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One lesson that will be learned from this experience: if the Fed persists in ignoring Credit and disregarding Bubbles, it will eventually have to accept that only quite tough/punishing policy action or bursting Bubbles will suffice when it comes to changing behavior (including interrupting boom-time Monetary Processes). And while the rationale for watching and waiting almost seems convincing, the exercise of anticipating a Bubble burning itself out is fraught with overwhelming risk. A case in point: the view today that U.S. housing market fragility might actually be working to bolster U.S. and Global Credit Bubble excesses should not be so contentious. A proper "risk management" policy approach dictates that Bubbles be addressed as early as possible. The contemporary fallout from "falling behind the curve" is runaway asset speculation, inflation and (Credit, asset, and speculative) Bubbles – that will inevitably burst.

As we’re witnessing, the profligate U.S. financial sector is no mood to back down. Of course not, they’re making too damn much "money." As demand for home mortgage borrowing has waned, lenders have simply responded with more aggressive commercial real estate and C&I lending. Losses on energy trades have only impelled the leveraged speculating community to press bets in the bond and Credit markets. The upshot is that the housing slowdown has to this point proven a catalyst for only greater Credit Availability and Liquidity throughout corporate and global finance. Little wonder, then, that U.S. employment has held up so well, while Income Growth has accelerated at home and abroad. Ultra-loose Financial Conditions are spurring the hedge fund, proprietary trading, M&A, LBO, derivatives and stock repurchase booms that play a critical role in handing the asset inflation baton effortlessly from U.S. housing to global debt and equities markets.

Contemporary finance is certainly rewriting the book on "inflation." No longer are consumer prices – especially "core" price indices – an even remotely accurate indicator of "monetary conditions." Indeed, "Financial Conditions" is supplanting "monetary conditions" as the more suitable moniker for describing general Credit and Liquidity conditions. "Financial Conditions" are today largely dictated by the ballooning U.S. Financial Sphere (including foreign holders of U.S. financial claims), a process chiefly governed by the unconstrained multiplication and leveraging of U.S. marketable securities and non-traditional Credit instruments.

Contemporary Credit and Liquidity Dynamics have very little in common with those of the past. Traditionally, the Fed dictated "monetary conditions" by overt methods and mechanisms whereby (banking system) "money" was regulated by reserve requirements and open-market operations. The determined management of system reserves and bank deposit growth would under normal conditions hold sway over loan growth and Credit conditions generally.

Today, the Fed employs little authority over the expansion of bank, Wall Street, or securities Credit outside of small (non-threatening) adjustments to the cost of short-term funds. The Fed, instead, attempts to manage the general financial environment through the manipulation of interest-rates and financial profits. These days, however, the Financial and Economic Spheres have bloated to the precarious point that the Fed presumes it dare not turn parental and remove the punchbowl. Such a circumstance does not go unnoticed by the rambunctious and is exploited with increasing daring as late-stage excesses snowball. And as long as financial players perceive it is to their advantage - as they clearly do today - to expand (loans, securities, leverage, derivatives, etc.), the Financial Sphere Inflation will continue in earnest.

Doug Noland is a market strategist at Prudent Bear Funds. Their website is www.prudentbear.com.