Saturday, October 4, 2014

06/05/2009 Counter-Cyclical or Counterproductive *

For the week, the S&P500 gained 2.3% (up 4.1% y-t-d), and the Dow jumped 3.1% (down 0.2% y-t-d). The Morgan Stanley Cyclicals surged 6.8% (up 23.5%), and the Transports rose 4.6% (down 5.3%). The Morgan Stanley Consumer index increased 1.7% (up 4.0%), and the Utilities gained 1.0% (down 8.8%). The broader market was again quite strong. The S&P 400 Mid-Caps jumped 3.6% (up 10.7%) and the small cap Russell 2000 surged 5.7% (up 6.2%). The Nasdaq100 rose 4.0% (up 23.2%), and the Morgan Stanley High Tech index gained 3.1% (up 32.8%). The Semiconductors slipped 0.2% (up 27.6%), while the InteractiveWeek Internet index jumped 3.7% (up 45.0%). The Biotechs surged another 4.6% (up 4.9%). Financials were mixed, with the Banks down 0.9% (down 16.4%) and the Broker/Dealers up 3.7% (up 33.3%). With Bullion slumping $24, the HUI gold index dropped 7.6% (up 21.6%).

Some tumultuous trading in the interest rate markets. One-month Treasury bill rates ended the week at 8 bps, and three-month bills closed at 19 bps. Two-year government yields surged 38 bps to 1.30%. Five year T-note yields jumped 49 bps to 2.83%. Ten-year yields rose 37 bps to 3.83%. The long-bond saw yields end the week up 30 bps to 4.63%. The implied yield on 3-month December ’09 Eurodollars surged a notable 42 bps to 1.365%. Benchmark Fannie MBS yields shot 58 bps higher to 4.90%. The spread between benchmark MBS and 10-year T-notes widened 21 bps to 107 bps. Agency 10-yr debt spreads were little changed at 32 bps. The 2-year dollar swap spread increased 8.25 to 49 bps; the 10-year dollar swap spread increased 19.25 to 38 bps; and the 30-year swap spread increased 17.75 to negative 13.75 bps. Corporate bond spreads were mostly tighter. An index of investment grade bond spreads narrowed 22 to 171 bps, while an index of junk spreads narrowed 45 to 876 bps.

The corporate debt issuance boom runs unabated. Investment grade issuers included GMAC $4.5bn, Express Scripts $2.5bn, BAE Systems $1.5bn, Met Life $1.4bn, PNC $1.0bn, Prudential $1.0bn, Chevron $700 million, Pricoa $500 million, Ace Ina Holdings $500 million, Enterprise Products $500 million, Mariner Energy $300 million, Ameriprise Financial $300 million, and Dartmouth $250 million.

Junk bond fund inflows jumped to $714 million this past week (from AMG), 12 straight weeks of positive flows. The long list of junk issuers included Tenet Healthcare $925 million, US Oncology $775 million, NRG Energy $700 million, Bunge $600 million, Yara International $500 million, United Rental $500 million, Domtar $400 million,Valeant Pharmaceuticals $365 million, Owens Corning $350 million, Harris Corp $350 million, Tesoro $300 million, Graphic Packaging $245 million, Holly Corp $200 million, Interface $150 million, and Affinion Group $150 million.

I saw no convert issuance this week.

International dollar debt issuers included SFEF $6.0bn, Vodafone $2.5bn, Commercial Bank of Australia $2.0bn, Qtel International $1.5bn, Svenska Handelsbanken $1.25bn, European Bank $1.25bn, RSHB $1.0bn, Banco Nac de Desen $1.0bn, WPP Finance $600 million and Geophysique $350 million.

U.K. 10-year gilt yields jumped 18 bps to 3.92%, and German bund yields rose 13 bps to 3.72%. The German DAX equities index gained 2.8% (up 5.5%). Japanese 10-year "JGB" yields added one basis point to 1.49%. The Nikkei 225 increased 2.6% (up 10.3%). Emerging stock markets were mostly higher, while emerging debt markets pulled back a bit. Brazil’s benchmark dollar bond yields jumped 15 bps to 6.01%. Brazil’s Bovespa equities index added 0.3% (up 42.1% y-t-d). The Mexican Bolsa gained 2.4% (up 11.3% y-t-d). Mexico’s 10-year $ yields rose 16 bps to 5.96%. Russia’s RTS equities index jumped 5.7% (up 82.0%). India’s Sensex equities index rose 3.3% (up 56.6%). China’s Shanghai Exchange surged 4.6% (up 51.2%).

Freddie Mac 30-year fixed mortgage rates surged 38 bps to 5.29% (down 80bps y-o-y). Fifteen-year fixed rates jumped 26 bps to 4.79% (down 86bps y-o-y). One-year ARMs rose 12 bps to 4.81% (down 25bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 8 bps to 6.56% (down 65bps y-o-y).

Federal Reserve Credit declined $8.2bn last week to $2.066TN. Fed Credit has declined $180bn y-t-d, although it expanded $1.188 TN over the past 52 weeks (135%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 6/3) rose another $7.4bn to a record $2.732 TN. "Custody holdings" have been expanding at an 20.2% rate y-t-d, and were up $439bn over the past year, or 19.1%.

Bank Credit declined $22.4bn to $9.754 TN (week of 5/27). Bank Credit was up $336bn year-over-year, or 3.6%. Bank Credit was down $160bn y-t-d (4.0% annualized). For the week, Securities Credit sank $34.2bn. Loans & Leases gained $11.9bn to $7.110 TN (52-wk gain of $199bn, or 2.9%). C&I loans rose $3.5bn, with one-year growth of 0.4%. Real Estate loans expanded $6.4bn (up 6.5% y-o-y). Consumer loans increased $2.8bn, while Securities loans fell $6.6bn. Other loans gained $5.7bn.

The ABS market continues to function better. Year-to-date total US ABS issuance of $65bn (tallied by JPMorgan's Christopher Flanagan) is about two-thirds of the $95bn from comparable 2008. U.S. CDO issuance of $22bn compares to last year's y-t-d $15bn.

M2 (narrow) "money" supply jumped $30.8bn to $8.358 TN (week of 5/25). Narrow "money" has expanded at a 4.9% rate y-t-d and 9.1% over the past year. For the week, Currency added $0.7bn, and Demand & Checkable Deposits gained $11.5bn. Savings Deposits surged $26.4bn, while Small Denominated Deposits declined $1.8bn. Retail Money Funds fell $5.7bn.

Total Money Market Fund assets (from Invest Co Inst) dropped $25.2bn to $3.764 TN. Money fund assets have declined $66.5bn y-t-d, or 4.1% annualized. Money funds have expanded $316bn, or 9.1%, over the past year.

Total Commercial Paper outstanding decreased $3.5bn this past week to $1.245 TN. CP has declined $437bn y-t-d (61% annualized) and $509bn over the past year (29%). Asset-backed CP fell $8.3bn to $557bn, with a 52-wk drop of $196bn (26%).

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were down $39bn y-o-y to $6.770 TN. Reserves have declined $176bn over the past 38 weeks.

Global Credit Market Dislocation Watch:

June 1 – Wall Street Journal (Maya Jackson Randall and Andrew Batson): “U.S. Treasury Secretary Timothy Geithner said… he believes Chinese leaders understand U.S. measures to tackle the financial crisis and are confident in the U.S. economy, while he in turn praised China’s own stimulus measures for helping steady the global economy at a time of crisis. ‘They have a very sophisticated, very accurate understanding of the basic strategy of economic policy in the U.S… I believe they understand and have confidence in the Fed’s capacity to keep inflation low and stable over time, and in our capacity to –once we get this recovery back in place – bring our fiscal deficits down over time.’”

June 5 - Bloomberg (Cordell Eddings and Linda Shen): "U.S. lenders are raising at least $100.2 billion to fill capital gaps found by government stress tests and clear the way for repaying the Treasury bailout fund... The banks have until June 8 to develop a capital-raising plan and Nov. 9 to implement it..."

June 4 – Bloomberg (John Glover): “The global default rate on speculative-grade corporate bonds rose to 9.2% last month, from 8.3% in April, Moody’s… said. Twenty-nine issuers worldwide failed to meet their debt obligations… R.H. Donnelley Corp., the Yellow Pages publisher that defaulted on a total of $10 billion, led the 23 U.S. defaulters, Moody’s said.”

June 4 – Bloomberg (Soraya Permatasari): “Airline losses worldwide this year will be wider than expected… the International Air Transport Association said. The group’s new industry forecast for 2009… will be ‘substantially worse’ than the March estimate of losses of $4.7 billion…”

Government Finance Bubble Watch:

June 4 – Bloomberg (Paul Abelsky and Alex Nicholson): “Russia’s central bank cut the main interest rates for the third time in six weeks… Bank Rossii cut the refinancing rate… to 11.5% from 12%...”

June 4 – Bloomberg (Michael Patterson): “The money supply is set to ‘explode’ and boost emerging-market stocks as global central banks ‘print money,’ Templeton Asset Management Ltd.’s Mark Mobius said.”

June 2 – Bloomberg (Patricia Lui and Michael Patterson): “The four-week flood of money into developing-nation stock funds that drove the MSCI Emerging Markets Index to an eight-month high is sending the strongest sell signal since equities peaked in October 2007. Inflows totaled $12 billion… the most since the 22-country benchmark hit its record high 19 months ago…”

June 5 – Bloomberg (Francois de Beaupuy): “France’s budget deficit may exceed the record set 16 years ago as the government lifts spending and the recession erodes revenue, Budget Minister Eric Woerth said. Woerth said in an interview yesterday the 2009 shortfall could be more than 1993’s 6.4% of GDP. ‘It’s possible that we will surpass the ‘93 record,’ Woerth said… ‘Tax revenue is coming in less quickly.’”

June 3 – Bloomberg (Colm Heatley): “Ireland’s budget deficit almost tripled in the five months through May… The shortfall of 10.6 billion euros ($15 billion) compared with a deficit of 3.6 billion euros in the year-earlier period, the Finance Ministry said…”

Currency Watch:

June 5 – Bloomberg (Lyubov Pronina): “Russian President Dmitry Medvedev questioned the U.S. dollar’s future as a global reserve currency and said using a mix of regional currencies would make the world economy more stable… The dollar ‘is not in a spectacular position, let’s be frank, and its prospects cause various questions as do the prospects for the global currency system,’’ Medvedev, who today hosts an international economic forum in St. Petersburg, said… Regarding the global financial system, ‘therefore our task is to make it more mobile and at the same time more balanced.’ …A new world currency may be on the agenda when Medvedev meets counterparts from Brazil, India and China on June 16 at a summit in the Ural Mountains city of Yekaterinburg, the Kremlin said… ‘This idea has potential, even though some of my G-20 colleagues aren’t actively discussing it at the moment,’ Medvedev told Kommersant. ‘However, for example, in the opinion of our Chinese colleagues it is quite a possible step. The most important thing is not to walk away from discussions on this topic.’”

June 5 – Bloomberg: “China is “actively” considering buying as much as $50 billion of International Monetary Fund bonds, the State Administration of Foreign Exchange said in a faxed statement. ‘If the terms of the bond issue meet China’s requirements in investing its foreign currency reserves in terms of security and a reasonable return, we are willing to actively consider investing up to $50 billion,’ the agency, which oversees the country’s record $1.95 trillion foreign-exchange reserves, said.”

The dollar index rallied 1.8% this week to 80.67 (down 0.8% y-t-d). For the week on the upside, the South Korean won increased 1.0%, the Brazilian real 0.5%, and the Taiwanese dollar 0.1%. On the downside, the Japanese yen declined 3.4%, the Swedish krona 3.3%, the Canadian dollar 2.5%, the New Zealand dollar 2.2%, the Norwegian krone 2.0%, the Swiss franc 1.7%, the Euro 1.3%, and the British pound 1.3%.

Commodities Watch:

Gold ended the week down 2.4% to $955 (up 8.3% y-t-d). Silver declined 2.2% to $15.27 (up 35.2% y-t-d). July Crude gained another $2.05 (3-wk gain of $11.36) to $68.36 (up 53% y-t-d). July Gasoline rose 3.2% (up 84% y-t-d), and June Natural Gas increased 1.2% (down 31% y-t-d). Copper rallied 3.3% (up 61% y-t-d). July Wheat declined 2.2% (up 2% y-t-d), while July Corn increased 1.8% (up 9.1% y-t-d). The CRB index recovered 1.9% (up 12.4% y-t-d). The Goldman Sachs Commodities Index (GSCI) rallied 2.8% (up 30.5% y-t-d).

China Reflation Watch:

June 3 – Bloomberg (James Peng): “China plans to build 5.2 million apartments and offer housing subsidies to help accommodate 7.5 million low-income families by 2011, the Ministry of Housing and Urban-Rural Development said.”

June 3 – Bloomberg (Colm Heatley): “China’s government said unemployment is worsening, a quick rebound in trade is becoming less likely, and the nation is yet to feel the full effects of a global slump. The foundations for an economic recovery aren’t solid, the State Council said… Trade faces ‘unprecedented difficulties,’ Vice Commerce Minister Zhong Shan said…”

June 2 – Bloomberg: “New home sales in Shanghai reached a 21-month high in May, the Shanghai Daily reported, citing data from real-estate agency E-House (China) Holdings Ltd.”

June 2 – Bloomberg (John Liu): “China, the world’s second-biggest energy consumer, will invest about 100 billion yuan ($14.6bn) to more than double its wind power capacity by 2010 from last year, a government official said. The country’s wind power capacity will rise to 30,000 megawatts from 12,000 megawatts…”

June 4 – Bloomberg (Katrina Nicholas): “The worst is probably over for Macau’s casinos, as trips by Chinese “high rollers,” the most profitable category of customer, have increased with China’s easing of loan rules, according to Credit Suisse Group AG.”

Japan Watch:

June 4 – Bloomberg (Keiko Ujikane): “Japanese companies cut spending at the fastest pace in 54 years as a slump in global demand eroded profits… Capital spending excluding software fell 25.4% in the three months ended March 31 from a year earlier… Profits tumbled a record 69%.”

Asia Bubble Watch:

June 1 – Wall Street Journal (In-Soo Nam): “South Korea posted a $14.3 billion jump in foreign-exchange reserves last month, the largest one-month increase since the Bank of Korea started compiling comparable data in 1997.”

Latin America Watch:

June 2 – Dow Jones: “Brazil’s foreign currency reserves increased $4.3 billion in May from the previous month, as the central bank resumed dollars purchases… Brazil’s foreign reserves totaled $205.5 billion at the end of May…”

Unbalanced Global Economy Watch:

June 2 – Dow Jones (Natasha Brereton): “M4 lending to businesses and households, and holdings of M4 by the household sector in the U.K., grew at the lowest rates since records began in 1997… annual growth of M4 lending to private non-financial corporations and households dropped sharply to 0.8% in April from 3.1% in March. M4 lending to the household sector increased 3.4% on the year in April…”

June 2 – Bloomberg (Svenja O’Donnell): “A U.K. index of construction rose to the highest level in 13 months in May as the pace of declines in the housing market eased, Markit said.”

June 1 – Bloomberg (Jeffrey Donovan and Mark Deen): “Europe’s manufacturing industry contracted at the slowest pace in seven months in May… A gauge of manufacturing activity rose to 40.7 from 36.8 in April, Markit Economics said…”

June 3 – Bloomberg (Mike Gavin): “Car sales in Germany rose about 40% to around 390,000 vehicles in May, Reuters reported, citing unidentified people in the industry…”

June 3 – Bloomberg (Nicholas Comfort): “As much as 100 billion euros ($143bn) in planned investments in German offshore wind farms are at risk as developers struggle to get funding, jeopardizing the deepest emissions cuts in the European Union.”

June 2 – Bloomberg (Klaus Wille and Simone Meier): “Switzerland’s economy contracted at the fastest pace in almost 15 years in the first quarter… Gross domestic product dropped 0.8% from the fourth quarter…”

June 3 – Bloomberg (Emma Ross-Thomas): “Spanish workers are finding that the cure for a decade-long borrowing binge may just make things worse. As Spain sinks deeper into recession and the jobless rate heads for 20%, the highest in Europe, employers are telling workers to accept wage cuts if they want to stay competitive.”

Bursting Bubble Economy Watch:

June 3 – Wall Street Journal (Justin Lahart and Erica Alini): “Americans are saving more of their paychecks than at any time since February 1995… Even as income grew, personal saving as a percentage of after-tax income rose to 5.7% in April… up from 4.5% in March…“

Central Banker Watch:

June 2 – Finanical Times (Bertrand Benoit and Ralph Atkins): “It is not the first time that Angela Merkel, the German chancellor, has complained about the ultra-loose monetary policy being conducted in the Anglo-Saxon world. But when she attacked the European Central Bank on Tuesday, for its planned purchase of cover bonds – an unconventional way to help financial markets recover – Ms Merkel broke an unwritten ban on German leaders commenting on monetary policy close to home. The message, it seems, is that Berlin is more worried than people had assumed. The chancellor is not just concerned about the long-term inflationary potential of excessive monetary loosening. Her main concern is that the expansionary fiscal and monetary policy being deployed across the industrial world to fight the economic crisis could be planting the seeds of future crises.”

June 2 – Finanical Times (Bertrand Benoit and Ralph Atkins): “Unconventional monetary policies being pursued by the world’s main central banks could aggravate rather than ease the economic crisis, Angela Merkel, Germany’s chancellor, suggested on Tuesday. Her surprisingly strong attack on the US Federal Reserve, the Bank of England and the European Central Bank was remarkable coming from a leader who had so far scrupulously adhered to her country’s tradition of never commenting on monetary policy. ‘What other central banks have been doing must be reversed. I am very sceptical about the extent of the Fed’s actions and the way the Bank of England has carved its own little line in Europe,’ she told a conference… ‘Even the European Central Bank has somewhat bowed to international pressure with its purchase of covered bonds.’ ‘We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time.’”

June 3 – Bloomberg (Michael McKee): “Federal Reserve Chairman Ben S. Bernanke comments on the receding danger of deflation and the Fed’s exit strategy from low interest rates and the expansion of its balance sheet… ‘The Federal Open Market Committee at the Federal Reserve is strongly committed to price stability. We will ensure price stability… Price stability means neither deflation nor inflation. And in the near term, our concern for a time was that the recession would be so severe that we would see deflation. And we’ve taken strong actions to try to avoid that. And I think the fear of deflation has receded somewhat. And that is a positive development. ‘For the time being we still need to maintain a strong, supportive position in order to help this economy begin its recovery. But, as that begins, at some point we are going to need to begin to withdraw the policy accommodation so that we can avoid any inflation down the road.”

Muni Watch:

June 4 – Bloomberg (William Selway): “U.S. states are ready to slash spending by the most in at least three decades, as officials deal with deficits that may persist long after the end of the worst recession in half a century, a survey found. The states may reduce general fund spending, the money allocated at the discretion of lawmakers, by 2.5% to $653 billion during the next budget year, the most since at least 1979, according to…the National Governors Association and the National Association of State Budget Officers.”

MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

June 3 – Bloomberg (David M. Levitt): “Real estate investment trusts in the U.S. may raise about $582 billion by 2013 for acquisitions as competitors sell properties and values fall, the National Association of Real Estate Investment Trusts said. Publicly-traded REITS will probably accumulate about $728 billion, including debt, for purchases…”

Speculator Watch:

June 1 – Bloomberg (Edward Evans): “KKR & Co., Henry Kravis’s and George Roberts’s private equity firm, swung to a loss in 2008 as leveraged buyouts dried up amid the credit crisis. The… firm posted a $1.2 billion loss for 2008…”

June 3 – Bloomberg (Saijel Kishan and Katherine Burton): “James Pallotta, the investment manager who split with longtime partner Paul Tudor Jones at the start of the year, plans to shut his Raptor Global hedge funds after losing almost 29% since the start of 2007.”

June 3 – Bloomberg (Tom Cahill): “The hedge fund industry’s worldwide assets will fall by 60% to about $750 billion this year from a peak of $1.9 trillion after many funds forgot ‘what hedging was about,’ David Smith, chief investment officer of fund of hedge funds GAM, wrote in the Financial Times.”

June 2 – Bloomberg (Saijel Kishan): “Hedge funds may increase assets by more than 8 percent this year as clients led by pension plans and rich families invest $50 billion of the cash they held while financial markets fell, according to a report by Barclays Plc. Investors have about 14% of their assets in cash, according to the survey released today by Barclays Capital…”

Crude Liquidity Watch:

June 1 – Bloomberg (Anthony DiPaola): “State-run oil companies and large non-government crude producers may spend more than $375 billion to develop hydrocarbon assets this year…Ernst & Young said.”

Counter-Cyclical or Counterproductive?:

My old “analytical nemesis”, Paul McCulley, is out with a long piece this week, “The Shadow Banking System and Hyman Minsky’s Economic Journey.” He begins by stating the rather obvious: “creative financing played a massive role in propelling the global financial system to hazy new heights…” Mr. McCulley then asks a most pertinent question: “How did financing get so creative?” His somewhat insightful article is deeply flawed in that it fails to provide a valid answer.

First and foremost, our Credit system ran amok because our “activist” central bank for years pegged and, over time, increasingly manipulated the cost of finance. The Fed essentially guaranteed liquid and continuous markets to an increasingly deregulated and unrestrained marketplace, while repeatedly moving aggressively to bail out the leveraged speculators. The Greenspan Federal Reserve championed “contemporary finance”, in the process creating astounding profit opportunities for those structuring, distributing and leveraging sophisticated Wall Street financial instruments. Dr. Bernanke promised to be there with helicopter money as needed.

The Fed, congress, and various Administrations championed financial deregulation – as financial operators salivated. And it certainly didn’t hurt that spurring mortgage borrowing and home ownership became a national priority, as the rapidly expanding government-sponsored enterprises transformed the liquidity and marketability of mortgage securities. Unfettered private Credit expansion created its own loose financial conditions, leaving Fed rate tinkering ineffectual for tightening Credit conditions and Federal Reserve doctrine unwilling to address mounting Credit and asset Bubbles.

To be sure, the Wall Street finance/mortgage finance Bubble propagated out of the massive post-tech Bubble inflationary effort. The so-called “shadow banking system” was only one rather conspicuous facet of a historic – and ongoing - experiment in government monetary management.

Mr. McCulley writes: “No, I’m not a socialist.” Ok. Over the years, I’ve referred to McCulley and his ilk as “inflationists.” An inflationist may not begin his trek as a socialist, but it’s the nature of such an endeavor to pretty much end up in that territory by the end of the day. Of course, the inflationists today are calling for more extreme and intrusive reflationary measures than those employed in previous crises and deflationary scares. It is now, apparently, necessary for the “full faith and Credit of the sovereign’s balance sheet” to stand behind our entire impaired private sector Credit system. At this fragile stage of the inflationary boom, the inflationists have no qualms “betting the ranch.”

Long-time readers know that I, like Mr. McCulley, am a huge admirer of Hyman Minsky. I have over the years deeply embedded Minskian analysis into my analytical framework in an effort to better comprehend the extraordinary financial and economic landscape. Others, including McCulley, have repeatedly invoked Minsky as part of their ideological rationalizations for bailouts and inflationism. And I today find great irony in Mr. McCulley’s piece: After touching upon Minsky’s preeminent analysis with respect to the nature of financial instability and “Ponzi Finance,” McCulley dogmatically prescribes unprecedented government intervention as the elixir to help restore system stability. It’s a flawed analytical framework that comes to a perilous recommendation. If Hyman Minsky were with us, he would surely share a similar view that Washington has trapped itself in a most dangerous “Ponzi Finance” dynamic.

We’re witnessing the same analytical errors today that were made in the post-tech Bubble analysis: the willingness to inflate an even greater Bubble for the cause of mitigating the pain from the so-called deflationary risks associated with a bursting of THE Bubble. And with each reflation comes a heightened governmental role in both the markets and real economy – to the point where Washington is essentially backstopping the financial and economic systems.

I used to find it rather perplexing that our nation’s largest bond fund managers were among inflationism’s most vocal proponents. I was na├»ve; it now seems all so obvious. Of course, market operators prefer to have the Fed and Washington there reliably backstopping the markets. An activist central bank pegging interest rates and manipulating the cost (hence, the flow) of finance creates wonderful opportunities for the savviest traders playing the money game most adeptly. The expansion of Bubbles creates great opportunities and then, for the enlightened, the bursting of these Bubbles provides only greater profits. Mr. McCulley is fond of blaming the “shadow banking system” for our acute financial and economic fragility. Yet the responsibility lies more generally with a deeply flawed monetary policy regime – a regime hopelessly locked in interest-rate manipulation and inflationism.

To this day I find it perplexing that leading “free market” proponents have been so happy to have the Federal Reserve setting and manipulating the cost of finance throughout the real economy. By now, it should be crystal clear that such a regime cultivates a financial apparatus that systematically misprices risk, over-expands Credit, fosters over-leveraging, emboldens speculation, and massively misallocates and misdirects both financial and real resources throughout. After awhile, so much of the financial apparatus is focused primarily on seeking central bank-induced financial profits. Economic profits and real economy price signals become further marginalized. And with each bursting Bubble and resulting reflation, the government’s role in the system’s pricing mechanism becomes more ingrained, intrusive and destabilizing. The Bubbles change, while the price distortions and imbalances become deeply embedded in the underlying economic structure.

I see no reason to back away from the view that the fundamental dilemma today lies not so much in finance but with our deeply impaired economic structure. This structure is a manifestation of years of mispriced finance, Credit and speculative excess, and resource misallocation. From this perspective, it should be obvious that greater Fed-induced market price distortions and Treasury/Fed-induced Credit expansion will only exacerbate structural impairment and delay readjustment. If I had to point to a significant weakness in Minsky’s work, it would be the lack of analytical attention paid to the underlying economic structure (and why it is imperative to incorporate Austrian analysis into our analytical frameworks!).

The inflationists today believe that massive (“counter-cyclical”) government market and economic intervention will help the system revive and repair itself. I see current policies as simply a desperate attempt to perpetuate unsustainable financial and economic structures. And system impairment will not have run its course until some semblance of a market-based cost of finance emerges to more effectively allocate financial and real resources throughout the economy. The wholesale socialization of risk may be “counter cyclical” but it is also terribly counterproductive.

After the 9/11 catastrophe, I expressed the view that - if our government was compelled to stimulate - it would be preferable to run temporary fiscal deficits instead of manipulating interest rates and the financial markets. Yet the manipulation of the quantity and cost of Credit is much easier for policymakers to implement, and the results (heightened liquidity, risk-taking, and inflating asset prices) can be rather immediate and heartening. Meanwhile, the associated costs are not evident let alone quantifiable. Yet such interventions – and resulting changes in the quantity and flow of finance - seductively take on a life of their own as they breed excesses, future crises and the inevitable call for only greater interventions and inflations.

Mr. McCulley concludes with the insight – and I’m paraphrasing here - that deregulated and innovative finance precludes the elimination of “Minsky Moments:” McCulley believes “it’s a matter of having the good sense to have in place a counter-cyclical regulatory policy to help modulate human nature.” I would strongly counter that it is absolutely imperative to have the good sense not to perpetuate Bubbles and inflate episodes of “Ponzi Finance” to the point where they risk systemic collapse. Bankrupting the entire country is a completely unacceptable outcome. At some point the inflationists should accept the reality that they are a big part of the problem – and not the solution. Is that what the bond market is beginning to tell us?