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Issing v. Greenspan


For the holiday-shortened week, the Dow and S&P500 were largely unchanged. The Morgan Stanley Consumer index added almost 1%, while the Morgan Stanley Cyclical index posted a small decline. The Utilities were small winners, while the Transports dipped almost 1%. The broader market traded on the soft side. The small cap Russell 2000 was down marginally, with the S&P400 Mid-caps were down about 1%. The NASDAQ100 was unchanged, while the Morgan Stanley High Tech index declined less than 1%. The Semiconductors and NASDAQ Telecom stocks were about unchanged, while The Street.com Internet index declined better than 1%. The Biotechs posted a small gain. The financial stocks remain resilient, with the Broker/Dealers up slightly and the Banks down slightly for the week. With bullion down $12.50, the HUI gold index dropped 5%.

Strong data and unsettled currency markets had the Credit market on edge. For the week, 2-year Treasury yields rose 4 basis points to 1.71% and 5-year Treasury yields added 7 basis points to 3.08%. Ten-year Treasury yields rose 5 basis points to 4.10%. The long-bond saw its yield increase 4 basis points to 4.95%. Benchmark Fannie Mae mortgage-backed yields, up 5 basis points, rose along with Treasuries. The implied yield on December 3-month Eurodollars rose 6.5 basis points to 1.845%. The Spread on Fannie's 4 3/8 2013 note was unchanged at 30bps and the spread on Freddie's 4 ½% 2013 note narrowed 1bps to 29. The 10-year dollar swap spread added 0.75 to 39.25.

Corporate bonds were mixed this week, with investment grade issues outperforming the wobbly junk. Investment grade issuers included Lehman Brothers $1.25 billion, Rogers Wireless $750 million, National Rural Utilities $600 million, Duke Capital $480 million, Nationwide Life $250 million, MGM Mirage $225 million, and PPL Capital Funding $200 million.

Reversing two weeks of meaningful outflows, junk bond funds received inflows of $227.4 million (from AMG). Junk bond issuers included Isle of Capri $500 million, AMC Entertainment $300 billion, AMF Bowling $150 million, Chattem $200 million, Odebrech Overseas $150 million, Comstock Resources $175 million, and Jo-Ann Stores $100 million.

Convert issuers included Fisher Scientific $300 million and CP Ships Limited $175 million.

Freddie Mac posted 30-year fixed mortgage rates dropped 8 basis points last week (down 14 basis points over two weeks) to 5.58%. These are the lowest rates since early July, and are down a notable 86 basis points since the early-September peak. Fifteen-year fixed mortgage rates declined 9 basis points to 4.87%, with a two-week decline of 16 basis points. One-year adjustable-rate mortgages could be had at 3.53%, down 4 basis points for the week and down 8 over two weeks. The Mortgage Bankers Association Purchase application index (seasonally-adjusted) rose 2.9% for the week. Purchase applications were up 22% from one year ago, with dollar volume up 37.3%. Refi applications were up 6.4%, with five straight weeks above 3000. The Average Purchase loan was for $216,200, with the average adjustable-rate mortgage at $299,000.

Federal Reserve Foreign "Custody" Holdings increased $9 billion to $1.135 Trillion, with 20-week gains of $161 billion (43% annualized).

Broad money supply (M3) expanded $14.4 billion for the week of February 9. Demand and Checkable Deposits declined $3.5 billion. Saving Deposits jumped $12.0 billion for the week to $3.22 Trillion. Savings Deposits were up $61.2 billion during the first six weeks of 2004, with 52-week gains of $365.1 billion, or 12.8%. Small Denominated Deposits were down $0.9 billion for the week, with Retail Money Fund Deposits declining $3.7 billion. Institutional Money Fund deposits dropped $7.1 billion, while Large Denominated Deposits jumped $15.6 billion. Repurchase Agreements dipped $3.2 billion, while Eurodollar deposits added $4.7 billion.

Total Bank Credit surged $46.0 billion during the week of February 11, with six-week gains of $113 billion. Securities increased $11.5 billion last week. Loans & Leases jumped $34.5 billion, with six-week gains of $111.5 billion. Commercial & Industrial loans declined $1.1 billion. Real Estate loans increased $8.9 billon ($16.8 billion in two weeks). Security loans increased $17.6 billion and Other loans rose $11.4 billion. Elsewhere, Total Commercial Paper (CP) increased $7.9 billion to $1.317 Trillion. Non-financial added $4.8 billion, while Non-financial rose $3.0 billion. Year-to-date, CP is up $48 billion (28% annualized). Financial sector CP borrowings have expanded $38 billion y-t-d to $1.2 Trillion.

Currency Watch:

Currency markets were wild, with the dollar gaining about 2% today against the yen, the pound, and the New Zealand and Australian dollars. The dollar index posted a 2% gain for the week.

The Brazilian real declined 2% this week in the face of unsettled stock and bond markets.

Commodities Watch:

February 14 - Financial Times (Kevin Morrison): "Coal is shedding its dirty and cheap image to become a sought-after commodity as customers shell out record prices for the black nuggets. The increase in coal prices has little to do with market speculation as the majority of coal prices are set through long-term contracts... The increase in demand has caught many coking coal producers by surprise and there are growing fears of shortages in the commodity as production capacity has failed to keep pace with the upswing in demand. Jim Lennon, metals analyst at Macquarie Bank, said the shortage of coking coal follows fears of a collapse in Chinese exports, as it diverts more of its coal production into domestic usage to satisfy the needs of the country's steel industry. Mr. Lennon said this has caused panic buying, with reports of Chinese coking coal export prices reading $400 per tonne before shipping freight costs. This is almost double the December price and up from less than $70 a tonne three years ago... US hot rolled coil steel, the most widely quoted steel price, reached almost $500 a tonne recently from less than $200 a tonne three years ago... Steel scrap prices have also risen sharply, with prices quoted at about $350 a tonne, a 75 per cent increase on three months ago."

February 20 - Bloomberg (Wing-Gar Cheng): "Asia's shortage of ethylene, a chemical used to make plastics for bottled water, drain pipes and textiles, may continue through March and keep prices near their highest in a decade as demand surges in China, traders said. Ethylene delivered to Northeast Asia this week have risen to as much as $810 a metric ton, according to petrochemicals oil pricing service ICIS-LOR. That's the highest since Nov. 6, 1992..."

February 19 - Bloomberg (Claudia Carpenter): "Copper futures in New York rose for a sixth straight session as demand in the U.S. and China, the world's biggest consumers of the metal, outpaced supply... Prices yesterday reached $1.3595, the highest price for a most-active contract since November 1995."

February 19 - Reuters: "Procter & Gamble Co. on Thursday said it would raise prices on tissue prices 5 percent to 6 percent this summer in order to make up for rising pulp and energy prices."

The CRB and Goldman Sachs commodity indices were down slightly for the week.

Global Reflation Watch:

February 20 - Dow Jones (Allison Bisbey Colter): "Revised data from TASS Research indicate the hedge-fund industry grew twice as fast in the fourth quarter as initially estimated. TASS said Thursday that investors added a record $26.8 billion to these private investment pools between October and December, compared with its preliminary estimate of $15 billion, released late in January. The revised data show that the industry's growth is picking up, rather than slowing down, compared with the third quarter, when hedge funds pulled in $24.6 billion of new money. For 2003 as a whole, new money flowing into the industry totaled $72.2 billion, a more than fourfold increase over $16.3 billion in 2002 and more than double the previous annual record of $32 billion in 2001. TASS now estimates the total size of the industry at about $750 billion." (The Financial Times this week used $800 billion for total hedge funds assets.)

February 19 - Reuters: "Emerging market debt trading bounced back in 2003, rising 29 percent to $3.97 Trillion over 2002's $3.07 Trillion... 'This is the highest level of annual trading since 1998, when fallout from the Asian and Russian financial crises resulted in a sharp and extended contraction in the emerging markets debt industry,' the (Emerging Market Traders Association) said in a news release. Last year's activity nearly doubled the $2.18 Trillion traded in 1999. Fourth-quarter 2003 volumes stood at $1.015 Trillion...32% higher than the $768 billion in the fourth quarter of 2002..."

February 20 - Bloomberg (Christian Baumgaertel): "European countries, consumers and non-financial companies raised money at a faster rate in the third quarter of last year than in the previous three-month period, the European Central Bank said. The financing growth rate for governments, households and businesses rose to an annual 5 percent from an annual rate of 4.7 percent in the second quarter, the Frankfurt-based ECB said..."

February 19 - Bloomberg (Julia Kollewe): "U.K. mortgage-lending last month surged at the fastest pace in two years, the British Bankers' Association said, suggesting higher interest rates haven't cooled consumer demand for home loans. Mortgage-lending rose by 5.9 billion pounds ($11 billion) in January, the largest increase since November 2001 and exceeding the average rise of 5.4 billion pounds in recent months... The Bank of England says it's been surprised by the strength of consumer spending. "

February 19 - Market News: "The UK's measure of broad money, M4, rose in January by 1.1% on the month, according to provisional, seasonally adjusted figures released Thursday by the Bank of England. The annual rate of growth was 8.4%, up from 6.9% in December."

February 19 - Bloomberg (Guy Faulconbridge and Marta Srnic): "Russia attracted a record $29.7 billion of foreign inflows last year as the longest economic boom since the Soviet Union's demise boosted demand for credit. Foreign inflows soared 50 percent from 2002. Foreign loans led the gains with $22.2 billion of the total $29.7 billion, the Moscow-based State Statistics Committee said... Foreign direct investment rose 69 percent to $6.8 billion and portfolio investment fell 15 percent to $401 million... Some of the biggest flows of money into Russia come from off-shore centers, which avoid restrictive regulations, taxes and other costs."

February 18 - Bloomberg (Todd Prince and Guy Faulconbridge): "The Russian stock and property markets may be rising too fast as foreign and domestic investors pump money into the former Soviet state, Economy Minister German Gref said..."

February 19 - Bloomberg (Guy Faulconbridge and Todd Prince): "Russia's foreign currency and gold reserves rose to a record $88 billion, posting their biggest weekly gain since mid-1998, as the central bank bought dollars from oil and gas exporters. Russia's reserves rose $3.7 billion in the week to Feb. 13 and have added $10.2 billion since the start of the year."

February 18 - Bloomberg (Daisuke Takato): "Japan's economy grew at a 7 percent annual pace last quarter, the fastest in more than 13 years, as companies such as Sharp Corp. and Canon Inc. increased investment and falling unemployment spurred consumer spending. The world's second-largest economy outpaced the 4.7 percent median forecast... Growth in the quarter was the fastest since Japan's bubble economy collapsed in 1990, slashing property values and leading to three recessions. Finance Minister Sadakazu Tanigaki said the government 'needs to continue to fight deflation,' responding to speculation that Japan sold yen to prevent its gains from curbing exports and pushing down import prices."

February 20 - Bloomberg (Mayumi Otsuma): "Japanese Finance Minister Sadakazu Tanigaki said the government and the central bank must continue working together to halt deflation. 'We cannot relax and ease our attempts' to overcome deflation, Tanigaki said at a regular press conference in Tokyo after a Cabinet meeting. 'Price declines continue in Japan and the government and the Bank of Japan need continued cooperation to end deflation,' Tanigaki said.

February 20 - Bloomberg (Sonia Tsang): "China's air passenger traffic will rise by 20 percent this year to 103.8 million as the economy expands and the government allows British Airways Plc and other overseas carriers to fly there more frequently, the international Air Transport Association said. Air cargo volume in the world's fastest-growing major aviation market will rise 18 percent to 2.5 million tons..."

February 20 - Bloomberg (Koh Chin Ling): "Taiwan raised its economic growth forecast for this year after record exports helped the economy expand at its fastest in more than a year in the fourth quarter. Gross domestic product rose 5.2 percent from a year earlier after increasing 4.2 percent in the previous three months, the statistics bureau said in a statement in Taipei. The government, which predicts a similar gain this quarter, raised its 2004 growth forecast to 4.7 percent from 4.1 percent previously."

February 19 - Bloomberg (Seyoon Kim): "South Korea's seasonally adjusted jobless rate fell to a nine-month low of 3.3 percent in January as booming exports stoke growth in Asia's fourth-largest economy. Last month's rate is the lowest since April and compares with 3.5 percent in December... Consumer confidence reached a 16-month high in January and wholesale and retail sales, a gauge of consumer spending, rose in December from the previous month."

February 19 - Bloomberg (Sam Nagarajan): "India's gross domestic product grew 8.9 percent in the fiscal third quarter to Dec. 31, Finance Minister Jaswant Singh told reporters in Mumbai. Asia's third-biggest economy will expand 8.1 percent, its fastest pace in 15 years, in the year to March 31, India's Central Statistical Organization said this month. Singh described the third-quarter GDP expansion as 'a remarkable achievement.' India's economy grew 8.4 percent in the three months ended Sept. 30."

February 20 - Bloomberg (Anil Penna): "For Sujatha Singhal, a phone company executive who lives near the Indian capital of New Delhi, being able to shop around for her $55,000 home loan was a luxury. 'Four years ago, there wasn't much of a choice,' said Singhal... 'Now you can negotiate lower rates like you'd bargain for a discount on a television. Banks are eager to lend.' Competition for India's new consumer wealth is turning a nation of traditional savers into debtors. Banks that promise to 'make your dreams come true in 72 hours,' tax incentives and interest rates at a 30-year low of about 8 percent have more than tripled individual loans in four years to $36.6 billion. Some bank stocks rose 400 percent in 2003 as locals competed against Citigroup Inc., HSBC Holdings Plc and ABN Amro Holding NV to offer easy credit. It may be a bad-loan debacle waiting to happen... Foreign banks are boosting consumer-lending efforts... Citigroup's Citibank NA advertises 'three-minute' online approval for loans for everything from computers to vacations. To 'make your dreams come true' it will finance the entire value of a property against collateral such as shares and mutual-fund investments. No guarantors are required. 'The Indian customer is still in the first stage of making a transition from being saver to a borrower,' said Amit Sah, Citibank's marketing director for retail banking. 'Approval decisions are made on either the collateral or the profile of borrowers.'"

February 19 - Dow Jones: "Argentina's economy expanded 8.4% in 2003 according to preliminary figures released Thursday, as the economy bounced back from a four-year recession to post its strongest growth in years. In a press release, Argentina's national statistics agency, Indec, also said gross domestic product grew 10.9% in December from a year earlier."

U.S. Bubble Economy Watch:

The New York State manufacturing index increased 3.2 points to a record 42.1. Prices Paid jumped almost 6 points to 33.6 and were up from November's 9.3. The Philadelphia Fed index declined more than expected, but January's reading was the second-strongest in the past decade. Prices Paid surged 8.4 points to 43.7, the highest level since February 1995. Prices Paid is up a remarkable 48.8 points since July.

January Housing Starts declined more than expected to an annualized rate of 1.903 million units. Starts remain strong, and it is likely that frigid temperatures impacted building in some regions. Starts were especially weak in the Midwest and Northeast. Year-over-year, January Starts were up 4.1%, with Multi-family starts up 14.7%. Building Permits were up 6.9% y-o-y, with multi-family permits up 11.1%. Homes under construction were up 13.2% y-o-y to a pace of 1.193 million units.

February 17 - Reuters: "IMS Health, which provides data on prescriptions and pharmaceutical sales, said Tuesday U.S. prescription drug sales rose 11.5 percent to $216.4 billion last year."

There were 30,533 bankruptcy filings last week, about 5% above the year ago level. 

California Housing Bubble Watch:

February 19 - San Francisco Chronicle (Kelly Zito): "The Bay Area real estate market chugged along in January, with sales posting a 15-year high for that month and year-over-year home prices jumping by about 12 percent... The median price for a single-family home in the nine counties hit $463,000 in January, up 11.6 percent from the $415,000 median last year, according to DataQuick... Prices for single-family houses in four counties -- San Francisco, San Mateo, Santa Clara and Marin -- were above the half-million dollar mark. For the seventh month in a row, the sales tally was the highest for that month in at least 15 years... DataQuick won't release information on February home sales for about four weeks. But agents in Santa Clara County say sales are rocketing. According to Richard Calhoun, owner of Creekside Realty in San Jose, about 429 homes have changed hands in the past week. That's about 56 percent more than the weekly average a year ago. Calhoun said that new types of mortgages, as well as lenders' willingness to allow buyers to devote more of their incomes to house payments, may be playing a role. He cited one client who is purchasing a San Jose condo with an interest- only loan... 'The old rule that you spend 2.5 to 3 times your income (on a home) is clearly out the window,' Calhoun said, noting that the purchase price of his client's home is roughly 5.5 times her income... 'It's difficult for buyers right now,' said Robin Kingsbury, an agent at Red Oak Realty in Berkeley, who added that the last four properties with which he's been involved have sold for more than $100,000 above their respective asking prices. 'Winning bidders are happy and sellers are happy.'"

February 19 - Los Angles Times (Roger Vincent): "Ventura County led Southern California in year-over-year home price increases last month with a 26.8% jump to a median of $430,000 as the hot market kept pressure on prices. The overall increase for six Southern California counties was 21.2%, to a median of $343,000, according to a report released Wednesday by DataQuick Information Systems...DataQuick said San Diego County's median home price rose 17.9% in January from a year earlier to $396,000. The Riverside County median - the point at which half the homes sold cost less and half more - rose 23% to $273,000. The median price in San Bernardino County rose 17.8% to $205,000... the median price in Los Angeles County went up 26.6% in January from a year earlier to $352,000."

February 18 - Los Angeles Times (Roger Vincent): "The median price of a previously owned home in Orange County hit $500,000 for the first time last month as property values continued their meteoric rise. Orange County is the first Southern California county to hit the half-million-dollar mark for resales, said analyst John Karevoll of DataQuick... The latest resale record reflected a 26.6% price jump from $395,000 in January 2003. ...prices keep going up because ' Orange County has more people who want to buy homes than there are for sale, (Karevoll) said. That means real estate agents like Alison McCormick of Strada Properties in Newport Beach are scrambling to find properties for their buyers. 'There is not a lot on the market, and what's there is going up and up in price.' The median price of an Orange County condo climbed 27.5% to $325,000 in January... The overall number of homes sold fell 12.5%...which McCormick attributed to lack of inventory. 'We are seeing a lot of panic in this market. People are buying things that they wouldn't normally.'

The California Housing Bubble is running out of control.

U.S. Credit Inflation Watch:

February 19 - Bloomberg (Ryan J. Donmoyer): "The U.S. will mail $37 billion more in refunds to Americans in the next three months than it did at the same time last year because of new tax cuts, the Treasury Department said. The average $300 increase may be enough to boost the gross domestic product, an economist said. 'Let's face it, this is a big amount,' said Bill Sullivan, senior economist at Morgan Stanley. 'This has the capability of adding 1 or 2 percent to the annual growth rate of GDP during this period.' The $37 billion, 23 percent increase to $195 billion amounts to a half percent of the $7.4 trillion that consumers spent last year."

February 19 - "Most states expect to ride out the fiscal year with only one-tenth of the budget shortfalls they carried at this point last year and 30 states report they should end the year with a modest surplus, according to a 50-state fiscal survey released today by the National Conference of State Legislatures. At the same time, states are projecting more than $35 billion in budget gaps for the 2005 fiscal year. NCSL's State Budget Update: February 2004, a survey of state legislative fiscal directors, shows the flow of red ink that states grappled with last year is ebbing, at least for now. States currently report only a $2.5 billion cumulative budget gap, compared with the $25.7 billion they reported one year ago."

This week Fannie Mae increased its estimate of 2004 mortgage originations by 12%: "We now expect home sales to be roughly equal to their record levels of last year -- with new sales at 1.08 million units and existing sales at 6.04 million units. If mortgage rates stay low for more than a couple of weeks (while the economy continues to grow solidly), we may raise our projection for home sales to new records over the next month or two. The lower level of mortgage rates should also boost refi activity, especially for cash-out refis (with continued strong home price gains). Purchase originations are now projected to rise by 5.2 percent to a record $1.25 trillion, while refis are forecast to plummet by 73.6 percent to $667 billion -- with total originations falling by nearly 50 percent to $1.91 trillion. Despite the declines in refinance and total originations, all three of these measures are higher in our latest forecast than in our previous one: by $731 billion for purchase originations, $63 billion for refis, and $794 billion for total origination. With stronger home sales, more refinance activity (especially for cash-out refis), and continued strong home price appreciation, our projection for single-family MDO (mortgage debt outstanding) has also risen for 2004 -- from a gain of 8.6 percent last month to 9.4 percent in our most recent outlook. This would mean that in the seven years since MDO growth recovered from the slow growth period of 1991-97, it would have grown at a 10.5 percent compound annual rate -- and from the beginning of this decade, it would have risen at an 11.3 percent rate."

Fannie Mae reported a somewhat subdued January. Total Book of Business expanded about $7 billion, or 3.8% annualized. Non-retained MBS expanded at an 18.5% annualized rate to $1.32 Trillion, while Fannie's Retained Portfolio contracted at a 14.6% annualized rate to $887 billion. Perhaps Freddie gained at Fannie's expense during January. Today from the American Banker (Jody Shenn): "Countrywide Financial Corp., which has long securitized nearly all its conforming loan production through Fannie Mae, appears to be sending much more of its business to Freddie Mac." Slower Fannie growth is also offset by the notable up-tick in bank Credit so far this year.

Golden West Financial saw January Loans expand at a 20% annualized rate, down from December's 32% pace. Loans have expanded at a 27% pace over the past three months. Total Assets were up 19% y-o-y to $82.9 billion.

Issing v. Greenspan

The unfolding discord between the ECB and the Greenspan Fed took an interesting and decidedly public turn this week, as the Wall Street Journal published an astute piece by ECB Chief Economist (and my personal favorite contemporary central banker) Dr. Otmar Issing. The follow are excerpts:

"There seem to be strong arguments that central banks should not target asset prices, and only assess their development in the context of their potential influence on goods prices... Even in the case of extreme high valuations of assets, a situation in which most observers would agree that the prevailing level of asset prices is not sustainable... there are strong arguments that a central bank should not try to 'prick the bubble.' The interest rate increase required to prick the bubble in times of collective exuberance would inflict heavy losses on the real economy. The negative consequences for the reputation of the central bank following such policy would be more than obvious.

All this is the consensus view.

But can central banks just leave it at that and reject any responsibility? I grant that it is a tough challenge to identify an overshooting of asset prices at an early stage. And to repeat, no central bank should pretend knowledge it cannot dispose of. Nevertheless, we have repeatedly experienced situations in which market participants found it more rewarding to follow a trend than to bet against it despite their own view that the development was not sustainable. It is worth noting that with hindsight, i.e. after the collapse, almost everybody seems to agree that a 'bubble' has burst. Is it not difficult, then, to accept the argument that it should be totally impossible to make any judgement ex ante? Should it not be the role of central banks to communicate concerns in an appropriate form and thereby to try to contribute to a more sober assessment of asset price developments?

Huge swings in asset valuations can imply significant misallocations of resources in the economy and furthermore create problems for monetary policy. Not every strong decline in asset prices causes deflation, but all major deflations in the world were related to a sudden, continuing and substantial fall in values of assets. The consequences for banks, companies and households can be tremendous...

Prevention is the best way to minimize costs for society from a longer-term perspective. Central banks are confronted with this responsibility, but there is no easy answer to this challenge. So far, only some tentative conclusions can be drawn. First, in their communication, central banks should certainly avoid contributing to unsustainable collective euphoria and might even signal concerns about developments in the valuation of assets. Second, the argument that monetary policy should consider a rather long horizon is strengthened by the need to take into account movements of asset prices.

Finally, it should not be overlooked that most exceptional increases in prices for stocks and real estate in history were accompanied by strong expansions of money and/or credit. Just as consumer-price inflation is often described as a situation of 'too much money chasing too few goods,' asset-price inflation could similarly be characterized as 'too much money chasing too few assets.'"

It is surely not by happenstance that Dr. Issing's article was titled Money and Credit, and I simply could not be more appreciative. We live, after all, in an idiosyncratic era where the critical analysis of "money and Credit" is bungled from all sides. It is dismissed as archaic by the New Paradigmers, and barely paid lip service by the New Era Apostles - The Experimental Greenspan Fed. It is applied duplicitously by the "supply-siders." The monetarists are hopelessly hamstrung by their fixation on narrow money. They disregard "Credit," the preeminent issue in contemporary (non-bank, securities and structured finance dominated) finance and economics. At the same time, and similarly frustrating, the vast majority of those analysts and pundits critical of the Fed (including the today's "Austrians," and "Elloitticians") absolutely butcher the analysis of contemporary money and Credit. Everyone has their own agenda that detracts from sound analysis.

Dr. Issing is the exception: Sound Money and Credit is his Agenda. His views and analysis therefore should be given top billing. And I would venture a little conjecture: His Journal op-ed piece is more an opening salvo than a definitive statement on this most important subject (the kid gloves come off later). The ECB has a fundamental problem with the policies of the Greenspan Fed that will not be resolved anytime soon - Irreconcilable Differences that will manifest into marketplace uncertainty.

I have always appreciated the concept of "sound money." Gold-backed monetary regimes throughout history demonstrated the virtues of financial and economic stability. Conversely, history provides many examples of seductive inflationary booms followed inevitably by the pain and suffering wrought by government fiat currencies and wildcat finance. I appreciate how systems, drifting gingerly yet purposely away from stable Money & Credit, eventually loose their bearings.

And after studying one of history's great financial follies "up close and personal," I have come to possess the utmost respect for the anchor of "sound money." Without it - as we have learned to anticipate - the financial and economic ships drift off and eventually become hopelessly lost at sea. What's more, I am now coming to grips with another critical facet of The Anchor: Especially today - as we grapple with the "blow-off"/parabolic stage of Credit and speculative excess - the mooring of sound Money & Credit is absolutely paramount. Without an analytical framework built around sound money and Credit, things become hopelessly adrift analytically, intellectually and ideologically.

In last week's discussion with Congressman Ron Paul, Dr. Greenspan explained that "we have statutorily gone onto a fiat money standard, and as a consequence of that, it is inevitable that the authority which is the producer of the money supply will have inordinate power." I disagree with this assertion. The Greenspan Fed long ago relinquished its command over "money." We have clearly moved beyond conventional "fiat money" to the dubious and destructive world of Wildcat Finance. Government issued currency is today a trivial part of total "money" and Credit issuance. Furthermore, there is no "authority" in control of either the quantity or the quality of monetary expansion. Dr. Greenspan, of course, is determined to perpetuate the ruse that the Fed is in full command of the situation.

Many analysts remain determined to view the world through the traditional prism of a Fed-controlled fiat bank money system. Bank money is "special," and the Fed maintains control over monetary expansion through the traditional management of "hot money" liquidity injections. But the reality of the situation is that Credit issued outside of bank deposit creation comprises the vast majority of Credit expansion. Traditional bank reserves are basically irrelevant and the Fed no longer monopolizes "hot money." Myriad institutions today issue liabilities completely unrestrained from the Federal Reserve.

And the heart of the matter revolves around Credit Bubble Dynamics - the creation of these liabilities in increasing quantities and decreasing quality. This liquidity becomes, over time, more speculative in nature and programmed to chase inflating asset markets. And especially due to the activities of the GSE and "structured finance," there is today an unmatched capacity to create endless amounts of perceived safe Credit. Wildcat finance "works" and balloons to unimaginable excess because of Fed and global central bank implicit guarantees. Moreover, the unparalleled scale of today's wildcat excess is surely augmented by the electronic journal-entry nature of the liability creation. There will be no alarming wheelbarrows full of government currency.

I mention this tonight as an important backdrop for this most extraordinary environment. While the Fed has quite limited control over the quantity and quality of Money & Credit creation, it does retain the powerful brute force of artificially low pegged interest rates. This capacity to set artificially low borrowing costs is the power to offer enticing speculative profits. And this power swells with the size and attentiveness of the speculating community. When it comes to the Fed's incredible power, these days it is truly The Best of Times and The Worst of Times.

The Fed may not hold sway over the mechanics of money and Credit expansion, but it today does better. It dictates speculative returns for a community of unprecedented global stature. Importantly, however, a monetary system actively managed by transmitting policy through leveraged speculation is anathema to Sound Money & Credit. It is the ultimate Ponzi Finance on a systemic, global level.

Back in the summer and fall of 2002 the Fed became panicked that U.S. corporate debt market dislocation was evolving into a systemic debt crisis. Our central bank aggressively cut rates, proposed the dropping money from helicopters, and promised to fight (unconventionally if necessary) the evil forces of deflation at all costs. This was the greatest call to leveraged speculation in history.

Many would today argue that it has been unimaginably successful. Risk assets of all stripes have provided tremendous returns - corporate bonds, junk bonds, equities, Credit default swaps and structured instruments, as well as emerging market stocks and bonds across the globe. Sufficient liquidity has been created to fuel higher prices in virtually all markets.

Many would, as well, argue that in the process the Fed (and administration) has orchestrated a smooth and advantageous decline in the dollar. The moribund U.S. manufacturing sector is really coming to life, and the farm sector is living high on the hog. Many can today rejoice at the return of pricing power, while stronger commodities prices are a boon to companies and economies alike. The explosion in corporate profits is seemingly a modern miracle. Liquidity is abundant everywhere, including campaign finance.

So what's the problem? Why the "lecture" from Dr. Issing? Well, he made a most pertinent comment last week: "There is no point in making some sort of flash in the pan. That was demonstrated in the case of Japan back in the late 1980s when it was pressurized by other countries to pursue a monetary policy that was too expansive."

Great inflations always commence with the fanciful appearance of wealth creation. Yet dangerous misperceptions inevitably collide with the harsh reality that wealth is not created but instead redistributed and too often destroyed. There are winners and losers. There are great injustices. Many are cheated out of their savings, many are buried in debt, and most all suffer come the unavoidable bust. As Dr. Issing pointed out, great asset inflations create huge distortions in spending and a misallocation of resources. Empower Credit-induced asset inflation and speculative dynamics with free rein, and the consequences for banks, companies and households will surely be tremendous.

The astute Dr. Issing recognizes that the wild Credit inflation responsible for a litany of seemingly positive developments will prove - as they always do - "a flash in the pan." What we have experienced is truly anathema to Sound Money & Credit on a global scale, and there will be no escape. Alas, the unstable environment is beginning to demonstrate the inevitable early signs of trouble. The timing of Dr. Issing's article was not by chance.

Global currency markets have turned acutely unstable, and these markets are increasingly setting the tone for unsettled interest-rate and commodity markets. The problem is two-fold. First, parabolic U.S. Credit Bubble excess is creating massive and unrelenting dollar liquidity that must be absorbed around the world. Like any inflation, the initial manifestations appear benign. But this "absorption," especially throughout Asia, is, with a lag, ultimately inflationary domestically and increasingly difficult to manage. Various inflationary pressures are now building throughout Asia and globally.

Second, the great Credit Bubble has rewarded, emboldened, and inflated the size of the global leveraged speculating community. The resulting dynamics have evolved (here as well) from being seemingly benign and stimulating, to now unwieldy and destabilizing. The Greenspan Fed's negligent policies of inciting leveraged speculator liquidity creation will be exposed. Yes, speculative dynamics fostered a most-impressive Reliquefication.

However, The Community's activities will not be so easily manipulated going forward. The seeming benefit from rising global markets has evolved to dangerous over-heating and fragility. The seeming benefit of rising commodity prices has evolved in some cases to panic buying and shortages. Is the parabolic rise in cooper prices a harbinger of what we should expect in international energy markets if today's massive global Credit inflation runs unabated?

We have clearly entered a most dangerous phase of the Great Credit Bubble Gone Global. Here at home, the California Housing Bubble is deep into the terminal stage of blow-off excess. This disaster was set in motion with the Fed's policy to ameliorate the effects of the bursting stock market Bubble. Having discarded The Anchor of Sound Money & Credit, the Fed follows each mistake with a greater one. The folly of stoking the Great Mortgage Finance Bubble provided the overriding source of global dollar liquidity stoking an overheated Chinese economy. The booming Chinese economy - within the backdrop of unprecedented global liquidity - has stoked a regional boom and global commodities boom. Inflation and speculation beget only greater inflation and speculation. Where it all stops, nobody knows...

Having "successfully" reflated the (imbalanced) U.S. economy and incited a (uneven) global recovery, the Fed would today surely today wish to call off the dogs and harness the inflationary forces. It will not be. The nature of Credit inflation and speculative dynamics is rather the opposite (the dogs have only grown bigger, with larger appetites and nasty dispositions). Instead, Credit and speculative excess escalate and take on a life of there own, refusing to accommodate (understandably) nervous and timid central bankers.

And, what about all that liquidity that has been available for virtually every market everywhere? Well, the resulting levitated asset prices and Bubble economies will be sustained only through enormous unrelenting global liquidity creation. And that's where the proverbial "rubber meets the road" - The Flash in the Pan Catch 22. When inflationary manifestations reach today's point of causing more conspicuous problems, it's too late. The point has already been passed where massive Credit excess is required to forestall the inevitable bust. Global central bankers may today wish to have speculators back away from selling the dollar, halt their commodity buying and ease off their accumulation of the riskiest assets. But this alters The Game and increases the probability that the epochal global liquidity mechanism sputters or worse.

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