John Mauldin called Paul McCulley's May 2005 essay "must reading" and although it wasn't until November 2005 that I noticed, I think he's still right. A few notes to set up the story. You can read the upshot of the Bretton Woods (BW) agreement--and how Nixon ended it--by clicking here. PIMCO and many others believe that a de facto "Bretton Woods II" (BW II) agreement has evolved, as explained by Chris P. Dialynas in this essay, where the dollar functions as the world's reserve currency and Asia ties their money to it by buying US bonds with every dollar the US spends on asian goods. As you have probably noticed, US salaries have gone nowhere for several years. You are doing well if you have beat your "personal inflation rate" (let's call this your personal cost of goods, insurance, housing and transportation). Many argue that wages will remain flat as long as Asia (especially China) has millions of rural workers migrating to cities for industrial--and eventually technological--jobs. McCulley writes:

...the Federal Reserve - the center of the BW II universe, just as it was in BW I - must pursue a structurally kinder, gentler real Fed funds rate policy, so as to:

• Generate robust aggregate demand growth in America, which is exported via the U.S. current account deficit to a demand-deficient world, and
• Support lofty valuations and inflation in asset prices, in particular property, to provide a source of capital gains to supplement the income of American workers challenged by tepid wage gains.

My God. If true, these comments mean that Greenspan was not at all uncertain a housing bubble existed, he was in fact counting on the bubble to last until Asia generated enough internal demand for their products to take over some of the "consumption burden" the US has shouldered. It's hard to believe he could win that bet, but it's Bernanke who will get the blame now...and all of us who will suffer if/when Greenspan loses. Many writers also point to the precarious Nash equilibrium that exists, where several asian countries (let's say China, Japan, South Korea and to a lesser extent Singapore, Malaysia, Thailand and Vietnam) all have to agree to buy US treasuries and bonds to make BW II work. If any one country gets nervous and starts selling its US holdings and buying, say, Euro-denominated equivalents, the other countries have to work harder to maintain the equivalent. If they all start to get nervous and move to Euros, BW II collapses and we probably see global recession for a few years until we find a new equilibrium. I think we'll be fine, though, as long as the 2 billion people involved agree not to look down.

In my attempts to understand the world, I often pause to assess whether I am making any progress. This dubious exercise requires me not only to decide whether I truly understand the world at all, but also to decide whether I have improved. That many people point at Warren Buffett's exemplary ability to tell you when he thinks he has failed only highlights how rarely anyone says so. I avoid this problem to some extent by concluding that I have greater and greater clarity on how little I know. My last good big thought came last winter. Walking & talking with French Eric, I stated that the USA economy has evolved from agrarian, to industrial to technological, as most people would agree. Where perhaps the majority and I diverge is with my argument that the USA stands midway--at least--in its transition to a finance-based economy. As the Simpsons Brad Goodman once said, "Folks, I'm often asked about my qualifications. Well, I may not have a lot of "credentials" or "training"...". Brad made air quotes all the way, but I won't. I lack training, education and credentials in finance and economy. I have only the quantities of finance news and commentary I read, mostly on the web. Years ago, if you read only the web, you wouldn't know much. These days, it's amazing what you can learn and who's willing to publish to the world for free. So it was with some joy that I read in the November letter from Bill Gross, the Managing Director at PIMCO, write "Because the U.S. economy has evolved into a highly levered finance-based economy, it stands to our reason that this modern day version is more sensitive to changes in interest rates than those of years past." Not only does Gross spends no more time in the essay on the notion the USA has become a financial economy, he furthers the argument by pointing to the vast financial leverage at work. The US economy sits on the brink in so many ways, it shows perhaps best how our two parties have moved so close together that the notion of a loyal opposition no longer exists. Our personal rate of savings has gone negative, our current account has been negative for years, our budget deficit grows, and our Congress proposes to solve it by cutting taxes. The world is losing faith in the US economy and objective measures show it. Gold has risen from around $425 to $500 an ounce in the last 12 months, beating the dollar (obviously) and the S&P 500 for gains. What's true for a family is true for a country, no matter how much either one would rather ignore it. Live within your means and save cash for a rainy day.

Further signs of a sea change in Mexican politics come via this smaller story on a Tijuana official who resigned after food intended for Chiapas victims wound up in the hands of PRI officials. The good PRI mayor of Tijuana leapt to the man's defense, saying that more experienced people had taken advantage. I suppose one could take this as praise for the experience of his fellow party members, but I'm guessing that's not how he meant it. Most notably, the PRI diverted this food in an attempt to help the flagging campaign of their presidential candidate, Roberto Madrazo. Which is to say, they have just been busted for the sort of thing they have done for decades. Here's hoping the crackdown on corruption--for all parties--continues. Maybe the effects could have an effect even on U.S. political corruption.