07/08/2004 Outside the Box *

The stock market was weak, with the more speculative areas of the marketplace under the heaviest selling pressure.  For the week, the Dow and S&P500 declined about 1%.  The Transports were hit for 2%, and the Utilities for less than 1%.  Demonstrating relative out-performance, The Morgan Stanley Cyclical index dipped 0.5% and the Morgan Stanley Consumer index declined 0.6%.  The broader market was under pressure, as the small cap Russell 2000 sank 3% and the S&P400 Mid-cap index dropped almost 2%.  The NASDAQ100 declined almost 3% and the Morgan Stanley High Tech index fell almost 4%.  The Semiconductors declined 1%.  The highflying The Street.com Internet index was pounded for 4%, and the NASDAQ Telecommunications index was down 3%.  The Biotechs sank better than 4%.  The financials were under pressure as well, with the Broker/Dealers down 4% and the Banks about 1%.  With bullion up almost $10, the HUI gold index gained 5%.  The Treasury market was happy to tread water after recent strong gains.  For the week, 2-year Treasury yields dipped 1 basis point to 2.52%.  Five-year Treasury yields were unchanged at 3.61%.  Ten-year yields were unchanged at 4.46%, and long-bond yields were unchanged at 5.21%.  Benchmark Fannie Mae MBS yields rose 1 basis point.  The spread (to 10-year Treasuries) on Fannie’s 4 3/8% 2013 note widened 1.5 to 37, and the spread on Freddie’s 4 ½ 2013 note widened 1 basis point to 37.  The 10-year dollar swap spread added 0.25 to 48.25.  Corporate spreads were generally little changed.  The implied yield on 3-month December Eurodollars dipped 1.5 basis points to 2.325%. Corporate debt issuance recovered to a respectable $9.35 billion.  Investment grade issuers included Marsh & McLennan $1.15 billion, TXU Energy $800 million, Canadian National Railways $800 million, Enurance Specialty Holding $250 million, Pulte Homes $400 million, D.R. Horton $200 million, Detroit Edison $200 million, and Camden Property Trust $100 million.  Junk bond funds reported outflows of $439.7 million for the week (from AMG). Junk issuance included NCL $250 million, LG Telecom $200 million, Horizon PCS $125 million, and Forest Oil $125 million.  Foreign dollar debt issuers included Kredit Wiederauf (KWF) $3.0 billion, Ontario Province $1.0 billion, and Brazil $750 million.  Japanese 10-year JGB yields added one basis point for the week to 1.80%.  Brazilian benchmark bond yields rose 20 basis points to 10.69%, giving back about half of last week’s gain.  Mexican govt. yields rose 5 basis points this week to 6.04%.  Russian 10-year Eurobond yields jumped 14 basis points to 6.58%.  The Russian bank system is in the midst of serious tumult, with bank failures and runs recalling 1998.  However, at this point – and especially considering the country’s huge international reserves and cash flows – the risk of 1998-style global financial contagion does not appear significant.  Freddie Mac posted 30-year fixed mortgage rates dropped 20 basis points this week to 6.01% (down 31bps in three weeks), the lowest level since late April.  Fifteen-year fixed mortgage rates dropped 20 basis points to 5.42%.  One-year adjustable-rate mortgages could be had at 4.05%, down 14 basis points.  The Mortgage Bankers Association Purchase application index jumped 15% last week, basically reaching the all-time record posted in January.  Because of the holiday, making y-o-y comparisons is not worthwhile this week.  Refi applications surged almost 28% (off a low base) to the highest level in seven weeks.  The average Purchase mortgage rose to $221,400, and the average ARM jumped to $301,100.  ARMs accounted for 34.1% of applications last week. Broad money supply (M3) jumped $31.7 billion (week of June 28).  Year-to-date (26 weeks), broad money is up $469.6 billion, or 10.6% annualized.  For the week, Currency gained $4.0 billion.  Demand & Checkable Deposits jumped $12.2 billion.  Savings Deposits declined $9.4 billion.  Saving Deposits have expanded $234.6 billion so far this year (14.9% annualized).  Small Denominated Deposits dipped $500 million this week.  Retail Money Fund deposits declined $1.9 billion.  Institutional Money Fund deposits added $5.6 billion, and Large Denominated Deposits rose $9.4 billion.  Repurchase Agreements jumped another $14.1 billion (up $49.1bn in five weeks).  Eurodollar deposits dipped $1.9 billion.       From JPMorgan:  “With $53 billion, June 2004 is second only to March 2004 on the list of highest public issuance of ABS for a single-month.  (First half) supply tallied up to $288 billion, on a record-breaking pace that is up roughly 30% over (first half 2003).” Bank Credit declined $8.7 billon for the week of June 30.  Bank Credit has expanded $278.8 billion during the first 26 weeks of the year, or 8.9% annualized.  Securities holdings rose $11.5 billion.  Commercial & Industrial loans declined $7.1 billion for the week, and Real Estate loans dropped $8.5 billion.  Real Estate loans are up $163 billion y-t-d, or 14.6% annualized.  Consumer loans declined $8.8 billion for the week, while Securities loans added $1.8 billion. Other loans gained $2.3 billion.  Elsewhere, Total Commercial Paper added $500 million to $1.322 Trillion.  Financial CP declined $6.5 billion, with Non-financial CP up $7.0 billion.  Year-to-date, Total CP is up $53.0 billion, or 8.0% annualized. Fed Foreign “Custody” Holdings of Treasury, Agency Debt jumped $10.1 billion to $1.236 Trillion. Year-to-date, Custody Holdings are up $168.8 billion, or 30.5% annualized. Currency Watch: The dollar index declined almost 0.6% to 87.67, its lowest level since the first day of April.  The euro traded above 124 for the first time since mid-March.  The Swiss franc traded to a five-month high and the British pound a three-month high against the greenback.  The Latin American currencies generally underperformed.   The “commodity” currencies performed well.  The South African rand gained almost 2%.  The Australian and New Zealand dollars each added about 1.5%. Commodities Watch: July 9 - Bloomberg (Claudia Carpenter):  "Copper futures in New York rose to a one-month high and are headed for their biggest weekly gain since February on signs of improved demand in China, the world’s biggest buyer. Chinese inventories that rose 20 percent last month fell 1.3 percent this week and have dropped 39 percent in the past year…  Increased demand in China and the U.S. has left global stockpiles at their lowest since 1996 and sent copper prices up 64 percent in the past year.  ‘The Chinese are back buying,’ said James Koppel, a managing director in New York at SG Corporate & Investment Banking, a division of France's Societe Generale SA.  ‘We’re seeing renewed fund interest in all of the metals.’” July 7 – Bloomberg (Stuart Wallace):  “European steelmakers, representing about a fifth of world production, have won ‘massive’ price increases in the third quarter, Sheffield, U.K.-based industry consultant MEPS (International) Ltd. said.  Arcelor SA, the world’s biggest steelmaker, planned price increases of as much as 15 percent this quarter for some of its products. London-based Corus Group Plc, Europe’s third-biggest steelmaker, last month said it would raise prices by at least 25 percent this month and may decide on another one in August.” Copper gained 5% this week.  Wednesday, gold posted its strongest gain in 13 months (up $9.70) and yesterday traded to a 12-week high ($408.35).  For the week, the CRB index rose 1.7 %, increasing y-t-d gains to 6.8%.  With August crude up $1.57 to $39.96, the Goldman Sachs Commodities index added 1.8% (up 14.6% y-t-d), trading above 300 for the first time since June 3. China Watch: July 9 – Bloomberg (Philip Lagerkranser and Tian Ying):  “China’s industrial production growth slowed in June for a fourth month, adding to evidence that government lending curbs are cooling the world’s fastest-growing major economy. Production rose 16.2 percent from a year earlier after gaining 17.5 percent in May…” July 8 – Bloomberg (Janet Ong):  “China’s tax revenue rose by a record 26 percent to 1.3 trillion yuan ($156 billion) in the first half of the year because of strong growth in industrial output and rising consumer and industrial prices, state-owned China Central television reported, citing the state tax bureau.” July 9 – Bloomberg (Christine Harper and Michele Batchelor):  “China’s banks are the  most at risk to a financial crisis and a bailout of the industry would cost about $650 billion or 40 percent of the country's forecast gross domestic product this year, according to Standard & Poor’s. China ‘stands out as the largest system vulnerable to future stress in its banking system,’ S&P said… ‘That said, the Chinese government has sufficient monetary reserves and the banks sufficient liquidity to maintain depositor confidence under most adverse scenarios.’  The nation’s four biggest state-owned banks, including Bank of China, had 1.89 trillion yuan ($228 billion) of bad loans, or about 19 percent of lending at the end of March.” July 7 – Bloomberg (Clare Cheung):  “China’s economy may grow at least 10 percent in the first half of this year, Wen Wei Po reported, citing Vice Premier Zeng Peiyan.  Industrial production, company profits and people's incomes had ‘faster’ growth in the first six months, the Hong Kong newspaper cited Zeng as saying at a forum in  Chongqing.” July 7 – Bloomberg (Jianguo Jiang):  “Shanghai International Port Bureau Group Co. handled 29 percent more containers in the first half of the year, compared with a year earlier, as trade increased…  The port operator handled 6.75 million standard containers in the first half and aims to handle as many as 14 million units in 2004…  The port handled 11.28 million units in 2003…” Asia Inflation Watch: July 7 – Bloomberg (George Hsu):  “Taiwan had its first trade deficit in four years last month as high oil prices pushed imports to a record and demand cooled in China, the biggest buyer of the island’s exports. Taiwan posted a trade deficit, its first since February 2000, of $203 million after recording a $1.2 billion surplus in May… Export growth slowed to 25 percent… July 9 – Bloomberg (Seyoon Kim):  “South Korea’s economic growth probably accelerated to more than 5.6 percent in the second quarter as exports surged, Finance Minister Lee Hun Jai said.  ‘Economic growth may top about 5.6 percent in the second quarter, helped by active exports,’ Lee said…” July 7 – Bloomberg (Seyoon Kim):  “South Korea maintained its economic growth forecast for this year at about 5 percent… South Korea’s finance ministry also raised its estimate for the current-account surplus to $20 billion to $25 billion, from a maximum $6 billion previously, and held its projection for the average jobless rate at about 3 percent.” July 7 – Bloomberg (Seyoon Kim):  “Foreign direct investment into South Korea rose for a second quarter in the April-June period, climbing as companies including Asahi Glass Co. build factories in Asia’s third-largest economy. Foreign direct investment rose 29 percent from a year earlier to $2 billion, the commerce ministry said in a statement in Seoul. For the first half of this year, investment surged 90 percent to $5 billion.” July 8 – Bloomberg (Seyoon Kim):  “South Korean consumer confidence fell to an eight-month low in June, adding to evidence that domestic demand will remain a drag on Asia's third-largest economy.” July 6 – Bloomberg (Francisco Alcuaz Jr.):  “Philippine exports rose in May at their fastest pace in 1 1/2 years as spending picked up in the U.S. and Japan, boosting demand for the nation’s electronic components. Overseas sales, about two-thirds of which are electronics, climbed 15 percent from a year earlier…” July 9 – Bloomberg (Adeline Lee):  “Malaysia’s Prime Minister Abdullah Ahmad Badawi said the country’s economy grew 7 percent in the second quarter and is poised to continue its expansion… The government will undertake projects to stimulate growth in a prudent manner to contain the budget deficit…” July 5 – Bloomberg (Stephanie Phang):  “Malaysia’s companies increased production at the slowest pace in three months in May on concern demand for disk drives and other electronics goods may ease as the Chinese economy cools and interest rates rise in the U.S. Production at Malaysia’s factories, mines and utilities expanded 12.8 percent from a year earlier, compared with a revised 14.5 percent increase in April…” July 6 – Bloomberg (Francisco Alcuaz Jr.):  “Philippine consumer prices rose more than expected in June as higher oil costs drove up transport fares. The central bank said it’s unlikely to raise interest rates this year because inflation will stay within its target.  Consumer prices rose 5.1 percent from a year earlier… That’s their biggest gain since October 2001…” Global Reflation Watch: July 9 – Bloomberg (Greg Quinn):  “Canadian new home prices rose in May at the fastest annual pace since February 1990, jumping 5.8 percent as builders tried to recoup the higher cost of labor and materials such as lumber and drywall. Statistics Canada's index of contractors’ selling prices increased 0.8 percent in May after April’s 0.7 percent gain. Land prices also rose in 13 of the 21 markets the Ottawa-based agency surveyed.” July 5 – Bloomberg (Todd White):  “Spanish lenders, led by commercial banks, are paced to boost home loans by 25 percent this year after mortgage lending rose 1.9 percent in May, the Spanish Mortgage Association trade group said… Economic growth is accelerating in Spain and the benchmark interest rate for home loans has remained below 3 percent for almost two years. That combination is helping spur home buying and mortgage growth, which has so far defied analyst predictions that lending will ebb in 2004.” July 8 – Dow Jones:  “Mexican automobile association AMIA said Thursday that domestic new car sales rose 10.5% to 509,821 units in the first half of the year.  …AMIA President Cesar Flores said Mexicans are likely to purchase 1.15 million new vehicles in 2004. In June alone, Mexicans purchased 80,816 new cars, or 7.5% more than in the same month in 2003.  An abundance of flexible financing plans has helped Mexico’s domestic car market grow in recent years, with consumers purchasing close to one million new vehicles annually.” July 6 – Bloomberg (Romina Nicaretta):  “Brazilian new vehicle registrations increased for a fourth month in June from a year ago as interest rates at a three-year low fuel a recovery in South America’s biggest economy. Registrations of new cars and trucks…rose 30 percent in June to 130,697 units from 100,276 units in the same month last year… Registrations rose 6.2 percent from May.” California Bubble Watch: July 8 – PRNewswire:  “The percentage of households in California able to afford a median-priced home stood at 19 percent in May, an 8 percentage-point decrease compared to the same period a year ago (to the lowest since 1989)…according to a report released today by the California Association of Realtors… The minimum household income needed to purchase a median-priced home at $465,160 in California in May was $108,450, based on a typical 30-year, fixed-rate mortgage at 5.77 percent and assuming a 20 percent downpayment. The minimum household income needed to purchase a median-priced home was up from $84,600 in May 2003, when the median price of a home was $367,630 and the prevailing interest rate was 5.62 percent.” Mortgage Finance Bubble Watch: From Countrywide Financial:  “Monthly purchase activity increased 20 percent over May 2004 to a record $17 billion, and was 33 percent more than June 2003 and accounted for 55 percent of total fundings.  Second quarter purchase volume of $46 billion rose 40 percent over the second quarter of 2003.  Year-to-date purchase activity was $78 billion, nearing the $86 billion in purchase volume produced in all of 2002. Demand for adjustable-rate, home equity and subprime loans remained strong.  For each category, new highs in monthly funding levels were achieved.  Adjustable-rate fundings rose 134 percent over June 2003 to $17 billion, and accounted for 54 percent of monthly funding volume.  Second quarter volume of $49 billion was 138 percent greater than the adjustable-rate volume produced during the prior Year’s comparable quarter.  Year-to-date volume of $82 billion is more than double the $36 billion in adjustable-rate volume produced in all of calendar 2002.”  Record Home Equity fundings of $2.8 billion were up 79% from June 2003, and Record Subprime fundings of $3.7 billion were up 160%.  Bank Assets were up 107% y-o-y to $27.1 billion. From National Century Financial:  “June’s production (mortgage originations) of $4.9 billon and second quarter production of $12.3 billion crowned the best monthly and quarterly production results in our company’s history.”  June originations were up 145% from June 2003, while second-quarter originations were up better than 110%. July 8 – Honolulu Star-Bulletin (Dan Martin):  “Home prices on Kauai topped Maui and Oahu last month, rising to the highest in the state. The median price of a single-family home sold on the Garden Island broke the half-million-dollar barrier in June for the first time to end at a Kauai record of $528,000, according to data from the Hawaii Information Service. That’s up sharply from May’s $472,500, and a 40 percent increase from June 2003’s $375,000… Condo prices on Kauai also hit a record in June, reaching a median $420,000, a 21 percent year-on-year increase…” U.S. Bubble Economy Watch: July 8 – New York Times Op-ed, “Campaign Money Flows Amok:  “This presidential election has already proved to be such a fund-raising bonanza that the parties are facing a crisis: what to call a fat-cat bundler who outstrips any of the current honorifics. To be dubbed a Ranger (Republican) or a Patriot (Democrat) used to mean that one had gone as far as one could go in putting the arm on business colleagues for individual donations, which were then grouped into eye-popping wads. But this year, the Rangers have done so well in meeting their minimum target of $200,000 apiece that the G.O.P. has felt compelled to raise the ante and create a caste of Super Rangers, who must garner a minimum of $300,000 to get, in turn, super-V.I.P perks from grateful candidates. No problem: 62 bundlers have already achieved superstatus. On the Democratic side, 17 bundlers have reached a new level, Trustee, by each delivering $250,000 or more in donations, leaving 171 Democratic Patriots ($100,000 minimum) in their golden dust, according to Public Citizen, a political watchdog group. No previous presidential challenger has raised as much as Senator John Kerry ($180 million and counting), and President Bush is setting a new personal best (more than $216 million this year). As the cost of running balloons at lower levels as well, millionaire candidates keep emerging. Politics was once seen — at least in myth — as a career for poor kids with good people skills. Now we’re getting rich recluses with ambitious handlers.” U.S. Financial Sphere Bubble Watch: General Electric reported Net Income of $3.924 billion, up 3% from the year ago quarter.  Revenues were up 11% y-o-y to $37.0 billion.  “Cost of sales, operating and administrative expenses” was up 21% compared to second-quarter 2003.  Total Assets expanded $35.0 billion (21% annualized), up from the first quarter’s $14.6 billion and the largest increase since the second quarter of 2002.  Consumer Finance Revenues were up 26% from comparable 2003 and Healthcare Revenues were up 40%. Outside the Box We are approaching the 2-year anniversary of the Greenspan/Bernanke “Great Reflation.”  In terms of longevity, this reflation is rather long in the tooth.  And it is the nature of orchestrated inflations to become increasingly destabilizing and unwieldy over time.  This one is proving no different, although the reality that this has been a grander reflation after a prolonged series of escalating inflations suggests an extraordinary degree of unfolding Monetary Disorder.  The late-stage of Reflations can prove an especially trying time for equity investors and speculators.  The general inflationary (company cash flow & profits) and liquidity (inflows & keen speculative interest) backdrops remain seductively enticing, while the experience of picking stocks and sectors takes on the challenge of walking through mine fields.  Disappointment and unfulfilled expectations are an integral aspect of the topping process, although the bullish contingent would not be expected to give up without a heck of a fight. From a broader perspective, earnings reports help to illuminate some of the consequences of Monetary Disorder.  For almost two years now, a veritable deluge of liquidity has spurred both the Financial Sphere and the Economic Sphere.  The monetary inflation driving stock prices (and financial asset prices in general) has been relatively uniform.  Yet the same cannot be said for the real economy, as cumbersome liquidity and speculative flows engender widely divergent effects on sector relative prices, profits, spending and performance.  Especially with the recent slew of technology earnings disappointments, it is apparent that many companies and sectors are increasingly being cast aside by the Post-boom Boom.  While disconcerting to those harboring illusions as to the true state of things, this is exactly what analysts should expect from an environment characterized by deranged lending, massive speculative flows, and resulting destabilizing system liquidity and spending (Monetary Disorder).  Nonetheless, it is these days coming as a surprising disappointment to management and shareholders alike, having confidently anticipated that resurgent markets and a rebounding economy were indicating a return of the (perpetual) boom.  But this is not 1999 - the post-LTCM reflationary environment, where technology was the key sector within the real economy demonstrating the commanding inflationary bias (fueled by myriad bubbles - junk/telecom debt, syndicated bank lending, IPOs, margin debt, derivative leveraging, etc.).  The inflationary bias today, stoked by the Great Mortgage Finance Bubble, is honed in on housing and asset-inflation induced household consumption, along with the industrial/commodity sectors benefiting from the weak dollar, rising prices and (overly) abundant global liquidity.  Meanwhile, the revved up tech sector is poised to lead the process of disappointment. Inflated expectations and wildly divergent sectoral performance create an important disconnect – and an inherent source of instability.  They are the consequence of a strong inflationary bias throughout the Financial Sphere, a bias that works innately to further destabilize the Maladjusted Economic Sphere. This is the fundamental nature of inflationary booms and why – at this stage of acute and cumulative Monetary Disorder - the notion that our system can and will “inflate its way out” of our debt problems is erroneous conjecture and dangerous policy.  And before I leave the issue of heightened stock market instability, I would like to touch further on the issue of Speculative Finance.  Arguably, the retail investor and public mutual fund manager is no longer providing the marginal source of liquidity for the U.S. stock market – no longer the “price setter.”  In this respect, the marketplace has evolved fundamentally over the past few years.  That hedge funds, Wall Street proprietary trading desks, and derivative players have displaced long-term investors as the instrumental source of liquidity is, indeed, a defining characteristic of the Post-boom reflationary Boom.  This development is today worth contemplating. Generally, the commanding nature of speculative finance has been of little interest and, perhaps, relevance during the reflationary bull market.  This, however, should change now that reflation and attendant asset inflation have begun to dissipate at the fringes.  Recalling back to the late-90s stock market bubble, according to ICI data, equity funds received inflows of $944 billion during the 5-year period 1996 to 2000.  The boom culminated during 2000, with “blow-off” flows of $260 billion.  And, despite absolutely dismal market performance, 2001 experienced additional flows of $54 billion.  Flows finally turned negative during 2002, but outflows totaled only $25 billion, or 0.89% of assets.  Flows held up surprisingly well, a dynamic surely fostered by the Fed’s aggressive interest-rate cuts and attendant mortgage Credit excess.  But, importantly for systemic stability, investors did “hold on.” Today, I would strongly argue that the nature of market risk is significantly more problematic.  First of all, one is hard-pressed to envisage a source of marketplace liquidity with anything comparable to the Mortgage Finance Bubble’s capacity to re-liquefy the household sector and financial system.  At the same time, it is my sense that the marketplace is much more complacent now compared to the nervousness associated with the huge flows into equity funds in the late-90s.  When the current bull market succumbs to the bear, speculators (today’s “price setters”) will surely not “hold on” (that’s not what speculators do!).  They will instead liquidate equity positions and hope to redeploy funds to other inflating asset-classes.  And the speculators could very well take these actions in a panic, desperate to get ahead of the crowd.  In regard to the U.S. equity market, there are already indications that flows are gravitating to outperforming foreign markets, currencies, and to better-performing asset classes (i.e. commodities).  More alarming yet, a strong case can be made that 2004 is demonstrating “blow-off” characteristics with regard to hedge funds, proprietary trading, and derivatives – individually and in concert as the infamous “Leveraged Speculating Community.” The current reflation, in so many ways, differs from those that preceded it.  The Great Mortgage Finance Bubble and the ballooning of a global pool of speculative finance are certainly two important facets.  The ballooning of global central bank balance sheets is a third that doesn’t get the attention deserved. To this point, Asian central bankers have been content to balloon their holdings of U.S. Treasury and agency securities (although the discerning Chinese authorities appear increasingly determined to use dollar liquidity to buy hard assets including crude oil, commodities and machine tools/heavy equipment).  I would posit that global central bankers have viewed their huge dollar purchases over the past year or so as more a response to a temporary market dynamic than the commencement of massive ongoing dollar support.  But with persistent dollar weakness (chronic imbalances), this view and their analysis as to long-term dollar soundness is due for thorough reevaluation.  While it gets little attention, the ballooning of central bank balance sheets with dollar instruments over the past couple years is one of history’s spectacular monetary inflations.  Ironically, it has to this point also been one of the least outwardly problematic (inflation having been recycled directly back to the expansive U.S. bubbles).  But what is the endgame for historic inflation?  At what point do central bankers become fearful and introspective, then move toward the rational course of “diversifying” away from dollar exposure?  And how might they attempt to procure true economic wealth for their citizens as opposed to electronic dollar balances (IOUs)?  What might they consider acquiring, and what would such a shift in central banking – and the inflationary process - all mean? And while I do not expect central banks to attempt to liquidate dollar positions anytime soon – there would be such limited liquidity – I do expect government authorities (Asian, in particular) to step up their effort to buy “things” other than U.S. bonds.  When I contemplate the potential list of things that they might be able to buy in such quantities to absorb sizable amounts of dollar liquidity, the obvious non-perishable non-obsolescence ones come to a short list of oil & energy products (a strategic energy reserve) and metals.  Surely it was coincidence, but energy and metals prices performed very well this week with a soft dollar. There has been a prevailing view that strong commodities prices were the result of inflated Chinese demand and speculative buying by the hedge fund community.  The thought has been that price gains would prove ephemeral; a Chinese “hard landing” and speculator deleveraging would actually put commodities markets at risk of collapse.  Well, perhaps there’s more to this (inflation) story than meets the conventional eye. I feel compelled these days to attempt to “think Outside The Box.”  Today’s environment is characterized by truly unprecedented non-productive U.S. Credit creation and unprecedented U.S. current account deficits.  Consequently, there is an unparalleled global pool of speculative finance, seemingly beginning to gravitate away from underperforming U.S. financial instruments.  There is, as well, unparalleled global central bank expansion of dollar holdings.  And there is, today, clear potential for an unfolding dynamic I will this evening refer to as “too many dollar balances chasing limited quantities of real ‘stores of value.’”  I am suggesting that the environment increasingly beckons for contemplating the potential for some truly extraordinary financial and economic developments – circumstances that would turn conventional analysis on its head.     I read analyses regarding the appropriate interest rate to stabilize the U.S. economy, but there is simply no rate that would rectify the U.S. financial and economic Bubbles.  There is, as well, some interesting discussion regarding the U.S. and Chinese economies and the global ramifications for potentially concurrent downturns.  But such analysis seems to me premature, while disregarding more pressing global financial issues.  And there continues to be much contemplation and hypothesizing with respect to the ongoing “inflation vs. deflation” debate.  At the same time, I read very little analysis regarding what I regard as the critical factor – the value of our currency.  The dollar is key to so many things. This week I saw indications of flows consistent with increasing dollar nervousness.  The dollar, U.S. stocks (especially the more speculative ilk), and Japanese equities in particular were under selling pressure.  The energy and metals groups were especially strong, and the “commodity” currencies outperformed.  Curiously, both the cyclical and defensive indices – comprising some companies with the potential to benefit from weaker dollar - held up well.  However, financial stocks – especially the securities firms and multi-national “banks” – performed as one might expect in an increasingly risky financial environment.  At this point, it is at least prudent to ponder (“outside the box”) how the world might change in the event of an abrupt and potentially disorderly dollar decline.  I reckon global central banks would have little immediate alternative than to support the dollar, purchases they would at least initially use to buy Treasuries (but watch out for those Credit spreads!).  And as much as the dollar would benefit from higher short-term rates, the Fed would likely look with only greater trepidation at the unknown consequences associated with a deleveraging of the U.S. Credit market.  Some stocks and equity markets would benefit, but U.S. and global equities would generally suffer an understandable bout of “fear of the unknown.”  U.S. stocks could face liquidation by foreign holders.  Asian central bank monetization would, barring financial dislocation, likely further stoke the regional boom.  The Chinese economy, with its pegged-currency, could face unwanted and destabilizing stimulus.  And the imbalanced U.S. Bubble economy could be – by artificially low mortgage rates, a weak dollar and acute Monetary Disorder – jostled into a terminal phase of economic confusion and disarray.      And, in such circumstances, it does not take a wild imagination to envisage a global flight to “stores of value,” including aggressive energy, metals and commodities procurement.  Panic buying of the limited number of perceived safe currencies would be expected.  And, really, I don’t think it requires a dangerous mind to daydream about a wild commodities bidding war, one pitting the enterprising speculators against panicked central bankers.  But I’m getting ahead of myself…