The World is Upside Down!

It must be, since the IMF recommends Deflation for Greece. Until now, bankers and politicians were nice and snug together in the inflation bed for decades.

So, the question is: If the IMF and the European Commission demand deflation, does Greece have the political will to go along with it? Will the Greek Unions accept pay cuts? Will the pain of deflation and civil unrest trump the fear of default?

This could turn out to be a huge turning point in the history of the Great Recession. The debt transferred from private to public accounts is quickly becoming an unsustainable burden.

Michael Pettis makes a great point about China. One that I keep forgetting. The level of state control permits the government to prevent collapses and panics. However, they shift the cost from a short-term crash out over many years, even decades.

Soros is buying gold and calling for a devaluation of the British pound. Lots of credit out there compared to the amount of real money. Gold looks set to break out. I'm going to buy some bullion, and maybe some ABX, as they got a great deal on Cerro Casale. I might pick up 1-2% of Orezone as well, as management proved their competence in developing the last deal and selling it to IAG.

Why Banks Won't Modify Mortgages.

They have $1,100,000,000,000 (trillion) in second-lien loans. According to Bloomberg, the four largest banks have reserved $29 billion in reserves against $366 in second-lien loans. While 8% is a large number, JP Morgan reports that 6.2% of their second-liens are delinquent. More extend and pretend. Analysts estimate that properly reserving for second-lien loans would wipe out expected profit for the year at JPM, BOA, WFC, and possibly Citigroup.

Rosenberg says that the earnings estimates and outlook is extremely optimistic, to the point where it correlates with a 1% drop in the S&P over the next month. Should I buy a couple SPY puts for a month out? By probability, the May 118 puts are priced at 1.3% for a fall of 1.4%. Hmmmm.... Tempting.

What if the Yuan Falls?

Jim Chanos asks this question on his interview with Charlie Rose. What would this mean for investing? Commodity prices would collapse along with demand from China.

Some evidence for this opinion comes from Bloomberg, as China May Post Trade Deficit. Typically, if a currency floats, a trade deficit will cause it to fall. So if China revalues, they may have trouble maintaining it. Another thing this signals is a reverse of China's U.S. Treasury buying binge.

Calm surface, turmoil below

Treasury bonds staged a huge rally yesterday. It seems that 4% on the 10-yr. brings buyers out of the woodwork. I think I'll stick with the bonds a little bit more.

Greece is in serious trouble. Their latest offering only brought in E390 mil. vs. a targeted E1 billion. Yields have surged to 8%. And Greece still insists it doesn't need a bailout. This coming from a country that has spent half its history in default, according to David Rosenberg. So is no bailout and default good for the Euro (as Russ Winter thinks) or bad, as the market currently thinks?

And regarding China. What does a currency revaluation mean? Commodity prices up or down? Down in Rmb or up in U.S. $? Depends on the amount of revaluation. One thing that seems pretty clear to me is that Chinese stock market prices will fall. So I've got to watch FXI and especially watch the options. I like the idea of playing the options because I'm not sure of the timing. Chanos says end of this year, early next year for the crash.

Trade

Closed SKF today. Ouch. Held on to this loser too tooo long. The banks are just too backed up by the Fed, and the leverage on this ETF loses money every month on options expiring. I'd much rather do something else with the money or at least keep some powder dry.

Buy to cover 10% SKF @ $18.11, -34%.

I just bought some EUO, as the Greek situation got much worse with bond yields gapping up over 7%.

Buy 10% EUO @ $21.12

Bonds Down, Stocks Up

The market can't have it both ways forever.

And in other news, Germany is pushing Greece toward default. While Greece wants to borrow at 4-4.5%, Germany says emergency bailout loans should be priced at 6-6.5%. The situation is impossible.

What I can't figure out is what Germany's thinking is on this. If they push Greece into default, maybe they figure the rest of the PIIGS will shape up. Ireland is trying their best. But it may not be enough, as their banks recently required recapitalization to the tune of 50% of GDP. At some point, an internal devaluation becomes a debt spiral. Real GDP could rise, even as nominal GDP falls due to deflation, raising the debt level. Maybe Germany knows that for moral hazard to be avoided, there must be a precedent of failure set. And in the long run, the Euro is probably stronger if Germany is the only country left using it. The strong euro is what Germany wants, and they are willing to sacrifice Greece to get it.

So, where am I in this mess?

For the past year, things have worked out like this. We have the Eurozone pursuing a policy of (relative) austerity. We have the U.S. in the middle, with the massive fiscal stimulus. And we have China, whose response was to increase credit by 25% of GDP.

No wonder raw materials and financial assets have rebounded. The question is where do we go from here? It doesn't look sustainable to me, but then what do I know?

The feeling I get is that we have a trend of worldwide fiat currency devaluation in an environment prone to deflationary/debt default shocks.

So, what's the thing to do here? Wait for a shock and buy the (temporary) fix. I like gold more than raw materials. Maybe that's because I have an idea that raw materials are not worth much if they're just hoarded.

Well, I'm only about 40% in with equities, and only half in with bonds. Might buy some more gold. It looks like Barrick got a steal with their latest deal with Kinross.

Trade!

Sold all ULE @ $26.92, -0.5%.

The bailout I expected for Greece is back to square one. Meaning that there is no bailout. The Germans are not on board. The French won't allow the IMF to come in.

Greece will try to sell bonds in April, and the markets are running away.

Taxpayer Hosed!

Bloomberg has finally gotten the Federal Reserve to reveal assets it accepted as collateral for the Bear Stearns and AIG bailouts.

While the value of Bear Stearns assets couldn't be valued precisely, the description is not promising. The $20 billion face value trust is worth pennies on the dollar. Maiden Lane II and III come from AIG. These have dropped from $35 billion to $15 (44 cents) and from $56 billion to $22 (39 cents).

Get ready for a nice round of taxes to pay for this!