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January 12, 2007

Nominal GDP
by Doug Noland

The Dow gained 1.3%, and the S&P500 rose 1.5%. Economically sensitive issues shined. The Transports surged 3.2% and the Morgan Stanley Cyclical index 2.6%. The Morgan Stanley Consumer index gained 1.5%, while the Utilities declined 0.8%. The broader market was strong. The small cap Russell 2000 jumped 2.4% and the S&P400 Mid-Cap index 2.5%. Despite a few notable early earnings disappointments, tech stocks rose. The NASDAQ100 jumped 3.3% (up 5.0% y-t-d), and the Morgan Stanley High Tech index increased 1.8%. The Semiconductors rose 2.9%. The Street.com Internet Index gained 1.4%, and the NASDAQ Telecommunications index increased 1.5% (up 4.6% y-t-d). The Biotechs surged 3.3%. The Broker/Dealers jumped 5.9% (up 6.3% y-t-d), and the Banks added 0.3%. With Bullion recovering $20.10 this week, the HUI rallied 1.9% (down 5.4% y-t-d).

Treasury yields generally surged to the highest levels since October. Two-year government yields jumped 13 bps to 4.88% and 5-year yields 12 bps to 4.76%. Ten-year Treasury yields gained 13 bps to 4.775%, the high since October 24th. Long-bond yields rose 12 bps to 4.86%. The 2yr/10yr spread ended the week inverted 10.5 bps. The implied yield on 3-month December '07 Eurodollars surged 19.5 bps to 5.06%, the highest rate since August 15th. Benchmark Fannie Mae MBS yields jumped 13 bps to 5.81%, this week performing in line with Treasuries. The spread on Fannie's 5 1/4% 2016 note widened 6 to 33, and the spread on Freddie's 5 1/2% 2016 note widened 6 to 31. The 10-year dollar swap spread increased 2.25 to 48.5. Corporate bonds generally outperformed Treasuries, with junk spreads narrowing several bps.

Investment grade issuers included Lehman Brothers $2.75 billion, UBS $1.0 billion, Monument Global $700 million, Catlin Insurance $600 million, Southern Company $500 million, Prime Property $400 million, Snap-On $300 million, and Hartford Life $250 million.

January 12 - Bloomberg (Jeremy R. Cooke): "U.S. universities borrowed more than $1 billion in the municipal bond market this week, as analysts highlighted the stability of higher-education credits and the importance of capital investment in attracting students."

January 9 - Moody's Investors Service global speculative-grade corporate bond issuer default rate fell from 1.9% in 2005 to 1.7% in 2006, marking the fifth consecutive annual decline and its lowest year-end level since 1996..."

January 12 - Bloomberg (Shannon D. Harrington): "The perceived risk of owning high-yield, high-risk U.S. corporate bonds fell to a record low this week as borrowers announced plans to repay debt and default rates remained near the lowest ever."

Junk issuers included American Real Estate $500 million, Chaparral Energy $325 million, and Ahern Rentals $90 million.

This week's convert issuers included Alexandria Real Estate $400 million.

International issuers included KFW $3.0 billion, Turkey $2.0 billion, ICICI Bank $2.0 billion, Glitnir Banki $1.25 billion, Philippines $1.0 billion, Turanalem Finance $1.0 billion, and Intelsat Bermuda $600 million.

Japanese 10-year "JGB" yields rose 2.5 bps this week to 1.735%. The Nikkei 225 dropped 1.7% (down 1.0% y-t-d). German 10-year bund yields jumped 8 bps to 4.06%. Emerging debt and equities markets were mixed. Brazil's benchmark dollar bond yields gained 5 bps this week to 6.06%. Brazil's Bovespa equities index rallied 2.0% (down 3.1% y-t-d). The Mexican Bolsa added 0.7% (down 0.5% y-t-d). Mexico's 10-year $ yields surged 17 bps to 5.74%. Russia's 10-year Eurodollar yields rose 4 bps to 6.66%. India's Sensex equities index gained 1.4% (up 2.0% y-t-d). China's volatile Shanghai Composite index gained 1.0% (down 0.3% y-t-d).

Freddie Mac posted 30-year fixed mortgage rates gained 3 bps last week to 6.21%, up 6 bps from a year earlier. Fifteen-year fixed mortgage rates added 2 bps to 5.96% (up 25bps y-o-y). And one-year adjustable rates rose 2 bps to 5.44% (up 29bps y-o-y). The Mortgage Bankers Association Purchase Applications Index jumped 16.2% this week. Purchase Applications were flat from one year ago, with dollar volume up 2.4%. Refi applications rose 17.3%. The average new Purchase mortgage rose to $226,100 (up 2.5% y-o-y), and the average ARM jumped to $374,200 (up 17.6% y-o-y).

Bank Credit declined $5.3 billion during the week (of 1/3) to $8.291 TN. Bank Credit expanded $803 billion, or 10.7%, over the past 52 weeks. For the week, Securities Credit fell $9.9 billion. Loans & Leases gained $4.6 billion to a record $6.080 TN. Commercial & Industrial (C&I) Loans expanded 12.9% over the past year. For the week, C&I loans rose 3.7$ billion, while Real Estate loans declined $5.0 billion. Bank Real Estate loans were up 13.9% over the past year. For the week, Consumer loans added $2.2 billion, and Securities loans increased $5.5 billion. Other loans dipped $1.6 billion. On the liability side, (previous M3) Large Time Deposits surged $21.5 billion.

M2 (narrow) "money" jumped $28.9 billion (3wk gain of $75bn) to a record $7.073 TN (week of 1/1). Narrow "money" expanded $376 billion, or 5.6%, over the past year. M2 has expanded at a 9.0% pace during the past 20 weeks. For the week, Currency increased $2.2 billion, while Demand & Checkable Deposits declined $13.3 billion. Savings Deposits surged $32.4 billion, and Small Denominated Deposits added $1.1 billion. Retail Money Fund assets increased $6.5 billion.

Total Money Market Fund Assets, as reported by the Investment Company Institute, dipped $1.9 billion last week to $2.390 Trillion. Money Fund Assets increased $326 billion over 52 weeks, or 15.8%. Money Fund Assets have expanded at a 23.2% rate over the past 20 weeks.

Total Commercial Paper dipped $1.5 billion last week to $1.990 Trillion. Total CP has increased $300 billion, or 17.7%, over the past 52 weeks. Total CP has expanded at a 22% pace over the past 20 weeks.

Fed Foreign Holdings of Treasury, Agency Debt increased $7.2 billion last week (ended 1/10) to a record $1.770 Trillion. "Custody" holdings were up $239 billion y-o-y, or 15.6%. Federal Reserve Credit dropped $14.9 billion to $844.5 billion. Fed Credit was up $28.7 billion y-o-y, or 3.5%.

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $770 billion y-o-y (18.8%) to a record $4.858 Trillion.

Currency Watch:

The dollar this week gained 0.5% to 84.82. On the upside, the British pound gained 1.6%, the Turkish lira 0.9%, the South African rand 0.7%, the New Zealand dollar 0.7%, and the Australian dollar 0.6%. On the downside, the Japanese yen dropped 1.4%, the Norwegian krone 1.4%, the Romanian leu 1.3%, and the Indonesian rupiah 1.3%.

Commodities Watch:

January 12 - Bloomberg (Jeff Wilson): "Corn prices surged [almost 7%] to a 10-year high, sparking rallies for soybeans and wheat, after the U.S. forecast the smallest global supplies in 29 years as record demand for ethanol uses up more of the crop."

For the week, Gold jumped 3.3% to $627.50, and Silver surged 5.9% to $12.95. Copper recovered 3%. February crude fell another $3.36 to end the week at $52.88, a 19-month low. February Gasoline dropped 4.3%, while February Natural Gas rallied 7.4%. For the week, the CRB index dipped 0.2%, and The Goldman Sachs Commodities Index (GSCI) fell 1.5%.

Japan Watch:

January 12 - Bloomberg (Toru Fujioka): "Japan's bank lending gained for an 11th month as companies and consumer borrowed more, confident growth of the world's second-largest economy will be sustained. Loans rose 1.7 percent in December from a year earlier, the biggest increase in four months..."

China Watch:

January 11 - Bloomberg (Nipa Piboontanasawat): "China's trade surplus swelled 74 percent to a record $177.5 billion last year as exports surged... Exports rose 27.2 percent and imports climbed 20 percent..."

January 11 - Bloomberg (Irene Shen): "China's vehicle sales rose 25 percent last year, surpassing Japan as the world's second-largest automobile market. Sales of passenger cars and commercial vehicles climbed to 7.22 million units in 2006... That compares to 5.72 million vehicles sold in Japan and 16.6 million in the U.S."

January 11 - Bloomberg (Zhang Shidong and Jake Lee): "China's stock market topped $1 trillion for the first time and the yuan rose past the Hong Kong dollar, reflecting an economy that's grown 10-fold since Deng Xiaoping opened the Communist nation to international investment in 1978."

January 12 - Bloomberg (Josephine Lau): "China's banking regulator urged banks to stop lending for stock investments and to recall any outstanding share loans, according to a document obtained by Bloomberg News."

January 10 - Bloomberg (Nipa Piboontanasawat): "Optimism among Chinese companies rose in the fourth quarter to the highest in almost two years, according to...the statistics bureau."

January 11 - Bloomberg (Helen Yuan): "China, the world's biggest buyer of iron ore, boosted imports of the raw material 19 percent last year to a record... China overtook Japan as the largest iron-ore buyer in 2003."

India Watch:

January 9 - Bloomberg (Cherian Thomas): "India's economy will grow close to 9 percent in the fiscal year ending March 31, 2007, Finance Minister Palaniappan Chidambaram said..."

January 12 - Bloomberg (Cherian Thomas): "India's industrial production expanded at the fastest pace in 11 years in November, increasing pressure on the central bank to raise interest rates this month to curb inflation. Production at factories, utilities and mines rose 14.4 percent from a year earlier..."

January 8 - Bloomberg (Cherian Thomas): "India's Prime Minister Manmohan Singh said the country's economic growth is constrained by 'a shortage of power, port capacity and skilled workforce' and vowed greater investments to address them. 'Be it power, be it port capacity, be it supply of skilled manpower - a variety of supply bottlenecks are holding the growth rate back...'"

Asia Boom Watch:

January 10 - Bloomberg (Seyoon Kim): "South Korea's jobless rate dropped to the lowest in almost four years in December... The jobless rate fell to 3.3 percent from 3.4 percent in November..."

January 11 - Bloomberg (Seyoon Kim and Kim Kyoungwha): "South Korea will add curbs on mortgage lending to cool soaring property prices and household debt the finance ministry and central bank say may cause financial instability."

January 12 - Bloomberg (Clarissa Batino): "The Philippine government today raised its economic targets for this... The government's economic managers, charting the fastest economic expansion in three years, lifted the target for gross domestic product growth to a 6.1 percent to 6.7 percent range..."

Unbalanced Global Economy Watch:

January 10 - Bloomberg (Alexandre Deslongchamps): "Canada's trade surplus widened more than expected in November to the largest since March, as exports of cars and energy products rebounded. The surplus widened to C$4.67 billion ($3.97 billion) from a revised C$3.76 billion in October..."

January 11 - Bloomberg (Simone Meier and Gabi Thesing): "Growth in Germany's economy, Europe's largest, last year accelerated to the fastest pace since 2000...Gross domestic product rose 2.5 percent after increasing 0.9 percent in 2005..."

January 10 - Bloomberg (Sandrine Rastello): "French industrial production unexpectedly fell in November as car output slumped. Production at factories, utilities and mines fell 0.2 percent from October..."

January 9 - Bloomberg (Robin Wigglesworth): "Norwegian retail sales growth exceeded economist expectations for the seventh consecutive month in November, rising an annual 7.8 percent."

January 10 - Bloomberg (Jonas Bergman): "Swedish industrial production rose at more than twice the expected monthly pace in November, gaining the most in seven months... Production rose 1.4 percent from October...and gained 6.2 percent from a year earlier..."

January 9 - Bloomberg (Alistair Holloway): "Finland's trade surplus widened to a seven-month high in November, led by exports... The surplus was...$1.1 billion..."

January 8 - Bloomberg (Steve Bryant): "Turkish industrial output surged 10.9% in November, the highest rate since June, as a weaker lira and growth in Europe drove exports to record levels."

January 11 - Bloomberg (Hans van Leeuwen): "Australian employment gained three times as much as forecast in December, capping the strongest year of jobs growth since 1989... Employment climbed 44,600 after advancing a revised 43,000 in November... A 30-year-low jobless rate may stoke wages growth and inflation..."

January 10 - Bloomberg (Hans van Leeuwen): "Australia's consumers were the most confident in 17 months in January and exports rose in November, suggesting growth may accelerate in the Asia-Pacific region's fifth-largest economy."

January 10 - Bloomberg (Mike Cohen): "South African house-price inflation slowed to an annual 13.5 percent in December after the central bank raised borrowing costs to a three-year high..."

January 10 - Bloomberg (Nariman Gizitdinov): "Kazakhstan's economy rose a preliminary 10.6 percent to $77.9 billion last year, led by the building industry, the government reported..."

Latin American Boom Watch:

January 9 - Bloomberg (Alex Kennedy and Guillermo Parra-Bernal): "Venezuelan President Hugo Chavez's plans to nationalize the country's largest phone company and utilities, gain greater control over the oil industry and seek authority to make laws by executive order are sending investors racing for the exits."

Central Banker Watch:

January 10 - Market News International: "While declining to comment on what the Federal Open Market Committee may decide about interest rates at future meetings, Chicago Federal Reserve Bank President Michael Moskow said... it is 'certainly' still the case that additional monetary policy firming may be necessary."

January 9 - Bloomberg (Minako Kawai): "The U.S. economy is showing signs of reacceleration, former Federal Reserve Chairman Alan Greenspan said, according to a Japanese ministry of finance official."

Bubble Economy Watch:

January 8 - Bloomberg (Darrell Preston): "Texas, the second most-populous U.S. state, will have $14.3 billion in additional revenue during the next two-year budget cycle thanks to growth in retail sales, housing market gains and higher oil and gas prices, state Comptroller Susan Combs said. State lawmakers who convene this week will be able to spend $82.5 billion in the general fund budget for fiscal years 2008 and 2009, a 21 percent increase over the current budget of $68.2 billion... 'Our state's strong economy is producing vigorous revenue growth,' said Combs..."

January 10 - Market News International (Chris H. Sieroty): "After successfully campaigning in November for ballot measures authorizing the state to borrow nearly $43 billion to spend on schools, roads and levees, California Gov. Arnold Schwarzenegger is proposing that the state approve borrowing an additional $43.3 billion. In his State of the State address Tuesday, the governor argued that the borrowing voters approved in November did not go far enough in meeting the needs of a state that is expected to grow in population by 30% over the next 20 years. 'We have a big state, and we have big needs...And we made a big down payment. But the job is not finished.'"

January 9 - Bloomberg (Henry Goldman): "New York City will reap $1 billion a year more in taxes than Mayor Michael Bloomberg estimated two months ago for 2008 through 2010, the city Independent Budget Office predicted. The budget office...said revenue from property and income taxes has grown so fast the city stands to collect $250 million more this year than the mayor predicted in November."

January 9 - The Wall Street Journal (Jane Zhang): "Growth in U.S. health-care spending slowed in 2005 for the third consecutive year, reflecting a sharp slowdown in the rise of prescription-drug spending, the federal government reported. The study, considered the most comprehensive tally of the nation's annual health spending, found that the U.S. spent $1.988 trillion, or $6,697 per person, on health care in 2005, the latest year for which data are available. That was a rise of 6.9%, down from 7.2% in 2004 and the lowest growth rate since 1999."

January 10 - Financial Times (Joshua Chaffin): "Sirius Satellite Radio is paying 'shock jock' Howard Stern an $83m bonus despite a 50 per cent share price fall since he joined the fledgling media group. The stock-based bonus comes on top of a $500m compensation package that Stern was awarded when he joined Sirius a year ago from terrestrial radio in what was seen as a milestone for the new industry. The bonus was based on incentives tied to Sirius's subscriber growth. Sirius, which competes with XM Satellite Radio, finished the year with 6.3m subscribers - 2m more than it had predicted before Stern's arrival."

January 11 - Bloomberg (Linda Sandler): "Christie's International, the world's largest art seller, said its auction totals rose 36 percent last year to...$4.7 billion as it sold a lions share of expensive paintings by Gustav Klimt and other artists. The U.S. was the fastest-growing market..."

Financial Sphere Bubble Watch:

January 10 - Financial Times (Michael Mackenzie ): "The total value of global financial assets is set to reach $200,000bn by the end of 2010, after which the rate of growth may slow as baby boomers start retiring and draw down their holdings of equities and bonds. In its annual "mapping the global capital market" survey, McKinsey Global Institute said the value of cash based securities that are bought and sold across financial markets - such as equities, bonds and loans - had risen to $140,000bn by the end of 2005, a record level. This is more than three times the value of global gross domestic product and a rise from $118,000bn at the end of 2003."

January 10 - Bloomberg (Kevin Foley): "Global capital, including stocks, bonds and bank deposits, may rise 53 percent to $214 trillion by 2010 from five years earlier, fueling demand for credit in financial markets, a McKinsey Global Institute report said."

Mortgage Finance Bubble Watch:

January 12 - Bloomberg (Bradley Keoun and Jody Shenn): "Mortgage Lenders Network USA Inc., a provider of home loans to people with poor credit, said 'human error' caused it to lend $600 million at below-market rates, fueling losses that led to the closure of its biggest unit."

Real Estate Bubble Watch:

January 12 - Bloomberg (Daniel Taub): "U.S. office rents rose 10 percent in the fourth quarter to their highest level in five and a half years as companies added workers, spurring employer demand throughout the country for office space."

Energy Boom and Crude Liquidity Watch:

January 10 - Bloomberg (Svenja O'Donnell): "Russia's oil fund surged to 2.35 trillion rubles ($88.43 billion) as of the end of last year... The fund surged 90 percent from...the end of 2005."

January 11 - Bloomberg (Zainab Fattah): "Dubai, United Arab Emirates, plans to build a skyscraper shaped as a traditionally-dressed Persian Gulf man to 'represent national culture and identity,' the 7DAYS newspaper reported. The 35-storey human-shaped 'Burj Al Arabi' hotel, which will be built with a fabric dress, is expected to cost 500 million dirhams ($136 million)..."

Climate Watch:

January 11 - Associated Press: "High late-December temperatures made 2006 the warmest year on record for the U.S., according to the National Climate Data Center. The temperature data was collected from a network of more than 1,200 stations across the country... Five states had their warmest December on record -- Minnesota, New York, Connecticut, Vermont and New Hampshire."

Fiscal Watch:

January 12 - Dow Jones: "The U.S. federal government ran a December budget surplus of $44.54 billion, a record for the month and three times greater than the year-earlier surplus, the Treasury Department said... Treasury's monthly budget statement shows receipts were $259.97 billion in December, up 7.5% from a year earlier and a record for the month of December. Meanwhile, outlays were $215.43 billion, down 6.7% from a year earlier."

Speculator Watch:

January 9 - Bloomberg (Rich Miller and Jesse Westbrook): "U.S. and European regulators, turning a spotlight on one of Wall Street's most profitable businesses, are conducting a joint probe into whether banks and securities firms set strict enough limits on loans to hedge funds."

January 9 - Bloomberg (Seth Lubove): "When news broke that Benjamin Waisbren had been fired as Hollywood frontman for Stark Investments, moviedom shuddered. Hedge fund managers such as St. Francis, Wisconsin-based Stark have become piggy banks for the U.S. film industry. Since 2005, these funds and private equity investors have committed $4.5 billion to movies, betting the box office can beat the markets. Movie industry bible Variety called Waisbren's abrupt exit in May a 'bellwether' for the future of fast money in Hollywood."

Nominal GDP:

Bloomberg's Tom Keene: "Bill [Gross], your note every month is always interesting. This last one is one of my favorites. As you know, I'm a big fan of nominal GDP - this, folks, is real GDP plus inflation. It's the 'animal spirits' that's out there. You say be careful, Bill Gross. It looks real good to me, Bill. I see 6% year-over-year nominal. You say that's going to end?"

Pimco's Bill Gross: "I think almost assuredly, because of oil prices. I'm not suggesting it end because of real growth going down - that's the Goldilocks scenario in which we have 2% plus or minus real growth. With oil prices doing what they're doing - if they hold in the $55 range - gosh, we're going to see CPI prints y-o-y over the next three or four months of 0.5% or 1.0% and that means nominal GDP is down in the 3% range."

Tom Keene: "And the important distinction here is you have two moving parts: GDP and inflation. So you've got roughly four outcomes: They both go up, they both go down, or they split the difference. You're suggesting - your focus - is more on the inflation part of nominal GDP or are you looking equally at the growth dynamics?"

Bill Gross: "Ultimately, the inflation component affects the real growth component. To the extend that you have nominal GDP - in my forecast 3 to 3.5%, that's really not enough growth in terms of the economy itself to support asset prices at existing levels. And so, declining assets prices ultimately factor into eventually lower real growth. But that's not for mid-2007 but perhaps for later in the year."

Tom Keene: "When we look at six months of low nominal GDP, is that enough to link directly into the 'animal spirits" of the business investment component of GDP - the "animal spirits" of business men and women?"

Bill Gross: "Well sure it is. When you realize that the average cost of debt in the bond market - and therefore in the economy and this includes mortgages - it is about 5.5%. If you can only grow your wealth and service that debt at 3.5% rate, then that has serious implications. When you go back to 1965, Merrill [Lynch] did this study - in terms of asset prices during periods of time when nominal growth grew less than 4%. Risk assets have been negative in terms of their appreciation and actually bonds have done pretty well. The question becomes why hasn't that happened yet, and I think we're simply in a period of time where there are leads and lags that are much like the leads and lags of Federal Reserve policy."

Tom Keene: "Where will the 10-year yield be 12 months from now?"

Bill Gross: "I think around 4.5%, and that's not a dramatic bull market, Tom. We're at 4.75% now and that would imply a point and a half of price appreciation on top of that yield, so maybe a 6% total return. But we're definitely moving into a period of time during which bonds begin to do better. Obviously, in the last month or two they have not, and risk assets - typified by equities - have done just the reverse. But I think we're beginning to get into a period in which this tightening effect will move things in the opposite direction."

I chose to highlight part of this interview because it touched upon a few key financial issues, in a year where I expect to analytically Fixate on Finance. I find Mr. Gross's focus on low Nominal GDP and the related "tightening effect" quite interesting. And Mr. Keene's view that Nominal GDP represents "animal spirits" is also worthy of contemplation.

My bias at this point would be to somewhat downplay the rapid moderation in Nominal GDP - or at least question the germaneness of traditional analysis. I certainly don't slower growth as the consequence of tightened Credit. I have a much different focus, believing instead that the widening divergence between slowing GDP and continued robust system Credit growth is evidence of loose (and likely loosening) Financial Conditions. As I've been noting for some time, the housing-driven Economic Sphere moderation provided a powerful catalyst for accelerated Financial Sphere expansion.

Sure, a decent case can be made that recent declines in housing, oil, and commodities are indicative of Mr. Gross's unfolding tightening process. But it could also be that some altogether different forces are at work here. What if the downturns in housing and oil are not at all related to restrictive finance, but are instead the upshot of the dynamics of ongoing highly liquefied and speculative markets? Markets do fluctuate, and there's certainly ample evidence elsewhere (global equities, booming M&A and meager risk premiums) to support the view of ongoing ultra-loose Financial Conditions. And to what extent do lower energy prices stoke Bubbles elsewhere?

For things to get really interesting, contemplate for a moment the possibility that moderating housing markets, oil prices, and Nominal GDP are indicative - not of tightened finance but instead - of dramatic price volatility associated with hyper Credit inflation-induced Monetary Disorder. After all, late-stage Credit Bubbles are Masters of Price Distortions. There is today a distinct possibility that analysts have been fooled into inflation and Credit Bubble complacency.

Not without justification, Mr. Gross believes that our current rate of "wealth" expansion is problematic when it comes to servicing our economy's 5.5% "cost of debt." Well, to begin with, in no way do I subscribe to the view that Nominal GDP is an accurate reflection of real wealth creation in our contemporary "services" economy. Even if it were, it still wouldn't provide the most useful analytical framework. With $900 billion annual Current Account Deficits and asset-based debt outstanding at multiples of Nominal GDP, it is important to conceptualize that we do not in reality service our "cost of debt" with real wealth creation. Instead, we "monetize" our mounting interest costs by creating only more debt.

The key metric for sustaining the asset markets is not GDP as much as it is total system Credit growth - of which there is today plenty. And I would question the relevance of historical relationships between Nominal GDP and risk asset returns. Traditionally, Credit created in the process of financing real business investment and economic output was the prevailing source of liquidity, fueling both the economy and asset markets. GDP was closely tied to monetary conditions. Today, asset and securities-based finance is the key system monetary mechanism - often operating outside of economic considerations and impacts. Real GDP and "output" inflation will capture varying effects of rampant Credit Inflation, although much of the created purchasing power/liquidity will impose unequal and divergent influences primarily on various asset prices and markets.

Bloomberg's astute Tom Keene likens Nominal GDP to "Animal Spirits." I would argue that the aged Credit Bubble has profoundly altered the landscape. Today, "Animal Spirits" - profit-seeking behavior - find their primary outlet in the Expansive Financial Sphere, where the men and woman of hedge funds and Wall Street finance today dictate system behavior to a profoundly greater extent than does real business investment. Again, I'll argue that moderating Nominal GDP has provided a boon to Finance - an impetus to only greater Credit Bubble excesses and risks.

I propose that this is the key dynamic explaining why risk assets have generally been notably robust (escalating Bubbles) in the face of what one would typically have expected to be a problematic US economic slowdown. Focusing on Nominal GDP, Mr. Gross believes the Fed now has much greater flexibility to commence the next easing cycle. Yet, if slower growth has indeed provoked only greater financial excess - Loose Financial Conditions - the upshot might instead be pressure on the Fed to resume the "tightening cycle." The Bank of England this week decided as much and sent its message loud and clear.

I doubt the Fed buys into the bond market's story. Understandably, the Fed is cautious when it comes to analysis professing underlying U.S. (Bubble) economy weakness. Much of the economy is booming and labor markets are generally tight. And a better case can be made that the recent mild inflation reports are more indicative of unusual price volatility than a sustainable trend. I will change my tune when Credit and income growth trends reverse.

The bottom line is that the Fed lost flexibility last year when the Financial Sphere was determined to "front run" the Fed's easing cycle - creating a problematic backdrop of excessive global financial leveraging, speculation and destabilizing liquidity. This rampant Bubble environment has the Fed both fearing that it would, if it eased, exacerbate excess and, if it tightened, risk bursting Bubbles. Sinking oil prices, rising market yields, and highly speculative risk markets create a volatile mix to begin the New Year.

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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