Tuesday, September 9, 2014

07/07/2005 The Flow of Finance *

The week was short, and sweet for the bulls.  For the week, the Dow and S&P500 gained 1.4%.  More impressively, the broader market surged to new record highs.  The Russell 2000 jumped 2.9% to a new high (up 1.6% y-t-d), and the S&P400 Mid-cap index rose 1.8% to a new record (up 6% y-t-d).  The S&P Homebuilding index rose 5.3% to a new record high (up 38% y-t-d).  The Broker/Dealers rose 3.3% to a new record high (up 9% y-t-d).  The Utilities were fractionally higher to a new record high (up 14% y-t-d).  The Biotechs surged 5.3% to the highest level since December 2001 (up 10% y-t-d).  The Morgan Stanley Cyclical index gained 2.1% for the week, and the Morgan Stanley Consumer index added 0.7%.  The Transports gained 2.3%.  The NASDAQ100 gained 2.8%, and the Morgan Stanley High Tech index added 2.5%.  The Semiconductors popped 5.3%, and the NASDAQ Telecommunications index rose 1.8%.  The Banks added 0.7%.  With gold down $4.30, the HUI gold index dipped 1%.

Treasuries were somewhat on the defensive.  For the week, two-year Treasury yields rose 2 basis points to 3.76%.  Five-year yields rose 5 basis points, ending the week at 3.88%.  Ten-year Treasury yields also gained 5 basis points for the week, to 4.10%, and long-bond yields rose 5 basis points to 4.34%.  The spread between 2 and 10-year government yields widened to 34.  Benchmark Fannie Mae MBS yields jumped 7 basis points, again underperforming Treasuries.  The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note was unchanged at 32, and the spread on Freddie’s 5% 2014 note was unchanged at 31.5.  The 10-year dollar swap spread was unchanged at 43.  Corporate bonds generally traded in line with Treasuries.  Auto bond and CDS spreads were mixed, with Ford spreads widening marginally.  Junk bond spreads narrowed this week.  The implied yield on 3-month December Eurodollars rose 2 basis points to 4.09%. 

Corporate issuance slowed to about $5.0 billion.  Investment grade issuers included Lehman Brothers $1.0 billion, American General $700 million, Lennar $500 million, Pitney Bowes $450 million, Bunge $400 million, and Valley National Bank $100 million.     

Junk bond funds reported inflows of $80.7 million (from AMG).  Junk issuers included CNS $500 million.     

Convert issuers included Cephalon $920 million.

July 5 – Dow Jones:  “Global syndicated loan volume surged to $1.5 trillion in the first half of the year, according to Thomson Financial, an increase of more than a quarter from 2004.  The increase was a result of a burst of activity in merger and buyout financing, as well as the continued popularity of refinancing.   In the U.S., which saw $728.7 billion in syndicated loan activity in the first half, leveraged lending took the spotlight, breaking a volume record in the second quarter. Leveraged loan issuance, or those loans rated below investment grade, hit $161.2 billion for the quarter and $276.4 billion for the half.  Volume in the risky loans was driven by a surge in leveraged buyout and acquisition deals…”

Japanese 10-year JGB yields rose 3.5 basis points this week to 1.205%.  Emerging debt markets were under some pressure.  Brazilian benchmark dollar bond yields rose 16 basis points to 7.79%.  Mexican govt. dollar bond yields ended the week up 14 basis points to 5.41%.  Russian 10-year dollar Eurobond yields rose 2 basis points to 6.01%. 

Freddie Mac posted 30-year fixed mortgage rates jumped 9 basis points to 5.62%, down 39 basis points from one year ago.  Fifteen-year fixed mortgage rates rose 8 basis points to 5.20%.  One-year adjustable rate mortgages increased 9 basis points to 4.33%, up 28 basis points from a year earlier.  The Mortgage Bankers Association Purchase Applications Index jumped 9.1%.  Purchase applications were up 23% compared to one year ago, with dollar volume up almost 39%.  Refi applications gained 10.2%.  The average new Purchase mortgage slipped to $238,000.  The average ARM jumped to $350,700.  The percentage of ARMs rose slightly to 30.7% of total applications.    

Broad money supply (M3) jumped $29.9 billion to $9.742 Trillion (week of June 27), with a notable six-week gain of $118.8 billion.  Year-to-date, M3 has expanded at a 5.5% growth rate, with M3-less Money Funds expanding at a 7.0% pace.  For the week, Currency added $0.3 billion.  Demand & Checkable Deposits rose $7.2 billion.  Savings Deposits declined $6.0 billion. Small Denominated Deposits added $3.1 billion.  Retail Money Fund deposits gained $1.3 billion, and Institutional Money Fund deposits jumped $17.6 billion.  Large Denominated Deposits declined $5.8 billion.  For the week, Repurchase Agreements added $1.8 billion, and Eurodollar deposits gained $10.4 billion.               

Bank Credit declined $30.9 billion during the last full week of the quarter.  Year-to-date, Bank Credit has expanded $437.4 billion, or 12.9% annualizedSecurities Credit added $3.8 billion during the week, with the year-to-date gain increasing to $145.8 billion (15.2% ann.).  Loans & Leases have expanded at a 12.5% pace so far during 2005, with Commercial & Industrial (C&I) Loans up an annualized 17.5%.  For the week, C&I loans dipped $2.8 billion, and Real Estate loans declined $6.5 billion.  Real Estate loans have expanded at a 14.5% rate during the first 26 weeks of 2005 to $2.726 Trillion.  Real Estate loans were up $335 billion, or 14.0%, over the past 52 weeks.  For the week, Consumer loans fell $6.0 billion, while Securities loans gained $8.3 billion. Other loans sank $27.7 billion (related to the end of the quarter?).   

Total Commercial Paper dropped $30.1 billion last week to $1.512 Trillion (likely related to end-of-quarter activity).  Total CP has expanded $98.5 billion y-t-d, a rate of 13.4% (up 14.4% over the past 52 weeks).  Financial CP declined $28.4 billion last week to $1.379 Trillion, with a y-t-d gain of $94.2 billion (14.1% ann.).  Non-financial CP dipped $1.7 billion to $133.8 billion (up 6.4% ann. y-t-d and 7.3% over 52 wks).

ABS issuance slowed to $4.0 billion (from JPMorgan).  Year-to-date issuance of $376 billion is 25% ahead of comparable 2004.  At $238 billion, y-t-d home equity ABS issuance is 29% above the year ago level. 

Fed Foreign Holdings of Treasury, Agency Debt dipped $2.2 billion to $1.438 Trillion for the week ended July 6.  “Custody” holdings were up $102.2 billion, or 14.7% annualized, year-to-date (up $202.4bn, or 16.4%, over 52 weeks).  Federal Reserve Credit rose $7.2 billion to $795.8 billion.  Fed Credit has increased 1.3% annualized y-t-d (up $40.8bn, or 5.4%, over 52 weeks). 

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi - were up $593.16 billion, or 18.1%, over the past 12 months to $3.877 Trillion.  Japan’s reserves were up 3.3% y-o-y to $824.97 billion.

Currency Watch:

The dollar index posted a small advance.  Over the past five sessions, the Canadian dollar gained 1.8%, the Swedish krona 0.8%, the Norwegian krone 0.7%, the Argentine peso 0.6%, and the euro 0.5%.  On the downside, the Czech krona declined 1.4%, the Thai baht 1.4%, the South Korean won 1.3%, and the British pound 1.2%.

Commodities Watch:

July 6 – Bloomberg (Saijel Kishan):  “The cost of shipping 2 million barrels of oil from the Middle East to Asia rose to an eight-week high as oil companies and traders booked vessels for August amid limited supplies. ‘Some owners are holding back vessels from the market in order to get higher rates,’ said Per Mansson, a broker at …Nor Ocean… Freight rates for very large crude carriers, or VLCCs, have risen 46 percent in the past two weeks as July bookings surged.”

July 5 – Financial Times (James Mackintosh and Kevin Morrison ):  “The car industry is preparing for the day when oil wells run dry by investing billions of dollars to develop clean and efficient hydrogen-powered vehicles.  But the new fuel comes with its own built-in commodity crisis. Today’s experimental hydrogen fuel cells use so much platinum that there is not enough of the precious metal to replace all the world’s petrol engines.  As Kazuo Okamoto, the new head of research and development at Toyota, Japan's biggest carmaker, says: ‘With the current type of technology we know already that [platinum supplies] will not be sufficient.’ …At the current 60g or so of platinum in each fuel cell, the world’s 780m cars and trucks would use 46,800 tons of the metal - just below the 47,570 tons estimated to be still in the ground.”

July 8 – Bloomberg (Peter McGill):  “Sugar futures closed at their highest in more than seven years in London because of higher-than-expected demand from countries such as Pakistan and Sudan amid declining supplies from Brazil, the world’s biggest producer… White sugar futures have gained 18 percent in the last two months on concern about reduced supplies of the highly refined white sugar… Russia, the world’s largest consumer, increased imports of cane sugar by 20 percent in the first six months…”

July 5 – Bloomberg (Choy Leng Yeong):  “Orange-juice futures in New York rose to their highest price in almost three years on concern that a storm in the Atlantic will damage citrus groves in Florida, the world’s second-biggest orange grower.”

July 6 – Bloomberg (Jason Gale and Megumi Yamanaka):  “Natural rubber prices rose 2.1 percent to a nine-year high in Tokyo on surging tire demand from China and as record oil prices make synthetic alternatives less competitive.  Rubber for delivery in December rose for a 10th day in 11, ending trading up 3.4 yen at 168.7 yen ($1.51) a kilogram on the Tokyo Commodities Exchange, the world’s largest rubber futures market. That’s the highest for a most-active futures contract since March 1996. The futures have rallied 29 percent this year.”

August crude oil rose 88 cents to $59.63.  For the week, the CRB index gained 2%, increasing y-t-d gains to 9.1%.  The Goldman Sachs Commodities index jumped 2.1%, with 2005 gains rising to 28.6%

China Watch:

July 7 – XFN:  “China’s gross domestic product is expected to grow 9.2% year-on-year in the first half of this year, the central bank said… That compares with 9.7% year-on-year growth rate recorded in the first half of last year.”

July 7 – Bloomberg (Wing-Gar Cheng):  “Power demand in Beijing rose to the year’s record yesterday as temperatures surged higher than 35 degrees (95 Fahrenheit) for five consecutive days, the official Xinhua News Agency… About 1,500 companies in Beijing are shutting down for a week on rotation to cut use of power…”
July 6 – Financial Times (Andrew Yeh):  “Beijing has ordered the closure of eight rural credit co-operatives in the sparsely populated western province of Qinghai after panicky depositors attempted to withdraw their savings from the institutions.  A frenetic two-day run on the Kunlun Credit Co-operative in the western city of Golmud in late May was sparked by rumours the lender was on the verge on default. Depositors’ fears surrounding Kunlun spread quickly, prompting similar runs on seven other credit co-operatives in the town… The bank run in Qinghai is a reminder of the fragility of trust in local lending institutions and the challenges faced by Beijing’s bank regulators to clean up the tens of thousands of small banks operating in rural areas.”
July 5 – Bloomberg (Joshua Fellman):  “Hong Kong’s shop rents surged as much as 13 percent in the first half of this year on higher spending by city residents and increased tourist arrivals, property agency Jones Lang LaSalle wrote in a research report.”

July 5 – Bloomberg (Joshua Fellman):  “Hong Kong property sales, mainly of apartments, rose in the first half of 2005 from the same period last year, according to Land Registry… Sales of properties, including factory and office units, jumped 32 percent by value to HK$233.4 billion ($30 billion)…”

Asia Boom Watch:

July 5 – Bloomberg (Theresa Tang):  “Taiwan is considering raising the island’s minimum hourly wage by 12 percent, the Commercial Times reported, citing the Council of Labor Affairs.”

July 7 – Bloomberg (Theresa Tang):  “Taiwan’s exports grew in June at the slowest pace in two years, helping push the trade balance into deficit, as high oil costs damped technology spending in the U.S. and Europe. Shipments rose 3.1 percent from a year earlier to $14.9 billion after gaining 4 percent in May…”

July 6 – Bloomberg (Seyoon Kim):  “South Korea reiterated its economy will expand about 4 percent this year, lower than the government’s initial 5 percent target, and said it will maintain ‘expansionary’ economic policies to boost demand in the second half of this year.”

Unbalanced Global Economy Watch:

July 8 – Bloomberg (Alexandre Deslongchamps):  “Canada’s unemployment rate fell to 6.7 percent in June, matching the lowest level of the last 30 years and suggesting the domestic economy continues to improve. Employers hired 14,200 workers last month, the fifth straight gain.”

July 8 – Bloomberg (John Fraher and Brian Swint):  “German exports, the mainstay of the nation’s economic expansion last year, gained more than expected in May, rising the most in four months as the euro’s decline against the dollar makes the country’s goods cheaper abroad.  Exports, adjusted for work days and seasonal changes, rose 3.8 percent after declining 0.5 percent in April…”

July 5 – Bloomberg (Matthew Brockett):  “Retail sales in Germany, Europe’s largest economy, rose in May amid signs unemployment is receding from a post World War II record and as oil prices dipped. Sales…increased 1.2 percent from April… Today’s results are based on a new, more comprehensive sample of retailers using 2003 as a base year. From a year ago, sales gained 2.7 percent.”

July 5 – Bloomberg (Ben Sills):  “Spanish industrial production grew for a sixth month in seven in May, signaling that Europe’s fifth-biggest economy remains on track to expand at a faster pace than the European Union for an 11th year. Production at factories, farms and mines gained 0.6 percent compared with a year ago…”

July 7 – Bloomberg (Victoria Batchelor and Gemma Daley):  “Australian employers unexpectedly hired extra workers in June, cutting the jobless rate in the Asia-Pacific region’s fifth-largest economy to the lowest in almost 29 years... Employment rose 41,700 last month… The jobless rate fell to 5 percent from 5.1 percent.”

Latin America Watch:

July 5 – Bloomberg (Eliana Raszewski):  “Argentina’s vehicle sales rose in June 26 percent from the same month last year as an economic recovery in its third year has made people more confident about taking loans…”

July 6 – Financial Times (Adam Thomson):  “Argentina’s consumer prices surged 0.9 per cent in June, signalling the return of inflation levels that are a cause for concern among government officials and private-sector economists.  The June figure - published yesterday by Indec, the government’s statistics bureau - brings inflation over the past 12 months to 9 per cent, compared with a rate roughly half that during the previous 12 months.  That sudden jump has brought the issue of inflation to the top of the macroeconomic agenda.”
July 5 – Bloomberg (Heather Walsh):  “Chile’s economy grew at the fastest pace in five months in May, raising the likelihood of an interest rate increase by the central bank to head off inflation. The economy expanded 6.4 percent from a year earlier…”

July 6 – Bloomberg (Alex Kennedy):  “Venezuelan vehicle sales rose 94 percent in June to a three-year high as increased government spending fueled consumer demand.”

July 6 – Bloomberg (Andrea Jaramillo):  “Colombia’s exports rose 36 percent in April, led by oil and coal. Exports rose to $1.73 billion…”

California Bubble Watch:

USA Today (Matt Krantz ):  “Malibu, Calif. — The crazy California real estate market has come to this: a million-dollar trailer.  A two-bedroom, two-bathroom mobile home perched on a lot in Malibu is selling for $1.4 million. This isn’t a greedy seller asking a ridiculous amount no one will pay. Two others sold in the area recently for $1.3 million and $1.1 million. Another, at $1.8 million, is in escrow. Nearby, another lists for $2.7 million.  ‘Those are the hottest (prices) I’ve ever heard,’ says Bruce Savage, spokesman for the Manufactured Housing Institute. He says prices in another hot spot, Key West, Fla., top $500,000. As if the price isn’t tough enough to swallow, trailer buyers: Don’t own the land. As with most mobile homes sold in Malibu, the land is owned by the proprietor of the trailer park, in this case, Point Dume Club.  Still pay rent. Not owning the land means paying what’s called ‘space rent’ that is as high as or higher than many mortgages in other parts of the USA. On the $1.4 million trailer, space rent is $2,700 a month.  Can’t get mortgages. Since the buyers don’t own the land, most of the mobile homes are paid for in cash or with a personal property loan that usually amounts to $100,000 or less… Why would anyone pay seven figures for a trailer? It gets you more than the typical mobile home. The $1.4 million trailer is in a gated, guarded community with a shared tennis court and panoramic views of the Pacific Ocean. It also is on a larger-than-usual ‘triple-wide’ lot.”

California Median Home Prices jumped $12,960 during May to a record $522,590.  Median Prices were up $59,270 (12.8%) over the past year, although this is somewhat deceiving.  Prices were up $138,120 over the past 18 months, or 36%.  Median prices were up $203,000 (64%) over three years and $302,180 (137%) over six years.  Median Condo Prices were up $12,630 during May to a record $420,740 (up 14.9 % since May ’04).  In just 18 months Condo Prices rose $120,130, or 40%.  Condo Prices were up 74% over three years and 153% over six years.  Home sales were down 2.8% from one year ago.  At 2.8 months, the Inventory of Unsold Homes has been relatively stable the past few months.  

Bubble Economy Watch:

July 7 – Bloomberg (Cotten Timberlake):  “U.S. retailers from Wal-Mart Stores Inc. to Nordstrom Inc. posted their biggest sales gain in 13 months in June as warmer weather and job growth spurred purchases of air conditioners and summer clothing.  Sales at stores open at least a year jumped 5.3 percent…, as most retailers beat analysts’ estimates. Wal-Mart…recorded a 4.5 percent rise and Neiman Marcus Group Inc. climbed 9.2 percent. J.C. Penney Co. boosted its second-quarter earnings forecast after a 7.4 percent increase.”

Mortgage Finance Bubble Watch:

July 8 - Dow Jones (Janet Morrissey):  “Real estate mogul Donald Trump is going head-to-head with one of his ex-wives - this time in the real estate arena. Trump and ex-wife Ivana have both jumped into the volatile Las Vegas market, where they are building competing luxury condominium projects.  A groundbreaking ceremony will be held Tuesday to begin construction on Donald’s 64-story Trump International Hotel & Tower Las Vegas… Further north at the end of the Strip, his ex-wife is trying to trump this by putting her name to a development, called the Ivana, that she’s touting will be the tallest residential condominium in Las Vegas at 80 stories.”

July 8 – Bloomberg (Heather Burke):  “Baby boomers returning to New Jersey beaches this summer in search of childhood memories are discovering something else: surging real estate prices.  Home prices along the coast from Sandy Hook to Cape May have more than doubled since 2000… That compares with a 62 percent increase in the rest of the state…  The rise in prices along the 127-mile stretch of Atlantic Ocean is three times as fast as in the rest of the U.S.”

According to Inside Mortgage Finance, year-to-date private mortgage conduit securitizations of $394.89 billion were up 42.4% compared to the year earlier period (“The private conduit market tracks new originations of prime, jumbo, Alt A, subprime and second-mortgage products…”)

Mortgage Bank IndyMac reported record second quarter originations of $14.2 billion, up 51% from the year ago period.  The company also stated that its earnings would be better than expected.
The Flow of Finance:

Bond “optimists” forecast 1% future inflation and 3% bond yields.  Perhaps they will be proven correct.  I may have been slow to figure things out, but the light bulb has finally flickered.  In the contemporary world of unlimited finance and "advanced” (services and asset market-based) economies, inflationary Credit booms are almost always good for bonds.  Since even intense demand for borrowings no longer affects the price of Credit, why not cheer for a borrowing boom?  Flowing liquidity engenders buoyant asset prices – certainly including bonds - on the upside, only for the marketplace to really fall in love with bonds when the boom (including other inflated asset classes and the general economy) appears increasingly vulnerable.  Is love forever? 

Current conventional thinking, along with my belated epiphany, flies in the face of past experience.  Today, Credit growth remains at record levels, and marketplaces at home and abroad are highly liquefied.  History educates – and we have been observing as much in real time - that Inflationary Manifestations become both more prominent and problematic over time commensurate with unwieldy Flows of Finance.  I hope readers will keep an open and inquisitive mind and observe the myriad affects of the increasingly global Credit boom.  The momentous expansion throughout U.S. real estate finance is increasingly augmented by its offshoot, the unfolding energy sector boom.  And it is the nature of inflation to beget greater inflation so long as it is accommodated by abundant liquidity and easy Credit Availability (“easy money”).  Global markets and central bankers could not be much more accommodative.  The mortgage, securities and, now, energy booms are on course to nurture additional inflationary offshoots. 

I suggest that the economy’s underlying resiliency – having been downplayed by many analysts – is consistent with the character of inflationary booms and Bubble economies.  System dynamics feed and are fed upon Credit and speculative excess, responding to myriad price pressures altogether differently than would be the case in a stable monetary environment.  Many businesses are these days enjoying enormous profits while the corporate sector realizes unprecedented cash flows; most households perceive their net worth has never been so high; builders, miners, farmers, and drillers are generally enjoying windfalls; and governments are encouraged by surging tax receipts.  Inflationary Expectations for rising profits; surging home, securities and commodity prices; and expanding government receipts have taken hold and spending is proceeding accordingly. 

Fixation on quiescent core CPI has provided a distinct advantage when it comes to predicting bond prices.  Yet, it does leave one rather inattentive to fascinating inflationary developments raging on multiple fronts.  Whether the bond market or the Fed will ever care is an open issue.  Still, the key dynamic remains the excess Creation and increasingly unwieldy Flow of Finance – most originating from U.S. mortgage and securities finance but increasingly augmented by Myriad Global Credit Booms.

The uneven Flow of Finance certainly sways the nature of U.S. employment growth.  With half the year complete, the 1.088 million jobs created are on pace to match 2004’s 2.194 million.  Many argue the number of new jobs is lagging, although I counter that this is consistent with the nature of highly imbalanced and asset-inflation centric Bubble economies (some do exceedingly well at the expense of many).  So far this year, about 10% (112,000) of newly created jobs have been “Goods Producing,” down from 2004’s already reduced 16%.  Despite the robust economy and the lowest unemployment rate since 2001, the disappearance of manufacturing jobs has actually accelerated somewhat.  Year-to-date losses of 64,000 are nearing 2004’s total of 74,000.  A total of 151,000 construction jobs have been added on top of last year’s 277,000. The economy has added 976,000 “Service Producing” jobs so far this year, a somewhat stronger pace than last year’s total 1.814 million.    So far this year, Retail Trade has added 98,000, Transportation & Warehousing 78,000, Financial 74,000, Business Services 235,000, Leisure & Hospitality 153,000, Education & Health Services 185,000 and Government 54,000.  This type of job creation does not appear conducive to reducing our massive Current Account Deficit, but rather a jobs mix dictated by The Flow of Finance and the resulting boom.

I would argue that the nature of economic activity is today heavily influenced by the massive Creation and Flow of Mortgage Finance.  With unrelenting Fed and marketplace accommodation, the Mortgage Finance Bubble runs dangerously out of control.  A few notable examples this week include USA Today’s million dollar “Mobile Home Madness” article excerpted above.  CNBC ran an online article, “Branching out in a hot housing markets – Investors look to neighborhoods once considered a waste of time.”  And from The New York Times, “Home Sweet Office Tower:”  “Across the country, buildings with character – old garment factories, warehouses, Art Deco skyscrapers and Beaux-Arts firehouses – are being revived as condominiums and loft apartments as cities try to draw residents back to their core.  But with that historic stock depleting, developers are now turning to uglier candidates for condo makeover: moribund office towers.” 

Mortgage Finance is providing an illuminating example of Credit inflation dynamics.  To indulge in the elixir of inflationary excess is to ensure that pressures intensify and broaden.  The Great California Housing Bubble, having come to life during the Silicon Valley Bubble, has spread to Malibu trailer parks and lots in Palmdale.  It is hard to imagine that the median price of homes throughout the entire state has surpassed $520,000, with the strongest price gains (30%+) out in the “High Desert.” Similar dynamics evolve around the nation.

It is worth noting that today’s real estate Inflationary Manifestations evolved directly from extraordinary Fed accommodation.  A massive mortgage finance infrastructure blossomed during the Fed-induced refi booms of 2001 to 2003.  When the easy money refi origination well began to run dry during the second-half of 2003, the industry simply gravitated to ARMs, option-ARMs, no downpayment, negative amortization and other “exotic” mortgages.  The policy alternatives were either Fed-induced wrenching industry “liquidation” or Fed-accommodated massive systemic Credit inflation. 

There is a popular perception that housing and consequent heightened inflationary pressures will quietly burn themselves out.  Well, I believe these types of systemic booms have a powerful proclivity for self-preservation – and they eventually end with bangs!  And even if the burnout scenario did have merit, the boom would not run its course before previously unimaginable real estate excesses had wreaked havoc throughout the system.  I am surprised, especially at this stage of the cycle, that this “harsh reality” viewpoint has so few adherents.  And the complacent view also disregards the capacity for serial booms (today notably, energy, capital goods, commodities, emerging mkts, etc.) to unfold both domestically and globally.  Over time, the system has developed a robust Credit and speculation-induced inflationary bias.  The stronger (and more global!) the bias, the tighter monetary policy necessary to break ingrained Inflationary Expectations (for real estate, bonds, crude, commodities, etc.). 

The Flow of Finance may be imparting a somewhat obscure influence on job creation and the underlying structure of the U.S. economy. Elsewhere, inflationary manifestations are much more conspicuous and dramatic. Energy prices are at record highs, and a veritable wall of liquidity is now inundating oil producing companies, economies and regions. Saudi Arabia’s major stock index is up 55% y-t-d, the United Arab Emirates 97%, Kuwait 35%, Qatar 56%, and Oman 61%. This week the Financial Times (voted the world’s best newspaper!) highlighted the spectacular booms taking root throughout the Middle East.

July 6 - Financial Times (Roula Khalaf, Gillian Tett and William Wallis): “Unlike in previous periods of oil-fuelled prosperity, much the extra funds are being kept within the region. Global banks are scrambling to gain a presence in the Gulf States… Aabar Petroleum Investments, an Abu Dhabi start-up billing itself as the future oil and gas services giant in the Middle East, was looking to raise $135m from Gulf investors earlier this year. But when National Investor, a local financial institution, marketed Aabar’s initial public offering it was inundated with demand for the shares. By the time the issue closed demand had reached a staggering $110bn. ‘It was a world record in IPOs - more than 800 times oversubscribed,’ says Karim el-Solh, the chief executive of National Investor at the time. ‘You can’t go wrong investing in the oil sector, with oil prices where they are.’ The frenzied reaction to the Aabar offering - more dramatic than anything seen during the US and European dotcom bubble - starkly illustrates the massive financial liquidity in the Gulf. After years of sluggish economic growth and accumulating budget deficits, the Middle East is enjoying a remarkable boom. The sharp rise in oil prices since 2000 is allowing governments, heavily dependent on oil, to clean up their balance sheets, accumulate financial reserves and resume capital spending. As the oil bonus trickles down, it is fuelling an unprecedented explosion in equity and property markets. ‘Liquidity is at an all-time high in the region and we only have two asset classes to put money in: equities and real estate,’ says Emile Habib, a National Investor managing director… ‘People have a lot of capital and very limited investment opportunities, which is putting a lot of pressure on prices.’ Since 2001, the market capitalisation in the six stock exchanges of the main oil exporters in the Gulf - Saudi Arabia, the United Arab Emirates, Qatar, Kuwait, Oman and Bahrain - has nearly tripled to about $875bn. The Shuaa Capital Arab composite index, which tracks 254 companies in 12 Arab countries, is up 67 per cent so far this year, on top of a 60 per cent gain in each of the last two years… In construction, prices are rising fast as the oil bonus creates skyscrapers, gargantuan shopping malls and futuristic tourism resorts.”

How the oil producing countries expend their enormous liquidity windfall will be a fascinating development to monitor closely (inflation begetting inflation!). Back in the ‘70s the inflating pool of “petro dollars” financed an emerging market borrowing binge that was followed by a painful and protracted bust. The more things change, the more they stay the same… I will conclude with excerpts from a recording of Wednesday’s Western Economic Association’s panel discussion in San Francisco.

Question from the audience: “Professor (Milton) Friedman, do you think there’s a role for the Fed in identifying and managing asset price bubbles?

Friedman:  “No.”

Questioner:  “Could you elaborate?”

Dr. Friedman:  “The role of the Fed is to preserve price stability.  Period.  And price stability in a broad aggregate – in a broad index.  It should not be concerned with the asset markets as such, only as they effect indirectly – somehow – the price stability as a whole.” 

Federal Reserve Bank of St. Louis President William Poole:  “If I could just add to that.  I absolutely agree.  And one of the reasons I take that position – I’m really a hardliner on this.  Let’s suppose that the Fed – as you would want with any good policy instrument – had perfect control over asset prices.  I think it is incompatible with a market economy to have a government agency setting asset prices that are meant to allocate capital.” 

Dr. Friedman:  “Asset prices embody a real magnitude that is a real interest rate.  And the Fed does not control the real interest rate.”

 My comment:  Contemporary, unrestrained, asset-based Wall Street Finance – operating without determined central banks ready to identify and hinder destabilizing asset inflation and asset Bubbles - is a recipe for “monetary” disaster.  And it pains me to listen to Dr. Friedman still professing that price stability – measured by some broad index - is dependent upon the Fed actively managing the “money supply” (he stated so during the discussion).   For systemic price stability – certainly including asset markets and the Current Account – the Federal Reserve must take an active role in regulating Credit expansions and system liquidity (“monetary” in the broadest meaning of “finance.”).  Special attention must be given to monitoring and disciplining the marketplace in the event of heightened leveraging and speculating. 

Admittedly, this would be a complex, radical and challenging departure from simply pegging short-term rates (or even “inflation targeting”), but one I believe is necessary.  And Dr. Poole may believe that a Fed role in “controlling” asset markets is “incompatible with a market economy.”  Yet, pegged interest rates, Fed assurances of abundant marketplace liquidity, and consequent inflating asset markets are these days dictating our system’s (gross mis)allocation of resources and “capital.”  The current Monetary Disorder, and its perversion of system pricing mechanisms, is anathema to our Capitalistic system.  Having asset markets as a prime focus of central bankers is not a “good policy instrument” – but an all-important process we’ll have to learn to live with.  The Creation and Flow of (contemporary) Finance is no longer manageable under the current system.