For a volatile week in global markets, the S&P500 gained 1.3% (up 22.4% y-t-d), while the Dow added 0.8% (up 18.4% y-t-d). The Banks rallied 2.7% (down 0.2%), and the Broker/Dealers jumped 3.9% (up 48.9%). The Morgan Stanley Cyclicals gained 2.8% (up 68.7%), and Transports jumped 4.6% (up 16.0%). The Morgan Stanley Consumer index added 0.8% (up 23.0%), and the Utilities gained 3.8% (up 3.0%). The S&P 400 Mid-Caps rallied 2.7% (up 30.4%), and the small cap Russell 2000 surged 4.4% (up 20.7%). The Nasdaq100 increased 1.5% (up 47.9%), and the Morgan Stanley High Tech index gained 2.3% (up 63.4%). The Semiconductors surged 8.2% (up 58.0%). The InteractiveWeek Internet index rose 2.4% (up 70.4%). The Biotechs gained 2.7% (up 40.5%). Although bullion ended the week down $16, the volatile HUI gold index ended the week little changed (up 55.7%).

One-month Treasury bill rates ended the week at 8 bps, and three-month bills closed at 4 bps. Two-year government yields jumped 15 bps to 0.84%. Five-year T-note yields jumped 22 bps to 2.25%. Ten-year yields surged 27 bps to 3.48%. Long bond yields jumped 19 bps to 4.39%. Benchmark Fannie MBS yields jumped 31 bps to 4.25%. The spread between 10-year Treasuries and benchmark MBS yields increased 4 to 78 bps. Agency 10-yr debt spreads declined 2 bps to 44 bps. The implied yield on December 2010 eurodollar futures jumped 25 bps to 1.375%. The 10-year dollar swap spread increased 5 to 14.5 bps, and the 30-year swap spread increased 2.5 to negative 13 bps. Corporate bond spreads were narrower. An index of investment grade bond spreads narrowed 4 bps to 137, while an index of junk spreads narrowed 6 bps to 577 bps.

Investment grade issuers included Xerox $2.0bn, Citigroup $1.875 million, International Paper $750 million, Con Edison $600 million, Nisource $500 million, Acuity Brands $350 million, Healthcare Realty Trust $300 million, Equity One $250 million, Genworth Financial $300 million and South Carolina E&G $150 million.

Junk bond funds reported inflows of $135 million. Junk issuers included Quintiles Transnational $525 million, Hanesbrands $500 million, Dynegy $235 million, Norcraft $180 million, and Otter Tail $100 million.

I saw no convert issues this week.

International dollar-denominated debt issuers included Finance for Danish Industry $1.5bn, Credit Agrigole $750 million, Essar Steel Algoma $400 million, and Petrotmex $275 million.

U.K. 10-year gilt yields jumped 16 bps to 3.71%, and German bund yields increased 7 bps to 3.23%. The German DAX equities index gained 2.3% (up 20.9% y-t-d). Japanese 10-year "JGB" yields rose 4 bps to 1.29%. The Nikkei 225 surged 10.4% (up 13.1%). For the most part, emerging markets traded well. For the week, Brazil's Bovespa equities index added 0.8% (up 80.0%), and Mexico's Bolsa rose 4.3% (up 43.5%). Russia's RTS equities index was up 2.9% (up 123.9%). India's Sensex equities index jumped 2.8% (up 77.3%). China's Shanghai Exchange surged 7.1%, boosting 2009 gains to 82.2%. Brazil's benchmark dollar bond yields declined 3 bps to 4.75%, while Mexico's benchmark bond yields rose 5 bps to 4.91%.

Mortgage rates moved to record low levels this week. Freddie Mac 30-year fixed mortgage rates declined 7 bps to 4.71% (down 82bps y-o-y). Fifteen-year fixed rates dipped 2 bps to 4.27% (down 106bps y-o-y). One-year ARMs sank 10 bps 4.25% (down 77bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 9 bps to 5.99% (down 116bps y-o-y).

Federal Reserve Credit slipped $2.8bn last week to $2.187 TN. Fed Credit has declined $59.5bn y-t-d, although it expanded $69.3bn over the past 52 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 12/2) increased $6.2bn to a record $2.932 TN. "Custody holdings" have expanded at a 17.9% rate y-t-d, and were up $437bn over the past year, or 17.5%.

M2 (narrow) "money" supply was little changed at $8.391 TN (week of 11/23). Narrow "money" has expanded at a 2.7% rate y-t-d and 4.9% over the past year. For the week, Currency slipped $0.2bn, and Demand & Checkable Deposits declined $6.7bn. Savings Deposits jumped $26.2bn, while Small Denominated Deposits fell $6.5bn. Retail Money Funds dropped $13.5bn.

Total Money Market Fund assets (from Invest Co Inst) declined $10.2bn to $3.319 TN. Money fund assets have declined $511bn y-t-d, or 14.4% annualized. Money funds dropped $424bn, or 11.3%, over the past year.

Total Commercial Paper outstanding slumped $20.7bn (16-wk gain of $161bn) to $1.236 TN. CP has declined $446bn y-t-d (28.7% annualized) and $416bn over the past year (25.2%). Asset-backed CP declined $2.6bn last week to $495bn, with a 52-wk drop of $237bn (32.4%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $811bn y-o-y to a record $7.579 TN. Reserves have increased $815bn year-to-date.

Global Credit Market Watch:

December 1 - Bloomberg (Simon Clark): "London's role as the European Union's equivalent to Hong Kong, a self-regulating financial center, is ending, according to Thomas Huertas, the banking director at the U.K.'s Financial Services Authority. The group of 27 European states plans to centralize oversight of markets in the wake of the global financial crisis, with proposals for new regulators for the banking, securities and insurance industries, Huertas said. 'The U.K. and London in particular has had the opportunity to be the Hong Kong to Europe,' Huertas said... 'I am not sure that the rest of Europe wishes to allow that situation to persist.'"

November 30 - Bloomberg (Yalman Onaran): "John Maynard Keynes proposed a tax on financial transactions in the middle of the Great Depression, and another economist, James Tobin, revived the idea in the 1970s as a way to counter currency market speculation. Neither effort gained much acceptance. Now, a growing number of economists and politicians argue that it's time for a levy on trading stocks, bonds, currencies and derivatives. U.K. Prime Minister Gordon Brown said... that a transaction tax might compensate for the billions of dollars that the public has spent on bank bailouts. Government officials in France, Germany and Austria have voiced their backing. U.S. Treasury Secretary Timothy Geithner answered Brown a day later, saying the tax was not something the U.S. would support. House Speaker Nancy Pelosi... says the idea has 'substantial currency' among congressional Democrats."

Global Government Finance Bubble Watch:

December 2 - MarketNews International: "Based on the current economic outlook, the Chinese government plans to keep domestic interest rates steady until the Federal Reserve raises U.S. rates, government officials have told Market News International. That plan indicates the level of concern within Beijing about the impact of capital inflows -- a situation some fear could be exacerbated by widening interest rate differentials -- but also the health of the Chinese economy so long as U.S. economic conditions remain weak... 'Economic data is relatively strong, but the foundation of the recovery is not strong,' one of the officials said. 'Economic stimulus policies won't be immediately withdrawn and interest rate increases will have to wait until the Federal Reserve raises first.'"

December 2 - Wall Street Journal (Yuka Hayashi, Megumi Fujikawa and Takashi Nakamichi): "Japan's central bank unveiled a surprise monetary-easing effort Tuesday that could inject up to $115.68 billion into an economy facing deflation and a soaring currency... The Bank of Japan's move followed increasing pressure from Japan's new government and came amid growing pessimism surrounding the country's economy... At an emergency meeting Tuesday, the BOJ adopted a new lending program to provide 10 trillion yen of funds for three months at a low rate of 0.1%, taking in exchange a wide range of collateral, from government bonds to deeds on loans."

November 30 - Bloomberg (Susanne Walker): "Less than a week after deflecting calls for his resignation, Timothy Geithner sold bonds on behalf of U.S. taxpayers at the lowest yields on record... Even as the nation's debt increased by $1.15 trillion this year to $6.95 trillion in October, the government's interest expense under Geithner dropped 15%, the biggest decrease since before 1989..."

December 1 - Financial Times (Henny Sender): "Some of the most controversial financing practices of the credit-bubble years - from cov lite loans to Pik toggle notes and dividend recap exercises - have returned to Wall Street, stoking fears that debt markets are growing overheated. The techniques fell into disrepute during the financial crisis... In a cov light - short for covenant light - loan, borrowers are granted credit with few, if any, conditions. Pik toggle transactions make it possible for debt to be repaid with more debt - payment-in-kind notes. In a dividend recap, companies take on additional debt to pay dividends to their owners. The reappearance of such instruments in recent weeks has stirred concerns that government efforts to stimulate lending are having unintended consequences, encouraging lenders to take positions based on rest-of-all-possible-worlds' assumptions."

December 3 - Bloomberg (Hanny Wan): "China and other fast growing developing nations will lure more funds away from advanced economies through the next two decades, according to Goldman Sachs... Those flows will counter any impact on China's capital markets from government measures aimed at curbing asset bubbles, said Thomas Deng, Goldman Sachs' head of China strategy. Corporate profit growth in China, estimated at between 20 percent and 30 percent on average next year, will fuel an equity market rally, Deng said."

November 30 - Bloomberg (Michael Tsang): "Initial public offerings in emerging nations are returning about 15 times more than IPOs in developed countries even as companies from China to Brazil flood the market with more shares than ever. Listings... helped raise $39 billion in emerging markets during the three months ending... That outstrips the amount sold in IPOs from 23 industrialized nations by $21.3 billion, the biggest gap since at least 2000..."

December 4 - Bloomberg (Toru Fujioka): "Former U.S. Treasury Undersecretary Timothy Adams said financial markets will be unstable next year as nations seek to withdraw emergency policies undertaken during the global recession. My biggest concern is that 'we are simply creating new bubbles,' Adams... '2010 is a year of volatility, as capital sloshes around the global markets in the search of yield as exit strategies are put in place at different times and at different magnitudes.'"

Currency Watch:

November 30 - Bloomberg: "Chinese Premier Wen Jiabao rejected 'unfair' calls for the yuan to appreciate and European leaders acknowledged that they had failed to shift the nation's stance on its currency. 'Some countries are now calling for yuan appreciation while imposing trade protectionism on China, which is unfair and actually limits China's development,' Wen said... In the financial crisis, 'a stable yuan is helpful to the development of the Chinese economy and the world's economic recovery,' he added."

Currencies went for a bit of a wild ride. The dollar index ended the week up 1.0% to 75.75. For the week on the upside, the Mexican peso increased 2.1%, the South Korean won 1.9%, the Australian dollar 0.9%, the New Zealand dollar 0.7%, the Brazilian real 0.5%, and the Canadian dollar 0.4%. On the downside, the Japanese yen declined 4.5%, the Swiss franc 1.1%, the Euro 0.9%, the Danish krone 0.9%, the Swedish krona 0.4%, and the Norwegian krone 0.3%.

Commodities Watch:

November 30 - Bloomberg: "China may use Dubai World's possible default as an opportunity to buy gold and oil with it foreign currency reserves, an official at the commission that oversees Chinese state-owned companies was cited as saying... The effects of Dubai World's possible default may last some time, giving China an investment opportunity, Ji Xiaonan, head of the supervisory committee at the State-owned Assets Supervision and Administration Commission, was cited as saying..."

November 30 - Bloomberg (Van Nguyen and Luzi Ann Javier): "Rice prices may climb about 50% next year as demand surges, according to a food official in Vietnam, the world's second-biggest exporter."

Commodities ended a volatile week with mixed results. The CRB index added 0.3% this week (up 19.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) declined 0.7% (up 44.2%). Gold declined 1.4% to close at $1,161 (up 31.7%). Silver added 0.9% to $18.51 (up 63.8%). January Crude slipped 35 cents to $75.70 (up 69.7%). December Gasoline rose 1.3% (up 87%), while January Natural Gas sank 11.4% (down 18%). March Copper gained 2.6% (up 127%). March Wheat fell 2.1% (down 9%), and March Corn sank 6.0% (down 5% y-t-d).

China Bubble Watch:

December 1 - Bloomberg: "China's manufacturing grew last month at the fastest pace in five years, a survey showed, helping Asia to lead the recovery from the global economic slump."

December 1 - Bloomberg (Tim Culpan): "China's third-generation wireless-phone subscribers will triple next year as demand increases for mobile applications in the world's largest telephone market, according to researcher IDC. The total number of connections for the high-speed mobile-phone services will climb to 9.85 million next year... China's 3G wireless market will grow to 51.7 million users with sales of $2.7 billion in 2013... Revenue from the high-speed mobile services will climb 91% next year to $926 million... China had more than 700 million mobile-phone subscribers at the end of October..."

November 30 - Bloomberg (Le-Min Lim): "A 4-meter abstract painting of falling snow by Chinese artist Chu Teh-Chun fetched a record HK$45.5 million ($5.9 million) in Hong Kong.... 'Vertige Neigeux,' an oil-on-canvas diptych that took France-based Chu (1920- ) about a decade to complete, topped estimates and went to an unidentified Asian private buyer. There was a 5-minute tussle among bidders on the phone and in the packed hall of about 400 people at Christie's International evening sale of 20th-century and contemporary Asian works last night... 'Works by established Chinese artists such as Chu and Zao Wou-ki are the most sought-after; they are driving prices,' Anthony Lin, a Hong Kong-based art consultant, said..."

December 2 - Bloomberg (Le-Min Lim): "A ring with a pink diamond the size of a chickpea sold last night for a record HK$83.5 million ($10.8 million) at a Hong Kong auction that was spurred by Chinese buying. The 5-carat, so-called fancy-vivid gem set by London-based jeweler Graff Diamonds and given the second-highest rating of potentially flawless, broke the per-carat record for a diamond set in May with Hong Kong property tycoon Joseph Lau's purchase of a 7.03-carat blue diamond in Geneva for 10.5 million Swiss francs ($10.5 million)."

December 3 - Bloomberg (Le-Min Lim): "Christie's International's five-day auction in Hong Kong... raised an above-estimate HK$1.65 billion ($213 million) as Chinese tycoons battled for the top lots. The total soared above the London-based auction house's presale forecast of HK$1 billion as Wang Wei, the wife of Shanghai collector Liu Yiqian, became a focal point, chasing down paintings by artists such as Liu Ye."

December 2 - Bloomberg: "Ford Motor Co.'s China venture boosted November sales of Ford-brand vehicles by 152% to 22,738 units... The company's total sales in the first 11 months rose 47% to 210,982 units..."

December 1 - Bloomberg: "China has 'big room' to boost domestic car sales, Chang Xiaocun, head of the Ministry of Commerce's market construction department, said..."

Japan Watch:

November 30 - Bloomberg (Mayumi Otsuma and Keiko Ujikane): "Bank of Japan Governor Masaaki Shirakawa pledged to take action 'decisively' to ensure economic stability as reports indicated the nation's expansion may be losing steam. Shirakawa... acknowledged that the economy was in deflation."

India Watch:

November 30 - Bloomberg (Cherian Thomas and Kartik Goyal): "India's economy expanded at the fastest pace in 1 1/2 years as manufacturing jumped... Gross domestic product grew 7.9% in the three months to Sept. 30 from a year earlier after gaining 6.1% in the previous quarter..."

November 30 - Wall Street Journal (Abhrajit Gangopadhyay and Neelabh Chaturvedi): "India has implemented several measures to temper a surge in food prices, but a global shortage in some commodities isn't helping, Finance Minister Pranab Mukherjee said... illustrating the government's increased concerns over runaway inflation. The rise in prices 'is due mainly to an imbalance in demand and supply,' Mr. Mukherjee told lawmakers. 'All necessary steps which we can take, we are taking,' he said... 'We have stopped exports of a large number of items, particularly essential food items.' Rising food prices--which jumped 13.3% in October from a year earlier--could impede India's economic recovery and persuade the central bank to increase rates, feel analysts."

Asia Bubble Watch:

December 1 - Bloomberg (Seyoon Kim): "South Korea's exports rose for the first time in 13 months in November as demand for the nation's semiconductors, display panels and auto parts increased. Overseas shipments gained 18.8% from a year earlier to $34.3 billion..."

December 1 - Bloomberg (Nguyen Kieu Giang): "Credit in Vietnam grew 36% this year to the end of November, central bank Deputy Governor Nguyen Dong Tien said."

December 2 - Bloomberg (Novrida Manurung): "Indonesia's central bank doesn't want to increase interest rates too early as inflation isn't yet a threat, said Senior Deputy Governor Darmin Nasution. 'We decided to hold the rate in October as we don't want to suddenly increase it in January,' Nasution told a seminar..."

December 2 - Bloomberg (Rodney Jefferson): "Ninety years after Johnnie Walker stopped making Scotch in Annandale, David Thomson wants to put the distillery back on the whisky map of the world. The plant... closed in 1921. With 5 million pounds ($8.3 million) in cash, Thomson plans to open it up again in 2011. 'We can make so much more of malt whisky as an industry,' said Thomson... 'We haven't even begun to tap into the potential interest.' More money is being invested in whisky than at any time since the late 1960s... The reason, producers like Diageo Plc say, is to make sure they have enough of it to serve China and India..."

Latin America Bubble Watch:

December 4 - Bloomberg (Fabiola Moura and Veronica Navarro Espinosa): "Brazil needs to curb a surge in spending to limit the budget deficit, keep interest rates down and stem the world's biggest currency rally, said former central bank President Arminio Fraga."

November 30 - Bloomberg (Daniel Cancel): "Venezuelan President Hugo Chavez said he has 'no problem' nationalizing the country's banking sector and that any private bank that breaks the nation's laws will be seized. Chavez criticized private banks for not extending development loans and said some refuse to comply with the country's laws. Four banks were seized on Nov. 20."

December 3 - Bloomberg (Daniel Cancel and Andrea Jaramillo): "Venezuela's bolivar sank to a two-month low and bonds tumbled as President Hugo Chavez's threat to seize more banks prompted investors to pull their money from the financial system and move it overseas. The bolivar plunged as much as 9% to 6.30 per dollar..."

December 2 - Bloomberg (Francisco Marcelino and Laura Price): "Carlyle Group, the world's second-largest private-equity firm, will soon announce two or three acquisitions in the 'mid-$100 million' range in Brazil to take advantage of faster growth, said co-founder David Rubenstein... He said it's important for the group to invest in Latin America's biggest economy because of its size and growth potential. 'You can't be global not being in Brazil... Brazil has the world's sixth-largest population, it's the ninth-largest economy and will become the fifth largest.'"

Dubai Watch:

December 2 - Bloomberg (Erik Schatzker and Matt Townsend): "Prince Alwaleed bin Talal, the billionaire Saudi investor, said banks that loaned money to Dubai World can't claim to be victims of the emirate's debt crisis because they should have understood the risks. 'These banks are very mature banks, and they have to differentiate between a corporate loan and a sovereign loan,' Alwaleed, 54, said... 'When things go sour, you can't have some banks in the West going to Dubai and saying 'oops' and crying wolf and saying, 'You should have guaranteed those loans.'"

Unbalanced Global Economy Watch:

December 4 - Bloomberg (Greg Quinn): "Canadian employers added more than five times as many jobs as expected in November... Employment rose by 79,100 last month, the most in more than a year... The jobless rate fell to 8.5% from October's 8.6%."

December 4 - Bloomberg (John Varoli): "Four London auction houses sold 39.7 million pounds ($65.7 million) of Russian art in four days of sales this week as wealthy collectors returned to the market after a year of declines in prices and demand."

December 2 - Bloomberg (Alex Nicholson): "Russia's inflation rate may reach 9% to 9.2% this year, Interfax said, citing Bank Rossii Chairman Sergey Ignatiev."

U.S. Bubble Economy Watch:

December 3 - Bloomberg (Bob Willis): "Service industries in the U.S. unexpectedly contracted in November as companies lost confidence the recovery will gather strength. The Institute for Supply Management's index of non- manufacturing businesses that make up almost 90% of the economy fell to 48.7 from 50.6 in October... Fifty is the dividing line between expansion and contraction."

November 30 - Wall Street Journal (David Enrich and Susanne Craig): "Conspicuous consumption is making a comeback on Wall Street. But no one wants to admit they are doing it. As traders and investment bankers near the finish line of what looks like a boom year for pay, some are spending money like the financial crisis never happened. From $15,000-a-week Caribbean getaways to art auctions to $200,000 platinum wristwatches that automatically adjust for leap years, signs of the good life are returning. 'What we're seeing in the last four to eight weeks is a fairly substantial uptick' in demand for extravagant purchases as Wall Street employees grow more confident that the market's steep rebound so far in 2009 will soon bring them fat bonuses, says David Arnold, senior vice president at Robb Report, a magazine targeted at the super-wealthy."

December 2 - Wall Street Journal (Gary Fields): "Highway-construction companies around the country, having completed the mostly small projects paid for by the federal economic-stimulus package, are starting to see their business run aground... Tim Word, vice president of Dean Word Co., a heavy-construction company...said his income is now coming mostly from projects that are winding up... 'Having something to bid on is the lifeblood of the industry, and it's running out,' said Mr. Word. He isn't sure what will happen next year without new projects. 'There's no pavement fairy that's going to help.'"

Central Banker Watch:

December 3 - Bloomberg (Christian Vits and Simone Meier): "European Central Bank President Jean-Claude Trichet said the ECB will scale back its flagship emergency financing operations next year as the euro region starts an 'uneven' recovery. 'The improved conditions in financial markets have indicated that not all our liquidity measures are needed to the same extent as in the past,' Trichet said... 'Liquidity will remain extremely abundant for a large number of months to come.'"

November 30 - Bloomberg (Arif Sharif): "The United Arab Emirates' central bank eased credit for lenders and said it 'stands behind' the country's local and foreign banks as they face the prospect of rising losses from Dubai World's possible default... Banks will be able to borrow money from the regulator for half a percentage point above the three-month local benchmark interest rate..."

December 2 - Bloomberg (Jacob Greber and Dan Petrie): "Australia's Glenn Stevens will continue leading the world in raising interest rates... Australia's economy has outpaced the U.S., Europe and Japan, which have all kept rates near record lows this year."

Fiscal Watch:

December 2 - Wall Street Journal (Nick Timiraos): "The Federal Housing Administration, faced with rising losses on home loans that it insures, is set to announce... a raft of measures it is considering to protect its dwindling reserves. Shaun Donovan, secretary of the U.S. Department of Housing and Urban Development, plans to ask Congress... to raise the cap on the annual insurance premium that the FHA can charge borrowers... he will also outline steps the agency is considering to set minimum credit scores, to require home buyers to put more money down, and to make lenders more accountable for loans that the agency insures. Those measures are designed to begin rebuilding the agency's depleted capital reserves."

December 2 - Washington Post (Dina ElBoghdady): "The Federal Housing Administration is proposing to increase the up-front cash paid by borrowers as part of an effort to shore up the agency's finances... The changes also include raising minimum credit scores for borrowers who receive FHA-backed mortgages and limiting the amount of money sellers can kick in, including paying closing costs or giving free upgrades... The FHA has played a critical role in propping up the housing market by insuring lenders against default after the mortgage market unraveled. Currently, the agency backs about 30% of all loans for home purchases and 20% of refinancings... 'We've learned from recent history that the market is fragile, and we have to plan for the unexpected,' [Housing Secretary] Donovan's prepared statement says. 'That uncertainty is complicated by an organization we inherited that, to be honest, was simply not properly managing or monitoring its risk.'"

Real Estate Watch:

December 1 - Bloomberg (Hui-yong Yu): "The commercial mortgage default rate on loans held by U.S. banks more than doubled to 3.4% in the third quarter as vacancies rose and rents declined, Real Estate Econometrics LLC said. Defaults climbed from 1.37% a year earlier and from 2.88% in the second quarter... 'Mortgages originated in 2006 and 2007 are experiencing the most significant shortfalls in current cash flow relative to current debt-service obligations,' Sam Chandan, chief economist...said..."

Muni Watch:

December 1 - Bloomberg (Jeremy R. Cooke): "New issues of Build America Bonds, the type of subsidized taxable debt Massachusetts will offer today, may rise 40% from this year's monthly average to total $110 billion in 2010, JPMorgan Chase & Co. strategists said."

California Watch:

December 2 - New York Times (Jennifer Steinhauer): "Long used to manageable property tax bills, California homeowners have been lamenting over the last few years that their assessments did not reflect the enormous slide in the value of so many homes here. Now, for the first time in more than 30 years...property tax bills will reflect negative price inflation, reducing most homeowners' tax bills come January."

New York Watch:

November 30 - Bloomberg (Michael Quint): "New York Governor David Paterson said he will issue executive orders to eliminate $1.6 billion of a $3.1 billion deficit, following six weeks of failed talks with legislators to close the gap... The governor said the deficit may be larger than estimated, referring to a report by Comptroller Thomas DiNapoli that the gap might total $4.1 billion."

Speculation Watch:

December 2 - Reuters (Jonathan Spicer and Jennifer Kwan): "High-frequency stock trading is spreading around the world into more and more asset classes... the high-frequency wave, estimated to be responsible for about 60% of U.S. stock trading, has already washed over much of Europe and is being felt in some emerging markets, particularly in Latin America."

Crude Liquidity Watch:

December 4 - Bloomberg (James Paton): "Chevron Corp.'s $40 billion Australian natural gas project will drive a global hunt for construction workers and has prompted calls to ease immigration rules to prevent labor shortages and cost overruns at energy and mining projects fueling the country's economy."

December 3 - Bloomberg (Eduard Gismatullin): "Integrated oil and gas companies such as Royal Dutch Shell Plc and BP Plc, Europe's largest, will benefit as higher oil prices and lower industry costs stem declines in cash flow, Moody's... said. The agency revised its outlook for the oil and natural-gas industry to 'positive' from 'negative,'... Rising demand and 'a gradual economic upturn are expected to underpin the recent recovery in oil prices in 2010,' Moody's said."

Malpass Spot-On

Today's non-farm payroll data provide fodder for those believing U.S. recovery is on track. I'll stick with the view that a 10% unemployment rate after more than a year of extraordinary fiscal and monetary stimulus is indicative of deep underlying structural impairment. Recent housing, household spending, mortgage delinquency, and state and local finances data all confirm our secular bearish prognosis.

I want to commend David Malpass for his spot-on op-ed piece in today's Wall Street Journal, "Near-Zero Rates are Hurting the Economy."

From the article: "The Federal Reserve implemented an emergency monetary policy after the 2008 Lehman bankruptcy to salvage the world financial system. In his testimony yesterday... Ben Bernanke said, 'We must be prepared to withdraw the extraordinary policy support in a smooth and timely way as markets and the economy recover.' This leaves all-out emergency monetary stimulus in place, but with a different, much weaker justification. With the system stabilized, the Fed hopes that artificially low interest rates and its purchases of mortgage-backed securities will spur growth. Instead they are pushing dollars abroad and wasting precious growth capital in asset and commodity bubbles... more than a year after the heart of the panic, the Fed is still promising near-zero interest rates for an extended period and buying over $3 billion per day of expensive mortgage securities... Capital is being rationed not on price but on availability and connections. The government gets the most, foreigners second, Wall Street and big companies third, with not much left over. The irony of the zero-rate policy, coupled with Washington's preference for a weak dollar, is a glut of American capital in Asia (as corporations and investors shun the weakening U.S. currency) and a shortage at home... Much of its current stimulus is being diverted to commodities and foreign economies -- hence Asia's complaint about bubbles... Wall Street will threaten a tantrum if the Fed even thinks about damping the air-raid sirens. The Street utterly loves the Fed's largess..."

Mr. Malpass and others have recognized the dangerous flaws inherent in Federal Reserve doctrine. It became the Greenspan Fed's crisis management modus operandi to call upon Wall Street Credit creation and leveraging to lead systemic market liquidity and reflationary efforts. For more than two decades, this proved history's most powerful monetary mechanism. Dominant "Monetary Processes" provided the key to "success." With the Fed guaranteed to slash rates and the GSEs guaranteed to buy and back hundreds of billions of mortgages at the first sign of trouble, the mortgage and mortgage-related securities arena attracted a massive and reinforcing influx of funds (what Mr. Malpass would refer to as "capital").

From my analytical framework, mortgage finance demonstrated a powerful "Inflationary Bias". Related forces inflated the GSEs, Wall Street firms, the hedge funds, home prices, household net worth, equity extraction, over-consumption, and malinvestment. The inflationary bias inherent in U.S. mortgage securities (and related instruments) was instrumental to two decades of major U.S. structural transformation to a de-industrialized "services" economy. Distortions in the pricing of mortgage finance fostered a massive misallocation of financial and real resources - both at home and abroad. It also fueled a historic housing mania and attendant acute financial and economic fragility.

Mr. Malpass recognizes that the world has changed in fundamental ways. Today, "capital" flows first and foremost to Asia and commodities rather than to job-creating U.S. businesses. The more liquidity created here the more things inflate there. In my nomenclature, predominant Inflationary Biases and related Monetary Processes have been radically altered. Importantly, mania has given way to U.S. housing depression, while faith in sophisticated Wall Street Credit instruments has been shattered. The dollar has been severely impaired. There is no returning to previous cycle dynamics.

The reliable old Monetary Process - where Federal Reserve and GSE reflationary measures would immediately stoke rapid (and self-reinforcing) mortgage Credit growth, housing inflation, inflating household net worth, equity extraction, spending and government receipts - is no longer operable. Reflationary liquidity that for years gravitated predictably to our MBS and agency debt now prefers "undollar" asset classes, including emerging debt and equities, gold and metals, and commodities more generally.

The Fed's capacity for domestic monetary stimulus has been greatly diminished, with U.S. and global economic systems these days responding altogether differently to reflationary policymaking. Yet the Bernanke Fed refuses to respond to the altered landscape. Dangerously, the Fed adheres steadfastly to its old policy approach - only implementing it more radically. Our central bank balloons its balance sheet with mortgage-backed securities, while pegging interest rates all the way down to zero. Worse yet, the Fed has signaled that the markets can bank on near zero percent for a protracted period. Global dynamics have changed, yet the Fed has locked itself into a precarious policy approach. Dr. Bernanke testifies that U.S. asset prices don't appear overvalued. Meanwhile, price distortions and Bubble dynamics engulf the world.

The discussion of what went wrong in Dubai is quite interesting. Some want to simplistically blame a combination of a lack of transparency and stupid bankers. Yet Dubai's debt problems are complex and really are a microcosm of global Credit and economic woes. Market price distortions are the essence of financial Bubbles. In Dubai, lenders assumed implicit government backing for corporate debt obligations. In a region seeing more than its share of liquidity excess, intoxicated lenders saw little reason for looking through to underlying project economics. And the bigger the Bubble inflated the more convinced the markets became that wealthy regional governments would have no stomach for a regional crisis of confidence.

The Dubai debt crisis appears at this point largely contained and may not prove a catalyst for a new crisis phase. But it certainly highlights crucial and ongoing global issues. Market distortions fostered by Global Liquidity Excess and Market Perceptions of Implicit Government Backing recalls our own GSE fiasco. Superfluous and mispriced finance fed Bubbles and precarious Ponzi finance dynamics. The Wall Street and Dubai miracles worked until they didn't. As we witnessed firsthand with the Wall Street/mortgage finance Bubble, the scheme preserved as long as sufficient new cheap speculative finance was enticed to play. It became a confidence game.

For months now, I have posited the emergence of a Global Government Finance Bubble. Global Liquidity Excess and Market Perceptions of Implicit Government Backing are, once again, playing an instrumental role in fostering Ponzi Dynamics. The Fed and most observers are seemingly oblivious to Bubble risk here at home. Yet the Treasury and agency markets are the epitome of dangerously distorted Bubble markets. Unprecedented global imbalances, ballooning central bank balance sheets, pegged ultra-low rates, and unwieldy speculative financial flows foment liquidity excesses and market price distortions - especially in the enormous U.S. Treasury and agency markets. At the same time, the markets perceive an Implicit Guarantee: That China, Japan, "emerging" Asia and the Middle East can be counted on to support Treasury prices and ensure dollar weakness doesn't turn disorderly. Moreover, markets perceive that Federal Reserve rate and monetization policies will continue to underpin U.S. corporate, municipal and household debts.

Markets have thus far been content to largely overlook underlying economic fundamentals when it comes to valuing U.S. government debt obligations. Importantly, the multi-trillion dollar expansion of (mispriced) Treasury and agency securities has been instrumental in rejuvenating both the U.S. Credit system, markets and the real economy. Markets have readily accommodated a massive expansion of U.S. government debt and perceive that ongoing Treasury and Fed Credit creation will bolster recovery. This perception - built into collapsing Credit spreads and increased Credit Availability - has been instrumental in stabilizing domestic incomes, corporate cash flows, and asset prices (homes, stocks, debt and "risk assets" more generally). I would argue that only the emergence of a government finance Bubble held much greater debt problems - along with necessary economic adjustment - at bay.

While perhaps not obvious from an asset price perspective, there are unmistakable Bubble and Ponzi Dynamics at work. The entire U.S. financial and economic recovery rests on a flimsy foundation of a highly distorted Treasury and agency market Bubble. I am the first to appreciate that Bubbles notoriously survive longer and grow larger than we Bubble analysts would expect. At the same time, the world has moved up the Bubble analysis learning curve. I find it disconcerting that many that recognize the unfolding Bubble landscape still believe they have plenty of time to profit and then get out before the bust. But I also sense the more sophisticated players are following developments with an increasing degree of angst.