Friday, May 6, 2011



The real issue here is which European banks now own Greece's debt and are carrying it par.

Well, whatever people say about Greece, the reality is that the markets are assuming that the country will default. This observation from Hussman Funds' recent commentary explains it very succinctly:

I should probably note that Greek 2-year government yields have shot to about 24%, compared with about 2% for 2-year German bunds.

Assuming a 35% haircut in the event of debt restructuring (65% recovery), that spread implicitly puts the probability of a Greek debt default at [(1-exp(-(.24-.02)*2))/(1-.65) = ] about 100%."

Twenty-four percent! It's all over but the shouting.

The real issue here is not whether Greece will repay its debt -- it won't and can't -- but which European banks now own that debt, and are carrying it par. I suspect there are some essentially bankrupt European institutions that are loaded with Greek, Portugeuse and Irish debt, but they cannot admit it yet. Unfortunately, there is no European AIG to act as a conduit to bail out the European banking system.

The Crack in Commodities

Sudden, violent and unexpected corrections are usually precursors of a meaningful change in long-term trend.

The huge bull was completely driven by the Fed's desire to create inflation. By printing massive quantities of dollars, the Fed devalued the currency and accordingly drove higher the prices of almost every commodity of which you can think. The U.S. dollar is trading at 30-year lows against baskets of other currencies.

Perhaps when Bernanke claims that inflation is "transitory," this is not an observation but a signaling of policy intentions? Using harsh monetary levers, central banks can halt inflation overnight. Back in the 1980s, Brazil was grappling with hyperinflation and stopped it cold by freezing bank accounts. No cash, no rising prices. Amazing how that works. That won't happen here, but we know QE2 is ending, and perhaps the implications of that effective tightening are starting to be recognized by the markets.