| At least for a week, it was a running of the bulls. For the week, the Dow gained 1.2% and the S&P500 rose 1.8%. Despite today’s sell-off, the Transports surged 5% to a new all-time high this week. The Morgan Stanley Cyclical index rose 3.6%. The Morgan Stanley Consumer index added 0.1%, while the Utilities declined 0.6%. The broader market was strong. The small cap Russell 2000 and the S&P400 Mid-cap indices each rose 3.6%. Technology stocks were on the fly, with the NASDAQ100 jumping 4.6% and the Morgan Stanley High Tech index posting a 3.7% advance. The Semiconductors surged 6.3%, and the NASDAQ Telecommunications index rose 4%. The Street.com Internet index was about unchanged. The Biotechs surged 5%. The Broker/Dealers jumped 3.9%, increasing y-t-d gains to 22%. The Banks were up 0.6%. Although bullion was hit for $16.50, the HUI index was down only slightly for the week. The Treasury bear is beginning to take a toll. For the week, two-year Treasury yields rose 8 basis points to 4.47%. Five-year government yields jumped 11 basis points to 4.56%. Bellwether 10-year yields rose 9 basis points for the week to 4.66%, the highest level since June 2004. Long-bond yields increased 9 basis points to 4.86%. The spread between 2 and 10-year government yields increased one to 19 bps. Benchmark Fannie Mae MBS yields surged 14 basis points to 5.95%, the highest yield since June 2004. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note and the spread on Freddie’s 5% 2014 note both were about unchanged at 34. The 10-year dollar swap spread increased 4.8 to 55.4, the high since May 2004. Corporate bonds somewhat lagged Treasuries, although junk bond spreads narrowed moderately. The implied yield on 3-month December Eurodollars rose 2 basis points to 4.50%. December ’06 Eurodollar yields surged 12.5 basis points to 4.95%, up 31.5 basis points in two weeks. Investment grade corporate issuance slowed to $6.4 billion. Issuers included Met Life $800 million, Principal Life $400 million, and Cooper Industries $325 million. Junk bond fund outflows increased to $132 million (from AMG). Issuers included Chukchansi Economic Development Authority $310 billion, Atlantic & Western $300 million, and Rural Cellular $175 million. Convert issues included Qwest Communications $1.1 billion and Chesapeake Energy $600 million. Foreign dollar debt issuers included Alliance & Leicester $2.0 billion and Evraz Group $750 million. With Japan’s Topix index at 5-year highs, Japanese 10-year JGB yields rose 9.5 basis points this week to 1.605%. Emerging debt and equity markets were somewhat mixed but remain resilient. Brazil’s benchmark dollar bond yields increased 3 basis points to 7.75%. Brazil’s Bovespa equity index surged 6% (up 17.9% y-t-d). The Mexican Bolsa rose 2% (up 23.1% y-t-d). Mexican govt. yields jumped 7 basis points to 5.80%. Russian 10-year dollar Eurobond yields gained 6 basis points to 6.51%. The Russian RTS equity index surged 8% this week, increasing y-t-d gains to 58%. Freddie Mac posted 30-year fixed mortgage rates jumped 16 basis points to 6.31%, up 60 basis points in eight weeks to the highest level since June 2004. Thirty-year fixed rates were up 61 basis points from one year ago. Fifteen-year fixed mortgage rates surged 16 basis points to 5.85, up 78 basis points in a year. One-year adjustable rates jumped 18 basis points to 5.09. One-year ARM rates were up 61 basis points in six weeks and 109 basis points from one year ago. The Mortgage Bankers Association Purchase Applications Index declined 6.2% last week to the lowest level since February. Purchase Applications were down almost 12% from one year ago, with dollar volume down 4.4%. Refi applications declined 2.8% during the week. The average new Purchase mortgage rose to $242,500, while the average ARM jumped to $371,400. Broad money supply (M3) expanded $10.2 billion (week of October 24). Over the past 23 weeks, M3 has surged $452.8 billion, or 10.6% annualized. Year-to-date, M3 has expanded at a 7.6% rate, with M3-less Money Funds expanding at an 8.5% pace. For the week, Currency added $1.0 billion. Demand & Checkable Deposits jumped $27.6 billion. Savings Deposits fell $36.4 billion. Small Denominated Deposits increased $2.5 billion. Retail Money Fund deposits jumped $6.1 billion, and Institutional Money Fund deposits added $0.1 billion. Large Denominated Deposits gained $5.2 billion. Year-to-date, Large Deposits are up $263.4 billion, or 29.59% annualized. For the week, Repurchase Agreements increased $8.7 billion, while Eurodollar deposits declined $4.7 billion. Bank Credit declined $9.7 billion last week. Year-to-date, Bank Credit has inflated $651.3 billion, or 11.6% annualized (up 10.5% from a year earlier). Securities Credit dropped $22.3 billion during the week, with a year-to-date gain of $147.4 billion (9.3% ann.). Loans & Leases have expanded at a 12.9% pace so far during 2005, with Commercial & Industrial (C&I) Loans up an annualized 16.3%. For the week, C&I loans dipped $1.6 billion, while Real Estate loans gained $6.7 billion. Real Estate loans have expanded at a 14.6% rate during the first 43 weeks of 2005 to $2.847 Trillion. Real Estate loans were up $354 billion, or 14.5%, over the past 52 weeks. For the week, Consumer loans rose $5.0 billion, and Securities loans gained $7.4 billion. Other loans declined $4.9 billion. Total Commercial Paper increased $5.5 billion last week to $1.642 Trillion. Total CP has expanded $228.2 billion y-t-d, a rate of 19.1% (up 19.4% over the past 52 weeks). Financial CP declined $3.4 billion last week to $1.481 Trillion, with a y-t-d gain of $197.1 billion, or 18.1% annualized (up 19.9% from a year earlier). Non-financial CP jumped $8.9 billion to $160.6 billion (up 28.4% ann. y-t-d and 14.6% over 52 wks). ABS issuance slowed to $13 billion (from JPMorgan). Year-to-date issuance of $648 billion is 18% ahead of comparable 2004. Home Equity Loan ABS issuance of $423 billion is 19% above comparable 2004. Fed Foreign Holdings of Treasury, Agency Debt rose $1.47 billion to $1.478 Trillion for the week ended November 2. “Custody” holdings are up $142 billion y-t-d, or 12.6% annualized (up $177bn, or 13.6%, over 52 weeks). Federal Reserve Credit jumped $3.96 billion to $801.9 billion. Fed Credit has expanded 1.7% annualized y-t-d (up $28.5bn, or 3.7%, over 52 weeks). International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi - were up $595 billion, or 17.5%, over the past 12 months to $3.985 Trillion. November 3 – Bloomberg (Halia Pavliva): “Russia’s foreign currency and gold reserves rose to a record $164.3 billion last week as the central bank bought foreign currencies to curb the ruble’s strength… The reserves may rise to about $180 billion by year’s end…” Currency Watch: The dollar index jumped almost 2%. On the upside, the Brazilian real jumped 2.4%, the Argentine peso 1.1%, the Iceland krona 0.9%, and the Chilean peso 0.8%. On the downside, the Polish sloty fell 3.5%, the New Zealand dollar 2.9%, and the Swedish krona 2.7%. Commodities Watch: November 3 – Bloomberg (Simon Casey): “Aluminum rose to its highest in more than 10 years… as consumers of the metal used in cans and aircraft reduced inventory on analysts’ expectations that there will be a shortfall in supply next year. Stockpiles tracked by the London Metal Exchange…today fell to their lowest since May 2001. The 495,500 metric tons left represents less than six days of global demand. Alcoa Inc., the world’s biggest aluminum maker, yesterday said it expects aluminum and parts sales for aircraft to rise 9.1 percent to $2.4 billion this year.” December crude oil fell 64 cents to $60.59. December Unleaded Gasoline dropped 3.5%, while December Natural Gas sank 12.6%. For the week, the CRB index declined 1%, reducing y-t-d gains of 12.3%. The Goldman Sachs Commodities index fell 3%, with 2005 declining to 35.9%. China Watch: November 2 – XFN: “China’s retail sales are expected to reach 6.1 trln yuan ($754 bln) this year, up 13% from a year earlier, Huang Hai, assistant to the commerce minister said. Huang added retail sales are predicted to expand more than 12% to 6.8 trln yuan next year.” November 1 – Bloomberg (Saijel Kishan): “China’s biggest shipping company expects 400 billion yuan ($49 billion) of spending on ports over the next five years as the industry tackles bottlenecks created by the nation’s unprecedented economic boom.” November 2 – XFN: “The Hong Kong Monetary Authority has raised the base rate for its discount window by a quarter percentage point to 5.50%, following a similar increase in the US Federal Reserve’s federal funds rate last night.” Asia Boom Watch: November 3 – Bloomberg (Amit Prakash): “The World Bank raised its 2005 economic growth forecast for East Asia to 6.2 percent from an April estimate of 6 percent, citing faster-than-expected expansion in China. China’s economy will probably expand 9.3 percent, more than an earlier projection of 8.3 percent…” October 31 – Bloomberg (Mayumi Otsuma): “Japan’s central bank said more than seven years of deflation will end this fiscal year and that the chances of it raising interest rates from zero percent will start to increase next April.” November 2 – Bloomberg (Alan Ohnsman): “Toyota Motor Corp. and Honda Motor Co., spurred by new car models, helped Asian auto brands win a record share of the U.S. market in October as sales plunged for General Motors and Ford… The combined market share for Japanese and South Korean automakers rose to 40 percent, up from 35.9 percent a year earlier…” November 1 – Bloomberg (William Sim): “South Korean exports rose to a record and business confidence reached a two-year high last month, suggesting growth is accelerating in Asia’ third-largest economy… Overseas sales rose 13.4 percent from a year earlier to $25.7 billion and business confidence was the highest it's been since February 2004…” November 1 – Asian Business Times: “Thailand’s inflation in October hit 6.2 per cent compared with a year earlier as soaring global oil prices pushed the rate to its highest level since the Asian financial crisis seven years ago... October inflation was the highest since September 1998 when Thailand saw prices rising 7 per cent in the aftermath of the Asian financial crisis. The outcome was also well above the Bank of Thailand’s inflation forecast of 4.5-5.0 per cent for this year…” November 1 – Bloomberg (Aloysius Unditu and Naila Firdausi): “Indonesia’s central bank raised its benchmark interest rate by a record 1 1/4 percentage points, the fifth increase in nine weeks, after a government report showed inflation jumped to a six-year high. Bank Indonesia raised the BI rate…12.25 percent… The bank called a meeting two weeks ahead of schedule after a report showed consumer prices rose a greater-than-expected 17.9 percent in October from a year earlier.” Unbalanced Global Economy Watch: November 3 – Bloomberg (Tracy Withers): “Reserve Bank of New Zealand Governor Alan Bollard said he is willing to raise interest rates ‘in a way that really hurts,’ to dissuade people from unrealistic expectations they can keep borrowing against their homes to spend… People need to stop using their homes as a source of cash, Bollard told Radio New Zealand… Consumer borrowing rose 15.2 percent in September from a year earlier, buoyed by the nation’s near-record-low 3.7 percent jobless rate and a 14 percent surge in New Zealand house prices the past year. ‘That’s why we will keep making these warnings and if necessary take further action…’ The central bank ‘can increase interest rates and we can do it in a way that really hurts.’” November 4 – Bloomberg (Greg Quinn): “Canadian employers hired 68,700 workers in October, more than triple analysts’ expectations, sending the unemployment rate to a 30-year low of 6.6 percent. The biggest job gain in two years was led by 30,100 retail and wholesale positions and 25,600 finance jobs…” November 1 – Bloomberg (Brian Swint): “European manufacturing expanded at the fastest pace in 13 months in October as the retreat of oil prices from a record bolstered the global economy and demand for the region’s exports. An index of manufacturing rose to 52.7 from 51.7 in September…” November 1 – Bloomberg (Craig Stirling): “U.K. house prices jumped the most in 15 months in October after the Bank of England’s August interest-rate cut stimulated demand in Britain's $6 trillion property market, Nationwide Building Society said. The average cost of a home rose 1.3 percent from September to 157,107 pounds ($277,937)…” November 4 – Bloomberg (Craig Stirling): “Insolvency declarations by people in England and Wales rose 46 percent in the third quarter from a year earlier as consumers struggled to cope with record debt. The number of personal bankruptcies and insolvency agreements with creditors in the three months through September was 17,562, up 11.6 percent from the previous quarter and the highest figure since records began in 1960…” November 1 – Bloomberg (Tasneem Brogger): “Danish manufacturing in October expanded at the fastest pace on record led by growth in production, new orders and employment. The purchasing managers’ index in October soared to 70.6 from 62.4 in September…” November 1 – Bloomberg (Tasneem Brogger): “Danske Bank A/S, the largest Nordic lender by assets, raised its forecast for growth in Denmark this year and warned the economy is close to overheating. Denmark’s $244 billion economy will grow 2.9 percent this year, the fastest in five years…” October 31 – Bloomberg (Trygve Meyer): “The pace of borrowing by Norwegian households and businesses in September advanced for an eighth month... Credit growth for households, companies and municipalities accelerated an annual 11.7 percent, the highest since April 2001…” November 2 – Bloomberg (Trygve Meyer): “Norway’s central bank raised its key interest rate by a quarter percentage point to 2.25 percent, the second increase in four months, to cool economic growth…” November 3 – Bloomberg (Halia Pavliva): “Russia’s services industries expanded in October at the fastest pace since January 2004 as the growing economy helped strengthen demand. The seasonally adjusted services index compiled by U.K.-based Moscow Narodny Bank was at 60.7 in October…” November 2 – Bloomberg (Elizabeth Konstantinova): “The economies of the Balkan region, crippled by corruption and civil war for more than a decade, are expanding at three times the pace of the euro region as foreign investment soars, a report released yesterday in Sofia said. The regional economy of Bulgaria, Romania, Albania, Moldova and six former Yugoslav republics grew 5.4 percent in 2004…” November 3 – UPI: “Saudi Arabia’s economy is on the rebound with real gross domestic product growth set to hit almost 7 percent this year. ‘Real GDP for 2005 is set to climb 6.8 percent, the highest growth level achieved in the country for the past two decades,’ says a report from the SAMBA group, the Saudi bank… ‘Nominal GDP will grow 29.8 percent, a phenomenal rise by any economic standards… The Saudi economy is booming and it is at its best performing period ever…’ the SAMBA report says, forecasting a surplus on this year’s current account of over $100 billion.” November 1 – Bloomberg (Mark Bentley): “Turkey’s exports increased 13 percent in October from the same month a year ago, according to preliminary figures released by the Turkish Exporters’ Assembly.” October 31 – Bloomberg (Nasreen Seria): “South African credit growth unexpectedly accelerated to an annual 22.9 percent in September as the lowest interest rates in 24 years boosted consumer borrowing to buy houses, cars and household appliances.” Latin America Watch: November 3 – Bloomberg (Eliana Raszewski): “Argentina’s annual inflation rate rose the most in 29 months in October led by higher clothing prices, the National Statistics Institute reported. Inflation rose to 10.7 percent in the 12 months through October from 10.3 percent in the previous month.” November 4 – Dow Jones: “Venezuela’s automobile industry sold 23,645 vehicles in October, up 74% from the same period last year and a representing a 34.5% rise from September, the Cavenez automobile industry chamber reported Friday. Sales of imported cars have begun to climb in recent months as the economy continues a robust recovery…” Bubble Economy Watch: September Personal Income was up a much stronger-than-expected 1.7%, with a y-o-y increase of 6.3%. September’s 2.9% y-o-y gain in Average Hourly Earnings was the strongest since March 2003. September Construction Spending was up 6.8% from a year ago to a record annualized pace of $1.12 Trillion. Construction spending was up 19% from September 2003. Residential Construction Spending was up 12.9% from September 2004. Retail Sales were robust to begin the fourth quarter. According to the International Council of Shopping Centers, total store Same Store Sales were up 4.4% during the month, an increase from September’s 4.0% and the strongest y-o-y rise since June’s 5.2%. The October ISM Manufacturing Index was a stronger-than-expected 59.1, with Prices Paid up 6 points to 84 (highest since May 2004). The ISM Non-Manufacturing index was up almost 7 points to a stronger-than-expected 60. The Prices Paid component slipped 3 points to 78, second only to the prior month. October 31 – Bloomberg (Kevin Carmichael): “The U.S. government plans to borrow a record $171 billion from January to March, reflecting increased strain on the budget to pay for rebuilding after three devastating hurricanes.” November 3 – Bloomberg (Cotten Timberlake and Lisa Kassenaar): “When Sydney Ramsden complained she didn’t have a purse for her 13th birthday dinner at Manhattan’s ‘21’ Club last year, her mother bought her a black nylon bag -- a $230 Prada ‘pochette.’ ‘It went perfectly with my outfit,’ says Sydney, an eighth-grader at a private, Upper East Side girls’… Teenagers are the new kids on the block for the luxury stores on Madison and Fifth avenues, where retailers pay the world’s highest rents. Fueled by mom’s and dad’s credit cards, girls are snapping up $1,500 bags and $480 cashmere tracksuits… The young customers include daughters of Wall Street bankers and lawyers, set to splurge into 2006 as their parents collect more than $17.5 billion in year-end bonuses…” November 1 – Bloomberg (Demian McLean): “Chief executives’ total pay swelled by almost a third last year to $2.4 million, doubling the rate of growth in 2003, according to a survey.” Speculator Watch: October 31 – Bloomberg (Al Yoon): “Mortgage-backed bond yields are at the highest relative to U.S. Treasuries in more than two years as debt sales outpace demand from investors concerned about potential losses from rising interest rates. The yield on the current coupon 30-year mortgage security increased last week to 5.81 percent, or 1.23 percentage points above 10-year Treasury yields… The yield difference was 0.87 points in January, the smallest in more than a decade. Sales of 30-year mortgage bonds by Fannie Mae, Freddie Mac and Ginnie Mae surged last month to $116 billion, the most since November 2003…” November 1 – Bloomberg (Ann Saphir): “The Chicago Mercantile Exchange, the biggest U.S. futures market, said trading rose 40 percent last month, as investors bought and sold a record number of stock-index contracts and boosted their use of computers to trade options.” October 31 – Bloomberg (Brett Cole): “U.S. private-equity returns rose to 20 percent in the year ended June 30…on an increase in mergers and acquisitions…. Buyout and mezzanine firms had returns of 27 percent in the 12 months…according to a survey by Thomson Venture Economics and the National Venture Capital Association.” October 28 – Bloomberg (Ann Saphir): “The Chicago Board of Trade, whose shares have more than doubled since its initial public offering last week, said third-quarter profit surged 63 percent on higher fees and increased trading.” “Project Energy” Watch: November 3 – Bloomberg (Thomas Black): “Mexico is proposing its state-owned oil company and Central America governments join private investors to build $7.5 billion of energy projects to supply the region with gasoline, natural gas and electricity. Mexico wants to begin the bidding process in the first half of next year on a $3.5 billion oil refinery to be built in Central America and use Mexican crude… Mexico also wants to build an electricity plant powered by petroleum coke and a gasification plant together with Central American countries…” Mortgage Finance Bubble Watch: November 1 – Freddie Mac: “In the third quarter of 2005, 72 percent of Freddie Mac-owned loans that were refinanced resulted in new mortgages with loan amounts that were at least five percent higher than the original mortgage balances… ‘We are forecasting that home equity extraction from the refinancing of prime first mortgage liens will result in an extraction of $204 billion in 2005, up from the $142 billion converted to cash in 2004,’ said Frank Nothaft, Freddie Mac vice president and chief economist… The Cash-Out Refinance Report also revealed that properties refinanced during the third quarter of 2005 experienced a median house-price appreciation of 23 percent during the time since the original loan was made… For loans refinanced in the third quarter of 2005, the median age of the original loan was 2.6 years…” November 3 – PRNewswire: “Median prices for Manhattan condominiums jumped up 22% to $814,000 in the third quarter of 2005 compared to a year ago, according to sales reports released…by the Real Estate Board of New York. There was mixed results for cooperatives as median prices per room for cooperatives set a record for studio/one-bedrooms jumping 24% to $173,000 per room, while overall median prices for cooperatives dipped 2% to $650,000. The reports, the most comprehensive available for the Manhattan market, also showed that Northern Manhattan cooperatives had another record-breaking quarter with median price surges of 54% for cooperatives to $470,000, and 50% for condominiums to $349,000.” The Global Financial Sphere: Representative Kevin Brady: “In your view, what do you see as the real world risk to the large amount of foreign holdings of our U.S. debt? And in the [current] account deficit, while we mostly look at that as a function of what we purchase and what we export, there’s a savings component in that trade deficit that I think is often ignored. Can you give your views to us on what impact we can have, what role that plays in the long term for us?” Chairman Greenspan: “I think as part of the globalization process, which has been accelerating over the recent years - especially since 1995 - in other words, the last decade has been a remarkable period of expanding trade, movement of capital and all the various measures which we use to say globalization has increased. What this has also meant is that, whereas you can compare, for example, the U.S. economy 150 years ago where we had a lot of interstate movement of goods and services and trade deficits between the states but very little outside of our borders. As we expanded into a national market, all of that activity that is going on between peoples in different geographical areas, which creates deficits and creates debt and all the variety of other elements, spills over our sovereign borders and now we look at it in a somewhat different way. But it really is not. I mean, I grant you that there is exchange rate risk and legal risk with respect to the question of whose jurisdiction you’re in. But a lot of what we are observing is economic process, which is adjusted - the markets are gradually adjusting. The big puzzle to everybody is: How is it possible for the United States to have financed more than 6 percent - to have a current account deficit of more than 6 percent of the GDP? It’s one of the major puzzles. And the reason why I believe it exists is that it’s a market phenomenon which is reflecting globalization. It can’t go on indefinitely, as I’ve indicated previously. But a lot of these variables - that is, the big increase in debt holding or U.S. Treasury holdings by foreign central banks or even larger holdings of American debt by foreign citizens - all of this is a build-up which is characteristic of the global markets. At some point, the globalization will slow down. But we’re in a period where it’s been undergoing extraordinary expansion and has had effects we have yet to fully understand. Indeed, one of the problems that we have run into, which was a great surprise to us, is how apparently the globalization forces have - what we would have expected in June of 2004 when we started our tightening of monetary policy - would impact on longer-term rates. It didn’t. And it didn’t because of these extraordinary forces which we’re just now beginning to understand.” So, what “extraordinary forces” might the Federal Reserve “just now beginning to understand”? To commence my analysis, I would like to remind readers that contemporary finance is chiefly a system of electronic journal entries – a massive multi-national computerized ledger of debit and Credit journal entries. Little more, little less. New financial claims are created (out of thin electrons and protons) simply through the power of double-entry “bookkeeping” entries, these days proliferating in unparalleled excess between myriad institutions, companies, entities, vehicles and individuals. There is nowadays – domestically as well as globally – no restriction on the expansion of financial claims (Credit inflation), in terms of either quantity or quality, with the explosion of securities market-based claims underpinned by the perception of all-powerful global central banks. And the vast majority of these new(fangled) claims are created when the financial sector intermediates loans extended to finance asset purchases (largely real estate and securities), a process where Credit inflation augments collateral value (more assets at generally higher prices) and begets only greater lending and intermediation. Analysts and policymakers will surely continue to frame their arguments around the “savings” and “capital” terminology; this despite a contemporary electronic financial apparatus of unrestricted financial claims creation, along with asset-based Credit systems, that has completely invalidated the traditional connotations of these terms. To downplay the risks of The Legacy of Intractable Current Account Deficits, chairman Greenspan enjoys using the comparison to trade between individual American states – in this case going back 150 years. And, sure, I imagine trade was not exactly balanced between geographic locations back then. There were, however, important limitations imposed on the nature of trading relationships. Most trade between states would be of the goods for goods variety. Each state survived without its own central bank to readily create perceived safe money to consummate transactions. Indeed, local banks that were too aggressive in their lending (deposit creation) would in short order face liquidity and solvency issues. Trade imbalances would tend to be driven by market forces, hence would be self-adjusting and correcting. Importantly, trading relationships from 150 years ago were governed by the Economic Sphere – the trading of goods for goods dictated by the interplay of supply and demand (note: gold and gold-backed money would be considered an integral aspect of the Economic Sphere). An expanding Financial Sphere, on the other hand, promotes Credit creation and the trading of financial claims for goods. Left untended, Financial Sphere inflation will foment a progressive process of trade and investment distortions and increasingly chronic imbalances; although for some time generally heightened trade and economic expansion will shield this corrosive process from either investigation or denouncement. Resulting trade imbalances are not generally outwardly problematic in interstate trading – since transactions are consummated and claims/IOUs denominated in the same currency. Financial fragility is not in this case induced by the dynamics of exuberant trading. Each state does not have its individual Financial Sphere in which to inflate its own respective financial claims, thus mitigating Credit inflation’s inevitable wealth redistribution and consequent acrimony, revulsion and financial and economic dislocation. Globalization has become the topic de jour, a curiosity for a process that has been running at full-throttle for quite some time. The role globalization has played in stimulating trade, increasing the supply of inexpensive foreign goods, pressuring developing nation wages, and generally fostering “disinflation” are by now well documented. Today, globalization is acclaimed by bond managers and Federal Reserve policymakers for permanently pressuring interest-rate markets as well. It is this leap of faith for which I today take strong exception. I would like readers to try to think in terms of the distinctions between the Global Economic Sphere and the Global Financial Sphere. For a long, long time the expansion of global market for trading goods and services has played a constructive role in fostering trade, commerce, investment, output and a rising general standard of living. Yet, it is the Global Financial Sphere that has demonstrated momentous change over recent decades – especially over the past twelve years or so. This evolution has gone seemingly unnoticed and its current predicament unrecognized. While global trade boomed, the Global Financial Sphere faced recurring impediments. It struggled with late-sixties U.S. monetary excesses, the post-Bretton Woods inflation and dislocation, the ‘70s oil crises, dollar vulnerability, the (Latin American debt) collapse of petro-dollar bubbles, and general global system instability. The nineties’ emergence of contemporary finance brought with it additional issues and vulnerabilities. The fledgling yet ballooning pool of speculative finance suffered a series of serious setbacks, including boom-turned-bust crises in Mexico, SE Asia, Russia, Brazil and Argentina, nurturing the end-of-decade King Dollar flight to dollar denominated securities. Ironically, ongoing financial tumult was actually constructive for globalization generally. In the Economic Sphere, post-Bubble economies were desperate for the stimulus trade surpluses could provide. At the same time, loose financial conditions in the U.S. and throughout the “developed” world provided abundant cheap liquidity for (over)investment in manufacturing capacity in the (export-oriented) emerging economies throughout Asia. A Financial Sphere in full bloom would have provoked a strong central banker response. In the Global Financial Sphere, the disinflationary environment wrought by the domino crises and resulting decimated Credit systems was just what the U.S. Credit system required to run at elevated levels without manifesting typical inflationary risks or typical Federal Reserve wrath – in the process inciting asset inflation and consequent intense demand for imports. The troubled global backdrop was conducive to an effortless private-sector absorption/accumulation of the inflating dollar financial claims. Moreover, central bankers from the troubled economies were keen to not only rebuild their (largely dollar) foreign reserves but to accumulate a large safety net. And once they began buying and their economies prospering on U.S. Credit Bubble excess, it became near impossible to stop. I am attempting to convey to you a momentous “globalization” process that has been progressing within the context of two distinct but interrelated phenomena. There has been the indomitable Economic Sphere, advancing global trade, investment and production. And there has been the Financial Sphere, enveloped in an ongoing struggle, with fits and starts, the cultivation of contemporary “Wall Street” finance, pervasive asset inflation, serial bubbles and busts, but – in the end - with massive and unending Credit inflation. We have witnessed a phenomenal confluence of economic and financial developments (crises, King Dollar, a ballooning global pool of speculative finance, ballooning central bank balance sheets, etc.) that is today quite risky to extrapolate. It is natural for the optimists to fixate on positive developments emanating from the Global Economic Sphere, without recognizing the prominent role that has and will be played by The Highly Inflated, Erratic and Perpetually Vulnerable Global Financial Sphere. Returning to real world analysis, will “globalization” contain inflationary pressures going forward? Will the “global savings glut” lastingly reduce U.S. and global interest rates? The consensus view says “affirmative” to both, although I liken this to looking through the rearview mirror using a flawed (analytical) prism. Importantly, the Global Financial Sphere is now perpetrating massive liquidity excess unlike anything experienced in the past. Global Credit systems – unleashed from the King Dollar straightjacket and at the same time inundated with global “hot money” liquidity, while these days enjoying surging demand and prices for their exports – have joined the U.S. to create an unprecedented Global Credit Bubble. In stark contrast to the past decade, domestic Credit systems are almost universally robust. Not only has the global pool of speculative finance experienced massive ballooning over the past several years, an overabundance of liquidity now flows throughout the “periphery” (emerging markets) instead of being quickly “recycled” right back to the “core” before it can impart inflationary effects outside of U.S. asset markets. Instead of checking into the infirmary when the U.S. gets the sniffles, the emerging markets now shrug. The major analytical error made of late is to confuse this newfound glut of liquidity for “savings.” This Splurge of Global Financial Sphere Inflationary Excess will not forever lower global market yields - quite the opposite. It is bound for awhile to press global central bankers to raise rates much higher than anyone had anticipated. As the Fed apparently has begun to recognize, the global liquidity glut significantly mollifies the impact of central bank (baby-step) rate increases. This is a similar dynamic to the muting influence global liquidity over-abundance is having on the capacity for rising prices of oil, natural gas, unleaded gas, copper, aluminum, platinum, and other commodities to temper demand. Marketplace liquidity and speculative dynamics have changed profoundly in the 17 months since the Fed was compelled to commence its timid policy reversal. To actually tighten global financial conditions today will entail concerted aggressive central bank rate increases, a scenario thought virtually impossible until recently - and still widely dismissed. While European and Japanese central bankers have domestic issues to contend with, the longer they delay the rate normalization process, the more of a headache created for themselves and the Fed. In advanced contemporary financial markets, liquidity is instantly created and rapidly flows from the lowest cost “producer” to higher yielding targets (“carry trade”), and it is today flowing in destabilizing excess from both Europe and Japan. The Fed and U.S. interest-rate markets are now faced with the (previously unanticipated) dilemma associated with widening rate differentials to these energized Credit systems, both inciting a reversal of speculative positions and enticing “hot money” flows. This liquidity will continue to mitigate the tightening influence from rising U.S. mortgage rates, in the process prolonging the inflationary boom and delaying the desperately needed adjustment process. The Mighty Global Financial Sphere expansion ensures that inflation is no longer a domestic issue. The Fed, or individual central banks for that matter, has lost control of the process. Talk today that the Fed has about reached “neutrality” is nonsense. The massive U.S. Current Account Deficit remains that greatest imbalance exacerbating the destabilizing global liquidity glut. Inflationary pressures are poised to broaden and become only more destabilizing until the Current Account is brought under control. To be sure, $800 billion Current Account Deficits are not indicative of rate neutrality. The highly leveraged U.S. Credit system is today a real wildcard. Huge bets were placed on a scenario altogether different than the one I have described. Never has a rate scenario seemed as pre-ordained, and never have leverage and derivatives been as easily incorporated into trading strategies. The speculators were banking on a fragile backdrop conducive to the Fed wrapping up their operations early and easy. It hasn’t been early and it’s not going to be easy. The speculating community also expected the U.S. consumer to buckle under higher energy prices and rising mortgage rates, not anticipating the mitigating influence the unprecedented global liquidity backstop would impose. The Mortgage Finance Bubble soldiered on and fueled ongoing asset price inflation and income gains, with global Credit systems playing aggressive catch up. As such, the U.S. Current Account was this year accommodated by rampant global Credit excesses and widening interest-rate differentials. This put the dollar bear trade in harm’s way, with the status of the myriad currency/interest-rate differential derivative plays now very much in question. Global Financial Sphere inflation is always evolving; its manifestations changing and tending to adapt and mutate rapidly at times. The current strain of global Credit inflation is as extreme as it appears resilient. This creates an extraordinary backdrop commanded by a confluence of overabundant and unwieldy liquidity, along with an enormous and powerful global speculator community. Global central bankers have their hands full. If only the Fed would have moved more quickly and aggressively… |
Tuesday, September 9, 2014
11/04/2005 The Global Financial Sphere *
