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Pondering Imponderables

Residential Construction Spending
Public Construction Spending
ISM Manufacturing Index
ISM  - New Orders

The specter of war in the Middle East and recognition that corporate profits will remain under pressure weighed on stocks this week. For the week, the Dow declined 1% and the S&P500 dropped 2%. The risk of surging oil prices hit the Transports for 5%. The Morgan Stanley Cyclical index declined 2%, while the Morgan Stanley Consumer index was unchanged. The broader market came under selling pressure, with the small cap Russell 2000 and S&P400 Mid-Cap indices dropping about 2%. Profit, debt and accounting issues teamed up on the technology sector. For the week, the NASDAQ100 dropped 5%, the Morgan Stanley High Tech index sank 6%, and the Semiconductors lost 4%. The Street.com Internet index declined 7%, and the NASDAQ Telecommunications index retreated 5%. Biotech stocks came under heavy selling pressure as well, with the leading indices down as much as 7%. Financial stocks were generally mixed, with the AMEX Securities Broker/Dealer index dropping 3% and the S&P Bank index declining about 1%. With bullion down $2.70, the HUI Gold index declined about 2%.

The U.S. Credit market enjoyed a significant rally. Implied yields on December eurodollar futures collapsed 33 basis points. For the week, 2-year Treasury yields sank 24 basis points to 3.47%; 5-year yields dropped 22 basis points to 4.58%; and 10-year yields declined 19 basis points to 5.20%. The long-bond saw its yield decline 14 basis points to 5.66%. Benchmark mortgage-back yields dropped 22 basis points, and the implied yield on agency futures dropped 23 basis points. The spread on Fannie Mae's 5 3/8 2011 note narrowed one to 66. The 10-year dollar swap spread contracted three to 66. The dollar index dropped about 1% for the week. UK government yields declined 10 basis points to 5.19% and German yields declined 12 basis points to 5.13%.

Today's jobs report had something for everyone, so we'll proffer that it's consistent with an imbalanced economy. Manufacturing lost another 38,000 jobs, although this was the smallest decline in 15 months. Hours worked in manufacturing jumped to 41.6, the highest in 16 months. Services employment jumped 135,000, the strongest performance since last May. Temporary help agencies reported an increase in 69,000 jobs, while retailers lost 6,000 jobs and the construction sector dropped 37,000. The booming government sector added another 37,000 jobs (included in services job gains). Manufacturing wages were up 3.9% year-over-year, while "service producing" wages were up 3.8% y-o-y. March had total seasonally adjusted non-farm payrolls of 131.3 million, down 1.39 million from the peak in March 2001. The number of jobs is back to about the level from March 2000, and remains up 23.2 million from the recession lows of May 1991. Interestingly, since May 1991, "goods producing" payrolls have increased by 375,000 to 24.2 million, while "service producing" payrolls have surged 22.8 million to 107.1 million. Try to keep these numbers in mind when we discuss the structure and nature of the "de-industrialized" U.S. economy. It is also worth noting that since last August's peak, services jobs have declined only 330,000 (a three-month's supply at March's growth rate).

Convertible bonds were the top-performing fixed income category during March, returning 3.56%. Junk bonds were close behind, posting a gain of 2.52%, followed by emerging market debt with returns of 1.24%. After decent returns in January and February, municipal bonds dropped 2.66% during March, followed by Treasuries that were down 2.4%, "investment grade" down 1.86%, agencies down 1.72%, Mortgages down 1.07%, and asset-backs were about unchanged. Is risk coming back into fashion? It worth noting that this week we saw Regal Cinemas, CS First Boston, and AOL Time Warner all significantly increase bond offerings to satisfy strong demand.

According to JPMorgan, asset-backed security (ABS) issuance jumped to $38.7 billion during March, a new all-time record (up 13% from the previous record set in March 2001). Last month's surge pushed first quarter issuance to $83 billion, also a new record. Interestingly, home equity deals are leading the issuance surge, with a record $17.4 billion sold in March (compared to credit card issuance of $4.1 billion). First quarter home equity ABS issuance of $33.3 billion is up 62% year-over-year. It is worth noting that 2001's home equity ABS issuance of $80.2 billion was an increase of 36% from 2000. JPMorgan's estimate puts 2002 home equity ABS issuance at $95 billion, which would be up 19% from 2001 and 61% from 2000. Adjustable-rate home equity ABS volume is up 130% y-t-d to $18.3 billion. Yet despite the issuance boom, spreads on home equity ABS contracted 12 basis points during March and are 27 basis points narrower so far this year. While the refinancing boom may have declined precipitously, American homeowners continue to aggressively extract cash from inflated home values. Elsewhere, y-t-d auto ABS issuance of $23.5 billion is up 20% y-o-y. Estimates put 2002 auto ABS issuance at $80 billion, up 15% from 2001's record and 27% from 2000. Estimates have 2002 credit card ABS issuance at $60 billion, only slightly above 2001's record and 15% above 2000. Estimates put total 2002 ABS issuance at an amazing $300 billion, up 10% from last year's record and 33% from 2000. For comparison, $95 billion of ABS were issued during 1995 and $152 billion during 1996.

Despite March's $4.3 billion of issuance, the strongest since December, y-t-d collateralized debt obligation (CDO) issuance of $14.9 billion compares to last year's $22.6 billion. The convertible securities market, however, remains on a blistering pace. Year-to-date, 51 deals at $29.2 billion is up 28% from last year's strong issuance. According to Credit Suisse First Boston, "Total municipal bond issuance rose 10% to $64.7 billion in the first quarter. This growth was fueled by 16.6% growth in new money issuance to $44.3 billion while refunding grew at a rate slightly below the broader market."

The Mortgage Bankers Association's weekly index of purchase applications jumped 6% from the previous week and is up almost 13% over two weeks to a level of 349.9. There have been only three previous weeks with stronger purchase application volume (one in November and two in January), with last week's level up 19% year over year. Factoring in an increase in average mortgage size, it is not then too surprising that estimates now place first quarter mortgage originations at a stronger-than-expected $500 billion pace. Despite the significant decline in refinancings, mortgage originations are running comparable to last year's (off-the-charts) $2.1 trillion record pace (40% above 1998's previous record). And with refinancings representing a smaller proportion of total mortgage originations, it is quite possible that net new mortgage debt creation is running significantly ahead of last year's record pace.

Placement firm Challenger, Gray & Christmas reported that companies announced plans to eliminate 102,315 positions during March, the smallest decline since May 2001. Announcements were down from February's 128,115, January's 212,704 and March 2001's 162,867. There were a combined 490,524 job cut announcements during September and October. The weekly Bank of Tokyo-Mitsubishi UBSW same-store retail sales report had sales up 6% year-over-year. The Instinet Redbook survey had same-store sales up 3.7% year-over-year, with March sale up 4.9% y-o-y. Industry reports had domestic auto production up 8.2% year-over-year, as analysts quickly raise estimates for 2002 vehicle sales.

The March ISI Manufacturing Index (formerly NAPM) jumped from 54.7 to 55.6, the strongest reading since February 2000. This rise was led by the strongest increase in New Orders since the 1980s. The New Orders component has now surged 27.3 points from October's low to 65.3. Backlog jumped to 62.5 from February's 53 (low set in October at 36), and Employment made a strong showing as it rose from February's 43.8 to 47.5 (October low at 34.9). While the jump in New Orders and Backlog were newsworthy, the big surprise was with the Prices component. Prices jumped more than 10 points during March to 51.9, up from November's 32 and the highest reading since February 2001. And while headlines focused on the slight sequential decline in the ISI Non-Manufacturing index to 57.3, it is better to recognize that March's survey confirms that February's huge jump was no aberration. For the month, non-manufacturing Prices jumped to 53 from February's 50, up 14.5 points from December and the strongest reading since June.

February construction spending was reported at a stronger-than-expected rate. Residential construction spending was up 4.5% from last year's record pace, and is running up 46% from February 1997 levels. Single-family construction ($257.8 billion annualized) is up about 6% y-o-y and 50% from pre-Bubble levels back in Feb. 1997. Multi-family construction spending ($34.7 billion annualized) is up 18% y-o-y and 48% from Feb. 1997. Spending on home improvements was flat y-o-y. Meanwhile, non-residential construction continues to falter. February's spending ($181.9 billion annualized) was down slightly from January and has dropped 17% y-o-y, although it remains about 5% above levels from February 1997. February (y-o-y) spending on new office buildings was down 30.4%, "industrial" down 36%, and hotels/motels down 25%. The public sector construction boom runs unabated, with total spending up 18.1% y-o-y to $218.8 annualized. Public sector construction spending has surged 50% over the past four years (Feb. 2002/Feb. 1998). Public housing construction spending is up 25% y-o-y, educational 26.7%, hospital 33.3%, and roads up 19.2%. Interestingly, public sector construction has gone from being about 80% the size of private non-residential spending back in February 1998 to 120% in February 2002.

March auto sales came in at a respectable (and somewhat better than expected) 16.4 million pace, just slightly ahead of the first-quarter's rate. For comparison, sales were at a 16.4 million pace during March 1999, 15.2 million during March 1998, and 15.8 million during March 1997. Expectations for a significant decline after the fourth-quarter sales boom failed to materialize. Toyota enjoyed a record March, with sales up 4% from strong year ago levels. A Toyota executive made interesting comments: "Strong personal income growth combined with new-vehicle price deflation has been a win-win for consumers. Industry sales continue to drive the economy by outpacing earlier forecasts by a significant margin." Record March sales at BMW were 19% ahead of strong year ago sales. Mercedes sales were up 13.4% from last year, a record March. Lexus enjoyed a record first-quarter, with sales up 8.4% year-over-year. A Lexus executive commented, "There's no doubt that our customers aren't thinking about a recession." Infinity enjoyed its best month ever. Nissan sales were up 15% y-o-y. It was the best March ever for Audi, Mitsubishi, and SAAB. Hyundai y-o-y sales were up 19% and Kia sales were up 16%. Ford sales were down 12%, Chrysler 4% and GM about 2%. Big Three passenger car sales continue to be a disaster.

We are witnessing some extraordinary ongoing developments in the Credit system. I almost feel like I should make a special appeal to be cognizant that we not allow ourselves to become numb to this protracted process, and that that we not let our eyes gloss over the intricate detail of this incredible financial puzzle. I am again reminded of my readings about the parallel period during the late 1920s. One author stated that by the summer of 1929 no one cared about broker call loans. After concern had become more heightened over the years to the point of considerable consternation with the increase in speculative lending during 1927, the boom continued and interest in the issue waned. Yes, we have been concerned with reckless Credit and speculative excess for some time; recent developments should greatly add to our worries.

We see that broad money supply (M3) declined $9 billion last week. Savings deposits dropped $17 billion, while large time deposits increased $17 billion. Institutional money fund deposits declined $15.5 billion, while repurchase agreements increased $3.6 billion and eurodollar deposits increased $4.6 billion. Retail money fund deposits declined $7.5 billion. Clearly, institutional money is "on the move," a circumstance that always captivates our attention. After last year's stunning increase of about $425 billion, or 55%, institutional money fund assets have declined $37 billion (3%) so far during 2002. The explosion of institutional money fund assets was a significant portion of last year's $903 billion, or 12.6%, surge in broad money supply. So far this year, broad money supply is up just $30 billion, an annualized growth rate of less than 2%. What's going on?

Some analysts are quick to equate the slowdown in money growth as confirmation of waning demand and a stagnant economy. Others view the dearth of money growth in the context of faltering liquidity in the financial markets. Then there are those that view "money" growth as the cause for inflation. This camp would view the sudden slowdown in monetary expansion as a potentially significant development for prices. We'll take a much different view from all of these. Our Credit-centric, "institutionalist" approach - holding that contemporary "money" is largely a "special" type of liability issued when the financial sector creates Credit - leads us to begin by asking two key questions. First, has there been a significant change in the Credit environment - would a decline in lending explain the sudden stagnation of growth in money supply (monetary liabilities)? Second, if the general Credit environment does not provide an explanation, what developments in financial sector debt management deserve our immediate attention?

Today, there is overwhelming evidence that lending and general Credit excess runs unabated, particularly throughout mortgage and consumer finance. Bloomberg's year-to-date tally of total domestic debt issuance stands at $457 billion, slightly ahead of last year's record pace (which is even more impressive considering that last year's issuance surely included a larger composition of debt being refinanced in response to significant rate declines). It also appears that syndicated bank lending has come to life over the past few weeks. We see enormous financial sector bond issuance, proceeds of which have been used at least partially to pay down short-term debt. Financial sector commercial paper borrowings have declined $33 billion during the past four weeks and are down almost $49 billion year-to-date, to $1.165 trillion. Non-financial commercial paper outstanding has declined $31.7 billion y-t-d to $193 billion. The other side of this (post-Enron and corporate debt scare) development is the huge bond issuance from by the likes of GE ($11 billion bond issuance last month), Morgan Stanley ($7.3 billion issued), Tyco, Bank One, Wells Fargo, Citigroup, Bank of America, Household International, Washington Mutual, Goldman Sachs, and on and on. Basically, these financial institutions are exchanging their short-term liabilities (much held by money market funds) for longer-term debt (not held as money market assets/not "money").

It is, as well, reasonable today to presume that the GSEs and other aggressive lenders are financing recent aggressive growth with a smaller composition of short-term liabilities. It is also likely that many "structured" vehicles that in the past financed their holdings in the commercial paper market are now issuing longer-term debt. Last year, with heightened risk aversion in the marketplace and expectations for ultra-low rates as far as the eye could see, the GSEs, "special purpose vehicles," speculators, and other lenders were quite content to finance their expansion by issuing short-term monetary liabilities (commercial paper, repos, etc.). This year's environment is markedly different, as is the composition of liabilities issued in the Credit creation process. On the margin, for the aggressive Credit creators, short-term monetary liabilities "are out," while bonds and longer-term borrowings "are in."

We will leave more thorough analysis of this development for another day. Suffice it to say that recent developments support the view that Credit creation - not money supply growth - is the key determinant of inflationary manifestations. It is Credit creation that today provides additional purchasing power; money is a residual of the Credit process. It becomes an especially significant residual to the Credit creation process when lenders issue liabilities to the money market to finance lending. Today, we see that investors and speculators are increasingly willing to hold risky junk bonds, asset-backed securities, mortgage-backs, agency debt, and even corporate bonds. This reduced risk aversion certainly holds the potential that, going forward, inflationary Credit creation might be on net largely financed by the issuance of longer-dated, non-monetary liabilities. If institutional investors, households, and others holders of the trillions of "safe money" turn more disposed to exchanging these claims for higher-yielding bonds and other riskier instruments, this would be an important development for how purchasing power is disseminated throughout the economy. Recent trends - likely remaining tenuous at this time - very well point to the possibility that a significant moderation of money supply growth could actually be consistent with heightened inflationary pressures.

We will pursue this at a later date, but for now we would lean toward the view that the recent slowdown in money supply is, ironically, indicative of a more accommodative Credit environment. In particular, we will be watching carefully to see if what appear to be generally easing Credit conditions lead to a significant easing in Credit availability to finance business spending and investment.

For now, it is fascinating to observe a market that is merrily accommodative to the leveraged financial players. The aggressive cadre, including GE, Tyco, the Wall Street firms, and money center banks, found that their borrow short (money market) and lend long speculations left them uncomfortably close to being in a pickle with commercial paper to roll. Yet, miraculously, the market develops an insatiable appetite for these company's bonds, even in the face of an economic recovery of surprising vigor and the specter of Fed rate increases. We've witnessed company after company making huge bond issuance announcements, only later significantly increasing the size of offerings to satisfy demand. It's been truly something to behold. I just can't shake comments Dr. Greenspan made back in November: "The purpose of monetary policy is to address the structure of financial markets - that's what we do."

I do not think it is a stretch to Ponder the possibility that the Fed is orchestrating a "soft-landing" for the leveraged speculators. It is to the point where this is not even a conspiratorial view, as it appears to me that the Fed likely views such operations as part of a "natural" evolution of their role in "managing" a contemporary "market"-based financial apparatus. One More Quiet Bailout would indeed explain why the GSEs have been going nuts of late. January and February put Fannie Mae and Freddie Mac - "The buyers of First and Last Resort for the Leveraged Speculating Community" - only a big March away from surpassing fourth-quarter 1998's record combined $88 billion asset growth. Their actions are certainly indicative of "Crisis Management Reliquefication Mode," although we haven't seen the system "seizing up" or spreads blowing out - developments that elicited such aggressive GSE response in the past. Regardless of their motives, there should be no argument that recent aggressive GSE liquidity creation has played a major role in fostering the buoyant demand for bonds that has let many a reckless borrower and speculator off the hook. At the same time, a dysfunctional Credit system once again dodges the bullet that would have forced the commencement of a long overdue and desperately needed adjustment. Dysfunctional monetary processes should be broken; they are ossified. There should be no doubt that the approximately $475 billion (almost 50%) Fannie and Freddie balance sheet growth since June 2000 provided one more "Coin in the Fuse Box." It is only curious that this now obvious explanation for how the Credit and Economic Bubbles so easily survived the piercing of the technology sub-Bubble receives absolutely no attention. What will be the cost of this reckless excess?

From Caroline Baum's column on Bloomberg: "Jim Bianco, president of Bianco Research in Barrington, Illinois, combed his database and found that the first quarter of 2002 'should go down as the worst forecasted quarter in economic history' going back to 1984. At the end of the fourth quarter, the median forecast was for a decline of 0.1 percent in first-quarter growth... Some forecasters lifted their first-quarter forecasts to 5 percent, following stronger-than-expected data on consumer spending, construction spending and manufacturing. Looking back at other big forecast errors -- the fourth quarter of 1987, following the October stock market crash; the post-Gulf War period; and the fourth quarter of 1998, following the Russian default and near-collapse of hedge fund Long-Term Capital Management -- Bianco diagnosed the problem as shock effect. 'Economic forecasters cannot handle shocks and surprises to the economy,' Bianco says. 'They consistently overestimate the negative impact they have.'"

Mr. Bianco may be quite correct, but I will take a somewhat different angle: It is not that "they consistently overestimate the negative" but that economists and analysts simply under appreciate the nature of the contemporary U.S. system. For one, the structure of the de-industrialized U.S. economy today is overwhelmingly "monetary" in nature, with Credit and finance generally as the key variables fostering largely intangible economic "output." Second, the unusual structure of the contemporary U.S. financial system has developed an unusual inherent attribute: the maladjusted Credit mechanism is hypersensitive to the type of Fed-orchestrated aggressive rate cuts that we see as automatic and predictable responses to any potential financial crisis. We saw these forces work conspicuously in 1998 and 2001, and somewhat less obviously during 1999 and so far in 2002. In the financial sphere, the GSEs absolutely love the opportunity for the extreme growth occasioned by financial crisis. In reality, this "growth" is pure Credit creation and "reliquefication," showering the financial system and economy with fresh liquidity. Fed crisis management operations, as well, play marvelously into the hands of the leveraged speculating community. Speculators, understandably, are more than happy to borrow at the Fed's artificially low rates and lend at significantly higher rates to the U.S. consumer.

For the consumption-based real economy, the consumer is absolutely tickled with the opportunity to refinance her mortgage at lower interest rates and, at the same time, extract some of her inflated housing equity. She is, as well, pleased to buy a new automobile at zero percent financing and make some extra purchases with low "teaser" Credit card rates. The inflationary mindset of speculating and "keeping up with the Jones'" easily weathered last year's slowdown. These are powerful forces. The determining factor behind this latest episode of "surprising" post-crisis growth is the unlimited availability of low cost mortgage Credit, the supply of which is dictated by the GSE and leveraged speculators. Similarly, the basically unlimited availability of auto and Credit card finance is driven by speculative demand for asset-backed securities and other structured instruments. Strong demand for consumer loans is, as well, augmented by the fact that the GSEs are gorging themselves with all the mortgage paper they get their hands on, leaving the rest of the financial community to scramble for non-conventional mortgage securities and other financial asset classes. The upshot is heightened general Credit availability. And with foreign manufacturers sitting on overcapacity and much of the global economy remaining weak, imports provide a convenient safety valve where even massive U.S. Credit creation has to this point not led to higher goods prices. But let there be no doubt, the popular and seductive claim that somehow U.S. productivity has much at all to do with these processes makes a mockery out of sound analysis.

I just get the sense that many economists today would prefer to stick with the traditional but archaic analysis that economic growth is driven by prudent bank loan officers financing sound business investment. With this mindset, one is led to overemphasize the role played nowadays by the faltering U.S. manufacturing sector, while at the same time expecting more cautious lending (and resulting slower growth) in response to systemic shocks and heightened risk. The better analysis today is to recognize the extreme imbalances of the U.S. Bubble economy and the speculative nature of the financial sphere. The financial sector has been conditioned to equate crisis with the best profit opportunities, with consequent "irrational exuberance" when one would generally expect fear. The "good" news is that our grossly distorted Credit system plays exceedingly well with the inflationary bias inherent in the asset-Bubble and consumption-based U.S. economy, stoking borrowing and spending virtually on demand. The very bad news is that severe structural distortions feed self-reinforcing crises, financial sector excess, real economy borrowing and spending profligacy, only greater structural distortions, and increasingly dangerous Bubbles in the financial sector and U.S. economy. Only the Fed can put an end to this vicious spiral, but they remain determined to paint this is a "virtuous circle" and do the exact opposite.

For "big picture" analysis, this has been another very interesting and seemingly pivotal week. This is a particularly fluid environment for market perceptions, and we as analysts are forced to watch carefully and try to keep an open mind. Bond yields declined significantly this week in the U.S. and globally. It appears that perceptions have shifted, with the market beginning to accept that corporate profits are going to lag the real economy. It also appears that the marketplace is becoming more comfortable that the Fed and global central bankers will err on the side of maintaining their highly accommodative stances. In this regard, Mr. McTeer (Larry Kudlow's choice to replace Greenspan) is hard at work penning his epic "How to Fail at Central Banking:"

From Marcus Kabel's Reuters article: "But McTeer…painted a picture of an economy as it emerges from a mild recession that has plenty of room to grow. 'I don't have a time period in mind. We've got slack in the economy. The unemployment rate is (about) 5-1/2 percent...(and) capacity utilization is about 73 (percent). That's pretty low… You don't have to say in three months I'm going to adjust my shower temperature. You just fiddle with it and keep changing it over time. You just watch the economy…So I don't know when 1-3/4 percent (federal funds rate) becomes intolerable. It's a matter of the performance of the economy rather than a passage of time.'

McTeer said he would be willing to consider [a] rate increase when unemployment and utilization figures warrant it, not simply to raise rates on the assumption that it will take six months or longer before they affect economic activity -- known as the lag time for monetary policy. 'When unemployment gets down below 5.0 percent and is falling and when capacity utilization is 77 (percent) and rising, then talk to me about lag because I might be more willing to go with a preemptive policy.' McTeer long has been a strong advocate of the 'new economy' view that higher productivity rates in today's economy allow the Fed to keep monetary policy loose for a longer time before higher rates are needed to ring out any excesses… 'I'm still willing to sort of experiment until I see the results of policy, rather than flying totally blind and on the dials. Logic will tell you that, as the economy does gain strength, watching it and not just anticipating it, those (current short-term) rates may be too low for a strong economy. They were just right for a weak economy.'"

Mr. McTeer has a knack for turning sound central banking on its head. If I read his comments accurately, he is stating categorically that to increase rates today would be "preemptive policy" (I think he is even saying that when unemployment "gets below 5%" rate increases would be "preemptive"). But are rates at 40-year lows consistent with what estimates now put at 5% first-quarter growth, surging consumer borrowing and spending, aggressive fiscal policy, a strong service sector, a booming housing market, and a conspicuous California real estate Bubble? And after all the Fed's "experimentation" with New Economy accommodation - and the resulting tumult the precarious Internet/telecom/technology Bubble is putting the system through - here we have Mr. McTeer "still willing to sort of experiment…" To make this even more ridiculous, he apparently believes that to reverse what is clearly overly accommodative policy today "would be flying blind," when the truth of the matter is that the Fed is now clearly the proverbial deer blinded into inaction by bright headlights.

We have no one else but the Fed to take responsibility for protecting the stability of the U.S. financial system. After shunning this responsibility as the technology Bubble escalated out of control, it is simply unbelievable that the Fed will today again disregard the extreme systemic risk inherent with the speculative Bubble in the Credit system and the evolving Bubble in the U.S. housing market. From reading McTeer's comments, one can surmise that as long as the U.S. manufacturing sector continues to wither away, 1¾% interest rates are perfectly appropriate. Well, if we are already not there yet, we will soon approach the point where it would make sense for Wall Street and the hedge funds to simply acquire and slowly liquidate domestic manufactures just to ensure the security of low rates for their enormous leveraged speculations. But, then again, we basically get the same effect from maintaining an overvalued dollar that ensures global competitiveness remains hopelessly out of reach for many U.S. manufactures.

I am sure it is at least as tiresome to read my incessant criticism of the Fed and the leveraged speculating community as it is to write. However, I think we are now to the point where we have had some critical issues resolved. The leveraged speculators do command the Credit system and the Fed has little alternative than to cater to their every want and need. That things have evolved to this point is a momentous failure; we now can surmise that the Greenspan Fed is content to live with it. This is very important for analysis, as today our best assumption becomes that, with the Fed's support, current dysfunctional monetary processes will be sustained until there is some financial accident. It then becomes reasonable to consider the possibility that things could spiral even further out of control.

As a student of markets, and particularly the brand of Credit excess-induced hyper speculative contemporary markets (from the late '80s junk bond fiasco, U.S. Credit market in 1993, Mexico, SE Asia, Russia, Argentina, the Internet/telecom debt/technology, natural gas, U.S. stock market and Credit markets, and so on) we have repeatedly witnessed a proclivity for markets to go to great extremes only then to commence a precariously destructive speculative "blow off." As we have watched the Bubble in U.S. mortgage and consumer finance develop over the years, we have Pondered the possibility that this Bubble could end in a similar manner. For years I naively believed that when the Fed came to recognize how the GSEs and leveraged speculators were the true sources of the liquidity that was fueling the stock market, technology, and real estate Bubbles they would move to control these destabilizing forces to protect the well-being of the financial system and economy. I didn't imagine that we would ever get this far down the road of unprecedented Credit and speculative excess, with the Fed so aggressively supporting GSE and speculator interests. With this in mind, I think the probability of the consumer debt Bubble developing into one final speculative "blow off" is increasing by the week. At the minimum, I see all the necessary factors firmly in place in both the financial sphere and the real economy.

The U.S. Bubble economy is grossly distorted and imbalanced, while the world is an especially dangerous place. The Fed need not look far to find myriad excuses to maintain its highly accommodative posture. Dr. Greenspan surely would prefer to take no chances, and there is no constituency for controlling monetary disorder or righting a dysfunctional Credit mechanism. Besides, right now the Credit system is directing the preponderance of excess to the housing and consumption Bubbles, with inflationary manifestations strongest in rising home prices and enormous trade deficits. Extraordinary "profits" may continue to be enjoyed by homeowners and property speculators, real estate agents, insurance salesmen, health care professionals, attorneys, defense contractors, retailers, aggressive lenders, financial players, and so on. The infrastructure for perpetuating asset inflation is as strong as ever. But these things are not important variables to Fed decision-making.

The flipside to the above inflationary manifestations is that current Credit excesses are not making their way to corporate revenues. Meanwhile, rising compensation, health care, retirement, insurance, and other costs will pressure corporate profits. This dilemma gets to the heart of intractable maladjustments and imbalances. The manufacturing sector will continue its ongoing struggle with deep structural issues and an overvalued dollar. Meanwhile, the post-Bubble technology sector will likely be a profits and financial blackhole for years to come. The inflated and liquidity-driven U.S. stock market will remain vulnerable, at best. Then there is the considerable risk of an exogenous shock (war, terrorist attack, oil embargo, etc.) that is now, unfortunately, a permanent fixture of the financial landscape. The issue of acute financial fragility is similarly here to stay. These negative fundamentals are all things of great concern to Alan Greenspan that, perversely, will likely implore continued Fed accommodation of gross Credit and speculative excess. And as we saw this week, the specter of war is not bad news for the Credit market. The Fed would not, of course, ever raise rates in the face of an international crisis. As analysts, it is now critical to differentiate negative fundamentals in the real economy and stock market from factors that could nonetheless foster continued Credit excess.

So Credit Bubble analysis must today consider the possibility that extreme Credit excesses run unabated. In fact, the absolute worst-case scenario now looks like a more distinct possibility by the week. That U.S. mortgage and consumer debt instruments are the vehicles of choice for the powerful financial players, and that such an inflationary bias is already prevalent throughout the real economy make this an especially flammable tinderbox. The hidden costs of all the "Coins in the Fuse Box" and financial sector bailouts now look poised to manifest in an uneven housing and consumer borrowing fiasco, with the Fed either incapable or unwilling to respond. I fully appreciate that such a scenario sounds far-fetched, but the possibility of the first-quarter 2000 melt-up in Internet and technology stocks in the midst of rapidly deteriorating fundamentals appeared virtually impossible to those who had the keenest grasp of true business conditions and valuations. Yet the steamroller of massive liquidity and dysfunctional market dynamics combined to crush fundamentals in a final spectacular market dislocation. I am not yet saying this is a likely scenario, but the ramifications for a similar development with the consumer finance Bubble are so momentous that we will be monitoring the situation carefully. We do know that a confluence of factors, including current extreme monetary disorder, indelible monetary processes and powerful speculative forces, and a Greenspan Fed with an acute predilection for voyeurism, has led us to a bout of Pondering Imponderables.

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