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Pondering Post-Bubble America

It was an even more volatile stock market than what has become the norm. For the week, the Dow and S&P500 dipped less than 1%. The Transports posted a fractional advance, while the Utilities declined about 1%. The Morgan Stanley Consumer index dipped 1% and the Morgan Stanley Cyclical index shed 2%. The broader market somewhat outperformed, with the small cap Russell 2000 declining less than 1% and the S&P400 Mid-cap index about unchanged. Earnings disappointments dampened technology enthusiasm, with the NASDAQ100 declining 1% for the week. The Morgan Stanley High Tech index dropped 2%, the Semiconductors 4%, and The Street.com Internet index 2%. The resilient NASDAQ Telecommunications index added almost 1% and ended January with a 6% gain. The biotechs declined 1% this week. The financial stocks were unsettled, as the Banks declined 1% and the Securities Broker/Dealer index ended unchanged. Although bullion gave up only 40 cents, the HUI Gold index dropped 5%.

Notably, the Treasury market gained little on days when equities suffered. For the week, the two-year Treasury yield inched up one basis point to 1.66%, while the five-year yield jumped six basis points to 2.94%. The 10-year Treasury yield increased three basis points to 3.96%, while the long-bond yield dipped two basis points to 4.84%. Benchmark mortgage-backs and agencies saw yields up five or six basis points. The spread on Fannie's 5 3/8 2011 note was unchanged at 37, and the 10-year dollar swap spread inched up one-half point to 44.5. The dollar finally enjoyed a winning week, with a late-week rally leaving the greenback slightly positive. The CRB index shot 2% higher this week, ending January up 6%. Propane prices had the strongest weekly gains in three years (21%), while cattle futures rallied to two-year highs, platinum and cocoa to 17-year highs. "Cost pressures" have led General Mills, Kellogg, and Quaker Oats to raise cereal prices.

There was almost $41 billion of U.S. Corporate and Agency debt issuance this week (according to Bloomberg). January issuance totaled $196.5 billion, up 14% from January 2002. Sales this week included GE Capital's $1.5 billion (up from $1.25 b), Citigroup's $2 billion (up from $1.5), GMAC's $900 million, National Rural Utilities Cooperative Finance Corp.'s $1.5 billion, and Avnet's $450 million. The convertible bond market continues to demonstrate signs of life. Micron sold $632 million of 7-year convertible bonds (2.5% convertible at $11.79 per share). ONEOK sold $400 million of converts and International Game Technology $500 million. January saw seven convert deals for $6.4 billion, compared to $54.5 billion for all of 2002. But stock market weakness appears to be responsible for a reversal to (AMG reported) $649 million of outflows from junk funds last week. Inflows remained positive for the month. The ABS market saw $6.4 billion issued, with January's $29.7 billion in line with January 2002. Booming home-equity ABS accounted for fully one-third of January issuance.

January 29 - Bloomberg: "Pulte Homes Inc. Chief Financial Officer Roger Cregg comments on the third-largest U.S. homebuilder's offering of $300 million of 6 ¼ percent 10-year notes… 'Certainly we were watching all the macro-economic and geopolitical issues out there. We were watching the rates and felt now was the best time to do it. 'We could have waited longer, we didn't need cash at the immediate moment. But we felt the timing was good, rates were really good as well… The issue was about three times over-subscribed,' Cregg said." Homebuilder Lennar raised $350 million this week.

January 30, 2003: "Fitch Ratings lowers AmeriCredit Corp.'s senior unsecured rating to B+ from BB… (the) rating action reflects deterioration in asset quality beyond expectations coupled with concerns regarding liquidity and ongoing access to the asset-backed securities markets. AmeriCredit is experiencing higher net charge-offs due to lower than expected recovery rates on repossessed vehicles. Fitch believes that used car prices will remain pressured due to continued high incentive financing, which indirectly depresses used car values." (Moody's followed today)

January 30, 2003 -Dow Jones (Judith Burns): "Regulators are worried that asset-backed securities issuers are making incomplete quarterly reports, a senior Securities and Exchange Commission official said Thursday. Asset-backed securities issuers provide the SEC with a modified version of the quarterly reports filed by public companies, including an accountant's report in lieu of an audit. SEC corporation finance division director Alan Beller said the SEC is 'developing a serious concern' because some asset-backed securities reports don't contain accountants' reports or reports from servicers. 'The required elements are not being included,' Beller told Dow Jones… Proposed rules for asset-backed securities are on tap, Beller indicated. Given the size of the asset-backed securities market, he said it's 'imperative that we get some rules' in this area." (Our comment: better very late than never.)

January 30 - Bloomberg: "Governor Bob Taft proposed overhauling Ohio's tax system to raise $2.3 billion of new revenue in the next two-year budget to close a deficit in the seventh-largest U.S. state… 'Our rainy day fund is empty and we are cutting spending sharply,' Taft said… The governor also said the state is closing a prison, cutting Medicaid spending and asking employees to go without pay raises for two years… Ohio's estimated $4 billion budget deficit is the sixth largest among U.S. states, according to the American Legislative Exchange Council. All states face an estimated $105.7 billion of deficits."

January 30 - Bloomberg: "California may issue warrants to preserve cash and pay off short-term notes sold last year as the state faces a record budget deficit, Governor Gray Davis said. Davis said California will probably need to sell warrants to investors in June to cover its bills and pay off $12.5 billion in one-year notes that come due June 20 and June 27. California law requires the state to pay off notes in the same fiscal year they are sold. Warrants can be repaid in a future fiscal year."

Broad money supply (M3) expanded $31.7 billion last week to $8.495 Trillion (up $3 Trillion, or 55%, in five years!). Currency added $1.9 billion to $631 billion, with Demand and Checkable Deposits up $16.9 billion to $575 billion. Savings Deposits increased $9.9 billion ($59 billion in six weeks) to $2.81 Trillion, while Small Denominated Deposits declined $1.2 billion to $873 billion. Retail Money Fund deposits were unchanged at $927 billion. Institutional Money Fund deposits declined $15.8 billion to $1.18 Trillion, with a noteworthy 5-week decline of $61.6 billion. Large Denominated Deposits increased $14.5 billion last week to $813 billion, and Repurchase Agreements added $6.2 billion to $461 billion. Eurodollars were unchanged at $216 billion. Elsewhere, Total Commercial Paper (CP) borrowings declined $1.0 billion last week. Interestingly, non-financial CP declined $6.7 billion to $152.4 billion, while financial CP added $5.7 billion to $1.195 Trillion. Financial sector CP borrowings are up $28.9 billion in five weeks to the highest level since the first week of December. Total Bank Assets jumped $50 billion last week. Securities were up $5.3 billion and Loans and Leases added $6.9 billion. Commercial and Industrial loans were up $800 million, while Consumer loans increased $4.4 billion and Real Estate loans added $2.5 billion.

Details from the fourth quarter GDP report are indicative of a vulnerable and grossly distorted economy. First, the 0.7% annualized growth was the weakest since the third quarter of 2001. Personal Consumption of Non-durables was up 3.9%, while consumption of Durables was down 7.3%. Gross Private Investment declined 0.7%, versus the third quarter's 3.6% increase and the first down quarter in a year. And while Residential investment was up 6.8%, investment in Nonresidential Structures sank 9.3%. Exports dropped 1.7%, while Imports increased 3.7% (a record 5.3% trade gap for the quarter!). Federal Government consumption surged 10.1%, with National Defense up 11.2% and Non-defense up 8.3%. It is also worth noting that Services Personal Consumption expanded by only 1.3%, the weakest performance since 2001's third quarter.

Data from the Forth Quarter Disposition of Personal Income are also worth pondering. Year-over-year, Personal Income was up 4.4%, with Wage and Salaries up 3.4%, Social Insurance up 4.9%, and Transfer Payments up 9.2%. With Personal Taxes dropping 15.5% y-o-y, Disposable Income was actually up 7.9% y-o-y. Interestingly, Wages and Salaries increased at a 4.2% rate during the quarter (q-o-q), up from the third quarter's 3.7%, the second quarter's 3.2% and the first quarter's 2.1%. Two thoughts come to mind. First, there is clearly an inflationary bias in the Personal Income data. Second, it should be quite alarming that the economy has stagnated in the face of surging government spending, rising disposable income growth, and an historic refi boom.

University of Michigan January confidence was a weaker-than-expected 82.4, approaching October's low of 80.6. The survey's Economic Outlook index sank a significant eight points during the month to 72.8, the lowest point since November 1993. There were 25,677 bankruptcies last week, up 2% y-o-y. The Conference Board's December Help Wanted index declined from 40 to 39, touching the lowest level since 1963. But, at the same time, we do not want to dismiss the stronger data from the Chicago Purchase Managers survey. January Orders added two points to 58, while Production jumped 10.5 points to 63.1. Also this morning, the New York Purchasing Management index was reported up 9.5 points to 51.9. With the corporate bond market open for business and a weaker dollar, we would not be surprised by an up tick in manufacturing. But we have reached the point where this would be a relatively insignificant development for the service/consumption-based U.S. economy.

The Mortgage Bankers Association Refi Application index jumped almost 8% last week to a level more than double one year ago. The purchase index increased almost 3% and remains about 10% above the year ago level. This historic refi boom has now reached 32 weeks and has the definite appearance of a major market speculative blow-off. Similar to NASDAQ in early 2000, it is impossible to know when the fervor will subside (and major tops invariably last much longer than one would think possible!). But it is also clear that these are the types of market environments that sow the seeds of their own destruction.

December Existing Home Sales jumped 5.2% for the month to a 5.86 million annualized pace, the third-highest level on record. Sales were up 12.7% y-o-y, with average (mean) prices up 6.5% to $204,600. Calculated Transaction Value (CTV: annualized volume multiplied by average prices) - an indication of relative mortgage Credit growth - surged 20% y-o-y to $1.2 Trillion. CTV is up 36% in two years and has surged $484 billion, or 68%, over five years.

Mirroring Fannie, Freddie Mac posted a huge fourth quarter. Total Assets expanded by $39.8 billion, or 23.4% annualized to $722 billion. This was the largest quarterly increase since the fourth quarter of 2001. Total Assets jumped $77.7 billion, or 24% annualized, during the second-half and were up 17% for the year. Looking at fourth quarter Average Balances, the Retained Mortgage Portfolio was up 13% y-o-y to $547 billion, while Investments were up 36% to $124 billion. Freddie bought back 6.2 million shares of stock during the fourth quarter and a total of 9.1 million shares for the year. Freddie's Total Book of Business (Retained Mortgage Portfolio and guaranteed mortgage-backs in the marketplace) jumped $50 billion, or 16% annualized, during the quarter to $1.31 Trillion (up 15.2% y-o-y). Freddie's Total Assets are up 57% over two years and a stunning 270% over five years. Its Book of Business has more than doubled in five years.

Fannie and Freddie combined for fourth quarter Total Asset growth of $89.4 billion, or 24% annualized, to $1.61 Trillion. This surpassed the previous record of $88 billion set during the infamous fourth quarter of 1998. In a truly historic Credit expansion, Fannie and Freddie Total Assets are up 174% in five years. It is worth noting that combined Total Assets surpassed $200 billion for the first time during 1992 and $400 billion in 1995. The combined Book of Business surged $128.4 billion during the fourth quarter, or 17% annualized, to $3.1 Trillion, and was up 16% ($429 billion) y-o-y. In numbers that are difficult to fathom, their combined Book of Business was up $855 billion, or 42%, in just twenty-four months (up $1.6 Trillion in five years!). And including Federal Home Loan Bank estimated Total Assets of $780 billion, "Big Three GSE" total exposure of $3.9 Trillion has more than doubled since the beginning of 1998. Stunning… Or coming at this phenomenon from another angle, total Big Three GSE exposure has jumped from 22% of GDP to 37% in just 60 months…and is climbing rapidly.

January 30 - Bloomberg: "U.S. housing prices aren't facing a bubble and the economic recovery is 'fragile,' said Richard Clarida, the Treasury's chief economist. 'There's really no evidence of a housing bubble,' Clarida said in an interview on Bloomberg television. 'Investment isn't contributing to growth the way it did in previous recoveries.'"

January 27 - Bloomberg: "Equity Office Properties Trust, the largest U.S. office building owner, has a 40 percent vacancy rate for its buildings on the San Francisco Peninsula, the San Francisco Business Times reported. Equity Office is the biggest landlord on the peninsula, which stretches from South San Francisco to Palo Alto, with 71 buildings encompassing six million square feet, the paper said. The company's vacancy rate is 24 percent on a direct basis and nearly 40 percent when sublease space is included, the paper said."

January 30 - Bloomberg: "Apartment rental demand fell in the fourth quarter to its lowest level in a year, as low mortgage rates lured renters into buying homes, according to the National Multi Housing Council. The Washington-based trade group's Market Tightness Index fell to 29 from 35 the previous quarter. The survey showed that 47 percent of respondents said market conditions worsened in the closing months of the year, 49 percent said conditions remained the same, and 4 percent said demand rose."

January 30 - Rocky Mountain News (John Rebchook): "The Denver-area apartment market, buffeted by a slow economy, overbuilding and low mortgage rates, posted an 11.7 percent vacancy rate at the end of last year, its worst performance since 1989. A year earlier, the vacancy rate stood at 8.7 percent, according to the survey authored by Gordon Von Stroh, a business professor… After the third quarter of 2002, the vacancy rate was 9.4 percent, making the December increase the biggest quarter-to-quarter jump since 1986. The vacancy rate has almost tripled over a two-year period… 'A number of different things are going on. The stagnant national and local economy is having impact on things. No. 2 are the low interest rates, which makes it easy for renters to buy homes. And we also have a significant number of new inventory coming on line, in a market that doesn't need the delivery of any new units.'" (Take note of what will be a national problem)

January 30 - Bloomberg: "The vacancy rate at U.S. industrial properties reached 10.4 percent in the fourth quarter, the highest in almost seven years, as business spending slowed, broker Cushman & Wakefield reported. At year-end, 786 million square feet of warehouses, manufacturing and so-called high-tech industrial space stood vacant, Cushman said. The vacancy rate rose from 8.6 percent the year before and 9.2 percent in the third quarter."

The REIT (real estate investment trust) Bubble runs unabated, although few have yet to report fourth quarter earnings. Novastar saw fourth quarter Net Income more than double from last year. Total Assets surged 85% during the quarter to $1.45 billion, up from the year ago $512 million. The company ended the third quarter with Shareholder equity of $165 million. "During 2003 we expect to originate between $4 billion and $6 billion of non-conforming loans…" Thornburg Mortgage reported strong earnings as well, with Total Assets up 81% y-o-y to $10.5 billion. A Thornburg exec was providing advice to a CNN evening audience this week. He suggested that, for many, interest-only mortgages were a good idea when higher yielding investments - such his company's 11% dividend - were available. FBR Asset Investment Corp. expects the REIT's MBS investments to post returns on equity in excess of 20%. And, according to Dow Jones, management continues to have "complete confidence" in Americredit's business model and management. The company owns 5 million shares of AmeriCredit stock (as of the third quarter). FBR ended the year with $5.2 billion of mortgage-backed securities (with repurchase agreement funding of $4.54 billion), up from the year ago $1.2 billion. The company ended the year with Equity Capital of $728 million

Mortgage Insurer PMI Group reported Net Income up slightly year-over-year. Primary Insurance in Force was up 7% y-o-y to $125.8 billion. The most interesting aspect of this release was the delinquency data. The Percentage of Domestic Primary Mortgage Insurance in Default jumped 40 basis points during the quarter to 3.84%. This is acceleration in Credit deterioration that has been proceeding steadily for many quarters. Going back to the third quarter of 2001, Delinquencies have increased from 2.40% to 2.67%, to 2.81%, to 3.07%, to 3.44%, to the fourth quarter's 3.84%. "Bulk Transactions" have seen delinquencies surge to 10.4% from the year ago 5.55%. Primary Claims Paid was up 33% y-o-y to $29.5 million. Further confirmation that all is not well in mortgage land…

"Last week the Federal Reserve released its triennial Survey of Consumer Finances (SCF), the most detailed report card on the state of the household sector's balance sheet and income statement currently available. There's no reason to equivocate on the general conclusion: the enduring hysteria that the household sector is over-levered and that this will inevitably be the catalyst for a collapse in spending is an enduring myth. Every cohort of the income distribution, every cohort of the age distribution, and every cohort of the net worth distribution have seen their debt burden (level of loan payments to income) fall in response to rallying interest rate markets and rising incomes. Whether rich or poor, old or young, your debt service burden is highly likely to be lower today than it was in the late 1990s, and there's a good chance it's the lowest it has been since the late 1980s, at least. What's more, leverage ratios (level of debt to assets) are falling just like the debt service burden. In aggregate, the household sector's debt as a proportion of assets is the lowest it has been since at least the late 1980s." January 30, 2003, Extracted from a Wall Street economic research report

There is something about major market tops that induce Bubble proponents to say and write silly things. The household sector is conspicuously over-leveraged and there is no disguising the fact that household borrowings are up about 50% in five years - and that's starting from an already lofty base. This bullish "consumer is in great shape" nonsense is akin to how Bubble proponents saw exorbitant technology P/E ratios as reasonable because they were in line with company and industry growth rates. The hitch was that heady growth rates were Bubble induced and absolutely unsustainable. Flawed analysis had things looking "great" right into the collapse. Not wanting to address obvious consumer borrowing excesses, the proponents today have only "debt service" ratios to play around with. But the momentous hitch this time around is that egregious consumer/mortgage sector Credit excesses are what is specifically fueling income growth and sustaining the Bubble economy. The issue is not debt service ratios, but the sustainability of the Bubble. On paper (and in dim light) the consumer may appear capable of servicing his debt load, but the day he tempers his borrowing and spending…

The Pension Benefit Guarantee Corp, the federal agency providing insurance for 44 million private-sector pensions, (according to the Washington Post) "yesterday reported an $11.37 billion loss for the last year, the largest in the insurer's 28-year history." This "shifted the agency from a $7.73 billion surplus to a $3.64 billion deficit." The unfolding pension shortfall debacle encompassing companies, state and local municipalities, and the federal government is one of the more intractable consequences of the protracted Bubble. It is also an issue that will incite calls for "reflation," a seductive elixir that will only further poison the patient. If only stock prices could return to previous levels; then there would be plenty of "money" for future retirees. Yet more money and Credit will not provide the comfortable retirement lifestyle promised to our aging workforce. Actually, the developing pension quagmire provides a solid argument against the inflationary status quo. The problem is only worsened by more consumption, higher housing prices, and a weaker dollar. The only possible solution is sound domestic investment and a stable currency providing the means of producing and trading for the goods and services to sustain our high standard of living.

From Robert Prechter's January The Elliott Wave Theorist: "…the recent rash of commentary on the assurance of continued inflation seems to require a renewed response. Here are my answers to the arguments extant today." - - (I have extracted only one of the arguments Mr. Prechter addressed) -- "Deflation Will Cause a Run on the Dollar, Which Will Make Prices Rise."

"This is an argument that deflation will cause inflation, which is untenable. In terms of domestic purchasing power, the dollar's value should rise in deflation. You will then be able to buy more of most goods and services. It is unknown how the dollar will fare against other currencies, and there is no way to answer that question other than following Elliott wave patterns as they develop. From the standpoint of predicting deflation, the dollar's convertibility ratios are irrelevant. There may well be a "run on the dollar" against foreign currencies, but it would not be because of deflation. I think the impulse to predict a run on the dollar comes from people who own a lot of gold, silver or Swiss francs. They feel the '70s returning, and so they envision the dollar falling against all of these alternatives."

We're big fans of Mr. Prechter and consider him one of the few around today deserving of the status market and social "guru." We certainly share his focus on the perils of Credit excess and inflated asset markets. But while we may see eye-to-eye on the problem, it is not so clear to us that the consequence of a Credit Bubble is a predestined "deflation." Indeed, we can look to the disparate environments in post-Bubble Japan and post-Bubble Argentina as evidence that collapsing Bubbles may end in a long, draw-out mild deflation or, in the case of Argentina, rapid financial implosion and devastating inflation. From the standpoint of attempting to analyze which of these polar extremes may best apply to Post-Bubble America, we are increasingly convinced that the dollar's performance will play an instrumental role. Rather than focusing on inflation/deflation, the primary analytical focal point of Credit Bubble analysis lies elsewhere.

Japan made truly incredible economic progress for several decades, before succumbing to extreme financial excess in the late eighties. Sadly, they "drank the poison" and basically destroyed their financial system in a few short years. Yet, post-Bubble Japan remained endowed with great wealth-creating manufacturing capacity. The Japanese multinationals have not only survived; they have prospered. With enormous trade surpluses, the economy has been able to muddle through a wrenching decade-long financial quagmire. Importantly, the related trade surplus and household saving attributes (Japan as Creditor nation) played an instrumental role in supporting the Japanese currency. The yen today trades at about 120 to the dollar. This is just off its 10-year average and above where it began the nineties. Importantly, (and especially for retirees) the frugal Japanese saver has maintained her purchasing power. There has been no run on Japanese financial assets.

Importantly, the Japanese Credit Bubble was a severe domestic debt problem, but international investors and speculators played a relatively insignificant role. The fate of the financial system and economy did not rest tenuously on yen confidence. The post-Bubble banking system has been an unmitigated disaster, but the Japanese economy's debt structures - supported by decades of sound investment and enormous household savings - proved resilient.

Stagnant private sector Credit growth was partially offset by large government borrowings, playing a critical role in tempering financial fragility and stabilizing the system. Excesses, both real and financial, had not reached the point where contracting private-sector debt growth would lead to unmanageable collapse. Fortunately, I would argue, the Japanese government used is fiscal and monetary powers to ease an arduous post-Bubble transition, rather than to sustain the Bubble. And while certainly encumbered, Japanese society has remained cohesive through a protracted and difficult adjustment period. The general population has not rioted or spent much time in protest, but rather fell back on financial discipline and its hard-work ethic. There has been too much (typical post-Bubble) talk of policy incompetence and not enough recognition of a most impressive performance by the Japanese people.

At the other extreme, an arguably much less formidable and pervasive Bubble in Argentina has left the financial system and economy in absolute tatters. Many savers have been completely wiped out, and the social fabric has been severely frayed. Argentine citizens have lost confidence in the government and the country's institutions. Sadly, bank runs have become commonplace. The Argentine peso has lost 70% of its value, with inflation running rampant. Foreign bankers, investors and speculators have abandoned the country, with international institutions (and "globalization") under justifiable attack from Argentine citizens, politicians, and monetary authorities. The economy has sunk into deep depression, with little benefit from a collapsing currency. Indeed, the sinking Argentine peso has been a major hindrance, in stark contrast to the experiences of post-Bubble South Korea, Thailand, Russia and Brazil.

The boom-time Argentine economy came to depend on foreign-sourced finance, much of it of speculative character. Once addicted, all involved were steadfast in refusing to recognize the sickness. Foreign borrowings financed too much consumption and too little of the type of sound investment capable of creating the necessary economic wealth to repay Creditors. Once this course was chosen, it was only a question of the dimensions of the inevitable financial and economic dislocation. Reliance on foreign borrowings in combination with economic maladjustments over time combined to create acutely fragile debt structures. Indeed, it was precisely the nature of the speculative capital flows fostering non-productive Credit excess that proved fatal to the Argentine financial system. Frail debt structures and economic maladjustment left the currency, Credit system, and economy hopelessly vulnerable to both the inevitable reversal of speculative flows and attendant capital flight. Confidence in the peso's peg to the dollar became of momentous consequence. Almost overnight, Argentine financial assets were no longer an acceptable medium for international exchange. Importantly, none of these types of issues have played a role in post-Bubble Japan.

So we have very difficult and complex questions to contemplate in our pursuit of What Will Be Post-Bubble America. Most regrettably, the Greenspan Fed, Wall Street, the GSEs and Washington politicians are resolute in their determination to stonewall the adjustment process. Importantly, this dangerous course of prolonging Bubble excesses is categorically based on continued Credit excess - inflating dollar financial claims. This should not today be in dispute, and incessant Credit inflation is why we remain fixated on dollar vulnerability and devaluation. There may certainly come a day when faltering confidence and a run on dollar financial assets wreaks (Argentine-style) havoc on the U.S. Credit system - especially its acutely fragile "structured finance" parallel "banking" system - but the system today retains its capacity for unchecked and rampant inflation of dollar claims (Credit inflation).

But as we've highlighted repeatedly, these new claims could not be of poorer quality. Nor could current Credit inflation impart greater distorting affects on the real economy. Recall that during the third-quarter Household Mortgage Debt expanded at a rate of 11.8%, while Corporate Debt was virtually unchanged. And that a meaningful portion of these new claims are acquired by leveraged speculators only adds an additional layer of debt structure vulnerability.

There is absolutely no way for the U.S. financial sector or economy to inflate out of this desperate quagmire. I continue to be amazed that individuals that should know better call only louder for greater U.S. inflation. It should be obvious that the dilemma we are facing has nothing to do with insufficient money or inadequate Fed-created liquidity. The Credit system continues firing on overdrive, while there remains in inflationary bias in wages and income. The dollar is the weakest in years, while gold and commodities are performing the best in some time.

In an attempt to simplify a very complex environment to accessible terms, I see two critical issues today. First, the U.S. "service sector"/consumption-based Bubble economy has about reached the end of its rope. The consumer is piling on debt at a precarious and unsustainable pace ("blow-off"). Furthermore, the degree of Credit excess necessary to sustain spending/"output" at boom-time levels (in the context of a severely maladjusted economic system) is increasingly destabilizing. Credit excess-induced created purchasing power stimulates over-consumption, massive trade deficits, and uneconomic "investment," with only a trickle financing sound investment. If one were to calculate a Stable Finance Ratio of "sound investment to total Credit growth" it would undoubtedly be crashing to an all-time historic low. Conversely, a Financial Fragility Ratio of "foreign liabilities to economic wealth creating assets" would now be rising exponentially. Continued rampant Credit inflation has in reality become dangerously counter-productive, and we look to the dollar level and gold price as confirmation of this view.

Second, the "structured finance" monetary regime that retains its dominance at the epicenter of our nation's financial system (The Master of the Great Credit Bubble) is absolutely and unalterably dysfunctional. Indelible Monetary Processes specifically direct finance to where it is not needed - to sectors where there remains an inflationary bias. The entire U.S. financial system, then, has become trapped in a consumer and Mortgage Finance Bubble that has the corporate debt and stock market Bubbles appearing quite manageable in comparison.

As monetary analysts, we've never respected nor trusted "structured finance." This is because it's all about lending volume and financial speculation - the nemeses of sound money and economic and financial stability. The Aggressive Loan Originator (and his cohorts Clever Securitizer, Oblivious Credit Insurer, Gumptious Rating Agency, and Enterprising Leveraged Speculator) has supplanted the anachronistic Prudent Loan Officer and his preciously mundane Bank Loan. Along with volume, the Structured Finance mob covets yield. As such, Structured Finance has a rather intense fancy for subprime. Poor credits provide an almost limitless captive audience - at least during the self-reinforcing, Credit excess-induced boom. Consumption-based lending, as we have witnessed, knows no bounds (when one governs over the world's reserve currency). Structured Finance also has a devoted love affair with asset-based lending and speculating. As we have witnessed, inflating asset (equities, homes, mortgage-backs, agency bonds, baseball teams, etc.) prices provide unbounded lending opportunities during the boom; again, music to the ears of Structured ("Speculative") Finance.

But why does Structured Finance treat sound investment with such utter disdain? Because of volume constraints and, to a lesser extent, yield inadequacies; in contrast to consumption and asset-based lending, there are definite bounds on the amount of sound investment. The more that is financed, the more vulnerable profits and the less sound the underlying Credits. Indeed, business profits provide rather tenuous collateral after Bubbles have passed their peak. It would truly be wonderful if we could today rev up the manufacturing sector and right the system. Beguiling perhaps, but this is not today a viable alternative. The financing of sound investment would prove woefully inadequate in terms of the quantity of Credit required to sustain the U.S. Bubble. Moreover - and a major issue today for the dollar and financial fragility - Structured Finance simply does not have the luxury of turning its back on the Consumption and Asset Bubbles it has so fervently nurtured. For the U.S. Bubble Economy it remains inflate or die. Reckless Japanese Credit inflation was terminated before it was too late. Argentina's was not.

The inescapable consequences of the U.S. Credit Bubble Dilemma include only more Credit and speculative excess, heightened financial fragility, deeper economic maladjustment and impairment, and a further debasement of our currency. Considering what we have and continue to observe, I do not feel it is at all outrageous to assert that our system has set a perilous course toward the collapse of the world's reserve currency. This is the harsh reality that we should recognize as a nation as we contemplate Post-Bubble America. And no amount of inflation will change the facts of economic life. There are no available shortcuts but many risky gimmicks to prolong the Bubble, hence only making the inevitable day of reckoning all the more painful and Balkanizing. There is nowadays only louder call for stimulating and "reflating," but there is absolutely no discussion of the consequences. There is so much a stake. It is our view that the longer we travel down this dangerous course the more rapidly the Post-Bubble America pendulum swings away from a Japanese scenario in the direction of Argentina.

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