Markets were about as unsettled (very) as sentiment is optimistic. For the week, the Dow dipped less than 1%, while the S&P500 declined about 1%. The Transports lost 2%, reducing y-t-d gains to 19%. The Utilities also declined 2%, and the Morgan Stanley Consumer index fell 1.5%. The Morgan Stanley Cyclical index was about unchanged (up 10% y-t-d). The small cap Russell 2000 and S&P400 Mid-Cap indices dipped 1%. The tech sector generally outperformed. The NASDAQ100 declined 0.4%, and the Morgan Stanley High Tech index was unchanged. The Semiconductors gained 2%, and the NASDAQ Telecommunications index was slightly positive. The Street.com Internet Index was slightly negative, but still sporting a 28% 2004 gain. The Biotechs were hit for a 4% loss. The financial stocks were unimpressive, with the Broker/Dealers down 2% and the Bank down 3%. With bullion surging $9.20, the HUI gold index was about unchanged.

For the week, 2-year Treasury yields jumped 10 basis points to 2.92%, the highest level since June. Five-year Treasury rates increased 5 basis points to 3.56%. Ten-year Treasury yields added 2 basis points at 4.20%. Long-bond yields ended the week at 4.88%, down 2 basis points for the week, with the spread between 2 and 30-year bond yields at the narrowest level in almost 2 years. Benchmark Fannie Mae MBS yields were unchanged. The spread (to 10-year Treasuries) on Fannie's 4 5/8% 2014 note narrowed 1.5 to 44, and the spread on Freddie's 5% 2014 note narrowed 1 to 39. The 10-year dollar swap spread dropped 2 to 40.5. Corporate bonds generally traded in line with Treasuries. The implied yield on 3-month December Eurodollars increased 3.75 basis points to 2.4675%.

At over $30 billion, this was the strongest week of corporate debt issuance in three years (from Bloomberg). Investment grade issuers included Household International $3.25 billion, Royal Bank of Scotland $3.0 billion, GMAC $2.5 billion, Merrill Lynch $2.35 billion, Amgen $2.0 billion, Morgan Stanley $1.95 million, HCA $1.25 billion, Lehman $1.15 billion, Computer Associates $1.0 billion, Tate & Lyle $500 million, MBIA $350 million, CIT $1 billion, Jones Apparel $750 million, Key Bank $650 million, Interpublic $600 million, Boston Scientific $500 million, Consolidated Natural Gas $400 million, Pricoa Global Funding $300 million, Hovnanian $300 million, DaimlerChrysler $300 million, GTech Holdings $300 million, Burlington Northern $275 million, Union Pacific $250 million, Clear Channel $250 million, Wisconsin Electric Power $250 million, Hornbeck Offshore $225 million, Mayne Group $200 million, Potomac Edison $175 million, Delmarva Power & Light $100 million, Energen $100 million and Avista $90 million.

Junk bond inflows dropped to $73.5 million (from AMG), with funds posting positive flows in 12 of the past 13 weeks. Issuers included Rogers Cable $2.0 billion, Qwest $825 million, Videotron $315 million, Pinnacle Entertainment $300 million, Stena $250 million, Neenah Paper $225 million, Gaylord Entertainment $225 million, Park-Ohio Industries $210 million, Ki Holdings $200 million, William Lyon $150 million, Trailer Bridge $85 million, GCI $70 million, Echelon $65 million and Broder Bros $50 million.

Convert issuers included Charter Communications $750 million, XM Satellite $300 million, Six Flags $260 million, and million.

Foreign dollar debt issuers included Ontario $1.0 billion, Tengizchevroil $1.1 billion, Eksportsfinans $1.0 billion, Panama $600 million,

Japanese 10-year JGB yields declined 3 basis points to 1.46%. Brazilian benchmark bond yields dropped 6 basis points to 8.32%. Mexican govt. yields ended the week at 5.23%, up 3 basis points. Russian 10-year dollar Eurobond yields dropped 7 basis points to 5.72%.

Freddie Mac posted 30-year fixed mortgage rates dipped two basis points this week to 5.74%. Fifteen-year fixed mortgage rates were one basis point lower to 5.15%. One-year adjustable-rate mortgages could be had at 4.17%, up one basis point. The Mortgage Bankers Association Purchase application was about unchanged last week. Purchase applications were up 14% from one year ago, with dollar volume up 34%. Refi applications jumped almost 11% during the week. The average Purchase mortgage jumped strongly to $233,600, while the average ARM dropped to $301,400. ARMs last week declined to 34% of total applications.

Broad money supply (M3) declined $2.6 billion (week of November 8). Year-to-date (45 weeks), broad money is up $480.7 billion, or 6.3% annualized. For the week, Currency added $1.1 billion. Demand & Checkable Deposits declined $11.3 billion. Savings Deposits rose $9.5 billion, with a year-to-date gain of $351.4 billion (12.9% annualized). Small Denominated Deposits gained $0.6 billion. Retail Money Fund deposits increased $1.5 billion, while Institutional Money Fund deposits declined $1.6 billion. Large Denominated Deposits added $1.4 billion. Repurchase Agreements dipped $1.2 billion, and Eurodollar deposits fell $2.8 billion.

Bank Credit expanded $13.2 billion for the week of November 10 to $6.73 Trillion. Bank Credit has expanded $455.6 billion during the first 45 weeks of the year, or 8.4% annualized. For the week, Securities holdings added $1.0 billion, and Loans & Leases jumped $12.2 billion. Commercial & Industrial loans dipped $700 million, while Real Estate loans gained $8.3 billion. Real Estate loans are up $282.7 billion y-t-d, or 14.7% annualized. Consumer loans were down $3.9 for the week, and Securities loans declined $5.1 billion. Other loans jumped $13.6 billion. Elsewhere, Total Commercial Paper jumped $13.7 billion to $1.382 Trillion, the highest levels since September 2002. Financial CP surged $16.1 billion to $1.250 Trillion (high since Jan. '01), expanding at an 8.7% rate thus far this year. Non-financial CP dipped $2.4 billion (up 25.5% annualized y-t-d) to $132.4 billion. Year-to-date, Total CP is up $113.7 billion, or 10.1% annualized.

This week's ABS issuance jumped to about $23 billion (from JPMorgan). Total year-to-date issuance of $570 billion is 38% ahead of comparable 2003. This year's home equity ABS issuance of $366 billion is running 84% ahead of last year's record pace.

Fed Foreign "Custody" Holdings of Treasury, Agency Debt increased $7.8 billion to $1.314 Trillion. Year-to-date, Custody Holdings are up $247 billion, or 26.2% annualized. Federal Reserve Credit rose $3.8 billion for the week to $778.6 billion, with y-t-d gains of $32.0 billion (4.8% annualized).

Currency Watch:

The dollar index lost another 0.3% this week to close at 83.32. The yen and Canadian dollar gained 1%, with the Swiss franc up 0.8% and the Australian dollar 0.74%. The Taiwan dollar, Brazilian real, Mexican peso, and Argentine peso all declined less than 0.4% against the greenback.

Commodities Watch:

November 15 - Bloomberg (Loretta Ng): "China's crude oil imports were at 99.59 million metric tons in the first 10 months of the year, state news agency Xinhua reported, citing Beijing-based Customs General Administration of China. That exceeded imports of 91.12 million tons for the entire 2003..."

Gold today closed at $447.05, extending its 16-year high. Copper rose another 4% this week. December crude surged $2.51 today to close at $48.89. The Goldman Sachs Commodities index added 2.8% for the week, increasing year-to-date gains to 32.3%. The CRB index gained 2% on the week, with y-t-d gains of 13.2%.

China Watch:

November 15 - Bloomberg (Allen T. Cheng): "Foreign investment in China picked up in October as companies including Wal-Mart Stores Inc. and Matsushita Electric Industrial Co. expanded to tap surging demand in the world's fastest-growing major economy. Foreign investment increased 23 percent from a year earlier to $53.8 billion through October after gaining 21 percent in the first nine months, the Beijing-based Ministry of Commerce said... That exceeds last year's tally, which was an all-time high."

November 15 - XFN: "China is facing water shortages of 30-40 billion cubic meters a year, state media said Saturday, threatening public health and economic development. Ministry of Construction official Zhang Qingfeng said some 110 cities in China are 'severely short of water', while another 400 are also facing shortages..."

November 15 - XFN: "China's retail sales rose 14.2% year-on-year to 498.3 billion yuan in October, up from a growth rate of 14% in September and 10.2% in October last year, the National Bureau of Statistics said..."

November 18 - Bloomberg (Clare Cheung): "Hong Kong's unemployment rate in October fell to its lowest in almost three years as hotels, restaurants and stores added workers to cope with surging visitor arrivals from mainland China. The jobless rate slid to 6.7 percent from 6.8 percent in September..."

Asia Inflation Watch:

November 17 - UPI (Indrajit Basu): "First came the crash. Then came a phase of painful consolidation that also saw scores going down under. But now, after a three-year drought following the dot-com bust of 2000 and the global economic slowdown, India's software and information technology services sector seems to be booming again. The financial results of top ranking software and IT services companies that have announced for the quarter ended September 2004 reveals net profits have climbed to a seven-quarter high that amounts to a 47 percent growth on a 41 percent growth in revenues."

November 17 - Bloomberg (Kartik Goyal): "Indian exports rose 9.5 percent in October from a year earlier, the Commerce and Industry Ministry said without giving any reason for the increase. Exports were $5.95 billion in October... Imports rose 20 percent to $8.28 billion, boosted by higher oil imports. The trade deficit widened to $2.33 billion from $1.49 billion in October last year."

November 16 - Bloomberg (Amit Prakashport): "Singapore's retail sales rose a faster-than-expected 10.6 percent in September from a year earlier as the economy added more jobs and higher tourist arrivals fueled spending on clothing, jewelry and cars."

Global Reflation Watch:

November 16 - Kyodo: "The World Bank on Tuesday raised its global economic growth projection for 2004 by 0.3 percentage point from April to a real 4.0 percent and its outlook for Japan by 1.2 percentage points to 4.3 percent, the highest expansion since 5.2 percent posted in 1990 in the heyday of the Japanese bubble economy."

November 15 - Bloomberg (Lindsay Whipp): "The number of corporate bankruptcies in Japan fell 17.8 percent in October from a year earlier, the 26th consecutive monthly decline, Tokyo Shoko Research Ltd. said."

November 16 - Bloomberg (Joao Lima): "Spanish house prices rose 17.2 percent in the third quarter, led by gains in the southeastern region of Murcia, the Spanish Mortgage Association said. The year-on-year rate compares with 17.4 percent in the second quarter..."

November 15 - Bloomberg (Halia Pavliva): "Russia attracted 39.4 percent more foreign investment in the first nine months of the year compared with the same period in 2003 as companies such as Pilkington Plc, the world's top maker of car windshields, entered the market. A total of $29.1 billion was invested in Russia from January to September..."

November 16 - Bloomberg (Julie Ziegler): "Developing countries increased their foreign reserves by 80 percent in the past four years to become major providers of financing in international capital markets, the World Bank said. Brazil, China, India, Mexico, Thailand and Turkey account for 45 percent of the foreign reserves held by developing countries... The accumulation of foreign reserves, about two-thirds of which are held in U.S. dollars, is helping finance the record high U.S. budget and current account deficits. 'The central banks of these countries have become one of the most important sources of financing for the large U.S. current account deficit, absorbing 51 percent of the overall increase in foreign officially held Treasury bills between March 2000 and January 2003,' the World Bank said."

November 16 - Bloomberg (Thomas Black): "Mexico's economy expanded at its fastest pace in four years in the third quarter as a surge in bank lending fueled consumer demand for cars, furniture and clothes. The economy grew 4.4 percent from a year before after expanding 3.9 percent in the second quarter, the Finance Ministry said. That growth rate [is] the highest since the fourth quarter of 2000..."

November 17 - Bloomberg (Romina Nicaretta): "Brazilian retail sales rose for a tenth month in September, the government said. Retail, supermarket and grocery store sales, as measured by units sold, rose 8.9 percent from the year-earlier period after rising 7.5 percent in August..."

Dollar Consternation Watch:

November 16 - Bloomberg (Veronica Espinosa and Flavia Krause-Jackson): "European finance officials said the U.S. may need to back up its appeal for a strong dollar by joining in coordinated purchases of the U.S. currency should it fall further against the euro. Reacting to Treasury Secretary John Snow's endorsement of a 'strong dollar' yesterday, Monetary Commissioner Joaquin Almunia said the 12-nation euro may continue to rise unless the U.S. government follows up its rhetoric with action. 'The more the euro rises, the more voices will start asking for intervention,' Almunia said... 'It has to be a coordinated effort but it seems that our friends across the Atlantic aren't interested.'"

November 15 - Bloomberg (Francois de Beaupuy): "French Finance Minister Nicolas Sarkozy comments on the U.S. dollar's decline. He spoke to journalists after a meeting of finance ministers from the countries using the euro in Brussels. 'We are worried about the dollar drop,' which is 'linked' to the accumulation of deficits of our U.S. friends.' The 12 nations using the euro have a unanimous 'concern regarding the rapid and destabilizing evolution of foreign-exchange rates.'"

November 18 - Dow Jones (Andrea Thomas): "Earlier this week, French Finance Minister Nicolas Sarkozy called on the U.S. to respond to the situation. 'We're worried about the rapid and destabilizing evolution of the world currency markets,' Sarkozy said. 'It's clear the greenback has become unhinged compared to the world's other currencies... Now it's up to the Americans to respond.'"

November 17 - UPI: "A group of top U.S. manufacturers said Wednesday said the dollar is still not weak enough for many companies. The Coalition for a Sound Dollar -- a group representing more than 95 industry and agricultural associations and that's associated with the National Association of Manufacturers -- said the dollar is 'still too strong.''The orderly downward adjustment of the dollar in global markets makes sense for U.S. businesses and will help reduce the huge $600 billion U.S. trade deficit...'

November 17 - UPI: "As the Muslim world yearns for the days of the caliphate, the Islamic Mint is bringing back a piece of it by issuing the Islamic Gold Dinar. The gold coins are available in the United Arab Emirates and the Dubai Islamic Bank. This is the first time in recent history that gold dinars are circulating through established and officially recognized channels. The Islamic Gold Dinar was the currency of the Muslim community from its beginnings up to the abolition of the Ottoman Caliphate in 1924. The coin could well come into rapid use if for no other reason than zakat, the charity giving which is one of the five pillars of Islam, cannot be paid using a promissory note but instead must be paid using gold, silver or certain categories of merchandise. Malaysia's former Prime Minister Mohammed Mahathir pressed for the establishment of an Islamic Trading Bloc with the Gold Dinar as the bloc's common currency. The coin is 4.25 grams of 22 carat gold, following the standard laid down by Caliph Umar Ibn al-Khattab, the prophet Muhammad's second successor."

California Bubble Watch:

November 18 - Bloomberg (Danny King): "About a quarter of California residents are considering moving, either to another part of the state or to another state, because of high housing prices, according to a Public Policy Institute of California poll. More than half of the respondents said the availability of affordable housing was a big problem in their region while 77 percent said they are at least 'somewhat' concerned that housing prices will prevent their children from buying a home in their area, the poll said. In September, the most recent month available, the median-priced single-family home rose 21 percent to $465,540 from $384,690 a year earlier... It said about 19 percent of households could afford a median-priced home...down from 24 percent a year earlier."

November 17 - Los Angeles Times (Annette Haddad): "When it comes to Southern California real estate, there's the big picture and then there's the neighborhood-by-neighborhood view. From a macro standpoint, the region's housing prices continue to appreciate at a double-digit pace from last year. In October, Southern California's median home price surged 23.1% year over year to a record $410,000... It was the third consecutive month, and 10th out of the last 12 months, that the median price...hit an all-time high. Yet, the data also showed that prices were leveling off in the more urban parts of the five-county region. For instance, Orange County's median has edged 2% lower since May; Los Angeles County's, 1.2% since June; Ventura County's, 4% since September. 'It's starting to look like prices in many of the more expensive neighborhoods have leveled off or have come down slightly from a summer peak,' said Marshall Prentice, DataQuick's president. Meanwhile, homes in mid-market and entry-level communities continue to see advances in prices."

November 1- Associated Press (Alex Veiga): "Home sales in California were down overall last month, but prices continued to rise, particularly in the more affordable inland areas... The median price of a home in October was $395,000, a 21.5 percent increase from $325,000 the same month a year ago and up 1.8 percent from $388,000 in September, according to DataQuick... For the month, a total of 54,300 new and resale houses and condos were sold statewide, a 6.2 percent decline from 57,900 in September and down 5.9 percent from 57,700 in October 2003..."

November 19 Bloomberg (Kim Chipman): "University of California regents yesterday voted to boost costs for the fourth straight school year, increasing undergraduate fees by 8 percent and graduate fees by 10 percent for 2005-06... The increase means total fees for California resident undergraduates in the university system will have risen almost 80 percent from 2001-02 to the coming school year..."

Bubble Economy Watch:

November 16 - MarketNews (Kevin Kastner): "In the face of increased competition from commercial banks as well as other sources of credit, banks operating in the United States appear to have eased their standards and terms on business loans at a time when demand has started to rise, the Federal Reserve's Senior Loan Officers Survey for October showed. The survey...which covers the three-month period from August through October, showed that banks view this increased competition as permanent change in the structure of commercial business lending, rather than a temporary change. The competition came from other commercial banks, as well as investment banks, insurance companies and hedge funds, and was significant enough for banks to ease their lending standards and terms at a time when banks were seeing increasing demand for commercial loans, including real estate."

November 15 - Bloomberg (Kristy McKeaney): "U.S. spending on Visa brand cards rose last week compared with the same week last year. In the week ending Nov. 14 purchases with Visa debit and credit cards rose 17.5 percent to $22.586 billion compared with the same week last year."

November 15 - Dow Jones (Kathy Chu): "The ranks of U.S millionaires surged 33% to a record 8.2 million households in mid-2004, buoyed by this group's steady investment in the market. An additional 2 million households this year joined those with more than $1 million in net worth excluding primary residence, according to TNS Financial Services' annual survey of the wealthy."

November 15 - UPI: "The Pension Benefit Guaranty Corp.'s insurance program faces a deficit of $12.1 billion for fiscal year 2004, the U.S. government agency said Monday. The program has $39 billion in assets and more than $62 billion in liabilities, Executive Director Bradley Belt said in a statement. The agency's fiscal year-end deficit increased to $23.3 billion from $11.2 billion a year earlier. For the first time, the total number of people owed benefits by the PBGC passed 1 million, and the total amount of benefits paid passed $3 billion."

November 16 - Bloomberg (David Pierson): "2004 year-to-date passenger traffic for 17 U.S. airlines rose 11.2 percent to 573.19 billion revenue passenger miles from 515.38 billion a year earlier."

Mortgage Finance Bubble Watch:

Fannie posted back-to-back strong months. The company's Book of Business expanded at a 9.1% rate during October to $2.30 Trillion. Fannie's Retained Portfolio grew at an 11.5% rate to $913 billion.

October Homes Under Construction were up 10.9% from one year ago to a new all-time record. Homes Under Construction were up 47.4% from October 1997. At 2.027 million annualized, New Home Starts were the strongest in 10 month.

November 18 - American Banker (Rob Blackwell): "The Federal Home Loan Bank of Seattle said Wednesday that its third-quarter earnings plummeted 53% from a year earlier. It blamed low interest rates and the poor performance of its Mortgage Purchase Program and advance business. It was the third batch of bad news this week for the housing government-sponsored enterprises. The Home Loan Bank of Chicago has announced that it is reviewing its past financial statements because of an accounting change and Fannie Mae has said it could take $9 billion of losses if it is forced to restate earnings."

Greenspan Watch:

Alan Greenspan was today on a panel at the European Banking Congress 2004, along with Kazumasa Iwata, Deputy Governor of the Bank of Japan, and Jean-Claude Trichet, President of the European Central Bank. Mr. Greenspan's remark that "given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point," garnered considerable media attention. I found the Q&A more intriguing.

Question: "You used the words "irrational exuberance" in your [December 1996] talk about the valuation of the stock markets. Since then we have seen a substantial correction. The new buzzwords are "hedge funds" or "the credit derivatives market." Is that something which you look at with concern, and do you take that into account in your monetary policy?"

Chairman Greenspan: "Strangely Mr. Chairman, I look at them with some significant positive attitudes for one very important reason. As the conversation evolved today, I think it becomes clear that as a consequence of the ever rapid movement of globalization that the adjustment processes- which invariably occurs as a consequence - run through the market system and not the result of governmental policies. Indeed, the vast amount of problems that emerge in the global system are never actually visible because market price adjustments and exchange rates and interest rates absorb the adjustment before it becomes visible. And so this is a system which I've often termed is the "international invisible hand." The onset of newer products such as Credit derivative swaps and institutions such as the newly-structured hedge funds actually are very major players in this issue of flexibility. As I have often observed, we went through the latter part of the 1990s - and indeed the 1998 crisis - with remarkable degrees of flexibility. And there was, for example, very large issuance of telecommunications debt - from I think, 1998 through 2001 - in the U.S. dollar equivalent of about a Trillion dollars worldwide. A significant part of that debt defaulted, yet largely as a consequence of Credit default swaps, collateral debt obligations, and other means by which risk was being transferred, no large financial institution in the world went into default or even into significant difficulty. The spreading of the risk was very critical - and indeed my suspicion is that without these risk-spreading instruments we would have been in far greater difficulty as a consequence of the problems which emerged, especially subsequent to the decline in 2000 and 2001 in most world financial markets. Hedge funds are evolving from what they used to be, and their main evidence within financial markets is as arbitrageurs. They seek abnormal profits by trying to find niche abnormalities in the marketplace, which means prices are out of balance and therefore create the possibility of above average rates of return. But the actual exploitation of that imbalance eliminates it. And, indeed, one can see the huge amounts of funds that hedge funds have moved in and out of various markets - in and out of various instruments - which has kept the system fluid and flexible. And I would be most concerned if we were to lose the flexibility added by either of these major instruments - like Credit default swaps - or new institutions such as hedge funds."

My comments: It is again clear the Mr. Greenspan fails to recognize the epic changes that have transformed global Credit system dynamics. Financial "evolution" has profoundly altered "risk intermediation" - increasing global Credit Availability from subprime to emerging markets. Contemporary financial engineering has dramatically affected "the moneyness of Credit." At the same time, the capacity for a diverse group of participants to leverage myriad debt instruments has created global markets liquefied like never before. Credit and liquidity excesses have so distorted the pricing mechanism to the point that the notion of an 'invisible hand" guiding market adjustments and self-corrections is pure fantasy.

And I do agree that "hedge funds are evolving from what they used to be." However, it is much more a case that the funds used to be "arbitrageurs" seeking to profit from market inefficiencies and pricing anomalies. Today, such opportunities would be trivial and not come anywhere close to providing even minimal returns for the nearly $1 Trillion invested in hedge funds (and unknown sums in "proprietary trading'). Instead, the speculation game evolved to playing for profits from discrepancies created by government policies - largely ultra-easy and carefully telegraphed monetary policies.

And while it may be tempting to trumpet the wonders of contemporary "market systems" and "the international invisible hand," there is a dangerous illusion at play. In reality, the market pricing mechanism has been completely maligned by the Fed and global central banks pegging short-term interest rates, while at the same time guaranteeing abundant liquidity. It is only this mirage of omnipresent liquidity that has nurtured both endemic over-leveraging and the proliferation of derivative hedging and speculating. And only with unrelenting leveraging and speculation does the massive intermediation - led by the GSEs and Wall Street structured finance - continue to transform risky loans (largely financing asset Bubbles) into perceived safe and liquid marketable securities.

And I have a big problem with the view that "flexibility" should be largely credited for the global system persevering through the telecom debt collapse. Rather, it was a case of the Fed and global central banks orchestrating an historic collapse in market rates and inciting unprecedented mortgage (and, in the case of the U.S., government) and securities borrowings. The telecom losses were monetized (system losses more than replaced by large quantities of newly created debt instruments, along with rising prices for all debt securities), just as the S&L and bank losses were monetized in the early nineties.

Yes, the hedge funds and Wall Street structured finance played an instrumental role in the Credit excesses/monetization. But we are today left with a system commandeered by leveraged speculators and asset Bubbles, and absolutely no viable option for disengaging Bubble dynamics. The danger of using leveraged speculators as part of the monetary policy transmission mechanism is that it works all too effectively in a declining rate and Credit Bubble environment. There is already a strong inflationary bias in the debt markets, while the size and scope of the speculating community is growing rapidly. Most importantly, however, monetizing previous Credit losses will become a much more arduous task on the downside of the Credit Bubble.

Question: "How long will the transpacific recycling machine for dollars run?"

Chairman Greenspan: "Well, obviously we have looked at the issue of the impact of monetary authority intervention in the dollar for purposes of sustaining exchange rates quite closely. Our interest is obviously focused on the impact on the exchange rate and on interest rates. Our general conclusion is that the impact has so far been moderate, not exceptionally large but clearly visible. One of the reasons it's not very large is the fact that U.S. Treasury and agency securities compete with a very large block of dollar-denominated private issues. And, as a consequence, these are very large markets and it is very difficult to dent specific interest-rate differences, especially when a significant amount of this intervention is in very short-lived bills and other instruments which obviously don't fluctuate terribly much in price and hence, create problems with respect to capital gains and losses. We do know that very large interventions, and I'll allow my Japanese colleague to pursue this issue later, do not create very large increases in exchange rates of a protracted nature. But clearly the impact is there. Remember that - in fact let me just raise it in this context - when you (the Bank of Japan) ceased intervention in March there was not terribly - from going from a very large amount of intervention - even including the time difference between intervening in dollar-denominated deposits and converting them to U.S. Treasury issues. You don't see a very clear picture of the impact on adjustment on the exchange rate. So it's quite an important notion because what it is suggesting is that the degree of sophistication in the international financial markets has reached the point where you can see fund flows of the order of magnitude that we're seeing with remarkably little change in either interest rates or exchange rates as a consequence of those particular flows."

My comments: The latest tally has Asian central bank (largely dollar) international reserves up $503 billion, or 32%, over the past 12 months to $2.09 Trillion. Econometric models will in no way capture the myriad effects this massive government intervention has had on market dynamics. Without this intervention, we would be today much further along in the unfolding dollar crisis. Instead, over-liquefied global markets have so mis-priced Credit, fostering precarious asset-Bubble dynamics and the mis-allocation of finance and real resources.

Question: "The monetary relations between the U.S. and Asia have been compared to the Bretton Woods system with some obvious implications. Would you accept that comparison?"

Chairman Greenspan: "Remember that Bretton Woods was a full lock, and there is a very significant difference to a partial lock and a full lock because you have a very substantial part of the currency markets to absorb any currency shocks. And as a consequence, while I would much prefer that those locks were not there, I cannot say that I would perceive it as a very significant undermining of flexibility or the adjustment process, which the global financial system has exhibited."

My response: I believe the global currency system is operating similar to the period preceding the breakdown of Bretton Woods. Dangerous imbalances were running out of control, while U.S. policymakers refused to take responsibility.

Question: "We had a discussion a year or two ago about the deflationary threat. Can we assume that the deflation theme will be solved for the years to come?"

Chairman Greenspan: "I was quite confident I could answer the question until you put the last several words on the question. Obviously we can't project for the years to come - it is sort of an open-ended issue. But what the period preceding 2003 and up to the summer of 2003 demonstrated, was that - in strong opposition to almost all economists' views in the post World War II period - that the old fashioned corrosive deflations of the pre-World War II period were not possible with a fiat currency. As a consequence, we never gave it a second thought because the first thought was largely that it just could not credibly happen, since central banks could always print money. The Japanese experience shook us, as I am sure it shook you (BOJ's Mr. Iwata) as well. And it got us to begin thinking about whether the nature of modern finance has become such that, even with a fiat currency, you could still create a system in which you got deflationary forces. Even though we always perceived - during in the Spring and Summer of 2003 in the United States that deflation was a very low probability, nonetheless our evaluation of the consequences of it occurring were it to occur were extraordinarily destabilizing. And as a consequence, we took actions to counter what is a very low probability event. And were that to happen, we would of course, do it again. However, it is clear that for the period since the summer of 2003 and, one would presumably argue for the period ahead - for several years - I think we can say we've obviously reduced the probability of deflation to such a low level that no counter-action for the immediate future seems conceivable - at least to me."

My comment: The issue has not been deflation per se but debt collapse. And after two years of astonishing global excess, the risk of a systemic liquidity crisis and bursting asset Bubbles is clearly much greater today than it was in 2002. Unfettered contemporary Credit systems - evolving to focus on asset-based lending - have developed a strong proclivity for fostering boom and bust dynamics. The reflationary policies of the past two years have increased the probability that U.S. debt and asset busts will run concurrently with a sinking dollar and attendant inflationary pressures.

Question: "Is the world, particularly emerging market economies, prepared for a period of increasing interest rates or are new crises around the corner?"

Chairman Greenspan: "Rising interest rates have been advertised for so long and in so many places that anyone who has not appropriately hedged this position by now obviously is desirous of losing money."

My comments: I recall Mr. Greenspan placing partial blame for the SE Asian financial collapse on "unhedged" foreign debt holdings. It often seems the case the he refuses to grasp the very essence of derivative markets and hedging. Market participants can and do shift risk exposures among themselves, and this mechanism works very efficiently and effectively in normal market environments. There is, however, a very important exception: It is simply impossible for a major "market" to hedge itself against a significant decline in prices. Quite simply, there is no one or group with the wherewithal to accommodate the offloading of market risk, leaving the task instead to thinly capitalized players (speculators) and their dynamic trading strategies.

Why didn't everyone that was invested in NASDAQ in early-2000 buy puts and lock in bull market gains? Indeed, I would argue that derivatives become especially dangerous when they are used by a large segment of the marketplace, while "insuring" against the same directional move. As was the case with NASDAQ, much of the final destabilizing "blow-off" melt-up was from panic buying related to the unwind of hedges and bearish speculations. The sellers of derivative protection (that would have then established short positions in the market to partially hedge their exposure) were forced to cover shorts into the final spike, only then abruptly forced to panic sell to re-hedge when the market reversed and began to collapse. I believe one of the untold market stories of 2004 has been the repeatedly unsuccessful attempts by market participants to hedge against rising rates. An over-liquefied market environment coupled with the proliferation of hedging programs incited repeated rallies (mini dislocations) that forced the unwinding of hedges. The upshot is today's artificially low market yields and a marketplace at considerably greater risk than would have been the case otherwise. Derivatives have been counterproductive and destabilizing - in various markets.

The currency markets could not be more fascinating these days. There is, understandably, much talk about the euro and other currencies being "over-bought." Sentiment indicators have dollar bearishness at very high levels, and there is a lot of bearish dollar talk these days in the media. Yet I hear very little concern for a dollar crisis or potential collapse. Well, I certainly see dynamics in play that risk a very serious dislocation in the currency markets - not unlike the breakdown of Bretton Woods.

The dollar has been declining now for over two years, yet the inevitable adjustment period has not even begun. Importantly, the Fed's misguided war against deflation has tremendously distorted our financial and economic systems. And it is now impossible for us or the rest of the world to "grow our way out" of the problem. If foreign central banks further push the accelerator to stimulate U.S. exports, get ready for $75 crude, $600 gold, and only more problematic global Monetary Disorder. Here at home, our central bank has nurtured a dysfunctional U.S. financial Credit system that is today only capable of sustaining mortgage lending excess. The nature of inflationary manifestations ensures over-consumption, minimal economic investment, massive trade deficits and global liquidity excess. These liquidity excesses and the attendant weak dollar have fueled a major inflation in non-dollar asset-classes, which has incited increasingly self-reinforcing speculative flows out of the dollar. As with all great inflations, the consequences become increasingly uncontrollable, while there is always a need for additional inflation to keep the game going.

The Fed is in a quagmire. It will not risk piercing the Credit or Mortgage Finance Bubbles, so the spigot of Credit and liquidity excess runs wide open. Asian central bankers are left to purchase massive dollar securities, in what should be an increasingly conspicuous self-defeating proposition. This only supports over-heated U.S. debt markets - and unrelenting Credit, speculation and liquidity excesses. The Fed is now facing its comeuppance. Greenspan should never have nurtured the Bubbles of leveraged speculation and asset-based lending. And only time will tell as to what accident is waiting to erupt in the currency derivatives markets. Simultaneously rising rates and a sinking dollar could spell trouble for our foreign creditors and derivative player. There have been similar Credit system Bubbles and dysfunctional dynamics in play over the past decade, and they have invariably ended in crisis.