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“The process by which banks create money is so simple that the mind is repelled.”

-John Kenneth Galbraith

I finally got my family to Thunder Bay for the holidays last night, so I figured I’d use a Canadian-American economist for my introductory quote. John Kenneth Galbraith became an economics professor at Harvard in 1949 and then published one of his more famous works, ‘American Capitalism’, in 1952.

The definition of American capitalism in the 1950’s is certainly different than the one you are seeing today. It’s sad. Galbraith was a Keynesian, and all for the government having a hand in the economy, but I highly doubt he envisioned the socialization of losses at Wall Street banks like we are seeing now.

As Galbraith points out, the process by which banks create money is not complicated. All you have to do is watch the Piggy Banker Spread, and you’ll have a pretty good idea what the direction of banker bonuses will be. Watch what this spread does, not what Timmy Geithner says.

This morning, the Piggy Banker Spread (or the Yield Spread) is trading at its widest spread EVER. Yes, I am sure Galbraith would agree – EVER is a long time! The yield spread is the difference between 10-year and 2-year US Treasury yields. That spread has finally eclipsed its prior all-time record from June of this year (276 basis points), shooting up to +283 basis points wide this morning. Is this a bubble?

You bet your Merry Madoff it is. I have said it before, and I will say it again - there is a long term bubble forming in US banker bonuses. For all the bankers out there who are running this American outfit, here’s my advice: if you can borrow short from your starving citizenry on the short end of this curve, then plug them with higher rates on the long end… have at it piggies! Your boys at the US government set this up for you on the silver platter for the holidays.

I wrote about this yesterday, but it’s worth highlighting one more time - He Who Sees No Inflation (Bernanke) is taking a world class face wash (as in the Thunder Bay kind, when a kid buries your face in the snow bank when your parents aren’t there to bail you out) on the marked-to-market pricing front. The US Dollar is breaking out to the upside, trading above my intermediate term TREND line, and now chasing the long end of the US Treasury yield curve higher to new 4-month highs at 3.71%.

While Ben Bernanke seeing his economic forecasts fall behind the curve is nothing new, the Chinese were out there again overnight attempting to fan the fires of a credit bubble. Chinese stocks got pummeled again, trading down another -2.3%, taking their 3-week correction to -8.6%. Can a bubble be on fire?

After what we have witnessed in terms of government bailouts in the last 18-months, anything is possible. From alchemy to Burning Bubbles, we may as well keep making things up here as we go. Heck, the US government telling you there is no inflation out there so that they can keep feeding these Piggy Bankers is one heck of a story.

As opposed to some of these Johnny-come-latelies out there who are now professional bubble watchers, at least I put a time stamp and a price on them before they start to burn. While I continue to feel shame for missing the YTD highs here in the SP500 (again! we hit 1114 last night), I can say that we called out the following bubbles in the first week of December:

1.       Gold – immediate term

2.       Short Term Treasuries – intermediate term

3.       Banker Bonuses – long term

Now, if you want to be in the business of calling things on the short side, particularly bubbles, you probably don’t want to start with one of Morgan Stanley’s latest financial innovations: “short term tactical” recommendations. As my retired firefighting Dad would say, never hire a banker to put out a fire.

From an immediate term TRADE perspective (3 weeks or less), the gold price bubble is burning. Since the US Dollar bottomed in the last week of November, the gold price has corrected -11%. We sold plenty of yellow rocks up there to the latest hedge fund artist turned alchemist, and I’ll be looking to buy back what is turning into a mother of a pain trade into year-end closer to my intermediate term TREND line of support for gold, which is at $1071/oz.

We shorted the SHY (1-3 year Treasury) ETF after we called short term Treasuries out as intermediate term bubbles. Since the He Who Sees No Inflation (Bernanke) lows were established in that prescient 1st week of December, the yield on 2-year Treasuries has locked in its intermediate term bottom. After taking a look-see at 0.66%, 2-year yields have tacked on a +35% move in the last 3 weeks. Ah, now we see Burning Bubbles

Since I used my longest term duration (the TAIL, 3 years or less) to make my bubble call on banker bonuses, I guess we’ll have to see how the next 3 years pan out. The Chinese are definitely getting a head start on Burning Credit Bubbles and the Asian banker bonuses embedded therein.

Last night, Chinese central bank Governor, Zhou, reminded his top 10 banks that he is going to tighten reserve ratios. The Shanghai Property Index got clocked again overnight and is now down -11% for December alone. Gold and Chinese property stocks down the exact same percentage over the exact same duration. Burning Bubbles? Ah, now that sounds like a story the Wall Street bubble watchers can poach.

My immediate term TRADE support and resistance lines for the SP500 are now 1102 and 1118, respectively.

Best of luck out there today.



VXX - iPath S&P500 Volatility
For a TRADE we bought some protection at the market's YTD highs by buying volatility on 12/14.

EWZ - iShares Brazil As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.

GLD - SPDR Gold We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   

CYB - WisdomTree Dreyfus Chinese YuanThe Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP - iShares TIPSThe iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

RSX – Market Vectors Russia
We shorted Russia on 12/18 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.  

EWJ - iShares Japan — While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

XLI - SPDR IndustrialsWe shorted Industrials again on 11/9 on the up move as the US market made a lower-high.  This is the best way for us to be short the hope of a V-shaped recovery.   

XLY - SPDR Consumer Discretionary We shorted Howard Penney's view on Consumer Discretionary stocks on 10/30 and 12/2.

SHY - iShares 1-3 Year Treasury BondsIf you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.