For the week, the S&P500 jumped 7.0% (up 4.1% y-t-d), and the Dow rallied 7.3% (down 0.4% y-t-d). The Morgan Stanley Cyclicals surged 12.3% (up 23.8%), and the Transports increased 6.5% (down 6.3%). The Banks surged 8.2% (down 16.3%), and the Broker/Dealers gained 5.9% (up 27.2%). The Morgan Stanley Consumer index rose 5.2% (up 3.0%), and the Utilities increased 3.7% (down 4.6%). The broader market was quite strong. The S&P 400 Mid-Caps jumped 7.3% (up 9.4%), and the small cap Russell 2000 rallied 8.0% (up 4.0%). Technology is putting up some big numbers. The Nasdaq100 gained 7.6% (up 26.0%), and the Morgan Stanley High Tech index surged 8.7% (up 38.8%). The Semiconductors surged 12.1% (up 36.9%), and the InteractiveWeek Internet index rallied 8.3% (up 45.2%). The Biotechs rose 5.3% (up 5.3%). With Bullion rallying $24.25, the HUI gold index jumped 10.9% (up 15.1%).

One-month Treasury bill rates ended the week at 14 bps, and three-month bills closed at 17 bps. Two-year government yields rose 9.5 bps to 0.915%. Five-year T-note yields jumped 28 bps to 2.46%. Ten-year yields surged 35 bps to 3.66%. Long bond yields were 34 bps higher at 4.53%. Benchmark Fannie MBS yields were 28 bps higher to 4.63%. Agency 10-yr debt spreads narrowed 2 to 11 bps. The implied yield on December eurodollar futures were little changed at 0.755%. The 2-year dollar swap spread increased 8.5 to 47.5 bps; the 10-year dollar swap spread increased 6.5 to 24.0 bps; and the 30-year swap spread increased 6.5 to negative 18.75 bps. Corporate bond spreads were mostly narrower. An index of investment grade bond spreads narrowed 10 to 186 bps, and an index of junk spreads narrowed 8 to 859 bps.

Investment grade issuers included Carefusion $1.4bn, Goldman Sachs $1.0bn, Rowan Companies $500 million, and USAA Capital $200 million.

Junk bond funds saw inflows of $162 million (from AMG). The list of junk issuers included Freedom Group $200 million.

I saw no convert issuance this week.

International dollar debt issuers included Ras Laffan LNG $2.23bn, Ecopetrol $1.5bn, Virgin Media $1.35bn, Kazmunaigaz $1.25bn, Lloyds Bank $835 million, BNP Paribas $775 million, Philippines $750 million, Korea Electric Power $500 million, Yonkers Racing $225 million, and Atlas Energy $200 million.

U.K. 10-year gilt yields rose 7 bps to 3.81%, and German bund yields jumped 14 bps to 3.40%. The German DAX equities index surged 8.8% (up 3.5%). Japanese 10-year "JGB" yields added 2 bps to 1.315%. The Nikkei 225 rallied 1.2% (up 6.0%). Emerging debt markets were strong and equities were stronger. Brazil's benchmark dollar bond yields dropped 16 bps to 5.80%. Brazil's Bovespa equities index rallied 5.8% (up 38.7% y-t-d). The Mexican Bolsa surged 8.8% (up 15.0% y-t-d). Mexico's 10-year $ yields declined 6 bps to 5.90%. Russia's RTS equities index recovered 10.7% (up 46.4%). India's Sensex equities index jumped 9.2% (up 52.8%). China's Shanghai Exchange inflated another 2.4%, increasing 2009 gains to 75.2%.

Freddie Mac 30-year fixed mortgage rates declined 6 bps to 5.14% (down 112bps y-o-y). Fifteen-year fixed rates fell 6 bps to 4.63% (down 115bps y-o-y). One-year ARMs declined 6 bps to 4.76% (down 34bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates increased 9 bps to 6.46% (down 74bps y-o-y).

Federal Reserve Credit jumped $34.2bn last week to $2.012 TN. Fed Credit has declined $235bn y-t-d, although it expanded $1.123 TN over the past 52 weeks (126%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 7/15) declined $4.6bn to $2.782 TN. "Custody holdings" have been expanding at a 19.6% rate y-t-d, and were up $434bn over the past year, or 18.5%.

M2 (narrow) "money" supply was little changed at $8.349 TN (week of 7/6). Narrow "money" has expanded at a 3.6% rate y-t-d and 8.9% over the past year. For the week, Currency declined $1.2bn, while Demand & Checkable Deposits added $2.3bn. Savings Deposits gained $13.4bn, while Small Denominated Deposits declined $7.6bn. Retail Money Funds dropped $6.9bn.

Total Money Market Fund assets (from Invest Co Inst) dropped $21.0bn to $3.647 TN. Money fund assets have declined $183bn y-t-d, or 8.9% annualized. Money funds expanded $149bn, or 4.2%, over the past year.

Total Commercial Paper outstanding sank another $39.7bn to $1.097 TN. CP has declined $585bn y-t-d (65% annualized) and $653bn over the past year (37%). Asset-backed CP fell $15.4bn to $441bn, with a 52-wk drop of $304bn (41%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $8.0bn y-o-y to $6.985 TN, the highest level since last October. Reserves have now increased $168bn year-to-date.

Global Credit Market Watch:

July 16 - Bloomberg (Lester Pimentel): "JPMorgan Chase & Co.'s EMBI+ index rose to a record high as the prospects for a faster recovery in developing economies boost demand for their bonds."

July 14 - Bloomberg (Matthew Leising): "The U.S. Justice Department is investigating the market for credit-default swaps, according to Markit Group Ltd., the data provider majority-owned by Wall Street's largest banks."

Government Finance Bubble Watch:

July 15 - Financial Times (Richard McGregor): "Beijing's foreign reserve holdings have surged through the $2,000 billion mark, as money pours back into China to take advantage of faster economic growth and rapidly inflating asset prices.. The People's Bank of China... announced... that foreign reserves reached $2,132bn... The reserve build up in the second quarter was $177.9bn, including a monthly record in May of $80.6bn. The quarterly figure far outstrips China's trade surplus and inbound foreign direct investment... proof that the accumulation of funds inside the country is being driven by other factors. 'China's foreign exchange reserve headache has returned,' said Stephen Green, of Standard Chartered... The latest figures also represent an abrupt reversal of an emerging trend of the previous two quarters. Foreign reserves increased by just $7.7bn in the first three months of the year, and $40.4bn in the fourth quarter of 2008... Chen Xingdong, of BNP-Paribas... calculated that after taking account of the trade surplus, foreign investment and the impact of changes in global currency valuations, about $70bn in hot money came into China in the second quarter..."

July 13 - Bloomberg (Vincent Del Giudice): "The U.S. budget deficit topped $1 trillion for the first nine months of the fiscal year and broke a monthly record for June... The excess of spending over revenue for June was $94.3 billion, the first deficit for that month since 1991... The June deficit compares with a surplus of $33.5 billion in the same month a year earlier. Spending last month surged 37% to $309.7 billion and revenue fell 17% to $215.4 billion..."

July 14 - Bloomberg (Norihiko Kosaka): "Japanese Prime Minister Taro Aso... is relying on pork-barrel spending to win voters who have turned cold on his ruling Liberal Democratic Party. Included in Aso's record 15.4-trillion yen ($167bn) stimulus package are 12.4 billion yen to get rid of fishing gear dumped by foreign boats and 400 million yen for cutting down trees to keep 'beasts and birds' out of towns... The money flow is unraveling the work of former Prime Minister Junichiro Koizumi, who set goals to contain the world's largest debt burden and cut spending by as much as 3% on public-works projects."

July 15 - Bloomberg (Shinhye Kang): "South Korea's plan to spend $84 billion in the next five years on improving energy efficiency may boost growth in Asia's fourth-largest economy by 4% annually..."

July 13 - Bloomberg (Valerie Rota): "Mexico's fiscal accounts may be heading toward 'unsustainable deficits' as a decline in oil production cuts government revenue, according to Morgan Stanley. Mexico may need to curb spending growth to keep the deficit in check... analysts Luis Arcentales and Daniel Volberg wrote..."

July 16 - Bloomberg (Oliver Suess): "Mohamed El-Erian, chief executive officer of Pimco... said governments in industrialized countries will face a 'massive challenge' due to the increase in spending to fight the financial crisis. 'While in the short term it makes total sense to increase deficits to react to the crisis, governments in industrialized countries are going to face a massive challenge as these are not long-term policies... It's not easy to exit this transition. It takes a long time.'"

Currency Watch:

July 13 - Bloomberg (Keiko Ujikane and Kyoko Shimodoi): "Japan's opposition party, leading in polls ahead of next month's election, said the nation should consider shifting its $1 trillion of foreign reserves away from the dollar and buying International Monetary Fund bonds. 'In the medium to long term, we need to do what we can to avoid the risk of currency losses or economic turbulence that could result if the dollar were to swing,' Masaharu Nakagawa, the shadow finance minister in the Democratic Party of Japan, said... 'Many countries are starting to diversify their reserves.' Japanese investors are the biggest foreign holders of Treasuries after China with $685.9 billion of the securities in April..."

July 14 - Financial Times (Abeer Allam): "Tim Geithner, US treasury secretary, sought to assure Gulf nations on Tuesday about their holdings of treasury bills when he told Saudi business leaders that his country "has a special responsibility to play" in defending the value of the dollar."

The dollar index declined 0.9% this week to 79.52. For the week on the upside, the Canadian dollar increased 4.2%, the Brazilian real 3.5%, the Australian dollar 3.0%, the New Zealand dollar 2.7%, the South African rand 2.7%, the Mexican peso 2.6%, the Norwegian krone 2.1%, the South Korean won 1.8%, the Swedish krona 1.4%, the Euro 1.2%, and the Swiss franc 0.9%. On the downside, the Japanese yen declined 1.8%.

Commodities Watch:

Gold ended the week up 2.7% to $937.40 (up 6.3% y-t-d). Silver rallied 5.7% to $13.37 (up 18.4% y-t-d). August Crude jumped $3.49 to $63.38 (up 42% y-t-d). August Gasoline rose 6.7% (up 66% y-t-d), and August Natural Gas surged 8.1% (down 35% y-t-d). September Copper jumped 9.6% (up 72% y-t-d). September Wheat rose 4.4% (down 11% y-t-d), while August Corn slipped 1.8% (down 21% y-t-d). The CRB index rallied 4.9% (up 6.8% y-t-d). The Goldman Sachs Commodities Index (GSCI) surged 6.3% (up 23.2% y-t-d).

China Reflation Watch:

July 16 - Bloomberg: "China's gross domestic product grew 7.9% in the second quarter as the nation became the first of the major economies to rebound from the global recession."

July 16 - Bloomberg (Tommy Stubbington and Andrew MacAskill): "China's economic growth pace still can't create enough jobs to meet the needs of the migrant workers who leave the country's rural areas every year to seek employment, said the statistics bureau's spokesman Li Xiaochao. 'We're still facing great pressure in generating jobs,' Li said..."

July 13 - Bloomberg: "China's June fiscal revenue rose 19.6% from a year earlier, while spending climbed 21.5%... Fiscal revenue has improved since May along with the economy, the ministry..."

July 16 - China Knowledge: "China's total fixed asset investment surged 33.5% year on year to RMB 9.13 trillion (US$1.34 trillion) in the first half of this year, according to... the National Bureau of Statistics..."

July 17 - Bloomberg: "China's crude steel production, the largest in the world, rose to a record in the first half as the nation's $586 billion stimulus package spurred demand from builders and carmakers. Output gained 1.2% to 266.6 million metric tons..."

July 16 - Financial Times (Lindsay Whipp in Tokyo and Patti Waldmeir): "China has overtaken Japan to become the world's second biggest stock market by capitalisation as investors pile into the fast-growing economy. China's listed companies had a market capitalisation of $3,210bn... compared with Japan's $3,200bn..."

July 13 - Bloomberg (Joshua Goodman and Andre Soliani): "China's central bank pledged to do more to guide loan growth as a record expansion in credit adds to the risks of asset bubbles and bad debts. The People's Bank of China will 'strengthen monetary and credit management,' Li Dongrong, an assistant governor, said... It will 'guide the direction of money and loans' to ensure stability in the financial sector, Li said. New loans rose almost fivefold in June as the credit boom revived growth..."

July 17 - Bloomberg: "China's government failed to sell as much debt as it planned for the third time in two weeks on speculation the central bank will push up money-market rates to prevent bubbles in stock and property prices... The average winning yield was 1.6011%, higher than the 0.85% rate at the last sale... on June 19."

July 14 - Bloomberg: "Land prices in 105 Chinese cities rose in the second quarter from the first three months of the year, China Business News cited the Ministry of Land and Resources... Home prices in 70 major Chinese cities rose 0.2% in June from a year earlier..."

July 13 - China Knowledge: "Daimler AG's Mercedes-Benz unit said its vehicle sales in China jumped 52% year on year to hit 5,100 units in June, surpassing the industry's average growth rate, Dow Jones... reported..."

India Watch:

July 14 - Bloomberg (Cherian Thomas): "India's Finance Minister Pranab Mukherjee said a wider budget deficit 'right now' is critical to accelerate growth, justifying the record 4.51 trillion rupees ($92bn) the government plans to borrow this year. 'It's a tremendous risk we have taken with the hope that the economy will turn around,' Mukherjee told lawmakers..."

July 17 - Bloomberg (Rakteem Katakey): "India needs an investment of $70 billion to build roads over the next three years, road transport minister Kamal Nath said."

July 17 - Bloomberg (Cherian Thomas): "India's record borrowing in the financial year ending March 31 will only have a "marginal impact" on yields and won't drive rates too high, Finance Secretary Ashok Chawla told reporters in New Delhi. The time is not ripe to reverse the expansionary monetary policy and the government's aim is to keep interest rates benign, he said."

Asia Bubble Watch:

July 14 - Bloomberg (Shamim Adam): "Singapore's government raised its economic forecast for 2009... Gross domestic product will shrink 4% to 6% this year, less than an earlier forecast for... 9%, the trade ministry said.... The economy expanded an annualized 20.4% last quarter from the previous three months..."

Latin America Watch:

July 14 - Bloomberg (Joshua Goodman and Andre Soliani): "Brazil's retail sales rose more than analysts expected in May, reinforcing bets that consumer demand is driving the rebound in Latin America's biggest economy. Sales rose 4% in May from the same month a year earlier..."

Unbalanced Global Economy Watch:

July 15 - Bloomberg (Chris Reiter and Laurence Frost): "European car sales rose in June for the first time in 14 months... New-car registrations increased 2.4% to 1.46 million vehicles..."

July 16 - Bloomberg (Tommy Stubbington and Andrew MacAskill): "The pension deficits of Britain's 100 biggest companies more than doubled in the first half to a record 300 billion pounds ($490bn)... Deloitte LLP said. The deficit compares with a 130 billion-pound shortfall at the start of the year..."

July 15 - Bloomberg (Kim McLaughlin): "Swedish house prices rose in the three months through June for the second period in a row... The average house price rose 3% from the previous three months..."

Bursting Bubble Economy Watch:

July 16 - Bloomberg (Dan Levy): "U.S. foreclosure filings hit a record in the first half... according to RealtyTrac Inc. More than 1.5 million properties received a default or auction notice or were seized by banks in the six months... That's a 15% increase from the year earlier. One in 84 U.S. households received a filing."

July 13 - Bloomberg (Sarah Rabil): "U.S. advertising revenue may drop 14.5% this year and continue to decline until an economic recovery sparks growth near the end of 2010, Magna Global said. Revenue may fall to $161.4 billion after declining 7.5% in 2008... Brian Wieser, Magna Global's forecasting director, said..."

July 13 - Bloomberg (Greg Bensinger and Gadi Dechter): "The Chicago Cubs may become the first Major League Baseball team in 39 years to file for bankruptcy as Tribune Co. seeks to sell the franchise after months of negotiations."

Central Banker Watch:

July 17 - Bloomberg (Jens Erik Gould and Hugh Collins): "Mexico's central bank slowed the pace of cuts to its benchmark interest rate and said it will hold off on further reductions amid signs of economic recovery."

Real Estate Bust Watch:

July 14 - Bloomberg (David M. Levitt): "Manhattan office rents fell by a record 7.4% in the second quarter... property broker Cushman & Wakefield Inc. said... The vacancy rate rose to 10.5%, up from 9.6% in the first quarter and 7.1% a year earlier."

MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

July 13 - Bloomberg (Jody Shenn): "Standard & Poor's boosted its projections for losses from Alt-A U.S. mortgages backing securities. Losses on loans backing 2006 securities will reach an average of about 22.5% of the original balances, while losses for similar 2007 bonds will total about 27%..."

July 13 - Bloomberg (Oshrat Carmiel): "Commercial mortgage delinquencies of securitized loans climbed by a record $2.2 billion in June, including five defaults of $100 million or more, Fitch... said... The largest sour loans included three hotel properties that defaulted during their terms and two regional malls sponsored by bankrupt General Growth Properties...Fitch said."

July 13 - Wall Street Journal (Marshall Eckblad): "For the third straight month, option adjustable-rate mortgages are generating proportionally more delinquencies and foreclosures than subprime mortgages... As of April, 36.9% of Pick-A-Pay loans were at least 60 days past due, while 19% were in foreclosure, according to... First American CoreLogic... Payment-option mortgages are heavily concentrated in the worst-hit regions in the housing market, including California and Florida..."

California Watch:

July 17 - Bloomberg (Michael B. Marois and William Selway): "California Governor Arnold Schwarzenegger and lawmakers failed to resume talks last night over how to solve a $26 billion deficit, even after the state's Treasurer said crippling penalties from Wall Street loom.... That prompted Treasurer Bill Lockyer... to warn that the impasse could leave the state with a junk rating on its debt and unable to borrow money. 'With every passing day, the state's credit rating moves closer and closer to the junk pile,' Lockyer said..."

July 16 - Los Angeles Times (Peter Y. Hong): "Southern California home prices may have finally hit bottom, with median values rising last month for the first significant increase in two years... Along with the 6.4% rise in prices from May, fewer than half of the sales were foreclosures -- the first time that has happened in nine months."

July 16 - Bloomberg (Dan Levy): "San Francisco Bay Area house and condominium sales rose 20% in June from a year earlier to the highest in almost three years... DataQuick said... The median price dropped 27% to $352,000."

New York Watch:

July 16 - Bloomberg (Henry Goldman): "New York City's unemployment rate rose 0.6 percentage points to 9.5% in June from May. The state jobless rate increased to 8.7% from 8.2%, the highest since October 1992..."

July 13 - Bloomberg (Henry Goldman): "New York City's unemployment rate will reach 9.5% by 2010, leaving 400,000 jobless for the first time since 1993, city Comptroller William Thompson said."

July 14 - Bloomberg (Oshrat Carmiel): "Home sales in the Hamptons, the oceanside summer getaway for Wall Street financiers and celebrities, plunged 58% in the second quarter..."

Muni Watch:

July 16 - Wall Street Journal (Amy Merrick): "Two weeks after Illinois' fiscal year began, Gov. Pat Quinn signed a $26 billion general-fund budget... that depends heavily on borrowing and pushes off a reckoning of the state's serious fiscal problems. The new budget requires the state to borrow $3.5 billion from its pension fund to fund some operations, and to postpone $3.2 billion in payments to vendors. It also leaves a spending hole of about $5 billion for the fiscal year that began July 1 that will have to be addressed eventually."

Speculator Watch:

July 14 - Bloomberg (Tom Cahill): "Hedge funds' so-called crowded trades, positions so widely held that they can't be easily exited, are a concern to the Financial Services Authority, according to Britain's Treasury Minister Paul Myners. 'The FSA is focused on gathering data where there is a build up of crowded trades,' Myners told a House of Lords committee..."

Global Reflation Update

Key global reflationary indicators were released this week. China official reserve holdings jumped to a record $2.132 Trillion. More importantly, second quarter reserve growth surged to a record $178bn. This was up dramatically from Q1 2009's $7.7bn increase and Q4 2008's growth of $40.0bn. It is worth also noting that the most recent quarter exceeded even the $154bn increase near the height of the "hot money" Bubble period back in early 2007. China began 2004 with $400bn of reserves.

China is central to my macro global reflation thesis. And I believe the "Core to Periphery" (i.e. dollar flows to China, Asia and emerging markets) flow of funds dynamic will fundamentally shape unfolding reflationary dynamics. I view the enormous increase in China's reserves as confirmation both that global speculative flows have been largely rejuvenated and that China and the emerging markets retain the most robust inflationary bias. On the margin, speculative flows will prefer Asia to the U.S. - providing reflationary crosscurrents/headwinds here at home. Meanwhile, things that Asia needs and wants will demonstrate upward price pressures over time.

There were also a slew of strong economic reports out of China this week. Second quarter growth was reported at a stronger-than-expected 7.9% rate, boosting China's first-half expansion to an impressive 7.1%. Fixed investment was up 33.6% y-o-y during the quarter, while industrial production rose 10.7%. First half steel production increased to a record. Another report had China's fiscal spending up 21.5% y-o-y in June, with receipts up 19.6%. Accounts have it that real estate prices are bubbling again. June M2 money supply expanded at a 28.5% pace. And after posting a 75% gain so far this year, Chinese stocks have again surpassed Japan's to take second place globally in terms of market capitalization. Economists are quickly raising second-half and 2010 growth estimates.

The emerging markets and commodities rallied strongly this week. The EMBI+ emerging market bond index traded this week to a record high. The Goldman Sachs Commodities Index surged 6.3%, increasing 2009 gains to 23.3%. Brazilian dollar yields dropped to 5.80%. Copper jumped 9.6% this week, silver was up 5.7%, and gold rallied 2.7%. It is also worth nothing that the Indonesian rupiah declined only two-thirds of one percent following today's terrorist attacks.

The massive scope of China's bank lending and "hot money" inflows ensures a historic policy challenge. There are indications that Chinese monetary authorities (People's Bank of China) are now attempting to tap the brake a bit, as somewhat reduced inter-bank liquidity pressures short-term borrowing costs higher. But don't expect central bank tinkering to have much more impact in China than it did here at home during the 2004-2007 Bubble period. I would expect the rejuvenated Chinese boom to be largely impervious to cautious policymaking. Or, stated differently, Bubble Dynamics would seem to dictate that increasingly unwieldy financial and economic Bubbles will keep policymakers on their heels and unwilling to decisively face growing risks. And as ultra-loose financial conditions in the U.S. and elsewhere spur a rebound in Credit growth (and attendant financial flows), the Chinese predicament will turn even more problematic.

Financial reports here at home also confirm a rejuvenation of speculative and global reflation dynamics. Goldman Sachs reported record quarterly net revenues ($13.76bn) and net earnings ($3.44bn). "Net revenues in Trading and Principal Investments were $10.78bn, 93% higher than the second quarter of 2008 and 51% higher than the first quarter of 2009." "Fixed Income, Currency and Commodities (FICC) generated record quarterly revenues... Equity underwriting produced record quarterly net revenues..." Investment Banking revenues were up 75% from the first quarter to $1.44bn. Second quarter debt underwriting revenues of $336 million compare to Q1's $248 million and the year ago $269 million. Second quarter equity underwriting revenues of $736 million compare to Q1's $48 million and the year ago $616 million.

At JPMorgan Chase, "Record firmwide revenue of $27.7 billion..." Net Income of $2.721 billion was up 27% from the first quarter and 36% from the year ago period. "...The investment bank reported record overall revenue for the first half of the year, which included record fees and Fixed Income." "Fixed Income Markets revenue was a record $4.9 billion, up by $2.6 billion from the prior year, driven by strong results across all products..." "Extended approximately $150 billion in new credit to consumers, corporations, small businesses, municipalities, and non-profits." JPMorgan approved 138,000 loan modifications during the second quarter.

While clearly struggling, Bank of America "funded $110.6 billion in first mortgages... Credit extended during the quarter...was more than $211 billion, compared to $183 billion in the first quarter..." BofA "earned" $3.4 billion in the quarter, "results driven by continued strong revenue performance in the wholesale capital markets businesses as well as in home loans..." "Bank of America Merrill Lynch ranked No. 1 in high-yield debt and leveraged loans..." "Sales and trading revenue... rose to a record $6.7 billion." BofA provided rate relief/modification to 150,000 customers.

Of course, Goldman and JPMorgan benefit greatly from their competitors' travails. But their greater advantage is that policymakers desperately need them to expand Credit. With bank lending stagnant, domestic reflation today depends chiefly upon the revival of the capital markets. And there are clearly no two institutions better positioned to profit from ultra-loose financial conditions than Goldman and JPMorgan. One can argue that the concentration of financial power to a few Wall Street firms played a major role in the Credit boom and bust. Ironically, reflationary policymaking is today fostering only greater concentration of power and market influence.

So far, I don't really see many surprising developments pertaining to reflation dynamics. Thing seem largely on track in Asia, while the struggling U.S. Credit system is regaining some fire power. At this point I see little justification for revising my expectation for lagging U.S. asset markets and economic performance.

At the same time, one can see the makings of future bouts of acute fragility. I see great risk in the system's increasing reliance on capital markets as the primary source for Credit expansion and liquidity creation. It is unfortunate - but not unexpected - that reflation requires a further concentration of financial power. Moreover, it is dangerous that Washington policymakers now completely hold sway over the Credit markets. "Federal" Credit - Treasury, agency, and GSE MBS - remains the vast majority of system Credit creation. It is worth noting that May and June GSE MBS issuance totaled almost $450 billion (from Bloomberg). There is an enormous amount of mortgage Credit and interest-rate risk being bundled and transferred to Washington - and our government already has too much of it.

The problem only seems to get clearer. The maladjusted US Bubble economy is sustained by $2.0 to $2.5 Trillion of new Credit - Credit that must largely be issued or guaranteed in Washington. This reflation (a.k.a. Credit inflation/currency devaluation) drives massive flows to China, Asia and the emerging markets that have few takers other than the central banks. And as economies recover and inflationary distortions reemerge, these enormous dollar flows can be expected to foment increasing policymaker angst. Asian reflation is poised to take on a wild life of its own, forcing policymakers at some point to confront today's reality that dollar flows are destabilizing and unmanageable. China, in particular, faces tough choices when it comes both to managing its Bubble and accumulating massive quantities of IOUs of deteriorating quality.