Relative calm returned this week to global financial markets, with Asian equity markets notably regaining their composure. U.S. equities were choppy, but generally little changed for the week. The Dow and S&P500 posted fractional declines. The Transports added about 0.5%. The Utilities and Morgan Stanley Cyclical indices were about unchanged, while the Morgan Stanley Consumer index declined 1%. The broader market was quiet, with the small cap Russell 2000 slightly positive and S&P400 Mid-cap index slightly negative. Technology stocks made a little headway, with the NASDAQ100 adding 0.5%. The Morgan Stanley High Tech index was slightly positive for the week. The Semiconductors and NASDAQ Telecommunications indices were up 1.5%, and The Street.com Internet Index gained 1%. The Biotechs declined about 2%. The financial stocks were mixed. The Broker/Dealers were about unchanged and the Banks added 1%. With bullion jumping $7.80, the HUI gold index rose 7%.

The bond market was also less unsettled. For the week, 2-year Treasury yields rose 2 basis points to 2.55%, and 5-year Treasury yields were unchanged at 3.90%. Ten-year yields dipped one basis point to 4.76%, while long-bond yields declined 2.5 basis points to 5.46%. Benchmark Fannie Mae mortgage-backed yields rose 4 basis points. The spread on Fannie's 4 3/8% 2013 note narrowed 4 to 41, and the spread on Freddie 4 ½% 2013 note narrowed 5 to 39. The 10-year dollar swap spread declined 2.5 to 49.5. Investment grade and junk debt spreads generally narrowed this week. The implied yield on 3-month December Eurodollars rose 6 basis points to 2.50%.

Corporate issuance was moderate this week. Investment Grade Issuers included GMAC $1.5 billion, Westpac Banking $1.5 billion, Credit Suisse FB $1.35 billion, Household Finance $1.25 billion, Sprint Capital $940 million, Allstate Life $800 million, American Honda Finance $750 million, American General Finance $600 million, IBM $500 million, SouthTrust $400 million, Sempra Energy $600 million, Keycorp $250 million, Residential Reinsurance $225 million, Magellan Midstream $250 million, Sweetwater Investment $165 million and Brunswick $150 million...

Junk bond funds reported $989 million of outflows for the week (from AMG), following last week's $2 billion drain. Junk issuers included UGS Corp $550 million, Chesapeake Energy $300 million, DTE Energy $240 million, Felcor Lodging $175 million, and Trans Tech Industries $100 million.

Tenneco this week cancelled its $420 junk deal.

Convert issuance included Thoratec $215 million, and Tower Automotive $110 million.

Foreign dollar debt issuers included Depfa Bank $1.5 billion, Pearson PLC $750 million, and Astrazenca $750 million.

May 19 - Bloomberg (Terence Flanagan): "General Motors Corp. and Ford Motor Co. bonds are among this month's worst performers as speculation that corporate profit growth will slow pushes investors to sell debt of some of the riskiest investment-grade issues. General Motors' 7.75 percent 2036 bonds have fallen 7.4 percent in May, the worst return of 3,749 bonds tracked by New York-based Merrill Lynch & Co. Automaker bonds have dropped 1.9 percent on average this month, compared with a decline of 1.4 percent for investment-grade bonds overall."

Brazilian benchmark bond yields rose 18 basis points to 11.75%. Russian 10-year Eurobond yields dropped 35 basis points to 6.57%, with Mexican bond yields down 5 basis points to 6.21%.

Freddie Mac posted 30-year fixed mortgage rates dipped 4 basis points this week to 6.30%. Long-term fixed rates were up 90 basis points in eight weeks. For the week, 15-year fixed-rate mortgage rates declined 5 basis points to 5.67% (up 97bps in 8 weeks). One-year adjustable-rate mortgages could be had at 3.99%, up another 9 basis points for the week (up 63bps in 8 weeks). The Mortgage Bankers Association Purchase application index declined 8% last week. Purchase applications were up 15% y-o-y, with dollar volume up 25%. Refi applications declined 17%. The average Purchase mortgage was for $217,900, and the average ARM was for $285,400. ARMs accounted for 35.2% of applications last week. ARMs accounted for almost 50% of total application dollar volume.

Broad money supply (M3) added $3.2 billion. Year-to-date (19 weeks), broad money is up $353.1 billion, or 11.0% annualized. For the week, Currency increased $0.8 billion. Demand & Checkable Deposits dropped $63.5 billion. Savings Deposits jumped $57.8 billion. Saving Deposits have expanded $254.3 billion so far this year (22.0% annualized). Small Denominated Deposits dipped $1.0 billion. Retail Money Fund deposits declined $1.6 billion. Institutional Money Fund deposits slipped $8.7 billion, while Large Denominated Deposits added $4.0 billion. Repurchase Agreements rose $10.4 billion, with four-week gains of $36.7 billion. Eurodollar deposits gained $4.9 billion.

ABS issuance amounted to a strong $16.0 billion (from JPMorgan), with y-t-d issuance of $216 billion running up 28% from comparable 2003. Home Equity ABS issuance is running up 72% from a year ago to $122 billion.

Total Bank Credit expanded $4.0 billion to $6.52 Trillion (week of May 12). Bank Credit is up $274 billion during the first 19 weeks of the year, or 12% annualized. For the week, Securities holdings sank $18.9 billion, with a two-week decline of $28.2 billion. Loans & Leases jumped $23.0 billion, with Real Estate loans up another $13.9 billion. Real Estate loans are up $163.0 billion y-t-d, or a blistering 20.1% annualized. For the week, Commercial & Industrial loans dipped $0.7 billion and Consumer loans were unchanged. Security loans added $5.4 billion. Elsewhere, Total Commercial Paper jumped $10.8 billion to $1.346 Trillion, the highest level since early last August. Financial CP added $6.9 billion, with Non-financial CP up $3.9 billion. Year-to-date, Total CP is up $77.9 billion, or 15.9% annualized.

Fed Foreign "Custody" Holdings of Treasury, Agency debt rose $7.0 billion to $1.20 Trillion. Year-to-date, Custody Holdings are up $133.0 billion, or 32.4% annualized.

Currency Watch:

Currency markets remain unsettled, with the dollar rally losing momentum. The dollar index declined better than 1% this week. The Swedish krona, Japanese yen, and British pound gained between 1.5% and 2%. Latin American currencies suffered, with the Brazilian real down 3%, the Columbian peso 2.75%, and the Argentine peso 1%.

Commodities Watch:

May 19 - Bloomberg (Choy Leng Yeong): "Surging copper demand will outpace the growth in production from mines and recycled scrap by 4.8 percent this year, twice the size of the gap expected in November, the Lisbon-based International Copper Study Group said. The deficit will more than double to 750,000 metric tons from 361,000 last year, forcing manufacturers to dig deeper into inventories, the group said after a meeting yesterday with government and industry officials from the world's major cooper-producing and consuming countries. Seven months ago, the group had forecast the deficit would be about 400,000 tons."

May 17 - Bloomberg (Matthew Craze): "Tin prices climbed to 15-year highs in London amid diminishing stocks in London Metal Exchange warehouses. Tin, used in solders for electronic equipment and in tin cans for the food and beverage industry, rose $300, or 3.4 percent, to $9,125 at 12:05 p.m. in London. Stockpiles in LME warehouses fell 10 tons to 3,565 tons, while a further 745 tons of canceled warrants mean only 2,820 tons are available."

The CRB index was about unchanged for the week (up 5.5% y-t-d). The Goldman Sachs Commodities Index declined 1.8%, reducing 2004 gains to 15.2%.

Central Bank Watch:

May 19 - Bloomberg (Julia Kollewe): "Bank of England policy makers said it may be necessary to raise interest rates faster than economists and investors expect to contain inflation, according to the minutes of this month's Monetary Policy Committee meeting. All nine members of the committee led by Governor Mervyn King opted to boost borrowing costs on May 6 by a quarter point to 4.25 percent. The committee also considered a half-point increase. Rates haven't risen that much since the bank took responsibility for monetary policy from the government in 1997."

May 17 - Bloomberg (Craig Torres): "Central bankers should help keep markets stable to avoid disruptions to their main objectives of full employment and stable prices, Federal Reserve Board Vice Chairman Roger Ferguson Jr. said. Markets are likely 'the most important channel of monetary policy transmission,' Ferguson said in the text of a speech on financial systems at a Belgian central bank conference in Brussels. Policy makers 'might well wish to consider market stress in their monetary policy deliberations' when there has been little change in inflation or growth forecasts, he said."

A question yesterday posed from the audience at the Houston World Affairs Council: "Here's a high tech question from an economist who's thinking like an economist. Here it is. Since 1900, we have had a recession about every nine to 12 years. Question, have our and our global market trading partners' governments, enough experience to stop or control this cycle?"

Federal Reserve Bank of Dallas President Robert McTeer: "Well, obviously, not but we have been getting better. The period in the 1980's was the longest period without a recession that we'd ever had. It was the record but then, we had a little short recession from August of '90 to March or April of '91 and then we went for 10 years without another recession, from March of '91 to March of April of '01. That became the new record. Both those recessions were fairly mild and fairly short. No, we'll never get rid of the business cycle but the business cycle is being dealt with much better than it used to be. Policy makers are smarter. They've got a lot of mistakes that they can learn from and we won't be able to have a smooth sailing, perfect economy but we won't make the tremendous errors in judgment that turned some of the past recessions into depressions and I'll include the Fed in that. In the early '30s when that episode started, there were a lot of bank failures that wiped out a lot of money and I don't know what the Fed could've done under those institutional arrangements but it, certainly, wasn't in there pumping out new money like we would be doing today. Today, every time we have a major emergency, you know, the first thing we do is get on the microphone and open up - you open up a spigot. I mean look at what happened in 9/11. I mean on 9/11, we just flooded the markets with liquidity because of all the damage in New York, you know, all these New York banks and investment banks, they're receiving billions in payments every day and they're making billions in payments and you know, if they don't receive it they can't make it and so, just a hitch or two in that system can bring the thing down. Well, we just pumped enormous amounts of liquidity in there through open market operations and our check clearing system, which the Houston branch is very involved in, we decided to give credit for checks deposited with us, on the next day when it would normally be done, even though all the planes were on the ground. We couldn't collect the checks but we pretended we were collecting the checks and we gave credit for those checks, created enormous amount of float, which by law, we're supposed to treat as a real cost, to us, but since we're more a public institution than a private institution, we decided not to put our cost situation ahead of the public good, anyway - I'm getting too far off. We know how to handle those things better now, not well enough but not bad."

China Watch:

May 17 - Bloomberg (Tian Ying): "China raised its first-quarter economic growth estimate to 9.8 percent from 9.7 percent, saying the country's service industries expanded more rapidly during the three months than earlier calculated. After the adjustment, China's gross domestic product totaled 2.715 trillion yuan ($328 billion) in the first three months, 2.2 billion yuan more than previously announced, the National Bureau of Statistics said..."

May 18 - Bloomberg (Janet Ong): "China's economy will expand 9.2 percent this year, slowing in the coming months to achieve a 'soft landing' as government efforts to curb investment start to bite, said an official at a state-owned think-tank."

May 18 - Bloomberg (Kyunghee Park and Samuel Shen): "Jiangsu Shagang Group, China's largest privately owned steelmaker, waits as long as 10 days to receive iron ore and coal shipments after they arrive in China because of bottlenecks at the nation's ports. 'Our cargo is getting stuck at ports,' said Gao Xiang, 40, a senior buying consultant for the Jiangsu province-based steelmaker. Its factory, a day's drive from the ports of Shanghai and Ningbo, loses as much as 70,000 yuan ($8,547) a day for each delayed shipment, Gao said. 'Imports are rising fast, and the existing transportation facilities can barely manage. The system isn't prepared for this kind of growth.' Ports in Chinese cities including Shanghai, Ningbo and Shenzhen in the south handled 48 million 20-foot cargo containers last year, 30 percent more than in 2002 -- surpassing the U.S. for the first time, China's Ministry of Communications said in January. Shanghai and Shenzhen's Yantian port are the world's third- and fourth-busiest after Hong Kong and Singapore."

May 19 - Bloomberg (Tian Ying): "China will hold off from raising interest rates because inflation remains below 5 percent and policy makers want more time to assess the effectiveness of measures taken so far to cool an investment boom, central bank Governor Zhou Xiaochuan said. 'We need further observation,' Zhou said after a speech to a financial conference in Beijing. Li Yang, a member of the People's Bank of China's monetary policy committee, said Monday the bank may raise interest rates if inflation accelerates to more than 5 percent."

May 18 - Bloomberg (Janet Ong): "China may need to raise interest rates to curb investment if the consumer price index climbs above 5 percent, said a central bank policy maker. 'If consumer prices become uncontrollable, that is rising above the bearable limit of 5 percent, China may have to raise interest rates,' Li Yang, a member of the central bank's monetary policy committee, said yesterday after a conference"

May 18 - Bloomberg (Tian Ying): "Investment in China's factories, buildings and other fixed assets slowed in April, suggesting a government clampdown on industrial expansion is starting to work. Fixed-asset investment, which accounts for almost half of the world's seventh-largest economy, rose 35 percent from a year earlier to 399 billion yuan ($48 billion) after climbing 44 percent in March..."

Asia Inflation Watch:

May 17 - Bloomberg (Mayumi Otsuma): "Eight quarters of growth shouldn't prompt Japan's central bank to change its policy of pumping money into the world's second-largest economy, Finance Minister Sadakazu Tanigaki said. 'There are some voices urging the Bank of Japan to exit the current policy, but we shouldn't rush to seek such an exit,' he said... 'The government and the Bank of Japan must continue to work together to overcome deflation.'"

May 18 - XFN: "The Japanese economy grew a stronger-than-expected 1.4% in the January-March quarter, or at an annualized rate of 5.6%, the Cabinet Office reported, capping the fastest year of growth by the world's second-largest economy in seven years. For the Japanese financial year to March, the economy grew by 3.2%, well above the government's official target of 2%. Growth in the preceding October-December quarter was revised up to 1.7% from 1.6%. The initial pace, equivalent to an annualized rate of 6.4%, was the fastest pace in 13-1/2 years."

May 19 - Bloomberg (Lily Nonomiya): "Japanese corporate bankruptcies fell 17 percent in April, the 20th month of declines, as a two-year economic expansion helped indebted companies stay afloat. Corporate failures fell to 1,236 cases from a year earlier, according to a report by credit-researcher Tokyo Shoko Research Ltd. The companies owed 826 billion yen ($7.29 billion) in debt, a 12 percent decline."

May 17 - Bloomberg (Linus Chua and Tan Hwee Ann): "Singapore raised its 2004 growth forecast by 2 percentage points to as much as 7.5 percent, as a pickup in the electronics industry helped the economy post its third straight quarter of expansion. In the first quarter, the economy expanded 11 percent from the October-to-December period, the trade ministry said in a statement."

May 21 - Bloomberg (Francisco Alcuaz Jr.): "Philippine first-quarter economic growth may exceed 5 percent because farm production posted its biggest gain in 15 years, Economic Planning Secretary Romulo Neri said."

Global Reflation Watch:

May 17 - Pensions and Investments: "GAM Holding AG, Zurich, one of the world's largest hedge fund-of-funds managers, has closed all of its 69 multi-strategy, multimanager funds while executives decide what to do with the huge inflows it is attracting from investors. Sources said GAM is the first - but won't be the last - big fund-of-funds manager to completely close the doors. GAM has grown at an extraordinary average of 50% in each of the past five years. In the first four months of this year alone, the firm took in $5 billion from new and existing clients. The firm has more than $18 billion under management now in hedge funds of funds... An additional $15 billion is in internally managed single-strategy hedge funds, which remain open... "A whole group of very clever people are seeking alpha in new places... But there probably are not enough clever people who will be able to come up with alpha generation tools to absorb $80 billion a year (of hedge fund inflows)..."

May 17 - Bloomberg (Jennifer Sondag): "Billionaire financier George Soros is looking for a mid-sized German mortgage bank to buy so he can use it as a springboard for real estate activities, newsletter Platow Brief said..."

May 19 - Bloomberg (Simon Packard): "French consumers stepped up their spending by the most in three years in the first quarter to spur growth in Europe's third-largest economy. Consumer spending, which accounts for more than half of gross domestic product, rose 1.1 percent from the fourth quarter, the Paris-based statistics office Insee said."

May 21 - Bloomberg (Dorota Bartyzel): "Polish Prime Minister Marek Belka said he expects growth to reach 6 percent in 2004, the fastest in six years and beyond the government's original target."

May 18 - Bloomberg (Francois de Beaupuy): "French President Jacques Chirac said rising oil prices may hurt global economic growth and swelling U.S. deficits may lead to 'risks' of exchange-rate and interest-rate fluctuations. 'As France and Europe pursue vital, though tough, reforms, stronger growth enjoyed by the U.S. is financed by widening budget and trade deficits,' Chirac told union and non-profit group representatives at the Elysee presidential palace in Paris, according to a copy of his speech. 'This situation bears risks, notably on the fluctuations of exchange rates and interest rates.'"

May 21 - Bloomberg (Duncan Hooper): "U.K. mortgage lending rose in April by a record amount, the British Bankers Association said, underlining the Bank of England's concern that consumers may be taking on too much debt."

May 18 - Bloomberg (Julia Kollewe): "U.K. house prices grew at their quickest pace in 1 1/2 years in the three months through April and surveyors predict further increases in the months ahead, confounding some economists' expectations of a housing crash, a survey said."

May 19 - Bloomberg (Ramya Venugopal): "India's gross domestic product may expand more than 7 percent in the current year as a global economic recovery gains momentum, the central bank governor said. 'A global recovery with India's continuing global presence can help India cross 7 percent growth this year,' Y.V. Reddy, governor of the Reserve Bank of India, said, a day after the RBI released its six-monthly monetary policy statement forecasting growth of up to 7 percent in the year to March 31."

May 19 - Bloomberg (Carlos Caminada and Romina Nicaretta): "Brazilian retail sales posted the biggest monthly jump in at least three years in March as falling interest rates prompted more consumer spending, led by purchases of household goods such as appliances and furniture. Retail, supermarket and grocery store sales -- as measured by units sold -- rose 11.4 percent from a year earlier, the government said, after rising a revised 5.0 percent in February and 6 percent in January. The March increase was the biggest since the government began keeping records in 2001."

California Bubble Watch:

May 19 - Associated Press: "The trustees of California State University approved a 14 percent increase in student fees on Wednesday as part of a budget deal with Gov. Arnold Schwarzenegger that promises eventual faculty raises and growth in enrollment... Student fees have jumped sharply in recent years at the 23-campus system, which has about 400,000 students. In December 2002, the system increased fees for graduates and undergraduates by 10 percent. A 30 percent increase followed last July. In San Francisco, a committee of the University of California regents also discussed a 14 percent fee increase..."

May 21 - San Francisco Chronicle (Kelly Zito): "Bay Area home prices surged at their fastest pace in more than three years last month, as buyers crowded into the real estate market amid climbing interest rates... The median price for an existing single-family home in the nine counties in April jumped 17 percent year-over-year to a record $520,000 -- the first time the price has crossed the half-million mark. That annual gain was the largest since February 2001, according to...DataQuick. The number of houses and condos sold in April vaulted 24 percent, to 12,421."

May 20 - Los Angeles Times (Debora Vrana): "Southern California home sales rose at their fastest pace in at least 16 years in April as buyers faced rising interest rates and still red-hot prices, which set records in six counties. Sales of homes and condominiums rose 7.3% to 32,916 last month as the median price...increased more than 20% from a year earlier in each of the region's six major counties... It was the busiest April since DataQuick began keeping records in 1988. In Orange County, the region's most expensive market, the median sales price surpassed the half-million mark for the first time, to $523,000, up 30.1% from 2003. In Riverside County, the median price closed above $300,000 for the first time, at $308,000, up 28.3%. 'You watch all this with growing astonishment,' said John Karevoll, a DataQuick analyst...In Los Angeles County, which accounts for one-third of all Southland sales, the median price jumped 27.7% to $387,000."

May 20 - Palm Springs Desert Sun (Jonathan B. Colburn): "Housing prices in the Coachella Valley broke the $300,000 barrier for the first time in April, jumping $12,000 in a single month. The rapid increase to a median sales price of $310,000 mirrored the rest of the Southern California, where home prices rose at the fastest pace in more than 16 years, according to DataQuick... The valley's median home price stood 33.9 percent higher than a year ago for all types of homes combined. Newly constructed houses were 50.2 percent more expensive than last year, with the median price for that segment reaching $391,750."

May 19 - Bloomberg (Vivien Lou Chen and Michael White): "The cost of a $32 ride past the Los Angeles area homes of Johnny Carson and Nicolas Cage is headed higher. So are prices for crab at Fisherman's Wharf in San Francisco and truck driver wages in Oakland, California. Gas prices in California are soaring faster than the rest of the country, topping $3 a gallon for full service. Low stockpiles and rising crude oil prices and seasonal demand will push the cost above yesterday's statewide record of $2.31 a gallon for regular unleaded... Mounting gas prices are rippling through California, whose economy is twice as big as Brazil's and which has more long-distance commuters than any other state. Higher costs for goods and services in the state may foreshadow what's to come around the nation if fuel keeps rising, UCLA Anderson Forecast senior economist Joseph Hurd said... 'Fuel costs are becoming uncontrollable -- something has to be done in California,' said Scott Taylor, president and chief executive of GSC Logistics, a Hayward, California-based trucking company. GSC raised drivers' pay 15 percent this month to end a weeklong strike by truckers protesting diesel costs."

U.S. Bubble Economy Watch:

May 20 - The Wall Street Journal (Ruth Simon): "With mortgage rates rising, a growing number of borrowers are opting for adjustable-rate mortgages in an effort to minimize their monthly payments. The ARM share of applications hit its highest level in nearly a decade this week... For some lenders, the shift has been huge. At Washington Mutual Inc., ARMs accounted for 53% of loan originations during the first quarter, up from just 27% a year earlier. ARMs now account for 30% of mortgage originations at GMAC Mortgage...up from 20% two months ago... Lenders are also marketing ARMs harder. Countrywide Financial Corp. is using direct mail, phone calls and e-mails to tell consumers how an adjustable-rate mortgage can cut their monthly payments. Countrywide funded $15.7 billion in adjustable-rate mortgages in April, up 134% from April 2003. Seattle-based Washington Mutual is featuring ARMs in billboards, advertisements and seminars aimed at consumers. It plans to expand its ARMs lineup this summer. ARMs accounted for 53% of the company's loan originations during the first quarter, up from just 27% a year earlier. The shift to ARMs is also being driven by higher home prices. One sign: Much of the growth in ARM usage is coming from borrowers taking out jumbo mortgages, as loans above $333,700 are called. More than 40% of borrowers with jumbo mortgages hold adjustable-rate loans. ARMs are also especially popular in markets that have seen the fastest growth in home prices. In California, for instance, more than 77% of home buyers who took out a jumbo mortgage during the first quarter opted for an ARM..."

Wednesday the Mortgage Bankers Association (MBA) released its latest monthly mortgage and housing forecasts. The MBA continues to forecast record home sales and Existing Home Sales only slightly below record levels. The MBA raised its estimate of second-quarter Purchase Mortgage Originations to $406 billion. This would be up 18% from the year ago period (an all-time record at the time) to a new record high. And to put this number into perspective, (pre-Bubble) Q2 1997 Purchase Originations totaled $155 billion, with full year originations of $590 billion. The MBA forecasts total 2004 Purchase Originations of a record $1.37 billion, 7% above last years record (and up 132% from 1997 and 255% from 1991).

May 19 - Bloomberg (Kathleen M. Howley): "Fannie Mae, the largest U.S. mortgage financier, pared its 2004 forecast for home-loan volume by 11 percent as a strengthening economy and a pickup in inflation pushed fixed rates to the highest level of the year. U.S. mortgage lending probably will fall to $2.29 trillion this year, Fannie Mae said in a statement. A month ago, the Washington-based company called for $2.58 trillion. Both estimates would make 2004 home-loan volume the third largest ever, down from the record $3.83 trillion lent last year."

April Housing Starts were reported at a strong 1.969 million annualized units. This was up 20% from April 2003. Building Permits were reported at a stronger-than-expected 1.999 million units, up 11.2% from the year ago period and up 41% from April 1997. Housing Completions were up almost 17% from April 2003, with Single-family Housing Completions reaching an all-time record 1.67 million units.

U.S. Financial Sphere Bubble Watch:

April was a curiously slow month for Fannie Mae. Its Book of Business expanded at a moderate 3.9% annual rate to $2.234 Trillion. Fannie's Retained Portfolio was about unchanged for the month at $880.5 billion, although this was the strongest performance in seven months. Growth will surely return in May, won't it...

Inflation Accommodation:

We operate in an extraordinarily uncertain environment. There is a great deal we simply don't know, and we are at no disadvantage admitting this reality. I thought Pimco's Bill Gross wrote an especially insightful piece this month ("Circus Game"). He makes the point that "Pimco made its fame and fortune partly on the basis of accurately forecasting those two primary secular trends" - a long wave of inflation from 1965-79 and a wave of disinflation from 1980 to 2000. Mr. Gross adds that, "The future may not be so simple." It surely will be quite complex and analytically challenging.

Mr. Gross aptly uses a metaphor for the global economy of a circus high-wire performer, tenuously balancing to avoid tipping either toward inflation or deflation. An eventual slip could lead to a crash landing. This metaphor provides a good starting point for analysis and contemplation.

First of all, my sense is that the key issue today is not so much an epic battle between the forces of Inflation vs. Deflation. Rather, we are in the midst of an increasingly unwieldy (historic) global Credit Inflation - the struggle between the powerful forces of Global Credit Boom vs. Bust. The "balancing act" is between global central bankers and market dynamics, jockeying with the processes of global financial excess, over-liquidity and boom and bust dynamics.

Over the past 18 months, U.S. Credit Bubble excess has gone global, with quite uncertain ramifications. Perhaps I would have a tight-rope performer rapidly peddling a bicycle instead of walking nervously. The wheels of global Credit creation are spinning rapidly. Two issues come immediately to mind: Is this Credit environment sustainable and is there a palatable end game?

The bottom line is that we have had very little pertinent experience with global Credit booms. Indeed, I would strongly argue that today's analysts, economists and policymakers have only the shallowest understanding of Contemporary Credit Inflation. With a focus on the narrowest of inflation indicators - CPI - analysis remains oblivious to the most powerful inflationary forces. There is certainly little appreciation for the nature of Contemporary Inflationary Manifestations nurtured by domestic securities-based Credit and speculative excess. Moreover, there is absolutely no appreciation for the consequences of unleashing U.S. Credit Bubble dynamics globally.

I am especially fascinated with the notion of "disinflation." Particularly during the nineties in the U.S., financial evolution, "globalization," and changes to the underlying structure of the economy altered the nature of inflationary manifestations. There were myriad powerful forces at work changing the financial and economic landscape, working to suppress goods price inflation while promoting asset price inflation. As I have written previously, inflation was not conquered but transformed. Importantly, the U.S. Credit system moved rapidly towards a marketable securities-based Credit system. Asset-based lending (securities and real estate) came to dominate, as aggressive institutions raced to harvest ultra-easy financial profits in an environment of generally declining and central bank- governed interest rates. It may have been a period of rather benign consumer price inflation, but our social, institutional, political, and regulatory biases fomented historic asset Bubbles.

In my view, it has always been a case of rampant U.S. Credit inflation impairing the dollar. What was not at all clear, however, was how the Federal Reserve, global central banks, our foreign creditors, investors, and speculators would respond when King Dollar eventually succumbed. We now have a much better idea. The Greenspan Fed is fully committed to sustaining U.S. Credit and financial excess (Inflation Accommodation). There will certainly be no domestic push to rein in mounting imbalances. Instead, the Fed is determined to impel foreign central bankers to adopt increasingly inflationary policies - hoping to balance ongoing U.S. inflation and imbalances with heavier global inflationary stimulus. Dollar purchases and global liquidity creation orchestrated by the Asian central banks over the past year have been unprecedented. And we know that, to this point, the resulting global environment (weak dollar & strong global liquidity) has global speculators and investors scampering to buy non-dollar securities and assets - as opposed to liquidating U.S. instruments.

Ballooning U.S. current account deficits and the newfound global financial melee have fostered some extraordinary economic and market effects. Clearly, the global "reflation trade" got completely out of hand. A mushrooming global leveraged speculating community crowded into trades long global equities, emerging market debt, and commodities. Over the past month or so, many of these trades have gone sour and been unwound. At what stage of liquidation we are these days is unclear. But thus far the consequences of "de-leveraging" are not as dramatic as I would have expected. There has and continues to be some tumult on the periphery, but signs of faltering systemic liquidity are at this point rather nebulous.

To say there are profound crosscurrents today does not do the current environment justice. Over the past 18 months global financial markets have been buffeted by unprecedented speculative leveraging and, more recently, de-leveraging. Conspicuous Bubble dynamics have been in force. But, at the same time, it is also clear that the global financial system is in the midst of some rather profound structural change.

I would contend that there has been a continuing push toward U.S.-style securities and derivatives-based Credit systems. With a couple key strokes on my Bloomberg, I can monitor India's bond futures and swaps pricing, Chinese repo and swap rates, and financial futures prices for countries from Brazil, to Poland to Turkey to Taiwan. And while there is nothing particularly new about global financial innovation and evolution, my sense is that it does not garner the attention and analytical focus it deserves. Developments have been profound, and I would argue the ramifications could continue to include heightened Credit Availability and liquidity for markets and economies across the globe.

While I see Bubble dynamics in play and recognize the vulnerability of this highly-leveraged global financial daisy-chain, sound analysis requires that we contemplate various scenarios. On the one hand, a serious bout of global "de-leveraging," faltering liquidity, and crisis could quickly impair these types of market-based Credit mechanisms. But, on the other hand, these systems could continue augmenting financial excess. Global central bankers are certainly keen to avoid the former and likely willing to risk the latter.

Repeatedly during the nineties, bouts of global financial tumult, and the resulting flight to the perceived safety of the dollar, brought many (especially "emerging") Credit systems to their knees. Global financial "evolution" was often sidetracked. It is today worth pondering - with the demise of King Dollar - to what extent the global backdrop has changed. Is there today less propensity for destabilizing flight away from periphery markets to the "safe harbor" of dollar assets? Has the weakened dollar actually created more robust Credit systems for many economies throughout Asia and the periphery?

I am reminded of the difficult analysis from last summer and autumn. The mortgage finance industry had ballooned to enormous size. Interest rates were rising, and it appeared that the mortgage-refi gravy train was set for a rapid slowdown. The outlook for the booming U.S. housing market and household consumption was in doubt. Well, the exact opposite of the slow-down scenario unfolded. The powerful mortgage lenders quickly adapted (helped immeasurable by an accommodative Fed), introducing and aggressively marketing products such as teaser adjustable-rate and interest-only mortgages. Home equity lending boomed. The Great Mortgage Finance Bubble did better than survive, and we are well on our way to a record year of mortgage Credit growth and home sales. This important episode reminds us to respect the immense power of booming contemporary Credit systems.

The global financial system has some very significant vulnerabilities; it also has some things working today in its favor. The Fed is at 1% and married to baby step gradualism. They will also likely signal to the markets an upper-bound on its rate intentions. The Japanese, despite a recovering economy, are understandably cautious and appear willing to err on the side of continued massive reflation. And it would appear today that the Chinese will as well err on the side of caution, accommodating strong growth but with more determined efforts to rein in excesses in key sectors. The global backdrop remains one of extreme central bank accommodation with extraordinarily low interest rates prevailing.

So, let's attempt a return to the issue of the balancing act of Inflation vs. Deflation, or Global Credit Boom vs. Bust. As analysts, we have challenging work ahead of us. With massive U.S. current account deficits as far as the eye can see, coupled with continued central bank accommodation, there is a distinct possibility that global Credit systems could continue to surprise on the upside. If central bankers are successful in arresting global de-leveraging (a not insignificant "if"), the global Credit system could very well follow a similar path to that of the U.S. mortgage system.

I would argue today that, despite generally rising market rates and not insignificant de-leveraging, along with notable financial stress, there are global inflationary biases unlike anything experienced in quite some time. The strongest inflationary manifestations are in housing and energy markets, and it is very much a global phenomenon. And for several years, we have witnessed how housing price inflation and Credit excess are self-reinforcing. Excess begets additional inflationary excess, with booming markets creating their own (over) liquidity. Now we will likely have the opportunity to study inflationary dynamics as they apply to energy markets and consumer prices more generally.

The history of inflation dynamics demonstrates that rising prices begets higher prices - 2% inflation begets 2.5% that begets 4%. Interestingly, the Fed appears to have the mindset that rising energy prices will work to crimp consumption, thus providing a drag on overall economic activity. But this is too simplistic. Using rising energy prices as an example of inflationary dynamics, we can envisage how higher gas prices lead to larger Credit card borrowings at the pump. Governments simply run larger budget deficits to finance huge energy purchases. Businesses and homeowners increase overall debt levels to indirectly finance rising energy outlays. Higher fuel, heat and cooling bills crimping household cash-flow? No worries, just take out a larger home equity loan. For the economy as a whole, we borrow more and run larger trade deficits. At home and throughout the world, surging energy prices foster a borrowing and spending boom as new sources of energy are sought and developed.

Meanwhile, global central bankers maintain ultra-low interest rates, foster abundant liquidity, and bolster vulnerable Credit systems. As such, it is difficult for me to imagine an environment more accommodative to mounting inflationary forces. The Fed's punchbowl needed to be removed before rising house prices led to energized borrowing, buying and an inflationary spiral in key housing markets. The punchbowl should have been pulled away before rising costs for services such as tuition and medical care led to rising borrowings and altered inflationary expectations. And now the punchbowl needs to be removed before rising energy prices are similarly monetized with rising debt growth and generally rising system liquidity. Instead, rising energy prices will be passed along to consumers, businesses, and governments in a significant escalation in inflationary dynamics. Inflationary pressures will now be dispersed much more broadly throughout the economy, likely only boosting system-wide debt growth. The Fed is now clearly accommodating generalized inflation.

We really don't know much about inflation these days, but we are learning. Many argue that energy usage as a percentage of GDP is much less than during past decades, hence rising energy prices are much less of a concern today. I think we are already witnessing that the key dynamic today is instead the resiliency of demand. And we already have witnessed how the Credit system easily adapts and accommodates rising home prices. Why should energy prices be any different? And globally, fueled by our annual $600 billion current account deficits, and potentially thriving domestic Credit systems, there is every reason to fear that we will be competing for our energy requirements against many "liquefied" competitors.

Surging energy prices likely mark a major inflection point for inflationary processes, to much more broad-based price gains. Still, I hesitate to focus on traditional notions of inflation. I would continue to expect that wild price swings and general global monetary disorder remain the key inflationary issues. And when selling related to the unwind of the crowded "reflation trade" abates, I would not be surprised by a resumption of price gains and some wild price spikes throughout the global commodities markets. Asian markets were percolating again this week, and I see the Asian boom - with its strong inflationary biases - poised to prove as resilient as the U.S. housing sector (with its strong inflationary bias).

And when it comes to walking tight-ropes, well, the U.S. bond market confronts a very difficult balancing act. On one side, the Fed is promising baby-step gradualism and perpetual accommodation - steep yield curves and irresistible spread profits to perpetuity. But on the other side is the clear possibility that a runaway global Credit Bubble stokes a booming global economy, with pricing pressures surprising on the upside. And if the tepid dollar rally over the past few months proves to be but a bear market rally, then things could turn rather interesting.

In the end, I expect the Inflation vs. Deflation debate to be largely determined by the status of the dollar. And I don't see the dollar on firm footing. There are some crucial flaws in reasoning with respect to the Greenspan Fed's hope that a global inflation will assuage U.S. imbalances. First of all, a global Credit boom implies the loss of control of inflationary process. Second, the nature of global inflationary manifestations will - because of differing economic, social, institutional, regulatory and political structures and biases - be of a different nature than the seemingly benign asset-variety inflation characteristic of U.S. "disinflation." Third, there is the distorted U.S. economy and runaway U.S. Credit system unknowingly providing the liquidity to stoke a significant global inflation at any point that such dynamics take firm hold. And, fourth, there is the Achilles' heel of a highly leveraged U.S. financial sector both complacent and acutely vulnerable to an inflationary shock.

Thus far, rising rates have tended to support the value of the dollar. However, if our foreign creditors come to recognize the vulnerability of the U.S. financial sector to the unfolding environment, the risk of simultaneously sinking bond and dollar prices could prove unnerving. Would a sinking dollar incite a flight of liquidity to non-dollar assets and markets (an environment with heightened inflation risk for the U.S. economy), or would sharply rising rates and U.S. de-leveraging render the entire linked global Credit system impaired (with the attendant risk of financial dislocation and debt collapse)? Is the expanding global securities-based Credit system sustainable or is it just a sideshow component of the fragile U.S. Credit Bubble? As I noted above, there is a lot we simply don't know.