For the week, the S&P500 sank 5.0% (down 8.3% y-t-d), and the Dow fell 4.5% (down 7.1% y-t-d). The S&P 400 Mid-Caps fell 5.8% (down 3.4%), and the small cap Russell 2000 dropped 7.2% (down 4.2%). The Morgan Stanley Cyclicals were slammed for 8.1% (7.8%), and the Transports dropped 7.2% (down 4.1%). The Morgan Stanley Consumer index fell 3.4% (down 5.7%), and the Utilities declined 2.2% (down 9.3%). The Banks were hit for 8.6% (up 5.3%), and the Broker/Dealers sank 7.8% (down 16.8%). The Nasdaq100 dropped 6.0% (down 7.1%), and the Morgan Stanley High Tech index declined 5.2% (down 11.0%). The Semiconductors sank 5.8% (down 7.9%). The InteractiveWeek Internet index was hit for 6.2% (down 6.2%). The Biotechs fell 6.8%, reducing 2010 gains to 6.8%. With bullion sinking $44, the HUI gold index dropped 8.1% (up 5.3%).

One-month Treasury bill rates ended the week at 15 bps and three-month bills closed at 13 bps. Two-year government yields declined one basis point to 0.59%. Five-year T-note yields dropped 7 bps to 1.76%. Ten-year yields sank 13 bps to 2.98%. Long bond yields sank 12 bps to 3.95%. Benchmark Fannie MBS yields dropped 9 bps to 3.75%. The spread between 10-year Treasury yields and benchmark MBS yields widened 4 bps to 77 bps. Agency 10-yr debt spreads narrowed one to 31 bps. The implied yield on December 2010 eurodollar futures fell 7.5 bps to 0.74%. The 10-year dollar swap spread increased 1.5 to 8.25. The 30-year swap spread was little changed at negative 18. Corporate bond spreads widened. An index of investment grade spreads jumped 9 to 123 bps, and an index of junk bond spreads increased 4 to 683 bps.

Debt issuance is slow. Investment grade issuers included Wal-Mart $3.0bn, Delta Airlines $450 million, FMR $400 million, Digital Realty Trust $375 million, and Campbell Soup $400 million.

Junk issuers included Dyncorp International $455 million, Insight Communications $400 million, Bankrate $300 million, Phibro Animal Health $275 million, and Vanguard Health $225 million.

I saw no converts issued.

International dollar debt sales included Veb Finance $1.0bn, Arbejdernes Landsbank $500 million, and Berau Capital Resources $350 million.

July 2 - Bloomberg (David Yong and Garfield Reynolds): "Global investors shifted money into emerging-market bonds by the most on record this year... Funds dedicated to debt in developing countries attracted $17 billion of net inflows in the first six months, compared with $14 billion in the second-half of 2009, EPFR Global said..."

July 2 - Bloomberg (Jason Webb): "Emerging-market companies are increasing bond sales this year at the fastest pace in more than a decade while U.S. and European corporate borrowing slumps... Companies... raised $79 billion from international bond sales in the past six months, a 146% increase from a year earlier..."

U.K. 10-year gilt yields declined 3 bps to 3.35%, and German bund yields fell 3 bps to 2.58%. Greek 10-year bond yields dropped 20 bps to 10.21%, and 10-year Portuguese yields sank 37 bps to 5.35%. The German DAX equities index dropped 3.9% (down 2.1% y-t-d). Japanese 10-year "JGB" yields fell 5 bps to 1.09%. The Nikkei 225 sank 5.5% (down 12.7%). Emerging markets were under pressure. For the week, Brazil's Bovespa equities index dropped 5.2% (down 10.4%), and Mexico's Bolsa declined 3.8% (down 2.3%). Russia's RTS equities index sank 6.0% (down 8.7%). India's Sensex equities index slipped 0.6% (unchanged). China's Shanghai Exchange fell 6.7% (down 27.3%). Brazil's benchmark dollar bond yields dropped 11 bps to 4.67%, and Mexico's benchmark bond yields fell 10 bps to 4.60%.

Freddie Mac 30-year fixed mortgage rates sank 11 bps last week to 4.58% (down 74bps y-o-y). Fifteen-year fixed rates fell 9 bps to 4.04% (down 73bps y-o-y). One-year ARMs increased 3 bps to 3.80% (down 114bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates declining 2 bps to 5.50% (down 103bps y-o-y).

Federal Reserve Credit declined $11.9bn last week to $2.316 TN. Fed Credit was up $96.3bn y-t-d (8.7% annualized) and $329bn, or 16.6%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 6/30) increased $7.8bn to a record $3.098 TN. "Custody holdings" have increased $142bn y-t-d (9.6% annualized), with a one-year rise of $332bn, or 12.0%.

M2 (narrow) "money" supply jumped $23.6bn to $8.588 TN (week of 6/21). Narrow "money" has increased $76bn y-t-d, or 1.9% annualized. Over the past year, M2 grew 1.6%. For the week, Currency added $0.9bn, and Demand & Checkable Deposits jumped $27.6bn. Savings Deposits slipped $0.7bn, and Small Denominated Deposits fell $4.5bn. Retail Money Fund assets added $0.2bn.

Total Money Market Fund assets (from Invest Co Inst) declined $5.6bn to $2.812 TN. In the first 26 weeks of the year, money fund assets dropped $481bn, with a one-year decline of $851bn, or 22.3%.

Total Commercial Paper outstanding was unchanged at $1.099 TN. CP has declined $71.4bn, or 12.2% annualized, year-to-date, and was down $38bn from a year ago (3.3%).

International reserve assets (excluding gold) - as tallied by Bloomberg's Alex Tanzi - were up $1.604 TN y-o-y, or 23.6%, to a record $8.410 TN.

Global Credit Market Watch:

June 30 - Bloomberg (Yalman Onaran): "Paul Volcker is disappointed with the final version of the rule that bears his name. As first envisioned, the Volcker rule would have banned banks from running private-equity and hedge funds, an attempt to curb risk-taking that fueled the financial crisis. Last-minute congressional negotiations aimed at winning Republican support led to a compromise that allows banks to invest up to 3% of their capital in such funds. Volcker... didn't expect the proposal to be diluted so much..."

June 30 - Bloomberg (Serena Saitto): "A recovery in mergers and acquisitions may fail to emerge in 2010 after dealmaking fizzled in the first half, with the biggest takeover collapsing and stock markets erasing gains for the year... That contributed to a 2% decline in global takeovers to $872.9 billion... 'The momentum has currently stalled as volatility in the capital markets is making for a challenging deal environment,' said Jeff Kaplan, global head of M&A at Bank of America..."

July 1- Bloomberg (Michael Quint): "After five years of paying Citigroup Inc. for bond guarantees that became too expensive to renew, Massachusetts state debt manager Colin MacNaught issued $538.1 million of notes without bank backing. Pennsylvania's Turnpike Commission and the District of Columbia also sold a new kind of debt with no bank support this year... The new notes show how municipal finance has entered a different world following the worst credit crisis since the Great Depression."

July 1- Bloomberg (Denis Maternovsky and Michael Patterson): "Russian companies, led by OAO Sberbank and Vnesheconombank, are borrowing as much as $2.5 billion in the international bond market for the first time in two years."

June 30 - Bloomberg (Scott Reyburn): "The recovery in the market for contemporary art suffered a relapse last night as almost half the lots at an auction in London failed to find buyers. Phillips de Pury & Co.'s 45-lot evening sale of contemporary works raised 4 million pounds ($6 million) with fees, missing a low estimate of 6.1 million pounds... Forty-seven percent of the material was rejected."

Global Government Finance Bubble Watch:

July 2 - Washington Post (Howard Schneider): "The world's top economic powers and the International Monetary Fund are studying creation of a global financial safety net that would give countries quick access to large amounts of cash as a way to stave off crises and discourage emerging-market nations from hoarding foreign reserves. In what would be a significant reordering of IMF operations, the proposals would change the agency from a solely reactive one... to a more activist organization that tries to anticipate where a crisis will spread and move in with enough money to calm markets and prevent broader problems. The idea may require a substantial increase in the amount of money that countries pledge to the IMF and a significant liberalization of its lending rules, potentially controversial changes."

July 2 - Wall Street Journal (Mark Gongloff): "Residential mortgage bonds, the center of the financial crisis not long ago, are once again darlings of the financial market. Investors are seeking out mortgage bonds backed by the U.S. government as a safe haven from the tumult of the global economy, a reversal of fortune that has helped drive mortgage rates for consumers to record low... The average rate for a 30-year fixed-rate mortgage tumbled this week to 4.58%, government-sponsored mortgage agency Freddie Mac said Thursday, from 4.69% last week. That is the lowest rate since Freddie Mac started keeping track in 1971."

Currency Watch:

The dollar index fell 1.1% to 84.41 (up 8.4% y-t-d). For the week on the upside, the Swiss franc increased 2.7%, the Japanese yen 1.7%, the Euro 1.5%, the Danish krone 1.4%, the Swedish krone 1.4%, the British pound 0.9%, the Norwegian krone 0.3% and the Brazilian real 0.3%. For the week on the downside, the Australian dollar declined 3.7%, the New Zealand dollar 3.5%, the Mexican peso 3.3%, the Canadian dollar 2.5%, the South African rand 1.5%, the South Korean won 1.1%, the Taiwanese dollar 0.7%, and Singapore dollar 0.3%.

Commodities Watch:

The CRB index dropped 4.2% (down 10.2% y-t-d). The Goldman Sachs Commodities Index (GSCI) sank 6.2% (down 8.4% y-t-d). Spot Gold dropped 3.5% to $1,212 (up 10.4% y-t-d). Silver sank 6.6% to $17.89 (up 6.2% y-t-d). August Crude dropped $6.59 to $72.27 (down 9% y-t-d). August Gasoline slid 8.2% (down 4% y-t-d), and August Natural Gas declined 4.6% (down 16% y-t-d). September Copper declined 5.6% (down 12% y-t-d). September Wheat surged 6.8% (down 7% y-t-d), and September Corn jumped 6.6% (down 10% y-t-d).

China Watch:

July 1- Bloomberg: "At least nine Chinese provinces and cities raised minimum wages by as much as a third today after Premier Wen Jiabao called for measures to head off growing worker unrest in the world's third-largest economy... Central China's Henan, the nation's most populous province with almost 100 million residents, raised its minimum wage by 33% to 600 yuan..."

July 1- Bloomberg (Frank Longid): "Casino gambling revenue in Macau, the world's biggest gambling hub, rose 65% last month as China gamblers placed more bets on baccarat and other card games."

Japan Watch:

June 30 - Bloomberg (Aki Ito and Keiko Ujikane): "Japan's industrial production and household spending slipped in May and the unemployment rate unexpectedly increased... The jobless rate reached 5.2% in May..."

June 28 - Bloomberg (Aki Ito): "Japan's retail sales rose at the slowest pace since January, a sign that government incentives to purchase cars and household appliances are fading. Sales advanced 2.8% in May from a year earlier..."

June 29 - Bloomberg (Mayumi Otsuma and Minh Bui): "The Bank of Japan may reach a limit on the amount of government bonds it holds by 2013, reducing its ability to fight deflation with debt buying, according to Nikko Cordial Securities Inc. The central bank has a self-imposed rule of keeping its government bond holdings below the outstanding amount of bank notes in circulation to assure investors it isn't financing Japan's record public debt... bank notes have stayed around 76 trillion yen ($850 billion) since 2007, while bonds on the BOJ's balance sheet have climbed."

India Watch:

June 30 - Bloomberg (Unni Krishnan): "India's current-account deficit widened to a record last quarter as an accelerating economy boosted imports of goods and machinery. The measure of trade and investment flows posted a $13 billion deficit..."

Asia Bubble Watch:

July 1- Bloomberg (Ambereen Choudhury): "Global investment banking fee income more than doubled in China and Hong Kong in the first half of the year, as the 'axis of power' shifted from western Europe. Securities firms' earnings more than doubled to $2.3 billion in China and Hong Kong from January to June..."

June 30 - Bloomberg (Eunkyung Seo and William Sim): "South Korea's industrial production rose for an 11th straight month in May... Output advanced 21.5% from a year earlier..."

Latin America Watch:

July 1- Bloomberg (Joshua Goodman and Matthew Bristow): "Brazil's industrial production rose less than forecast in May and at the slowest annual rate since November. Output climbed 14.8% in May from the same month a year earlier..."

Unbalanced Global Economy Watch:

June 28 - Bloomberg (Christian Vits): "Loans to households and companies in Europe grew at a faster annual pace in May as economic growth accelerated. Loans to the private sector rose 0.2% from a year earlier... M3 money supply... declined an annual 0.2% in May, the same as in the previous month."

June 28 - Bloomberg (Ilya Khrennikov and Paul Abelsky): "Surging food prices may slow growth in emerging economies and fan inflation, according to Russian billionaire Oleg Deripaska. Rising food prices should be one of the major concerns for investors in developing nations as they could stoke inflation, Deripaska, chief executive officer of United Co. Rusal, the world's biggest producer of aluminum, said..."

June 30 - Bloomberg (Greg Quinn): "Canada's gross domestic product unexpectedly stalled in April after seven previous gains, as retailing and manufacturing declined while mining and wholesaling advanced."

June 30 - Bloomberg (Josiane Kremer): "Norway faces increased risk of a housing bubble because Europe's sovereign debt crisis has forced the Nordic nation's central bank to keep borrowing costs low to avoid strengthening the krone, the financial watchdog said."

June 29 - Bloomberg (Sophie Leung): "Russia and the U.S. have the most protectionist trade measures among the Group of 20 leading industrialized countries, according annual rankings... by the International Chamber of Commerce."

July 1- Bloomberg (Paul Abelsky): "Russian manufacturing growth jumped in June to the highest level in more than two years... The Purchasing Managers' Index rose to 52.6..."

U.S. Bubble Economy Watch:

July 1- Bloomberg (Shobhana Chandra): "The number of contracts to purchase previously owned houses plunged in May... after a homebuyer tax credit expired. The index of pending home resales dropped 30% from the prior month..."

July 2 - Bloomberg (Steven Church): "U.S. consumer bankruptcy filings rose 14% to 770,117 in the first six months of 2010 from the same period a year earlier, the American Bankruptcy Institute reported. 'Years of rising consumer debt and low savings rates' are pushing totals near the record set in 2005, when proposed changes in bankruptcy law triggered a surge in filings, ABI Executive Director Samuel J. Gerdano said..."

June 30 - Bloomberg (Christopher Palmeri): "San Carlos, a Silicon Valley suburb that calls itself the City of Good Living, will hire contractors to maintain parks and negotiate with county officials to take over policing, becoming the latest California community eliminating basic services to close budget deficits... About 70% of U.S. municipalities are cutting jobs to cope with declining tax revenue, according to a survey...by the National League of Cities... One in five communities cut public-safety spending and revised union contracts, and almost one-quarter reduced health care."

Central Bank Watch:

June 28 - Bloomberg (Steve Matthews): "Federal Reserve Governor Kevin Warsh said any decision by the central bank to expand its balance sheet must be subject to 'strict scrutiny.' Warsh, in a speech in Atlanta, said he would need to be convinced that the economic benefits of such a move 'outweighed any costs owing to erosion of market functioning, perceptions of monetizing indebtedness, crowding-out of private buyers, or loss of central bank credibility.'"

GSE Watch:

July 2 - Financial Times (Aline van Duyn): "Fannie Mae and Freddie Mac, the mortgage financiers seized by the US government during the financial crisis, have paid $635m in fees to banks this year, making them Wall Street's biggest capital markets customers in the first half of 2010, according to recent analysis. Fannie and Freddie are now providing financing for more than 90 per cent of the US mortgage market, following the collapse of the market for bonds backed by private sector mortgages."

June 28 - Bloomberg (Jody Shenn): "Fannie Mae and Freddie Mac... should take advantage of demand for government-backed mortgage debt and sell their holdings, according to Pacific Investment Management Co. 'Since the government's going to want to unwind them at some point anyway, why not do it at the best levels ever?' Scott Simon, the mortgage-bond head at...Pimco... said... 'It's good for taxpayers, good for stakeholders, good for everybody.'"

Real Estate Watch:

June 30 - Bloomberg (Dan Levy): "Homes in the foreclosure process sold at an average 27% discount in the first quarter as almost a third of all U.S. transactions involved properties in some stage of mortgage distress, according to RealtyTrac Inc."

Fiscal Watch:

June 30 - Bloomberg (Brian Faler) -- House Democrats today proposed adding $10 billion to a pending war-funding bill to prevent layoffs of an estimated 140,000 school teachers as part of an effort to revive a stalled jobs agenda."

July 1 - Washington Post (Lori Montgomery): "President Obama's overhaul of the health-care system has done little to improve the nation's fiscal outlook, and his pledge to extend an array of tax cuts for the middle class would only make things worse, congressional budget analysts said.. In its latest long-term forecast, the nonpartisan Congressional Budget Office predicted that the national debt... would continue rising in the coming decades despite cost-containment measures in the health overhaul Obama signed this spring. 'Growth in spending on health-care programs remains the central fiscal challenge,' CBO Director Douglas W. Elmendorf said... 'In CBO's judgment, the health-care legislation enacted earlier this year made a dent in the problem, but did not substantially diminish that challenge.'"

July 1- Bloomberg (Max Berley and Brian Faler): "Wall Street financier Peter G. Peterson got a decent return on his investment last week when Senate Republicans ended the Democrats' third attempt to push though an extension of unemployment benefits and President Barack Obama failed to persuade his European counterparts at the Group of 20 meeting... to maintain economic stimulus programs. 'I haven't seen anything like this kind of concern in the 30 years I've been talking and writing about this,' says the 84-year-old fiscal hawk."

California Watch:

June 28 - Bloomberg (Michael B. Marois): "California Governor Arnold Schwarzenegger said he struck agreements with two more unions representing public workers to roll back pension benefits he has said are bankrupting the most-populous U.S. state. The deals reached with unions for 14,000 state dentists and engineers require them to contribute 5% more toward their own pension and to take one day a month of unpaid leave."

June 30 - Bloomberg (Michael B. Marois): "California Governor Arnold Schwarzenegger said he will ask lawmakers to pull an $11 billion water-bond measure off the November ballot so he can focus on reaching a compromise on the state's budget. Schwarzenegger... last November championed a bill to let voters decide on financing an overhaul of the state's water system with debt. The supply network depends on aqueducts, reservoirs and pipelines, some almost 100 years old."

New York Watch:

July 1- Bloomberg (Michael Quint): "New York lawmakers expect to adjourn without considering a $1 billion package of tax and revenue measures needed to pay for spending bills they passed two days earlier, Senate Democratic leader John Sampson said. The delay is needed to develop a contingency plan should as much as $1 billion in extra federal Medicaid money fail to arrive..."

June 29 - New York Times (David M. Halbfinger): "Finally, Gov. David A. Paterson and legislative leaders have found something they can agree on: that hedge fund managers from Connecticut and New Jersey should pay the state of New York millions more in taxes. As they grapple with a gaping budget shortfall, Mr. Paterson and the lawmakers plan to enact a tax change that will treat much of the compensation earned by the fund managers who work in New York but live outside the state as ordinary income."

June 30 - New York Times: "Finally, Gov. David A. Paterson and legislative leaders have found something they can agree on: that hedge fund managers from Connecticut and New Jersey should pay the state of New York millions more in taxes. As they grapple with a gaping budget shortfall, Mr. Paterson and the lawmakers plan to enact a tax change that will treat much of the compensation earned by the fund managers who work in New York but live outside the state as ordinary income."

Muni Watch:

July 1- Bloomberg (Dunstan McNichol): "California and New York remain the only U.S. states without budgets today as the new fiscal year begins for most amid concern that cuts to federal financing for health care will add to dwindling revenue and looming deficits. Lawmakers in Pennsylvania, Delaware and North Carolina approved spending plans yesterday, and the governor of Illinois... said he will put the finishing touches on his state's budget today."

July 2 - Bloomberg (Brendan A. McGrail and Justin Doom): "The Metropolitan Transportation Authority, which runs New York City's subways, buses and commuter trains, shrank a $555 million taxable debt offering by 16% as it struggled with a deficit and as investors sought to avoid risk... The MTA, grappling with an $800 million deficit, paid 2.75 percentage points more than yields on 30-year Treasuries... Four months earlier, the so-called spread on the MTA's 29-year Build Americas was 2.1 percentage points. 'Any issue with a hint of a credit component is struggling,' said Dan Close, a portfolio manager of the $650 million Nuveen Build America Bond Fund..."

June 29 - Wall Street Journal (Jeannette Neumann): "Some public-sector unions, trying to avoid furloughs and layoffs, are accepting less-generous pension benefits for current workers and retirees, often for the first time in years. In California, where Gov. Arnold Schwarzenegger has said he wouldn't sign a budget without a pension-fund overhaul, his office on Monday announced tentative contract agreements with two unions, following two years of wrangling over benefit cuts. Earlier this month, four unions agreed to similar tentative contracts. The agreements would potentially curtail benefits to 37,000 workers.

Unions and workers' associations in states such as Vermont, Iowa, Minnesota, Colorado and Wyoming also have recently supported rollbacks not just for new hires, an easier political sell, but for current union members, whose benefits have long been considered sacrosanct."

Derivatives Watch:

June 29 - Bloomberg (Sarah Frier): "Berkshire Hathaway... may have to set aside $8 billion in collateral for derivatives under proposed changes to U.S. financial regulations, a Barclays Capital analyst said. Berkshire owns derivatives with a notional value of about $62 billion and has 'negligible' collateral requirements, Barclays analyst Jay Gelb said... Buffett's firm... may need to post $6 billion to $8 billion in collateral under rules being debated by the U.S. Congress, he said."

Crude Liquidity Watch:

July 1- Bloomberg (Netty Ismail): "Norway's sovereign wealth fund, the world's second largest, will increase investments in Asia, as the region leads the global economic recovery, said Norges Bank Governor Svein Gjedrem. The fund is currently underweight in Asia, said Gjedrem..."

Speculator Watch:

July 2 - Bloomberg (Lars Paulsson): "Energy hedge funds in Europe are collapsing after investor withdrawals forced managers to scale back bets amid sliding prices for oil, coal and electricity. At least six funds managing more than $158 million shut in the first half, including four in May and June... The average loss from January through May for global energy funds was 19% percent, according to a June 10 report from JPMorgan..."

Unavailability of Spending Crisis:

My thesis holds that the market's structural debt fears are shifting from the Eurozone to here in the U.S. The Euro gained 1.5% this week against the dollar. The Swiss franc jumped 2.7%. European debt markets showed hopeful indications of stabilization. For the week, Greek (5-yr) Credit default swap (CDS) protection dropped 130 bps to 840 bps. Portuguese CDS fell 50 bps to 280 bps, and Spain CDS declined 10 bps to 255 bps.

It is worth noting that credit protection (5-yr CDS) is higher for the states of California (342bps), Illinois (360bps), and Michigan (283bps) than it is for troubled Portugal (280bps). New Jersey (276bps) and New York (276 bps) are priced above Spain and just a little less than Portugal. A strong case can be made that these debt markets are on the cusp of a crisis of confidence.

The New York Times' Paul Krugman attracted some attention this week with his article, "The Third Depression": "We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost -- to the world economy and, above all, to the millions of lives blighted by the absence of jobs -- will nonetheless be immense. And this third depression will be primarily a failure of policy. Around the world -- most recently at last weekend's deeply discouraging G-20 meeting -- governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending... In the face of this grim picture, you might have expected policy makers to realize that they haven't yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy."

With energy and commodities under renewed selling pressure this week - with gold even dropping $44 - unsettled global markets provided additional fodder for those focused on so-called deflationary risks. U.S. economic data has indeed gone from unimpressive to increasingly alarming. The recovery is in trouble, and there will be increasing calls for additional fiscal and monetary stimulus.

Mr. Krugman writes of a "stunning resurgence of hard-money and balanced-budget orthodoxy." I haven't seen it. Nor do I see policymakers "obsessing about inflation." Rather, I see "post-Bubble" policymaking confronting a predictable predicament: massive government debt issuance, liquidity creation, and market interventions that are counterproductive and potentially quite destabilizing. We've reached the stage where even massive inflationary stimulus provides only ephemeral effects.

For almost two years now, global policymakers have partaken in sovereign debt excess unlike anything experienced in history. Central bankers have monetized and provided marketplace liquidity to an extent never before deemed possible. These interventions and market intrusions have, predictably, led to additional distortions and more problematic imbalances. Markets, having luxuriated in policymaker-induced reflation, are now focused on hangover effects.

The problem today is not some misguided focus on inflation and balanced budgets. Hard money? Come on. The key issue is instead the evolving and worsening stresses associated with an historic boom in (all varieties of) marketable debt. To be sure, the markets are increasingly questioning the creditworthiness of various types of government debt from Greece to California. It should be recognized as a major issue that Credit concerns have made their way to the realm of sovereign and U.S. state obligations - the heart of contemporary "money" and Credit mechanisms.

Mr. Krugman - along with many - believes the solution is only greater stimulus through the further expansion of government deficits and central bank balance sheets. Their prescriptions are misguided and have been proved misguided. Yet the layers of complexities involved - not to mention ideology - preclude the possibility of an enlightened debate and a desperately needed change in the direction of post-Bubble policymaking.

Regrettably, the "Keynesian" approach has already been implemented too many times and in regrettably undisciplined excess. And it's become a spent force. Policies implemented earlier in this decade to combat so-called "deflation" risk instead fueled spectacular Bubble excess. In the process, the Creditworthiness of non-government mortgage finance was virtually destroyed - along with swaths of the Credit system. The 2008 vintage of deflation fighting is now working to destroy the creditworthiness of government obligations. The stakes are incredibly high. Rather than recognize the problems associated with ongoing Credit excess, the inflationists (as they've tended to do throughout history) cling to the notion that the issue is insufficient government borrowing and spending. And there will be no reasoning with them.

In a CNBC interview earlier in the week, New York Governor Patterson rose above the economics profession with his comment that the problem was "An Unavailability of Spending Crisis." It's not that politicians wouldn't prefer to stimulate; it's that they increasingly fear they are losing the capacity to pile on more debt. Officials recognize that they risk destroying their state's (or city's, county's, nation's) creditworthiness. Dr. Bernanke has often referred to the role that a shortage of money played in exacerbating the Great Depression. He argues that this dearth of money was primarily a post-Bubble policy blunder. I would counter that a runaway ("Roaring Twenties") Credit Bubble ensured a post-Bubble money and Credit crisis of confidence.

These days, markets have begun to protest ever expanding debt levels, and investors/speculators will now demand additional returns to compensate for heightened risk. They'll want more liquidity. In a sign of today's changed environment, ballooning government deficits may very well lead to rising risk premiums on debt throughout the system. And higher borrowing costs, as Greece can attest, can radically alter a borrower's risk and solvency profile. And - especially in speculative, trend-following markets - faltering debt values tend to set in motion an exodus from those instruments, resulting in illiquidity and market dislocation. At this point, the best policymakers can do is to focus on the longer term and endeavor to enact economic policy that will over time support our debt load - rather than further expand and impair it.

In the markets, financial conditions continue to tighten, although this flies in the face of conventional thinking that near-zero Fed funds and ultra-low Treasury yields equate to "easy money." Risk aversion is increasingly entrenched, which ensures that "money" is becoming a lot less easy to come by. In particular, the leveraged players continue to be stung - hurt by faltering global risk markets, illiquidity, and acute instability throughout.

And with policymakers - fiscal and monetary - at this point largely hamstrung, one is hard-pressed to fashion a scenario where the leveraged players are anytime soon incited into re-risking and re-leveraging. Over the past couple of months, the speculator community has gone from playing government-induced reflation for all it's worth - to wishing they could somehow unwind long positions and perhaps even go short. When the markets' marginal source of liquidity is in the process of changing from leveraged long to bearishly short, the marketplace faces a period of tough conditions.