The Germans must be ecstatic about the most recent inflation figures out of the European Union. Their reluctance to allow the ECB to expand their balance sheet has indeed kept Germany’s much feared inflation in check. In fact, not only has inflation been kept under control, but they have managed to completely slay this terrible beast. The latest inflation figures show that the European Union has now slipped into deflation. The year over year change in the CPI index is now –0.2%.

Although the Germans must view this as a victory, all I can say is, what a bloody train wreck.

The German adherence to relatively hard monetary policies and austerity programs for the troubled PIIG nations has doomed Europe. They are now experiencing deflation at approximately the same level that was seen in the depths of the 2008 credit crisis. Europe is a complete shit show.

The Germans and other hard money advocates might think they are enforcing the much needed economic restructuring, but the reality is that all they are doing is delaying the inevitable. Given the massive over indebted nature of the European nations (and most other Western nations for that matter), there is no way you are going to grow your way out of debt. Therefore there are two realistic options. You can go the Austrian economic route and have a massive cleansing economic depression that resets all the debts through default. Or you can inflate your way out of the mess. But the one thing that will not work is the status quo. The Germans think that you can cut your way out of debt. However, that simply causes deflation, which only increases the real debt burden. The Germans want to get blood out of stone. The reality is that there is no way that the debt is ever going to be paid back, so the sooner they accept this reality, the sooner they can go about fixing the problem.

In the mean time, as the Germans impose these draconian policies on the rest of Europe, the economic pressure increases. And as the economy sinks, this gives rise to new political leaders that are more extreme in their views.

Germany is deathly afraid of monetizing the debt. But they are being a penny wise and a pound foolish. By not allowing the monetization of the debt (as the Federal Reserve and Bank of Japan have done), Europe is being forced to import the world’s deflation. It is no surprise that they are now officially experiencing actual general price declines. Their policies have been a blundering short sighted dog’s breakfast.

I am not sure if the recent tick into actual deflation will be enough for the Germans to relent. My guess is that they will reluctantly allow some form of Quantitative Easing that once again is simply not enough. The ECB will do just enough to say they are trying, but not enough to fix the problem.

Europe needs bold leaders that will aggressively stimulate their economy. These half measures are not going to cut it. I hope I am wrong and that the ECB finds a way to expand their balance sheet at the rate that the Federal Reserve and the Bank of Japan have done. But the time for Draghi to be able to soothe the markets with only words has long passed. To stop this deflationary self reinforcing feedback loop they need to come through with deeds that rival the Fed and the BoJ.

Crude oil punting

In true tourist fashion, I have decided to take a punt on buying the May 2015 WTI contract and selling the Dec 2015 WTI against it.

The May contract is trading at a $5 dollar discount to the December contract. The storage is obviously full, but we are approaching levels where it makes sense for large traders to rent super tankers, take delivery of crude oil, sell the crude forward and send the ship idling around the world until the expiry date. I obviously can’t do that trade, but by buying May and shorting December, I am hopeful that their arbitrage will stop this spread from expanding further.

As crude oil has collapsed the curve has gone from the near months trading at a premium to the farther out months, to the complete opposite.

The near term supply glut has caused a real dislocation in the front months. We are approaching the “stupid” point where it makes sense to fade the panic.

I am sure that this move in crude oil is a 4 or 5 sigma move. But as I like to joke with one of my buddies, “the problem with fading 4 or 5 sigma moves is that they often become 7 or 8 sigma moves before they revert.” Be aware that volatility is through the roof. I do think we are getting close to the end of the down move, but that the final puke might be painful to sit through. However, I expect that sometime in the coming weeks, we will get a face ripping short covering rally that will surprise everyone.