UNEDITED!

Considering that the broader market - or at least the Russell 2000 and S&P400 Mid-cap indices - traded at or near all time highs Wednesday morning, the market ended the week unimpressively. For the week, the Dow declined 0.8% and the S&P500 dipped 0.6%. The Transports fell 1.8%, and the Utilities declined 1.1%. The Morgan Stanley Cyclical index declined 1.1% and the Morgan Stanley Consumer index fell 0.9%. Two days of selling pushed the small cap Russell 2000 to a 2.5% decline for the week. The S&P400 Mid-cap index dropped 1.7%. Technology stocks generally outperformed. The NASDAQ100 was slightly negative and the Morgan Stanley High Tech index slightly positive. The Semiconductors and The Street.com Internet indices were down less than 1%, and the NASDAQ Telecommunications index slipped 0.2%. The Biotechs were resilient, declining about 0.5%. The Broker/Dealers declined 1.1%, and the Banks fell 1.0%. With bullion jumping $7.50, the HUI gold index was up about 4%.

Looks like a bear. For the week, two-year Treasury yields jumped 9 basis points to 4.10%, the highest yield since July 2001. Five-year government yields surged 11 basis points to 4.23%, the high since the late-March price spike. Ten-year Treasury yields gained 11 basis points for the week to 4.39%, and long-bond yields jumped 11 basis points to 4.58%. The spread between 2 and 10-year government yields widened 3 to 29. Benchmark Fannie Mae MBS yields rose 12 basis points, slightly more than Treasuries. The spread (to 10-year Treasuries) on Fannie's 4 5/8% 2014 note was unchanged at 29, and the spread on Freddie's 5% 2014 note was unchanged at 28. The 10-year dollar swap spread increased .75 to 45.25 (11-week high). Corporate bonds continue to trade with narrow spreads to Treasuries, although auto bond and CDS spreads widened moderately this week. Junk bond spreads were little changed for the week. The implied yield on 3-month December Eurodollars rose 5.5 basis points to 4.32%, while December '06 Eurodollar yields jumped 13.5 basis points to 4.635%.

Corporate issuance rose to $15 billion. This week's investment grade issuers included Wells Fargo $1.0 billion, Merrill Lynch $950 million, Wachovia Bank $750 million, Regions Financial $750 million, Aiful $500 million, New York Life $500 million, Key Bank $500 million, Caithness Coso $465 million, PSEG Funding $460 million, XLLIAC Global Funding $450 million, Domtar $400 million, Thomson $400 million, Amerus Group $300 million, Marsh & Ilsley $250 million, Hovnanian $300 million, Branch Banking & Trust and Standard Pacific $175 million.

Junk bond fund reported outflows of $2.9 million (from AMG). Junk issuers included Sirius Satellite $500 million, Acco Brands $350 million, Cardtronics $200 million, Life Care Holding $150 million, and Stanley-Martin $150 million.

Convert issuance included Human Genome Sciences $230 million and Lifepoint Hospitals $200 million.

Foreign dollar debt issuance included RAS Laffan LNG$2.25 billion and Japanese 10-year JGB yields rose 8 basis points this week to a 4-month high 1.38%. Emerging debt markets were generally impressive considering the tone of the Treasury market. Brazilian benchmark dollar bond yields declined 5 basis points to 7.85%. Mexican govt. yields rose 8 basis points to 5.58%. Russian 10-year dollar Eurobond yields increased 4 basis points to 6.09%.

Freddie Mac posted 30-year fixed mortgage rates rose 5 basis points to 5.82%, up 29 basis points in five weeks (down 17 basis points from one year ago). Fifteen-year fixed mortgage rates increased 4 basis points to 5.38%, a 16-week high. One-year adjustable rates added one basis point to 4.47%, up 23 basis points in five weeks and 39 basis points higher than a year earlier. The Mortgage Bankers Association Purchase Applications Index rose 1.9% last week to a four-week high. Purchase applications were up 9.5% compared to one year ago, with dollar volume up 22%. Refi applications increased 3%. The average new Purchase mortgage rose to $239,400. The average ARM jumped to $350,500. The percentage of ARMs declined to 28.5% of total applications.

Broad money supply (M3) expanded $12.3 billion to a record $9.761 Trillion (week of July 25). Year-to-date, M3 has expanded at a 5.2% growth rate, with M3-less Money Funds expanding at a 6.5% pace. For the week, Currency gained $0.9 billion. Demand & Checkable Deposits jumped $25.3 billion. Savings Deposits dropped $27.9 billion. Small Denominated Deposits added $3.2 billion. Retail Money Fund deposits slipped $1.4 billion, while Institutional Money Fund deposits rose $10.5 billion. Large Denominated Deposits increased $5.6 billion. For the week, Repurchase Agreements dipped $0.3 billion, and Eurodollar deposits declined $3.5 billion.

Bank Credit jumped $18.9 billion last week. Year-to-date, Bank Credit has expanded $511.4 billion, or 13.1% annualized, more than the $496 billion growth during the entire year 2004. Securities Credit declined $10.7 billion during the week, with a year-to-date gain of $137.9 billion (12.5% ann.). Loans & Leases have expanded at a 13.8% pace so far during 2005, with Commercial & Industrial (C&I) Loans up an annualized 19.7%. For the week, C&I loans increased $5.9 billion, and Real Estate loans expanded $5.0 billion. Real Estate loans have expanded at a 15.9% rate during the first 30 weeks of 2005 to $2.774 Trillion. Real Estate loans were up $374 billion, or 15.4%, over the past 52 weeks. For the week, Consumer loans increased $7.2 billion, and Securities loans gained $6.0 billion. Other loans added $5.5 billion.

Total Commercial Paper surged $32.1 billion last week to $1.577 Trillion (high since March '01). Total CP has expanded $163.6 billion y-t-d, a rate of 19.4% (up 16.8% over the past 52 weeks). Financial CP jumped $30.0 billion last week to $1.435 Trillion, with a y-t-d gain of $150.2 billion (19.6% ann.). Non-financial CP gained $2.1 billion to $142.9 billion (up 17.4% ann. y-t-d and 9.8% over 52 wks).

ABS issuance was about stable with last week at $11 billion (from JPMorgan). Year-to-date issuance of $441 billion is 22% ahead of comparable 2004. Home Equity Loan ABS issuance of $281 billion is 27% above comparable 2004.

From Merrill Lynch research: "US Cash CDO issuance is up 76% YTD 2005 versus the same period in 2004, with YTD volume of $75.1 billion."

Fed Foreign Holdings of Treasury, Agency Debt added $1.1 billion to $1.455 Trillion for the week ended August 3. "Custody" holdings are up $119.4 billion y-t-d, or 15.0% annualized (up $207bn, or 16.6%, over 52 weeks). Federal Reserve Credit jumped $5.8 billion to $799.1 billion. Fed Credit has expanded 1.8% annualized y-t-d (up $41.5bn, or 5.5%, over 52 weeks).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $589 billion, or 17.8%, over the past 12 months to $3.901 Trillion. Russian reserves are up almost 76% over the past year.

August 4 - Bloomberg (Torrey Clark and Marta Srnic): "Russia's foreign currency and gold reserves increased to $144.3 billion as rising oil revenue helped reversed three weeks of declines. Reserves rose by $2.3 billion in the week ending July 29..."

Currency Watch:

Curiously disregarding rising U.S. yields, the dollar index dropped 1.4% this week. On the upside, the Czech koruna gained 3.6%, the Brazilian real 2.9%, Swedish krona 2.7%, Chilean peso 2.5%, and Swiss franc 2.2%. On the downside, the Taiwan dollar, Mexican peso, and Argentine peso declined slightly against the dollar.

Commodities Watch:

August 4 - Reuters: "China's demand for crude oil will rise about 6 percent from last year to 310 million tonnes (6.2 million barrels per day) in 2005, the government estimated in a new survey that underscores weak domestic consumption data. Domestic crude production in the world's second-largest oil consumer would only rise 3 percent to 180 million tonnes (3.6 million bpd)..."

August 5 - Bloomberg (Gene Laverty): "Natural-gas futures rose to the highest in nine months as hot weather forecast for much of the U.S. threatens additions to winter reserves. Air-conditioner use will average 12 percent above normal across the U.S. through Aug. 12, according to Weather Derivatives. Gas inventories, which had been 20 percent above the five-year average at June 3, had been pared to 7.6 percent above...by last week..."

September crude oil jumped $1.74 to a record $62.31. For the week, the CRB index rose 1.5%, increasing y-t-d gains to 11.5%. The Goldman Sachs Commodities index surged 3%, with 2005 gains rising to 33.6%.

China Watch:

August 4 - AFP: "Chinese state media has condemned US political intransigence over oil group CNOOC's bid for Unocal, saying its opposition calls into question the free trade dogma Washington often trumpets to the world. 'The high-profile takeover battle demonstrated to the world that the United States is not a free economy as it claimed to be,' the official China Daily said in an editorial. 'An asset for sale has not gone to the buyer that most prized it because of regulatory concerns fuelled by bogus fears and hidden interests.' CNOOC...drew heavy fire from Capitol Hill for its attempted takeover of the United States' ninth largest oil group... 'The unprecedented political opposition that followed the announcement of our proposed transaction ... was regrettable and unjustified,' CNOOC said... The China Daily editorial went on to say that not only had Unocal shareholder interests been damaged but that the failure would 'poison the current prevailing mood..." 'The explicit message the takeover battle sends to the world is that American business is defined by political needs... That practice will incur many unknown costs for foreign investors. In the long run, the casualty will be US competitiveness if the market is to play second fiddle to protectionism with political patronage.'"

August 5 - Bloomberg (Koh Chin Ling): "China's top 30 retailers, including Shanghai Bailian Group Co., Gome Electrical Appliances Holdings Ltd. and Carrefour SA, had a 30 percent increase in sales in the first half, the Ministry of Commerce said."

August 2 - Bloomberg (Zhang Shidong): "China's retail sales will grow by 12.7 percent this year, the official Xinhua News Agency reported, citing a Ministry of Commerce survey and analysis of 600 major consumer products."

Asia Boom Watch:

August 3 - Bloomberg (Lily Nonomiya): "Japan's manufacturers plan to boost spending at the fastest pace in 15 years this fiscal year, a report by the Development Bank of Japan showed. Manufacturers plan to boost spending by 19.8 percent in the year ending March 31..."

August 4 - Bloomberg (Cherian Thomas): "India's industrial production grew 12.8 percent in June on year, Commerce and Industry Minister Kamal Nath said... Industry had grown 10.8 percent in May compared with the same month last year."

August 4 - Bloomberg (Cherian Thomas): "India's Prime Minister Manmohan Singh said the country needs $150 billion of overseas investment in roads, ports and other infrastructure in the next eight years to accelerate economic growth."

August 1 - Bloomberg (Anuchit Nguyen): "Thai inflation accelerated to a more than six-year high in July as higher fuel prices made transportation more expensive, reinforcing expectations the central bank will raise interest rates further this year. The consumer price index rose 5.3 percent from a year earlier after climbing 3.8 percent in June..."

August 3 - Bloomberg (Stephanie Phang): "Malaysia's exports unexpectedly accelerated in June, boosted by U.S. demand for electronics such as semiconductors and higher oil shipments to China. Exports rose 11.7 percent to 44.5 billion ringgit ($11.9 billion) from a year earlier..."

August 1 - Bloomberg (Arijit Ghosh and Soraya Permatasari): "Indonesia's inflation rate accelerated in July after the government increased cigarette prices and a weaker rupiah made imported goods more expensive. Consumer prices rose 7.8 percent from a year earlier after gaining 7.4 percent in June..."

Unbalanced Global Economy Watch:

August 3 - Bloomberg (Alexandre Deslongchamps): "Canadian sales of cars and light trucks rose 17 percent in July, as offers of employee prices for all buyers helped General Motors Corp., Ford Motor Co. and DaimlerChrysler AG to gains of more than 20 percent each. Sales advanced to 154,830 vehicles from 132,783 a year earlier..."

August 5 - Bloomberg (Laura Humble): "U.K. house-price inflation slowed to the lowest in more than nine years in July, HBOS Plc said, after the country's economy grew at the slowest annual pace since 1993 in the second quarter. Prices rose 2.3 percent in the quarter through last month compared with a year earlier..."

August 4 - Bloomberg (Matthew Fletcher): "U.K. new-car sales fell 6.6 percent in July, the seventh straight decline this year, after automaker MG Rover Group Ltd. collapsed and higher interest rates deterred buyers, said the country's carmaker's association."

August 5 - Bloomberg (Jeremy van Loon): "Bayerische Motoren Werke AG, the world's largest maker of luxury cars, said worldwide sales in July gained 14 percent as buyers chose new versions of the 3-Series car and new models such as the X3 sport-utility vehicle."

August 1 - Bloomberg (Tasneem Brogger): "Danish retail sales rose 1.5 percent in June from May as falling unemployment and rising consumer confidence encourage consumers to spend more on goods including clothes. Retail sales rose an annual 7.5 percent..."

August 1 - Bloomberg (Trygve Meyer): "Norwegian domestic borrowing growth in June accelerated to the highest in almost four years, led by consumer and business credits. Credit growth for households, companies and municipalities accelerated to an annual 10.6 percent, the highest since July 2001, from 10.5 percent in May..."

August 4 - Bloomberg (Jonas Bergman): "Swedish economic growth accelerated in the second quarter as companies increased investments and falling borrowing costs fueled consumer spending. The largest Nordic economy grew 0.6 percent from the first three months and an annual 2.2 percent..."

August 4 - Bloomberg (Bradley Cook): "Russian economic growth probably accelerated to an annual 6.7 percent in July, the fastest pace in 11 months, as record oil revenue fuels consumer spending, Moscow Narodny Bank said. Economic expansion, led by manufacturing and services, accelerated from 5 percent in the first quarter..."

August 3 - Bloomberg (Todd Prince): "Russian millionaires may control as much as $350 billion, equivalent to about two-thirds of the country's gross domestic product, according to Scorpio Partnership, a U.K. wealth-management firm."

August 4 - Financial Times (Christopher Hitchens ): "As central Europe basks in the summer heat, its stock markets are also enjoying their day in the sun: since mid-May, the region's three main markets, in Warsaw, Budapest and Prague, have pushed steadily into record territory, driven by solid corporate profits and a burst of interest from US-based emerging market funds. In Warsaw, the region's largest market, investor interest has concentrated on blue-chips, sending the WIG20 blue-chip index up 23 per cent since mid-May... Budapest's BUX closed at a record high of 21,354 on Tuesday...a rise of 33 per cent since mid-May and 42 per cent on the year."

August 2 - Bloomberg (Victoria Batchelor and Gemma Daley): "Australia's retail sales increased by the most in two years in June as rising wages and record employment stoke growth in the Asia-Pacific's fifth-largest economy. Bonds dropped and the nation's currency rose after the statistics bureau said today retail sales gained 1.3 percent from May. That was more than double the median forecast of a 0.5 percent..."

August 1 - Bloomberg (Dania Saadi): "Iran, the site of the world's second- largest oil and gas reserves, expects to have record oil sales of $40 billion this year as prices reach an all-time high, the country's oil minister said."

Latin America Watch:

August 5 - Bloomberg (Guillermo Parra-Bernal and Camila Dias): "Brazil's industrial output rose in June at the fastest pace in six months, suggesting that record exports are tempering a slowdown in South America's biggest economy. Output by miners and manufacturers rose 6.3 percent in June from a year earlier, following a 5.5 percent increase in May..."

August 1 - Bloomberg (Katia Cortes): "Brazil's trade surplus surged to a record in July, powered by a jump in the shipment of commodities, such as soybeans, coffee and tobacco. Brazil's surplus jumped $980 million in July, the biggest monthly gain this year, to a record $5 billion from $4 billion in June..."

August 3 - Bloomberg (Daniel Helft): "Argentina's annual inflation rate rose to a two-year high in July as an increase in government spending sparked a surge in consumer demand. Inflation quickened to 9.6 percent in the 12 months through July from 9 percent in July and 8.6 percent in May..."

August 5 - Bloomberg (Heather Walsh): "Chile's economy grew faster than 6 percent for a third straight month in June as manufacturers increased output to fill orders at home and abroad. The economy grew 6.4 percent in June from a year earlier..."

Bubble Economy Watch:

August 3 - Bloomberg (Bill Koenig and Barbara Powell): "General Motors Corp., Ford Motor Co. and DaimlerChrysler AG, bolstered by employee discounts for all customers, led the second-biggest month ever for U.S. auto sales. Toyota Motor Corp., Nissan Motor Co. and Honda Motor Co. also had gains in July. U.S. auto sales rose to an annualized 20.9 million units in July, compared with 17.2 million a year earlier..."

August 3 - The Wall Street Journal (Ryan Chittum): "Consumers continued spending in the second quarter, which boosted the retail real-estate market and drove vacancies in shopping malls to four-year lows and pushed rents up solidly in strip malls. Mall vacancies fell to 5.1% on average in the second quarter from 5.3% in the first quarter, but average rents were flat at $37.75 a square foot a year (according to Reis Inc.)... Strip-mall vacancies fell to 6.7% on average in the second quarter from 6.9% in the first quarter... Absorption...in strip malls was particularly strong in the second quarter, jumping by 8.7 million square feet, the second-biggest rise in 4 1/2 years."

Speculator Watch:

August 3 - Dow Jones (Steven C. Johnson): "U.S. consumers may be spending at a record-setting pace, but their appetites have been easily matched by those of investors, who remain hungry to buy consumer debt - even as risk premiums approach historic lows. Global investors are snapping up asset-backed securities - consumer loans repackaged into new bonds and sold to investors - just as quickly as banks can issue them. Nearly $30 billion in new securities have hit the calendar since mid-July, a time when volume usually slows to a trickle... This follows a 28% surge in new issuance - from $262 billion to $335 billion - in the first half of the year, analysts at RBS Greenwich Capital...reported ..."

August 4 - Bloomberg (Katherine Burton): "Multibillion-dollar hedge funds run by Paul Tudor Jones, Louis Bacon, Bruce Kovner and Barton Biggs boosted investment returns in July after gaining no more than 1.2 percent in the first six months of the year. Tudor's $4 billion Tudor BVI fund returned 3 percent in the year through July 20 and Bacon's $5 billion Moore Global Investments gained 2.4 percent, investors said. Biggs's $1.7 billion Traxis Fund rose about 2.3 percent and Kovner's $9.3 billion Caxton Global Investment fund advanced about 1.8 percent through the end the month."

California Bubble Watch:

California Median Home Prices jumped $19,820 during June to a record $542,720. Home Prices were up 16% over the past year ($74,670) and 35% over 18 months ($141,000). Condo Median Prices were up $13,090 during the month to a record $$433,690. Condo Prices were up 15.7% over the past year ($58,740) and 40% over 18 months ($123,640). Over three years, Home and Condo Prices were up 67% and 79%, and over six years 142% and 155%. June Home Sales were up 6% over June 2004, with Condo Sales up 13%. According to the California Association of Realtors, "Inventory levels in recent months were nearly double that of a year ago." The Unsold Inventory Index rose to 2.7 months, up from 1.7 one year ago.

August 3 - PRNewswire: "California households, with a median household income of $53,840, are $70,480 short of the $124,320 qualifying income needed to purchase a median-priced home at $530,430 in California, according to the California Association of Realtors Homebuyer Income Gap Index report for the second quarter of 2005..."

Mortgage Finance Bubble Watch:

August 3 - Bloomberg (Kathleen M. Howley): "Mortgage refinancings in which borrowers received cash rose 25 percent in the second quarter as interest rates fell to the lowest level in more than a year. So-called 'cash-out refis' rose to $212.3 billion from $169.6 billion in the first quarter, Freddie Mac said... The cash-out share was 74 percent of all refinancings, a four-and-a-half-year high..."

August 3 - Bloomberg (Kathleen M. Howley): "The affordability of U.S. homes dropped to a 14-year low in the second quarter, when prices rose at the fastest pace in more than a quarter century. The average household had 120.8 percent of the income needed to purchase a property at the median home price of $208,500, according to a report issued today by the National Association of Realtors... That share was the lowest since the third quarter of 1991, when it was 113.7 percent. Prices for existing homes gained 14 percent in the second quarter from a year earlier, more than at any other time since 1979, NAR said."

August 2 - Bloomberg (Min Zeng): "The sale of debt backed by commercial real estate is on a record pace, bolstered by falling interest rates and rising property prices, according to Moody's... Issuance of commercial mortgage-backed securities, which consist of loans on everything from hotels to office buildings, rose 65 percent to $72 billion in the first half of the year from the same period of 2004... The full-year record for issuance was $93 billion, set in 2004."

August 4 - New York Times (Jennifer Steinhauer): "It may not replace the Empire State Building or the MetroCard, but the most fitting symbol of New York City today could be the knotty plywood wall enclosing a housing construction site. From Bensonhurst to Morrisania to Flushing, new homes are going up faster now than they have in more than 30 years. In 2004, the city approved the construction of 25,208 housing units, more than in any year since 1972, and that number is expected to be surpassed this year. Already, officials have authorized 15,870 permits. Looked at another way, the city has 38 percent of the region's population but accounts for half of its new housing starts. Much of that development is being fueled by private money, a phenomenon not seen since the 1970's. The mushrooming of housing development is an outgrowth of the city's decade-long population boom, low interest rates, government programs and a slide in crime, housing experts and city officials say. It has affected every borough and most neighborhoods... Throughout Brooklyn, in areas where single- and two-family homes have dominated for generations, six-story buildings are rising on every other block along some stretches, and their apartments are quickly being sold, often to first-time buyers. Large tracts of Queens, once home to factories and power plants, are being readied for apartment complexes... In East New York, Brooklyn, once known for its crack trade and killings, single-family homes are rising for the first time in a generation."

Mortgage REIT New Century Financial reported better-than-expected earnings but cut future guidance. Mortgage lending margins are evaporating, forcing institutions to go for volume and accept greater risk. Total Assets expanded by $4.7 billion during the quarter (87% annualized) to $26.4 billion. Assets were up 53% from one year ago and have ballooned from $4.2 billion to end year-2000.

The Downside to Transparent Baby Steps:

August 1 - Financial Times - Excerpted from Henry Kaufman's exceptional Op-Ed Piece, "New Fed Chairman Must Tread an Uncertain Path: "When a new chairman of the US Federal Reserve assumes office next year, the transition will be greeted by great fanfare and widespread market apprehension. He or she will succeed a long-serving predecessor and one of the most widely known chairmen in Fed history. The new chairman will also be forced immediately to confront some knotty domestic and international challenges... The new chairman will need to make tough judgments on the housing sector. Unfortunately, the Fed does not yet view this with alarm. It has drawn attention to isolated instances of exuberance while publicly applauding aggregate data on housing activity and the financial strength of households. Nevertheless, household debt has risen sharply, and the grave risks this poses can be minimised only by low interest rates, rising household income or a combination of the two. For the new chairman the question will be: can households continue to serve as a stabilising force in the next recession or have they already been marginalised by the household debt binge? For their part, financial markets will watch closely to see if the new chairman maintains the current tactical monetary approach. Under Alan Greenspan, this has consisted primarily of two tenets - measured responses to economic developments and increasing transparency in monetary policy. Since the inception of this approach several years ago, the central bank has raised its Federal funds rate 25 basis points after each meeting of the [FMOC]. Fed officials have tried to reassure market participants through frequent public utterances. This approach has wrought several unintended consequences. For one, it has contributed to a massive carry trade... This is because investors have been conditioned to expect moderate and steady increases in money rates, which their quantitative analysis shows will pose limited risks, if any, along the yield curve. This, in turn, has led them to conclude that the carry trade can be the source of substantial profits... Although spread compression typically yields smaller profits from carry trades, profits have remained high as investors have enlarged their positions. In short, the Fed's recent monetary approach, combined with the US Treasury's practice of confining much of its new borrowing to short- and intermediate-term notes, explains a great deal of what the Fed has dubbed a "conundrum"... The second unintended consequence of the Fed's measured response policy has been the massive growth of debt. Investors have reacted to the assurance of a measured response by borrowing more. In highly securitised and innovative financial markets, which by themselves encourage entrepreneurial financial behaviour, rapid debt growth is a natural consequence of measured response policies..."

Mr. Kaufman is the master. He may no longer dazzle the markets with his uncanny ability to forecast interest rates as he did years ago, though this is no fault of his. The financial landscape changed profoundly from his heyday as ace market forecaster, an evolution he so brilliantly prognosticated in his 1986 book, "Interest Rates, the Markets, and the New Financial World."

We do operate these days in a Financial New Age, where limitless Wall Street finance has completely overturned the traditional dynamic whereby market rates were determined through the interplay of the supply of savings with the demand for borrowings. No longer does Kaufman-style diligent analysis of financial flows and Credit demand provide an edge in forecasting bond yields (a contention well supported by the quantities of egg I've had to wipe from my face!). The game has changed profoundly to "simply" predicting the Fed's next move(s). This is not only a one-heck-of-a-lot-less arduous endeavor than analyzing the supply and demand for system finance. It has, as well, been made far too easy by the Greenspan Fed's "evolution" to Transparent Baby Step Monetary Management.

There is no doubt that Fed policy has nurtured leveraged speculation and incited unprecedented financial leveraging and consumer borrowing, as Mr. Kaufman so adeptly and concisely articulated. And there is little doubt that Transparent Baby Steps was an outgrowth of the fragilities associated with previous excesses. The Fed has been highly cognizant of the speculative and leveraged-rife Credit system and an over-indebted economy. I have argued that the resulting Fed timidity and accommodation were absolutely the wrong approach to deal with such a financial and economic backdrop - the Credit Bubble "blow-off" and deeply maladjusted Bubble Economy. It has been a case of policy errors begetting more dangerous mistakes. The predictable consequences include dangerous asset Bubbles, greater leveraged speculation, a more debt-laden and vulnerable U.S. economy, acute system fragility and, increasingly, a much more precarious global Credit boom backdrop.

When the Fed nudged rates up 25 basis points a year ago June to 1.25% and made it clear that it was prepared to delicately reduce accommodation over an extended period, Street pundits (along with speculators) were afforded free rein. They relished in theorizing that the Fed had won the long, hard battle against inflation, while forecasting that the spoils of war would include a 2.50% top for short-term borrowing costs. Apparently, savers were no longer deserving of a respectable return, while mortgage borrowers and the leveraged speculating community were to forever delight in financial windfall.

Well, 2.5% came and went, yet the analysis steadfastly stayed the same: Inflation was dead, and the Fed was perpetually almost done. Furthermore, system fragility would hold Fed tightening at bay, while the "disinflationary" economy would forever be at the brink of abrupt slowing. Accordingly, there was every reason to expect that bond yields could remain permanently in the cellar (prices in the penthouse suite). And if anyone was tempted to wager against bond prices, the emboldened bulls were tickled at the opportunity to take their money. One aspect of Monetary Disorder was an orderly one-way bond market. The historic confluence of unprecedented US household mortgage borrowings, financial sector leveraging and speculation, and foreign central bank balance sheet ballooning assured overly-abundant marketplace liquidity to inflate virtually all asset prices everywhere (and explaining the "conundrum").

I have (stubbornly) taken the other side of the unavailing inflation "debate," arguing that inflation is anything but dead and bond prices anything but a sure bet. While intellectually stimulating (at least to me), it has to this point been a waste of time. The bulls have steadfastly fixated on core CPI, low long-term rates, and the flat yield curve, while scoffing at any analysis bearing inflation as a risk factor. There has been no "debate," but times they are changing.

Market players will likely continue to trumpet quiescent (narrow) CPI inflation and completely disregard (broad) Credit inflation. Yet the bottom line is that the U.S. economy (and globally to a lesser extent) is in the midst of a major inflationary boom. CPI is essentially irrelevant, while the dynamics of broad inflation in Credit and its myriad Inflationary Manifestations are the key issue.

Admittedly, inflation hasn't mattered to the markets to this point because it hasn't been a factor with respect to Fed Transparent Baby Step Monetary Management. But I think this may have begun to change this week. The Credit Bubble, the Mortgage Finance Bubble, the Leveraged Speculation Bubble, and the Distorted U.S. Bubble Economy have scoffed at the feeble little Baby Step rate increases. There has been no tightening - none. Mortgage Credit creation is currently at record levels, Credit spreads remain unusually narrow, markets remain over-liquefied, and easy Credit Availability has never been as widespread.

With respect to Credit inflation dynamics, housing inflation has been accommodated and monetized, in the process nurturing inflating household net worth and incomes, along with (largely through the resulting Current Account Deficit) the Commodities Boom and the Energy Boom. Crude, energy and commodity price gains have been accommodated and monetized, adding further impetus to the U.S. Credit and Economic Bubbles, the China/Asia Bubble and emerging market excesses. As inflation dynamics have tended to do throughout the ages, Credit excess begets higher prices that beget only greater Credit excesses. Inflation dynamics and (to this point) limitless Wall Street finance make for a precarious mix. Perhaps the markets are beginning to take notice.

No longer are the issues of Inflation, Disinflation and Deflation merely fodder for intellectual theorizing. If I am correct - that Credit Inflation and Inflationary psychology are now firmly embedded in the U.S. Bubble economy - only significantly higher rates and/or financial crisis will sufficiently rein in Credit excesses. Mortgage Credit creation must be reduced, something made quite challenging by recent housing inflation, financial innovation, and unparalleled Credit Availability. The Fed is certainly hoping to orchestrate a soft-landing for U.S. housing prices. But, as we witnessed with technology and NASDAQ, it is not the nature of powerful booms to quietly succumb. When accommodated, they have an intense propensity to go to wild extremes only to then collapse.

For sometime now the bulls have enjoyed having a copy of the Fed's playbook. This unusual luxury allowed them to create a fanciful world comprised of a productivity miracle, downward wage pressures, general dis-inflationary pricing pressures, a global savings glut, world-wide manufacturing overcapacity, a stable new "Bretton Woods II" global monetary regime and perpetually low global interest-rates. And, Thinking Soros, market perceptions do have a fascinating way of engendering their own reality - for awhile. The great bond bull market was granted an extended life, right along with an Extraordinarily Dangerous Credit Cycle.

As one would expect, this imaginary nirvana has incited speculation, along with the unwinding of hedges. In the process, we have witnessed the type of wholesale capitulation by bond bears (investors, traders, derivative players, and pundits alike) consistent with a major market top. As such, it would appear that the markets are today unusually susceptible to speculative de-leveraging and derivative-related dynamic trading strategies. And, in regard to "Bretton Woods II," I will assume that the Chinese today feel Washington has changed the rules mid-game. After accumulating $700 billion of reserves, it's ok for the Chinese to buy Treasuries and MBS. But we won't look kindly at our trading "partner" if they use some of those dollars to buy things we really want.

Over the past year we have watched (1999-like) end-of-cycle excesses throughout all aspects of mortgage finance - certainly including systemic risky lending and securitizing, leveraged speculation in various mortgage instruments, and the ridiculous mortgage REIT Bubble. The consumer has capitalized on inflated home equity and spent with reckless abandon. The combination of elevated consumption and surplus market liquidity has fostered a huge (end-of-cycle extrapolation) boom in consumer-related investment spending (certainly including housing, retail, and restaurants). The Bubble Economy distortions went to unimaginable extremes, only to have maladjustments "double."

The Downside of the lionized Transparent Baby Step Monetary Policy is that it has significantly postponed necessary monetary tightening and accommodated further late-cycle Bubble excesses. New Age thinking may have it that, since there's no inflation, the Fed cannot fail behind the curve. But Age-Old Credit Inflation Dynamics dictate that the longer boom-time psychology becomes ingrained in the financial and asset markets; throughout financial institutions; in businesses, governments and households, the greater the monetary tightening inevitably required to goad the system back on a more sustainable course. It is the case that the longer and more robust the inflationary boom the more spectacular and problematic the unavoidable bust. The dilemma today is that we are long past the point of any possibility for an orderly return to stability. The interest-rate markets are now faced with the prospect of guessing if the Fed will actually attempt a true tightening and, if so, how high would rates have to go?

Things have all the sudden become more challenging for the leveraged player and bullish bond pundit. The inflationary boom has become hard to deny and the fanciful imaginary world increasingly easy to rebut.