I’ve discovered the glory that is smoked paprika.  Yesterday afternoon, we had a smoked pork shoulder, seasoned in this wonderful spice, plus a few other choice flavorings.  The results were remarkable; I’ve got the urge to start rubbing the stuff on every cut of meat I’ve ever sampled, just to see what it does.

The 9^th floor is starting to reveal a lull coming.  I wouldn’t say I’m less busy at the moment; I’m still rushing to get things done.  But for the first time in a while, I can start to see light at the end of the tunnel.

One of these days, I’m going to finish a process, reach over to grab the next document on my desk, and find my hand comes up empty.  It will be, without a doubt, satiating.  It’s hard to believe that barely more than a year ago, I was sitting around doing nothing.

So, how about those manufacturing numbers out of Europe, eh?  Coupled with the GDP numbers, the employment numbers, the deficit numbers, and just about everything else I have seen, I’d say there won’t be much left of Europe in another couple of months.

Atlantis?  Pssh, step aside…

The problem for us and Europe is that, while the economies in Europe are definitely contracting, their costs are simultaneously ramping higher.  This makes easing a very difficult maneuver for them.  It also means that their economies will likely continue contracting until something breaks.

My guess: foreign currency holders start asking why the hell they’re holding onto euros if Europe’s manufacturing (sometimes called “stuff you actually buy”) continues to evaporate.

How I see the next few months playing out is something as follows:

1.  As EU stealth printing (LTRO, ESM, EFSF, etc.) starts to show a multi-trillion dollar nightmare and currency traders realize this is just to keep things going as they have been (contraction), the euro will be sold heavily against the dollar.  EURUSD goes to 1.00.

2.  The exchange rate damage this causes is dreadful, as Europe’s trade partners take a massive exports hit.  The US sees all recent growth exenterated.  China’s GDP slams towards zero and their loans start blowing up.

(HAHAHA. A quick aside, have you looked at China’s claims on loan losses?  Apparently the banks discovered a few million “high quality” people they could write loans to who are expected to default at a fraction of the rate of the rest of their portfolio….enabling them to hold much less in loss reserves and claim significantly more cash flow as income.  SURE, and I just found El Dorado.  Those loans are fucked…)

3.  And finally, we get a significant correction, exactly as we have for the past two years in a row.

But this time, you can bet I’m out of all shorts before September.  What we’ve seen, consistently, is central banks letting commodities take a hit so that the blood of traders can give them ground to ease further.  I’m not betting they don’t print more money.  I’m just betting we bleed again first.

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“Further significant improvements in the unemployment rate will likely require a more rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies.” – Ben Bernanke

Does this mean QE3 is full steam ahead?  Or does this mean Ben Bernanke is beating that dead confidence-horse, reminding us (again) that rates are not going to be raised.

Don’t be surprised when you get caught having read too far into this.  If Bernanke could get away with printing, he would have done so already.  It’s not exactly a secret that the jobs market is fostering under-employment.

I’ve already picked my side.  I’ll see you QE3 speculators at your one year anniversary.

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Do you even realize what these fucking imbeciles just accomplished? And no, don’t tell me that they bailed themselves out without triggering default. That’s just what they did on the surface.

Beneath the surface, what they’ve really managed to do is totally fuck any chance of having private market cooperation in rolling over their mountains of debt – which last I checked is all coming due, oh…now-ish.

By crushing CDS contracts, these myopic fools have undermined the entire game that is modern bond investors. And not just for Greece. Now, the validity of every CDS contract will be questioned in each scenario where a “special” government is involved.

Italy. Check.

Portugal. Check.

Spain. Check.

Etcetera, etcetera, etcetera.

Who buys insurance when the counterparty can just back out so easily? If this move is held up in court, you can guarantee that a big chunk of the current Credit Default Swap market will dry up and stay dead for the next three decades, at a minimum.

More importantly, who invests in the debt of these places without insurance? You going long Italian bonds when, should they default, you’ve basically just been handing money away to people who aren’t going to honor your claim?

Which leads us to the real problem here. By the ECB getting involved, they have simultaneously driven away all private money that might have otherwise invested in Europe. When a central bank becomes a player, it becomes the only player.

Plenty of the active market is not going to buy long dated bonds of these governments without some insurance. And without private markets stepping in sufficiently, the ECB is going to have to cover the short fall. Which means those who would be otherwise willing to go long bonds without insurance now have to ask, “but will I go long those bonds, naked, while the ECB is printing like mad?” Keep in mind that in the past three months, the ECB has already managed to add somewhere between 1-1.5 trillion euros. That’s more than doubling the number outstanding.

And that’s just to save Greece’s dumb ass while keeping the rest of the zone from the edge of the cliff. But without private money stepping up…well then, the most money they need to drop this year is another trillion. Let’s just leave it at that. It’s two trillion to get you to 2014.

And by then, you’re a year away from the EU banks needing to pony back up their LTRO funds. Assuming they haven’t been given any more, either.

I’d say, 1 trillion in LTRO outstanding, plus 2.5 trillion over the next four years when including the firewall they want (obviously some of the 1 trillion LTRO will go back into euro bonds). Just putting a broad guess out here, but by 2015, I’d say Europe will have dropped another 2-3.5 trillion euros – just to stay current. That’s before we factor in damage that inflation from that money will do to economies, which will harm tax receipts, which will of course make deficits worse. And there is no room in there for any form of “stimulus.” Not even governments backing off austerity (which is failing).

But the end result here is that true private money is not going to be investing much longer in the EU. They will have two varieties of bond buyers. People who have been given money by the ECB, and the ECB.

Which leads me to ask the great question: with the threat of such broad devaluation by means of people not wanting to buy euro denominated bonds, who the fuck wants to be exposed to euros?

Greece was to be the great experiment. It was the first country to be bailed out. And it was an appalling failure. The euro will now be subject to a most terrible burden – people giving up on it.

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Look, this will sound silly, because I’m basically arguing that you should worry when European yields go up, and ignore them when they go down. But that is exactly what you should do, and here’s why:

The ECB is doing the buying.

Now, on that point alone, the ECB can make EU bonds look as low as they want. Markets and auctions are funny things. You could have 99% of trades say that Security A is worth $10. And then the final 1% of trade activity can go for $15 and suddenly the 99% of price discovery never mattered; except that it did matter, way more than a few dumbasses crowding in overpriced sales at the end of the day (and especially if those trades are designed to create suckers to buy much larger volumes of Security A tomorrow at inflated prices).

That’s what’s meant when people talk about markets “pricing on the margin.” It’s why econometrics rarely predicts anything. It’s why, in general, you can get massive bull rallies on little to no volume, or huge price collapses on the same.

The ECB could make Italian 10 years tomorrow read .01%, and it wouldn’t change the situation in the least. But if they did that, then the jig would be up, now wouldn’t it? They’d be called out. So instead, it’s steady drift downwards, and much talk of “renewed market confidence,” which these bastards are still convincing themselves is all that’s missing from the grand success they deserve.

There are two outcomes here which should concern you, given the magnitude of the debt that needs to be cycled. The first is, the ECB keeps buying their member’s bonds, while professing they aren’t/won’t/never, and receiving no help from private equity markets.

In this case, the euro goes to par against the dollar, and our (U.S.) exports go to zero.

The second is, the ECB, realizing they will not trick private market participation, throws in the towel and sends some very large nations into default.

In this case, European demand dries up, and…our (U.S.) exports go to zero.

Are you seeing a pattern here?

The case that avoids these outcomes is not contingent on printing/no-printing. It’s contingent on cooperation from private creditors willing to roll over the debt on their backs, and keeping the EU monetary supply in balance.

If that happens, I will be proven wrong and I will reluctantly cover my oil and energy shorts, hands in pocket, face to the ground.

But now, I ask you, are private markets falling for the “All is well! All is well!” sounding board? Bank participation in European debt is at an all-time low. Money is being held up in reserves. Corporate balance sheets have never been higher. Greece and Portugal are looking read to go over the edge.

But hey, Italian and Spanish yields are lower. Just this: who’s buying?

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I’m back in the swing of my usual day, after spending most of the weekend in western New York, attending a funeral service.

Weddings in the summer…funerals in the winter…that about sums up my years.

Now, for whatever reason, oil markets are cascading down, bowing to reason. I don’t know if this will be the lead up to the big plunge, or if it’s just another head fake before more pain. But what I do know is that oil prices right now are completely unrealistic. Oil should be in the $80’s, at most.

The Iran embargo is only better for oil prices. There’s more than enough oil for the major economies, but we fight over every barrel produced. The embargo is a de facto division of the planet’s oil; Iran and some others go to China; the rest of the Middle East is Europe’s; and China and Europe in turn butt out of American oil.

This simple restructuring could allow prices to plummet, as you can bet supply will not be affected by this act. However, demand will be controlled, artificially, by non-compete agreements. We’re making a buyer’s market here, but you are all too busy crying in a corner to see the big picture.

Finally, Europe remains a train wreck. The issue at hand is not a Greek default, although it’s proven very funny watching the talking heads go from dismissing a Greek default to declaring it imminent but dismissing any real consequences.

You lot are nuts; the big looming issue is that Europe, in net, needs to either default on a trillion euros this year, or print them, because private markets are not in the least interested in investing in countries with 100%+ GDP and swelling incompetent windbags for leadership.

If (When) Europe continues to break down, the repercussion is going to be U.S. exports that crumble. That will crush U.S. growth as U.S. multinational conglomerates, plus half of emerging markets, are going to see earnings get slaughtered from exchange rate dependent “one-time” line items…indefinitely.

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I want to show you a couple of things I’m looking at.

Firstly, the Baltic Dry Index versus the price of oil:

(Image from investmenttools.com)

A bit of background; the BDI has been plunging as represented by the cost people are willing to pay globally to ship goods to other parts of the world. This coincides with a drop in global demand as represented by worldwide manufacturing.

I’m hearing the voices trying to dismiss the BDI as a poor indicator; the BDI like basically every other type transaction, determines price on the margin, which is to say very small net imbalances relative to the gross numbers coincide with disproportionately large price swings (a small shortage causes prices to skyrocket and a small amount of excess can collapse them). Okay, well then you’ll have to dismiss more or less every other indicator also, because that’s how trade works.

I could agree that the BDI is off mark if it weren’t that it is coinciding with other ominous signs. Firstly, as I’ve already displayed with the image above, is that oil and fuel prices are increasing. If energy prices were increasing because of demand, then wouldn’t the BDI be increasing alongside them? Secondly, look at the collapse of rail traffic that occurred last month. The third is the strengthening U.S. dollar, and the weakening euro, which really together powerful sway global trade.

So why is the BDI dropping like this? I admit it could be that the prices of basic materials have been dropping, and so raw material producers are demanding a subsequent decrease in shipping margins. This is the most sanguine outcome. Dollar strength, in and of itself, is causing lower good prices forcing concession on the part of shippers, but that strength is only redirecting trade flows and net transactions are actually stable.

(Image from Yahoo)

However, because of the magnitude which input costs like fuel affect the room for prices to move, I am inclined to believe that a bigger reason is that, globally, demand for goods is slowing down.

Now more directly to our situation here in the U.S.: our GDP is probably about $15 trillion, give or take. Meanwhile, thanks to a cheaper dollar up until mid-2011, our exports were booming and our imports were stabilized, resulting in some steady reductions of our trade deficit…until recently. Our exports according to World Bank numbers, as of 2010, were 13% of GDP; so how much directly would exports have to collapse, by themselves, to utterly abolish any hopes of the U.S. growing?

The answer is about 20%. That reduction would more than suffice to send U.S. growth screaming to zero.

But in actuality, the amount needed is less. Reduction in exports also causes U.S. unemployment which will directly harm U.S. domestic spending. How badly does it skew? Well it’s impossible to lock down for sure, but understanding how consumer participation in networking works, if our trade deficit starts to blow out because of exports collapsing, then the U.S. economy could see a multiple of those base numbers; maybe 2:1, maybe much more. So really a reduction of U.S. exports by 7-10% would definitely be more than sufficient to crush U.S. growth.

And the worst part is, the Fed would be nearly powerless to fix such a problem in the current environment.

It’s tempting to fall on the old crutch; well Bernanke will just devalue the dollar improving U.S. exports.

Will he now?

But at $100 a barrel, oil is already straining the margins of business profits considerable, slowing the flow of currency, and any act of easing would cause oil prices to go higher, not lower. What would that do to the economy? It is unfortunate, but at some point, dollar devaluation is incapable of being absorbed by the population, and reality materializes anyway…plus additional consequences. Do not overlook the fate of the nations of history, who dared to believe that printing money was some catchall. I couldn’t tell you if this next round of expected printing would actually fail; all I can say for sure is that, where we are now, printing is a wild card with uncertain ends.

If basic demand is really inverse to price, then Bernanke cannot increase exports without creating a counter effect on domestic consumption and production. And besides, it’s not like devaluing the monetary supply to increase exports is some great secret of the 21st century. Every other country on Earth could use the extra cash flow, so why do you think a Bernanke print job would not be simultaneously met by all the emerging markets of the world?

Now, the latest report from November shows net exports shrinking about 1%. Another 6 months of that and I’d bet all U.S. growth is gone. However, the potential for a shakedown of exports is much worse than that. Remember, the greatest growing export of the U.S. is actually fuel.

How much fuel do you think Europe is going to need, if they keep shrinking? Ditto for emerging markets, given the precarious state of their biggest buyer?

Actually, the decline of our exports could accelerate based on the developments in Europe. And if fuel costs begin to fall dramatically in fashion, then our exports could be hit by a third force of momentum.

So, based on the latest trade reports, I’d guess we’re about one quarter of the business cycle away before hope that the U.S. somehow mystically leaves the rest of the planet behind is extinguished in a plume of disappointment. And the worst part is I don’t think Europe or other markets are going to greatly benefit from our stronger currency because the disappointment from the U.S. letdown will very likely temper purchases of imports. Not to mention that their problems are so extensive, continued austerity and reservation will overpower whatever slight benefit they gain in trade pricing.

In conclusion, dollar strength is persisting because of investors looking for safe havens, a weak economy in foreign trade partners, and a broad drop in most basic materials – energy notwithstanding. This, and the plunging demand abroad plus softening demand at home, is causing the Baltic Dry Index to plummet; which is very likely a good indicator of the direction which economies and markets are headed right now, rather than some sort of false signal. I expect the dollar to continue to gain against other currencies going forward, further decrease in demand globally, a discontinuation for the expectation of growth in the U.S. and most other nations, and eventually a run lower in markets for both equities and commodities as people finally acknowledge these developments and adjust to them.

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