03/05/2004 A Banner Year for Asset Inflation *

The stock market appeared calm relative to the wild trading environment that has engulfed currency, interest-rate, and commodity markets. For the week, the Dow and Transports were about unchanged. The S&P500 and Utilities added about 1%. The Morgan Stanley Cyclical and Morgan Stanley Consumer indices also gained 1%. The broader market was stronger, with the small cap Russell 2000 (up 8% y-t-d) and S&P400 Mid-cap indices (up 7% y-t-d) rising 2%. The NASDAQ100 was unchanged and the Semiconductors posted a slight advance. The Morgan Stanley High Tech (up 5% y-t-d), The Street.com Internet (up 5% y-t-d) and NASDAQ Telecommunications (up 5% y-t-d) indices added 1%. The Biotechs rose 3%, increasing 2004 gains to 14%. The financial stocks continue to perform well. The Broker/Dealers gained 2% (up 12% y-t-d) and the Banks 1.5% (up 5% y-t-d). With bullion recovering $5.10, the HUI gold index rose 3%. Weak job gains pushed the Treasury market into a bout of panic buying. Five-year Treasury yields sank 19 basis points and 10-year yields dropped 17 basis points today. Price gains were said to be the largest since the session following the September 2001 terrorist attacks (from Bloomberg), with yields sinking to the lowest levels since last July. The implied yield on December 3-month Eurodollars sank 22.5 basis points today to a contract low 1.57%. For the week, 2-year Treasury yields declined 9 basis points to 1.56%, 5-year yields 14 basis points to 2.28%, and 10-year yields 12 basis points to 3.85%. The long-bond saw its yield decline 8 basis points to 4.76%. The yield on Fannie Mae benchmark mortgage-backeds dropped 11 basis points. The 10-year dollar swap spread narrowed 0.5 to 39.25. Corporate spreads generally narrowed throughout the week, at least until today’s Treasury melt-up. Market trading dynamics have completely pushed fundamentals to the side, as was captured by Agnes T. Crane, of Dow Jones, in his afternoon Treasury commentary. “Traders said speculators, or those investors who tend to trade the market on a short-term basis, drove the rally while portfolio managers and individual investors stood aside waiting for the dust to clear before making any changes to their asset allocations. ‘I don’t think the end buyers have capitulated yet to the lower rate environment’ said John Spinello, bond market analyst at Merrill Lynch… With the 10-year holding near 3.80%, mortgage investors could emerge as big buyers next week as the lower rate environment forces them to protect their holdings against lower rates and another wave of mortgage refinancings. ‘There’s much more concern about the potential for the convexity guys to kick in here,’ said Thomas Girard, senior portfolio manager at Weiss, Peck & Greer… Although overshadowed by the jobs report, the Bank of Japan’s massive intervention in foreign markets is likely to lend a bid to Treasurys next week, particularly as it suggests that central bank will be a big buyer in the five-year and 10-year Treasury auctions. Currency traders said the Japanese monetary authority bought at least $10 billion worth of the greenback, with some estimates reaching $20 billion. The purchases boosted the dollar against the yen to a five-month high…” Bloomberg tallied $13.6 billion of corporate issuance this week, the strongest sales in two months. Investment grade issuers included JPMorganChase $1.6 billion, Donnelley & Sons $1.0 billion, Ras Laffan Gas $665 million, HCA $500 million, Cargill $500 million, Allstate Life $350 million, Waste Management $350 million, Jefferies Group $350 million, US Bank $300 million, Masco $300 million, Trinity Industries $300 million, Istar Financial $250 million, US Bank $200 million, Hartford Financial $200 million, Phelps Dodge $150 million, Airgas $150 million, and EOG Resources $150 million. Junk bond funds saw inflows of $135 million during the week (from AMG). Junk issuers included Visteon $450 million, Station Casinos $450 million, WH Holdings $275 million, Global Cash $235 million, Gold Kist $200 million, Evergreen Resources $200 million, Friendly Ice Cream $175 million, Newark Group $175 million, True Temper $125 million, JB Poindexter $125 million, and AMR Rock Salt $100 million. Convert issuers included Amdocs Limited $450 million, MGI Pharma $350 million, Avnet $270 million, Incyte $250 million, First Horizon $125 million, PSS World Medical $125 million, Bell Micro $110 million, Covad Communicaitons $100 million, Willbros Group$60 million, and Intellisync $60 million. Foreign dollar debt issuers included America Movil $1.3 billion, Oester Kontrollbank $1.25 billion, and Indonesia $1 billion. The flood of asset-backed security issuance continues, with $15 billion of new supply this week (from JPMorgan). Year-to-date issuance of $96 billion is running an eye-opening 33% above last year’s record pace. Home-equity loan ABS issuance of $49.7 billion is running 62% above the year ago period. Amazing… Freddie Mac posted 30-year mortgage rates added one basis point this week to 5.59%. Fifteen-year fixed rates dipped one basis point to 4.88%. Meanwhile, one-year adjustable-rate mortgages could be had at 3.47%, down three basis points for the week and down 14 basis points over four weeks. One-year ARM rates out in the West were unchanged at 3.32%. The Mortgage Bankers Association Purchase application index was about unchanged last week. Yet purchase applications were up 21.5% from one year ago, with dollar volume up 42.8%. Refi applications were up 5.0% for the week to the highest level since August. The Average Purchase loan was for $219,300 and the average adjustable-rate loan was for $304,900. According to Friedman Billings research, “ARM activity as a percentage of the total dollar volume of originations continues to inch up, reaching 42.3% for the week.” Broad money supply (M3) increased $14.6 billion during the week of February 23, with 10-week gains of $138.2 billion. Demand & Checkable Deposits rose $7.6 billion and Savings Deposits increased $7.8 billion. Small Denominated Deposits declined $1.0 billion and Retail Money Fund deposits dipped $1.5 billion. Institutional Money Fund deposits rose $6.9 billion and Large Denominated Deposits gained $8.6 billion. Repurchase Agreements declined $12.8 billion and Eurodollar deposits dipped $1.1 billion. Federal Reserve Foreign “custody” Holdings of U.S. Debt, Agencies increased $8.8 billion. After weeks of heady expansion, Bank Credit declined $23.9 billion during the week of February 25. Securities holdings declined $6.3 billion. Loan & Leases dropped $17.7 billion, with Commercial and Industrial loans down $3.4 billion. Real Estate loans were unchanged and Consumer loans declined $2.5 billion. Securities loans were down $5.8 billion and Other loans dropped $6.0 billion. Elsewhere, Commercial Paper (CP) rose $9.0 billion last week. Total Financial CP jumped $9.9 billion to $1.2 Trillion, while Non-financial CP dipped $0.9 billion to $119.5 billion. Total CP is up $51.1 billion during the first nine weeks of 2004 (23% annualized). Currency Watch: Wow. Currency markets have turned tumultuous. The dollar’s modest recovery was brought to an abrupt end with today’s weak employment report. The dollar index ended the week with a gain of less than 1%, although the daily moves were at times stunning. The strongest currencies for the week included the Brazilian real, Canadian dollar, and Mexican peso. The Japanese yen led the losers, dropping almost 3% this week against the dollar on the back on continued strong Japanese intervention. Commodities Watch: March 4 - Market News (Gary Rosenberger): “Prices for steel in the U.S. are soaring on rising raw material costs, strengthening global demand and domestic supply constraints, creating painful inflationary pressures among manufacturers who consume steel, say industry officials. The price for hot-rolled steel, a benchmark product, has more than doubled in the last six months -- with the biggest increases having occurred since January, they say. Producers say the price rise is occurring in the context of unprecedented increases in the cost of raw materials and a global ‘bull market’ for all commodities, from rice to tin, amid a recovering world economy. All have slapped on hefty ‘raw materials’ surcharges on the order of $90 to $100 a ton on top of base price increases in response to unprecedented increases in the price of ore, coke, natural gas and, most critically, scrap steel. Users of finished-steel products complain of severe supply constraints and of enforced price increases amid contracts that are not as ironclad as they thought. But what is clear is that the tables have turned on giant manufacturers that have long squeezed their suppliers -- and suppliers are happy to return the favor. ‘All those companies that were making record profits while their suppliers were losing money are now getting their payback,’ said a major steel distributor. ‘Prices keep changing by the week, by the day and by the minute. As soon as I hang up the phone, there’ll be a new price.’” March 3 –Reuters: “U.S. rough rice prices rose to a 5-1/2-year high on Wednesday on hopes that unexpected rice imports by China would lift prices, and on hopes for U.S. rice sales to Iraq, analysts said.” March 5 - Dow Jones: “India’s crude oil imports during April-January rose 11.2% on year to 75.95 million metric tons due to higher exports of petroleum products and a marginal increase in domestic consumption, an Indian Petroleum Ministry official said Friday… India imports around 70% of its annual crude requirements. During the current financial year ending March 31, the country is aiming to import around 85 million tons of crude oil.” March 3 - Bloomberg (Tracy Withers): “New Zealand’s commodity export prices rose for an eighth month in February led by lumber, aluminum and milk powder, according to Australia & New Zealand Banking Group ltd. An index of prices rose 1.5 percent after a 2.3 percent increase in January. The index is close to a nine-year high…” Crude oil ended today’s session at $37.26, up $1.10 for the week to the highest price since immediately preceding last year’s war with Iraq. May silver closed today at $6.99, up 28.5 cents for the week. While dizzyingly volatile, commodity prices generally held their own this week, even as the dollar was posting strong gains. The CRB index was about unchanged, while the Goldman Sachs Commodity Index (GSCI) gained less than 1%. Monday’s GSCI close was the highest since December 1980 (from Bloomberg). Asia Inflation Watch: March 5 - Bloomberg (Theresa Tang): “Taiwan’s foreign-currency reserves, the third-highest in the world, rose to a record $224.8 billion in February… The Central Bank of China said Taiwan’s foreign reserves, which rank behind those of Japan and China, rose 4.6 percent from $215 billion in January.” March 5 - Bloomberg (Seyoon Kim): “South Korean producer prices had their biggest gain in more than five years in February as vegetable prices rose, and increases in the prices of crude oil and other raw materials made industrial goods more expensive. Producer prices rose 4.5 percent from a year earlier after climbing 3.8 percent in January, the central bank said… That’s their biggest increase since November 1998…” March 2 - Bloomberg (Jasmine Yap): “Hong Kong property sales, mainly of apartments, almost quadrupled in February, gaining for a fifth month as more people bought homes amid an economic recovery… The buying spree has been fueled by an economic rebound in Hong Kong… Property prices have rebounded 34 percent since April, according to Midland Realty Holdings Ltd., the city’s biggest listed realtor.” Global Reflation Watch: March 2 - Bloomberg (Keiichi Yamamura and Tim Kelly): “Japan has spent more than 10 trillion yen ($91 billion) selling its own currency this year in response to rapid changes in the yen’s value against other currencies, Chief Cabinet Secretary Yasuo Fukuda said. Japan’s yen selling was not aimed at helping the U.S ease its current account deficit, Fukuda said…” March 2 - Bloomberg (Tatsuo Ito): “The Bank of Japan’s Deputy Governor Kazumasa Iwata comments on the advantages and disadvantages of the central bank’s monetary policy. The BOJ cut interest rates to zero in March 2001, and currently makes as much as 35 trillion yen ($320 billion) of reserves available to banks. ‘Basically, by supplying abundant liquidity, we eliminate the risk for a liquidity dearth, and thus provide stability to the bond market. Through this, we solidify the path to economic recovery. We’ve been adhering to our monetary easing policy with escaping deflation as our ultimate goal.’” March 4 - Bloomberg (Anjana Menon): “Emerging market companies and governments sold more bonds on international markets last month than in any February to date as Poland, Lithuania and other high-grade issuers sold debt, according to CreditSights Inc. Bond sales on world markets by borrowers from developing countries totaled almost $7 billion during the month, taking issuance this year to $23.1 billion, CreditSights said in a research note. An additional $19 billion may be sold in the next two months, it said.” March 3 - Bloomberg (Shanthy Nambiar and Netty Ismail): “Indonesia sold $1 billion of bonds in its first overseas debt offering in more than seven years, doubling the size of the sale after receiving orders for more than eight times the amount originally sought. The 10-year bonds were priced to yield 6.85 percent, or 2.77 percentage points more than U.S. Treasuries of like maturity…” March 2 - Bloomberg (Julia Kollewe): “U.K. retail sales grew at the fastest pace in 1 1/2 years during the quarter through February, a survey of 223 companies showed, suggesting higher interest rates haven’t hurt consumers’ willingness to spend.” “U.K. manufacturing output is growing at the fastest pace in seven years in the current quarter as companies boost exports, an industry survey shows.” March 2 - Bloomberg (Simon Packard): “French housing starts increased 13 percent in the quarter ended Jan. 31 from a year earlier as homebuilders kept pace with a rise in sales bolstered by borrowing costs near record lows and by tax breaks… Housing permits, a gauge of future demand, rose 21 percent in the same period. New home sales increased 20 percent last year as home-buyers took advantage of cheaper mortgages since the European Central Bank lowered its benchmark interest rate to the lowest for France in 57 years.” U.S. Bubble Economy Watch: March 3 - Bloomberg (Andrew Ward): “The Internal Revenue Service refunded $86.8 billion to taxpayers as of Feb. 27, 10.2 percent more than at the same time last year, as more taxpayers filed returns by computer. The average refund so far this year is $2,230, up 4.4 percent from $2,136 in 2003…” Consumer Debt expanded a stronger-than expected $14.3 billion (8.6% rate) during January, the largest gain since last May. Revolving Credit expanded at an 8.6% rate and Non-revolving increased at an 8.9% rate. During the month, the average new car loan was made for 59.9 months, at 3.20%, at 94% loan-to-value, for $27,240. This week from Freddie Mac: “Freddie Mac announced today that its quarterly Conventional Mortgage Home Price Index found that home values rose 8.4 percent from the fourth quarter of 2002 through the fourth quarter of 2003…The quarterly growth rates show a more marked increase in home values in the fourth quarter. Nationally, home values increased by an annualized rate of 17.8 percent nationwide in the fourth quarter of 2003.” By region (annualized fourth quarter), Pacific was up 29.2%, Middle Atlantic 25.6%, New England 23.9%, South Atlantic 18%, West North Central 15.4%, East North Central 12.0%, Mountain 11.5%, East South Central 8.5%, and West South Central 8.4%. The third quarter 2003 annualized growth rate was revised upward to 5.9 percent.” “The Pacific states continued to maintain their four-quarter streak of leading the nation in annual house-price appreciation, growing at an impressive annual rate of 13.1 percent for the year. The Middle Atlantic states were second in growth with an annual appreciation rate of 11.9 percent. The New England states were not far behind, showing the next largest gain for the nation with an annual home-price growth rate of 11.2 percent. Then came the South Atlantic states, registering a gain of 8.9 percent, followed by the West North Central states with a smaller, but still very healthy, increase of 7.1 percent.” Q4 2003 Z.1 Report – A Banner Year for Asset Inflation: Yesterday the Federal Reserve released the fourth quarter Z.1 “flow of funds.” Once again, the report does not disappoint when it comes illuminating The Great Credit Bubble. During the fourth quarter, Total Credit (non-financial and financial) expanded by a record $804.8 billion ($3.22 Trillion annualized!), or 9.6%, to $34.45 Trillion. This was up from the third quarter’s $671 billion expansion. Non-financial Credit increased $475.2 billion, or 8.7% annualized, to $22.39 Trillion. Financial Sector borrowings expanded by $317.5 billion, or 11.5% annualized, to $11.4 Trillion. A record quarter capped off a record year of Credit creation. For 2003, Total Credit expanded by $2.75 Trillion (up 8.7%). This compares to the nineties’ average of $1.28 Trillion, and was up 17% from 2002’s record Credit growth. Total Credit growth amounted to 25% of GDP. Over the past six years, Total Debt was up $13.12 Trillion, or 62%, while GDP increased $2.68 Trillion, or 32%. Total Debt is now 314% of GDP, up from 1997’s 257% and 2000’s 279%. For the year, Total Non-financial Credit increased by $1.72 Trillion, or 8.3%. This was 20% above 2002’s Non-financial borrowings. In six years, Non-financial Debt has increased from 184% to 204% of GDP. Financial Sector borrowings/Credit expanded $1.04 Trillion during 2003, up 10.1%. Financial Sector Debt growth was up 13% from 2002's increase. Since the beginning of 1998, Financial Sector borrowings have surged from 62% of GDP to 104%. Once again, The Mortgage Finance Bubble fuels extraordinary lending growth that has come to dominate the financial system and economy. For the quarter, Total Mortgage Credit expanded at an annualized $939.2 billion, a rate of 10.2%, to $9.47 Trillion. Mortgage debt has now increased $4.2 Trillion, or 80%, since the beginning of 1998. In the process, the ratio of Total Mortgage Debt to GDP has jumped from 63% to almost 82%. For the year, Total Mortgage borrowings increased a record $1.0 Trillion, or 11.8%. This compares to average annual mortgage growth of $276 billion during the nineties (’90-’97 avg. of $206 billion). Household Mortgage borrowings expanded at an annualized $739.6 billion, a rate of 10.4%, during the fourth quarter to $7.28 Trillion. Borrowings increased $820.0 billion, or 12.7%, for 2003. Household Mortgage debt was up 82% over six years. Recall that “money supply” declined during the fourth quarter. This, atypically, was in the face of an expanding economy and quite liquid financial markets. We now have confirmation that the dip in the monetary aggregates was not caused by a contraction in Credit (anything but!). In fact, Credit excess, along with the historic financial sector expansion, runs unabated. It then becomes all the more informative to delve into the details of financial sector liability creation. It remains my view that the expansion of financial sector liabilities (and, concurrently, asset holdings) provides the key source of market liquidity (not merely the increase in “money” supply). Financial Sector borrowings expanded by a near-record $317.5 billion ($1.27 Trillion annualized), an 11.5% rate, during the fourth quarter. The financial sector expansion continues to be dominated by “structured finance.” GSE asset growth slowed to an annualized $76 billion annualized, or 2.7%, to $2.82 Trillion during the fourth quarter. However, mortgage-backed securities ballooned at an annualized $471.6 billion, or 14.0%, to $3.49 Trillion. Outstanding Asset-backed Securities expanded by an annualized $291.2 billion, or 11.0%, to $2.71 Trillion. Combined “structured finance” (GSE, MBS & ABS) expanded by an annualized $838.8 billion, or 9.5%, to $9.02 Trillion. For the year, GSE Assets expanded by $271.8 billion (10.7%), MBS $330.2 billion (10.5%), and ABS $280.9 billion (11.6%). Total “structured finance” assets increased $882.9 billion, or 10.9%. Over the past six years, GSE Assets have expanded $1.72 Trillion (157%), MBS $1.66 Trillion (91%), and ABS $1.72 Trillion (175%). Total “structured finance” has expanded an incredible $5.1 Trillion, or 131%. As a percentage of GDP, total “structured finance” has increased from 28% to begin 1990, to 48% at the end of 1997, and then to 82% by the end of 2003. So we must remain mindful that GSE debt, MBS and ABS comprise the vast majority of liabilities created in today’s “monetary” expansion. Contemporary finance is a much different animal than traditional bank-lending and deposit-creating finance. During the fourth quarter, total outstanding Agency Securities (GSE debt and MBS) expanded $150 billion ($602 billion annualized), a rate of 10.5%. Meanwhile, Checking Accounts & Currency increased $10.4 billion (2.4% ann.) and Time & Savings Accounts expanded $38.5 billion (3.2% annualized). And illuminating the ongoing historic disintermediation out of the money fund complex (and the overriding cause of the slowdown in the monetary aggregates), we see that Money Market Fund Assets declined by $41 billion ($168bn ann.), an annual rate of 7.9%. At the same time, Fed Funds & Repo surged $180 billion ($719bn ann.) or a rate of almost 50%. Interestingly, declining money supply masked an aggressive fourth quarter Commercial Bank expansion. Bank Assets actually jumped $173.2 billion during the quarter, a 9.1% growth rate (up from the Q3’s 1.0%) Total Loans expanded at a 6.6% rate to $4.4 Trillion, while holdings of U.S. and Agency Securities increased at a 13.9% rate to $1.13 Trillion. Corporate bond holdings expanded at a 19.3% rate during the quarter to $506.4 billion. On the liability side, we already know that Deposit growth was tepid. However, the liability “Federal Funds and Security Repo” was up $96.4 billion (39% annualized) and “Credit Market Borrowings” was up $22.5 billion (14% annualized). But it was not only the banking system that posted strong fourth-quarter growth. Broker/Dealers expanded liabilities $190.4 billion annualized, a 13.4% pace, to $1.52 Trillion. Liabilities were up 21.2% for the year, with “Repos” expanding at a 67% rate during the 4th quarter and 40% for the year to $480.7 billion. Finance Companies expanded at a rate of 12.4% ($165.2 billion annualized) during the fourth quarter to $1.47 Trillion, with liabilities up 17.3% for the year. REITs expanded borrowings at a 15.5% rate during the quarter, with growth for the year at 10.2%. Credit Unions expanded at a 3.2% rate during the fourth quarter, with 2003 expansion at 10.1%. The Federal Reserve expanded its holdings by $18 billion during the quarter, or 9.4% annualized, to $796.9 billion. Fed holdings increased $43.3 billion, or 5.7%, during 2003. Our Washington politicians are certainly doing their part to sustain the Credit Bubble. The federal government expanded its debt by $151.9 billion during the quarter, a rate of 12.8%. Debt increased a record $443.5 billion, or 9.7%, for the year to $5.02 Trillion. This was up from 2002’s borrowings of $283.9 billion. For the year, federal Receipts declined 0.9%, while Expenditures were up 7.7%. State& Local governments increased borrowings by $37.2 billion, a rate of 6.7%. 2003 debt growth of $142.7 billion (6.7%) was actually down from 2002’s $168.4 billion. State & Local Receipts were up 5.3% for the year (benefiting from reflation) and Expenditures were up 5.1%. Historic currency intervention to support the dollar was evident in unprecedented Rest of World U.S. claims accumulation. This has been another important source of liquidity. For the quarter, Rest of World increased holdings of U.S. Financial Assets by $286.4 billion ($1.15 Trillion annualized), a rate of 15.2%, to $7.8 Trillion. Holdings were up $732.9 billion, or 10.4% for the year, more than double 2002’s increase of $319.8 billion. And while Foreign Direct Investment did increase to $31.4 billion during the quarter (7.9% annualized), securities comprise the vast majority of increased foreign holdings. Holdings of Credit Market Instruments (CMI) surged an eye-opening $201.9 billion during the quarter, a growth rate of 22.8%, to $3.74 Trillion. CMI was up $611.3 billion for the year (20%), a 50% increase over 2002’s growth of $406 billion. Official Foreign Holdings of Government Securities increased $68.2 billion during the quarter (27.6% annualized) and was up $158.2 billion for the year (18%). *** I had been anxiously awaiting this Z.1. My curiosity has been focused on general fourth-quarter Credit growth, the degree of financial sector expansion, and the nature of financial sector liabilities created in the process of expansion. But I was also roused to examine the household balance sheet after a quarter and year of rampant “reflation.” We know that despite tepid jobs gains and concerns for the health of the national economy, household spending has been strong. What gives? Well, fourth-quarter data suggests that the Household Sector has never had it so good – financial wealth has never been as high. The Household Balance Sheet is these days a good place to focus Credit Bubble analysis. It is certainly invaluable when it comes to appreciating the immense power of the ongoing reflation. It is today - as was the technology sector and stock market back in 1999 - the epicenter of asset inflation and Bubble dynamics effects. During the fourth quarter, Total Household (and non-profit organizations) Assets surged $2.38 Trillion, or 18.3% annualized, to a record $54.17 Trillion. This was the strongest asset inflation since the wild fourth quarter of 1999. For 2003, Total Assets increased $5.59 Trillion, or 11.5%, surpassing even 1999’s historic increase of $5.51 Trillion. And for comparison, Total Household Assets declined $783 billion during 2002, dipped $67.2 billion during 2001, and increased only $259.4 billion during 2000. Little wonder retail sales are off to such a strong start this year. It is illuminating to dig further into the detail. Household Real Estate holdings were up $632 billion, or 15.9% annualized, to $16.55 Trillion during the fourth quarter. This surpasses the previous record quarterly gain in Real Estate holdings of $378 billion (during Q3 2002) by 67%. For the year, the value of Real Estate holdings surged $1.50 Trillion, or 10%. This was up from last year’s record $1.29 Trillion gain and compares to 1999’s gain of $914 billion. Real Estate holdings have increased from 118% of GDP to 147% of GDP over the past six years. Yet the truly Banner Inflation was registered in holdings of marketable securities. The value of Household Financial Assets holdings jumped $1.7 Trillion during the fourth quarter, or 20.8% annualized, to $34.34 Trillion. For the year, holdings surged $3.93 Trillion, or 12.9%. This was second only to 1999’s record $4.47 Trillion “melt-up.” For comparison, the value of Financial Asset holdings had declined for three straight years: down $2.24 Trillion during 2002, $1.30 Trillion during 2001, and $1.04 Trillion during 2000. Those losses (from inflated values) were largely reversed in twelve months. During the fourth quarter, Household holdings of Deposits increased $63 billion, while holdings of Agencies jumped $110 billion. Expanding 8.7%, Household Liabilities also rose strongly, although from a much smaller base (to $9.76 Trillion). Liabilities increased $207.1 billion during the quarter, less than one-tenth the amount of inflating asset values. For the year, Total Household Liabilities rose a record $944.7 billion, or 10.7%. This was 28% larger than 2002’s record Household debt increase of $735.4 billion. It is also worth noting that Household Liabilities rose during 2003 at almost three times the nineties’ (ten-year) average of $342.7 billion. Some make the seemingly reasonable case that households are “tapped out.” But such analysis does not give Deserved Credit to Asset Bubble Dynamics and the Paramount Importance of Inflating Household Net Worth. During the fourth quarter, Household Net Worth surged $2.16 Trillion, or 20.5% annualized, to a record $44.41 Trillion. This was about 20% of the year’s GDP, and the strongest increase since 1999’s fourth quarter. For the year, Household Net Worth surged $4.65 Trillion, or 11.7%. This even surpassed 1999’s record increase by 15%. Even including ballooning late-nineties’ Net Worth, the average annual increase throughout the decade was $1.68 Trillion ($1.1 Trillion avg. during the first 7 years). Fed Governor Bernanke was out again this week espousing Milton Friedman’s flawed views of the causes of the Great Depression: “The Fed’s first grave mistake, in their (Friedman and Schwartz) view, was the tightening of monetary policy that began in the spring of 1928 and continued until the stock market crash of October 1929… This tightening of monetary policy in 1928 did not seem particularly justified by the macroeconomic environment…. Why then did the Federal Reserve raise interest rates in 1928? The principal reason was the Fed’s ongoing concern about speculation on Wall Street. Fed policymakers drew a sharp distinction between ‘productive’ (that is, good) and ‘speculative’ (bad) uses of credit, and they were concerned that bank lending to brokers and investors was fueling a speculative wave in the stock market.” Well, the Fed is now deeply immersed in “fighting the last war.” Convinced not to rein in leveraging and speculative excess as the Fed belatedly did during the late twenties, the Greenspan Fed instead assures that leveraged speculation runs uninterrupted. One serious problem with this approach is that is ensures that the dimensions of the speculative community balloon over time. Moreover, the scope of the speculators’ impact has a more pronounced influence over an increasing number of marketplaces. All the while, increasingly over-stimulated and distorted markets impart greater deleterious impact on the structure of real economies. We have a ringside seat for the whole process. Today, truly grotesque “easy money” is having its greatest impact on the two kindred sectors with the strongest inflationary biases – housing and the Credit market. And while Dr. Bernanke and the Greenspan may believe we are in a post-Bubble environment, the reality of the situation is that the stock market never was THE Bubble. During the late twenties, the stock market was the key Bubble marketplace – the epicenter of leveraged speculation-created liquidity excess; the liquidity that then meandered about to inflate asset prices, pervert spending and investing decisions, and increasingly distort the fabric of the (U.S. and global) economy. These days the spigot of destructive liquidity runs wide-open throughout the U.S. Credit system (and, of late, globally). And, as we are witnessing, dysfunctional processes have taken complete control. Rampant Credit and asset inflation beckon for higher market rates and restraint. Degenerate markets – over-liquefied from the Fed’s artificially low interest rates, unprecedented global central bank monetization, and years of unparalleled speculative excess - provide the opposite. The Fed was on quite solid analytical footing in the late twenties with its serious concern for runaway speculative excess and its “sharp distinction between productive and speculative uses of Credit.” Their mistake was not that they moved to rein in destabilizing and unsustainable excess, but only that they waited too long as financial systems became only more fragile. As we are witnessing, such problems don’t magically abate. Rather, they mushroom to more dangerous extremes and become increasingly unwieldy. And, as is being experienced throughout the Credit, housing, “emerging,” commodity, and currency markets, the Fed’s strategy of waiting to fight the consequences of a bursting (stock market) Bubble only guarantees its propagation. And come that fateful day when the Great Credit Bubble succumbs, the Fed’s balance sheet is going to look awfully puny in relation to the job at hand. Total Credit is expanding at multiples of Fed Credit, as Banner Years of Asset Inflation significantly compound the Fed’s dilemma.