We are living through yet another great awakening. Today’s markets and political landscape are handily dividable between believers and doubters. These are days of present and absent faith. Pain staking, boring, old fashioned investigation of events and trends has barely a seat at the great tables of decision. There are no better illustrations of this than recent developments in equity markets and the President’s ability to be approved of by multitudes of folks on both sides of every major domestic policy issue. I will address this short work toward the former and leave the latter for greater minds and history to sort out.

Things are getting better because they have in the past; we have waited a long time and spent lots of money. This is the conventional wisdom that has driven the S&P500 up 42% from 667 to 950 across the last three months. We have heard stories of China’s rebound, emerging market immunity to the business cycle, falling second derivatives of change. All of this boils down to belief. The common thread is that things get better over time because they have to, we are expecting them to, pundits see green shoots, rates of decline themselves decline. In other words, things will improve because we expect them to, need them too. We believe.

Over the last 3 and 6 month periods, Chinese indexes have led a global rally. China has outdone emerging markets broadly and has left US indexes well behind. [[FXI]] has outperformed [[EEM]] and the S&P 500. This does not fit standard macroeconomic patterns, theory or intuition. Leveraged industrial exporters and credit providers do not walk through the blazing destructive fires of the present global economy without getting burned. For 20 years, China has accelerated into the most rapid and sweeping large country industrial revolution we have ever seen. The changes are real. We are seeing a transfer of industrial production from many locations. Transnational firms from the US, Euro zone and Asia have come for the infrastructure, wage rates, environmental policy, workers and market. They have also come for the bubble. It is very difficult to separate the bubble from the real economic revolution. Both are clearly present. For the last 4 months it has been the bubble that has been the dominant element in China perception and investment. The China centric emerging market bubble has led us up since February 2009.

The Public Private Investment Program for Legacy Assets

This plan leans heavily on The Federal Reserve, particularly the Term Asset Backed Securities Lending Facility ((TALF)). FDIC auction management, regulation and debt assurance are melded with remaining TARP money. The Public Private Investment Program provides non-recourse loans and does NOT cap executive compensation.

The Federal Reserve Flow of Funds Z1 table makes clear that America invested in a Madoff economy. In the 12 months between 4Q2007 and 4Q2008 American households and Non-Profits experienced an $11.3trillion decline in asset value. In one year 15% of the consumer wealth of this country was destroyed. The last three months of 2008 saw $5.4 trillion in asset losses in US households and nonprofit organizations, 8% of wealth. These are mind boggling numbers.

In the last 3 months of 2008 GDP was $3.55 trillion. More asset wealth was destroyed than total income generated in the 4th quarter of 2008. The US economy performed like a giant financial institution with asset write downs exceeding income. Like a grand Ponzi scheme, global imbalance was revealed by the receding credit tide. Everyone hates the banks and screams for Madoff blood. I fully understand the sentiments. However, the greater issue should be the tens of trillions lost not by Bernard Madoff. Lost in the shuffle seems to be that our macro economy looks suspiciously similar to a giant bank balance sheet or a portfolio run by Bernie. Thus, we are mad and off in our narrow anger.

Last February I wrote to you about how mistaken it was to see monetary policy and Fed intervention as magical cures for structural and solvency crises. Sadly, very little has changed in the market trade. Stocks have collapsed, still many believe in magical governmental cures. This time is it the President-elect and fiscal policy that are to prove the magic bullet? This delusion will end at least as badly as the magical monetary policy, permanently high home prices and endlessly expanding equity multiple bubbles.

Why? Can't we just will a rebound and trade it into existence? The answer is yes and no. Yes, we can use future tax receipts and what remains of our good global name to borrow over $1 trillion per year. Yes, the Fed can continue to increase its balance sheet by several hundred billion dollars a month. Yes, it appears that terrified investors - many from overseas - will loan to us at shockingly low rates of interest in a currency that we are actively destroying. Perhaps the $3 trillion we have sold to foreign central banks and agencies will expand by a trillion or two? Maybe China will want to buy another $693 billion in US government obligations as her economy slumps and her exports stall? Yes, we can sell our past credit errors to the government. Some of us can even front run government purchases or trade ahead of multitudes of eager and ill informed rebound seekers.

We remain amazed at the endless procession of punditry parading its certainty amidst the panic. The markets have not recovered. Equity selection and strategy remain mired in the defining myopias and manias of the 2003-2007 Bull Run. Prices have fallen, firms have failed and so very little has been learned. The lessons of the post tech bubble markets are starting to emerge. There is no systemic evidence that these lessons are being factored. In fact, with each trading session since 10 October, 2008, it becomes increasingly clear that group delusions of reassembling Humpty Dumpty are the order of the day. We should have learned that integrated, globalized economies are defined by profound interdependence and that debt is excusable only insofar as it is more productive than costly. Lowering credit cost and standards only inflates bubbles; it does not assure returns sufficient to cover obligations.

We have all learned - brutally - that debt can not substitute for income and cheap policy contrived credit provision can not replace prudent business modeling. Or have we? De-leveraging financial firms by leveraging the Fed and Treasury is not a solution. Like credit creation and rule relaxation, it is a stop-gap measure. It is only productive if the time it buys is productively utilized to develop and follow a new basic business strategy. Want to see an example? Stay tuned regarding the auto industry bridge loans. We have changed the cooks and are following the same rotten recipe. The Fed has expanded its balance sheet by $1.38 trillion this year with much more to come. The Treasury has spent $350 billion of the TARP and will have deployed the second $350 billion well before 2009 draws to a close. Everyone is playing reg arb, regulation arbitrage. Furious effort is made to move in front of increasingly large, often rushed and seldom wise intervention.

There are two massive shaping forces operating in global markets today. One is the bust, bail, repeat dynamic earlier outlined on these pages. The other is the game of leap frog between declining stock and flow measures of wealth and economic activity. The stock measures I have in mind are values/prices of assets. The flow variables I have in mind are incomes, expenditures and measures of incomes and expenditures.

Over the last 13 months we have seen rapid and violent episodes of asset price decline ahead of falling measures of macroeconomic health. Deep into asset slides, bailouts and trading rallies occur. During these rallies markets surge ahead and negative economic news builds up unpriced. Eventually, asset prices get ahead of macroeconomic flow variables. In the next act, asset prices plummet until they have oversold the building economic weakness. It appears we are now well into an episode where oversold markets rise as macro data falls.

I can't bring myself to join the gleeful investing masses. Watching shorting become illegal around the world and tax billions pledged, I feel an acute sense of unease.

Secretary Paulson has attempted to declare himself the most equal of pigs in our Animal House economy. The Treasury seeks more than $700 billion for itself under the sole auspices of the Secretary whose management helped bring us right over the brink. I say more because unlike so many commentators, I read the proposal. It only limits Treasury to $700 billion in balances at any one time (Section 6).

This is now a national disaster. The centrality and import of inexpensive and available credit to America's function is total.

We have moved well beyond a sub-prime crisis. We have moved well beyond a financial industry crisis. The position of the US economy is in jeopardy and the employment security and wealth of the nation is now very much in play. Like the nations of East Asia in the aftermath of the Asian financial crisis (1998), or Eastern Europe after the collapse of the USSR, our way of economic life - warts and all - is imperiled. No matter what happens today (September 18, 2008) our lives have changed. Shock waves are emanating out from the debt collapse ground zero. $3.6 trillion in global stock market wealth has evaporated this week. The job losses and macro effects are not far off.

A conservator will take full managerial/ownership control and 79.9% of common shares under a contractual agreement. The intent is to wind this arrangement down toward the end of 2010- presumably as stability returns to residential real estate and financial markets. The portfolios will not grow across this period or will shrink to their approximately $850 billion June 30, 2008, levels by the end of 2009. Thereafter, Fannie (FNM) and Freddie (FRE) [GSE] portfolios will shrink toward $250 billion in 10% increments. The Treasury Department will receive senior notes yielding 10% with 12% penalty rates and will replenish capital as needed. Further authority will not be required unless or until these commitments sum to more than $200 billion total.

In addition, the US Treasury will begin buying mortgage backed securities [MBS] from Fannie and Freddie. There are no limits to this process. Thus, the guarantee business will continue, portfolio holdings will be moved onto Treasury books and the firms will be moved away from their ballooning and painful function as mortgage portfolio holders. The stated triple aim of buoying asset markets, home mortgage provision/affordability and protecting taxpayers clearly run at cross purposes. If they did not, past assurance would have worked and this take-over would not be needed.

On August 28, 2008 the Bureau of Economic Analysis [BEA] released two very widely followed and important reports. Both are backward looking and detail national macro conditions and corporate profits. Gross Domestic Product and Corporate Profits Second Quarter 2008 (Preliminary) are the reports in question. Markets have surged on the good headline news regarding 2Q2008 GDP growth. Indeed the 3.3% reported growth was well ahead of expectations- mine included. The upward revision from the advance estimate was also huge, going from 1.9% to 3.3%. This is an increase of 73%- not too shabby. Of course there was that second report as well, you know corporate profits. There are even a few folks who believe that corporate profits have some relation to where share prices ought to be.

On that first report on GDP, the sources of the quarter over quarter growth are a little troubling. About 90% of the quarterly growth came from falling imports and rising exports. All measures are in falling dollars and rising foreign currencies converted to the dollar. Thus, a very large share of the good news boils down to our declining greenbacks- during the second quarter- and the newfound poverty of American consumers. What do I mean? Our smashed dollar makes our goods cheaper- more exports- and theirs more expensive-fewer imports. Our smashed consumers are buying less- falling imports. More than a little of yesterday's celebration is excitement over our weak currency- which has been strengthening- and our broke consumers- 70% of the US GDP. Export driven GDP gain is ominous given increasing fear of a Euro Zone slowdown and further difficulties in Japan. Import reduction and export growth may not be helped by the recent strengthening of the dollar?

Shares plummet and pundits rage. Everyone has an opinion about the health and best future for the semi-governmental agencies designed to smooth attainment of the American Dream. It is sad that few have found the time or interest to explore the history, function, predicament of these pillars of middle class home ownership and international finance.

Fannie Mae (FNM) was created in the depths of the great depression to decrease foreclosure and increase homeownership. In 1968 it was re-chartered as a public company. Since its inception in 1970 [PDF file], Freddie Mac (FRE) has financed 50 million homes. As both enterprises' mission statements make clear, they exist to facilitate, ease and cheapen home ownership by acting as liaisons between international capital markets and those seeking to purchase private residences in the US. They borrow at preferential rates, based on the implicit/explicit assurance of the US government. Borrowed funds are used to buy mortgages and bundles of mortgages aimed at reducing the bank risk and buyer cost of home mortgages. These firms exist to facilitate, ease and accelerate bank lending for home purchase. Firms, central banks, investors and funds lend to get returns above the Treasuries that carry an explicit form of Uncle Sam's guarantee and lower yields.

As we debate and react to an endless series of micro trends, there has been a turning away of attention from the macro. This is dangerous, to say the least. It is potentially crippling if the macro trends are in flux - and they are. Globalization is going nowhere fast on the policy front. Our recent globalization boom (globoom) is at risk of becoming a globalization bust (globust). Public support has become strident opposition. Discomfort and reaction define the positions of many politicians toward international interdependence. All of this as we come to rely ever more on imports, exports, capital flows and global investment. International financial markets, business press pundits and anti-globalization activists seem to be the only people who have not taken note.

The World Trade Organization [WTO] has been working on the Doha round of trade negotiations since November 2001 with agricultural and service meetings taking place since early 2000. There has been no real progress in nearly a decade! In late July 2008, to almost no attention, the latest round of negotiations failed in rising tides of acrimony. Feared shortages and rising prices - despite recent reversals - in basic materials, agricultural commodities and energy have created a patchwork of protection measures, export restrictions, hoarding efforts and accusations. Thus, the most integrated global markets for basic production inputs have swerved away from the market-led globalization path that defined the last 25+ years. Brazil has announced a $1 billion action to be brought against the US for agricultural subsidies - cotton specifically.

We are a year into the financial pain and virtually no systemic problem has been solved. Markets have entered into a new unsustainable cycle. The new dance is a two-step. Home prices slide, delinquencies rise, defaults rise. This puts additional pressure on housing going forward. Financial firms announce greater write-offs. Retailers slump and contagion goes global. Selling grips the markets, the good and the bad are sold off indiscriminately. Commodities rise, fear escalates and reaches a crescendo as at least one major institution nears or reaches insolvency. Forecasts of impossible return to the good old days are debated and rebound timetables are pushed back. In the depths of the swoon, the Fed opens the discount window to some new and previously barred set of institutions. Bail-outs are readied, Treasury checks are cut and we rebound off the lows. Bad news becomes good, commodities sell-off and financials soar.

We are at least three episodes deep. Discount window borrowing is open to anyone not convicted of a federal crime. Interest rates are under half the official rate of inflation. House prices keep falling, delinquencies keep rising and losses keep mounting. Mountains of dubious debt have and will be parked on the Government's books. Bad mortgages, mortgage bundles and sundry cycle on and off Fed books as the Treasury writes checks to the public, maybe JPMorgan Chase (JPM) and likely Fannie Mae (FNM) and Freddie Mac (FRE). The dollar rallies when folks ignore that the Greenback is ever more backed by home mortgages. Interest-rate jawboning replaces inflation management and traders adapt to buying policy driven rallies and shorting on rising fear and fading intervention. Fear returns, babies are tossed with bath-water, commodities rally and short attacks batter firms based on rumor and trend.

Months into a long overdue exploration of energy prices, few seem to mention issues related to the long history of affordable oil and capital, labor substitution. The age of oil has been a period of rapid and rapidly rising production of goods, services and wealth. The ability to harness technology-driven productivity and output enhancement has transformed the world in wave after wave. The vast quantities of wealth produced and the enormous increases in human population, food output, longevity, literacy and health all attest to this. Abundant and price competitive energy was substituted for human physical labor in industry after industry, nation after nation.

Listening to debates about housing, oil and commodity prices is surreal. In the first 3 months of 2008 housing and medical costs represented 33% of personal consumption expenditures, or $3.3 trillion. Across the same three months sky high energy and food costs accounted for 18% of personal consumption expenditure, or $1.8 trillion. Housing and medical costs suffered massive and sustained inflation for years. Housing prices- the single largest cost facing American families- went nuts from 1996-2007.

Not only were there virtually no complaints, every imaginable policy action was taken to extend and increase run-away and unsustainable house price inflation. Speculators drove housing price inflation. Individuals bought more, larger and more expensive homes constantly. How? Why? They got larger and larger loans on easier and easier terms. Lenders could bundle and sell the home mortgages to speculators around the world. The resulting speculator driven asset inflation was celebrated as successful wealth building.

Wages/salaries, wealth/savings, credit access and cost, prices of basic goods and services are all moving against the consumer. Consumption was 71% of US GDP in 1Q2008. This explains the anemic GDP growth. Investment spending by firms, government spending and net exports (exports minus imports) round out the list.

Consumption and government spending were the "positive" elements in the most recent GDP numbers. Consumption, dubiously adjusted for modest inflation, increased by 1% on a quarter over quarter basis. Government spending turned in a robust 2% rate of quarter over quarter growth. Private investment spending was negative and net exports grew as a negative number despite Dollar weakness. Things are bad and continue to worsen.

Share prices and corporate fortunes are being riled by the rediscovery of long known and recently denied basic facts. GM (GM) and Ford (F) are overly dependent on SUVs and trucks, shocking! Banks, including investment banks and broker dealers, have many bad securities, leverage issues and further losses? Who would have guessed it? Anyone who has read the news, listened to news radio or contacted any financial press in any way over the last year.

Then again, two and half months ago the Fed solved all the financial economy's problems by making more credit available, against many more classes of collateral for longer time periods. Oh yeah, and if you can get it, credit is cheaper too! What that failed to do new regulations and checks from the Treasury will surely solve. The other shocking revelation about autos, airlines and others requiring cheap fuel is that gas and oil prices have been rising- at least that is the rumor. Wow, shocking new developments abound!

Through the second half of 2007, to the collapse of Bear Stearns (BSC), US equity indexes were indicating a long hard fall. Selling pressure was relentless. As lagging assistance was offered by The Fed, there were short reversals. Selling became buying for a few weeks to a few days. It never took long for markets to fall after the euphoria and false promise were sniffed out. The Federal Reserve led the world in offering monetary policy accommodation. Rates were slashed, credit was pumped, soothing words were shouted in any and all directions. This failed until late March and again after the 30 April 2008 cuts. Bulls announced buying opportunity after buying opportunity, until Bear Stearns. Quickly tech, de-coupling and commodity plays came to dominate buy side recommendation.

A strange thing has taken shape ever since. We have seen the emergence of several mutually exclusive buying binges. In short, everything is up- if unevenly. Everything except the usual defensive plays that guard capital and return in recession. Shorts, gold, and many defensives have performed as you might expect in a recovery. What we actually have is a recession, no longer a possible recession but, a real one. Inflationary dreaming and valuation scheming have hidden this from view. Agricultural commodities (MOO), the broad commodity index (DJP), emerging markets MSCI (EEM), the S&P 500 (GSCI) and US financials (IYF) are all up since March 17.

One of today’s great debates involves the presence or absence of coming trauma to developing countries/emerging markets from US and EU economic pain. I do not share the prevailing wisdom that de-coupling/de-linking will smoothly occur. US and Euro Zone slowing will be global in impact. As has always been true, different states will grow- or shrink- at very different rates.

What interests me, and I humbly submit should interest you, involves the speed and size of de-linking between the American Macro-Economy and our leading multinational enterprises [MNE]. The mirror image of this is the growing link between our MNE and other economies. I believe this has quietly been driving much offshore growth and onshore underperformance. US, Japanese Euro Zone MNE investment, sourcing, growth and operational decision looks to be at the center of a form of de-linking. It is also the core of another form of linkage or coupling.