10/06/2004 Sphere Analysis *

Energy worries and tough talk from central bankers weighed on global equities.  For the week, the Dow and S&P500 were hit for 2.6%.  The Transports fell 1.7%, and the Morgan Stanley Cyclical index was walloped for 3.4%.  The Morgan Stanley Consumer index declined 1.5%, and the Utilities sank 3.8%.  The broader market was under heavy selling pressure.  The small cap Russell 2000 dropped 3.5% and the S&P400 Mid-cap index fell 3.3%.  The NASDAQ100 declined 2.9%, and the Morgan Stanley High Tech index fell 2.3%.  The SOX sank 3%, The Street.com Internet Index 2.7%, and the NASDAQ Telecommunications index 2.7%.  The Biotechs were hammered for 4.7%.  The financial stocks outperformed, with the Broker/Dealers down 2% and the Banks 1%.  Although bullion jumped $5.55 (to another 17-year high), the HUI gold index declined 1% this week. Treasuries were unimpressive in the face of weak global equity markets.  For the week, two-year Treasury yields added one basis point to 4.18%.  Five-year government yields rose 3 basis points to 4.22%.  Bellwether 10-year yields added two basis points for the week to 4.35%.  Long-bond yields were about unchanged at 4.57%.  The spread between 2 and 10-year government yields widened one to 17 bps.  Benchmark Fannie Mae MBS yields jumped 5 basis points, once again underperforming 10-year Treasuries. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note was unchanged at 30, and the spread on Freddie’s 5% 2014 note was also unchanged at 30.  The 10-year dollar swap spread widened 0.25 to 46.25.  Corporate bond spreads were little changed, with junk bond spreads widening slightly.  The implied yield on 3-month December Eurodollars was unchanged at 4.385%.  December ’06 Eurodollar yields added 0.5 basis points to 4.615%.         Investment grade corporate issuance slowed to about $7.0 billion.  Issuers included Lowes $1.0 billion, Seminole Tribe $730 million, Dover Corp $600 million, Developers Diversified Realty $350 million, MGIC $300 million, Duke Energy $200 million, Washington REIT $150 million, and Puget Sound Energy $150 million.  Junk bond funds saw outflows drop to $69.4 million (from AMG).  Issuers included Iffinion Group $270 million, Activant Solutions $185 million, Sunstate Equipment $150 million, Pregis Corp $150 million, and Dycom Industries $150 million. October 5 – Dow Jones (Matthew Cowley):  “Indonesia on Wednesday sold $1.5 billion in 10 and 30-year bonds, as rampant investor demand for emerging market debt eclipsed concerns over sky-high oil prices and terrorism in the Asian nation.  The successful bond offering…comes as risk premiums on emerging market debt are at near-record lows, opening up avenues of cheap funding for companies and governments alike.” Foreign dollar debt issuers included Indonesia $1.5 billion and Banco Votorantim $200 million. Japanese 10-year JGB yields rose 3 basis points this week to 1.50%.  Emerging debt and equity markets were under pressure.  Brazil’s benchmark dollar bond yields jumped 27 basis points to 7.55%.  Brazil’s Bovespa equity index dropped 5%, reducing y-t-d gains to 14.4%.  The Mexican Bolsa declined 4% (up 19.5% y-t-d).  Mexican govt. yields rose 15 basis points to 5.55%.  Russian 10-year dollar Eurobond yields jumped 17 basis points to 6.27%.  The Russian RTS equity index fell almost 6% this week (up 54.5% y-t-d).  Freddie Mac posted 30-year fixed mortgage rates jumped 7 basis points to 5.98%, a 27-week high and up 16 basis points from one year ago.  Fifteen-year fixed mortgage rates rose 7 basis points, to 5.54%.  One-year adjustable rates jumped another 9 basis points to 4.77%, up 31 basis points in three weeks.  One-year ARM rates were up 69 basis points from the year ago level.  The Mortgage Bankers Association Purchase Applications Index dipped 1.9%.  Purchase Applications were up 3% from one year ago, with dollar volume up 11.6%.   Refi applications were unchanged during the week.  The average new Purchase mortgage increased to $243,900, while the average ARM was about unchanged at $367,600.  The percentage of ARMs rose to 29.8% of total applications.     Broad money supply (M3) jumped $20.3 billion to a record $9.984 Trillion (week of September 26), with a noteworthy 19-week gain of $359 billion, or 10.2% annualized.  Year-to-date, M3 has expanded at a 7.1% rate, with M3-less Money Funds expanding at an 8.0% pace.  For the week, Currency added $1.3 billion.  Demand & Checkable Deposits jumped $13.6 billion.  Savings Deposits dropped $21.0 billion. Small Denominated Deposits added $1.9 billion.  Retail Money Fund deposits increased $2.0 billion (7 straight gains), while Institutional Money Fund deposits declined $4.6 billion.  Large Denominated Deposits jumped $16.0 billion.  Year-to-date, Large Deposits are up $232 billion, or 28.7% annualized.  For the week, Repurchase Agreements increased $11.3 billion, and Eurodollar deposits added $0.4 billion.                Bank Credit expanded $15.9 billion last week.  Year-to-date, Bank Credit has inflated $643 billion, or 12.7% annualized (up 10.7% from a year earlier).  Securities Credit added $3.3 billion during the week, with a year-to-date gain of $169.1 billion (11.8% ann.).  Loans & Leases have expanded at a 13.4% pace so far during 2005, with Commercial & Industrial (C&I) Loans up an annualized 17.5%.  For the week, C&I loans gained $5.1 billion, while Real Estate loans rose $2.7 billion.  Real Estate loans have expanded at a 14.5% rate during the first 39 weeks of 2005 to $2.82 Trillion.  Real Estate loans were up $363 billion, or 14.5%, over the past 52 weeks.  For the week, Consumer loans dipped $1.1 billion, while Securities loans added $0.2 billion. Other loans expanded $5.7 billion.    Total Commercial Paper dipped $1.8 billion last week to $1.610 Trillion.  Total CP has expanded $196.1 billion y-t-d, a rate of 18.0% (up 20.4% over the past 52 weeks).  Financial CP added $0.1 billion last week to $1.469 Trillion, with a y-t-d gain of $184.5 billion, or 18.7% annualize (up 21.4% from a year earlier).  Non-financial CP declined $1.9 billion to $141.1 billion (up 11.6% ann. y-t-d and 10.2% over 52 wks). October 3 – Bloomberg (Walden Siew):  “The finance units of General Motor Corp. and Ford Motor Co. are among companies that may sell a record $100 billion in debt backed by loans this year after the two biggest U.S. automakers’ debt was cut to junk in May, Standard & Poor’s said.” ABS issuance was up somewhat this week to $14 billion (from JPMorgan).  Year-to-date issuance of $583 billion is 18% ahead of comparable 2004.  Home Equity Loan ABS issuance of $380 billion is 20% above comparable 2004. Fed Foreign Holdings of Treasury, Agency Debt dipped $198 million to $1.464 Trillion for the week ended October 5.  “Custody” holdings are up $128.0 billion y-t-d, or 12.5% annualized (up $172bn, or 13.3%, over 52 weeks).  Federal Reserve Credit declined $402 million to $800.2 billion.  Fed Credit has expanded 1.6% annualized y-t-d (up $35.3bn, or 4.6%, over 52 weeks).  International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi - were up $600 billion, or 17.8%, over the past 12 months to $3.962 Trillion. October 6 – Bloomberg (Bradley Cook):  “Russia’s foreign currency and gold reserves are about $163 billion as of today, Interfax reported…  The reserves stood at $160 billion at the end of September…” Currency Watch: Currency markets were especially unsettled this week.  The dollar index reversed from earlier strength to end the week down about 0.5%.  On the upside, the Indonesian rupiah jumped 2.5%, the Swill franc 1.9%, the Danish krone 1.8%, and the Euro 1.8%.  On the downside, the South African rand fell 1.5%, the Argentine peso 1.0%, the Canadian dollar 0.7%, and the Mexican peso 0.7%.     Commodities Watch: October 3 – Financial Times (Kevin Morrison ):  “The rise in natural gas prices to record highs last week has replaced healthcare expenses for workers as the biggest cost concern to US manufacturers. Industries from chemicals to steel complain that the sevenfold increase in US gas prices over the past four years will cause more manufacturers to move offshore.” October 7 – Bloomberg (Rip Watson):  “Persistent delays in Mississippi River barge shipments are driving up agricultural shipping costs… Spot charter rates for barges are triple the average for the past three years, Weeden Co. analyst Kevin Starke said… Shipping costs rose 25 percent in a month, National Corn Growers Association economist Paul Bertels said.” November crude oil sank $4.40 to $61.84.  November unleaded gasoline fell 13% this week and November Natural Gas dropped 5%, although neither gave up all of last week’s gains.  For the week, the CRB fell 2.3%, reducing y-t-d gains to 14.5%.  The Goldman Sachs Commodities index sank 5.5%, with 2005 gains slipping to 42.9%.   China Watch: October 3 – China Knowledge:  “Credit and debit card payments in Beijing, Shanghai, Guangzhou, and Shenzhen account for 30% of total retail spending, according to the People’s Bank of China…  Total credit and debit card retail spending in China reached RMB 600 ($75bn) billion in 2004, an almost four-fold an increase over RMB 128 billion in 2001…” October 7 – XFN:  “China’s trade surplus will triple to about $90 bln  to $100 bln this year from last year's $32 bln, generating new trade  frictions and adding to pressure for a revaluation of the currency, the China Daily said.  The state-run newspaper cited a Ministry of Commerce report that said a 30% jump in exports to $750 bln will account for much of the increase, outstripping an 18% rise in imports to $660 bln over the same period.” Asia Boom Watch: October 4 – Bloomberg (Kyoko Shimodoi and Mayumi Otsuma):  “Oil price gains may partly need to be passed to Japan’s consumers because companies can’t keep absorbing rising costs, said Hiroyuki Hosoda, the chief government spokesman. ‘That’s an issue companies are discussing about, as oil price are soaring and businesses are under pressure to pass on rising costs’ to consumers, Hosoda told a daily briefing…” October 7 – Bloomberg (Cherian Thomas):  “India’s tax collection rose 19 percent from a year ago to 1.43 trillion rupees ($32 billion) in the six months ended Sept. 30… Direct tax collections, which include taxes on personal income and company profits, rose 24 percent…” October 4 – Bloomberg (William Sim):  “South Korea’s economic growth will accelerate to about 5 percent in the second half as consumer spending picks up and exports remain strong, the Ministry of Finance and Economy said.” October 7 – Bloomberg (Theresa Tang):  “Taiwan’s exports grew in September at the fastest pace in five months, helped by a weaker currency and rising demand from China and Japan for the island's electronics. Shipments rose 8.5 percent from a year earlier to $16.2 billion…” October 4 – Bloomberg (Stephanie Phang):  “Malaysia’s exports grew in August at the fastest pace in five months…   Exports rose 12.5 percent…” October 3 – Bloomberg (Anuchit Nguyen):  “Thailand’s inflation accelerated in September to the highest in seven years as rising fuel prices increased transport and construction costs, adding pressure on the central bank to raise interest rates. The consumer price index rose 6.0 percent from a year earlier…” October 7 – Bloomberg (Anuchit Nguyen):  “Thailand’s revenue from tax collections, profits of state companies and other income rose 13 percent last financial year, boosted by higher corporate earnings and consumer spending, the finance ministry said.” October 3 – Bloomberg (Arijit Ghosh and Aloysius Unditu):  “Indonesia’s inflation accelerated at its fastest pace in 33 months in September… Consumer prices in Southeast Asia’s largest economy climbed 9.1 percent from a year ago…” October 4 – Bloomberg (Amit Prakash):  “Manufacturing in Singapore expanded more than estimated in September to reach its highest level in a year after factories reported gains in export orders and production, a key gauge showed.” October 5 – Bloomberg (Jason Folkmanis):  “Vietnam’s inflation rate accelerated in September as higher fuel prices pushed up costs in industries such as transportation. Consumer prices rose 7.8 percent from a year earlier, up from a 7.3 percent annual gain in August…” October 3 – Bloomberg (Jason Folkmanis):  “Vietnam’s economy accelerated in the in the first three quarters, driven by faster manufacturing growth and a services industry benefiting from the country’s rising consumer wealth and increased tourist arrivals. Gross domestic product expanded 8.1 percent during the first nine months of 2005…” Unbalanced Global Economy Watch: October 4 – Financial Times:  “Oil exporters are the new kids on the global imbalances' block but being new does not make them unimportant: they have been the prime movers in driving trade imbalances higher in the past few years.  The $40 a barrel increase in the price of oil since the beginning of 2002 has shifted $1,200bn a year from oil consuming countries to oil producers.  The magnitudes are not just large in absolute terms. Middle East oil exporters now have a larger current account surplus than the whole of emerging Asia, including China, and their surpluses account for about 30 per cent of the US current account deficit. Include Russia, Nigeria and Venezuela and the importance of oil exporters cannot be overlooked.” October 6 – Bloomberg (John Fraher and Simone Meier):  “European Central Bank  President Jean-Claude Trichet moved closer to raising interest rates for the first time in five years, saying the ECB is becoming increasingly concerned about inflation in the dozen nations using the euro. ‘Strong vigilance with regards to upside risks to price stability is warranted,’ said Trichet… ‘All the elements we have indicate that risks to price stability are on the upside. We will move if needed at any time.’” October 5 – Bloomberg (Sandrine Rastello):  “European service industries growth accelerated more than expected in September, indicating the economy in the dozen nations sharing the euro may be picking up. An index of industries such as banks and airlines rose to 54.7 from 53.4 in August…” October 6 – Bloomberg (Matthew Brockett):  “Factory orders in Germany, Europe’s largest economy, fell for the first time in four months in August, led by a drop in demand from abroad for goods such as factory machinery. Orders dropped 3.7 percent from July, when they jumped 4.1 percent…” October 5 – Bloomberg (Laura Humble):  “U.K. consumer confidence dropped to the lowest in at least 17 months in September, a survey of 1,000 people by Nationwide Building Society showed.” October 5 – Bloomberg (Aaron Pan):  “The surge in U.K. house prices is contributing to ‘binge’ drinking, as younger people who can’t afford houses spend cash on alcohol instead, the Daily Telegraph said, citing a Lancaster University Management School professor.” October 3 – Bloomberg (Jacob Greber):  “Manufacturing growth in Switzerland accelerated to the fastest pace in more than a year in September, an industry report showed today, adding to evidence Europe’s eighth-largest economy is strengthening…” October 3 – Bloomberg (Tasneem Brogger):  “Danish manufacturing growth in September accelerated at the fastest pace since December 2003, led by a surge in new orders and an increase in production.” October 5 – Bloomberg (Paul Tobin and Ben Sills):  “Spain’s industrial production rose the most in 11 months in August as an export-led recovery in France and Germany fed through to Spanish producers. Production at factories, farms and mines increased 3.2 percent from a year earlier…” October 5 – Bloomberg (Bradley Cook):  “Russia lured $10.7 billion in foreign direct investment in the first half of the year, more than double the $4.5 billion it received in the same period last year, the daily Vedomosti said, citing central bank data.” October 5 – Bloomberg (Halia Pavliva):  “Russia’s services industries expanded in September at the fastest pace since May 2004 as the growing economy helped strengthen demand, Moscow Narodny Bank said.” October 4 – Bloomberg (Nasreen Seria):  “South African vehicle sales surged 26 percent in September from a year ago as the lowest interest rates in almost a quarter of a century boosted consumer and business spending, an industry group said.” Latin America Watch: October 6 – Bloomberg (Guillermo Parra-Bernal):  “Brazil’s industrial production rose more than expected in August as companies bolstered output capacity to meet growing demand for home appliances and cars. Output by miners and manufacturers rose 3.8 percent from the year-earlier period, up from growth of 0.6 percent in July…” October 5 – Bloomberg (Daniel Helft):  “Argentina’s annual inflation rate surged to a 28-month high in September as retailers marked up goods on growing consumer demand ahead of the summer season. Consumer prices rose 10.3 percent in the 12 months through September…” October 4 – Bloomberg (Matthew Walter):  “Chile’s inflation rate rose to a 30-month high in September as fruit and vegetable prices soared and  record oil prices drove up transportation and heating costs. Consumer prices jumped 1 percent in the month…” October 5 – Bloomberg (Peter Wilson):  “Venezuela, the world’s fifth-largest oil exporter, expects 2006 spending to rise by at least 16 percent, El Nacional reported, citing the head of the country’s budget office.” Bubble Economy Watch: October 7 – PRNewswire:  “Almost one third (31%) of Americans say they are using more credit to pay the higher prices for energy and other consumer goods resulting from Hurricane Katrina, according to the Cambridge Consumer Credit Index.  19% say they are using less credit, while 50% say they are using the same amount of credit as they did a year ago.” October 3 – Bloomberg (Art Pine):  “Inflation, which Federal Reserve policy makers have proclaimed ‘well-contained’ at least 11 times this year, is threatening to burst its container. Rising energy costs are rapidly spilling over into the prices of everything from a bottle of Pepsi-Cola to a room at the Marriott, sparking concern that such increases are seeping into the pricing patterns of companies, and may accelerate throughout the economy.  ‘The dangers of high energy prices spilling over into core inflation are clearly increasing,’ says former Federal Reserve Governor Lyle Gramley…” October 7 – Reuters:  “U.S. inflation pressures climbed in September to their highest in over five years, according to a report on Friday that suggested the Federal Reserve was right to remain vigilant over price increases. The Economic Cycle Research Institute said its Future Inflation Gauge rose to 122.7 last month, its highest since June 2000, the tail end of the late 1990s economic boom.” October 3 – Bloomberg (Bob Willis):  “U.S. construction spending rose in August to a record, led by a jump in highway projects, and may climb for the rest of the year as rebuilding after Hurricane Katrina accelerates. Spending on construction rose 0.4 percent to $1.109 trillion at an annual rate… Construction spending, which rose 6.1 percent in August from a year earlier will add to economic growth in the second half of the year as government spending picks up following passage of a $286.5 billion highway bill …” October 5 – Bloomberg (Rip Watson):  “North American railroad freight rates, already at ‘unprecedented’ levels, may rise faster in the next six months… according to a Morgan Stanley survey. The survey of 300 customers showed that shippers of coal, grain and other cargo expect an average increase of 5.6 percent, excluding fuel surcharges…” October 3 – Bloomberg (David M. Levitt):  “Manhattan’s office vacancy rate fell to 9.6 percent in the third quarter as demand by large users absorbed available space, said officials of Cushman & Wakefield Inc… Commercial rents in Manhattan, the U.S.’s larges and most expensive office market, rose to $41.35 a square foot from $40.80 the quarter before…” Mortgage Finance Bubble Watch: October 4 – Bloomberg (Kathleen M. Howley):  “Manhattan apartment prices fell 13 percent in the third quarter, the most in 16 years, evidence the most expensive market in the U.S. may have peaked. The average apartment price dropped to $1.15 million from a record $1.32 million in the second quarter, according to a report today from Miller Samuel Inc…and Prudential Douglas Elliman, a Manhattan real estate broker. Prices had soared 30 percent in the previous three months.” October 4 – New York Times (David Leonhardt and Motoko Rich):  “A real estate slowdown that began in a handful of cities this summer has spread to almost every hot housing market in the country, including New York. More sellers are putting their homes on the market, houses are selling less quickly and prices are no longer increasing as rapidly as they were in the spring, according to local data and interviews with brokers. In Manhattan, the average sales price fell almost 13 percent in the third quarter from the second quarter… The amount of time it took to sell a home was also up 30.4 percent over the same period.  In another sign that the housing market might have reached a peak, executives at big home builders have sold almost $1 billion worth of company stock this year. Outside Washington, in Fairfax County, Va., the number of homes on the market in August rose nearly 50 percent from August 2004.”  Sphere Analysis: Sphere Analysis is these days one of the more useful tools available in our analytical toolkit.  There is the Economic Sphere that comprises the makeup and functioning of the real economy (production, services, distribution, imports/exports, employment, spending on goods, services, and investment, etc).  It gets most of the attention from conventional analysts.  And there is the Financial Sphere, loosely embodying the Credit system, financial and asset markets, and the financial system generally.  Its dynamics are of critical significance today, although it doesn’t fall within the context of most analytical frameworks and tends to be ignored.  Credit inflation, by its very nature, is product of Financial Sphere expansion.  Inflationary manifestations, on the other hand, are both Financial Sphere and Economic Sphere phenomena, very much depending on the interplay between the nature of the financial system and structure of the real economy.  The types of predominant inflationary effects vary considerably depending on commanding Monetary Processes and the structure of the underlying economy, along with expectations for prices, business profits and financial returns. I believe that the Federal Reserve made a serious policy error when it aggressively cut rates during the second-half of 2002 and held them at 1% through the first-half of 2004.  And while I appreciate the conventional Wall Street view that the global economy was facing a serious deflationary risk, this threat was exaggerated.   Importantly, the King Dollar Bubble was already in the process of bursting as the Fed initiated its ultra-aggressive monetary stimulation.  I argue strongly that King Dollar Monetary Processes had played an integral role in shaping atypical Inflationary Manifestations during the 1999 to 2002 period - domestically as well as globally.  Historic Credit Inflation was becoming deeply rooted throughout the U.S. Financial Sphere, although the created liquidity/purchasing power was having its most pronounced effect on U.S. asset markets - first technology stocks/telecom debt and later U.S. bonds and housing.  Endemic asset inflation was nurturing an enormous and aggressive speculator community, with contemporary finance commissioning The Community with armaments of astounding sophistication and power. In the Economic Sphere, there were three pronounced spending distortions:  a massive technology investment binge; a housing construction boom; and a wealth-induced consumption boom.  The technology sector provided an extraordinary (unprecedented?) opportunity for wildly inflated expenditures to manifest without fomenting traditional inflationary pressures.  The housing sector also provided an outlet for enormous new purchasing power, with rising home prices and a construction boom also largely outside of traditional inflation radar.  And exuberant homeowner could trade in his Taurus for an Expedition, spend more on a bevy of services, communications, technology, digital media and, of course, imported goods.  He could go “upscale” on everything.  Core CPI was tame and safely out of the fray. The Economic Sphere’s consumption boom was easily accommodated.  Domestically, the transformation to a services-based economy was well underway (also helping buttress the U.S. economy from global manufacturing strains).  The tech, telecom and media booms both promoted spending and provided enormous capacity to absorb elevated expenditures (misdiagnosed as a “productivity miracle”).  Foreign suppliers – especially Asian – had both excess capacity (over-investment and tepid domestic demand) and a hankering for King Dollars that only appreciated in value.  Asia was still recovering from its devastating financial and economic crisis, while Latin America was frantic to stave off a similar regional collapse.  King Dollar offered much more than just a favorable Medium of Exchange for imported goods and energy.  Bubble Dollars were being directly recycled back to booming U.S. securities markets, with Monetary Processes inundating U.S. markets with liquidity at the expense of markets and economies across the globe.  What many interpreted as mounting deflationary pressures and risks were, paradoxically, in realty Inflationary Manifestations engendered by Credit Bubble dynamics and highly dysfunctional Monetary Processes.  But things were about to change and dramatically.  The inevitable bursting of the King Dollar Bubble was to profoundly remake Monetary Processes.  Liquidity from the unrelenting U.S. Credit Bubble was poised to spread across the globe, although our mortgage lending excesses guaranteed that global flows did in no way impinge domestic monetary conditions (liquidity abundance).  The global liquidity onslaught would stimulate economies, markets and prices generally, especially energy, commodities and emerging securities markets that had borne the brunt of the one-dimensional King Dollar monetary regime.  Additionally, the weaker dollar would stimulate U.S. exports and fuel a major investment boom throughout U.S. basic industry (that had been starved of finance during the tech/telecom/Internet boom).  The falling dollar (recognizing the ill-structured U.S. economy) would foster only more egregious Current Account Deficits, ensuring that the liquidity spigot being opened to the world would in no time overflow with excess.  Importantly, the weak dollar and newfound global liquidity would increasingly provide great leeway for domestic Credit systems (especially China and the emerging markets) to expand (inflate), a rather abrupt reversal from the forced discipline imposed by weak and vulnerable currencies and Credit systems.  Synchronized domestic Credit Inflations also buttressed the flagging greenback, postponing a crisis that would have surely subverted Monetary Processes and impaired Credit-creating mechanisms.  Wall Street asset-based finance took strong hold throughout Europe and elsewhere. Here at home, 1% Fed funds provided unneeded rocket fuel for a Mortgage Finance Bubble already well-advanced and demonstrating an especially robust inflationary bias.  Similarly, ultra-loose monetary policy pushed the Global Leveraged Speculation Bubble to blow-off excesses.  Liquidity flooded into the hedge fund community, only to come out the other side as even greater (leveraged) liquidity.  Wall Street balance sheets ballooned to finance customer trades and their own leveraged holdings.  The Credit default swap market became a frenzy of excess, supporting the global boom in debt securities issuance.  An unparalleled Financial Sphere inflation created liquidity more than sufficient to inflate asset markets around the world. It has been remarkable to observe pundits fixate on the deflation thesis throughout history’s greatest Credit Inflation.  The Fed and conventional analysts focused their inflation analysis on the Economic Sphere.  For sure, a rather convincing argument was made that productivity and globalization had forever altered inflation dynamics, analysis that neglects the realty of changing Financial Sphere and Inflation dynamics.  It also became popular to refer to inflated home and securities values as “wealth creation.”  This was all well and good, except for the reality of a massive and relentless Financial Sphere Inflation. There are myriad problems associated with uncontrolled Financial Sphere Inflations.  For one, conventional analysis completely ignores – is oblivious to - them.  When the prevailing Inflationary Manifestation happens to be rising asset prices, there will be no constituency favorable to reining in Credit excess; increasingly powerful interests will, instead, assure their survival.  As we have also witnessed, monetary authorities will be unwilling to even acknowledge - let alone pierce - increasingly commanding Bubbles.  Meanwhile, the combination of abundant liquidity and inflating asset markets ensure the amount of finance committed to speculative pursuits expands exponentially (nurturing a ballooning pool of speculative finance and a Global Liquidity Glut).  To accommodate Financial Sphere excess is to ensure an escalating problem and future crisis. Protracted Financial Sphere expansions transform perceptions and expectations.  Asset inflation is extrapolated and abundant marketplace liquidity is taken as a given.  Optimistic assumptions on future spending patterns are made and are embedded in the economic structure.  Most importantly - wait long enough and the nature of Inflationary Manifestations will change.  Altered inflationary dynamics then catch investors, speculators, businesspersons and policymakers totally unprepared.  Liquidity conditions – so taken for granted during the boom – can change abruptly when the highly leveraged players reverse positions.  When greed inevitably turns to fear, there is no one able and willing to take the other side of enormous speculative trades (a dynamic of critical issue today with the explosion of speculative leveraging and derivative trading).  Debt structures, built so confidently during the asset inflation, become immediately suspect when pumped-up prices reverse.  In the Economic Sphere, the post-Bubble pattern of spending can offer an abrupt and radical departure from expectation.  It is my view that we are in the early stage of some rather profound changes in Inflationary Manifestations.  Not only is there today a Global Liquidity Glut, U.S. securities markets are underperforming much of the rest of the world.  Will the U.S. dollar and securities markets enjoy the traditional benefit of safe-haven status come the next episode of global financial tumult?  There is today global Marketplace Liquidity and Credit Availability like never before.  Inflation expectations have evolved to the point where businesses and governments around the world have serious concerns regarding procuring necessary energy supplies (along with other commodities).  Here at home, we are at the cusp of a full-fledged energy crisis.  Policymakers, executives, business owners, and households will now fear a cold winter, then a hot summer and another active hurricane season and another winter...       Financial Sphere expansion and Rooted Monetary Processes have for too long directed cheap finance for the construction of too many large homes, too many inefficient vehicles, and too much asset-inflation induced over-consumption.  Worse yet, unending Financial Sphere expansion is providing a horde of purchasing power to global economies to compete against us for a limited supply of energy resources.  Monetary Processes have fostered an economy that consumes too much energy and produces too little, along with a global liquidity environment conducive to price spikes and shortages.  It is difficult to see this dynamic sustained for much longer.  Importantly, prevailing Financial Sphere (Credit Bubble) Inflationary Manifestations are being transmuted to the energy arena from the asset markets.  This latest strain of inflation, by its nature, will feed directly through to goods and services prices.  The longer it is accommodated by easy Credit and liquidity, the greater the self-reinforcing “secondary effects.”  Heightened (traditional) inflation will promote various outlets of Credit growth, along with wage and benefit cost pressures, while stimulating a range of economic activity that will tend to underpin inflationary pressures generally.  It appears the Fed is quickly waking up to the risk.  Not only is the Fed regrettably late to this recognition, the reality of the situation is that rampant energy inflation is a global phenomena and issue.  Global liquidity must be reined in, a task no longer accomplished by tinkering with U.S. rates or even stabilizing the U.S. Current Account Deficit.  Here at home, the challenge for the Fed was to actually tighten liquidity and Credit conditions – to bridle the Financial Sphere expansion.  But the Greenspan Fed – much to Wall Street’s satisfaction – focused on the Economic Sphere and system fragility rather than the Financial Sphere’s overwhelming inflationary bias.  Financial Sphere Bubble Dynamics assured that “measured transparent baby-steps” was never going to work.  Instead, it accommodated the Mortgage Financial Bubble blow-off, the Global Liquidity Bubble, and the Great Global Energy Inflation.  Financial Sphere expansion (note: growth in bank Credit, ABS, Wall Street balance sheets, “repos,” hedge funds and foreign official reserves) went to dangerous blow-off extremes and, hence, became much more difficult to control. To what extent the Fed now recognizes its dilemma is unclear.  And while the focus is on how high the Fed will (baby-step) push rates, this misses the larger issue:  Financial Sphere expansion – The Credit Bubble – must be reined in.  The mechanism creating the excess liquidity and Credit must be checked; dysfunctional Monetary Processes must be broken; and speculative impulses that have come to command liquidity dynamics in markets across the globe must be quashed.  And if anyone has any notion that such a feat can today be accomplished without major financial and economic disruption, I suggest they read more financial history. Major Financial Sphere Inflations are not amenable to slowdowns, let alone reversals (faltering liquidity, de-leveraging, marketplace dislocation, economic upheaval, etc.).  But let’s not get too far ahead of developments.  The first order of business is to recognize that the U.S. Credit system must redirect its emphasis.  There is now little alternative than for our economy to devote significantly greater resources to locating, extracting, producing, refining, researching, and conserving energy resources.  Especially since there is little existing slack in the Economic Sphere, the vast resources required for “Project Energy” must be redirected from other sectors.  And it does not take rocket science to see how the distended housing and household consumption sectors play into The New Equation.  Not only are they currently gluttons for system (Financial and Economic Sphere) resources, they are clearly integral aspects of burgeoning inflation problem (too much energy consumption and too much global liquidity). Housing and retail stocks are signaling that an important inflection point has been passed.  To some, developments point to a healthy moderation of growth that will temper inflationary pressures and lend support to the bond market.  To others, the economy is at the edge of a cliff.  I’m not so convinced of either.  Barring financial crisis, it will take some time (and dislocation) before significant resources are redirected from the housing/consumption boom.  In the meantime, the Time is of the Essence Project Energy (not to mention hurricane recovery) will place increasing demands on the system.  Those zestfully awaiting the bursting of the housing Bubble for another (NASDAQ bursting-like) bond market gravy train may instead face something much less hospitable.      There are major Financial Sphere and Economic Sphere developments in the offing.  There’s too much Credit being created and much of it misallocated.  There is, as well, excessive and destabilizing speculation.  These Credit Bubble facets - seemingly innocuous for quite some time - are finally imparting conspicuously deleterious effects on an increasingly maladjusted Economic Sphere.  For good reason, the Fed is getting nervous.  No longer can Federal Reserve and Wall Street analysts simply ignore Financial Sphere developments.  And global central bankers have at this point surely given up hope that the Global Financial Sphere would commence the process of returning to some semblance of order and sustainability with the imminent slowdown in U.S. housing finance.  Not only has U.S. mortgage growth accelerated this year, global central bankers are today facing the prospect of a global energy crises and systemic liquidity-induced asset Bubbles.  They now likely recognize that ultra-loose global monetary conditions have lasted far too long and accommodated precarious excesses.  It’s going to be a very interesting – and I’ll bet tumultuous - fourth quarter.   Central bankers are nervous connoting that the leveraged players are anxious.  And this week did have the feel that the leveraged speculating community “boat” began again to rock back and forth a bit – the energy markets, the currencies, global equities, gold…  And when the boat starts to rock and we know that there are too many on the boat and too many all huddled together for safekeeping, well – unexpected things are bound to happen.