BEST OF DOUG NOLAND

November 15, 2005

I would be exceedingly careful in extrapolating the extraordinary success of Wall Street finance. There is overwhelming evidence supporting the Bubble thesis. And it’s one thing enjoying a competitive advantage in the production of goods or the development of new technologies, but it is quite another when one’s advantage is transforming the perceived risk profile of pools of (increasingly risky) loans. The latter nurtures Credit, speculation and marketplace liquidity excesses. The latter cultivates marketplace distortions that reinforce excesses, while circumventing market adjustment and self-correction. The latter breeds spectacular asset Bubbles, booms and busts.

I would also be careful when forecasting a "slow and orderly" current account adjustment and the unlikelihood of a "hard landing." That the system has demonstrated such a propensity for excess and adjustment avoidance portends quite the opposite. And it is the character of Bubble processes that the system becomes only increasingly vulnerable to any slowdown in Credit growth, moderation of liquidity, rise in risk aversion and/or reversal in asset prices.

Indeed, the defining feature of this incredible subterfuge of Wall Street finance is that it foments unrecognized financial and economic fragility. Our currency’s reserve status does afford us the opportunity to borrow in dollars, but this does not mitigate the risk associated with the massive and unprecedented foreign accumulation of perceived safe and liquid dollar claims. And it is the widening gulf between perceptions and reality that ensures future tumult, revulsion and dislocation. Moreover, the reality of the situation is that monetary - and not economic - forces are driving this Bubble, further nullifying the likelihood of a prolonged adjustment period and sanguine outcome.

The rallying dollar, sinking crude, and surging financial stocks do today create a rather inspiring backdrop for the optimists and Pollyannas. But I caution that we do live in an age of 8,000 hedge funds, unprecedented Wall Street and global proprietary trading, and unfathomable amounts of derivatives and sophisticated trading strategies. Markets will fluctuate and the big trades – whether long or short – will have a tendency to on occasion catch the crowd especially poorly positioned - and soon positioned poorly in any number of trades concurrently. And when the "dollar system fragility" trade is being unwound it does give impetus to further Bubble excess.