley Consumer index was flat. Economically sensitive issues continue to shine, as the Transports added 2% (up 29% y-t-d) and the Morgan Stanley Cyclical index gained 1% (up 38% y-t-d). The broader market performed well again this week, with the small cap Russell 2000s 3% advance raising 2003 gains to 42%. The Russell is now less than 12% below its all-time high. The S&P400 Mid-cap index added 2%, rising to a new record while increasing y-t-d gains to 30%. The technology speculative Bubble enjoyed the week, as the Semiconductors jumped 6% (up 82% y-t-d) and the Morgan Stanley High Tech index added 3% (up 62% y-t-d). The NASDAQ100's 1.5% rise increased 2003 gains to 46%. The Street.com Internet index gained 2% (up 74% y-t-d), while the NASDAQ Telecom index was unchanged (up 62% y-t-d). The Biotechs were largely unchanged (up 38% y-t-d). The Broker/Dealers added 2% (up 59% y-t-d) and the banks increased 1% (up 27% y-t-d). With bullion down $1.20, the HUI gold index dropped 3%.

Nervousness is returning to the Treasury market. Two-year government yields jumped 18 basis points to 2.0%, their highest yield in 11 months. Five-year Treasury yields surged 19 basis points to 3.43%, and 10-year yields increased 14 basis points to 4.44%. The long-bond saw its yield rise 12 basis points to 5.25%. Benchmark Fannie Mae mortgage-backed yields jumped 16 basis points. The spread on Fannie 4 3/8 2013 note narrowed 1 to 38.5; Freddie's 4 ½% 2012 note narrowed 1.5 to 37.5; the FHLB's 10-year narrowed 4 to 31. The 10-year dollar swap spread added 1 to 43. Corporate spreads narrowed further this week, with junk spreads moving to more than 3-year lows. The implied yield on December 2004 Eurodollars jumped 21 basis points this week to 2.715%, the highest since early September. UK 10-year yields rose 7 basis points to 5.075%, while Australian government yields surged 16 basis points to 5.92%.

Bloomberg tallied a strong $16.4 billion of corporate debt issuance for the week (2003 weekly average of $12.6 billion). Investment grade issuers included Tyco International $1 billion, JPMorgan Chase $750 million, American General Finance $750 million, BP Capital $750 million, Triad Hospitals $600 million, Carnival Corp $550 million, Autozone $500 million, Allied Waste $350 million, Capital One $300 million (three-times oversubscribed), Eastman Chemical $250 million, Mellon Funding $250 million, Aleutian Investments $250 million, Commercial Metal $200 million, Beazer Homes $200 million, Pinnacle West Capital $165 million, MBIA $150 million, Mettler-Toledo $150 million, and State Auto Financial $100 million.

Junk bond funds enjoyed $440.5 million of inflows (from AMG), as huge issuance continues. Dex Media issued $888 million, Charter Communications $500 million, American Towers $400 million, Calpine $400 million, Premcor Refining $385 million, Massey Energy $360 million, MSW Holdings $225 million, Dollar Financial Group $220 million, River Rock Entertainment $200 million, Stratus Tech $170 million, PCC Escrow $100 million, Michael Foods $150 million, Manitowoc $150 million, Quality Distribution $125 million, and Tabletop Holdings $136 million.

Converts: Calpine $400 million and Actuant $125 million,

International dollar debt issuers included Italy's $3 billion and Royal Bank of Scotland's $750 million.

Considering the strength of U.S. economic data and that the dollar is seemingly over-due for a typical bounce, the greenback continues to trade unimpressively. Today's 1% dollar index decline following strong payroll data was not encouraging. The flip-side is the resiliency of commodity prices and non-dollar markets. Emerging debt markets generally outperformed again this week.

"Emerging" stock markets continue to inflate. The Mexican Bolsa gained almost 5% this week to reach a new all-time high (up 38% y-t-d). The Brail Bovespa's 4% rise increased 2003 gains to 66%. Argentina's Merval index rose 3%, increasing y-t-d gains to 83%. In Asia, Thailand was up 5% this week (up 88% y-t-d); South Korea Composite Index gained 3% (up 28%); Philippines Composite added 1% (39%); Singapore Straits Times up 3% (32% y-t-d); India's Mumbai up 1% (up 47% y-t-d); Indonesia's Jakarta was unchanged (up 47% y-t-d) and Taiwan was unchanged (up 36% y-t-d). South Africa's major equity index traded to a 15-month high.

Commodities Watch:

The CRB index today traded to the highest level since May 1997. The Journal of Commerce Industrial Commodity rose almost 1% this week to the highest level since September 1996. Cattle futures were up almost 7% this week and about 35% over the past six months. A shot of cold weather spooked the edgy energy sector, with crude jumping to a three-week high.

November 6 - Bloomberg: "China's iron ore imports jumped more than 34 percent in the first eight months of this year and may reach 145 million metric tons by the end of 2003..."

Global Reflation Watch:

November 5 - Bloomberg: "European service industries such as banking and transport, the biggest part of the region's $8 trillion economy, expanded at the fastest pace in almost three years in October amid increasing signs that economic growth is reviving. Executives across Europe are becoming more upbeat, according to a European Commission survey, which showed confidence at the highest in almost 2 1/2 years in October... European airlines' international passenger traffic rose 6.3 percent in the week ended Oct. 26, led by growth on trans-Atlantic and European routes, the Brussels-based Association of European Airlines said."

November 3 - Bloomberg: "U.K. manufacturing activity grew at its quickest pace in almost four years during October, adding to evidence growth in Europe's second-biggest economy is accelerating." Nov. 4: "U.K. construction activity expanded in October at the fastest pace since July 2001..." "U.K. retail sales rose in October from a year ago at the fastest pace since April 2002..." Nov. 5: "Britain's service industries, including banking, railroads, hotels and restaurants, expanded last month at the quickest pace since November 1999, a survey of 500 companies showed." Nov: 6 "The U.K. Society of Motor Manufacturers and Traders said 2003 vehicle sales would probably be the highest ever as price cuts and incentives lured buyers."November 3 - Bloomberg: "Swiss manufacturing in October expanded at its fastest pace in two-and-a-half years, adding to signs the economy may be emerging from its longest recession in more than a decade."

November 5 - Bloomberg: "Spanish home prices rose at an annual pace of around 17 percent in the third quarter, a bank report estimated, surpassing previous forecasts by appraisers and lenders, who had expected prices to slow in the second half."

November 7 - Bloomberg: "Prague real-estate prices have risen as much as 30 percent this year and are poised to increase further as record-low mortgage rates and rising wages fuel a construction boom in the Czech capital... Czechs borrowed a record 25.8 billion koruna in mortgage loans in the first nine months, or 63 percent more than the same period last year..."

November 4 - Bloomberg: "Irish consumer confidence rose in October to its highest in more than a year..."

November 6 - Bloomberg: "Australia's jobless rate fell to a 14-year low and the economy added four times as many jobs as economists forecast... Australia's new vehicle sales rose 9.5 percent in October from a year earlier... Vehicle sales rose to 79,225 last month, a record for October..."

"China's inflation rate may climb to a six-year high by the end of this quarter as raw material prices increase amid an investment boom, a state researcher said. Consumer prices may rise 2 percent from a year earlier by the end of December." "South Korean producer prices rose in October at their fastest pace in seven months..." "Russian consumer prices rose in October at the fastest rate in six months, led by prices for wheat and grain." "Taiwan's consumer prices in October posted their biggest gains in seven months..." "Philippine inflation accelerated in October to its fastest in three months as oil refiners raised prices to reflect higher crude costs and peso weakness... Even as inflation gathers pace and the peso slides, the central bank said it plans to keep its key overnight interest rates at decade lows until the May general election." Nov. 6: U.K. shop prices grew at the fastest pace on record last month, the British Retail Consortium said. Prices grew 2.4 percent in October from a year ago, the biggest annual gain since the survey began in 1997. Prices rose 1.4 percent in the month."

November 4 - The Wall Street Journal (Robert Guy Matthews): "A recent surge in ocean-shipping rates to their highest levels in decades is adding upward pressure on already rising commodity prices that could push up the cost of imported goods in the U.S. and other countries. With the demand for seafaring vessels far outstripping supply, the cost of shipping iron ore, soybeans, coal and other commodities used in the manufacture of a wide range of goods has nearly tripled this year. The Baltic Dry Index, the key industry indicator for commodity freight rates, has doubled in just the last two months. Industry officials say there are no signs of relief on the horizon in terms of lower prices or additional supplies of vessels... China's surging economy is creating a huge demand for ships to import the basic raw materials the country needs to build infrastructure, supply its massive manufacturing sector and satisfy a growing consumer market... Although ships come in different sizes and shapes, the current spot cost to rent a typical bulk ship -- the length of between two and three football fields -- to ferry coal or iron ore is about $75,000 a day, say traders and shipbrokers. That compares with $20,000 to $28,000 a day in January."

November 3 - Bloomberg: "China's purchases of goods from abroad surged 41 percent in the first nine months of 2003, positioning it to pass Japan this year as the world's third-largest importer, behind the U.S. and Germany. The buying spree has helped boost prices for producers of commodities from metals to agricultural products... China has become the engine of global growth,' said Donald H. Straszheim, a former Merrill Lynch & Co. chief economist..."

November 6 - Bloomberg: "China's foreign-exchange reserves, the world's second biggest after Japan's, rose to a record $401 billion in October, Chinese Vice Premier Zeng Peiyan said... China's exports rose 32 percent to $308 billion in the first nine months of this year and the nation drew $40 billion of investment from overseas, up 12 percent from a year earlier." China reserves jumped $17.1 billion during the month.

November 5 - Bloomberg: "Taiwan's foreign-currency reserves, the third-highest in the world, rose to a record $196.6 billion in October, the island's central bank said in Taipei. The Central Bank of China said Taiwan's foreign reserves, which rank behind those of Japan and China, rose 3.1 percent from $190.6 billion in September." Taiwan October exports were up 10% from the year earlier period.

November 4 - Bloomberg: "South Korea's foreign-exchange reserves rose to a record in October... The reserves rose $1.78 billion during the month to $143.3 billion..."

November 4 - Bloomberg: "Thailand's automobile sales may rise to an eight-year high in 2004 as faster economic growth boosts incomes, encouraging more consumers to buy vehicles, Toyota Motor Corp.'s Thai unit said." Thai October exports were said to have risen 12% from a year ago.

November 4 - Bloomberg: "Singapore's manufacturing expanded at its fastest pace in three years in October..."

November 4 - Bloomberg: "Turkey's exports jumped 36 percent in October from a year earlier..."

November 5 - Dow Jones(Tom Marshall): "The first-ever securitization out of Kazakhstan will come to market by the end of the year, and more deals backed by Kazakh assets could be on the way as structured finance becomes popular in emerging markets."

November 6 - Bloomberg: "Brazil said foreign companies' plans for direct investment jumped 62 percent this year from last, led by capital-intensive industries responding to slower inflation and a stronger currency. Domestic and foreign companies boosted their announced investment plans to $67.9 billion, compared with $42 billion in the same period last year..."

November 5 - Bloomberg: "Brazil's industrial production rose for the first time in six months in September, a sign South America's biggest economy has started to pull out of a slump, the government said. Output rose 4.2 percent in September from the year earlierperiod after shrinking 1.8 percent in August..."

November 3 - Bloomberg: "Argentina's tax revenue rose 32 percent in October as a rise in spending helped boost collection of value-added taxes."

Domestic Credit Inflation Watch:

This afternoon the Federal Reserved reported that September Consumer Credit increased $15.1 billion, or 9.7% annualized. This was three times estimates and the strongest increase since January. Non-revolving (auto, RV, vacation loans, etc.) increased $12.1 billion, or 12.5% annualized (up $19.1 billion over two months). For some time I have found the growth of (non-mortgage) Consumer debt in the face of a massive refi boom a conundrum. Recognizing that so many were borrowing cheap equity finance to pay down higher-yielding consumer debt, why was consumer debt still growing? Well, with a couple post-refi boom months under our belts, it would appear that the answer lies with exceptionally strong underlying consumer borrowings.

November 5 - Bloomberg: "Merrill Lynch & Co., the world's biggest securities firm by capital, will provide prices for bonds based on the IBoxx European index of credit-default swaps to extend the range of the credit derivatives it offers clients. Credit-default swaps, the most common credit derivative, are contracts used to insure against companies defaulting on bond or loan payments. The IBoxx European index tracks the credit-default swaps of 100 European companies that investors and traders use as a benchmark for their credit derivatives investments. Products based on the index allow clients to move in and out of the credit market cheaply and quickly,' said Neil Walker, Merrill's head of credit-derivatives trading in London. It is a highly liquid benchmark.' The global credit-derivatives market is the fastest growing part of the derivatives market, increasing 25 percent to $2.7 trillion in the first half of this year..."

Year-to-date asset-backed security (ABS) issuance of $388.8 billion is up 19% from comparable 2002 (according to JPMorgan data). It should be noted that 2002 ABS issuance was up 83% from 1999. This year's issuance will be double the level from just four years ago. Home Equity Loan (HEL) securitizations have grown to become the dominant sector. Year-to-date HEL issuance of $178.2 billion is running one-third above last year's record pace (2002 HEL issuance was up about 50% from 2001). Year-to-date Credit card securitizations of $56.1 billion are running 3% above 2002, while y-t-d Auto securitizations of $65 billion are running 12% below last year.

It is not easy to take issue with today's Non-farm Payroll data. At 126,000, total Non-farm jobs were added at double the consensus estimates. Moreover, September job creation was revised to 125,000 from the original 57,000, while August's 41,000 lost jobs were revised to a gain of 35,000. For October, Service-producing jobs jumped 143,000, up from September's 138,000. Retail Trade added 30,000, Professional Business Services 43,000, and Education, Health added 56,000. Local Governments added 21,000. The 24,000 lost Manufacturing jobs were the lowest since November 2000.

November 7 - Bloomberg: "U.S. railroads' cargo shipments rose 7.3 percent in October, including the biggest rise in rail-truck shipments in at least four years, a sign that the U.S. economy is strengthening.... The Association of American Railroads trade group said shipments of other cargo, such as grain and chemicals, rose 1.6 percent, the biggest increase since March. The increase in rail shipments (included) a 5.6 percent rise in chemicals and 5.2 percent for grain... The improvement has been rather broad-based,' Morgan Stanley analyst James Valentine said..."

The Institute for Supply Management's Services (Non-manufacturing) index gained for the seventh straight month. October's reading of 64.7 (up 1.4 points during the month) was the second-highest in the six years of the index. New Orders were up 4.5 points to 64.4. For comparison, the New Order index was at 52.3 during October 2002 and 41.3 during October 2001. Interestingly, the Employment index added almost 4 points to 52.9. This is the highest reading since November 2000, and is up from last year's low reading of 43.7. Prices Paid declined 1.4 points to a still strong 58.7.

September's (stronger-than-expected) record Construction Spending was fueled by a remarkable 10.7% y-o-y increase in Residential construction. Yet there are indications of broadening strength/recovery. Spending on Lodging construction was up 15.9% y-o-y, and Commercial was up 3.2% y-o-y. Office construction was down only 7.2% y-o-y, its best performance in some time. Total Private Construction Spending was up 7.9% y-o-y, with Public Spending up 3.7%.

November 7 - Bloomberg: "The National Association of Realtors said mortgage rates that were less than 6 percent for most of the year will help propel U.S. home prices to a record increase. The median price for an existing single-family home likely will jump 8.8 percent to $172,100 this year, beating the record 7.7 percent rise in 1972 when the median price was $26,700... Cheaper borrowing costs mean buyers can afford to pay more for homes. Sales this year will climb to 7.04 million units, higher than 2002's record 6.54 million..."

November 7: "Newcomers entering the real estate industry accounted for three-fourths of a large increase in membership of the National Association of Realtors during last year, according to a survey released at a news briefing at NAR's annual REALTOR® Conference & Expo. More than 23,000 Realtors and guests are attending the Nov. 7-10 meetings in San Francisco. NAR Chief Economist David Lereah said NAR membership growth parallels the historic rise in home sales. NAR has added 102,000 members in the last year for a total of 962,000 - a record that reflects the historic level of home sales while other sectors of the economy experienced weakness.'"

November 5 - Bloomberg: "U.S. sales of condominium and cooperatively owned apartments rose to a record in the third quarter, and prices gained at the second-fastest pace ever, as low mortgage rates fueled home sales. Sales climbed 13 percent from the prior quarter to 971,000 units at a seasonally adjusted annual rate, according to a reportfrom the National Association of Realtors (NAR) in Washington. The median price increased 16.6 percent to $167,200, the second- highest year-over-year gain since the 16.9 percent seen in the second quarter of 2002... (Quoting NAR economist Lawrence Yun) The sales pace for both single-family and condominium sales has been a blow-out number every time the figures come out, because of the low rates. The condominium market is seeing bigger gains because it traditionally brings in more entry-level buyers.'"

The Mortgage Bankers Association Purchase application index bounced back strongly last week. The index was up almost 10% for the week to 404.3. This was 9% above the year earlier level and 27% greater than two years ago. By dollar value, Purchase applications were up 19% y-o-y. Adjustable-rate mortgages were 25% of total new mortgages last week.

The California Association of Realtors (CAR) reported that September sales were up a notable 28% from last September. Median prices increased 17.9% y-y-y to $380,040. Condo prices were up 18.1% y-o-y to $293,820, with unit sales up 25.4%. Despite a major building boom, the inventory of available homes sits at only 2.1 months. Notable y-o-y price inflation includes Los Angeles at 26.6%, High Desert at 24.5%, Riverside/San Bernardino 24.4%, Ventura 25.7%, and Northern California 21.0% (sales up 32% y-o-y).

Bankruptcy filings surged to 35,114, up 12% from the year ago like week. The Manheim Auctions index of Used Car Prices rose during October to the highest level since September 2002. Year-over-year prices actually were up 0.3%, a notable improvement from the double-digit declines from earlier in the year.

Freddie Mac posted 30-year mortgage rates rose 4 basis points to 5.94%. Fifteen-year fixed-rates increased 5 basis points to 5.26%. One-year adjustable rates were unchanged at 3.73%.

Total Bank Assets declined $15.7 billion during the week of October 29. Securities holdings declined $2.5 billion (following the previous week's $32.2 billion gain). Loans & Leases added $2.1 billion, led by a $9.6 billion increase in Security credit. Commercial & Industrial loans declined $2.1 billion and Real Estate loans dropped $8.8 billion. Elsewhere, outstanding Commercial Paper (CP) declined $3.9 billion. Non-financial CP decreased $3.0 billion and Financial CP dipped $0.9 billion.

Last week, Foreign ("custody") Holdings of U.S. Debt, Agencies increased $6.3 billion. "Custody" holdings (Fed holdings for foreign central banks) have surged $70.2 billion over 14 weeks (28% annualized) and $194.4 billion over 52 weeks (24%).

Broad money supply (M3) declined $19.8 billion for the end of October 27. Currency increased $1.6 billion and Demand and Checkable Deposits added $5.1 billion. Savings Deposits declined $15.1 billion and Small Denominated Deposits dipped $0.9 billion. Retail Money Fund deposits declined $3.4 billion, the ninth straight week of decline. Institutional Money Fund deposits added $1.7 billion, while Large Denominated Deposits declined $7.2 billion. Repurchase Agreements slipped $1.6 billion and Eurodollars declined $0.1 billion.

Over the past 14 weeks, M3 has declined $62.1 billion, or 2.6% annualized. This compares to a $300 billion expansion (13% annualized) over the preceding 14 weeks (April 14 to July 21). Digging into the detail, we see some rather interesting divergences. While Savings Deposits have increased $50.7 billion, or 6.1% annualized over the past 14 weeks, Retail Money Fund deposits have declined $37.6 billion (16% annualized) and Institutional Money Fund deposits have dropped $43.0 billion (13.5% ann.) Combined Retail and Institutional Money Funds are down $80.6 billion, or 14.6% annualized. I continue to believe that the fact that money supply has stagnated in the face of continued Credit and liquidity excess is related to current historic long-term debt issuance boom. In particular, I believe the symbiotic ballooning of GSE and foreign central bank balance sheets is a major factor in recent unusual "money" behavior (and I will dive into this analysis next week).

For now, it is worth noting that China's foreign-exchange reserves jumped $17.1 billion during October to $401 billion. Year-to-date, largely dollar reserve holdings have surged $114.6 billion, or an annualized 48%. Chinese reserves increased $74.2 billion during 2002. For further perspective, China's reserves expanded $5.0 billion during 1998, $9.7 billion during 1999, $10.9 billion during 2000, and $46.6 billion during 2001. Through September, Bank of Japan foreign-exchange reserves have surged $132.6 billion, or 39% annualized. Bank of Japan reserves increased $63.7 billion for all of 2002. Combined Chinese and Japanese foreign-exchange reserves are on pace to balloon $314 billion this year (43%), compared to last year's $138 billion. Gone Parabolic.

Quite simply, the world has never witnessed financial sector and global central bank liquidity creation such as we are currently experiencing. "Reliquefication" having run out of control...

The Fed's early-nineties systemic reliquefication -- to recapitalize the U.S. banking system impaired from the consequence of previous excesses -- nurtured today's Powerful Leveraged Speculating Community and U.S. Credit Bubble. It also fueled the Mexican debt Bubble (among others). As we saw in the early nineties and we see today, liquidity will flow to the groups, sectors, markets, and economies with the strongest inflationary biases ("Liquidity Loves Inflation"). The post-Mexican collapse bailout emboldened the fledgling speculator community (inflationary bias) and nurtured the incipient SE Asian and emerging market Bubbles (inflationary bias). Post-SE Asia meltdown global liquidity excess bolstered the Russian and leveraged strategies/LTCM Bubbles. The post-LTCM reliquefication poured gas on the inflationary fire engulfing the Internet/NASDAQ/telecom debt Bubbles. Rampant liquidity coupled with an exceptionally strong inflationary bias (manic conditions) fostered one of history's spectacular periods of blow-off excess. Yet the Fed was ready for more.

The technology Bubble nurtured manic housing Bubbles in Silicon Valley, the Pacific Northwest, and the Northeast, while playing an instrumental role in pushing the dollar Bubble to destabilizing blow-off ("King Dollar") excess. The post-technology Bubble reliquefication stoked the Mortgage Finance ("home prices always go up" and "can't lose lending against housing") inflationary bonfire. And as we are witnessing, ingrained inflationary biases will burn much longer and hotter than reasonable analysis would expect (often more than imaginable!). Indeed, eventual manic blow-off excess is virtually assured as long as the required Credit and liquidity excesses are forthcoming. Unfettered contemporary finance easily accommodates. Unless a responsible central bank moves to restrain excess, a jubilant financial sector will rise to the occasion to finance truly outlandish excess. Over the past two years, unprecedented mortgage finance excess has pushed our current account deficit to blow-off extremes, and in the processes has helped stoke the Chinese economy into it own runaway boom. The Chinese boom now stokes other booms, and so on and so forth.

The Post-King Dollar Global Liquidity Bubble is now nurturing an emerging markets borrowing boom, with unprecedented speculation and Credit Availability internationally. Importantly, The Great Credit Bubble is reaching the stage of becoming an all-encompassing global phenomenon. Global dollar liquidity excess coupled with the Chinese boom fuels an expanding boom throughout Asia. Surging demand and rising prices (especially in dollar terms), has now engendered an inflationary bias throughout the commodities markets. Analysts should be cautious in dismissing the fledgling commodities Bubble. After all, we have witnessed over the previous years scores of incipient Bubbles develop into spectacular ones.

The unfolding Asian boom together with the reckless U.S. Post-boom Boom, is nurturing a synchronized global Credit and economic boom. The U.S. service sector, having maintained its strong inflationary bias, has benefited early and mightily from Credit excess. Importantly, however, the expanding boom is now beginning to impact lagging sectors (previous minimal inflationary bias) such as capital goods spending and the European economies generally. This is a major development. Credit excess begets inflationary manifestations that beget Credit excess.

Meanwhile, unprecedented mortgage excess fuels dangerous housing Bubbles in California, the Northeast and elsewhere. Inflation effects (housing, wages, insurance, etc.) and the resulting negative business climate in California spur businesses to flee the "Golden" state, setting in train booms in states such as Nevada, New Mexico, and Arizona. Post-boom Boom's unparalleled mortgage Credit growth and inflated homeowners' equity fuel record U.S. consumption. Meanwhile, liquidity-driven financial markets team with asset-inflation induced over-consumption to impart significant spending effects throughout the real economy, while stoking self-reinforcing (rampant) speculation, Credit Availability, and lending excess throughout the financial sphere.

The point being? Bubble excess has gone to new extremes. After years of nurturing Credit and speculative excess, the U.S. and global economies have developed significant inflationary biases, in some cases quite extraordinary biases. Each new major inflationary boom sets in train manifestations elsewhere. And with a global financial backdrop that could seemingly not demonstrate a stronger proclivity toward Credit and speculative excess, a powerful mass of speculative finance will today pounce on any advancing market or economy. Excess begets only greater excess. The bottom line is that we're in the midst of an historic Credit-induced global boom. We should expect it to be increasingly unwieldy, subject to unexpected twists and turns. It will certainly have many unintended consequences, mostly negative. The boom has gathered sufficient "critical mass" globally and -- as long as Credit and liquidity continue to be created in such gross excess -- we should be on the lookout for only more pronounced inflationary manifestations.

For now, it is much more analytically productive to recognize inflationary biases than it is to pretend they don't exist. At the same time, with global rates on the rise, we must be especially vigilant in our quest to identify what might precipitate the beginning of the end for the Great Credit Bubble. As growth expands and broadens, borrowing demands will only accelerate. And with the Australian and British central banks now moving in an attempt to rein in borrowing and spending excess, the first salvo has been fired. The leveraged players ought to be nervous. Central bankers will also be increasingly anxious, as the strength of the current inflationary boom will find it immune to little baby step "restraint."

There are two systemic vulnerabilities that are today conspicuous. If the marketplace begins to seriously question their expectation of No Fed for A Considerable Time Scenario (another Fed gaffe?), then things could quickly turn sour throughout the interest rate markets (securities and derivatives). On the other hand, the strong performance of things non-dollar - both real and financial - continue to point toward an unfolding dollar supply vs. demand problem. Days like today, with sinking bond prices and a reeling dollar, must be trying for our foreign creditors. An enthusiastic leveraged speculating community and eager foreign lenders have been instrumental to the long-lived Credit Bubble. We've always taken them for granted, their propensity to be on the long-side of our financial Bubble. With things today so overheated, we can't afford for either to get cold feet.

Providing stark contrast to last week's astute observations from the ECB's Otmar Issing, I will excerpt from "Remarks by Governor Ben S. Bernanke: November 6 - The Global Economic and Investment Outlook Conference." I would title it Central Bank Drivel.

"In lieu of involving myself (unproductively) in this debate [the tradeoffs of free trade], I will make two broader points that put the current trade issue in some context. First, the recent shift in trade patterns cannot at bottom be explained by microeconomic factors such as trade barriers or changes in consumer preferences for imported versus domestic goods. Rather, the shifts in trade are fundamentally the result of a macroeconomic phenomenon--namely, the U.S. current account deficit. The current account deficit, now close to 5 percent of U.S. GDP, reflects both U.S. economic weakness and U.S. economic strength. It reflects weakness in that one of its causes is the relatively low rate of U.S. national saving. Low national saving forces us to meet domestic funding needs by borrowing abroad, and the high rate of domestic spending implied by a low saving rate forces us to meet domestic demands by importing more than we export. But the current account deficit also reflects U.S. economic strength, shown both by the attractiveness of the U.S. economy to foreign investors (which has stimulated capital inflows and supported the value of the dollar) and by the fact that economic growth in the United States is proceeding more rapidly than that of most of our trading partners (which has resulted in imports increasing more than exports).

As is widely recognized, the U.S. current account deficit cannot be sustained indefinitely at its current high level and will eventually have to be brought down to a more manageable size. However, eliminating the U.S. current account deficit too quickly is neither desirable nor feasible. Any attempt to do so would probably involve sharp reductions in domestic spending, which would have far worse effects on U.S. employment than the current account deficit does. Thus the hypothetical scenario to which I alluded earlier, in which domestic and foreign demands are unchanged but export and import shares are those of 1999, is simply not a feasible alternative right now. For now, our best strategy is to encourage pro-growth policies among our trading partners, in the expectation that more-rapid growth abroad will raise the demand for U.S. exports. At the same time, we should do what we can to help U.S. workers displaced by shifting trade patterns to retrain and relocate, if necessary.

The second point I will make may surprise you; it is that, despite the inroads made by imports, in real terms manufacturing production in the United States has risen rapidly over the past fifty years. The recent recession has affected that trend only modestly. For example, although as of September 2003 U.S. manufacturing output was about 6 percent below its mid-2000 peak, it was also about equal to the level reached in 1999 and half again the level attained in 1990. If manufacturing output has not declined in the United States, then what explains the sharp reductions in U.S. manufacturing employment that have occurred not only in the past few years but over preceding decades as well? The answer is a stellar record of productivity growth."

"Manufacturing production in the United States has risen rapidly over the past fifty years"? And, "Our best strategy is to encourage pro-growth policies among our trade partners"? Well, whitewashing our economy's deep structural distortions, while patently disregarding our system's dangerous Credit and speculative excesses is a rather flagrant case of Derelict Central Banking. As Dr. Issing accurately inferred, our policymakers believe it's "Our deficit, your problem!" They are deluded.

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