End of the World or Muddle Through? This week I try to explain in simple terms the very complicated story of how we went from some bad mortgage loan practices in the US to the point of world credit markets freezing up. There is a connection between the retirement plans of Mr. and Mrs. Watanabe in Japan and the subprime problems of Mr. and Mrs. Smith in California. We find the relationship between European banks and problematic hedge funds. And finally, we try and see how we get out of this mess. Oddly, I think it is hedge funds (and maybe Warren Buffett) to the rescue, but not in the way you would think. It is a lot to cover, so let's jump right in. (And there are a lot of charts, so while this will print out long, it is only a little longer than the usual in word length.)

But first, since this letter is likely to be forwarded a lot, if you get this and would like your own free weekly subscription, you can go to www.2000wave.com and simply put in your email address. You can be one of my 1,000,000 closest friends who get this letter for free. We will send my Thoughts from the Frontline to you each Saturday morning, along with my Outside the Box , which features the writing of other analysts and comes out on Tuesday.

To say the credit markets are frozen is an understatement. Talking to any number of people who have been in the markets for decades, this is the worst in their memory. Ironically, it is the 100-year anniversary of the Panic of 1907, when one banker (J. P. Morgan) stepped in and provided liquidity to the markets. The central banks of the world are providing liquidity; but as we will see, it is not mere liquidity that is needed.

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 the US mortgage market to see what fallout there is from the subprime mortgage woes. It is both less of a problem and/or more of a problem, depending on your perspective, as I predicted it would be last year. Score one for your analyst, which said score is needed as the stock market continues to rise in spite of my concerns in the face of a slowing economy.

This will be part of a speech I give next Thursday in Edinburgh, Scotland at the Credit Development Academy. While it will print out long, there are a large number of charts and graphs, so it is not as long as it appears. We also look at the recent move by China to enter the private equity world, and show that this is just the tip of the iceberg, while pondering how to interpret the recent housing data. There should be something of interest for everyone.

This week we look at the possible latest entry into the hedge fund world, The People's Republic of China; review the cockroach principle of subprime mortgages; and investigate the possibility of whether we need more derivatives and not less than the $283 trillion or so we now have. It's a lot to cover, but it should all be interesting.

But before we get into the meat of the letter, I want to announce a brand new web site. For the last six months, we have been in the process of creating a Chinese language web site of Frontline Thoughts. I have wanted to do this for years, and we are finally ready to go public. If you would like to read this weekly letter in Chinese, you can go to www.frontlinethoughts.cn. You will be prompted to click on English or Chinese and then enter your email address. You must have cookies enabled.

We will then send you the weekly letter in Chinese, just like we do the English version. The translation in Chinese will have the English version appended to the end of the letter. Of course, it takes my translator a few days, so typically you will get it on Monday rather than Saturday morning.

I am in South Africa as this week's letter is being sent out; so it is with some irony that the letter is focused on a topic that generally concerns only US-based investors, although what the SEC does has an effect on regulatory bodies abroad. This is a letter you may want to forward to your friends and associates.

The Securities and Exchange Commission (SEC) has posted a new proposed rule that would raise the minimum net-worth requirement needed to invest in private funds from $1,000,000 total net worth to $2.5 million liquid net worth. This is a major change, and it means that some 7% of American households will no longer be able to invest in private offerings. In my opinion, it is likely to become law in the not too distant future unless there is significant public comment. This week we look at the proposed rule and some of its consequences, as well as a very interesting proposal by SEC commissioner Roel Campos.

Let's start with some background. The current definition of an accredited investor was adopted in 1982 and was set at $1,000,000 total net worth, including your home and other assets. At the time, according to the SEC, some 1.87% of all US households were qualified to invest in hedge funds and other private equity offerings. Due to inflation and the growth in all sorts of assets, including homes, today about 8.5% of US households are eligible. The original rule was proposed to keep supposedly unsophisticated investors from getting involved in investments like hedge funds, which were considered riskier than mutual funds.

This week we continue to look at the imbalance in global trade and the US trade deficit. What are the ramifications for the dollar? I am going to weave together several different lines of thoughts from analysts all over the world and see if we can see a pattern emerge. While I give a brief synopsis of last week's letter below, for those interested you can read the full letter at http://www.2000wave.com.

As I wrote last week, the first Bretton Woods system came about when representatives of most of the world's leading nations met at Bretton Woods, New Hampshire, in 1944 to create a new international monetary system.

Be careful what you ask for, the ancient wisdom says, because you just might get it. The world markets are asking for a return to balance, where the US trade deficit shrinks, the US saves more and we balance our government budget. All laudable goals, and ones I would applaud. But the road to a balanced global market may not seem like a walk in an economic Lake Woebegone, where stock market returns are strong, stagflation does not darken the path and where all our portfolios have above average returns.

Having had the luxury this week to read more than my usual mountain of material, I am struck by the sheer complexity of the world economy. It is a puzzle with seemingly obvious answers yet exceedingly difficult to solve; or a riddle with many answers, none of which are exactly right; or maybe it is more like a great mystery, where there are clues on every page, but it is only when we come to the end that we can recognize that we had been given a clue.