Tuesday, May 22, 2007

Deflation Part Two

Market Action:
Not much movement of any kind on Tuesday.

Nothing to report on the market except it didn’t do much and didn’t give us much to comment on.

Deflation Part Two:
The current global liquidity madness is brought to you mostly by the credit hungry US government and its citizens. As credit, more appropriately called Debt, continues to expand, inflation has no where to go but up. The calculators of the CPI factors are doing their best to make sure the actual inflation doesn’t come through. Some of this is due to the need to contain Social Security payments because the increases in monthly Social Security are tied directly to the CPI.

The main ingredient of a credit expansion that exudes inflation is the creation of money through various means. The one we are concerned with is the mortgage market and how it gets its funding. Much of the funding there comes in the form of securitization which means that the various mortgage pools are sold to investors.

Some, well, a lot, of the mortgage pools are packaged into CMO’s that slice and dice the payments from this pool into cash flows for various pieces, called tranches. The interesting thing that we don’t fully know is who would buy the riskier tranches.

What we do know is that some of the subprime mortgages have failed to provide for some of those risky classes. Someone has taken a huge loss in them and we know that they are still showing losses in some of the later pools.

Our natural answer to the question of money expansion is that the Fed stands in the background and buys Treasury securities to provide general liquidity to the planet. The government spends more money than in takes in and sells bonds to whoever will buy them. This has recently been overseas countries. So, as we purchase goods from them, they have an excess of dollars which they use to buy our government bonds. From there the cycle continues; but, where is the Fed in this maze?

We think they have been very supportive in this endeavor but other foreign central banks have aided and abetted them. As we purchase goods from all over the world, those central banks can provide more liquidity than they would have otherwise. In fact China has been booming for several years based mainly on the trade surplus they have with the US.

We see this as Part One, that is, the credit expansion phase. Next comes the credit contraction phase which the Fed knows is coming but is trying to put it off as long as possible. This is not a good thing.

Dow Industrials: 13,539.95 -2.93 (down?)
VIX: 13.06
HUI: 324.85
QQQQ: 47.05?
QQQRS: 0.17 bid
QQQRT: 0.32 bid
RYVNX: 14.88
RYAIX: 20.25
RYCWX: 30.68
TLT: 86.74
BEGBX: 13.80

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