For the week, the S&P500 declined 0.8% (up 1.9% y-t-d), while the Dow was little changed (up 1.7% y-t-d). The volatile Banks dipped 0.7% (up 9.3%), and the Broker/Dealers fell 1.6% (up 2.5%). The Morgan Stanley Cyclicals dropped 1.8% (up 5.1%), and Transports declined 1.0% (up 2.0%). The Morgan Stanley Consumer index added 0.3% (up 1.1%), and the Utilities gained 0.8% (down 0.3%). The S&P 400 Mid-Caps declined 1.2% (up 2.3%), and the small cap Russell 2000 fell 1.0% (up 2.0%). The Nasdaq100 dropped 1.5% (up 0.2%), and the Morgan Stanley High Tech index fell 1.2% (down 0.3%). The Semiconductors sank 6.3% (down 4.2%). The InteractiveWeek Internet index declined 1.0% (down 0.1%). The Biotechs added 0.9% (up 4.2%). With bullion down $7, the HUI gold index sank 5.2% (up 2.0%).

One-month Treasury bill rates ended the week at 3 bps, and three-month bills closed at 6 bps. Two-year government yields dropped 11 bps to 0.77%. Five-year T-note yields sank 18 bps to 2.35%. Ten-year yields fell 16 bps to 3.68%. Long bond yields dropped 14 bps to 4.58%. Benchmark Fannie MBS yields dropped 15 bps to 4.37%. The spread between 10-year Treasury and benchmark MBS yields narrowed one to 69 bps. Agency 10-yr debt spreads widened 3 to 33 bps. The implied yield on December 2010 eurodollar futures declined 13.5 bps to 1.085%. The 10-year dollar swap spread was little changed at 10.75, while the 30-year swap spread increased 3.25 to negative 11. Corporate bond spreads were mixed. An index of investment grade bond spreads widened 2 to 80 bps, while an index of junk spreads narrowed 6 to a new two-year low 505 bps.

January 11 - Bloomberg (Daniel Kruger and Anchalee Worrachate): "The correlation between Treasuries and German bunds that has prevailed since credit markets started freezing in 2007 is breaking down... Yields on U.S. 10-year Treasury notes rose twice as fast as German debt with a similar maturity since the start of December... The bonds had traded almost in tandem since April 2007..."

Investment grade issuers included Pepsico $4.25bn, Prudential $1.25bn, Stryker $1.0bn, Brocade Communications $600 million, Praxair $500 million, MDC Holdings $250 million, and Delphi $250 million.

Junk issuers included Ford Credit $1.25bn, Icahn Enterprises $2.0bn, Virgin Media $1.0bn, Hexion $1.0bn, Sorenson Communications $735 million, Antero Resources $525 million, Verso Paper $350 million, B&G Foods $350 million, CMS Energy $300 million, Jarden Corp $275 million, Stone Energy $275 million, Marquette Transportation $250 million, United Airlines $700 million, Scotts Miracle-Grow $200 million, and DJO $100 million.

I saw no convert issues.

International dollar-denominated debt issues this week included Credit Suisse $2.5bn, Indonesia $2.0bn, Bank of Tokyo-Mitsubishi $2.0bn, UBS $1.5bn, Santander $1.5bn, Banco do Brasil $1.0bn, Mexico $1.0bn, Banco Votorantim $750 million, Manitoba $600 million, Colbun $500 million, Teekay $450 million, Urbi Desarrollos $300 million, Banco Industr $275 million, and Gibson Energy $200 million.

U.K. 10-year gilt yields fell 12 bps to 3.94%, and German bund yields dropped 12 bps to 3.26%. Bond yields in Greece surged 41 bps to 5.99%. The German DAX equities index dropped 2.7% (y-t-d decline of 1.4%). Japanese 10-year "JGB" yields declined 3.5 bps to 1.32%. The Nikkei 225 jumped 2.8% (up 4.1%). Emerging markets were mixed to lower. For the week, Brazil's Bovespa equities index fell 1.8% (up 0.6%), and Mexico's Bolsa declined 1.9% (up 0.4%). Russia's RTS equities index was little changed (up 7.9%). India's Sensex equities index was unchanged (up 0.5%). China's Shanghai Exchange rallied 0.9% (down 1.7%). Brazil's benchmark dollar bond yields rose 4 bps to 5.08%, while Mexico's benchmark bond yields fell 6 bps to 5.04%.

Freddie Mac 30-year fixed mortgage rates dipped 3 bps to 5.06% (up 10bps y-o-y). Fifteen-year fixed rates declined 5 bps to 4.45% (down 20bps y-o-y). One-year ARMs jumped 8 bps to 4.39% (down 50bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 6 bps to 6.02% (down 77bps y-o-y).

Federal Reserve Credit increased $9.3bn last week to $2.226 TN. Fed Credit was up $156.5bn from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 1/13) declined $10.9bn to $2.951 TN. "Custody holdings" expanded $423bn, or 16.7%, over the past year.

M2 (narrow) "money" supply dropped $46.5bn to $8.367TN (week of 1/4). Narrow "money" expanded 1.9% over the past 52 weeks. For the week, Currency slipped $0.6bn, while Demand & Checkable Deposits jumped $36.8bn. Savings Deposits sank $77.3bn, and Small Denominated Deposits declined $7.1bn. Retail Money Funds increased $1.9bn.

Total Money Market Fund assets (from Invest Co Inst) fell $21.7bn to $3.286 TN. Over the past year, money fund assets declined $636bn, or 16.2%.

Total Commercial Paper outstanding gained $26.2bn last week to $1.102 TN. CP dropped $617bn over the past year (35.9%). Asset-backed CP increased $7.0bn last week to $427bn, with a 52-wk drop of $345bn (44.7%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $826bn y-o-y, or 12.1%, to a record $7.639 TN.

Global Credit Market Watch:

January 9 - Wall Street Journal (Gregory Zuckerman and Jenny Strasburg): "Banks are boosting their lending to hedge funds and private-equity firms to levels unseen since before the financial crisis, raising their risk levels and adding fuel to the buying power of key players across the stock, debt and buyout markets. Banks and investment banks... are offering levels of borrowing -- known as leverage -- that they haven't provided in more than two years... Borrowing terms also are easing, though not to the extent witnessed several years ago. 'You'll see some funds start to crank up leverage this year,' says Jon Hitchon, Deutsche Bank's co-head of global prime finance."

January 12 - Bloomberg (Anna-Louise Jackson): "High-yield bond issuance is poised this year to surpass the record-breaking levels of 2009... according to CreditSights Inc. New issues may reach $120 billion with the refinancing of maturities through 2014 alone and $150 billion is 'easily achievable' in a small asset-allocation shift... analyst Chris Taggert wrote..."

January 15 - Wall Street Journal (Damian Paletta): "Senate Banking Committee Chairman Christopher Dodd is considering scrapping the idea of creating a Consumer Financial Protection Agency... an initiative at the heart of the White House's proposal to revamp financial-sector regulations. The Connecticut Democrat... has discussed the possibility of abandoning the push for a new agency during negotiations with key Senate Republicans as a way to secure a bipartisan deal on the legislation, these people said."

January 14 - Bloomberg (Esteban Duarte and Jody Shenn): "Europe's asset-backed bond market, dormant for a year, is coming back to life as Bayerische Motoren Werke AG and Ford Motor Co. sell more than 1 billion euros ($1.45 billion) of debt backed by automobile loans and leases."

January 11 - Bloomberg (Zainab Fattah): "Dubai's housing rout sent prices down 52% in the past year, prompting some homeowners to abandon their cars and mortgage payments and flee the country. Not one received a foreclosure notice. Until now. Barclays Plc won the sheikdom's first foreclosure cases in court, clearing the way for lenders holding about $16 billion of Dubai home loans to take action when borrowers don't pay."

January 11 - Bloomberg (Scott Reyburn): "Prices for the most desirable works by contemporary artists such as Lucian Freud are set to surge as much as 30% in 2010 as collectors spend again, dealers and advisers predicted in a Bloomberg News survey."

Global Government Finance Bubble Watch:

January 12 - Wall Street Journal (Peter Eavis): "The Federal Reserve's blowout 2009 profit is no reason to cheer. Rather, it is a reminder of the dangers inherent in the extraordinary policies the central bank has pursued during the credit crunch. Last year, the Fed earned $52.1 billion, with most of that income coming from interest payments on bonds that it bought during the year... Anyone with access to printing presses could have racked up similar gains."

January 15 - Financial Times (Kevin Brown): "Inflation is emerging as the key economic problem for India and China as growth surges in the wake of the global financial crisis, the Asian Development Bank warned... The ADB also said that south-east Asian economies would need to make significant financial, fiscal and structural adjustments to protect themselves against future economic shocks... The ADB is forecasting that Asia excluding Japan will grow by 6.6% this year, with China's economy expanding by 8.9%. The region grew by 4.5% in 2009."

January 13 - Dow Jones (Natasha Brereton and Ainsley Thomson): "The risks of sovereign debt crisis, asset-price bubble collapse and hard-landing in the Chinese economy will be high on the agenda of global leaders convening in Davos, Switzerland, for the World Economic Forum this month. Launching the Forum's fifth global risks report, WEF Managing Director Robert Greenhill warned that the most pertinent risks weren't the ones that are unknown but those left unaddressed."

January 14 - Bloomberg (Maria Petrakis): "Greece will cut spending and raise revenue by about 10 billion euros ($14.5bn) this year as part of a three-year plan adopted today to bring the European Union's biggest budget deficit within the EU limit in 2012. 'We will do whatever it takes,' Greek Prime Minister George Papandreou said... 'Our country can and is obliged to exit as soon as possible this vicious circle of misery. We will not retreat; we will proceed quickly."

January 14 - Bloomberg (Milda Seputyte): "Lithuania's budget deficit widened to 'close to' 9.5% of gross domestic product last year from 3.2% in 2008... The government will delay until 2012 plans to bring its shortfall within the European Union's limit of 3% of GDP..."

Currency Watch:

The dollar index declined 0.4% this week to 77.175. For the week on the upside, the Japanese yen increased 1.1%, the British pound 1.5%, the South Korean won 0.7%, the Singapore dollar 0.3%, the Taiwanese dollar 0.3%, the New Zealand dollar 0.2% and the Canadian dollar 0.1% For the week on the downside, the Brazilian real declined 2.6%, the South African rand 0.6%, the Norwegian krone 0.2%, the Australian dollar 0.2%, and the euro 0.2%.

Commodities Watch:

January 9 - Wall Street Journal (Mark Whitehouse, Scott Kilman and Alex Frangos): "From corn to crude, prices for a wide range of commodities are on the rise across the globe... In recent months, global food prices have been growing at a rate that rivals some of the wildest months of 2008, when food riots erupted across the developing world."

The CRB index dropped 3.2% (down 0.7% y-t-d). The Goldman Sachs Commodities Index (GSCI) sank 4.2% (down 0.8% y-t-d). Gold slipped 0.6% to $1,131 (up 3.1% y-t-d). Silver was down 0.3% to $18.41 (up 9.3% y-t-d). February Crude fell $4.80 to $77.95 (down 1.8% y-t-d). February Gasoline sank 5.1% (down 0.4% y-t-d), and February Natural Gas dipped 1.0% (up 2.2% y-t-d). March Copper declined 1.0% (up 0.6% y-t-d). March Wheat sank 10.3% (down 5.8% y-t-d), and March Corn fell 12.2% (down 10.4% y-t-d).

China Bubble Watch:

January 14 - Bloomberg (Zijing Wu and Kevin Crowley): "China's economy is overheating as asset bubbles and inflation pressures build, posing a 'major risk' to global growth, the World Economic Forum said. A drop in momentum in the world's fastest-growing major economy 'could adversely affect global capital and commodity markets,' the group said..."

January 11 - Bloomberg (Chia-Peck Wong): "China's economy may grow as much as 16% this year with accelerating inflation and the risk of a property bubble unless policy makers reduce stimulus measures, government researchers said... 'If the government continues with the same strength of macro-economic stimulus as in 2009, there will be notable economic overheating in 2010," Yao Zhizhong and He Fan, economists with the Chinese Academy of Social Sciences, said... Local media reported today that new lending surged last week."

January 13 - Bloomberg: "China raised the proportion of deposits that banks must set aside as reserves to cool the world's fastest-growing major economy as a credit boom threatens to stoke inflation and create asset bubbles. Reserve requirements will increase by 50 bps... The existing levels are 15.5% for big banks and 13.5% for smaller ones. Chinese lenders added a record 9.21 trillion yuan ($1.3 trillion) of loans in the first 11 months of 2009..."

January 13 - Bloomberg: "An unexpected shift by China's central bank to restrain lending may foreshadow higher interest rates and a relaxation in the nation's currency peg against the dollar. The People's Bank of China... raised the proportion of deposits that banks must set aside as reserves by 50 basis points starting Jan."

January 13 - Bloomberg: "Chinese consumers may 'rescue' the global economy over the next few years as they shop more, save less and replace Americans as the biggest spenders, Credit Suisse Group AG said... The savings ratio dropped to 12% from 26% during the period, according to a survey of 2,700 people in eight cities..."

January 11 - Bloomberg: "China supplanted the U.S. as the world's largest auto market after its 2009 vehicle sales jumped 46%, ending more than a century of American dominance that started with the Model T Ford. The nation's sales of passenger cars, buses and trucks rose to 13.6 million, the fastest pace in at least 10 years... In the U.S., sales slumped 21% to 10.4 million, the fewest since 1982, according to Autodata Corp."

January 11 - Bloomberg: "China's exports surged in December and imports rose to a record in a stronger-than-forecast trade rebound that may lessen the case for governments to sustain stimulus programs this year. Exports climbed 17.7% from a year earlier, the first increase in 14 months, and imports jumped 55.9%..."

January 14 - Bloomberg: "China's property prices rose at the fastest pace in 18 months in December, highlighting the government's struggle to rein in speculation while maintaining economic growth. Residential and commercial real-estate prices in 70 cities climbed 7.8% from a year earlier..."

January 11 - Bloomberg (Lee J. Miller): "China will invest more money in railways than highways next year for the first time in at least a decade even as the nation overtakes the U.S. as the world's largest auto market, according to Credit Suisse Group AG... The nation will invest 900 billion yuan ($132 billion) on roads this year... Rail spending will increase 22% to 732 billion yuan and surpass investment on roads in 2011, the bank said..."

January 13 - Bloomberg (Chia-Peck Wong): "New home sales in Hong Kong rose 60% in 2009... Centaline Property Agency Ltd. Said..."

India Watch:

January 14 - Bloomberg (Kartik Goyal): "India's wholesale prices rose the most in more than a year, strengthening the case for the central bank to withdraw monetary stimulus later this month. The benchmark wholesale-price index climbed 7.31% in December from a year earlier, following a 4.78% gain in November..."

Latin America Bubble Watch:

January 14 - Bloomberg (Adriana Brasileiro): "Brazil's retail sales rose 8.7% in November from a year ago, the national statistics said."

January 13 - Bloomberg (Francisco Marcelino): "Banco do Brasil SA, Latin America's largest lender by assets, has begun talks with banks and companies to arrange a loan of about 9 billion reais ($5.1bn) to help finance construction of an Amazon dam project."

January 12 - Bloomberg (Daniel Cancel and Jose Orozco): "Venezuelan consumers are rushing to buy flat screen televisions before prices jump, while U.S. companies including Colgate-Palmolive Co. brace for profit declines after President Hugo Chavez devalued the currency. Shoppers picked through half-empty shelves at the Game-Zone electronics store in Caracas yesterday after a surge in demand drove up sales 70% over the weekend..."

January 13 - Bloomberg (Daniel Cancel): "Venezuelans will face rolling blackouts for the next five months starting today as the worst drought in 50 years threatens to shut the nation's biggest hydroelectric plant and collapse the power grid."

Unbalanced Global Economy Watch:

January 12 - Bloomberg (Greg Quinn): "Canada unexpectedly posted a trade deficit in November, led by rising imports of energy, machinery and automobiles, keeping the country headed for its first annual deficit in goods trade since 1975."

January 13 - International Herald Tribune (Jack Ewing): "Growth in Germany was near zero at the end of 2009... as Europe's economic powerhouse struggled to climb out of its worst recession since World War II."

January 13 - Bloomberg (Emma Ross-Thomas): "The Portuguese and Greece economies may face a 'slow death' as they dedicate a higher proportion of wealth to paying off debt and investors demand a premium to hold their bonds, Moody's... said."

January 14 - Bloomberg (Jacob Greber): "Australian employment soared for a fourth straight month as companies added three times more jobs than economists estimated... The jobless rate fell to 5.5% from a revised 5.6%."

U.S. Bubble Economy Watch:

January 12 - Wall Street Journal (Justin Lahart and Phil Izzo): "The U.S. trade deficit widened in November, as rising imports to the U.S. outstripped export gains... The trade deficit rose 9.7% to $36.40 billion in November from the month before... U.S. exports rose to $138.24 billion, the highest level in a year, up 0.9%. But imports rose at a faster pace, up 2.6% to $174.64 billion."

Central Bank Watch:

January 14 - Bloomberg (Joshua Zumbrun): "New York Federal Reserve Bank President William Dudley said short-term interest rates may remain low for at least six months and possibly for as long as two years. 'Short-term rates are going to stay low for a considerable period of time to come,' Dudley said..."

January 13 - Wall Street Journal (Jon Hilsenrath): "In a monthly survey of mainly Wall Street and other business economists, 42 said low interest rates were partly to blame for the housing boom, while 12 sided with Mr. Bernanke and said they weren't. Academic economists who specialize in monetary policy were split in a separate survey: 13 said low interest rates helped cause the housing bubble; 14 said they didn't. It is more than an academic argument. Fed officials have been trying to understand what went wrong last decade to avoid repeating it... The Fed pushed its benchmark federal funds interest rate... to 1% in 2003 when Alan Greenspan was Fed chairman and Mr. Bernanke was a member of the Fed board. With the economy weak and deflation a concern, the Fed pushed rates up gradually beginning in 2004. Mr. Bernanke became chairman in 2006."

Fiscal Watch:

January 13 - Bloomberg (Vincent Del Giudice): "The U.S. registered its largest December budget deficit on record... The excess of spending over revenue rose to $91.9 billion last month, compared with a deficit of $51.8 billion in December 2008... The U.S. has posted a record 15 straight monthly deficits... The government's $787 billion economic rescue plan contributed to the record $1.4 trillion deficit in fiscal year 2009 that ended in September... The deficit will probably exceed $1 trillion for the second consecutive fiscal year, according to estimates by White House and congressional budget officials... Government spending last month increased 7.3% from the same time a year earlier to $310.8 billion... Revenue and other income dropped 7.9% to $218.9 billion..."

Real Estate Watch:

January 14 - Bloomberg (Dan Levy): "A record 3 million U.S. homes will be repossessed by lenders this year... according to a RealtyTrac Inc. forecast. Last year there were 2.82 million foreclosures... More than 4.5 million filings are expected this year, including default or auction notices and bank seizures, said Rick Sharga, senior vice president for the...the seller of default data and forecasts. There were 3.96 million filings in 2009."

Muni Watch:

January 11 - Bloomberg (Terrence Dopp): "Jon Corzine, only the second sitting New Jersey governor to lose a general election since 1947, makes his farewell speech tomorrow with the third-most indebted U.S. state facing spending cuts as steep as 25% to close a record $8 billion budget gap."

California Watch:

January 12 - Bloomberg (Michael B. Marois): "California Governor Arnold Schwarzenegger shouldn't expect the federal help he's seeking to erase a $20 billion deficit the most-populous U.S. state faces, fiscal analyst Mac Taylor said. 'While the odds seem favorable for some federal relief sought by the administration, we believe that the likelihood of Washington agreeing to all of the governor's requests is almost non-existent,' Taylor, from the non-partisan California Legislative Analyst Office, said in a report."

January 14 - Bloomberg (Michael B. Marois and William Selway): "California bondholders got an early glimpse of what the state's budget-negotiation season may bring as a looming $20 billion deficit led Standard & Poor's to cut its credit rating for the second time in less than year. S&P... lowered its assessment on $64 billion of the most-populous U.S. state's general obligation bonds one level to A-..."

New York Watch:

January 14 - Bloomberg (John Gittelsohn): "Manhattan apartment rents dropped 9.4% in the fourth quarter of 2009 from a year earlier as Wall Street jobs vanished in the recession. The median rent fell... according to... Prudential Douglas Elliman Real Estate and appraiser Miller Samuel Inc."

Crude Liquidity Watch:

January 13 - Bloomberg (Paul Abelsky): "Russia's government probably ran a deficit of 2.2 trillion rubles ($74.2 billion) last year, almost 27% smaller than previously estimated, as state finances benefited from higher energy revenue, according to UniCredit SpA."

Speculation Watch:

January 12 - Bloomberg (Tomoko Yamazaki and Warren Giles): "Hedge funds had their best annual performance in six years in 2009 as the global economy began recovering and investor confidence returned, according to Eurekahedge Pte. The Eurekahedge Hedge Fund Index, tracking more than 2,000 funds, rose 0.9% in December, bringing its 12-month return to 19% and total assets to $1.48 trillion..."

January 14 - Bloomberg (Tom Cahill and Alexis Xydias): "Hedge-fund managers that use computers to predict trends in futures prices... posted the biggest losses in more than two decades in 2009... Managed-futures funds fell an average of 4.7% last year, according to an index of 50 top funds compiled by BarclayHedge Ltd. The decline, which compared with a gain of 13.5% in 2008, was the first in 15 years and the largest since BarclayHedge began tracking returns in 1987."

Current Account Deficits: 25 Years and Counting

The U.S. ran small current account surpluses in 1980 and 1981. By 1984, the current account had turned to a (at the time a massive) negative $94bn. The deficit ballooned further to $118bn in 1985, $147bn in 1986 and $160bn in 1987. Prior to 1983, the largest current account deficit was the $15bn posted in the inflationary year 1978

Fears of mounting "twin deficits" were at the time viewed as a factor behind the dollar weakness and the jump in yields that precipitated the 1987 stock market crash. The simultaneous rapid escalation in current account deficits and stock prices in the eighties was no coincidence. Credit was expanding rapidly. Total (consumer and mortgage) Household debt growth jumped from 1982's 5.6% to 1983's 11.1%, 1984's 12.6%, 1985's 16.1%, 1986's 11.5% and 1987's 10.4%. On the business side, borrowings expanded 9.9% in 1982, 9.1% in 1983, 16.2% in 1984, 11.0% in 1985, 11.4% in 1986%, and 7.7% in 1987. Things really got heated up after the Greenspan Fed's post-crash reflation: junk bonds, leveraged buy-outs, Michael Milken, Ivan Boesky, and the "decade of greed."

By decade, the U.S. posted cumulative deficits of $3bn in the seventies, $778bn in the eighties, and $1.230 TN during the nineties. And while the 2009 deficit will have shrunk significantly on a year-over-year basis, the year's more than $400bn shortfall will put the past decade's cumulative current account deficit at a staggering $5.83 TN. Taking a different perspective on the issue, the Fed's Z.1. "flow of funds" report has the Rest of World (ROW) holding $943bn of U.S. financial assets at the end of 1985. ROW holdings ended last September at $15.052 TN. I have referred to this massive agglomeration of (largely U.S.) financial claims as the "global pool of speculative finance." It is the primary fuel for what has become pervasive and unrelenting global boom and bust dynamics.

An op-ed piece by David Backus and Thomas Cooley in Monday's Wall Street Journal caught my attention:

"In the 1920s, capital began flowing from Massachusetts to North Carolina, a process that continued until after World War II as textile mills migrated to the South from New England. Beginning in the 1950s capital moved again as textile manufacturing moved to Mexico, India and Malaysia. Capital has long moved to where it can be used most productively, and by and large, that has been a good thing. Whether capital moves within a country or between countries, its flow addresses imbalances between available local capital and uses for capital (otherwise known as investments). Through much of history, the major capital flows have been from rich countries to poorer ones. England financed canals in this country and railroads in Australia and India. That's no longer the case. The most notable importer of capital in recent times has been the United States... Germany, Japan, China and Switzerland have been significant exporters of capital. Over the past 10 years, oil-exporting countries have been exporters of capital. These facts are collectively referred to as 'global imbalances.' The standard view in policy circles is that they represent a serious threat to economic stability rather than a sensible market reallocation of capital. In the standard view, such imbalances are 'unsustainable' and the longer they last, the more drastic and painful will be the ultimate 'adjustment.' After 25 years of such threats, you might think positions would change. Instead, the same people are now arguing that these capital flows were one of the root causes of the financial crisis."

I strongly believe years of massive U.S. current account deficits created a global financial backdrop that foments historic booms and busts. Our system's Credit excesses were indeed the root cause of the imbalances that ensured financial crisis. And I have to admit that I have difficulty these days grasping how analysts could see it any other way. A big stock market recovery and resurgent optimism have emboldened views that should have been thoroughly discredited.

For years, I've been amazed at the prevalence given to the view that our current account deficits were the result of global "capital" clamoring to own our assets. Messrs. Backus and Cooley even refer to the current account deficit as "the net amount of capital flowing into the country." It has been painful to see likeminded analysis in the past from both Greenspan and Bernanke - who surely must know better. Dr. Bernanke persists in blaming our asset Bubble problem on the surfeit of international "capital" that pushed global yields down.

Traditionally, large and persistent current account deficits were recognized as important evidence of excessively loose monetary conditions. During periods of stable global monetary regimes (under gold standards or even Bretton Woods), policymakers understood that balanced trade flows were a critical facet of overall financial stability. Trade imbalances nurtured pernicious financial dynamics. Only in the last 25 years has creative thinking concocted a hypothesis that such deficits are not only not dangerous - but they are indicative of a healthy allocation of "capital" and the superiority of the U.S. markets and economy. And the bigger our deficits, the more vocal the apologist became in rationalizing our lack of financial discipline.

I have argued over the years that there is no "chicken or the egg" issue. It is our Credit system that creates new financial obligations (Credit) that then leave the country in enormous quantities to finance purchases of oil, manufactured goods and other imports, commodities, and foreign securities and direct investment. These dollar-denominated global financial flows (U.S. IOUs), by their nature, must find their way back to the U.S. Credit system - predominantly through the acquisition of our debt securities and other financial assets.

It is not a case of the Chinese exporting their "capital" to the U.S. - they instead send us goods in exchange for our debt. They reinvest dollar financial claims received both from exporting goods and being on the receiving end of massive "hot money" and direct investment inflows. I refuse to refer to the recycling of U.S. financial obligations back into our securities markets as an injection of "capital." These are electronic journal entries and have little to do with "capital" in the traditional meaning of the word.

The inflationists focus almost exclusively on deflation risk. They use this recurring argument that (fiscal and monetary) stimulus is necessary to stabilize prices and avoid a downward debt spiral. They are inherently current account deficit apologists. Despite rapidly rising mortgage debt growth and 2001's $400bn current account deficit, the inflationists argued for massive monetary stimulus back then to combat deflationary forces. Not surprisingly, considering the monetary backdrop, current account deficits expanded even more rapidly - $459bn in 2002, $522bn in 2003, $631bn in 2004, $749bn in 2005, and $804bn in 2006. Fed funds began 2006 at 4.25% and mortgage Credit expanded almost $1.4 TN during the year.

In hindsight, it should be apparent that unrestrained global Credit and consequent asset inflation, Bubbles, and boom and bust dynamics were the pressing systemic risk - not deflation. Fighting the burst tech Bubble and "deflation" through the massive inflation of mortgage Credit was an unmitigated disaster. Problems were "papered over" and a much greater Bubble emerged. While the apologists were trumpeting the wonders of "Bretton Woods II," massive U.S. current account deficits were exporting U.S. Credit Bubble dynamics to the rest of the world.

Trillions of combined federal government debt issuance and Federal Reserve monetization have become this cycle's ammo for battling "deflation." I have stated my belief that this unprecedented inflation of government Credit is both delaying necessary economic adjustment and creating a very dangerous Bubble backdrop. I have argued that reducing our economy's dependence on massive Credit expansion is fundamental to creating a more stable financial and economic environment. Comprehensive economic restructuring is essential for reducing Credit dependency and dramatically shrinking our current account deficits. But with the markets up and the economy rebounding, focus on structural problems and imbalances has been relegated to the "permabears" - who have apparently learned little during the past 25 years.