Whatever you say Janet… What ever… you say.

Members of the FOMC are getting tired of answering questions about the dollar’s strength and its effect on the US economy.  Each time the question is brought up, the FOMC member conjures up his or her best BS and everyone else just nods along. Now I believe they are full of it and that they know they are full of it. They are just cheerleading the economy the best they can because in truth their words are the only bullets they have left.

After all, last summer, the Bank of International Settlements (BIS) which Janet Yellen is a board member of, released a report  screaming about the dangers of the US dollar carry trade. Ever since the Fed printed trillions of dollars out of thin air, corporations around the world decided to borrow them to the tune of $9 trillion. As the DXY rises towards new decade highs, anyone who borrowed dollars in the last decade is now losing money and they will keep losing money as the dollar continues to rally. I’ve mentioned this multiple times on this blog, but it bears repeating because if these morons raise interest rates, they will blow up this carry trade and the global economy with it.

A lot of people see similarities in the Fed’s willingness to hike rates today and when it tightened back in 1937. However, there is a big difference. Back then, the dollar was not yet the world’s reserve currency. The gold standard had just broken down at the time and the global monetary system was in flux. In today’s world, the Dollar IS the reserve currency, and when the Fed tightens it forces the whole world to tighten with it, whether its ready to or not. So I argue, that any form of tightening by the Fed will be much worse now than it was in 1937. Because let’s face it, the world is not ready for a strong dollar by any means, ESPECIALLY CHINA.

China has not only pegged it’s currency to the dollar but of the $9 trillion carry trade, Chinese companies are said to have borrowed $3 trillion. So China finds itself between a rock and a hard place. Right now the strong dollar is artificially inflating the value of the Yuan and therefore hurting Chinese exports. Which means China loses competitiveness to Japan who has been able to devalue its currency by 20% against the dollar in the last year alone. If China were to devalue its currency by 20% to stay competitive then the $3 trillion those Chinese companies owe, would also increase by 20%. Good luck paying that back eh? So you’d expect a wave of defaults in China. With an over levered banking system that makes the US banks seem solvent, good luck taking that medicine. So either way China is screwed by the dollar’s rise.

Perhaps this is all part of the Fed’s and by extension the US government’s plan? Cripple China before she gets too strong? To me that’s the best idea I’ve come up so far other than Ockham’s choice that the FOMC members are arrogant fools.

Long oil was supposed to be the most obvious trade of the year. A drop of 60% in 6 months? That can’t be sustainable people thought.  So traders and speculators rushed in to buy as much oil as they could and put it in storage till the price rose again. Even the owners of the oil storage space bought oil in hopes that oil would make a V shaped recovery. And in Feburary their prayers seemed to be answered as WTI rallied from $44 to $54. But once again, reality set in. As supply rose and demand faltered, oil continued to drop reaching a new 6 year low in the past 2 days.

Now anyone who bought oil in hopes of making a profit in the future has lost money. Those loses will continue to mount as the cost of storing that oil has risen several multiples while the available storage space continues to plummet. The tanks in Cushing could fill up by as early as April, long before OPEC meets in June.

But it’s not just America who is running out of room. Storage space in Asia is rapidly running out. From Wolfstreet:

“I don’t think there is much space left to fill,” a Chinese storage executive told Reuters under the condition of anonymity. He said that in the Zhoushan area of Zhejiang province, where two SPR bases and major commercial storage facilities are located, tanks “are so full that one VLCC tanker owned by a state refiner has had to wait for almost 15 days to discharge.”

So what happens when the 2 largest importers of oil in the world run out of room? Consumption will drop. And we are already seeing that. Asian crude imports have dropped 5% from the peak in December. It appears that the Asian countries blew their load to early as oil prices are only set to fall from here. Which is devastating for the oil producers both companies and countries who need the oil revenues to survive.

People laughed at Robert Schiller when he said oil could hit $20 a barrel. With supply and demand mechanics like these he could have the last laugh. At some point production will have to be fall. OPEC doesn’t meet again till June, and before then I expect quite a few American shale companies to file for bankruptcy. I still believe the Oil and Gas sector is a great short as the market is discounting the likely hood of a further and SUSTAINED drop in oil prices.

The United States used to be a unique and wonderful place. We take it for granted but that’s because it’s all we’ve ever known. Go back just three centuries and the average person’s life wasn’t much different from a person living four five or even six centuries ago. Each person was a prisoner of his or her fate.  If you were born poor you would die poor. If your father was a stone mason, you too would become a stone mason. These people saw the sun rise and set each day, the seasons come and go and thus they believed in cycles.

Today we have a more linear way of thinking, where progress builds on itself. If your father is a stone mason, he can work and put you through college so that you become an architect. You then could build a skyscraper, larger than any castle your father ever dreamed of. And so we thought ourselves masters of our own fate and with enough hard work we can rid ourselves of these unnecessary cycles.

But we were wrong. We live in a UNIVERSE of cycles. The sun still rises and sets. The seasons come and go. We may be able to fly to Miami for the winter but that doesn’t change the fact that it’s snowing in Buffalo. We may be able to print money when the economy turns down, but that doesn’t change the fact that there was mal-investment that led to the downturn. Although we’ve taking quantum leaps in hiding the cycles, they still never go away.

My generation, may be the first in the history of America to have a shorter lifespan than the previous generation.home ownership is declining. Work participation is declining. The good high paying jobs are leaving. The older generations are cannibalizing the younger ones in a desperate attempt to squeeze out a few more good years before Winter arrives. The funny thing about winter is that it comes whether you want it to or not. My grandfather wonders why the young people don’t carry sticks on election day and go around beating the elderly into submission and I must say I too am starting to wonder. But at least I don’t live in peripheral country in Europe where youth unemployment is above 50% and it’s practically illegal to fire someone.

Slowly but surely Europe will realize how screwed it is. Like an old man on his death bed coming to realize that all men must die. Talks of A New Marshall Program to save Europe from the deflation dragon are starting to spring up which immediately piqued my interest. There must be some irony here! And lo and behold there was!

The original Marshall Plan was the largest stimulus program of it’s time. The US spent billions upon billions of dollars rebuilding Europe after the most devastating war in human history. A war that resulted in the complete and utter destruction of entire cities, populations and ethnic groups. Farms factories, roads, towns, and millions of lives were destroyed in this most extreme example of human folly. WWII was awful. Everyone knows this, and the following stimulus program had to be of both equal and opposite in magnitude in order to bring Europe back from the dead.

So here’s where I see the absurdity. Europe needs a New Marshall Program but there’s been no major war for decades. Most of the major countries don’t even have a sizable army to waste precious resources on. There’s been no mass murders. No second holocaust. No Total War that resulted in the obliteration of humanity AND YET the politicians of these countries are calling for a New Marshall Program because there has been massive destruction. Millions of people have lost their life savings due to a banking system so corrupt and devastating that it requires a stimulus response equal to that of the post WWII era to counteract. Think about. European bankers and their counterparts in government have done economic damage equivalent to that of WWII. Or don’t, because when you do, it’s depressing … especially when you realize that Germany has once again conquered Europe.

Central Banks have been able to mask the destruction for a while now but that won’t last. The call for a new marshal program is another desperate gasp of an old man coming to grips with his mortality. It’s time to get ready for the end game. EU Morghulis.

Put this shot on the list of things more likely to hit its target than the Fed’s inflation expectations.

Janet Yellen has a better chance playing Ethan Hunt in the next mission impossible film than she does successfully raising rates without disaster. As the days go by and central bank after central bank eases monetary policy even further the prospects of a rate hike dims. The currency wars are full on now as countries try to export deflation and import inflation and yet the Fed is going to try and buck the trend. It’s confusing to me and it’s confusing to the market which believes a rate hike is more likely to occur at the end of the year.

I’ve been trying to make sense of a decision that on the surface following the Fed’s (and I’m using this word very lightly here) “logic” they shouldn’t raise rates. I specifically remember being reassured by a Fed president that if inflation gets too high he only needs 10 minutes to beat it back down. So why raise rates? The Fed hasn’t achieved 2% inflation yet. It stopped printing money before the goal was ever achieved and now it’s tightening monetary policy even further as inflation expectations continue to fall. The Fed was close to its 2% inflation target why not wait till they hit it and then worry if there is too much. Did Jason the Argonaut toss his sword away just before he got to the Minotaur? Did Achilles throw away the Hephaestus’ shield before his duel with Hector? Did David throw away his sling before he fought the Goliath? No. Of course not. So why the Hell is the Fed tightening into a deflationary environment!? It seems almost every central banker in the world is trying to get his or her hands on the secret elixir that is inflation. But here the Fed is tossing it away like it’s a love potion from Bill Cosby.

On the surface, it appears the Fed once again is overestimating the strength of the US economy. Bernanke a “student” of the depression knows very well how devastating an artificially strong currency can be during times of a currency war. And yet this is exactly what the Fed is risking with a June/July rate hike.

Already the USD has strengthened to a point where it is affecting American companies. Proctor and Gamble as well as Microsoft are some of the big name companies to suggest the strong dollar is providing a headwind for growth. Growth that the world economy is depending on to sustain itself through these lean times.  Remember the Fed hasn’t even hiked interest rates yet. Imagine what would happen if they did. And that’s the point…

Four months from now, will the Fed be armed with enough data to support a rate hike? It certainly doesn’t look likely, which is why the market believes a Fed rate hike won’t occur till late in the year, but perhaps the market falls victim to the belief that five extra months will make all the difference. The dominant force in the world isn’t inflation right now. It’s deflation. So given even more time, which is most likely to win out? Most likely, deflationary forces will force the Fed into an awkward position come June.

This brings up a potential answer to the question “why hike rates?”. Simply put, if the Fed waits too long they won’t have enough data support a rate hike. Then when the next crash comes the Fed won’t have enough ammunition. It’s important to remember these people are academics. They don’t run businesses or take risks. They take the easy way out. Which is what I think they are trying to do now. Is that a real fear? Not having ammunition? I don’t know if this is actually a real argument or not. But imagine if we do go into a recession with the fed funds rate at zero. What do they do? Do they go negative like Europe?

Perhaps there is a misunderstanding of where the world economy is at the moment compared to where it was nine years ago when they last hiked rates. Back in 2004, the demographics of the developed world were RISING towards their respective peaks. But now the demographic trends are stacking up against the developed world. As the population ages and the young remain depressed, unemployed, and underemployed we won’t see any growth to support a tightening of monetary policy.

What I think most people can agree on is that the Fed’s behavior is unusual. They didn’t have to tell the market they were going to hike rates. They didn’t have to give a specific date when they would like to do so. But they did. And that was a huge misstep on their part because it opened them up to doubt. Doubt in their omnipotence. Doubt in their omniscience. Doubt in the public’s belief in their ability to control the economy. Four months from now I still expect the Fed to hike rates but it seems silly to put their credibility at risk for a couple of basis points.

Like Greece No One Was Surprised.

Something amazing happened last week. Something that isn’t getting enough attention. Something that for once is a change for good. I’m talking about Greece and it’s new government Tsyriza. Greece’s newly elected Prime Minister has called for a write down of the debt and he’s now gained support from France, Spain and ironically enough President Obama. I don’t think President Obama realizes the consequences a Greek write down will have for the world. But that’s OK, it’s not like his opinion matters…

Anyways for the first time in a long time, we have a government is opposed to the “extend and pretend” status quo. Extend debt out to longer term and pretend it doesn’t matter any more. This is the very Bullshit our world runs on. But now that’s coming to an end. Greece is forcing the whole world reexamine its debts. It’s obvious that Greece can’t pay off its debts which stand at 175% of gdp. It’s also obvious that a lot of other developed countries can’t pay their debts. But no one has yet admitted it… Until now. Or at least Alexis Tsipras did last week in an open letter to the citizens of Germany. This amazing moment cannot be overlooked as the tiny country of Greece whose citizens have been pushed to the breaking point finally shout out “WE’VE HAD ENOUGH!”

Welcome to the end game, where the coyotes start to tilt their heads below the horizon and the solid ground vanishes into thin air.  Greek debt won’t be the last to be written down. A favorable outcome for Greece will spur other indebted peripheral members to seek debt deals of their own. The most obvious case is Spain where the anti-austeriy party Podemos (“We Can”) Party which was only formed one year ago is now leading the polls ahead of Spain’s elections later this year. Podemos is seen as the Spanish counterpart to Greece’s Syriza. Change happens slow and then all at once. The latter will be a rude reminder to the politicians of Europe as the populist movements use each victory to rally more to their cause.

Investment Idea: The first idea that jumps out is shorting the Spanish 10 year bond. At a rate of 1.38%, Spain’s government can some how borrow at lower rate than the US government. Strange to think, especially considering Spain’s debt has jumped from 36.9% of gdp in 2007 to 95% today. A 160% increase in just 6 years! That certainly isn’t sustainable. Italy and Portugal are two other countries who will most likely be forced to write down part of their debts before this is all over. But I like Spain in the short term due to their impending elections and a popular party willing to challenge the unelected overlords in Brussels.

Economists and analysts and politicians are telling us how good it is that commodity prices have fallen. Get your oil while it’s cheap says our president. Yes it’s great that things are cheap I agree but why dear God why are they so cheap? What has changed? Let me put it this way…

If the world was a coal mine, these guys would all die with the canary. They see an effect but no cause. When the canary stops chirping these guys say “Oh how wonderful. It’s so nice and quiet.” They don’t ask the question why is the canary dead? They don’t ask why are commodity prices are falling?

Yes, why are commodity prices falling? There a few obvious factors such as a stronger dollar and falling demand. The world economy is slowing down due to generational patterns in the developing world as a result of WWII. Yes we still feel the effects of WWII today. When you wipe out tens of millions of people in just a few years time which is quickly followed by the largest burst in population in the history of the world, you tend to get some lingering generational effects. But it’s not just developed countries that are slowing down.

China, the world engine, has been preparing for a hard landing for the past decade. Some how they’ve managed to scoop enough water out of the boat to keep it from sinking. But there is a cost. As I predicted in my first post back in December of 2013, that China would slow down and although we wouldn’t get accurate data from the Chinese themselves we only have to look at what’s going on with their trade partners and the commodities they consume.

First thing’s first, commodities are falling like it’s the second great recession. Oil wasn’t the only commodity to lose half it’s value in a year. Iron ore suffered the same fate as well. Copper is in the tubes and still falling.  So what about China’s trading partners? Well Australia and Canada aren’t doing too well. Weak demand for the commodities they export is starting to hurt their economies. So what do they do? Well they devalue their currency to make their exports more competitive. But China isn’t doing that. China has it’s yuan pegged to the dollar. So when the dollar strengthens so too does the Yuan. A strong Yuan hurts chinese exports which causes a slowdown in their economy which in turn hurts their trade partners who devalue their currencies which once again reinforces a strong Yuan. How long does this go on for? Does China devalue the Yuan? These are questions for another time, but I doubt the SNB will be the only group of unelected bureaucrats to go back on their promise.

I feel like a nerdy sci-fi reference is long overdue and what better way to jump into the European Union’s problems than with a reference to the best show to ever be canceled, Firefly. On the show, humanity has left earth and colonized/terraformed an entirely new solar system. The CORE planets or those closest to the star formed The Alliance, an interplanetary union. With their combined strength and technology they were able to conquer and extend their sphere of influence over the outer planets which were seen as backwaters and underdeveloped. The show takes place following the failed uprising of the periphery planets over the core planets. Our main characters are a group of outlaws who navigate the murky backwater planets while avoiding the overreaching control of the Alliance. Of course, the show takes place in this unique and strange world that has absolutely no similarities to the one in which we live today. So I actually have no idea why I even brought it up.

Seven years into the Eurozone’s depression the ECB decides to print money in a desperate attempt to buy even more time for the European Bureaucracies to sit on their hands. It’s insane to think that the politicians in charge of Europe will do anything different with the added 6 months, maybe a year of time the ECB just bought them. They didn’t do anything for the first seven years why should another year change that?

Draghi is in essence doing the classic spray and pray tactic employed my most video gamers when a random bad guy jumps out from behind a corner. Unfortunately the money he’s spraying is a drop in the bucket compared to what would really be necessary for him to blast his target of 2% inflation to smithereens. I don’t want to put a number on it, because that would be falling folly to the very same “logic” these arrogant psychopaths employ so well. Needless to say 1.1 trillion Euros isn’t enough to save the EU from itself.

If Draghi or anyone at the ECB was a student of history they’d know this. Hell, they don’t even have to be students of history. All they’d have to do is look at what is going on in Japan. Japan’s economy is 1/3rd the size of the EU. Yet the ECB is planning on printing the same amount of money per year.  Last time I checked, Japan wasn’t suffering from too much inflation even with the absurd amount of money they have been printing. From a basic numbers perspective, the failure of the ECB’s action is all but guaranteed.

Perhaps the amount printed doesn’t even matter. For no amount of money can save the EU when it is this divided! Only 20% of the purchases will be shared. 20 freaking percent! This low amount of risk sharing speaks volumes about the division in the EU, which is behaving more like a confederacy of nation states than the union it claims to be. The lines are already being drawn. The periphery resents the core for harsh austerity and the core has grown impatient with the periphery’s inability to grow out of its debts. We can already see this resentment growing in the periphery countries like Spain and Greece who is on the verge of electing the uber left wing Syriza party. Everyone knows the Greek debt will never be repaid. How long till they finally act on it?

2015 is going to be quite the year for central bankers (Isn’t every year?). The SNB reneged on its promise to keep the CHF pegged to the Euro and has caused what seems to be irreparable damage to the public’s trust in said institution.  I’ve been long European Equities since the Swiss abandoned the peg virtually waving the white flag for the ECB to step in and restore public faith in central banking omnipotence with a QE programs two and a half years in the making.

Back in 2012, Draghi said he would do whatever it takes and that it would be enough. I believe the first part but not the second. You can’t expect to slay the deflation dragon by pushing on a string, especially with both hands bound behind your back with the Gordian knot that is European Governance. You’d think after a few centuries of notably pathetic attempts at central planning, kings presidents or whatever you call the man sitting on the throne would step back and realize that they are no different then their predecessors. Which is probably a good thing because who would want to live in a world where their ego-maniacal theories actually hold water?

I’m getting off topic. Back to Draghi, who I should be thanking for the extra cash I’ve made this week due to my leveraged long European equities position. He’s finally making good on his promise and he’s not the only Central Banking Overlord that will do so.

The Federal Reserve has promised to raise interest rates in the first half of this year. Although most people seem to think they’re full of goose poop, I am of the mind that they will do it sooner than expected. To help support my theory I present, the president of the St. Louis Fed, James Bullard.  He was talking to the WSJ, but who needs them when all you had to do is listen to me two weeks ago iterating the same thing.

Mr. Bullard said U.S. long-term rates are being pulled down by global factors, and not new threats to the domestic economy. He wants to “get going” with rate increases.

I advise you to read the whole article for yourself. There are some other juicy quotes that I left out for brevity, but the synopsis is this: The Fed means business. It wants to raise rates. Whether that is to give it some extra “dry powder” for when things go south again or because they want to crash the economy, or maybe they really believe that now is really the best time I’ll leave that up to you.

What you should think about now is what does a Fed rate hike mean for me as an investor? For one the dollar will strengthen. Short term interest rates will rise while long term interest rates fall causing the yield curve will flatten like it’s 2006. Yes I still believe there is room for the RECORD LOW long term US interest rates to fall even further. Just look at Switzerland where interests rates last week out to 12 years were NEGATIVE. So please, buy some long bonds before I hit you for not recognizing the most obvious trade of 2015.

Just one day after an European court declared Outright Monetary Transactions OMT (aka QE, aka Money Printing) legal, the Swiss National Bank followed up with a shocking move… They removed the Swiss Franc’s peg to the Euro. This incredibly bold move has reeked havoc on the financial markets as the Swiss Franc soared, the Swiss stock market crashed, and commodities bounced higher with oil reaching +5% on the day at one point. To try and counter the new found strength in the currency, the SNB decided to out do Japan and lower short term rates to -.75%. As I write this article Swiss bonds out to 9 years offer negative interest rates!

But why now? It’s been three years since the Swiss pegged their currency to the Euro so why now? The obvious answer is that the Swiss fear what the peg would do to their economy after the ECB launches a new QE program. Just two days ago, a European court declared that Outright Monetary Transactions (aka QE) by the ECB are legal. So Draghi has all the authority he needs to go into the meeting next week on January 22nd and start the new QE program.

I of course remain skeptical that printing money will have any long term positive affects on the Eurozone economies. Short term I expect a bounce in equities but as for European bond yields, I’m not sure. There could actually be a temporary upward bounce in yields like we saw in the US when the first QE programs were launched due to fears of inflation.  Those fears seem to still hold water today as we saw commodities rally hard with gold up over 2% on the day. It appears the market too believes that European QE is all but certain.

Of course there is always the contrarian position that Draghi has been blowing smoke this whole time and if he could have or wanted to do QE he would have done it by now. However, if the January 22nd meeting does pass without the start of the QE program we could see a massive drop in commodities and European equities. Is he really going to risk that? At this point I think not but we’ll see. Of course this is the central problem with central planned economies. A group of unelected people deciding where the entire world should put their money on a daily basis is absurd beyond any measure of logic. This will end so badly it’s almost comical.

Good luck to all the investors out there. May you correctly guess which way the wind is blowing!