BEST OF DOUG NOLAND

July 12, 2005

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 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."