Free money and a profligate fiscal policy in the US have achieved the near impossible - job creation. But don't count on a sustained upswing and meanwhile look to equities as the asset of last resort.

A high-spending chancellor and a continuing consumer boom might not be in the long-term interests of the UK. They are, though, fundamental to foreign investment that is pushing up sterling.

Money will, of course, remain cheap. Indeed, the forward market now forecasts that the Federal Reserve will not raise interest rates this year. But it has been cheap for a long time. It has already driven massive amounts into equities and reduced volatility to historical lows. In early January, the options put-to-call ratio reached levels indicating that no-one wanted to take out any insurance against equity markets falling. However, the recent turn in these indicators suggests that a wall of worry is now being built.

Central bank and government profligacy in the west and Japan looks set to buoy up the gold price for some time to come.

We enter the year to a deafening beat of bullishness. The long rally since the lows of March last year has brought US and European equity prices back to 70% of their peak in March 2000. Optimism rules and the consensus is for further upside in 2004.

It is a common view, especially in the US, that continental Europe is shackled by big government and a lack of reform. The corollary is that its economy and its stock markets will underperform those of the US or the UK.

The US economy is growing at over 8% a year. Jobs are returning, industrial production is improving and households are still spending. Everybody expects this business cycle to be like those before and they've lapped up stocks in the US and Europe, in anticipation.

The decision of the Organization of Petroleum Exporting Countries to cut production means that oil prices are set to stay high. This will keep Europe's consumers spending less and will dim prospects for eurozone recovery.

Last month's G7 finance ministers' meeting in Dubai prompted a sharp fall in the dollar. I reckon this is a turning point in the fortunes of the currency since its peak in February 2002.

The bulk of corporate earnings results for the second quarter of 2003 from S&P500 companies are now in and equity bulls are claiming that they justify the sharp equity rally since mid-March. I'm not convinced. More companies beat analysts' expectations, but then estimates had been revised down sharply.

Does the recent widening of government bond yields, especially in Japan, signal the bursting of the bond bubble? I think not. Both the equity and bond markets are bubbles and both will burst eventually. But equities are more likely to pop first.

There are several big bubbles driving the global economy and its financial markets. There are the twin bubbles of US household debt and house prices, driven by easy money. And there is the Japanese government bond bubble, fed by excess savings and cheap credit. But the next great bubble in the world is continental European (principally German) labour. This euro wage bubble is sustained by sticky prices and state subsidies.

At its latest committee meeting, the Federal Reserve stressed the perils of deflation. Fed chairman Alan Greenspan made it clear that if there's a whiff of it the Fed will act. In sharp contrast, European Central Bank president Wim Duisenberg slumbers on, occasionally mumbling about the dangers of inflation.

Now that the military battle in Iraq is over, my sense is that equity markets want to go up. But I don't believe that this is the start of a new bull market. It is just the eye of the storm of the secular bear market. The bounce will eventually die down and the bear market will reassert itself. We have not seen the lows yet.

The new world order, established after the fall of communism in Russia and eastern Europe, is set to shatter. Global leadership by the US confronting the USSR was succeeded by US leadership flying solo. Now comes fragmentation. The US might be the most powerful nation but over the next few years its role will be contested by China, the EU, South Korea and even Japan. This implies a much higher risk premium for financial assets.

UK prime minister Tony Blair is facing the biggest test of his political career as he tries to persuade the British public to support military action against Iraq in alliance with the US. But his government is not just dealing with a major foreign policy problem. The UK economy is also under scrutiny.

Stock markets started 2003 in a relatively buoyant mood. The view seemed to be that the world economy would come out of a soft patch, that the Bush administration would deliver tax cuts that sustained US consumer spending and that war in Iraq would go smoothly and quickly, slashing oil prices.

Last month's surprise resignation of US Treasury secretary Paul O'Neill and White House economic adviser Lawrence Lindsey smacks of desperation in the Bush administration. Only two weeks earlier, O'Neill had indicated that a costly stimulus package was unnecessary as the US economy was recovering nicely. He suggested that a simplification of the tax code was his sole priority and that government funds should be directed only to troubled sectors, such as the airlines.

We are in what amounts to a bear market rally. Many analysts and investors don't see it that way and complacency is back. US corporate earnings in the third quarter of 2002 were up 9%, ahead of analysts' downward-revised 6% expectations. The Republicans have taken full political control and will cement existing tax cuts and make new ones. And now the Federal Reserve has surprised the market with a big interest rate cut.

With the public corporate bond markets volatile and unreliable, companies need to take advantage of MTN opportunities. Debt capital market bankers have the time to present them with imaginative proposals. But some of these, such as private-to-public deals, are not without their perils.

There was a huge rally in global equities in the middle of October after markets reached six-year lows. The catalyst was the third-quarter earnings reports of US corporations. Most seemed to beat consensus forecasts.

Banks are heavily discounting syndicated loans for relationship reasons and taking a double hit when they hedge their risks with more realistically priced credit swaps.

The Irish covered bond, endlessly promised and hyped for the past couple of years, is set to emerge in the new year. Some features that were unique attractions when the legal framework was first proposed in early 2000 have been nullified by other markets' progress in the meantime - the amended German mortgage banking act, for example, allows the inclusion of assets from a wider range of countries in Pfandbrief covered pools.

Last month I argued that the summer rally in US equities would not last. The S&P index hit its year low on July 23 at 797. It rallied to 972 on August 27. Now it's back below 900. In August, investors had turned bullish on hopes of interest rate cuts. And they were encouraged about corporate governance: CEOs signed off accounts with few nasty surprises.

In my view the bear market in equities will resume beyond the so-called summer rally. Crucially, the huge fall in household wealth will dampen consumer demand and rising risk aversion will delay a revival of global investment. There will also be much weaker corporate earnings growth, making equities overvalued; a weaker dollar spreading deflation into emerging economies; and poor leadership from the US administration on global economic policy and geopolitics.

The recent equity collapse may well mark the end of the bear market. But I doubt it. Sure, there is a strong equity rally from oversold levels out there somewhere. And improving corporate and macro news will at some point drive it. But there are powerful opposing forces. Wealth destruction in equity markets, a plummeting dollar and rising risk aversion in debt capital markets will damage the global economy.

The euro continues its recovery against the US dollar. Everything seems rosy in the EU garden. Dissatisfaction among citizens has not become a concerted anti-European platform. The extreme right in France has failed in elections and it is inconceivable that German dissatisfaction with the euro will spill over into actual opposition to it. The British government is growing increasingly confident about its ability to take the UK into monetary union. Above all, enlargement seems to be on target.

At some point in the next two quarters, the global backdrop for emerging market bonds will turn increasingly gloomy.

In last month's column, I wrote about the revolution in Korea's economic model, moving from a high savings, high investment, export-led economy to a more mature, consumer-led, market economy. That structural change is also visible in Taiwan but with some important differences.

China