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400 Basis Points (and counting) to Sustain the Unsustainable

Money Supply (M3)
Mortgage Purchase Application Index
Total U.S. Imports
U.S. Current Account Deficit

Extreme marketplace liquidity is for now fueling rising financial asset prices. For the week, the Dow and S&P500 added 3%. The Utilities gained 4%, with the Transports and Morgan Stanley Cyclical index rising 3%. Defensive stocks were the laggards, with the Morgan Stanley Consumer index gaining only fractionally. The broader market was in the black, but generally without the gains enjoyed by the large-caps. For the week, the small cap Russell 2000 gained 1% and the S&P400 Mid-Cap index added 2%. The technology sector recovery continues, with the NASDAQ100 jumping 6%. The Morgan Stanley High Tech and Semiconductor indices gained 4%. The Street.com Internet index surged 14%, while the NASDAQ Telecommunications index posted a 5% gain. Biotech stocks generally added 1%. Financial stocks reacted favorably to the Fed's 50 basis point cut, with the S&P Bank index advancing 5% and the AMEX Securities Broker/Dealer index jumping 7%. With bullion suffering a $3.10 decline during the week, the HUI Gold index dropped about 1%.

The credit market remains volatile, but despite late selling mustered another week of declining interest rates. For the week, 2-year yields dipped 5 basis points to 2.44%, with 5-year yields dropping 5 basis points to 3.56%, and 10-year yields declining 7 basis points to 4.31%. The now popular 30-year bond saw its yield dip another 7 basis points to 4.88%. Spreads were mixed, with generally a marginal narrowing of corporate spreads. The dollar index gained about one-half percent.

Broad money supply (M3) increased $19.7 billion last week, putting the seven-week increase at $202.8 billion. Year-to-date (43 weeks), broad money supply has expanded $772.5 billion, or 13% annualized. Over the past 52 weeks, broad money supply has increased an unprecedented $997 billion, or 14.4%. Most of last week's increase is explained by a $5.6 billion increase in Institutional Money Market fund assets, $6 billion expansion of Repurchase Agreements, and $6 billion additional Eurodollar deposits. Institutional Money Fund assets have increased $107 billion over the past six weeks to $1.12 trillion. Today's Fed data has total bank credit surging $40 billion last week, as security holdings jumped almost $37 billion.

November 7 (Bloomberg) - "International bond sales are poised to beat last year's record $1.458 trillion today or tomorrow as lower interest rates and falling stocks spur companies to issue debt. Borrowers have sold $1.456 trillion of bonds this year, according to Dealogic Capital Data... International bond issues slowed after setting a record in the first half of the year. Sales in June, July, August and September all fell short of the amounts sold in the same months during 2000, according to Dealogic data. Sales bounced back in October, with $164 billion of debt sales compared with $106 billion in October 2000… 'We look at our European pipeline of bond issues and it's probably as big if not bigger in terms of number of transactions than at any time in the year,' said Charlie Berman, co-head of European credit markets at Schroder Salomon Smith Barney. 'If you'd asked me on Sept. 12 whether I'd have expected that I'd have given you a resounding 'no'."

November 7 (Moody's) - "The global speculative-grade bond default rate rose in October to its highest level in nearly 10 years -- 9.7%, up from 9% in September, but still short of the post-Great Depression record of 13% set in July 1991… The rating agency said it expects the default rate will rise to 10% for calendar 2001, up from 5.7% in 2000. Looking ahead, Moody's forecasts that the speculative-grade default rate will peak near 11% (first quarter of 2002)... This is about one percentage point higher than the rate forecast before the Sept. 11 attacks on the U.S. 'The attacks have rendered many economic forecasts prior to that date invalid,' said David T. Hamilton, director of default research at Moody's, who added that the 'contraction of economic activity in the U.S. and reduced access to capital, trends that were exacerbated by the September 11 attacks, have helped push up the default rate for leveraged issuers. Moody's would like to emphasize that the economic aftershocks of Sept. 11 introduced very few additional factors into the analysis. The trends affecting the direction and severity of corporate defaults were well in place before Sept. 11.' Last month's default rate is the highest since January 1992, toward the end of the last recession in the U.S. It also exceeds the forecast of 8.3% for October 2001, which Moody's made in October 2000. Year-to-date, some 207 issuers have defaulted on US $91 billion of bonds. During the entirety of last year, 167 issuers defaulted on US $49.1 billion of bonds."

From Gary Rosenberger's excellent "Reality Check" column (www.marketnews.com) - "U.S. health insurers have accelerated rate increases for premiums up for renewal next year, citing hospital mergers and alliances that have eroded their ability to dictate costs and limit care. They further blame continuing prescription-drug inflation. The increases tend to average close to 16%, but it's not unusual to see increases into the 30s, they add. They also note that the increases were determined before Sept. 11, so acts of bioterrorism haven't yet been a factor… Humana, a national HMO based in Kentucky, plans to increase commercial premiums by around 12% to 14% effective Jan. 1…" An executive from a health insurance consulting firm was quoted as saying, the increases "could not have come at a worse time" for businesses already grappling with a slowing economy and a need to cut operating costs. "It's the beginning of a really painful cycle." Another industry consultant "pegs the average premium increase for 2002" at 15.6%, effective Jan. 1. "This compares to a 10.4% increase in 2001, 10.6% in 2000, 8.3% in '99, 4.6% in '98, and 2.6% in '97."

November 7 (Bloomberg) - "Voters across the U.S. approved about 92 percent of the largest local bond requests yesterday, with Texas residents leading the way by passing $3.5 billion for water projects, new roads and other improvements. Voters elsewhere also supported municipal bonds for schools, sewers, parks and other public purposes, passing 18 of the 20 largest proposals tracked by Bloomberg… If the 92 percent approval ratio holds up, it would be the highest since the 92.4 percent recorded in 1988, according to The Bond Buyer newspaper." According to The Bond Buyer, total municipal bond issuance jumped to $29 billion during October, 46.5% above year ago levels. New money raised (excluded refinancings) was up 27% for the month to $21.4 billion.

From the financial networks to my readings, it appears the economic consensus expects a typical recession, of the shallow variety with recovery coming probably mid next year. It seems rather silly, and surely unsuitable, to describe the current environment in terms of either "typical" or "normal." Ponder this: October saw the most job losses since May of 1980, while vehicle sales posted their strongest month ever. We will easily set a new record for mortgage credit growth this year, and the U.S. economy is on track for one of the strongest years of sales for both autos and homes. At the same time, a panicked Fed aggressively cuts interest rates to the lowest level since the early 1960s. This environment is categorically atypical.

Vehicles sold in October at an annualized rate of 21.4 million units, surpassing the previous high mark established with the benefit of tax law changes back in September 1986. Year over year, GM sales were up 31% (truck sales up 46%), Ford up 36% (cars 40% and trucks 34%), and DaimlerChrysler up 5%. Of course, zero-cost financing and other incentives played a prominent role, but even manufactures that did not participate in such programs reported strong sales (could it be….mortgage refinancings?). Toyota sales were up 28% from last year (second-best month ever), with year-to-date sales up 7.3%. Lexus enjoyed its best October ever, with sales up 9% (y-t-d also up 9%). It was the best October ever for Honda (which did not offer zero-cost financing!), with sales up 18%. It was a record month for Acura, as sale rose 17% above year ago levels and are running up 22% year-to-date. Nissan sales were up 7% from last year, led by a 19% jump for its luxury Infinite line. It was a record October for Hyundai, with sales up 95%. Kia experienced its best month ever, as sales surged 79% (y-t-d up 42%). It was the best October on record for Mitsubishi (up 18%) and Suzuki (up 37%), with Volkswagen enjoying its best October since 1974 (up 11%). It was the third-best month ever for SAAB (up 31%), with sales also up 31% at Jaguar. Sales were up 1% at BMW (up 9% y-t-d), 6% at Mazda, 38% at Isuzu, and 17% at Subaru. And, importantly, this sales blast put industry inventories at historical lows. As a master of the obvious, I will state that this data is not indicative of the dark depths of recession.

Hopefully, this detail supports our contention that the major problem for the U.S. economy is not a general lack of demand. Households definitely continue to borrow and spend, we would argue in dangerous excess. This past week, the Mortgage Bankers Association composite mortgage application index jumped to a new record, almost doubling in seven weeks. Total application dollar volume up is now running more than triple the level from one year ago. Notably, purchase applications jumped 20% last week to the highest level since early August (purchase dollar volume running up almost 5% y-o-y). Mortgage refi applications jumped 24% last week, almost returning to the all-time record set three weeks ago (refi dollar volume up 763% from last year). To put the current environment into perspective, compare last week's purchase index level of 318.4 to readings during the first week of respective Novembers for the years 1995 through 1997. The index was at 183.7 in November 1995, 189.7 in November 1996, and 202.1 during the first week of November 1997. The U.S. economy has now experienced seven weeks of extreme financial stimulus, and we'll be on watch for consequences. We've already witnessed booming auto sales and home refinancings, a meaningful bump in home sales, stronger retail sales, and a better than expected pop in consumer confidence.

It is also worth noting that retail sales bounced back in October. Industry heavyweight Wal-Mart reported a 14.6% increase in year-over-year sales to $16.2 billion. Wal-Mart same-store sales were up a better-than-expected 6.7%, with Sam's Club comparable sales up 6%. The Bloomberg year-to-date same-store sales index rose to 1.97%, with discount stores rising 4.33% while specialty/apparel sales dropped 4.29%. Sales at the Gap were down 11%, AnnTaylor declined 9%, Intimate Brands 7%, Neiman Marcus and Nordstrom down 8%, and Saks Fifth Avenue dropped 16%. The real story here is not faltering demand as much as it is significant overcapacity and changing patterns of final demand. As one would expect, post-boom tastes are changing…story to continue…

It is now commonplace to read reference to the Fed "pushing on a string" and having lost effectiveness with being caught in the infamous "liquidity trap." While I am sympathetic to these concepts and can imagine both applicable at some point in the future, they remain largely inappropriate today. After all, how can one argue that lower rates are not stimulating borrowing and spending with the key interest rate-sensitive sectors booming? It's worth keeping in mind that household mortgage credit expanded at an 11.4% rate during the second quarter, a torrid pace likely being surpassed with the current refi boom. Furthermore, businesses borrowed at a 7.2% rate during the second quarter, while financial sector debt increased at an 8.8% rate and State and Local government debt expanded at 8.4%. The dilemma, as we have addressed for some time now, is not that policy is ineffective in stimulating normal borrowing and spending patterns. The insurmountable problem is that a Bubble economy of such historical proportions requires enormous sustained credit excess - feeding to all the beckoning valleys, cracks and crevasses - to maintain the semblance of a normally functioning system. Clearly, excesses of such magnitude are problematic and increasingly destabilizing for both the economy and financial system. This then explains why the frantic "terminal stage" of Credit Bubble excess is generally (and fortunately) short lived.

Nonetheless, the authorities have embarked on a futile and increasingly precarious course of attempting to resuscitate unsustainable boom-time demand. Do they truly believe it is advisable to stimulate a wild burst of vehicle sales, unprecedented mortgage credit creation, and such extreme money supply growth? While these actions are indeed forestalling a severe downturn, they are significantly increasing the probabilities for much worse down the road. The U.S. economy's greatest ills are structural, the unavoidable consequences of previous gross borrowing, speculating, and spending excesses. It is our view that these types of deficiencies and imbalances are only growing more dangerous. The patient has been poisoned by credit and speculative excess, has suffered severe damage to internal organs, and is in critical need of extended bed rest and carefully guarded recuperation. The Fed is injecting steroids and prescribing an aggressive exercise program. This will be a regrettable case of the Federal Reserve being forced to learn the hard way that there is no shortcut for a necessary healing process/adjustment period.

It does not today take a wild imagination to come up with a scenario where collapsing demand in the overheated auto and residential real estate markets lead the economy into a very deep and protracted downturn. Indeed, objective analysis would today have to consider such a circumstance as a reasonably high probability scenario. These are, after all, markets that have been operating at a feverish, credit-induced, pace for some time now. It is, similarly, disconcerting to ponder how the U.S. credit system will operate in the event of faltering auto and home lending. Developing over many years, auto and particularly real estate finance have become keys drivers within the U.S. credit system. They have generated huge credit expansion that is paramount to fueling spending throughout the economy, as well as sustaining financial market liquidity. Perhaps the Japanese could provide valuable insights as to the keen difficulty in generating systemic monetary expansion in a post asset Bubble environment. They have certainly witnessed first hand how monetary processes become exceedingly more difficult to manipulate when the key asset class (real estate) responsible for previous systemic lending excess begins depreciating in value. But that's why feeding asset inflation is a dangerous game, and why we fault the Fed for playing it so recklessly. It also explains why "pushing on a string" will surely be applicable to the U.S. credit system at some point in the future. I hate to be the unrelenting curmudgeon, but the Fed's seething travails to forestall recession are laying the financial and economic groundwork for depression.

I apologize for repetition (although I do believe it is a valuable tool in the learning process), but I continue to be amazed at how the scope of previous credit excesses goes unexplored in the business and popular press. In the aggregate, over the past 14 quarters (1998 through 2001's second quarter) total credit market debt increased 33% ($7 trillion) to $28.3 trillion. And really, for a basic but sound level of understanding of today's predicament we need only to garner a general appreciation for the effects (inflationary manifestations) emanating from such extreme credit profligacy. The spectacular speculative and spending excesses throughout the technology sector - and the consequent devastating maladjustments, ravaged industry profits, and wasted resources - are now conspicuous. The historic inflation in equity markets, real estate prices and other assets (radio stations, cable franchises, professional sports franchises and athletes, golf courses, collectables, etc.) also severely distorted the structure of demand and the accumulation of debt. Individuals are much more apt to freely spend "profits" from inflating asset prices on non-necessities and luxuries. It is not rocket science to see how these processes feed unstable demand and self-reinforcing boom and bust dynamics.

We also note that total U.S. Personal Income jumped by 20% in three years (1998-2000) to $8.57 trillion, led by a 32% increase in service sector income (conspicuous evidence of distortions to the underlying structure of demand). Allowed to run uncontrolled, credit excess leaves an increasingly indelible mark on income growth. Excess also impacts spending habits, as was evidenced by the astonishing 40% increase in imports over three years ('98-00) to $1.22 trillion. The current account deficit over the past four quarters mushroomed to $450 billion (more than 4% of GDP), compared to $109 billion during 1995, $121 billion during 1996, and $140 billion during 1997. It sure seems that the extraordinary nature of excesses and resulting distortions could not be more conspicuous. Usually recessions provide necessary adjustment periods that bring problematic imbalances more in line, as we saw with the almost $7 billion current account surplus that developed during the recession year of 1991.

So, trying to keep Credit Bubble analysis "manageable," we see how credit excesses fueled (in a self-reinforcing cycle) spending and speculative excess, assets price and income inflation, a literal flood of imported goods, and unprecedented current account deficits (with their resulting financial and economic distortions both at home and abroad). The key point to appreciate today (in questioning the efficacy of Fed policies) is that these factors imparted severe distortions to the structure of demand and the underlying foundation of the U.S. economy and financial system. Entrepreneurs, businessmen, investors, speculators, bankers and politicians in droves misjudged a Bubble for a New Era, and made the critical blunder of extrapolating the frantic "terminal stage" of excess far into the future. For too long, inflating asset prices masked entrepreneur mistakes. For too long, credit excess impaired the market pricing mechanism and distorted relative values. In the process, momentous errors were made and exacerbated - mistakes that will not be made right with ultra-low rates and additional credit excess. Today, the Fed nurtures misjudgment and the throwing of good "money" after bad, having created an environment with wild price volatility, extreme general uncertainty, and systemic instability. The Adjustment Monster gains intimidating stature as it lies patiently and confidently in wait.

From Joseph A. Schumpeter, addressing the early 1930s in Business Cycles, 1939:

"For reasons we know, capitalist evolution spells disturbance. We also know that it spells simultaneous disturbances of different order of importance and different range in time. Junctures therefore occur in which the symptoms incident to scrapping and rearranging dominate the scene. Among these junctures there are some in which adjustments to long-range and more fundamental, and adjustments to short-range and less fundamental industrial changes do not occur at the same time, and there are others in which they doRealizing from historical observation the extent of the revolution that had occurred in the industrial structure and was in the act of upsetting its system of values, shall we be surprised at the emergence of a situation in which perhaps three-quarters of all businesses in the United States (including farms) had to face the necessity of an adaptation that threatened them with economic death? And is there really much to object to in the statement that this situation was the fundamental fact about the world crisis, compared with which all other factors, however, important, were after all but mitigating or accentuating accessories?"

We will admit to being partial to "old fashion" analysis, but we look at a $450 billion current account deficit as an unmitigated disaster. A painful adjustment of this historic distortion is only a matter of when and under what circumstances. We also view the economic consensus' sanguine attitude toward dismal U.S. trade performance and underlying dollar fundamentals as being a classic case of the news and "analysis" following the direction of the market. Bloomberg's William Pesek Jr. recently penned an interesting column "When a Dollar Crisis Exists Only in the Mind." "To hear Japanese officials tell it, the U.S. dollar is experiencing a full-blown crisis. The once mighty reserve currency, they claim, is in freefall. Trouble is, no one else seems to think so." Finance Minister Masajuro Shiokawa, was quoted going into last month's Group of Seven meeting, "We would like to pay our utmost attention to the stability of the foreign exchange markets. That's our priority now." "That Japan's hopes for a currency pact were ignored is hardly surprising. The so-called instability in currency markets - code for 'the yen is getting too strong' - is little more than a figment of Tokyo's imagination. Only in the hushed halls of the Ministry of Finance and Bank of Japan does anyone think that the dollar's recent drop is a problem."

Well, as far as we're concerned, if our key creditor, the Japanese, do in fact view the current situation as a crisis, it's a crisis. They are, after all, certainly in a position to recognize and fear a looming dollar problem. The Bank of Japan reported foreign reserve assets of $405.6 billion at the end of October, up by more than $33 billion during just the past two months. These reserves increased almost $133 billion, or 49%, over the past two years alone. Perhaps a crisis is more than a "figment of Tokyo's imagination," with the Bank of Japan appreciating that their aggressive accumulation of dollar (and other currency) assets has done little more than stabilize the dollar/yen exchange rate. And apt analogy would be the largest shareholder of a "hot" stock that is then forced by aggressive selling to add to its position to keep the price from sinking. Such operations may suffice for a while and garner little concern in the marketplace, but there is definitely one key market participant that recognizes all too clearly the situation in the context of an unfolding problem. It is the major holder - the price supporter - that keenly appreciates true market dynamics and lives in increasing trepidation for the inevitable day when they will be forced to terminate price support operations and join the sellers. Yes, we do have the beleaguered Japanese by the barrel, as they are forced to support the dollar or face problems in their important export sector. But one of these days…

As much as it remains ridiculous to us to this day, the New Paradigm crowd in Washington convinced themselves that the U.S. trade deficit was actually the positive result of all the foreign money clamoring to invest in the wondrous U.S. "New Economy." No, it was not extreme credit excess and resulting asset inflation that was stoking exorbitant purchases of foreign products (an inflationary manifestation). It was in their minds, instead, that investment capital flooding in to the U.S. miracle economy had to be spent. (It will not be a simple task to convince future generations that bright people actually believed the nonsense that passed for "analysis" during The Bubble). The always accommodating - when it's in their interest - Wall Street research departments were all too happy to manufacture "analysis" to support this delusion, and we somehow get the headline "Why the Trade Deficit Doesn't Matter" on the cover of the May/June 2001 issue of Foreign Affairs magazine.

The article - "The U.S. Trade Deficit: A Dangerous Obsession" - was penned by Joseph Quinlan from Morgan Stanley Dean Witter and Marc Chandler from Mellon Financial Corp. I am addressing the subject this week, as it is our view that trade deficits do matter tremendously and that the perpetuation of flawed policies at the Federal Reserve and Washington-based government-sponsored enterprises are building toward an unavoidable dollar crisis. Going forward, the vulnerable dollar is a critical point where the Fed's best-laid plans can go astray. Yet, to Quinlan and Chandler it is not the trade deficit that is the problem, but that "economists (and analysts like myself) worry that the huge trade deficit, which must be financed by foreign investors, could lead to a full-blown financial crisis if and when those investors become unwilling to fund the imbalance." "…A simple and important fact is absent from the debate: the trade balance is no longer a valid scorecard for America's global sales and competitiveness. Given a choice, U.S. firms prefer to sell goods and services abroad through their foreign affiliates instead of exporting them from the Untied States. In 1998, U.S. foreign-affiliate sales topped a staggering $2.4 trillion, while U.S. exports - the common but spurious yardstick of U.S. global sales - totaled just $933 billion…"

If there is anything "spurious" it is their and conventional analyses. An analogy came to mind: a family perpetually spends more than it earns. And while their ingrained borrowing and spending habits create what appears to be an intractable debt-load, the head of the household nonetheless claims this is not a problem because a family business overseas generates $100,000 of revenue each year. Well, ok, but this amount of information is of course completely insufficient for judging the family's true financial position. First of all, foreign sales provide us little if any indication of true financial health. U.S. companies could buy up foreign rivals all over the world and show phenomenal sales growth, but that will tell us nothing about profitability or financial soundness. Revenues must be matched against expenses to get some indication of actual profits and cash flows generated overseas. Importantly, revenues do not provide the wherewithal to service debts; profits and cash flow do. Furthermore, we must determine if these cash flows are required to be reinvested back into the business or are instead available to be repatriated back to the U.S. to help service ballooning liabilities. Just look at Enron, with its projects and global revenues. Quinlan and Chandler make a typical Wall Street error in focusing on revenues and revenue growth, at the expense of the critical examination of cash flows, debt loads, and balance sheets. The dramatic and continuing deterioration of the U.S. "balance sheet" is today's critical yet conveniently ignored issue.

Concluding, they wrote, "In the end, U.S. exports and imports neither represent America's global linkages nor indicate how or where U.S. firms compete. Yet many still view global competition through the 200-year-old eyes of Adam Smith and David Ricardo, who saw trade as the chief form of economic exchange. Others harbor equally archaic mercantilist prejudices, assuming that exports are good while imports are bad. These observers regard a trade deficit as a sign of national weakness, a warning signal that something is amiss. But U.S. global engagement involves far more than just trade. If policymakers continue to interpret a large trade deficit as a loss of global competitiveness or a result of unfair trade practices, protectionist backlash could result, which could trigger retaliation around the globe. Under this scenario, there would be no winners - only losers. The United States' obsession with its trade deficit belies the fact that corporate America has never been better positioned to compete in the global marketplace. It is time to say goodbye to Adam Smith's outdated framework of global competition and to embrace instead a more complex understanding of America's economic engagement with the world."

No thanks. We'll stick with Adam Smith, and we absolutely see a $450 billion current account deficit as "a warning signal that something is amiss." How can one not? But, then again, Credit Bubble analysis has a penchant for sound and proven economic theory, and a touch of disdain for nebulous and esoteric New Age notions. And while we view these analysts as being off in "left field," they have much company with a consensus that is missing the critical issues in regard to trade and the dollar. This is surely no time to throw out Adam Smith's (and Ricardo's) "framework" that incorporates the division of labor, comparative advantage, and mutually beneficial trade relationships. Importantly, however, the trade relationship as envisaged by Smith encompassed trading goods for goods in the context of a "sound money" regime of currencies convertible to gold - fair trade within the auspices of a disciplined and self-regulating monetary system. The current historic aberration of the U.S. trading dollar IOUs for goods while for years accumulating unimaginable foreign liabilities is, in reality, the antithesis of Smith's vision. I view it as more a case of dysfunctional mercantilism in the guise of laissez faire. As a nation we accumulate foreign produced goods by issuing dubious liabilities. There will be backlash and revulsion to such a dysfunctional arrangement. As such, we view the current situation as unsustainable and eventually acutely problematic.

Looking at massive trade deficits from a domestic perspective, we see several generally unrecognized problems. During the zenith of the Credit boom, trillions of stock market gains and ultra-easy money flowed freely and briskly, funneling purchasing power through virtually every river, bayou, creek, and brooklet of the economy. There was spending power created aplenty, with more than enough to procure both heady domestic profits and endless demand for foreign sourced goods. The profit bonanza also benefited from the natural lag of employment and other costs. It was wonderful, even magical, but a seductive Credit Bubble illusion all the same. Here, as became all too common in the general euphoric mindset, a major error was committed by extrapolating the Bubble much into the future. Today, a key part of the puzzle (and misdiagnosis by the Fed) of how profits can falter so miserably in the face of what should be considered relatively strong consumer outlays lies in the continued flood of imported goods. Keep in mind we are now importing almost $100 billion of goods each month, imparting keen pricing pressures at the margin throughout the economy (witness today's decline in producer prices).

Quinlan and Chandler's musings aside, the unusual confluence of protracted credit and spending excess and a strong U.S. dollar is an unfolding disaster for domestic goods producers and workers. The U.S. has commenced what will be a protracted profit drought. And while consensus opinion believes that this predicament can be rectified by more easy money and stimulated demand, they've, once again, got it wrong. It's not a demand issue and cutting interest rates will not rectify it. Instead, this is very much a structural problem that has developed from years of failed policy, unrelenting excesses and increasingly perilous maladjustments. With wages rising steadily and other costs (insurance, pension, etc.) escalating, the U.S. worker is being priced out of global competitiveness. And excluding software engineers and investment bankers and the like, it would not be all too surprising going forward if the "stickiness" of wages and compensation costs becomes an increasingly important issue. After all, workers will demand the compensation necessary to afford the elevated costs of homes, college education, insurance and such. I would even go so far to promulgate the view that the system will be forced to continue with its inflationary bias (distorted as it is) in an attempt to forestall what has clear potential to develop into a dangerous real estate downswing. I can envisage how the U.S. becomes hostage to its real estate Bubble, with the consequence an even more problematic deterioration in the global competitiveness of its workforce. Quinlan and Chandler's analysis focused on the global "competitiveness" of U.S. corporations, while the much more important issue is the position of U.S. workers. It is U.S. households that will eventually be required to produce something of value to trade with foreign suppliers, and somehow create real economic value to service the massive accumulating debt.

And let's not forget the nagging problem of financial fragility. With $100 billion plus quarterly current account deficits, there is no room for any waning demand for U.S. securities. And while one can recognize the appeal both of inflating U.S. equity prices during the stock market boom and inflating credit market instrument prices while the Fed remains in "Crisis Management Reliquefication Mode," it would appear the Fed is running out of room to inflate financial assets prices. Future foreign demand for U.S. securities has not obviously been a factor in Fed decision-making. All the same, it was not too terribly long ago that the marketplace held the perception that a faltering dollar would necessitate higher U.S. interest rates. If circumstances ever dictate a return to this previous conventional wisdom, the highly leveraged U.S. financial sector is going to find itself in one untenable quagmire. I also often wonder why there is not some association of the massive U.S. current account deficits with the pool of destabilizing global speculative "hot money." Where do people think all that "money" came from in the first place.

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