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[Suresh]

Doug Noland warns that the Federal Reserve, instead of looking at resource utilization as a rising inflation indicator, ought to be looking at economic and asset price growth in developing countries, as that is where money is flowing.
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PrudentBear: About a Half Paradigm
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The Bernanke Fed has now locked itself into a policy course that will ignore global reflation dynamics and instead fixate on specific U.S. economic indicators. Instead of adopting a more hawkish posture and laying the market groundwork for withdrawing extraordinary monetary stimulus, the Fed flew even farther into uncharted dovishness. This adds to a long series of (compounding) errors from our central bank. Most importantly, the Federal Reserve signaled “resource utilization” (markets read “unemployment rate”) as a key factor that will determine the course of policy normalization. If I had to choose one economic indicator guaranteed to notably lag global reflationary dynamics, well, I’d bet on U.S. payrolls.

So, from a macro perspective, a clearer view is coming into focus – a new Paradigm is emerging. New global reflationary dynamics have gained important momentum. Credit systems in China, India, Asia, Brazil and the developing world – the “Periphery” - are today significantly more robust than they are here at home (the “Core”). Powerful global financial flows to the inflating Periphery (“Monetary Processes”) also work to ensure market and economic outperformance. The rising Periphery – with its billions of consumers and rising demand for commodities – has realized a robust and self-reinforcing inflationary bias. Moreover, secular dollar weakness has increased the investment and speculative merits of commodities and other hard assets when contrasted to dollar securities. Dollar weakness begets global reflation that begets dollar underperformance that begets a new Paradigm.

The balance of financial and economic power has shifted decisively away from the U.S. The Periphery has supplanted the Core as the epicenter of global economic reflation, recovery, and expansion. Yet the more the world changes the more the Fed remains the same. Disregarding both the impaired dollar and global reflationary dynamics, the Fed has locked itself into pegging rates based singularly on dismal U.S. economic fundamentals. And these ultra-low Core rates are providing a very hefty global interest-rate anchor.

I will humbly suggest that a momentous global economic transformation is at this point About Half a Paradigm. Powerful global economic and inflationary forces have decisively shifted to the Periphery. Meanwhile, the Federal Reserve (Core) still retains remarkable dominance over global market yields. I believe we are in a transition period, with the Fed’s power over global yields waning over time (or perhaps abruptly in a future crisis backdrop). In the meantime, however, global yields are mismatched to the reflationary backdrop. This predicament implies ongoing market distortions, a rather extraordinary global mispricing of the cost of finance, along with all the myriad financial and economic costs associated with unrelenting “Monetary Disorder” (i.e. assets Bubbles, imbalances, mal- and over-investment, financial and economic fragilities, etc.)

Of late, there’s some loud clamoring with respect to the dollar carry trade and global asset Bubbles. Little doubt the “carry trade” (borrowing at low rates in the U.S. to play higher-yielding assets globally) is a meaningful source of global liquidity, although it should not be overstated in the context of rapid synchronized Periphery Credit growth. And, clearly, speculative excess has found its way to “developing markets” (some years ago I would write “liquidity loves inflation” to describe how financial flows inherently gravitate toward the inflating asset classes). But I would stress that a reasonable portion of this year’s spectacular market gains are associated with a fundamentally-based revaluation of Periphery and commodity-based assets. There’s more to this year’s global market moves than mindless buying of risk assets and Bubble excess. Furthermore, I believe the Core-to-Periphery Dynamic is a secular trend that will prove less vulnerable to bursting Bubbles than others would contend.
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A major yet unappreciated domestic risk associated with Fed policy is that ultra-low interest-rates are being only further embedded into Credit and economic structures. The Fed has manipulated short-rates and market yields in the most extreme degree. This intervention has amounted to massive distortion throughout the markets, while this process has further spurred the Paradigm shift of power from the Core to the Periphery.

Each month, the U.S. Credit system and economy become only more vulnerable to a rise in yields (mortgage and Treasury borrowing costs, in particular). Imagine the U.S. housing market in an environment of much higher mortgage rates and then ponder the scope of the Fannie/Freddie/FHLB/FHA bailouts in the event of a spike in yields. Picture the dilemma faced by Treasury if its borrowing costs jump significantly. How about the fiscal position of state and local governments? Could our frail banking system handle a surprise rise in rates? And imagine the corner policymakers would find themselves boxed into when the Fed loses control over market yields.

It is not clear to me whether it will unfold over months or years. But I do expect a more complete Paradigm shift to foster waning influence of the Fed over global market yields commensurate with fading U.S. economic dominance. Unless global reflationary forces dissipate, this implies a future adjustment period for U.S. interest-rate and risk asset markets. And when the Fed eventually loses command over market yields, the risks associated with today’s policy course will likely manifest into a very problematic financial and economic crisis.
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Suresh

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[Suresh]

Bloomberg: Fed May Cause Next Crisis, Hong Kong’s Tsang Suggests

The Federal Reserve’s policy of keeping interest rates near zero is fueling a wave of speculative capital that may cause the next global crisis, Hong Kong’s leader said.

“I’m scared and leaders should look out,” said Donald Tsang, chief executive of the city, said in Singapore today. “America is doing exactly what Japan did last time,” he said, adding that Japan’s zero interest rate policy contributed to the 1997 Asian financial crisis and U.S. mortgage meltdown.
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“We have a U.S. dollar carry trade at the moment,” Tsang, 65, said in a speech where leaders of the Asia Pacific Economic Cooperation forum are gathering for a weekend summit. The carry trade is where investors borrow cheaply in one currency and use the funds to invest in other currencies.

“Where is the money going -- it’s where the problem’s going to be: Asia,” Tsang said. “You can see asset prices going up, not only in Korea, in Taiwan, in Singapore and in Hong Kong, going up to levels that are incompatible or inconsistent with the economic fundamentals.”

Past Experience

Tsang was Hong Kong’s financial secretary during the 1997- 98 Asian crisis, when countries from South Korea to Indonesia were forced to borrow from the International Monetary Fund because of an investor exodus sparked by concerns officials couldn’t maintain the value of their currencies. Together with Hong Kong Monetary Authority chief Joseph Yam, he intervened to buy $15 billion of Hong Kong stock, successfully defending the territory’s exchange-rate peg to the dollar.

Hong Kong’s interest rates track those of the U.S. because of the currency’s peg to the dollar, which means that foreign capital flows into stocks and property. Real estate prices in the city have risen more than 25 percent this year, prompting the International Monetary Fund to warn this month of a possible bubble. Hong Kong Financial Secretary John Tsang said Nov. 4 the government was “very concerned” about the rise.
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Suresh

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[Suresh]

Telegraph: Zhu Min, a man worth listening to
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Zhu Min, now deputy governor of China's central bank[,] ... has just warned Davos of another inconvenience raised by Economic Agenda in September: the potential unwinding of the "dollar carry trade". America's "near-zero" interest rate response to sub-prime has seen traders borrow in dollars, then re-invest this cheap money in high-yielding non-dollar assets. The trouble is that when the US currency strengthens, carry-traders' dollar debts rise while the value of their non-dollar investments plummet. Against a basket of six major currencies, the dollar is now at five-month high.

The size of the carry-trade is estimated at $1,500bn (£939bn). This is far bigger than the yen carry trade of the late 1990s, the unwinding of which sent financial shockwaves around the world. "The big risk in 2010 is the dollar carry-trade," said Zhu Min on Thursday. "It's a massive issue."
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BP 2010Q1
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.