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The Mythical 'Great Moderation'

I won't be dismissing this week's policy and market developments. We're in a phase where the markets react to - and, really, are positioned for - extreme policy intervention. So this week's announcement of concerted liquidity measures by the world's major central banks plays directly to a very captive audience. Markets responded in dramatic fashion. Spanish 10-year yields sank 104 bps, Italian yields dropped 58 bps and French yields fell 42 bps. Here at home, stocks went into melt-up mode and risk spreads narrowed rather dramatically. While European stocks surged, the euro curiously rallied only 1.15%.

I don't anticipate central bank dollar liquidity swap arrangements having much lasting impact. Neither the Germans nor the ECB have the resources to mount a successful European bailout. In desperation, Europe will surely come to more agreements to marshal only greater resources toward crisis management. I just believe the scope of the Credit dislocation is too great.

A little background is in order. Italian sovereign yields surpassed 13% in 1995. Spain's yields traded above 9% in 1992. One can make a strong case that the developed world, including the U.S., was a fiscal train wreck in the making some twenty years ago. Italy, for example, sported a debt-to-GDP ratio of 125% back in 1995 (up from 97% to end 1990). Huge deficit spending saw Spain's debt-to-GDP ratio jump from about 44% in 1991 to 67% by 1996. Greece's ratio surged from just over 80% in 1991 to 110% by 1993. With a then huge 5.0% of GDP deficit back in 1992, gross U.S. federal debt had jumped to 55% of GDP in 1993. Miraculously, as the nineties progressed, the U.S., Italy, Greece and others ran budget surpluses. Market yields collapsed.

By the late nineties, the talk had turned to a "New Era" and "New Paradigm." Dr. Bernanke popularized "The Great Moderation." U.S. central bankers were the quickest to point to enlightened policymaking as having tamed inflation, in the process allowing a New Age productive economy to grow above previous "speed limits." One has to only read Mr. Greenspan's 2007 "The Age of Turbulence..." to get a sense for how outdated some of the old notions seem not many years later. Heading right into the 2008 crisis, Greenspan was still trumpeting the newfound resiliency of the U.S. economy.

Technology advancements over the past couple decades have been nothing short of phenomenal. There is also no doubt that so-called "globalization" had momentous impacts on economies and markets. I have been skeptical that adept policy had much to do with global inflation, economic growth or market dynamics. And for more than twenty years now I've been convinced that financial innovation has been the great untold story, largely explaining everything from policymaker overconfidence, the proliferation of leveraged speculation, serial assets Bubbles, U.S. de-industrialization and the rise of China and the "developing" world.

A historic expansion of private sector debt (and attendant tax receipts bonanza) turned early-nineties fiscal deficits into marvelous surpluses. The explosion of financial sector leveraging played an instrumental role in the collapse of U.S. yields. The ballooning balance sheets at Fannie, Freddie, the Federal Home Loan Banks, and Wall Street securities firms' created unprecedented demand for debt securities. The proliferation of asset-backed securities (ABS), mortgage-backed securities (MBS), sophisticated Wall Street debt structures (CDOs, CLOs, special purpose vehicles, auction-rate securities, etc.), and endless derivatives equipped Wall Street risk intermediation with the most powerful tools to transform endless risky debt securities into "AAA" instruments - with this contemporary "money" enjoying virtually unlimited demand.

A unique financial and regulatory backdrop essentially created a circumstance where extraordinary demand for Credit was supplied at collapsing borrowing costs. And home prices inflating at multiples of after-tax mortgage borrowing costs created unprecedented demand for mortgage Credit (and housing units).

The nineties saw incredible growth in "repo" (repurchase agreement securities financing) and hedge fund leveraging. These unstable debt structures showed their perilous side in 1994 and then again in much more dramatic fashion with the 1998 LTCM blowup. Fatefully, policymakers intervened and both the hedge fund community and the "repo" markets were incentivized to expand to astounding dimensions and power - at home and globally. Repeated policy interventions "stabilized" these sophisticated leveraging structures - at a staggering cost to long-term financial and economic stability.

Financial innovation, leveraging and policy accommodation nurtured the U.S. mortgage finance Bubble, which spurred over-consumption and massive U.S. Current Account Deficits. Our Credit system unleashed upon the world unfathomable amounts of dollar balances, along with the mechanisms and policy doctrines to spur Credit systems all around the world. I have always felt that it was this profligate financial backdrop that really solidified European monetary integration. A backdrop comprising a sound dollar and restrained global finance likely wouldn't have accommodated the type of fiscal and monetary convergence necessary to transform 17 national currencies into an experimental currency unit named the euro.

Italian 10-year yields collapsed from almost 14% in March 1995 to 4.0% by the end of 1998. Real GDP went from slightly negative in 2002 to above 3% in 1999 and 2000. Italy's budget deficit declined from 9.5% in 1993 to less than 1.0% by year 2000. Similar dynamics transpired in Greece, Spain and throughout the European Union. Strong growth, weak inflation, booming stock and bond markets, policymaker brilliance and general exuberance ("reflexively") created a New Paradigm of good will, cooperation and currency integration in euro land.

Finance and economics are similarly dangerous. In both "disciplines" it is impossible to convince anyone that what the consensus believes is a really good idea will come back as a very big problem in, say, 10, 20 or even 30 years. Warnings of dire long-term consequences simply will not resonate, whether one is an elected politician or PhD policymaker.

Fannie and Freddie's market intervention and balance sheet growth back in 1994 set the stage for near Credit system implosion in 2008. And there was Mr. Greenspan's belief that derivatives work to disperse risk, while hedge funds create a more liquid marketplace. Dr. Bernanke's references to "helicopter money" and the "government printing press". Hundreds of Trillions of derivatives. A global "repo" market of tens of Trillions. A global leveraged speculating community now with more than $2 Trillion of assets (and multiples more in positions). A global "reserve" currency governed by a central bank without rules and a penchant for experimentation. U.S. deindustrialization, Current Account Deficits and Fiscal Deficits. Global currency pegs and currency regimes. Many risks are easily ignored until disaster strikes.

U.S. household mortgage debt is on track to decline in 2011 for the third consecutive year. Despite the most extreme fiscal and monetary measures imaginable, the housing bear market persists. Japan's Nikkei index closed today at 8,643.75, down some 78% from a high posted almost 22 years ago. Our NASDAQ Composite index closed this week at 2,627, about half of year 2000's record 5,133. Burst Bubbles tend to have negative consequences for years and even decades - commensurate with the excesses during the preceding boom. And it is also true that aggressive policy responses are much more likely to inflate the next Bubble than they are to reflate the one in the process of bursting. There is extensive historical experience to support this thesis.

I believe the European debt Bubble has burst - and this would no doubt be a momentous development. For years, European debt was being mispriced in the (over-liquefied, over-leveraged and over-speculated global) marketplace. Countries such as Greece, Portugal, Ireland, Spain and Italy benefitted immeasurably from the market perception that European monetary integration ensured debt, economic and policymaking stability. Similar to the U.S. mortgage/Wall Street finance Bubble, the marketplace was for years content to ignore Credit excesses and festering system fragilities, choosing instead to price debt obligations based on the expectation for zero defaults, abundant liquidity, readily available hedging instruments, and a policymaking regime that would ensure market stability. Importantly, this backdrop created the perfect market environment for financial leveraging and rampant speculation - in a New Age global financial backdrop unsurpassed for its capacity for excess. The arbitrage of European bond yields was likely one of history's most lucrative speculative endeavors.

The year 2011 - following by three short years the so-called "hundred year flood" of '08 - should put a dagger in the heart of The Mythological Great Moderation. Instead of lower inflation and enlightened policymaking nurturing greater financial and economic stability - they've done precisely the opposite. Today's extraordinary uncertainty and financial instability are not conducive to financial leveraging, a circumstance posing a serious dilemma for a global system having grown dependent upon ongoing Credit excess. European bond markets have suffered the inevitable effects of de-risking and de-leveraging. And while policy measures, including those from this week, can exert rather dramatic risk market rallies, there is little politicians and central bankers can do to alter the market's re-pricing of the region's debt obligations. Don't count on the ECB, IMF, or Fed to stabilize such a generally unstable financial, economic, social and political backdrop.

Policymakers in Europe have little flexibility and capacity to alter the dynamics of their bursting debt Bubble, and the markets are understandably dismissive of most measures and pronouncements. If only there were Eurobonds and an ECB committed to unlimited "buyer of last resort" support, Italian and other yields could drop back to previous manageable levels. But it's past the stage where gimmicks will work, as the re-pricing of debt throughout the region has fundamentally altered the capacity to leverage, speculate and insure sovereign debt risk. Focusing on Italy, the re-pricing of Italian debt has made its debt load unmanageable. And if Italy is insolvent the European banking system is in serious trouble - and monetary integration is in serious jeopardy. The risk backdrop has changed profoundly, and a historic debt and speculative Bubble is bursting.

At the same time, the markets remain quite responsive to coordinated measures and, in particular, policy moves from Washington and Beijing. Importantly, ongoing U.S. and Chinese Credit Bubbles provide policymakers from these two powerful countries considerable firepower and flexibility.

The financial world has changed profoundly - and all nations should today be keenly focused on getting their respective Credit systems, fiscal positions and economies in order. And while I don't expect policy measures to have much more than a fleeting impact on the European debt situation, the crisis is prolonging Credit excess and related imbalances in the U.S., China and much of the "developing" world. Dangerous Bubble dynamics see Treasury debt increase by about $100bn a month and Chinese lending grow about $100bn a month, and in both cases its late-cycle debt of dubious quality.

I was again this week reminded of the 2007/08 dynamic whereby policy responses to heightened systemic stress for months fostered market volatility, heightened speculation and an increasingly fragile backdrop. It would be a much healthier situation if U.S. financial asset prices were adjusting to new global financial realities. Instead, the U.S. government debt Bubble goes to only greater degrees of excess, with market participants anticipating only more extreme policy measures to come. Meanwhile, our stock market is priced as if recent growth and corporate earnings trends are sustainable. Looking at the world and the rising tide of debt revulsion in the marketplace, I would not extrapolate our nation's recent debt trajectory.

My hunch would be that the underlying structure of an already maladjusted Italian economy suffered from more than a decade of mispriced finance and associated distortions. Only time will tell if years of excessive government spending and deindustrialization, along with poor demographic trends, have fashioned a vulnerable and Credit-dependent economic structure. What we've learned about the Greek economy over the past two years is quite troubling. I fear for the Italian and U.S. economies. I agree with the German view that there is no solution to structural debt problems other than structural reform - and that the problem is global and not just European.

I'll conclude with a couple quotes extracted from Otmar Issing's insightful op-ed piece from Wednesday's Financial Times, "Moral Hazard Will Result From ECB Bond Buying:" "Stressing the role of the central bank as the ultimate buyer of public debt should be seen as an indication of the pathological state of public finances not as a sign of strength... Pressing the ECB into the role of ultimate buyer of public debt of individual member states would create the biggest conceivable moral hazard."

For the Week:

The S&P500 surged 7.4% (down 1.1% y-t-d), and the Dow jumped 7.0% (up 3.8%). The broader market was exceptionally strong. The S&P 400 Mid-Caps jumped 8.5% (down 2.9%), and the small cap Russell 2000 rallied 10.3% (down 6.2%). The Banks rallied 10.6% (down 26.1%), and the Broker/Dealers gained 10.5% (down 30.6%). The Morgan Stanley Cyclicals rose 9.6% (down 13.7%), and the Transports surged 9.1% (down 3.1%). The Morgan Stanley Consumer index gained 5.5% (down 2.2%), and the Utilities increased 3.8% (up 9.0%). The Nasdaq100 was 7.0% higher (up 3.8%), and the Morgan Stanley High Tech index was up 7.4% (down 7.9%). The Semiconductors surged 8.8% (down 9.0%). The InteractiveWeek Internet index jumped 7.5% (down 6.7%). The Biotechs rallied 6.7% (down 17.6%). With bullion surging $63, the HUI gold index rallied 7.0% (down 1.4%).

One and three-month Treasury bill rates ended the week at about zero. Two-year government yields were down 2 bps to 0.25%. Five-year T-note yields ended the week a basis point lower at 0.87%. Ten-year yields rose 6 bps to 2.04%. Long bond yields jumped 11 bps to 2.99%. Benchmark Fannie MBS yields were down a basis point to 3.06%. The spread between 10-year Treasury yields and benchmark MBS yields narrowed 7 bps to 102 bps. Agency 10-yr debt spreads were down 4 bps to zero. The implied yield on December 2012 eurodollar futures sank 14 bps to 0.715%. The two-year dollar swap spread dropped 10 bps to 45.5 bps. The 10-year dollar swap spread declined 2 bps to 17.6 bps. Corporate bond spreads narrowed. An index of investment grade bond risk dropped 22 to a four-week low 125 bps. An index of junk bond risk sank 130 bps to 707 bps.

Debt issuance picked up this week. Investment-grade issuance this week included Disney $1.6bn, John Deere $1.2bn, Johnson Controls $1.1bn, Raytheon $1.0bn, Safeway $800 million, Scripps Networks $500 million, National Fuel Gas $500 million, Pacific Gas & Electric $250 million, Vornado $400 million, Caltech $350 million, Agco $300 million, Memorial Sloan-Kettering $250 million, and Questar Pipeline $180 million.

Junk bond funds saw outflow decline to $1.0bn (from Lipper). Junk issuance included Optima Verisk Analytics $250 million, Specialty Steel $175 million and Landry's $115 million.

Convertible debt issuers included Lennar $400 million.

International dollar bond issuers included Qatar $3.0bn, Transocean $2.5bn, BP $1.6bn, Tesco $1.0bn, Hyundai $500 million, Canadian Pacific Railroad $500 million, Empresa Nacional $500 million and International Bank of Reconstruction and Development $400 million.

Italian 10-yr yields ended the week down 58 bps to 6.66% (up 185bps y-t-d). Spain's 10-year yields sank 104 bps to 5.63% (up 19bps). Greek two-year yields ended the week up 1,144 bps to 121.67% (up 10,943bps). Greek 10-year yields rose 39 bps to 28.49% (up 1,603bps). German bund yields declined 13 bps to 2.13% (down 83bps), and French yields dropped 42 bps to 3.25% (spread to bunds narrowed 29 to 112bps). U.K. 10-year gilt yields were unchanged at 2.29% (down 122bps). Ten-year Portuguese yields jumped 106 bps to 13.37% (up 679bps). Irish yields dropped 61 bps higher to 8.86% (down 19bps).

The German DAX equities index surged 10.7% (down 12.1% y-t-d). Japanese 10-year "JGB" yields rose another 4 bps to 1.065% (down 6bps). Japan's Nikkei jumped 5.9% (down 15.5%). Emerging markets were for the most part sharply higher. For the week, Brazil's Bovespa equities index gained 5.5% (down 16.5%), and Mexico's Bolsa jumped 6.3% (down 4.7%). South Korea's Kospi index surged 7.9% (down 6.6%). India's Sensex equities index recovered 7.3% (down 17.9%). Curiously, China's Shanghai Exchange slipped 0.8% (down 15.9%). Brazil's benchmark dollar bond yields fell 13 bps to 3.39%, while Mexico's 10-year dollar bond yields were little changed at 3.65%.

Freddie Mac 30-year fixed mortgage rates added 2 bps to 4.00% (down 46bps y-o-y). Fifteen-year fixed rates were unchanged at 3.30% (down 51bps y-o-y). One-year ARMs dipped a basis point to 2.78% (down 47bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 2 bps to 4.65% (down 60bps y-o-y).

Federal Reserve Credit dropped $15.1bn to $2.793 TN. Fed Credit was up $385bn y-t-d and $475bn from a year ago, or 20.5%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 11/30) declined $5.5bn to $3.451 TN (11-wk decline of $23.9bn). "Custody holdings" were up $101bn y-t-d and $110bn from a year ago, or 3.3%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $1.165 TN y-o-y, or 16.9% to $10.214 TN. Over two years, reserves were $2.635 TN higher, for 35% growth.

M2 (narrow) "money" supply dropped $35.7bn to $9.619 TN. "Narrow money" has expanded at a 9.9% pace y-t-d and 9.5% over the past year. For the week, Currency increased $3.2bn. Demand and Checkable Deposits fell $12.9bn, and Savings Deposits dropped $18.3bn. Small Denominated Deposits declined $4.0bn. Retail Money Funds slipped $3.6bn.

Total Money Fund assets rose $6.1bn last week to a 17-wk high $2.652 TN. Money Fund assets were down $158bn y-t-d and $158bn over the past year, or 5.6%.

Total Commercial Paper outstanding increased $2.4bn (20-wk decline of $235bn) to $1.002 TN. CP was down $31bn y-t-d, with a one-year decline of $19bn.

Global Credit Market Watch:

November 30 - Bloomberg (Alex Tanzi): "Following is the text of Coordinated Central Bank Action to Address Pressures in Global Money Markets as released by the Federal Reserve: Coordinated Central Bank Action to Address Pressures in Global Money Markets. The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing coordinated actions to enhance their capacity to provide liquidity support to the global financial system. The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity."

December 1 - Bloomberg (Tony Czuczka): "German Chancellor Angela Merkel is set to snub investor pleas to back an expanded European Central Bank role in solving the debt crisis, as she pushes her demand for tighter economic ties in Europe as the only way forward. On the eve of a speech to German lawmakers tomorrow outlining her stance before a Dec. 9 European summit, Merkel is digging in on her plan to rework the European Union's rules to lock in budget monitoring and enforcement. That risks a showdown with fellow EU leaders and extends her conflict with financial markets looking for immediate measures to end the contagion."

November 28 - Bloomberg (Rainer Buergin): "Chancellor Angela Merkel's spokesman Steffen Seibert said Germany doesn't have 'unlimited financial strength,' which is the reason why the government is skeptical toward suggestions to provide the European Financial Stability Facility with enough capacity for it to function as a 'bazooka.'"

December 1 - Dow Jones (Stephen L. Bernard): "Euro zone officials have just a few weeks left to take decisive steps to ensure the common currency's long-term future, former U.K. Prime Minister Tony Blair said... 'We're reaching the final decision point,' Blair said... Blair said European officials must put the full weight of the region's monetary system behind the effort or else it could fail."

December 2 - Bloomberg (John Glover): "Europe's banks will compete with their governments to borrow $2 trillion next year as the two groups refinance maturing bonds and bills. Euro-area governments have to repay more than 1.1 trillion euros ($1.5 trillion) of long- and short-term debt in 2012, with about 519 billion euros of Italian, French and German debt maturing in the first half alone... European banks have about $665 billion of debt coming due in the first six months, with a further $370 billion by the end of the year... 'Serious investors are fleeing from both European sovereign and European bank debt in droves,' said Mark Grant, a managing director at Southwest Securities... 'The financials of both classes are in question, and nothing of substance has been achieved to correct the problems and quell the European crisis.'"

November 29 - Bloomberg (Simon Kennedy): "Banks and ratings companies are sounding their loudest warnings yet that the euro area risks unraveling unless its guardians intensify efforts to beat the two-year-old sovereign debt crisis. As European finance chiefs prepare to meet this week, and Italy seeks to raise as much as 8.8 billion euros ($11.7bn) in bond sales, economists from Morgan Stanley, UBS AG, and Nomura International Plc say governments and the European Central Bank must step up their crisis response. Moody's... said today the 'rapid escalation' of the crisis threatens all of the region's sovereign ratings."

November 29 - Bloomberg (Dakin Campbell): "Bank of America Corp., Goldman Sachs.... and Citigroup Inc. had long-term credit grades reduced to A- from A by Standard & Poor's after the ratings firm revised criteria for dozens of the world's biggest lenders. S&P made the same cut to Morgan Stanley and Bank of America's Merrill Lynch unit today. JPMorgan Chase & Co. was reduced one level to A from A+. S&P upgraded Bank of China Ltd. and China Construction Bank Corp. to A from A- and maintained the A rating on Industrial & Commercial Bank of China Ltd., giving all three lenders higher grades than most big U.S. banks."

November 30 - Financial Times (Kerin Hope): "The head of Greece's central bank said... that deposits had shrunk significantly in the past two months as the public withdrew billions of euros in reaction to mounting political tension. George Provopoulos, the central bank governor, told a parliamentary committee that outflows from the banking system increased to €5.5bn in September and €6.5bn in October... Outflows tripled compared with the same two months of last year..."

November 30 - Bloomberg (Ben Martin and Hannah Benjamin): "European companies are selling the fewest bonds in six years as the sovereign crisis sidelines cash-rich treasurers increasingly wary of the region's banks."

December 1 - Bloomberg (Patrick Donahue): "Italy and Greece scored the lowest among euro-area countries in a global corruption ranking as their inability to tackle graft and tax evasion exacerbated the debt crisis, watchdog group Transparency International said."

December 1 - Bloomberg (Ben Moshinsky): "Bank of England Governor Mervyn King urged banks to enhance efforts to bolster their defenses against the euro area's debt turmoil, which now looks like a 'systemic crisis.' 'An erosion of confidence, lower asset prices and tighter credit conditions are further damaging the prospects for economic activity and will affect the ability of companies, households and governments to repay their debts,' threatening banks' balance sheets, King told reporters... 'This spiral is characteristic of a systemic crisis.'"

November 29 - Bloomberg (Keith Jenkins): "ICAP Plc, the biggest broker of transactions between banks, has prepared its electronic trading platform for a potential return of the Greek drachma amid concern the country will cease using the euro."

December 1 - Bloomberg (Widya Utami): "Emerging economies are facing the threat of a capital reversal as the risk of contagion from Europe becomes 'very real,' Bank Indonesia Governor Darmin Nasution said. An escalation of Europe's sovereign-debt woes may prompt investors to allocate their assets into other currencies instead of putting them into the safest euro sovereigns, Nasution said... A bout of risk aversion may result in investors avoiding emerging-market assets as well, he said."

December 1 - Bloomberg (Jacob Greber): "Commonwealth Bank of Australia, the nation's largest bank, and its three biggest rivals were among Asia-Pacific financial institutions downgraded by Standard & Poor's following a revision of its rating criteria."

Global Bubble Watch:

December 2 - Bloomberg (John Detrixhe and Tim Catts): "With less than a month to go, returns in the U.S. bond market are poised to reach the highest in nine years, even as the amount of U.S. government borrowing surpasses $15 trillion for the first time. Everything from Treasuries to corporate bonds to mortgage securities is on pace to gain 7.32% on average, according to Bank of America Merrill Lynch... That would exceed the 6.8% gain in all of last year and be the most since the 10.3% in 2002. Yields on dollar-denominated notes have fallen below the rest of the world's debt by the most on record."

November 29 - Bloomberg (Daniel Kruger and Cordell Eddings): "The biggest bond dealers in the U.S. say the Federal Reserve is poised to start a new round of stimulus, injecting more money into the economy by purchasing mortgage securities instead of Treasuries. Fed Chairman Ben S. Bernanke and his fellow policy makers, who bought $2.3 trillion of Treasury and mortgage-related bonds between 2008 and June, will start another program next quarter, 16 of the 21 primary dealers of U.S. government securities that trade with the central bank said... The Fed may buy about $545 billion in home-loan debt, based on the median of the firms that provided estimates."

November 30 - Bloomberg: "China reduced the amount of cash that banks must set aside as reserves for the first time since 2008 as Europe's debt crisis threatens exports and growth. The government moved two hours before the U.S. Federal Reserve, the European Central Bank and the monetary authorities of the U.K., Canada, Japan and Switzerland said they were cutting the cost of emergency dollar funding to ease strains in financial markets. Chinese banks' reserve ratios will decline by 50 bps..."

December 1 - Bloomberg (Henry Meyer): "BRICS nations may gain a 'big role' in the International Monetary Fund if they provide aid to the euro region, European Bank for Reconstruction and Development President Thomas Mirow said. 'This is an ongoing trend, that the emerging economies and countries need to get a big role at the IMF, and of course if there would be a necessity to get additional funding for the IMF for Europe, that would probably accelerate this process,' Mirow said..."

November 30 - Bloomberg (Frances Schwartzkopff): "Denmark's home-loan industry, the world's biggest issuer of mortgage-backed covered bonds, is looking to Germany to avoid a repeat of the housing bubble that sent Scandinavia's weakest economy to the brink of a recession. Realkredit Danmark A/S, Denmark's second-largest mortgage lender, wants the $495 billion industry to reject loan applications if house prices exceed what German banks call the mortgage lending value, which strips out temporary price fluctuations to arrive at a long-term valuation."

Currency Watch:

The U.S. dollar index declined 1.2% to 78.63 (down 0.5% y-t-d). On the upside, the South African rand increased 6.2%, the Brazilian real 5.6%, the Australian dollar 5.2%, the New Zealand dollar 5.0%, the Mexican peso 4.4%, the Swedish krona 3.7%, the South Korean won 2.9%, the Canadian dollar 2.7%, the Norwegian krone 2.4%, the Singapore dollar 2.2%, the Danish krone 2.2%, the euro 1.2%, the British pound 1.0%, the Swiss franc 0.9%, and the Taiwanese dollar 0.9%. On the downside, the Japanese yen declined 0.3%.

Commodities and Food Watch:

The CRB index rallied 2.7% this week (down 5.8% y-t-d). The Goldman Sachs Commodities Index surged 3.5% (up 4.2%). Spot Gold rose 3.8% to $1,747 (up 23%). Silver rallied 4.9% to $32.61 (up 5.5%). January Crude jumped $4.19 to $100.96 (up 11%). January Gasoline surged 7.1% (up 7%), while January Natural Gas declined 1.2% (down 1%). March Copper rallied 9.2% (down 19%). December Wheat jumped 6.6% (down 23%), and December Corn increased 0.7% (down 7%).

China Bubble Watch:

December 1 - Bloomberg (Freeman Klopott): "China's manufacturing recorded the weakest performance since the global recession eased in 2009, underscoring the case for monetary stimulus as Europe's crisis weighs on the world's second-largest economy."

November 30 - Financial Times (Robert Cookson): "For most of the year, Hong Kong's 'dim sum' bond market appeared invulnerable. Even as other asset classes suffered, renminbi-denominated bonds remained in strong demand from international investors. In recent months, however, enthusiasm has waned. Dim sum bond prices have declined substantially since September, when investors started to question the widely-held belief that the renminbi will only appreciate against the US dollar. 'The game has changed,' says one fund manager. 'There's less excitement around appreciation and there are fears of a Chinese hard landing."

December 1 - Bloomberg: "Record bond premiums for high-yield Chinese companies over top-ranked issuers show that investors are shunning riskier debt as economic growth slows."

December 1 - Bloomberg (Frederik Balfour): "A Ming dynasty flask joined cases of Bordeaux wines and Chinese paintings on the unsold list as Christie's International wrapped up a six-day Hong Kong auction marathon that raised more than HK$2.84 billion ($370 million). Record prices for some lots were balanced by muted bidding as the Asian art market's growth slows. Tight money in China and economic concerns reduced enthusiasm, said dealers."

Japan Watch:

December 2 - Bloomberg (Masaki Kondo, Monami Yui and Shigeki Nozawa): "An auction of benchmark Japanese debt saw the lowest demand in a year yesterday, adding to signs fiscal concerns are mounting in the world's most-indebted nation as the government prepares its fourth extra budget and a domestic rating company threatens an unprecedented downgrade."

India Watch:

November 30 - Bloomberg (Kartik Goyal): "India's economy grew last quarter at the slowest pace in more than two years after the nation's central bank raised interest rates by a record to tame the fastest inflation among so-called BRIC nations. Gross domestic product rose 6.9% in the three months through September..."

Asia Watch:

November 30 - Bloomberg (Eunkyung Seo): "South Korea's industrial output fell, India's economy grew the least in more than two years and Thailand cut interest rates as an Asian slowdown limits the region's ability to support a faltering world recovery."

Latin America Watch:

December 1 - Bloomberg (Matthew Bristow and Andre Soliani): "Brazil's central bank signaled it will keep cutting interest rates at its current half-point pace as it tries to prevent Europe's spreading debt crisis from stunting growth in Latin America's biggest economy. The bank's board... voted unanimously to reduce the benchmark rate 50 bps for a third straight meeting, to 11%..."

December 1 - Bloomberg (Arnaldo Galvao and Matthew Bristow): "Brazil suspended a levy on foreign stock purchases as part of more than 1 billion reais ($559 million) in tax cuts to fuel 5% economic growth next year. The government also reduced levies on consumer loans, home appliances, food staples, home building and foreign purchases of corporate bonds tied to infrastructure projects..."

Unbalanced Global Economy Watch:

December 1 - Bloomberg (Henry Meyer): "Risks are rising for eastern Europe from the debt crisis as European banks are squeezed by deteriorating loan quality and slowing growth, European Bank for Reconstruction and Development President Thomas Mirow said. Central and southeastern Europe are exposed because they are 'heavily dependent on the euro area as their major trade partner, and this comes on top of contagion risks through the banking sector,' Mirow said..."

December 1 - Bloomberg (Dorota Bartyzel): "Polish manufacturing contracted in November to the lowest level in more than two years as export orders fell amid the worsening debt crisis in the euro region, Poland's main market."

December 1 - Bloomberg (Michael Heath): "Australian home-building approvals unexpectedly plunged in October and retail sales growth slowed, snapping the local currency's three-day advance as investors raised bets the central bank will cut interest rates next week."

U.S Bubble Economy Watch:

December 2 - Reuters: "The finances of three major U.S. airports could weaken from the bankruptcy filings of American Airlines and its parent company, Fitch Ratings said... An estimated $4 billion in joint revenue improvement bonds for Dallas-Fort Worth International, $6 billion of aviation revenue bonds sold on behalf of Miami International Airport and $6.5 billion of airport revenues bonds issued on behalf of Chicago O'Hare International Airport are particularly vulnerable from the Chapter 11 filings made by AMR Corp and its American Airlines subsidiary, Fitch said."

Central Bank Watch:

December 2 - Bloomberg (Boris Groendahl): "It would be a 'severe mistake' for the European Central Bank to purchase unlimited amounts of euro- area government bonds, Otmar Issing, the ECB's former chief economist, told Austrian radio ORF in an interview. 'It would be an absolutely severe mistake which the ECB will certainly not commit,' Issing told ORF's morning news show. "To guarantee the debt of all countries would mean to hand over control of the printing press to politicians, and history teaches us what happens next... At the moment the ECB is the only institution that is trusted... If its reputation is tarnished, the euro would be in trouble.'"

November 28 - Bloomberg (Bob Ivry, Bradley Keoun and Phil Kuntz): "The Federal Reserve and the big banks fought for more than two years to keep details of the largest bailout in U.S. history a secret. Now, the rest of the world can see what it was missing. The Fed didn't tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day. Bankers didn't mention that they took tens of billions of dollars in emergency loans at the same time they were assuring investors their firms were healthy. And no one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed's below-market rates, Bloomberg Markets magazine reports in its January issue."

November 30 - Bloomberg (Joshua Zumbrun and Vivien Lou Chen): "Federal Reserve policy makers sharpened their differences over the signs of economic decline that would warrant more asset purchases by the Fed in speeches yesterday. Vice Chairman Janet Yellen said the Fed still has 'scope for action' to fight unemployment she predicted would remain 'painfully high' for years. Atlanta Fed President Dennis Lockhart said he doubted more bond buying would make a difference, while the Minneapolis Fed's Narayana Kocherlakota said policy makers should begin tightening in 2012, assuming forecasts for lower unemployment and stable inflation prove accurate. The officials' remarks underscore a divided Fed that's struggling to bring down a jobless rate stuck near 9% or higher for more than two years."

December 1 - Bloomberg (Craig Torres): "Federal Reserve Bank of Richmond President Jeffrey Lacker said he dissented against the Federal Open Market Committee's currency-swap decision because it was a form of fiscal policy. 'I opposed the temporary swap arrangements to support Federal Reserve lending in foreign currencies,' Lacker said... 'Such lending amounts to fiscal policy, which I believe is the responsibility of the U.S. Treasury.'"

December 1 - Bloomberg (Joshua Zumbrun and Matthew Winkler): "James Bullard, president of the Federal Reserve Bank of St. Louis, said recent economic reports point to stronger economic growth, and policy makers shouldn't rush to ease further. 'The data have come in stronger than expected, so I think the logical thing now is to wait and see,' Bullard said..."

Muni Watch:

November 29 - Bloomberg (Romy Varghese): "U.S. states must tackle at least $40 billion in budget gaps in the year beginning in July as federal stimulus funds decrease and expenses rise, according to a survey... by the National Governors Association and the National Association of State Budget Officers. Not all states have made forecasts for that year -- only 17 made deficit predictions -- and most are still grappling with shortfalls for fiscal 2012 that total $95 billion, the groups said. Revenue, while improved in 2012, won't meet costs in areas such as health care and prisons, the report said."

November 30 - Bloomberg (Freeman Klopott): "Governor Andrew Cuomo is considering restructuring New York's tax code as he prepares a budget that must close a deficit as large as $3.5 billion after a temporary surcharge on those earning at least $200,000 expires Dec. 31."


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