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The Flow of Finance

Stocks were choppy... For the week, the Dow ended unchanged, and the S&P500 dipped 0.3%. The Utilities were hit for 1.9%, and the Transports declined 0.8%. The Morgan Stanley Cyclical index was unchanged, and the Morgan Stanley Consumer index finished up 0.1%. The broader market was stronger. The small cap Russell 2000 added 1.0%, increasing y-t-d gains to 12.0%. The S&P400 Mid-cap index added 0.2%. The NASDAQ100 slipped 0.3%, while the Morgan Stanley High Tech index added 0.4%. The Semiconductors jumped 1.7%. The Street.com Internet Index fell 0.6%, and the NASDAQ Telecommunications index declined 0.4% (up 20.3% y-t-d). The Biotechs dropped 2.5%. Both the Broker/Dealers and Banks dipped 0.3% this week. With bullion up $5.90 to $560.10, the HUI gold index gained 3.8%.

More yield curve vacillations... For the week, two-year US Treasury yields rose 7 bps to 4.71%. Five-year government yields gained 4 bps to 4.66%, while bellwether 10-year Treasury yields dipped one basis point to 4.67%. Long-bond yields declined 3 bps to 4.69%. The 2yr/10yr spread ended the week inverted 4 bps. Benchmark Fannie Mae MBS yields were about unchanged at 5.85%, this week performing in line with Treasuries. The spread on Fannie's 4 5/8% 2014 note narrowed 1.5 bps to 33, and the spread on Freddie's 5% 2014 note narrowed 1.5 bps to 34. The 10-year dollar swap spread declined 0.5 to 53.0. Investment-grade and junk spreads were unchanged to narrower. The implied yield on 3-month December '06 Eurodollars rose 4 bps to 5.075%.

March 22 - The Wall Street Journal (Jesse Eisinger): "Debt investors expect prices in the market to be stable and returns to be meager for as far as the eye can see. So they are coming to a natural conclusion: It is time to borrow more money and make riskier bets. That type of thinking is often dangerous. Investors make these bets mainly through esoteric products designed by Wall Street math whizzes to spread the risk of owning debt. These products bundle bunches of loans and slice them up into less-risky and more-risky sections that are sold to investors. The problem is that nobody knows just how much the few investors who buy the riskiest portions stand to lose if things go badly. These are the folks who bet, say, $1 million and stand to gain $10 million -- or lose $5 million or so. Such highly leveraged bets are being taken in products that lack transparency. Nobody knows how much is at risk in the entire market if there is a big blowup."

Investment grade corporate issuance increased to $16.5 billion. Issuers included Home Depot $4.0 billion, Mid-American Energy $1.7 billion, Bank of America $1.5 billion, Lehman Brothers $1.25 billion, Omnicom $1.0 billion, XTO Energy $1.0 billion, Brandywine $850 million, Prologis $850 million, Allstate $650 million, Prudential $500 million, CIT Group $500 million, Allstate Life $350 million, Symetra Financial $300 million, Mellon Bank $250 million, Marshall & Ilsley $250 million, Safeway $250 million, First Tennessee Bank $250 million, First Midwestern Bancorp $100 million, Hartford Life $100 million, and International Transmission $100 million.

Junk issuers included MGM Mirage $750 million, Mobile Satellite Venture $750 million, Sierra Pacific Power $300 million, HRP Myrtle Beach $300 million, and Compton Petroleum $150 million.

Convertible issuers included King Pharmaceutical $400 million, Time Warner $325 million, and Biomarin Pharmaceutical $150 million.

Foreign dollar debt issuers included Pakistan $800 million.

Japanese 10-year JGB yields added one basis point this week to 1.725%, as the Nikkei 225 index surged 2.9% (up 2.8% y-t-d). Two-year JGB yields rose to the highest level since December 2000. Emerging debt and equity markets were mixed this week. Brazil's benchmark dollar bond yields rose 12 bps to 6.46%. Brazil's Bovespa equity index fell 1.2% (up 12.3% y-t-d). The Mexican Bolsa added 0.9%, increasing y-t-d gains to 8.6%. Mexican 10-year govt. yields rose 12 bps to 5.80%. Russian 10-year dollar Eurobond yields dipped one basis point to 6.70%. The Russian RTS equities index added 0.4%, increasing 2006 gains to 26.2%. India's Sensex equities index gained 0.8% (up 16.5% y-t-d).

Freddie Mac posted 30-year fixed mortgage rates declined 2 bps to 6.32%, up 31 basis points from one year ago. Fifteen-year fixed mortgage rates dipped one basis point to 5.97% (up 41 bps in a year). One-year adjustable rates, however, rose 4 bps to 5.41%, an increase of 117 bps over the past year. The Mortgage Bankers Association Purchase Applications Index declined 2.3% last week. Purchase Applications were down 13.8% from one year ago, with dollar volume 11.7% lower. Refi applications dipped 0.6%. The average new Purchase mortgage declined to $230,600, while the average ARM slipped to $341,900.

Bank Credit surged $28.4 billion last week to a record $7.677 Trillion, with a y-t-d gain of $170.6 billion, or 10.7% annualized. Over the past year, Bank Credit inflated $638 billion, or 9.1%. For the week, Securities Credit increased $6.8 billion. Loans & Leases jumped $21.6 billion, with a y-t-d gain of $100.7 billion (16.2% annualized). Commercial & Industrial (C&I) Loans have expanded at a 15.7% rate y-t-d and 13.1% over the past year. For the week, C&I loans jumped $8.1 billion, and Real Estate loans added $0.5 billion. Real Estate loans have expanded at a 9.8% rate y-t-d and were up 12.6% during the past 52 weeks. For the week, Consumer loans gained $0.6 billion, and Securities loans increased $5.1 billion. Other loans expanded $7.5 billion. On the liability side, (M3 component) Large Time Deposits expanded $13.6 billion.

So much for M3, having already expanded $150 billion y-t-d. M2 money supply dropped $26.8 billion to $6.753 Trillion (week of March 13). Year-to-date, M2 has expanded $63.4 billion, or 4.5% annualized. Over 52 weeks, M2 inflated $288.2 billion, or 4.5%. For the week, Currency added $1.0 billion. Demand & Checkable Deposits dropped $18.4 billion. Savings Deposits sank $16.0 billion, while Small Denominated Deposits gained $4.6 billion. Retail Money Fund deposits added $2.0 billion.

Total Money Market Fund Assets, as reported by the Investment Company Institute, jumped $15.2 billion last week (week ended March 22) to $2.055 Trillion. Money Fund Assets are down $1.6 billion y-t-d, with a one-year gain of $149 billion (7.8%).

Total Commercial Paper dipped $0.3 billion last week to $1.711 Trillion. Total CP is up $62.3 billion y-t-d (12wks), or 16.4% annualized, while having expanded $261.8 billion over the past 52 weeks, or 18.1%. Last week, Financial Sector CP borrowings were unchanged at $1.577 Trillion (up $68.4bn y-t-d), with a 52-week gain of $272.7 billion, or 20.9%. Non-financial CP declined $0.3 billion to $134.8 billion, with a 52-week decline of 7.5%.

Asset-backed Securities (ABS) issuance jumped to $21 billion (from JPMorgan). Year-to-date total ABS issuance of $172 billion is 10% ahead of 2005's record pace, with y-t-d Home Equity Loan ABS issuance of $125 billion running 23% above last year.

Fed Foreign Holdings of Treasury, Agency Debt ("US marketable securities held by the NY Fed in custody for foreign official and international accounts") declined $8.0 billion to $1.587 Trillion for the week ended March 22. "Custody" holdings were up $67.9 billion y-t-d, or 19.4% annualized, and $198 billion (14.3%) over the past 52 weeks. Federal Reserve Credit added $0.8 billion last week to $821 billion. Fed Credit has declined $5.6 billion y-t-d, or 2.9% annualized. Fed Credit expanded 4.8% during the past year.

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - are up $174 billion y-t-d (18.6% annualized) and were up $463 billion, or 12.3%, over the past 12 months to a record $4.220 Trillion.

March 24 - Bloomberg (Ramya Venugopal): "India's foreign-exchange reserves rose by $2.24 billion to $146.16 billion in the week ended March 17..."

Currency Watch:

The dollar index rose 1.3% this week. On the upside, the South African rand gained 0.5%, the Uruguay peso 0.2%, and the Indonesian rupiah 0.2%. The old favorite higher yielding currencies were under heavy ("yen carry"?) liquidation. For the week, the Iceland krona dropped 5%, the New Zealand dollar 2.6%, the Hungarian forint 1.6%, the Czech koruna 1.6%, and the Australian dollar 1.6%.

Commodities Watch:

March 21 - Bloomberg (Claudia Carpenter): "Orange-juice futures in New York rose to their highest price since 1992 on speculation the government will reduce its estimate of Florida's orange crop because of damage from dry weather. Florida is the world's second-biggest grower."

Copper and zinc traded this week to new record highs. May crude rose 6 cents to $64.26. April Unleaded Gasoline jumped 3.4%, and April Natural Gas gained 1.3%. For the week, the CRB index added 0.4% (y-t-d down 1.5%). The Goldman Sachs Commodities index rose 0.4%, going slightly in the black for 2006.

Japan Watch:

March 23 - Bloomberg (Lily Nonomiya): "Japanese imports gained the most in almost a decade, narrowing the trade surplus, on demand from consumers and companies as the economy headed for its longest postwar expansion. Imports jumped 30 percent in February from a year earlier, causing the surplus to narrow 11.8 percent to 955.7 billion yen ($8.2 billion)... Exports rose 21 percent, the fastest in nine years."

March 24 - Bloomberg (John Brinsley): "Japan's service industries expanded in January by more than double the pace expected as wages rose and companies increased spending, suggesting the economy will keep growing in the first quarter of the year. The tertiary index rose 2.2 percent in January from December..."

March 23 - XFN: "The average price of land in Tokyo rose for the first time in 15 years in 2005, according to an annual Japanese government survey... The survey conducted by the Ministry of Land, Infrastructure and Transport showed that the average price of residential property in the capital rose 0.8% in 2005 while the average price of commercial land increased 2.9% from a year earlier."

China Watch:

March 22 - Financial Times (Richard McGregor and Geoff Dyer): "China will take measures to meet US complaints about their bilateral trade imbalance as part of next month's trip to Washington by Hu Jintao, Chinese president, but has warned the US also to take responsibility for its economic problems. Wen Jiabao, China's premier... promised new initiatives on issues such as abuse of intellectual property rights, a long-running complaint of investors. "But it is unfair for the US to scapegoat China for the US's own structural economic problems," Mr Wen added...

March 22 - Bloomberg (Allen T. Cheng and Todd Prince): "China aims to more than double trade with Russia to as much as $80 billion in five years as the nations increase cooperation in energy, commodities and technology, Chinese President Hu Jintao said."

March 23 - Bloomberg (Nerys Avery): "Sales by China's top 100 chain store operators rose 42 percent last year from a year earlier to 708 billion yuan ($87 billion) as they opened more outlets, the China Daily reported"

March 24 - Bloomberg (Nipa Piboontanasawat): "Hong Kong's export growth picked up in February as trade with China increased after the Lunar New Year holiday. Overseas sales rose 20.5 percent last month from a year earlier to HK$153.6 billion ($20 billion)..."

March 22 - Bloomberg (Patricia Kuo): "Hong Kong prime office rents may jump 30 percent this year to record highs after new supplies fell to a 35-year low, the South China Morning Post reported."

Asia Boom Watch:

March 22 - Bloomberg (Kartik Goyal): "The Indian government expects exports to reach $100 billion, exceeding an earlier target, by the March 31 end of the fiscal year, Trade Minister Kamal Nath said... India's economy is growing at a fast pace of more than 8 percent per year,' the minister said... 'Our exports have been growing at 26 percent per year for the past two years and will most likely touch $100 billion this year.'"

March 23 - Bloomberg (James Peng): "Taiwan's export orders in February rose at the fastest pace in more than a year, led by demand for notebook computers and semiconductors. Orders, indicative of actual shipments in one to three months, gained 25 percent from a year earlier after climbing 20 percent in January..."

March 24 - Bloomberg (Seyoon Kim): "South Korea's consumer confidence climbed to its highest in almost four years in the first quarter, adding to evidence that citizens are poised to increase spending."

March 22 - Bloomberg (Stephanie Phang): "Malaysia's central bank said economic growth will accelerate to 6 percent, more than analysts expected, on higher electronics and oil exports and government spending. Inflation may rise to an eight-year high."

March 21 - Bloomberg (Aloysius Unditu): "Indonesia's economy may expand as much as 6.4 percent next year due to rising foreign investment, Finance Minister Sri Mulyani Indrawati said."

Unbalanced Global Economy Watch:

March 21 - Bloomberg (Matthew Brockett): "Germany is enjoying a 'credit boom,' suggesting the economic recovery will gain pace, the Handelsblatt newspaper reported, citing Bundesbank and European Central Bank data."

March 20 - Bloomberg (Andreas Scholz and John Fraher): "European Central Bank Chief Economist Otmar Issing said the bank can't ignore the inflation risks posed by the increase in the availability of money in the dozen nations sharing the euro. 'A large liquidity build up has developed and we can't ignore it,' said Issing... 'In the last quarter, growth has moderated, but we can't forget what's already happened.'"

March 20 - Bloomberg (Gabi Thesing): "German producer-price inflation accelerated in February to the fastest pace in almost 24 years, led by a surge in energy costs. Goods from plastics to newsprint were 5.9 percent more expensive in February than at the same time last year..."

March 21 - Bloomberg (Simon Kennedy and Simone Meier): "French consumer spending jumped in February by the most since October 2004, suggesting Europe's third-largest economy is gathering speed after a fourth-quarter slowdown."

March 21 - Bloomberg (Hugo Miller): "Swiss watch exports rose 9.5 percent in February from a year earlier as watchmakers including Swatch Group tapped rising demand among wealthy Asian consumers and shipments to Germany recovered."

March 22 - Bloomberg (Brian O'Neill): "Irish house prices rose an annual 11 percent in February, the fastest pace in 18 months, as population growth and rising employment underpinned demand for property, according to a survey by Irish Life & Permanent Plc. House prices rose 1 percent from the previous month to an average of 284,096 euros ($343,000)..."

March 23 - Bloomberg (Tracy Withers): "New Zealand's annual current account deficit widened to a record in the fourth quarter as soaring oil prices and increased consumer demand drove up the value of imports, outpacing growth in exports. The annual gap widened to NZ$13.69 billion ($8.6 billion) from a revised NZ$12.99 billion in the year through September..."

March 24 - Bloomberg (Tracy Withers): "New Zealand's economy contracted for the first time in more than five years in the fourth quarter as record-high interest rates slowed household spending and stalled business investment. The economy shrank 0.1 percent from the third quarter, when it grew a revised 0.1 percent..."

March 23 - Bloomberg (Nasreen Seria): "South Africa's current account deficit... widened to a record in the fourth quarter... The deficit widened to a seasonally-adjusted 71.6 billion rand ($11.3 billion), or 4.5 percent of gross domestic product..."

Latin America Watch:

March 23 - Bloomberg (Patrick Harrington): "Mexico's exports rose in February, led by a surge in oil exports and automobile sales in the U.S. market. Exports rose 22 percent to $18.8 billion from $15.4 billion a year earlier, following a 36 percent increase in exports in January... The country's trade surplus widened to $461 million..."

March 21 - Bloomberg (Guillermo Parra-Bernal): "Brazilian retail sales surged in January at the fastest pace in 10 months as rising wage levels in the country's major metropolitan regions stoked spending on clothing and food. Retail, supermarket and grocery store sales, as measured by units sold, rose 6.54 percent in January..."

March 23 - Bloomberg (Matthew Walter): "Chile's economy grew faster than economists expected in the fourth quarter, as prices for copper, the country's top export, rose to records. Gross domestic product grew 5.8 percent in the fourth quarter from a year earlier..."

Bubble Economy Watch:

February Existing Home Sales (EHS) bounced back to a robust and stronger-than-expected 6.91 million annualized pace. February EHS were about flat from a year ago, with Average (mean) Prices up 6.7% to $256,000. EHS was up 7% from two years ago, with Prices up 19%. Conversely, February New Homes Sales were a much weaker-than-expected 1.08 million annualized. Sales were down 13.4% from January 2005, with Average Prices up 2.6% to $296,700. The mounting Inventory of New Homes jumped another 20,000 to a record 548,000, up 22.9% from January 2005, to a 6.3 months supply.

March 20 - Bloomberg (Andrew Ward): "Commercial construction, one of the last industries to recover from the most recent recession, is poised for the best year since 2001, contributing more to economic growth just as homebuilding starts to ebb... Job growth and falling vacancy rates may push investment in non-residential construction up 9 percent this year to $531 billion, the most since at least 2001, according to the Associated General Contractors of America..."

March 23 - The Wall Street Journal (M.P. McQueen): "The hurricanes that ravaged the Gulf Coast last summer are beginning to wreak havoc with homeowners' insurance coverage in states far removed from where the storms hit. Still reeling from an estimated $56 billion of hurricane-related losses, major insurers are dropping policies or not writing new ones in coastal areas from Texas to Florida and up the Eastern Seaboard... Insurers including Allstate Corp. and Nationwide Mutual Insurance Co. say they need to reduce the financial risk... Allstate, the nation's second biggest home insurer...says it plans to seek premium increases in a 'majority' of the 49 states in which it does business... The company recently raised home-insurance premiums by 8.5% in New York state and says it plans soon to ask regulators in Connecticut and New Jersey to approve rate increases."

Mortgage Finance Bubble Watch:

Freddie Mac's Book of Business expanded $19.2 billion, or 13.5% annualized, during February to a record $1.722 Trillion. Freddie's Book of Business surged $198 billion, or 13%, over the past year. The company's Retained Portfolio expanded at 2% rate during the quarter to $705 billion, with a 12-month gain of 7.8% (up $51bn). Outstanding MBS expanded at a 21.7% rate during the month to $1.107TN, with a 12-month gain of 16.9% ($147bn).

Fannie Mae's Book of Business expanded $13.4 billion, or 6.9% annualized, during February to a record $2.351 Trillion. Fannie's Book of Business was $44 billion over the past year, or 1.9%. Fannie's Retained Portfolio contracted at a 7.4% pace during the month to $720 billion (down $154bn y-o-y). Outstanding MBS expanded at a 13.3% rate during the month to $1.631 TN, with a y-o-y gain of $199 billion (13.9%).

Energy and Crude Liquidity Watch:

March 20 - Bloomberg (Wing-Gar Cheng and Ang Bee Lin): "PetroChina Co., the nation's biggest oil producer, posted the largest profit of any publicly traded Asian company because of higher prices and rising energy demand. Net income increased 28 percent to 133.4 billion yuan ($16.6 billion) in 2005..."

March 23 - Bloomberg (Lucian Kim): "OAO Rosneft, Russia's state oil company, will spend $30 billion in the next decade to increase production after the country's output growth slowed last year. Rosneft plans to buy new fields, Chief Executive Officer Sergei Bogdanchikov said... The company plans an initial sale share in July that may raise a record $20 billion."

Speculator Watch:

March 22 - Financial Times (Stephen Schurr): "Hedge fund investors expect the amount they put in to such funds to increase by 28 per cent this year, according to a survey by Goldman Sachs... Global macro and equity long-short strategies are expected to see the greatest increase in capital allocation by asset weight, the study found."

The Flow of Finance:

Question from Representative Mark Kennedy: "As you know, our nation's trade deficit continues to be an issue that is a focal point of many in Congress. While various views have been put forth about how to interpret the numbers by the Commerce Department in recent years, last year you proposed an alternative view as to the likely cause of the U.S. trade deficit. Specifically, you have indicated that the trade deficit is largely dependent on the saving surplus in developing countries. In essence, a big part of the trade deficit and [current] account deficit is because the rest of the world wants to invest in the U.S., because of our dynamic and rapidly growing economy and the returns on investment our economy is capable of generating. With our trade deficit for 2005 having just been reported, do you still see your analysis as an accurate portrayal of our country's trade imbalance?"

Written response from Fed chairman Bernanke: "As indicated by the question, in my March 2005 speech, "The Global Savings Glut and the U.S. Current Account Deficit," I identified the excess of notional saving over investment rates in the developing countries as a major factor underlying the large U.S. current account deficit. The speech proposed several reasons for why the current account balance of developing countries had swung into surplus, including the reaction of developing Asian economies to the financial crisis of 1997-98 and the effect of rising oil prices on the revenues and trade balances of the oil-exporting countries. Nothing has occurred since March 2005 to diminish support for the "global saving glut" hypothesis, and the factors contributing to this 'glut' generally remain in place. The U.S. trade deficit has widened $106 billion between 2004 and 2005, but the surplus of the developing economies is generally estimated to have widened as well. Much of the widening of the U.S. deficit and of the developing country surplus is attributable to higher oil prices - a factor identified in my March speech. Additionally, U.S. economic growth again exceeded that of a trade-weighted average of industrial economies in 2005, thus continuing to support the relative attractiveness of investments in the United States."

I suppose it was wishful thinking on my part that Dr. Bernanke's "global saving glut hypothesis" (propaganda) had been quietly left behind at the office of the President's Council of Economic Advisors. Such analysis is certainly not befitting of the Chairman of the Federal Reserve.

ECB Chief Economist Otmar Issing, quoted earlier in the week in a Bloomberg interview: "A large liquidity buildup has developed and we can't ignore it. In the last quarter, [ECB money] growth has moderated, but we can't forget what's already happened.'"

March 24 - Bloomberg (Matthew Brockett): "European Central Bank Chief Economist Otmar Issing comments...on money supply growth and asset prices: 'You can't ignore developments in money and credit.' The issue of asset price increases 'for me is one of the biggest challenges of central banks of our time: how to deal with that. We are far from final answers... One of the advantages of our strategy, which is now more and more recognized, is that there's hardly any development in asset prices which can't be' connected 'to developments in money and credit. So giving money and credit a strong role in your analysis is forcing you to take account of that...' The ECB says it bases interest rate decisions on the two 'pillars' of analyzing the economy and money supply, and Issing has advocated a policy of 'leaning against the wind' to avoid asset price bubbles."

Mr. Bernanke refers sanguinely to a "global savings glut," while the astute Mr. Issing frets over a "large liquidity buildup." Bernanke discusses conveniently ambiguous concepts such as "excess saving over investment rates." But what, may I inquire, is the role played these days by "saving" in an integrated financial world of unconstrained Credit expansion and massive Financial Flows. And how might we define, account for and analyze contemporary "investment," anyway?

Conversely, Issing speaks directly to the risks associated with rapid liquidity expansion. Disregarding "money" and Credit, Dr. Bernanke and the (Greenspan) Federal Reserve erringly claim that it is impossible to identify Bubbles until after the fact. Their purposefully nebulous analytical framework has no place for Financial Flow analysis. Conversely, Dr. Issing clearly articulates that "asset price bubbles" are a phenomena connected to observable "developments in money and Credit." Here, the Flow of Finance is fundamental.

Traditionally, a dearth of savings eventually imparted restraint on economic booms (and financial speculation!) through the rising cost and limited availability of finance (surging interest rates and liquidity crises!). At some point, borrowings would be moderated, spending restrained, speculation squelched, and saving augmented. Interest rates and the attendant Flow of Finance were fundamental facets of the system's adjusting and self-correcting mechanism. Some of the more insightful business/Credit cycle analysis (i.e. Hyman Minsky) was predicated on the Credit boom inevitably meeting its demise at the hands of the funds/"money" market. Frenetic and increasingly speculative ("Ponzi") demand for borrowings - within a system dictated by a bounded supply of "saving"/funds - would ultimately push market rates to levels too onerous for a progressively fragile financial apparatus.

Well, finance now operates with a decisive difference: the expansive market for finance (interconnected Credit systems worldwide) is fully integrated globally and operates on the basis of the unlimited capacity to create additional funds/liquidity/Credit. In the case of the U.S. - the champion of contemporary liquid and highly-rated Credit "money" creation and intermediation - domestically created liquidity Flows in abundance internationally, only to be effortlessly recycled right back to "money"-like debt instruments (Treasuries, agencies, MBS, ABS, "repos," CP, etc.). The "recycled" liquidity then provides the basis for only further lending excess, priced at a small spread to whatever level the Fed has pegged money market rates.

Within the ballooning pool of available global finance, there can be no delineation between wholesome "saving" and infectious speculative-based liquidity. The historic slow-motion evaporation of U.S. saving has imparted no restrictive influence on American or international funds availability or placed upward pressure on rates. "Crowding out" has been proven an urban myth. No amount of borrowing for the purposes of asset speculation has impinged upon the supply of finance; quite the contrary, with speculative leveraging continuing to be a crucial facet of both new global liquidity creation and speculative Financial Flows.

There may be today greater recognition of the global nature of the pool of liquidity (and its influence on rates and yield curves generally), yet there is at the same time dreadful appreciation as to the nature of its creation. When it comes to liquidity, there is no chicken and egg dilemma. It is the expansion of Credit - the creation of new liabilities by a "deficit unit" when borrowing - that creates new financial claims/purchasing power for the holder of the new "liquidity" ("surplus unit"). The Unending Flow of Dollar Balances inundating the world is not coming into existence out of thin air, but is the residual of borrowings undertaken by American households, government units, financial institutions, corporations and financial speculators.

If global trade was dictated by the exchange of goods for goods, we would not enjoy the capacity of running massive Current Account Deficits. And there would be no need for the U.S. (and other "deficit units") to issue new Credit instruments (Credit Inflation) to consummate import purchases. There would be no massive global "liquidity buildup" and no marketplace perceptions of endless cheap liquidity. Central bank policy would not be governed by the fear of bursting Bubbles, and the global financial landscape would be unrecognizable from the present.

Cumulative ongoing (chiefly U.S.) Current Account Deficits are the root source of the unprecedented global pool of liquidity that is today fueling Asset Inflation and Bubbles the World Over. Dr. Bernanke can adhere to a sanguine view only because the current Global Flow of Finance is concurrently financing ongoing massive investment of goods producing capacity (especially throughout Asia) - with attendant restrained goods prices - and almost across-the-board Asset Inflation. He is left to only hope that a "precipitous" decline in the dollar is "unlikely," and that the U.S. economy would withstand a dollar crisis of confidence.

Dr. Issing, on the other hand, has very good reason to agonize. He appreciates that this massive buildup of global liquidity is highly unstable and controllable only as long as unsustainable Flows of Finance and asset inflation are sustained. His focus is where it should be, on the intermediate and longer-term. Not only is the primary source of The Flow of Finance suspect (unsustainable U.S. asset Bubbles, American over-consumption and problematic international imbalances, along with global leveraged securities speculation). Inevitably, the ballooning pool of speculative finance ensures that this Flow of Finance becomes over time only larger, more unwieldy and increasingly destabilizing. Observing how abruptly Flows to Iceland have reversed, an arguably unavoidable reversal away from U.S. securities would prove quite problematic to the U.S. Bubble economy. It would also put the entire global Credit apparatus at risk.

There exists today the delusion that the costs associated with dismal U.S. saving and spending habits, as well as financial leveraging, are negligible. The Fed is narrowly fixated on core consumer prices, an essentially irrelevant indicator of both contemporary Credit Inflation and liquidity conditions. Credit Inflation's prominent materialization is instead the manifestation of today's destabilizing Flows of Finance at home and abroad. The Fed is pursuing an unachievable goal of sustaining the U.S. boom by raising the cost of borrowing at the margin. But such accommodation of the current Credit boom only ensures self-reinforcing massive Flows of Finance and attendant Credit and Asset Bubbles around the globe.

I find the increasing discussion of the Fed's tendency to "overshoot" misguided. In late-stage Credit and Economic Bubbles, the Flow of Finance dictates system behavior much more materially than interest rates changes at the margin. As we have witnessed, baby-step rate increases are ineffective in restraining the manic frenzy of lending and speculating excess. Instead, it is the Unwieldy Flows of Finance that notoriously "overshoot," inundating sectors and asset markets and introducing problematic speculative dynamics. We witnessed as much during late-1999 and early 2000 throughout the technology Bubble. The marketplace thumbed its nose at Fed "tightening," spellbound instead by the prospect of chasing hot stocks, squeezing shorts, and with general marketplace shenanigans and manipulation. Amazingly, when the highly speculative and destabilizing Flow of Finance eventually reversed and the bust emerged, many blamed the carnage on the Fed for needlessly raising rates.

It is the nature of the scope and speculative component of contemporary Flows of Finance that dictate that time is very much of the essence. Specifically, it is incumbent upon central bankers to move early and with sufficient conviction to impede speculative leveraging and interrupt the Flow of Finance to asset markets. The alternative is a runaway Bubble, popular delusions of grandeur, and resulting policymaker paralysis and duplicity. With a flawed analytical framework and the wrong policy focus, the Fed is content to move late and timidly. Not only has this not restrained excess, it has in fact cultivated and bolstered Dysfunctional Monetary Processes and their Destabilizing Flows of Finance.

It is my view that the Global Credit Bubble - with the magnitude and mobility of its pool of speculative finance - has reached the point where efforts to stabilize international asset markets are quite likely to prove futile. It's boom or bust, depending on The Vagaries of The Crowd's Greed and Fear and the resulting direction of The Flow of Finance. It is also worth noting that liquidity-driven and short-term oriented speculative Bubbles can be expected to be, at least for awhile, oblivious to unfolding geopolitical risks - almost to the point where it is perceived that they don't matter. They do. Untenable global imbalances, heightened global trade tensions, increased "finger-pointing" and "scapegoating," and a risky deterioration in prospects for stability throughout in the Middle East, to name just a few, have created a highly uncertain backdrop seemingly on a collision course with global financial Bubbles.


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