Featured Trades: (WHAT THE TEA PARTY DOESN'T KNOW ABOUT THE BOND MARKET)

 

3) What the Tea Party Doesn't Know About the Bond Market. I have spoken to several Tea Party leaders since the movement sprung up a year ago, and have come to several conclusions. This is a genuine, grass roots movement composed of people who are unhappy about the changes that have swept the country for the last 30 years. By and large, these are simple, decent, hardworking and retired people.

Their list of complaints is long, and include the downhill slide of public education, declining standards of living, falling wages for working people, the ballooning immigrant population, and the huge losses they suffered to their retirement savings and the value of their homes in the 2008 crash. They all want their lives to return to the simplicity of decades past. To a man, they want lower taxes and for the government to get out of their lives. I sympathize with them on many of their complaints.

They are also not financially sophisticated. They have no understanding of the global financial system and its many intricate moving parts. They distrust Wall Street and bankers, having been conned or victimized in the past. This is a big problem.

It is safe to say that the Tea Party leadership could care less about what happens in the bond market. The scary thing is that they think this market is something that can be simply turned on and off again like a light switch. They do not realize that:

1) US Treasury bonds are the lynchpin of the global financial system.
2) Once you break confidence in this instrument, you won't be able to put it back together again.
3) The pricing of all debt securities and loans around the world key off of US Treasury bonds.
4) Tamper with the pricing of your benchmark instrument, and the entire global financial system goes haywire.
5) The unintended consequences are uncountable.
6) Interest rates will rise across the board. LIBOR rates have already started to creep up.
7) Since many financial institutions meet their capital requirements with Treasury bonds, any undermining of their credit worthiness forces a capital call which could trigger a secondary banking crisis.
8) Short term money markets will freeze up, starving corporate borrowers of cash. This has already started to happen.
9) Mess with Treasuries, and the value of your home is toast, if it is not already.
10) Dump 'full faith and credit' and you undermine the reserve status of the dollar, one of the greatest free lunches for America of all time.

The bottom line here is that you have a bunch of kids playing with matches in a fireworks factory. It is reminiscent of the first failed TARP vote in congress, when the same group of ideologically driven republicans ignored their party leadership and torpedoed their own president's bill.

You may recall that the Dow fell 700 points that day. I do. You may also remember that the following backlash at the polls set their party back a generation. I do. Wait until they have to explain on the campaign trail that their supporter's' IRA's dropped by half again because of a principal.

If this were any other country, the center of the democratic and republican parties would break off from their radical wings, create new parties, and then form a coalition government. But we are stuck with our 220 year old form of government, so that is not an option. But the final solution to the debt ceiling crisis may resemble something like this, subject to the confines of our own, arthritic political confines.

By the way, I want to thank the many readers who have been forwarding my letters to the White House, Senator Harry Reid's office, and John Boehner's staff. I have heard from all three. Keep up the pressure.

I am hoping for the best this weekend. But I am not holding my breath.

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Must the Government Be Destroyed in Order to Be Saved?

Keep in mind that what the republicans in the House of Representatives are trying to pull off here nothing less than a Coup '?d Etat. Their machinations are a blatant attempt to expand the power of the House while they command a majority. The debt ceiling has never before been used in this way.

They have taking a normal housekeeping matter and to turn it into a political weapon. Now that they have set the precedent, you can expect the democrats to behave just as badly next time they are in the driver's seat, making all our lives permanently miserable.

I have traded markets like this before, and there is only one way to do it. Close your eyes and stop thinking. Become a robot yourself. If the market is up big, sell it. If it is down big, buy it. It is impossible to predict how the next headline will read. Stocks are really operating independent of the though process. Try an analyze this, and it will just blow up in your face.

Using this twisted, but functional logic, the thing to do after a 50 point sell off in three days is to buy. Just write the damn ticket. If you are mercifully mostly in cash, as I am, then you have plenty of dry powder to do this with. If you don't, you're screwed.

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Oops, There Goes My Position

Featured Trades: (REPORT FROM EUROPE, PART IV)

 

3) Report From Europe, Part IV. Milan, Italy appears to be a city entirely populated by fashion models riding bicycles on the city's frenetic streets. That is one's first impression coming out of the monolithic Milano Centrale train station, built by Mussolini to reaffirm faith in his state. Despite years of allied bombing during WWII, the building is as imposing as the day it was built.

You Think It's Easy Fitting into a Size 0?

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I came to this medieval city to speak at another strategy luncheon, which was attended by readers from throughout Europe, from the surgeon hailing from Trondheim, Norway, to the Hungarian hedge fund manager. The Westin Hotel provided a spectacular lunch, as only the Italians can.

Much of the conversation revolved around the Euro, which everyone in the room to a man believed was grotesquely overvalued, given the continent's economic outlook. Still, as long as the European central bank pursues its mindless policy of raising interest rates to control commodity driven inflation, it will remain firm.

We discussed various breakup scenarios for the EC which come into vogue every time Greek debt gets downgraded, which is often. This is unlikely, given the modern European's dislike for open conflict. Bring nationalism into the equation, and things could deteriorate quickly. Germany could bail, unwilling to refinance the debt of lazy, tax avoiding, garlic eaters. Southern Europe could do a disappearing act, unwilling to pay their debts to the sauerkraut eaters up North.

Yes, I Can Be Bribed

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In either case, the European currency bloc shrinks, or disappears completely. It is just a matter of time before an opportunistic political party rides this fast track into power. The Germans will tell you from hard earned experience that this always ends badly.

I cautioned that the risk of nationalism was probably greater in the US now than in any other major country. Of the dozen republicans now vying for the presidential nomination, at least three could be described as extremist, pandering to conservative America's worst fears (high taxes, immigration, cap and trade, gay marriage, the rise of minorities).

An isolationist America would withdraw from international organizations, like the United Nations, the World Bank, and the IMF. Bush's wars in Iraq and Afghanistan would be stepped up, while we would probably walk away from Obama's war in Libya. It would adopt a more threatening posture towards Russia and China. Remember, Sarah Palin threatened to launch a nuclear war against Russian for its invasion of Azerbaijan. We laughed, the Russians, not so much.

I had exactly one free afternoon to spend in this amazing city. I visited Michelangelo's Last Supper at Santa Maria della Grazie monastery, looking for evidence of the conspiracy theories long ascribed to this masterpiece. I did a quick run through the Galleria and stepped on the bull's balls, conducting three clockwise rotations to bring good luck. Looking at my performance since then, it obviously worked. The impact of the fashion industry on Milan is enormous, with every conceivable brand imaginable on show.

I managed to scoot into the main Brioni store just before closing. There, I watched two Russian Mafia types in their thirties buy a half dozen exquisitely tailored, 200 thread count suits each for $6,000 apiece. That's $72,000 worth of clothes'?. for guys! Alas, they don't carry an American size 48 long in stock, it would have to be a custom order, so I left with only a couple of Leonardo ties in hand. In any case, I happen to know that I can get the identical suit at the Brioni shop Caesar's Palace in Las Vegas for half, thanks to flaccid Uncle Buck, plus they likely have my size. And I will be there in two months for a strategy luncheon (see above).

The next morning found me in a mad dash back to the train station, my taxi driver artfully weaving in and out of traffic, where I boarded a first class Eurostar train. The engine powered North towards the Italian Alps, passing through the Milan slums. Retracing the route seen in the classic Frank Sinatra war flick, Von Ryan's Express. Next stop: Zermatt, Switzerland, and the Matterhorn.

To be continued.

Featured Trades: (BRING BACK THE SMOKE FILLED ROOMS), (SPX), (TBT)

2) Bring Back the Smoke Filled Rooms. I write this from poolside at the historic Claremont Hotel in Berkeley, California. The weather couldn't be more perfect, and the local beauties, many coeds on summer break from the university, are strutting their wares, or the lack thereof. It is shocking what some people will tattoo on their bodies these days, and where they will do it. The blue sun umbrellas array themselves around the water like a postmodern impressionist painting.

I am sending out the letter late today in the hope that I will get some insight into the debt ceiling negotiations before the markets open. So far, no joy. The (SPX) opened down 15 points in Asia, oil is tanking, Treasury bonds (TBT) are getting beat up on a prospective downgrade, and Uncle Buck is getting mugged. Fortunately, my long in equities is partially hedged by my short on the bonds. Is it possible that I have underestimated the stupidity of congress?

In days of old, when such impasses presented themselves, Speaker of the House, the rosy cheeked Tip O'Neil, would meet his counterpart in the Senate for a night of poker. Several bottles of Scotch later, a deal would get struck, and the two would be photographed together shaking hands the next morning, talking about the good of the country. The process moved on.

That doesn't happen anymore. Speaker John Boehner is new at the job, with a mere six months in the post, and he is learning through trial and error, mostly the latter. He is up against a world class constitutional law professor. I can't imagine Boehner playing cards with Harry Reid, Obama, or anyone.

Even if he does come to an agreement, it is unlikely that he can make it stick by getting his own party to follow him. Many of the new junior house members are from the Tea Party, whose understanding of economics, financial markets, and the law making process is shaky at best. In another six months they have to start campaigning again, going to their supporters and financial backers with a list of what they have achieved. Raising the debt ceiling is not on that list.

If Tip O'Neal faced recalcitrant members of his own party, he would threaten a cut off of all pork barrel projects in their district, banish them to the least popular committees, and kill any bill they brought to the floor. But at least if Tip cut a deal, you knew he could deliver the votes. Today, rebellious republicans won't even take a call from Boehner, who view him with almost as much hostility as they do Obama.

What we are seeing here is sausage making in public, in all its odiferous ugliness. It is negotiation out in the open, never a good idea, especially when both sides believe the other is doing so in bad faith.

All of this leads us to bemoan the passing of the Reagan republicans, who you could work with and get a few laughs along the way. It also means that the volatility that I promised you last week will be arriving by the boatload in coming days. I still believe a deal will get made in the coming nine days, so I will use the sharp dips to add selective risk exposure. Watch this space.

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