macro-parasitism's bubbles (17.1.06, update 9.4.08)

Thinking Things Over (#21)
Private, national & common wealth in the post-socialism/capitalism era
Bewildered by what's been happening, both nationally and globally, in the wake of the fall of the Berlin Wall?
I.e. where the unwittingly weakened nation-state - formerly a bulwark against plain-levelling & globalization -
no longer tempers the social, economic & other pitfalls foreseen by Marx, Gramsci, Minsky, McCulley,etc.
Where - as the Laffer & Rider Curves illustrate in the tax & the social fields - excessive poor/rich gradients
are upsetting the delicate social fabric, thus washing away fertility factors with uncontrolled erosive powers.
Where indeed, as Patrick Martin pointed out, monopolistic capitalism and the associated reckless greed
are no longer kept in check by Adam Smith' invisible hand, i.e. by the balance of contradictory interests.
And where the capacity for self-correction is increasingly inhibited by loss of freedom, mooring & orientation
which led to market frenzies & false alpha birds feeding on hype & bubbles, reminiscent of the Roaring 20s.
IMF & FATF estimate black funds (drugs, tax evasion etc) to be 2-5% of world's GDP (2006: $960-2400bn).
An IMF Report indicates these funds to be increasingly chased under anti-terrorism & ever flimsier pretexts.
Courtesy by the IV Reich's Secret Service, the world has indeed been made hostage of ill-considered rules
which impede more legitimate business than crime. For big time money laundering, the US Treasury set the
standard in 2001 with its 31% confiscatory backup withholding tax on unidentified investors in US securities,
turning foreign bankers from trustees of clients into IRS agents (qualified intermediaries) subject to US laws.
Private equity & hedge funds thus found a government-sponsored access to black funds, while the latters'
entry into subprime markets was also eased by the Internet. Results: predatory lending & systemic risks.
Society's organization needs re-thinking with Plato, Gottlieb Duttweiler, José María Arizmendiarrieta etc.
For man's evolution may only be stressed by technological leaps but not accelerated beyond natural limits.
Also: return on investment rates above productivity gains & organic growth are predatory & not sustainable.
If driven by managers, lawyers & funds on the back of other stakeholders, M&As are thus Ponzi schemes
where shareholder value adepts can maraud with stacked Monopoly cards, helped by micro-economic laws.
Like compulsory social insurance systems whose doom is delayed or obscured only by inflation, war, etc.
And where the cunniest operators are state-supported by myopic magistrates hood-winked into fiscal deals.
Gary J. Aguirre's US Senate testimony details fraud & market mechanics which were at work before 1929,
e.g. Ponzi structures, unregulated pools of money, siphoning from unsuspecting mutual fund investors, and
abuse-prone market dominance: hedge funds' $1.5 trillion drive half of the $28 trillion NYSE's daily trading.
Tongue-in-cheek, Warren Buffet famously opined: "derivatives are financial weapons of mass destruction";
yet, under increasing performance & compliance pressures, some bankers still see a future in fee hunting.
Society wised up against churning of accounts by undelicate trustees, but not yet against macro-parasitism
which feasts on ignorance, sucks & devours a firm's life-preserving substance, & weakens society's pillars.
Which turns economic rat races into societal tailspins with early burn-outs & senior citizens being wasted,
& instills values causing youth to be educated out of sync, resulting in drug, violence & €1000 generations.
With profit-driven quarterly thinking & cost-cuttings also eroding due infrastructure maintenance & renewal,
& democracy's promises ridiculed by Fatf, EU & UN bureaucratic lawmaking as if Berlin Wall fell eastwards.
So why not thinking things over & “Revisiting Das Kapital while some dance on the Titanic”? Iconoclast

    The Bush administration has finally publicly acknowledged what U.S. and international law enforcement agencies suspected for decades: North Korea seeks to finance its impoverished economy, and fund its nuclear and other arms programs, with massive production of counterfeit U.S. dollars.
    Scan Garland, 71, a Veteran of the Irish Republican Army, was arrested in Belfast in September. He awaits extradition to the United States on a federal warrant that alleges that he and others bought, moved and either passed or resold high-quality counterfeit $100 notes.
    The United States further charges that Garland, who denies his guilt and was released on bail pending receipt of U.S. extradition papers, arranged with North Korean agencies "for the purchase of quantities of notes and enlisted other people to disseminate" the bogus money, known as superdollars or supernotes.
    U.S. federal prosecutors broke decades of official silence about North Korea's printing and distribution of top-quality $100 counterfeits and related traffic in cigarettes, drugs and arms last August. In California and several other states, arrests were made of people linked to a major Asian crime ring. Prosecutors named the Asian Delta Bank in Macao, the former Portuguese colony in China, as a "primary money-laundering concern," for helping North Koreans distribute forged currency and other criminal activities.
    The North Korean counterfeiting story begins almost simultaneously with the late Shah of Iran's purchase in 1975 and 1976 of two intaglio-color-8 presses, the type then used by the U.S. Treasury to print genuine dollars, from De La Rue Giori, in Lausanne, Switzerland. These survivedthe Shah's overthrowby Islamic revolutionaries in 1979 and provided an industrial base for the flood of expertly crafted superdollars. Specimens first appeared in Singapore in 1983, then, a decade later, inundated Europe and the Middle and Far East.
    Kim II Sung's hermetic and desperately poor North Korean dictatorship purchased a similar press from the same Swiss Company, also in the mid-1970s. Several North Korean defectors have described the press's subsequent location as central Pyongyang. Distribution networks were organized that extended into China and later into Southeast Asia and as far as North America.
    After criminal complaints against North Korean diplomats who have been caught distributing supernotes since 1994, Phil Williams, a professor at the University of Pittsburgh, observed: "We've rarely seen a state use organized crime in this way. This is a criminal state, not because it's been captured by criminals but because the state has taken over crime."
    In 1994, an alert teuer in the Hong Kong branch of the New York-based Republic National Bank discovered that currency shipments from the Delta Bank in Macao were larded with supernotes. U.S. Secret Service agents traced them to North Korean businessmen in Macao, but the North Korean ringleader escaped to mainland China and the trail went cold.
    The forged dollars migrated across the Pacific into North America. The Canadian police discovered the main masterminds: a Chinese crime gang called Dai Hien Jai or the Big Circle Boys. During the mid-1990s, they spent and laundered superdollars in casinos in Lake Tahoe, Nevada, in New York's East Broadway Chinatown district and elsewhere.
    The most publicized law enforcement breakthrough was the arrest and conviction in Thailand in 1996 of Yashimi Tanaka, a former Japanese Red Army terrorist who had taken refuge in North Korea in 1970. Tanaka was caught in Cambodia trying to laun-der into Thai currency supernotes with a face value of $250,000.
    In the summer of 1998, the U.S. Treasury refused comment when the Japanese Navy seized a North Korean ship stuffed with superdollars. The Japanese police, backed by the Tokyo field office of the US, Secret Service, rounded up intended distributors in Japan. Within 48 hours of the ship's seizure, officials in Tokyo and Washington had muffled the affair.
    Washington's tardy but welcome acknowledgment of Pyongyang's role in counterfeiting, and further developments in the Sean Garland case and other related cases, deserve careful scrutiny for links be-tween the now supposedly disarmed IRA and other violent groups, including AI Qaeda, and the rogue money printers in North Korea.

John Cooley is a retired American foreign correspondent. His books include "Unholy Wars: Afghanistan, America and International Terrorism."

    SHANGHAI, Jan. 16 -- China's state media on Monday reported that the country's foreign currency reserves swelled by more than one-third last year to a record $819 billion as its factories churned out goods for markets around the world, heightening the likelihood of fresh trade tensions with the United States.
    Coupled with news only days earlier that China's world trade surplus tripled last year, to $102 billion, the country's burgeoning foreign exchange reserves seemed certain to intensify demands that China increase the value of its currency, the yuan, the worth of which is linked to the dollar. U.S. manufacturing groups argue that China's currency is priced too low, making its goods unfairly cheap on world markets. Lawmakers in Congress have pressed a bill that would impose across-the-board punitive tariffs on all Chinese goods unless the country substantially raises the value of its currency.
    "This could give the senators more meat for their argument," said Stephen Green, a senior economist with the bank Standard Chartered PLC in Shanghai.
    Chinese officials braced for further conflicts with the United States, particularly as many economists anticipate that the country's trade surplus will widen. A flood of investment into industries such as steel, automobile manufacturing and electronics has erected too many factories and produced more goods than China can absorb, sending prices falling while encouraging Chinese firms to seek sales abroad. Diminished profits and slowing investment temper China's demand for machinery and raw materials, limiting the need for imports.
    "It's almost certain that China's trade surplus will remain at a high level in 2006," said Mei Xinyu, an economist at the Chinese Academy of International Trade and Cooperation in Beijing, a research institute operated by the country's Ministry of Commerce. "Obviously, there will be further pressure from trade protectionists in the United States."
    China argues that it is being used as a scapegoat in Washington for the decline of U.S. manufacturing: The flow of capital to lower-cost manufacturing areas is a global phenomenon that is transferring jobs not only to China, but also to Latin America, Eastern Europe, India and Southeast Asia. About two-thirds of China's exports are produced in factories that are financed at least in part with foreign investment, undercutting the notion that this country's growing trade is coming at the expense of everybody else.
    Analysts said the stance of China's Communist Party-led government will not change, despite the broadening of its global trade surplus and its buildup of foreign exchange. Beijing will continue to move only gradually to widen a band within which the yuan trades against the dollar, lest it unleash uncertainty in a financial system rife with risks -- not least, the existence of an estimated $500 billion in bad debt choking its banks.
    China is loath to increase the yuan enough to dampen growth in its coastal factories. Exports are a key source of jobs in a country that must find tens of millions of them for poor farmers and workers laid off by bankrupt state factories in the continued transition from communism to capitalism.
    Last July, China bumped up the value of the yuan by 2 percent against the dollar, somewhat diminishing tensions with the United States. But in the months since, the yuan has moved little against the dollar, though it has strengthened considerably against other currencies, such as the euro, as the dollar itself has climbed.
    Still, some economists said China's reserves were now growing so huge as to compel the central bank to deliver a significant revaluation. Otherwise, China risks that its reserves will leak into the banking system and be lent out for speculative investments that will only worsen a feared glut of real estate and factory capacity. "The renminbi [yuan] is fundamentally undervalued," said Ha Jiming, chief economist at China International Capital Corp., a giant state-owned investment bank. "As foreign exchange continues to grow, it will force a revaluation."
    The details disclosed in Monday's state press accounts and reported Sunday on the Central Bank's Web site confirmed that China is on track this year to exceed $1 trillion in foreign exchange reserves. That would probably elevate China to the biggest holder of foreign currency, eclipsing Japan, which has $847 billion.
    In recent weeks, Chinese policymakers have signaled a rethinking of investment priorities as they debate what to do with the reserves. Traditionally, China has sunk three-fourths of its reserves into U.S.-dollar-denominated investments, such as U.S. Treasury bills. Some have called for large purchases of oil to create a strategic petroleum reserve. Others have suggested that China will now devote a larger percentage of reserves to other world currencies such as the euro and the yen to reflect its balance of trade.
    Some analysts say the size of the reserve gives China a tool to manage trade tensions. "The more China possesses U.S. dollars, the more China can invest in the U.S. and buy U.S. bonds and U.S. products like Boeing aircraft," said Shen Dingli, an American relations expert at Fudan University in Shanghai.
    China has consistently harnessed its largesse in this way, timing the announcement of big-ticket purchases from the United States to mollify critics. As Shen acknowledged, however, China's investments have themselves stoked tensions -- not least, last summer when the state-owned oil company Cnooc Ltd. tried and failed to buy Unocal Corp. China and Japan have propped up the value of the dollar and financed U.S. spending by continuing to absorb U.S. debt via the purchase of Treasury bills. Yet these purchases have sown unease, with some in Washington complaining that the United States has relinquished control of its destiny to foreigners. "The U.S. could fear concerns that as China possesses U.S. debt, that could give China the ability to influence the U.S. financial situation," Shen said.
    The huge leap in China's foreign exchange and its trade surplus reflect a basic reordering of global manufacturing. Only a few years ago, laptop computers and televisions, for example, were completed in South Korea, Japan, Taiwan and Malaysia before being loaded onto tankers bound for U.S. ports, to be counted as exports from those countries. Today, much of the final assembly work is completed in Chinese factories, adding to China's trade surplus.
    Still, even as the "Made in China" label grows ubiquitous, many of the most valuable pieces inside these products continue to be manufactured and designed elsewhere -- computer chips in Taiwan and Malaysia, liquid-crystal display panels in South Korea, computer software in Japan. "China's trade surplus is a function of a fundamental imbalance of trade," Green said. "But in fact, these are not China exports: They are really Asian exports."

    The United States trade deficit widened to a record $726 billion in 2005, the government reported yesterday, adding more fuel to the increasingly partisan debate between advocates of further globalization and those who contend that free trade is causing the loss of too many American manufacturing jobs.
    Hitting its fourth consecutive annual record, the gap between exports and imports reached almost twice the level of 2001. It was driven by strong consumer demand for foreign goods and soaring energy prices that added tens of billions of dollars to the nation's bill for imported oil. The nation last had a trade surplus, of $12.4 billion, in 1975.
    The continued growth in the trade deficit, particularly with China, is likely to renew a fight in Congress as early as this spring over President Bush's trade policies. Lawmakers have seized on the growing imbalance with China to call on the White House to take a harder line with Beijing over its currency practices. But as long as the American economy is growing faster than most of its trading partners and energy prices stay at elevated levels, economists expect little improvement, and perhaps even a slight widening, in the trade imbalance this year. "You would need a dramatic slowdown in domestic U.S. demand to bring down the U.S. trade deficit, and we think that is unlikely," said Dean Maki, chief United States economist at Barclays Capital in New York.
    That means the nation will go deeper into debt with the rest of the world as Americans continue to rely on the strong flow of foreign money, particularly from central banks in Asia, to finance the trade gap. China, Japan and other foreign governments are some of the biggest holders of government securities, lending money to cover the substantial federal budget deficit and helping to keep interest rates and home mortgage costs here relatively low. As a result, American consumers are able to spend more and save less.
    Many economists say this situation is unsustainable over the long run, arguing that the United States could eventually face a harsh correction that would depress spending, increase the cost of borrowing and sharply lower the value of the dollar. "There are certainly going to be inflows, the question is at what price?" said James O'Sullivan, an economist at UBS, an investment house. "As time goes on, it will become a little more difficult to attract foreign funds. That's another way of saying the dollar will fall."
    But other economists argue that the huge trade gap mostly reflects stronger American growth and that money is flowing into the country at relatively low rates because of the attractiveness of the United States as a place to invest. They see little reason to fear a dollar crisis. "As long as foreigners are willing to put their capital in the United States, we can sustain a trade deficit of 6 percent or more" of overall economic activity, said Phillip L. Swagel, a resident scholar at the American Enterprise Institute in Washington who served as a staff economist for President Bush's Council of Economic Advisers. "It would be better that we saved more on our own," Mr. Swagel added, "but given that we aren't, I would rather have investment go on by foreign capital."
    For its part, the Bush administration urged caution on the deficit. Commerce Secretary Carlos M. Gutierrez, touring an I.B.M. operation in North Carolina, told The Associated Press, "We can't overreact and make tactical choices that will hurt our economy."
    As a share of the gross domestic product, the trade gap increased to 5.8 percent, from 5.3 percent in 2004 and 4.5 percent in 2003. While most economists dismiss the importance of bilateral trade imbalances, it is the deficit with China that has set off the most political fireworks. That nation had the largest gap with the United States of any country, at $201.6 billion for the year, up 24.5 percent from 2004. In December, the deficit with China narrowed nearly 12 percent, to $16.3 billion.
    Following increased pressure from the White House, the Chinese government allowed the yuan to rise by about 2 percent in July and allowed its currency to float in a narrow band. Since then the yuan, also known as the renminbi, has risen by an additional 0.7 percent. One dollar buys about 8.0505 yuan. A stronger Chinese currency would make imports to the United States more expensive and American exports to that country cheaper. Most analysts agree the yuan would rise significantly if it were set free, but many experts also worry that many financial institutions in China are not strong enough to survive the shocks that might accompany a fully convertible currency.
    In the Senate, Charles E. Schumer, Democrat of New York, and Lindsey Graham, Republican of South Carolina, have proposed imposing a 27.5 percent tariff on Chinese imports if the country does not allow its currency to appreciate further against the dollar. Late last year, the senators agreed to hold off on the measure after the Senate voted against stopping a floor vote on it. Mr. Schumer said "there is a very strong likelihood that we will move our bill in March should the Chinese not show further movements." "If you believe in free trade, you play by the rules," he said when asked if a protectionist tariff would hurt the American economy. "The long-term damage of the Chinese pegging their currency far exceeds any immediate benefits and almost every economist would agree with that. They might not agree with our methodology."
    Experts note that a large portion of the deficit with China reflects its growing role as a hub for the assembly of goods as Asian manufacturers have shifted production there to save money. The overall deficit with Asia has changed little in recent years. Bush administration officials have said they, too, would like to see the yuan appreciate further, but have contended that sanctions like a tariff would be counterproductive and would hurt consumers. This month, the Treasury Department urged the International Monetary Fund to improve its policing of currency manipulations by governments, without directly referring to China.
    Treasury Secretary John W. Snow is expected to bring up the issue of exchange rates at a meeting of the Group of 8 finance ministers in Moscow this weekend.
    But even some longstanding advocates of free trade are growing increasingly frustrated with China's intransigence on the currency front, warning that it may be inviting protectionist legislation by repeatedly deflecting Washington's requests. "The administration," said C. Fred Bergsten of the Institute for International Economics in Washington, "has to let the Chinese know that it may not be able to stop it even though it doesn't want it."
    While China draws most of the attention, perhaps the most important factor behind the swelling deficit last year was the rising cost of importing oil and other energy supplies. Trade in petroleum products accounted for 29 percent of the total deficit, up from 25 percent in 2004. Imports of petroleum goods climbed 39 percent, to $251.6 billion, after rising by 39 percent in 2004.
    Over all, the deficit jumped nearly 18 percent in 2005 compared with the previous year. Excluding oil and other petroleum products, the trade gap grew by 10 percent. After China, the United States' second-biggest deficit was with Japan, at $82.7 billion, up 9.4 percent, followed by Canada, a big supplier of oil and natural gas, at $76.5 billion, up 15.1 percent.
    The deficit with members of the Organization of the Petroleum Exporting Countries increased by 29 percent, to $92.7 billion. For December, the trade deficit grew by 1.5 percent over the previous month, to $65.7 billion, as imports of computers, cars and airplanes rose and exports of planes, which had risen sharply in November, dropped. It was the third-largest monthly trade gap on record. And with oil prices rising again, said Ashraf Laidi, chief currency analyst for the MG Financial Group in New York, "we can expect to see worse numbers to come."

    OUTSOURCING isn't just a one-way street on which rich countries shift jobs overseas. In recent years, some developing countries have contracted out the work of setting monetary policy to the United States. Ecuador and El Salvador, in 2000 and 2001, respectively, abandoned their own currencies, adopted the dollar and placed their monetary policy in the capable hands of Alan Greenspan, then the chairman of the Federal Reserve.
    When outsourcing involves manufacturing and software programming it is often endorsed by economists and condemned by populist political leaders. So, too, is the tactic of outsourcing of monetary policy — known as dollarization, or euro-ization. After all, noted Robert E. Litan, senior fellow at the Brookings Institute, "currencies are symbols of national sovereignty, and countries are reluctant to give them up."
    And yet nations can impose enormous costs on their citizens when they take extraordinary efforts to maintain independent currencies. "Devaluations of currencies cost people their savings and bring on rapid inflation," said Benn Steil, a senior fellow at the Council on Foreign Relations and co-author with Mr. Litan of "Financial Statecraft" (Yale University Press, 2006). The two argue that the globe's mélange of 200-plus currencies, backed only by the faith of investors, is inefficient and dangerous. Many emerging economies, they say, would be well advised to swap their currencies for strong, stable, widely used ones like the dollar or euro.
    Steve H. Hanke, professor of applied economics at Johns Hopkins University, has examined economic development in 32 countries that adopted foreign currencies from 1950 and 1993. He found that they had faster rates of G.D.P. growth, lower inflation and greater fiscal discipline than their counterparts who hung onto their sovereign currencies. Professor Hanke has been an adviser to Ecuador, which in 2004 was among the best-performing economies in Latin America, growing at a 6.6 percent rate with inflation at 2.7 percent.
    "Dollarization tends to deliver low inflation, and relatively low and stable interest rates," said Ricardo Hausman, a former chief economist of the Inter-American Development Bank who now teaches at the Kennedy School of Government at Harvard.
    So what's not to like? "It's not like dollarization is a magic drug," Mr. Steil said. It certainly doesn't end the risk that countries will default on dollar-denominated debt. Panama has been using the dollar since 1904 and has repeatedly run into difficulties. And El Salvador's economic performance hasn't outpaced those of its Central American neighbors.
    Some Latin American countries, notably Mexico, have tamed inflation without abandoning their own currencies. "If you have sound economic policies in a country, you don't need dollarization," said Nouriel Roubini, professor of economics at New York University's Stern School of Business. "And if you follow poor policies, I don't think dollarization will solve your problems."
    But economists say that smaller countries can encourage investment by lashing their monetary fortunes to larger regional powers. In Latin America, companies that need to make long-term investments — like utilities — are forced to borrow in dollars while they operate in local currencies, leaving them exposed to currency risk. Now that El Salvador has adopted the dollar, companies there can borrow or engage in hedging transactions in dollars with relative ease.
    And when small monetary boats tie themselves together or link themselves to larger ones, it encourages stability. "European financial markets were able to navigate problems of 9/11 and the Madrid and London bombings without too much instability, because they didn't have the extra layer of exchange-rate problems," said Barry Eichengreen, professor of economics and political science at the University of California, Berkeley.
    But one economist's reassuring stability can be another's troubling rigidity. If the price of coffee plummets or the price for textiles falls because of competition from China, a Latin American country that has dollarized won't have the option of cutting interest rates to stimulate growth. "Dollarization takes away the option of depreciation," Professor Hausman said.
    Dollarization advocates say that this is all to the good. Mr. Steil notes that the Dominican Republic, where a currency crisis in 2004 wiped out the savings of a significant chunk of the population, conducts about 85 percent of its trade with the United States. "Why on earth would they need their own currency?" he asks.
    Large countries like the United States have to tread lightly in advocating that small countries give up their currencies. In 2000, Congress considered — but did not pass — the International Monetary Stability Act, which would have provided financial assistance to countries that adopted the dollar.
    WHAT'S more, moving to unite monetary policies without integrating political and labor systems is problematic. The 12 member nations of the euro zone have solved the political problems created by common currencies by adopting a transnational institution—the European Central Bank — and giving every country a seat at the table, Professor Eichengreen said. "Where is Ecuador's seat on the Federal Reserve Board?" he asked.
    Advocates of dollarization recognize that the trend is also at odds with the prevailing political winds in the Western Hemisphere. "There is a mini-anti-American revolt going on in Latin America as we speak," Mr. Litan said. "Countries that would otherwise be interested, like Bolivia and Venezuela, have elected leftist governments" that are ardently opposed to dollarization.
    But Mr. Litan says he believes that time may be on the side of the dollar: "History has marched toward the euro, and it is slowly marching toward the dollar."

    Borrow and spend fiscal policies are very much in vogue among governments and consumers, the global housing bubble bas reached unprecedented proportions, and many of the world's stock markets are so hyperinflated that investors seem to have forgotten the basic law of physics — what goes up must corne down.
    India's stock market shot up by 42 percent and Malta's rocketed by 60 percent last year, but investors keep pour-
ing money into the markets. This investor frenzy is occurring on the heels of some of thé largest corporate bankruptcies and fïnancial boondoggles in history and indicates that investors appear not to have learned much in the process.
    Investors appear to believe that for some reason the age of globalization has made the prospect of a global economie meltdown remote, and that the global economy will recover from whatever is thrown its way. Their thinking is that since the world's economies are so closely linked together, they will ail somehow swim, not sink, when the next major shock to the System occurs. The more logical conclusion, however, is that globalization has made all the world's economies more vulnerable to collective shock.
    Unlike the past, those shocks can be more severe because of the economie linkages and because of new threats to the system with unpredictable consequences such as global terrorism, nuclear proliferation among rogue states, and the threat of a global pandemic.
    The price of oil currently hovers between $60 and $70 per barrel — near historie inflation-adjusted highs — without any major disruption in the tight global supply. Any major disruption in supply — from a terrorist attack, an oil worker strike, or a decision to withhold supply by a major oil producing nation — could send the price of oil into the stratosphere. The resuit would be predictable: consumers would stop spending and the economie ripple effects would take their toll.
    If the U.S. consumer stops buying, the U.S. economy and the many economies dependent upon it will be affected. China's export machine would downshift from Overdrive to first gear, the commodity boom would stop in its tracks, and the global production machine would slow down dramatically.
    If a bomb on a container ship were to explode in the port of Los Angeles or Rotterdam, global container traffic would be disrupted for weeks or months. Global imports and exports would be halted temporarily, with incalculable damage to the global shipping business and to the global economy.
    If a chemical, biological, or nuclear weapon were to explode in the financial district of New York or London, financial activity would probably have to be halted in those locations for years, as it would be too dangerous to occupy, much less rebuild. The global implications would be severe.
    Yet the capital markets are humming as if there were no tomorrow and investors seem impervious to the risks that are now ever present in the global economie system. Some governments have made their fiscal quagmire worse by piling more debt on the national books and continuing to spend recklessly, while doing little or nothing meaningful to increase national revenues.
    Some home financiers have reacted to the housing bubble by adding fuel to the fire, creating no-down-payment schemes, encouraging more speculation and continued high-stakes risk taking. Many banks have continued to offer consumers new
credit cards, and consumers have responded in kind, spending until their credit cards are maxed out and borrowing
from the banks until they can take out no more home equity loans. How can this possibly continue?
    Governments, investors and lenders continue to build the house of cards, with little apparent regard for the long-term consequences or the many risks that could cause its collapse at any time.
    Al Qaeda's recent attempt to bomb a major oil facility in Saudi Arabia was a wake-up call. Just one major supply disruption could resuit in a super spike in the price of oil. As was the case with 9/11 and with SARS, a terrorist attack or bird flu pandemic could cripple the travel industry, with severe economie consequences. And one action by a rogue nation could send the markets into a tailspin.
    Nothing but a bunch of gloom and doom you think? World War I, remember, started with a single gunshot.

    Recent stock market turmoil has been a plus for United States Treasury securities. Over the last couple of weeks, investor demand for safety has generally pushed up the price of the benchmark 10-year Treasury bond, making it cheaper for the government to borrow. But there is still plenty of reason to worry about the United States' borrowing binge.
    By definition, federal borrowing eventually results in a transfer of income from American taxpayers, whose taxes go to pay the interest on the debt, to the investors who hold the Treasury bonds. As long as the bonds are owned by Americans, the transfer is simply from one group of citizens to another. Bond holders may get richer, while taxpayers who don't own bonds get poorer, which could add to troubling disparities in personal wealth. But shuffling the income between the two groups doesn't reduce America's overall wealth.
    Today, however, 43 percent of the United States' publicly held debt of $4.8 trillion is held abroad, mainly by central banks in Japan, China and Britain and by offshore hedge funds. That's up from a 30 percent share in 2001, an extraordinary increase. Indeed, during the Bush years, 73 percent of new government borrowing has been from abroad.
    Paying the interest on the foreign-owned portion of the debt will be a burden on future Americans, draining their wallets and siphoning off the nation's wealth.
    Reliance on foreign lenders poses current dangers, as well. A shift in investor sentiment, away from dollar-based investments and into other countries' assets, could be very destabilizing, forcing a drop in the dollar, higher interest rates and higher prices. Such shifts can be sudden, as in the Asian financial crisis in 1998.
    Of course, no one knows the future. But we can size up our present reality: America is living beyond its means, and foreigners are increasingly supporting the excess — in exchange for a government guarantee that a chunk of America's future collective income will benefit them, not the Americans who earn it.

But as the history of debt in America shows, condemnations of extravagance can obscure more than they illuminate. The equation of debt and decline assumes that once upon a time Americans lived within their means and saved for what they bought. This is fantasy: there never was a golden age of thrift. Debt has always played an important role in Americans' lives — not merely as a means of instant gratification but also as a strategy for survival and a tool for economic advance.

Yet our moral traditions have concealed this complexity. "Owe no man anything," St. Paul warned, and from the New England Puritans forward, legions of Protestant ministers made this their text. Indebtedness signified a sin against the Protestant ethic of self-control; it also threatened the ideal of independent manhood that underwrote the founders' vision of a virtuous republic. The indebted man "must smile on those he hates, he must extend his hand where he would strike, he must speak pleasantly with a curse in his throat," a Harper's contributor wrote in 1894. "He wears dependence like a yoke."

Benjamin Franklin coined similar lessons in aphorisms later memorized by generations of Victorian-era schoolchildren: "The Borrower Is a Slave to the Lender." "Be frugal and free." The link with lost freedom was more than metaphorical: you could still be imprisoned for debt in many places (including New York City) down to the early 1900's.

Still, the case against debt was more principled than practical. Every generation of moralists imagined the same fall from financial rectitude. In their novel "The Gilded Age" (1873), Mark Twain and Charles Dudley Warner mourned the disappearance of the antebellum "horror of debt" amid the speculative borrowing of the post-Civil War years.

In 1924, the editor of The Saturday Evening Post complained that "the firmly rooted aversion to debt in any form which prevailed a generation ago has almost completely evaporated." In 1958, John Kenneth Galbraith noticed that "there has been an inexplicable but very real retreat from the Puritan canon that required an individual to save first and enjoy later."

In fact, debt is as American as cherry pie. For George Washington and Thomas Jefferson, debt was the price they paid to participate in the world of big-spending Southern planters. Among plainer rural folk, through most of the 19th century, cash was scarce, and country-store ledgers carried local peoples' debts for years, sometimes forever.

Factory workers and laborers used debt to make ends meet, resorting to pawnshops, loan sharks, relatives and friends. Even moralists admitted distinctions between good ("productive") debt and bad ("consumptive") debt. The other side of debt, after all, was credit — "Beautiful credit! The foundation of modern society," as Twain and Warner called it in "The Gilded Age." They had a point. The root of credit was credo — "I believe" — and faith was a necessary component of most transactions in an expanding economy. Borrowing money was "getting trusted," in the argot of Victorian commerce. Among businessmen, indebtedness was a sign that you were "a man of importance in the community," as a euphoric young John D. Rockefeller said after he was "trusted" by a Cleveland bank for $2,000. Not financial obligations but the failure to meet them was what made you "good for nothing."

Among the failures in the late 19th century were farmers, whose crop prices fell while they struggled to pay for threshers and combines. Desperate for relief from creditors, they demanded an expansion of the money supply through the free coinage of silver. The "money question" peaked in the election of 1896, when the Northeastern creditors' candidate, William McKinley, defeated William Jennings Bryan, the spokesman of the agrarian South and West. Those last two regions, a writer for The Atlantic Monthly observed, had "nothing in common but a lack of thrift." Imprudent borrowers took on debt "with only a speculative opportunity to pay" — and this, the magazine charged, violated the trust required to maintain the credit system. This rhetoric of "sound money" concealed a clash of interests between bankers and farmers, Wall Street and Main Street. It would not be the last time that moralism would mask class conflict in debates over monetary policy.

After 1900, the proliferation of mass-marketed products encouraged a more open tolerance for consumer debt. By the 1920's, millions of middle-class Americans bought durable goods on time payments — sewing machines, washing machines, radios, automobiles, houses. Lenders acquired legitimacy, reinforced by reassuring names like Household Finance Corporation or General Motors Acceptance Corporation. "Acceptance" implied membership in a national community of responsible borrowers.

Indebtedness could discipline workers, keeping them at routinized jobs in factories and offices, graying but in harness, meeting payments regularly. Good consumers would be good producers. The economist who proposed this idea was Simon Nelson Patten, in "The New Basis of Civilization" (1907). By providing new sanctions for spending, Patten helped create a cultural landscape where consumer debt could find a decent suburban home. He predicted that workers' desires for things would not undermine their capacity for disciplined achievement, as generations of moralists had claimed; rather, the multiplication of wants would become part of the civilizing process, as workingmen and their wives would broaden their horizons and take pride in their accumulating possessions.

Patten's New Basis began the project that E.R.A. Seligman would complete in "The Economics of Installment Selling" (1927) — the abolition of the distinction between "productive" and "consumptive" debt. Patten was onto something. The disciplining power of debt was undeniable. Even during the Depression, while Americans cut back on new borrowing, they also denied themselves food and clothing to avoid repossession of refrigerators or real estate. "Oh, the tension in the house," one of Studs Terkel's informants recalled in "Hard Times," "when Pa used to scramble around trying to get enough money to pay that installment loan. That was the one degrading thing I remember." In 1932, a Harper's contributor observed that the middle-class homeowner "no longer has possessions but only obligations." This homeowner did not exactly represent an ethos of self-gratification.

The true fulfillment of Patten's vision depended on an economically secure working population. These conditions awaited the rise of strong industrial unions and the comparative prosperity of the post-World War II era. The acquisition of appliances, cars and houses was often financed on the installment plan or with the assistance of government agencies like the Federal Housing Administration. Thanks largely to union power, more fortunate workers could depend on steady wages that allowed them to pay off big-ticket items over time. Patten would have been pleased.

The upward spiral of earning and spending survived until the 1970's, when the midcentury ideal of corporate citizenship evaporated in the harsher climate of renewed international competition. Fearing foreign rivals, American business ended its implicit social contract with unions by seeking cheap labor in overseas markets. During the 1980's, while real income continued to stagnate for most Americans, the ascendancy of Ronald Reagan gave government sanction to unprecedented consumer spending.

Reagan's rhetorical refusal of limits combined with the deregulation of the lending industry to detach dreams of luxury from previous constraints. As money worship mounted, job security disappeared and inequalities widened, pundits spoke of a new Gilded Age. By the 1990's, bloated icons of affluence proliferated: the gargantuan pseudo-military vehicle, the 10,000-square-foot hacienda. A bigger standard package of household goods demanded deeper debt and accelerated the pace of the consumer treadmill. No one wanted to look like a "loser."

But for many borrowers, debt has not been just about keeping up appearances. Less-affluent Americans have resorted to borrowing for groceries as well as cars. Public policies have intensified their plight. The freezing of the minimum wage, the tightening of unemployment insurance and workmen's compensation programs, the shifting of the tax burden from the rich to the rest — these changes have starved public services while leaving ordinary Americans more dependent than ever on debt. One of the most consistent statistical findings of recent years is that about half of all personal bankruptcies have been caused by medical bills. Whatever else our current indebtedness may signify, it is hardly a riot of hedonism.

Jackson Lears, editor of Raritan: A Quarterly Review, is the author, most recently, of "Something for
Nothing: Luck in America."

    Italy's central bank has switched a quarter of its foreign currency reserves into sterling, dumping billions in US Treasury bonds, in the most dramatic move to date by a G7 country to slash exposure to the dollar. The Bank of Italy, now under new governor Mario Draghi, said in its half-year report that it had raised the sterling share of its reserves to 24pc, up from zero in 2004.
    Dollar holdings were cut from 84pc to 63pc, a shift that is certain to be analysed closely by traders as a gauge of sentiment among the 12 central banks of the eurozone system. The yen share fell from 14pc to 10pc. Sterling closed yesterday at $1.8787 against the euro, near its peak for the year.
    Italy's huge purchase of pounds is the latest vote of confidence in Britain's economic management, a sign that sterling is regaining its historic role as a benchmark of stability, even if it is too small a player to serve as the anchor of the global system.
An Italian official said the Banca d'Italia was taking action in advance of a dollar slide, widely expected as the US interest rate cycle peaks this summer and investors focus once again on the US's $800bn (£425bn) current account deficit. The official said: "There are not many places to go once you decide to get out of the dollar.
    Japan is always a question mark. "At least the British economy is humming along OK and UK bonds offer a decent yield [4.63pc]. At the end of the day, Britain is still the biggest single trading partner for the eurozone."
    The Banca d'Italia is viewed as one of the world's most market-savvy central banks, holding onto every ounce of its gold reserves when others, including the Bank of England, under Treasury orders, sold much of their bullion at the bottom of the market.
    However, it co-ordinates policy closely with both the European Central Bank and its peers in the euro system, led by the German Bundesbank and the Banque de France. Tony Norfield, chief currency analyst at ABN Amro, said it was likely that other euro-zone banks were also selling dollars, although most of the rest do not reveal the exact breakdown of their foreign currency holdings. Mr Norfield said: "The Italians have been quite sneaky, but I wouldn't be surprised if others are doing the same thing. The Bank of France is worth watching."
    Dollar flight has been gathering pace at smaller central banks. In Sweden the Riksbank announced in April that it had cut its dollar holdings from 37pc to 20pc, while the United Arab Emirates and the gas sheikhdom of Qatar have both signalled plans to move into euros.
    The Swiss National Bank switched 10pc of its holdings into pounds in 2004, and Russia is now following suit. Russia's central bank said it had cut the dollar share of its surging reserves from around two thirds to 40pc, a weighting that matters more and more as Russia vaults up the foreign reserve league. At last count, Moscow was poised to move into third place with $251bn.
    However, for China and Japan, the two giants, with combined reserves of some $1,800bn, it is much harder to diversify smoothly out of the dollar. Any sign that they are liquidating their holdings of US bonds could trigger a global stampede, causing a dollar crash and a broader financial crisis. The two countries would be left with sharply devalued holdings.
    The fashion for sterling is a stark contrast to the grim days of the 1960s and 1970s when the UK pound was invariably the sick currency of the rich club. The silent accumulation of sterling by the heavy brigades would help explain the strength of sterling, the star performer on the currency markets this year.
    The International Monetary Fund said the UK pound had overtaken the yen to become the world's third biggest reserves currency, after the dollar and the euro. Known global reserves of pounds have risen from £55bn to £111.5bn over two years.

    LENDING is a sober business punctuated by odd moments of lunacy. Genoese lenders' indulgence of Philip II of Spain's expensive taste for warfare caused not only the world's first sovereign bankruptcy in 1557, but the second, third and fourth as well. Lenders recycled petrodollars to third-world countries in the 1970s in the wilfully naive belief that countries, because they cannot go bust, will not default.
    The world is once again in the grip of a spree of lending, but this time to companies rather than countries. What is striking is that much of this lending is happening not through public share and bond markets, nor exclusively through banks (see article). The issuance of syndicated loans vaulted to $3.5 trillion last year, from $2.3 trillion in 2000.
    Thanks to the low cost of debt, private lenders, such as hedge funds, are extending vast amounts of credit to leveraged buy-out firms and other private borrowers. Forsaking the sunlit uplands of global finance, the market for capital is plunging into the shadows.
    For the financiers, that is an irresistibly lucrative place to be. In thinly traded, lightly regulated and untransparent markets, the bold can make an awful lot of money—and they can lose it on an even more extravagant scale. A bunch of investors is $6 billion or so poorer this week, after it emerged that Amaranth Advisors, a hedge fund that had some $9 billion under management, suffered catastrophic losses in a few weeks on the back of falling natural-gas prices (see article).
    There is every chance that the markets can cope with a wilting Amaranth, or worse. Moreover, business people have perfectly good reasons for wanting to operate out of the public gaze. The trouble is that the vulnerabilities of debt's dark side have not yet been fully tested by the next act of collective lunacy. The shadows are scary because nobody quite knows what secrets they hold. That has got regulators worried—and rightly so.

Dark matter
    Back in the days of claret-filled city lunches, life was so simple. Company pension funds and mutual funds put money into the securities of states and listed firms and hoped that they did well. Things are a great deal more complicated now. Even as the private world has eclipsed public markets, finance has been convulsed by a computer-enhanced frenzy of creativity. In today's caffeine-fuelled dealing rooms, a barely regulated private-equity group could very well borrow money from syndicates of private lenders, including hedge funds, to spend on taking public companies private. At each stage, risks can be converted into securities, sliced up, repackaged, sold on and sliced up again. The endless opportunities to write contracts on underlying debt instruments explains why the outstanding value of credit-derivatives contracts has rocketed to $26 trillion—$9 trillion more than six months ago, and seven times as much as in 2003.
    In many ways, these complex derivatives are good for economies. Because they allow investors to lay off the risk of borrowers' defaults, they free lenders to lend more. Because risk is dispersed to those who have an appetite for it, the system should be more robust. Because derivatives are traded in liquid markets, they rapidly transmit information about the creditworthiness of borrowers. The benefits of this hyperactive shuffling of money spread well beyond financial markets. If companies are borrowing more cheaply and sensibly to make acquisitions, pay dividends and buy back their own shares, businesses everywhere should run more efficiently.
    That is the theory, at least. And so far, it has broadly been borne out. The markets struggled to cope with financial crises in Asia and Russia in the late 1990s and with the implosion of Long-Term Capital Management, a hedge fund, in 1998. By contrast, there were never serious fears that the dotcom bubble burst, September 11th 2001, or, more recently, the collapse of General Motors' bonds and investors' flight from risky investments, would lead the system to collapse.
    Regulators understand very well how much the world stands to gain from this revolution in finance, but they are nevertheless nervous. Because of the lack of transparency, they cannot see whether these volatile new debt instruments are in safe hands or how they will behave in a crisis when everyone is heading for the exits. As Donald Rumsfeld might have put it, they have left a world of known unknowns for a twilight landscape of unknown unknowns.
    Last week Timothy Geithner, the Federal Reserve's man on Wall Street, gave warning that all this might make financial crises less common, but more severe. Britain's Financial Services Authority complained this week that investment banks and hedge funds were sloppy and prone to conflicts of interest. In a panic, incomplete paperwork could cause the whole system to collapse amid disputes about who owns which liabilities. Worryingly, firms had wildly different estimates for the risks of similar portfolios of investments.

Someone somewhere is investing on flawed assumptions.
Sensible things can be done. Mr Geithner and the New York Fed have with some success been demanding that the derivatives markets sort out their bureaucracy. He wants banks to increase the cushion of collateral they require from highly leveraged clients, in case trades go bad. Banks, which routinely play computerised war games simulating the risks in their trading strategies, are being asked to be harder-nosed about assessing which hedge funds they deal with. Because the great fear is ignorance, regulators are commendably seeking unobtrusive ways to keep tabs on the markets.
Regulators also hint that it might eventually be necessary to supervise credit hedge funds, now monitored via their brokers. Here the markets' desire for obscurity contains a lesson as well as a threat. The rush into the shadows is also partly a flight from regulation, to be free of the costs and the burdens of compliance and to preserve the "cover" that helps an outfit keep a profitable trade to itself. When the next recession reveals the next act of lunacy and the urge to re-regulate finance takes hold, remember that today's successes were founded partly on those freedoms.

THE International Monetary Fund meeting in Singapore last month came at a time of increasing worry about the sustainability of global financial imbalances: For how long can the global economy endure America’s enormous trade deficits — the United States borrows close to $3 billion a day — or China’s growing trade surplus of almost $500 million a day?

These imbalances simply can’t go on forever. The good news is that there is a growing consensus to this effect. The bad news is that no country believes its policies are to blame. The United States points its finger at China’s undervalued currency, while the rest of the world singles out the huge American fiscal and trade deficits.

To its credit, the International Monetary Fund has started to focus on this issue after 15 years of preoccupation with development and transition. Regrettably, however, the fund’s approach has been to monitor every country’s economic policies, a strategy that risks addressing symptoms without confronting the larger systemic problem.

Treating the symptoms could actually make matters worse, at least in the short run. Take, for instance, the question of China’s undervalued exchange rate and the country’s resulting surplus, which the United States Treasury suggests is at the core of the problem. Even if China strengthened its yuan relative to the dollar and eliminated its $114 billion a year trade surplus with the United States, and even if that immediately translated into a reduction in the American multilateral trade deficit, the United States would still be borrowing more than $2 billion a day: an improvement, but hardly a solution.

Of course, it is even more likely that there would be no significant change in America’s multilateral trade deficit at all. The United States would simply buy fewer textiles from China and more from Bangladesh, Cambodia and other developing countries.

Meanwhile, because a stronger yuan would make imported American food cheaper in China, the poorest Chinese — the farmers — would see their incomes fall as domestic prices for agriculture dipped. China might choose to counter the depressing effect of America’s huge agricultural subsidies by diverting money badly needed for industrial development into subsidies for its farmers. China’s growth might accordingly be slowed, which would slow growth globally.

As it is, however, China knows well the terms of its hidden “deal” with the United States: China helps finance the American deficits by buying treasury bonds with the money it gets from its exports. If it doesn’t, the dollar will weaken further, which will lower the value of China’s dollar reserves (by the end of the year, these will exceed $1 trillion). Any country that might benefit from China’s loss of export market share would put its money into a strong currency, like the euro, rather than the unstable and weakening dollar — or it might choose to invest the money at home, rather than holding more reserves. In short, the United States would find it increasingly difficult to finance its deficits, and the world as a whole might face greater, not less, instability.

Nothing significant can be done about these global imbalances unless the United States attacks its own problems. No one seriously proposes that businesses save money instead of investing in expanding production simply to correct the problem of the trade deficit; and while there may be sermons aplenty about why Americans should save more — certainly more than the negative amount households saved last year — no one in either political party has devised a fail-proof way of ensuring that they do so. The Bush tax cuts didn’t do it. Expanded incentives for saving didn’t do it.

Indeed, most calculations show that these actually reduce national savings, since the cost to the government in lost revenue is greater than the increased household savings. The common wisdom is that there is but one alternative: reducing the government’s deficit.

Imagine that the Bush administration suddenly got religion (at least, the religion of fiscal responsibility) and cut expenditures. Assume that raising taxes is unlikely for an administration that has been arguing for further tax cuts. The expenditure cuts by themselves would lead to a weakening of the American and global economy. The Federal Reserve might try to offset this by lowering interest rates, and this might protect the American economy — by encouraging debt-ridden American households to try to take even more money out of their home-equity loans to pay for spending. But that would make America’s future even more precarious.

There is one way out of this seeming impasse: expenditure cuts combined with an increase in taxes on upper-income Americans and a reduction in taxes on lower-income Americans. The expenditure cuts would, of course, by themselves reduce spending, but because poor individuals consume a larger fraction of their income than the rich, the “switch” in taxes would, by itself, increase spending. If appropriately designed, such a combination could simultaneously sustain the American economy and reduce the deficit.

Not surprisingly, these recommendations did not emerge from the International Monetary Fund meetings in Singapore. The United States retains a veto there, making it unlikely that the fund will recommend policies that aren’t to the liking of the American administration.

Underlying the current imbalances are fundamental structural problems with the global reserve system. John Maynard Keynes called attention to these problems three-quarters of a century ago. His ideas on how to reform the global monetary system, including creating a new reserve system based on a new international currency, can, with a little work, be adapted to today’s economy. Until we attack the structural problems, the world is likely to continue to be plagued by imbalances that threaten the financial stability and economic well-being of us all.

Joseph E. Stiglitz, a professor of economics at Columbia and the author, most recently, of “Making Globalization Work,” was awarded the Nobel in economic science in 2001.

It’s a brisk Wednesday morning in the windy caverns of Wall Street and Sarah Clark’s toes are cold. Dressed in a purple flight attendant outfit, Ms. Clark, a 26-year-old model, is trying to entice recent bonus recipients at Goldman Sachs into using a charter plane service, handing out $1,000 discount coupons to people in front of the investment bank’s Broad Street headquarters.

“Where am I going?” asks one man, heading toward the Goldman building. “It’s your own private jet,” says Ms. Clark with a smile. “You can go wherever you like.” For Wall Street’s elite, the sky may well be the limit.

In recent weeks, immense riches have been rained upon the top bankers and traders. After a year of record profits, investment houses like Goldman Sachs, Lehman Brothers and Morgan Stanley are awarding bonuses as high as $60 million. And a select group of hedge fund managers and private equity executives may be taking home even more.

That is serious money. And the serious luxury goods markets are feeling the impact. Miller Motorcars, in Greenwich, Conn., is fielding more requests for the $250,000 Ferrari 599 GTB Fiorano than it can possibly fill. One real estate broker laments a dearth of listings for two clients trying to spend $20 million on Manhattan properties. Financiers already comfortably settled in multimillion-dollar apartments and town houses are buying $5 million apartments for their children. Vacation homes, usually bought and sold in the spring, are now hot this winter, including ones in private resorts like the Yellowstone Club in Montana near Yellowstone National Park.

“Last year, everybody bought Ducatis,” said one investment banker, referring to the Italian motorcycle. “This year it’s vacations. I’m on my way to St. Barts,” he said, en route to the airport. Like most bankers, he spoke on the condition that he not be identified, because he was not authorized to talk to a reporter by his company.

The 2006 bonus gold rush has re-energized some luxury markets. The Manhattan real estate market, for example, had softened; sales of apartments fell 17 percent in the third quarter this year compared with a year ago, according to the Corcoran Group.

Then came bonus day. Last week, Michele Kleier, president of Gumley Haft Kleier, received a call from a hedge fund manager in his late 30s. He had spent $6 million on an apartment two years ago and, with his bonus, wanted to upgrade. His new price range? “Not more than $20 million.” Ed Petrie, a broker at Sotheby’s in East Hampton, N.Y., is now fielding two bids for $8 million to $10 million properties in exclusive Georgica Pond — properties that have been on the market since the spring. “The fall was relatively slow and then suddenly, with news on bonuses, there has been quite a bit of activity,” he said.

Many brokers noticed not just the bonus effect, but the bonus-anticipation effect. Buyers who sat on the sidelines in 2006, waiting for real estate prices to come down, saw news of outsized bonuses and started signing deals to pre-empt any price increase driven by new Wall Street payouts. “Part of our recent increase in sales activity has been buyers not in financial services trying to beat the bonus rush,” said James Lansill, senior managing director at the Corcoran Sunshine Marketing Group. Once the bonus rush started, Mr. Lansill witnessed a trend he had never seen in his 14 years in the business: people who had signed contracts for apartments under construction 5 to 6 months ago were doubling the size of the properties they were purchasing.

In the last three weeks, the Corcoran Sunshine Marketing group sold the last four apartments in the Richard Meier apartments at 165 Charles Street in Greenwich Village. The last one to go: a two-bedroom, two-bathroom apartment with 2,350 square feet that sold for just under $7 million.

Patricia Warburg Cliff, senior vice president and director for European sales at the Corcoran Group, said that until recently, 2006 had been characterized by calmer, more informed buyers. “Now there’s a feeling, ‘I need to sign because I don’t want it snatched away,’ ” she said.

Adding to the spending spree is a rash of young hedge fund analysts, first big bonus checks in hand, scooping up the $2 million to $3 million starter apartments (most popular features: glass walls, marble bathrooms and kitchens — likely to go unused — with top-flight appliances). “We love hedge funds, they are our favorite people” Ms. Kleier said. “They don’t feel like the money is real and they don’t mind spending it — they don’t mind going up by $500,000 or $1 million increments.”

Hedge fund analysts are not the only ones celebrating bonus season. Private equity firms like the Blackstone Group and Kohlberg Kravis & Roberts helped fuel a record deal-making year. Private equity’s deal-making has trickled down to Wall Street in two ways. For one, the banks served as advisers on the deals and financed them, raking in enormous fees. (Kohlberg Kravis is said to pay more than $700 million a year in fees to the Street.) But bankers also see a pay effect: top executives insist they must pay up because of the danger that their best dealmakers could leave for higher-paying private equity firms or other hedge funds considered more flexible and fun.

Those young, single hedge fund managers are bringing holiday cheer to car dealerships as well. This year, drama surrounds the very limited production of the Ferrari 599 GTB Fiorano, a car with 612 horsepower that can go from zero to 60 miles an hour in 3.6 seconds. “It is the most sought-after car ever made,” said Richard Koppelman, president of Miller Motorcars. With a waiting list of 50, Mr. Koppelman expects to get only one. Who will be the lucky customer? “It’s very difficult,” he said. “We try to take care of our best clients.”

Private planes, or shares of them, are also on the rise, with demand for charter planes at one company up 40 percent to 50 percent among financial services executives. “There is a noticeable difference this year compared to the past, especially in the financial sector,” said Jeffrey Menaged, founder and head of Chief Executive Air, the company that hired Ms. Clark for the day. A typical price for a charter flight is $30,000. Sales of “jet cards,” a sort of debit card for private flying, increase during bonus season, Mr. Menaged said, as executives lock in last year’s gains with guaranteed comfort for the new year.

Exotic destinations are also being pitched to the Wall Street ultrarich. Unlimited Speed started Victory Lane in November, a 3,000-acre development in Georgia for motor racing aficionados. Along with a 4.5 mile racetrack, the development also has a 1,600-acre nature preserve, equestrian facilities, a golf course and spa. It already has 27 reservations, a quarter of them coming from Wall Street, said Andrew Goggin, president of Unlimited Speed.

Not everyone on Wall Street is getting multimillion-dollar bonuses. The average managing director — who stands at the top of Wall Street’s hierarchical food chain, but far from rock-star status — will be getting $1 million to $3 million, which will likely be stashed in savings as memories of the 2001 bear market remain fresh. “I’m putting it in the bank because I know next year I could be out of a job,” said one managing director at a leading bank.

For hedge fund traders and managers, markets were rough in the spring and summer, and some did not make gains until stocks rallied this fall. “It was a terrible year,” said one young hedge fund professional. “I am going to the movies with my bonus. By myself."

At cocktail parties, comparisons to 1999 abound. That year marked the height of the technology boom and the eve of a painful crash. “It feels a little bit like the top,” said another banker.

The morning Goldman Sachs announced record fourth-quarter and 2006 earnings, Lloyd C. Blankfein, chairman and chief executive, implored his employees — many whom would directly benefit from the bountiful earnings — to avoid excess. “As stewards of the firm’s reputation, I ask each of you to remember that our actions — inside and outside of the office — reflect on Goldman Sachs. Even a perception of arrogance hurts all of us,” he said in a voice mail sent to the entire firm.

Back handing out vouchers in front of Goldman, Ms. Clark wondered why there weren’t more people coming to work during the early hours. Then, at 7:30 a.m., a black Mercedes pulled up, depositing Mr. Blankfein in front of Ms. Clark. The night before, he had been awarded a $53.4 million bonus. She offered him a voucher. “How are you?” he said, smiling quickly but refusing the voucher. “I guess he didn’t want it,” she lamented.

If the bankers, investors and regulators who populate the global financial markets are not already anxious, they should be. The easy money that has buoyed the global economy for much of this decade is getting harder to come by.

At a similar point a decade ago, Russia defaulted on its foreign debt and Asia came unglued, weakening global growth. This time, the trigger could be the rapid erosion in the quality of American home mortgages — reflected in surging delinquencies and rising defaults.

Two economists, Mark Zandi and Juan Manuel Licari of Moody’s Economy.com, detailed the dangers recently. In 2005 and 2006, lenders wrote an estimated $3.2 trillion in new home mortgages, which was a record — and lowered their credit standards considerably to do it. In 2005 alone, 20 percent of the mortgages taken out were “subprime” — made to borrowers with poor credit — and many more had worrisome features like interest-only payments.

Not surprisingly, as interest rates rose last year, mortgage delinquencies soared. Delinquency rates are expected to peak in 2008 at over 3 percent, well above the level of the last recession. Many of these risky mortgages were sold to investment banks, who carved them up into complex i.o.u.’s that they sold to investors worldwide. More than 20 percent of global private debt securities is now tied to housing in the United States. That works out to $7.5 trillion — far larger than the market for United States Treasuries. So if America’s mortgage market heads south, the losses could be widespread.

The odds of a global financial crisis are still low, according to Mr. Zandi and Mr. Licari, but they are rising. There is not a lot now that can be done about the risks in the mortgage market. But the growing possibility of hard times ahead is another argument for rolling back many of the recent excessive tax cuts, so the government will have more resources available to respond if a crisis comes.

Edward N. Jones, a former NASA engineer for the Apollo and Skylab missions, looked at low-income home buyers nearly a decade ago and saw an unexplored frontier.

Through his private software company in Austin, Tex., Mr. Jones and his son, Michael, designed a program that used the Internet to screen borrowers with weak credit histories in seconds. The software was among the first of its kind. By early 1999, his company, Arc Systems, had its first big customer: First Franklin Financial, one of the biggest lenders to home buyers with weak, or subprime, credit.

The old way of processing mortgages involved a loan officer or broker collecting reams of income statements and ordering credit histories, typically over several weeks. But by retrieving real-time credit reports online, then using algorithms to gauge the risks of default, Mr. Jones’s software allowed subprime lenders like First Franklin to grow at warp speed.

By 2005, at the height of the housing boom, First Franklin had increased the number of subprime loan applications it processed sevenfold, to 50,000 every month. Since 1999, Mr. Jones’s software has been used to produce $450 billion in subprime loans.

The rise and fall of the subprime market has been told as a story of a flood of Wall Street money and the desire of Americans desperate to be part of a housing boom. But it was the little-noticed tool of automated underwriting software that made that boom possible.

Automated underwriting software spawned an array of subprime mortgages, like those that required no down payment or interest-only payments. The software effectively helped move what was a niche product only a decade ago into the mainstream.

Automated underwriting “replaced the ways we used to extend credit,” said Prof. Nicolas P. Retsinas, director of the Joint Center for Housing Studies at Harvard.

Automated underwriting is now used to generate as much as 40 percent of all subprime loans, according to Pat McCoy, a law professor at the University of Connecticut who has written on real estate lending.

The software itself, of course, cannot be blamed for lowered lending standards or lax controls. But critics say the push for speed influenced some lenders to take shortcuts, ignore warning signs or focus entirely on credit scores.

“Used properly, automated underwriting is a wonderful thing,” Professor McCoy said. The problem, she said, comes when lenders customize it to approve the wrong borrowers.

During the housing boom, speed became something of an arms race, as software makers and subprime lenders boasted of how fast they could process and generate a loan. New Century Financial, second to HSBC in subprime lending last year and now on the brink of bankruptcy, promised mortgage brokers on its Web site that with its FastQual automated underwriting system, “We’ll give you loan answers in just 12 seconds!”

Dozens of little-known software companies compete with Arc Systems. They include MindBox of Greenbrae, Calif.; Metavante, in Milwaukee; Mortgage Cadence of Greenwood Village, Colo.; and Overture Technologies in Bethesda, Md.

With small staffs, the companies typically sell their software to home lenders with vast networks of call centers employing hundreds of thousands of loan officers. Some big Wall Street banks and housing lenders bought the software, then developed their own systems. First Franklin, which has been acquired by Merrill Lynch, said that it stopped using Arc Systems’ software last year to create its own proprietary system.

Subprime lenders like automated underwriting because it is cheap and fast. A 2001 Fannie Mae survey found that automated underwriting reduced the average cost to lenders of closing a loan by $916. The software quickly weeds out the very riskiest of applicants and automatically approves the rest. “You don’t have to chase every lead — just greenlight ’em,” Mr. Jones of Arc Systems said in an interview. And greenlight them they did.

By mid-2004, Countrywide Financial, a major subprime lender, had used MindBox’s automated underwriting system to double the number of loans it made, to 150,000 monthly. “Without the technology, there is no way we would have been able to do the amount of business that we did and continue to do,” Scott Berry, executive vice president for artificial intelligence at Countrywide Financial, told a trade publication, Bank Systems & Technology, in the summer of 2004. Countrywide now uses a proprietary system.

Early forms of automated underwriting were first developed and used in the 1970s to process car loans and credit card applications. By the mid-1990s, software for home buyers with good credit had gone mainstream at Fannie Mae and Freddie Mac, the large government-sponsored mortgage finance companies, and big traditional lenders. But none had been developed for subprime lending, then a niche market.

There are no estimates of the sales volumes for this software niche, but companies like Arc Systems often have annual revenues in the tens of millions of dollars. Arc Systems, whose name is something of a pun — Mr. Jones’s middle name is Noah — earns $10 to $30 each time a borrower submits a loan application.

Proponents say the software makes things fairer and more objective for risky borrowers. “It takes the subjectivity out of the good ol’ boy system in which Martha knows Joe, who approves the loan — then you end up with a bad decision,” Mr. Jones said.

Samir Rohatgi, a vice president at MindBox, said that old system of manual underwriting actually encouraged loan officers working on commission to grant bad loans. “Those people were feeling pressure because of the way their company’s performing, so the decisions are sometimes biased,” he said.

Mr. Jones said that because his program, LendTech, could parse credit reports for more than 3,000 risk variables, “we had better analytics than the trading desks” on Wall Street. But some question whether such analysis gave comfort where it was not deserved.

“Automated underwriting put the credit score on such a pedestal that it obscured the other important things, like is the income actually there,” said Professor Retsinas of Harvard. “Before there was A.U., down payment mattered a lot. Where we’ve crossed the line in recent years is to say, we don’t need down payment.” Michael Perna, Arc Systems’ marketing director, said that income “is supposed to be verified by a person.”

Mr. Jones founded Arc Systems in 1984 to produce software for Suwannee County, Fla., which used it to track when policemen issued parking tickets and when jail wardens fed inmates. Then in 1992, a local subprime lender called Home Inc. asked Mr. Jones to develop a program to screen risky borrowers. In 1997, amid the adoption of the Internet, “we ditched that software and went Web-based,” Mr. Jones said.

Since 1999, his software has been used by major subprime lenders including HSBC and its former Household subsidiary, Deutsche Bank and the Virginia Housing Development Authority. Lehman Brothers and the Ellington Management Group, a big seller of mortgage-backed securities, have used LendTech to analyze pools of billions of dollars of subprime loans that they sold to big institutional investors. “We’ve had clients all along the food chain,” Mr. Jones, who is 66, said.

An electrical engineer by training who worked at NASA in the 1960s and then Unisys, Mr. Jones keeps his NASA patches on a wall in his office. He likes to clear cedar and juniper brush on his 100-acre property near Austin. His wife, Gayle, a nurse by training, is the company’s executive vice president. Arc Systems has 52 employees and at one point employed seven married couples. “We like to have picnics and play softball,” Mr. Jones said.

Since the subprime housing market began falling apart late last year, Arc Systems’ sales have dropped 30 percent. Still, Mr. Jones sees a sparkling future for automated underwriting. “The smart money on Wall Street is now looking for the gems — and they’ll use A.U. to find them.”

Then he added, “You know that old symbol of the snake eating its own tail? Well, we’ve always thought the industry was that. And that’s kind of where we’re at right now.”

    The world's top 25 hedge fund managers earned an average of $570m each last year, despite the crush of 8,000 funds all competing for a smidgeon of extra yield in the global marketplace. That much we know. Dr James Simons, a maths PhD and former cryptanalyst for the Pentagon, netted $1.7bn at Renaissance Technologies Corp, followed by Citadel's Kenneth Griffin on $1.4bn.
    Less known is how the stars operate, and how they view the world. For a glimpse into their clandestine affairs, try Steven Drobny's book, Inside The House Of Money, based on long lunches with 13 American, British and European fund managers, each a legend in their own sector, and each replete with tales of how they nearly "blew up" - hedge fund parlance for going bust.
    Such funds are not new. John Maynard Keynes ran his "Syndicate" for a group of friends, and another for King's College, Cambridge. The "College Chest" made a 13.2pc annual return from 1928 to 1945, through the Great Depression. Keynes learned the hard way like everyone else, sage though he was. His personal account was wiped out by a margin call in the commodity slide of 1929.
    Hedge fund man is by nature a contrarian. He - rarely she - bucks consensus as a way of life, profiting whenever the price of any asset, derivative, or country, looks out of whack. No surprise that so many view the current blow-off rally in junk bonds and Chinese stocks with deep suspicion, a sign that the cycle is nearing a top.
    More unnerving is the number who fear something worse, afraid that governments may have upset the workings of capitalism by holding interest rates too low for too long - that is, by mispricing credit. The villain of this book is former Fed chief Alan "Easy Al" Greenspan.
    "My gut feeling is that there will be a lot of pain because we still have to pay for the 1990s, and that worries me," said Christian Siva-Jothy, founder of SemperMacro. His ordeal by fire came as a cocky trader for Goldman Sachs when he bet $1bn that sterling would rise against the yen in 1994. Politics intruded, a recurrent theme.
    President Clinton threatened Japan with car tariffs over alleged currency manipulation (sound familiar? China?). The yen soared. "If that wasn't bad enough, five days later UK inflation numbers were simply awful. Sterling went into a free-fall. It was classic - the market found me," he said.
    "On day eight of this episode, when I lost about $40m in one day, I felt this overwhelming desire to walk out and pretend it wasn't happening. Instead I took a deep breath and liquidated everything. Confidence is a very dangerous thing," he said.
    His top trade is to buy eurodollar futures whenever the Fed starts cutting US rates. It worked like a charm after the Russian crisis in 1998, and again after the dotcom bust in 2001. "It's the most obvious trade in the most liquid market in the world. It's not brain surgery," he said.
    Dr Sushil Wadhwani, best known for his stint on the Bank of England's Monetary Policy Committee, also came unstuck on the yen when at Paul Tudor Jones, this time in 1998 as China was threatening devaluation (ironically). "I got seduced by stories that said dollar/yen was going to 180. I remember one or two people saying they thought the US would intervene because of China's complaints, but I'm afraid I didn't pay enough attention," he said. "In June, the Fed intervened, along with the Bank of Japan, and the dollar dropped like a stone. When something is going up or down in a straight line and you start getting political resistance, you had better pay attention," he said.
    Dr Wadhwani politely accused the Fed and old MPC colleagues of fatally ignoring property and asset inflation. "If you take your eye off the ball vis-à-vis asset price misalignments, then you are storing up trouble. What you've got now is huge asset market distortions and one of these days the chickens will come home to roost," he said. "Alan Greenspan has always argued that it's better to deal with a bubble after it has burst than to worry about pre-empting the bubble. I take a different view," he said.
    As for Britain, Mr Wadhwani said that the MPC should have tightened interest rates earlier to cool house prices, even if inflation fell below target. Like others, Jim Leitner from Falcon Management is waiting pensively for the denouement. "Right now there are a lot of bad things lurking, but I'm just not sure when we're going to fall on the knife," he said.
    Or take Scott Bessent, from Bessent Capital: "At some point, we will have the Big One. It's out there. I don't know whether it's financial asset depression, or a real depression. Financial assets can't keep doing what they're doing, with so many people rewarded for being imprudent," he said.
    Or the anonymous currency guru in the last chapter: "When you look at the whole world and see what it's built on, it is totally, clearly not sustainable. I get so bearish that I think about buying a castle in Scotland and moving up there with a couple of loaded shotguns and a truckload of canned food," he said.
    Regulators are now fretting, afraid that the funds have grown too big. They warn that speculators clustered on the same trades might lurch en masse across deck, capsizing the boat. That is a self-serving critique. Hedge funds have multiplied in a sea of credit, and who is ultimately responsible for that excess credit? Central banks, of course.

Britain's leading "star" investment manager, Anthony Bolton of Fidelity, yesterday broke ranks with City colleagues to condemn multi-billion pound private equity deals for exposing banks to a default risk on a scale not seen since the stock market crash of the late 1980s.
Mr Bolton has sold nearly all his bank and financial stocks and is using new powers to "short" stocks in the belief that many, particular smaller and mid-cap shares, are over-valued. He said the bull market in equities is four years old, which is a longer lifespan than most bull runs, and that a correction is inevitable.

Just a day after the CBI said private equity firms should be applauded for rejuvenating companies, Mr Bolton warned that unchecked lending to finance the current rash of merger and acquisition deals is leaving Britain's banks seriously exposed to the risk of a major default.
Mr Bolton is himself best known as a "king maker" in several big City deals. He shot to fame in 2003 when he orchestrated the sacking of Michael Green, then chief executive of Carlton Communications, earning him a title he loathes: the Quiet Assassin.

But yesterday he warned that the quality of lending by banks to private equity firms is deteriorating. Much of the lending is, he said, "covenant-lite" meaning if a firm goes bust, the bank will have little ability to reclaim the money lent. "Covenant-lite, as far as I'm concerned, means there is no covenant at all."

He added that the flood of private equity deals has similarities to the spate of mergers and acquisitions financed by easy lending in the late 1980s. The stock market, he said, is in the latter stages of a bull run and the behaviour of many of the participants in Wall Street and in London is a cause for worry.

"The head of a major New York investment bank told me in private that because the scale of the private equity deals are so big, the bank can't afford not to take part in them. There's a feeling that if they don't participate, then someone else will."

Mr Bolton has spent 27 years at Fidelity, running many of its biggest funds, including Fidelity European and Special Situations, a £6bn behemoth which he split into two funds last year. He handed one half of the fund to be managed by a relatively unknown Fidelity manager, Jorma Korhonen, and yesterday he paved the way for the remaining £3.2bn to be handed to another Fidelity insider, Sanjeev Shah.