Two weeks ago I presented my thoughts on the current economic situation at my 6th Annual Strategic Investment Conference in La Jolla (co-hosted with Altegris Investments). The speech was well-received, at least to judge from the comment forms. So this week and next, we are going to revisit that talk (with a few edits). Let's start with a little set-up to explain the first few paragraphs.

My speech was Saturday morning. On Friday, I wore a nice grey suit with a Leonardo tie. For those who know about Leonardo's, they are "statement" ties. I should note that Tiffani picked the tie out for me about ten years ago and persuaded me to wear it. It took some getting used to. It is 16 silk-screened colors, bright blues and pinks and grays, the central feature of which is a very vivid parrot. It is not subdued.

When my good friend George Friedman of Stratfor gave his speech on Friday, he commented rather derisively about my taste in ties, which got him a few laughs. This did not bother me too much since, while George is a brilliant geopolitical analyst, his sense of sartorial style is not exactly top-drawer. So now, let's jump into the speech.

Leverage is an eight-letter word, which the markets now regard as twice as bad as the two four-letter words debt and pain (or fill in your own four-letter words). This week I try to give some insight into what is happening in the credit markets, some of it below the radar screen of most analysts. We will look at the potential for deflation and the Fed's response. There is a lot to cover, so let's jump right in.

I talked with a friend who runs a collateralized loan obligation fund, or CLO. There are a lot of these funds in the Shadow Banking System. Typically they buy certain types of debt, with a lot of it in the bank loan space. In the "old" days of the last few years, banks would make loans to corporations and then sell them to CLOs and other institutions, making a spread on the loan and a profit on the servicing business. Some funds would typically leverage up somewhat and make a decent return.

Today, many highly rated loans are selling for 80 cents on the dollar. There is nothing wrong with the collateral or the corporation which owes the money; there is just no one with ready cash to buy the loans. I asked my friend why he doesn't buy them, since they offer very good returns.

President Nixon instated price controls on the 15th of August, 1971. Inflation was a little over 4% at the time. Price controls manifestly did not work (resulting in shortages of all sorts and a deep recession) and were rescinded a few years later. President Ford went to Congress with programs to fight inflation that was running closer to 10% in October of 1974, with a speech entitled "Whip Inflation Now" (WIN). He famously urged Americans to wear "WIN" buttons. That policy too was less than effective, and the buttons, in a history replete with silly gestures by governments, should stand on anyone's top ten list of such silly gestures.

Cynics more thoughtfully wore the buttons upside down and said the inverted letters (which looked like NIM) stood for "No Immediate Miracles." They were right. There was no miracle, just eventual pain and lots of it. Ultimately, Paul Volker defeated inflation, but at the cost of two serious recessions and a lot of economic misery, with unemployment levels over 10% for nine months in 1983.

This week we were given the data that inflation as measured by the Consumer Price Index (CPI) over the last year was 4.2% and unemployment is now 5.5%. Some call for the Fed to raise rates so that we do not have to experience another lost decade like the '70s and then ultimately see some future Volker forced to raise rates and drive unemployment back to 10%. Others suggest that "core" inflation is what should be paid heed to, and urge caution.

This week we look at the cost of what could be a renewed effort to Whip Inflation Now, not just here but in countries worldwide. Will Trichet in Europe raise rates even as the European economy seems to be slowing down? If you think inflation is bad in the US and Europe, take a peek at Asia. And I ask, "What will Ben do?" It should make for an interesting letter.

This week we look at inflation. Is it just over 2%, giving the Fed room to cut rates, or will it be closer to 4% by the next FOMC meeting, making a rate cut problematic? How do they get those numbers? When and how can two opposite things be true at the same time? The answer depends on how many dimensions you are living in when you are asking the question. The Fed is going to be faced with a very difficult decision at its next meeting, and there results of there deliberations will be felt by you.

But first, an observation about a milestone passed last week. I started this letter 7 years ago with about 2,000 names and it has grown to where it is sent to more than 1,000,000 of my closest friends each week. For the last year, this letter has been translated each week into Chinese and posted on a Chinese version of Thoughts from the Frontline web site by my Chinese assistant Coryne Wei.

This last week we passed 1,000 subscribers that get the Chinese version. I know that is small, but it is a beginning. It will be interesting to see how it grows over the years. If you would like to get this letter in Chinese, you can go to www.frontlinethoughts.cn and subscribe.

"Of his bones are coral made:
Those are pearls that were his eyes:
Nothing of him that doth fade,
But doth suffer a sea change
Into something rich and strange"
(The Tempest - Shakespeare)

The term "sea change" has come to mean a profound transformation ever since Will Shakespeare used it in The Tempest. I think this week we witnessed a true sea change in central bank policy, on both sides of the Atlantic. The stock market rejoiced over a 50 basis point cut from the Fed, assuming that it will stimulate growth and avoid anything more than a slowdown. In this week's letter, we ponder several questions. Why did the Fed decide to cut now when the rhetoric of just a few weeks ago was that of inflation fighting? What do they see? Are more rate cuts coming? Will they make any difference? And who is Frederic (Rick) Mishkin and why is he maybe the most important Fed governor you haven't heard of? There's a lot of ground to cover, and it should make for an interesting letter.

But first, I need to acknowledge an anniversary of sorts. Some seven years ago I put this e-letter on the internet, with (maybe) 2,000 names to send it to. Today, it goes out every week to more than 1,000,000 readers and is posted on scores of web sites and blogs. I have to confess with being a little (well, a lot) amazed by it all. It has changed my business practice in ways that I could not imagine seven years ago, and all for the better. Someone asked me what I will do when I retire. I told them I would read, write, travel and speak, which is pretty much what I do now, along with a few extra duties here and there.

But it is a great life and I want to thank you for allowing me to come into your home or office, and for recommending this letter to friends, which is the way the readership has grown. And because I want to keep writing for a long time and I want to keep you as a reader, I am going to make available to you a speech on how we can all live longer by Dr. Mike Roizen, who wrote You - The Owner's Manual (and You - On a Diet , and the other monster best-sellers in the series). He also appears on Oprah about six times a year. I am lucky enough to call him both friend and my doctor.

With the economy increasingly looking like it will slow down materially in the last half of the year, there is a drum beat for the Federal Reserve to cut rates. But how likely is a rate cut this year? We take a very different look at inflation to see if there is any room for the Fed to give a boost to the economy. We look over our shoulder at Japan and the yen carry trade and ask a heretical question: does the Fed cutting rates make any difference?

Last Monday, I used an excellent piece by friend and money manager John Hussman for my Outside the Box. Buried at the end in the piece was a throwaway line that really intrigued me and spurred some research:

"If you look carefully at the CPI figures (and tinker with the monthly numbers), you'll also discover that even if the figures average a 2% annual rate in the months ahead, the year-over-year headline CPI inflation rate will be pushing 4% by November. This is already 'baked in the cake.' Since Bernanke is clearly concerned with the inflation expectations of the public, as well as the Fed's credibility, that headline CPI figure may create some complications for cutting rates in the months ahead, unless resource utilization falls out of bed."

This week we look at something which has far more potential to hurt the economy than subprime loans - the US Congress. We muse on inflation data and why the economy may do better than I think.

But first, and quickly, my young assistant Micah Davis is leaving soon to go full time in an entrepreneurial venture (and I wish him the best), which means I will be in need of an assistant. The duties are varied. You get to be the one to read my emails from readers first (and we get a lot, which I do try and read as many as possible), help me with formatting various letters, research and some writing (writing skills are very helpful). Micah has been working a little more than half a day recently as he has been starting his new enterprise, but there are other things that could be added to the list of duties depending on the talent of the person. This is not an analyst position, although we do some. This could be a person just graduating from college. If you know of someone, have them drop me a resume.

It's been a random walk through the data fields this week. The headlines say that inflation rose a mere 0.1% in August. The markets liked that. But digging deeper, the data is not as sanguine. We had the depressing Philly Fed manufacturing index last week, but today we find that Chicago is doing more than fine. The Dow flirted with a new all-time high, but then took the train home early for the weekend, leaving those who care about such things feeling like a teenage boy at a Baptist youth camp, flush with excitement during the day but frustrated as you go back to your dorm. But there's always tomorrow. Or maybe not.

Copper is the metal with a Ph.D in Economics. But has the metal been too smart for its own good? Looking at some recent trends in copper usage, we can learn something about an economic concept called substitution and the cure for high prices. I comment on my "debate" on Kudlow and Company this week, and muse on growing older and the passage of time. Let's jump right in.

Is the Fed right to be worried about inflation, or is that so last quarter? What do musty old academic papers suggest about Fed policy? And can we translate that into something that gives us a clue as to why markets around the world are in seeming lockstep on their way to the exits? (Quick, guess which market has done the best in the last month. No peeking!) Whatever happened to the diversification of our portfolios? This week we look at a wide range of topics trying to get some insights into where the markets are headed this summer.

First, let's look at the world equity markets. I had my new assistant, Micah Davis, do a search for how the world equity markets have done this year from their recent peaks. All in all, we looked at 64 markets. I assumed we would have at least a few up markets. There always seems to be some market somewhere that can buck a downtrend.

Interestingly, all 64 markets are off their recent highs. Two-thirds of world markets are down 10% or more, with Middle Eastern markets in free fall for the past few months. Indeed, they seem to have been a warning sign of trouble, as they have led the way down.

How can inflation be so low over the past few years if we see rising energy prices, ever-increasing medical costs and especially the cost of housing rising so dramatically? Today, for the first time we see inflation actually showing the results of rising energy costs, and the number is ugly. But it is not as ugly as it could be. This week we look at how the Consumer Price Index is calculated. Like the making of sausage and laws, it is not pretty. It will make for a fascinating read, I think.

But first, I am compelled to make a comment on the Refco situation. Dennis Gartman has what he calls the cockroach theory. There is never one cockroach. If you see one, there are a lot of them in the walls. Observers have been seeing cockroaches at Refco for a long time. When the whole story comes out, it is not going to look good. How you can hide almost a half a billion in losses when going through a public offering is mind-boggling. Refco has had a long history of problems. Most never make the light of day, but there is one that you might recall.