Friday, September 28, 2007

Consumer Spending, Capital Spending And Other Ramblings To Close Out The Week

I haven't looked underneath the headline consumer spending numbers released this morning but there is likely some anomaly. Anyone who lives in the U.S. and has some semblance of reality knows consumer spending is very weak. Car sales, truck sales, general retail sales and durables are all reporting poor to outright awful numbers. Backing out food and energy inflation from consumer spending and artificial demand from the financial sector bubble, the economy has likely been in a recession for a year. Much of the global liquidity flows supports this perspective. Especially from Asia. But, given Wall Street is likely in its biggest bubble ever, those propping up the economy and the markets are not going to simply roll over on the spot. When this market rolls over much of the people in the financial industry are likely going to never find employment in that industry again. That is not a pleasant thought for anyone. Making a top in this environment is going to take time as they are fighting for their survival whether they realize it or not.

As I've written, there is also ample evidence that the rally over the last year was a flight to safety as opposed to some renewed belief that the economy is picking up the pace as was generally reported at the time. But, you'll seldom get a dose of reality from the media. As financial markets tighten up, you can expect the messiness to increase. If for no other reason than that the paper pushers are propping up a very unbalanced economy. Additionally, as I have written incessantly, capital spending has been in a recession or depression for the last seven years. I just shake my head when pundits start telling everyone to load up on technology related stocks because capex is going to improve. That is based on ignorance and never comes with any quantitative explanation. To the contrary, as we have discussed, some of the semiconductor companies have reported the worst order backlogs I've ever seen. Now, I've said the move to technology is to get out of anything debt or finance related so now I'll finally tell you a simple reason why capex is not going to pick up. The only thing propping up technology capex so that it looks anything better than horrendous has been the financial industry. Most people outside of the industry have little knowledge of a simple fact that the financial sector consumes nearly thirty percent of all technology capex in the U.S.. With financial companies peaking and set to experience a very painful period of time, you can expect all of the lemmings running to capex to feel very severe pain as reality sets in. CFOs are going to cut budgets, increase hurdle rates, approve only projects with a short term ROI and cancel many ambitious projects. I've lived this mess and speak from a perspective of reality not wishful thinking. What did Buffett say about Wall Street and lemmings? If you don't know that quote, you should put your money on the lemmings if it's a choice between Wall Street and the little critters. Here's a final thought to ponder on this topic. If the finance industry is in a major bubble and they account for a disproportionate amount of technology related capital equipment purchases anyway, their capex related purchases are artificially high this cycle. That's a double negative. So, how dreadful is capex outside of the finance sector? In other words, get ready to pound the last nails into the capex coffin soon enough.

Back to consumer spending. I see a large number of store closings. More so than any time in my adult life. I was talking to a friend who has been in the retail business for twenty years and he has never seen anything like this. While that is anecdotal, it's reality. Ethan Allen, probably one of the best run furniture chains, closed a store after it was open less than a year. Restaurants are closing at a rapid clip as well. Want something more concrete? A measure of net chain store openings and closings across the country turned negative some time ago. Is that concrete enough? How anyone believes consumer spending is anything better than awful with that data point is beyond me.

There you go. Sometimes I share.
posted by TimingLogic at 10:47 AM

Wednesday, September 26, 2007

Magna Carta Goes To The Auction Block

One of only a handful of copies of the Magna Carta or "Great Charter" is going to the auction block with an expected price tag of up to $35 million. That's about a twenty times increase over its purchase price a few decades ago. Think there's a bubble in art and collectibles? There's also a global assault on many of the principals outlined in the Magna Carta. Ironically, one country whose citizens are under such pressure is the same country who created this timeless piece of human dignity.
posted by TimingLogic at 2:18 PM

Tuesday, September 25, 2007

Banking Industry Buying Pressure

As I wrote last year, there is a premise from which one needs to operate when it comes to a community's money; oversight, oversight and oversight. There is absolutely no circumstances under which banks should be allowed to get into unregulated businesses or legally skirt regulation through accounting shell games and business relationships. There is also no circumstance under which politicians should not be keeping the financial industry under their thumb of oversight as the industry finds ways to innovate out of regulated areas. Instead politicians have buckled under corporate lobbyists who aren't paid to think about the consequences of their actions. Or put another way, the law of unintended consequences. If Alan Greenspan is guilty of anything, I suspect it is his support of the many incarnations of financial deregulation or lack of regulation over the years. Mr. Greenspan likely supported such a position more as a result of his political leanings rather than analyzing said decisions from the point of view that confidence in the financial system is the only matter of primary importance. A lesson that might be taken away from this fact is that academics or apolitical economists might make better choices for decision making roles within the Federal Reserve.

Support of deregulation and the implied assumptions by regulators and politicians that banks will employ risk management practices is a false truth. In other words, risk cannot be removed and neither can human nature be changed. The repeated messes created by concentration of power without oversight is a timeless truth. Our founding fathers realized this about government. Why would we not apply the same litmus test to our monetary system? As I wrote in a comment some time ago, assuming there is an entity on the other end of the risk trade is another false truth. When you buy car insurance, does risk disappear? Hardly. It is simply transferred. Wall Street, for all of their sophisticated terminology, employs strategies no different than you do while buying car insurance. Risk never disappears and is incredibly hard to quantify let alone control . Arguing anything other than this fact is simply talking to the hand.

We discussed many topics last year that nearly everyone must have thought was very bizarre, not relevant or quite ridiculous; the finance industry peaking, banks being unsafe, a scenario unfolding where banks might not lend, moving my assets out of financial institutions I feared might be at serious risk, the repeal of Glass Steagall, financial deregulation being a serious mistake, etc. This at a time when market professionals couldn't get enough of financial stocks. Or telling the public to buy them for their dividend or explosive earnings growth. So, does that all seem bizarre and ridiculous today? Especially since some of these seemingly bizarre issues have already started to unfold? Not just in the U.S. but globally. It seems so many have been caught off guard by the events unfolding. No one could have predicted this seems to be a general conclusion drawn by most. The new favorite term of this being a "Black Swan" or an event that could not have been predicted or expected. According to whom? These events are symptomatic of the macro environment surrounding the global economy and should have been anticipated in one form or another.

Last year many bears were talking about the foolishness of the American consumer while the bulls were oblivious of any problems whatsoever. I'm not sure how to interpret those perspectives on the consumer. To me it seems an elitist mentality implying the masses are incapable of managing their own affairs. And, by extension that they aren't capable of self determination and democracy is a farce. Well, Americans, as an example, have comparatively managed their affairs quite well over the last two hundred years now haven't they? I suspect peoples in other democracies feel quite the same. Do people make mistakes? Sure. But in a free society, that is our choice. It is our right. An inalienable right. But then individuals aren't going to destabilize the financial system either. The consumer is going to suffer as is housing but the consumer is incapable of bringing down the economy. If you believe the current situation is a result of consumer foolishness, you need to rethink your thesis.

So, now we see start to see the iceberg's tip and who we should really worry about. First to rear its head is Wall Street. A term I use to loosely implicate the global financial industry. I don't believe there was any malicious attempt at creating messes as a *general rule* but that again misses the point. Wall Street isn't smart money. It's market moving money. Wall Street will dish out their version of reality as long as there is ample opportunity to do so. What they leave in their wake is for the general public to deal with. Or as I've said repeatedly, "Wall Street is always wrong eventually.". The mess extends well beyond the borders of the U.S. to Australia, Europe, Canada, etc. It is indeed global group think. Fubar. In fact, to date it appears we have seen more stresses on non U.S. financial systems. Don't worry. There is no need to jump to the front of the line. Everyone will get their fair share of gruel.

Below is a chart of buying pressure for the banking industry over the last ten years up until the second quarter of 2007. Unfortunately, it would be cheating to give you a current chart. What fun is life without a little imagination? So, what do you see? Buying pressure up through 2000, the biggest stock market bubble in history, has been dwarfed by buying pressure since 2003. Conclusion? Supposed "smart" money has shown an incredible exuberance and belief in their own invincibility by investing with wreckless abandon in their own industry.

A little side story about psychology on that topic. Last fall I went to a social event with a handful of friends. That included an acquaintance I know who manages about $400 million for a major Wall Street firm. Over the evening we exchanged views of the markets. He said his team was moving clients out of emerging markets and into high dividend yielding stocks such as banks and financial institutions. After I picked my jaw up off the floor, I shared a perspective of the mess that was about to confront his industry. He seemed caught off guard by my conclusions. The moral of the story? Those benefiting from a bubble are always the last to realize a trend is ending. What industry has an overwhelming influence on the media, advertising, politicos and therefore society in general? So much so as to convince society that a secular change has taken place even though it actually hasn't? Believe society is beyond social engineering? Who do you think created the "White picket fence, a house in the suburbs, Golden Retriever, 2.5 kids and a corporate job" version of the American dream? Today's version of the American dream is far different than the one of a century ago before mass media was coursing through our veins. Or should I say coercing through our veins. What industry is attracting all of the oblivious MBAs and scientists in record numbers? I can assure you that most hedge funds, banks, investment banks and other Wall Street organizations generally have little idea what is awaiting their future. It is terribly unfortunate but as we discussed last year, the good news is those resources will be reallocated into productive and new businesses needed to fuel a new bull. When the tide rolls out, you're going to see the tenuous underlying fundamentals of the global economy come to light. I suppose that sounds as bizarre today as my comments about banks and financial institutions sounded last year. On a go forward basis I expect the best that can be attempted is mitigation of some outcomes. Will that prolong the negative imbalances? We shall see first hand. But, on a positive note I must say that I'm glad Bernanke is the one who is going to lead the Fed through this time. Although as I wrote on another blog some time ago, I believe the Fed is toothless and always has been. (Not that they aren't without merit. Because there is much merit.) Okay, they do have a few teeth. They had better get out the toothbrush because it's time for them to smile for the camera.

In closing, if buying pressure is over three times what it was in the biggest stock market bubble in history, what do we have today? A picnic? I believe the long future is bright for the world's democracies after we conclude this cycle. But, there will be a time for cleansing and a system reset. And what will likely be a very unpleasant one at that.

Update Tuesday afternoon: After I posted this I saw a few commentaries where some impetuous types are calling this credit situation over. Nothing like a sign of the times where lack of reasoning and impulsive decisions are rampant. A more appropriate perspective would be that it hasn't even started. T-i-p-o-f-t-h-e-i-c-e-b-e-r-g.
posted by TimingLogic at 9:10 AM

Wednesday, September 19, 2007

Random Thoughts On Events Of The Day

"Those who stand for nothing fall for everything"
--Alexander Stephens

I put that quote at the top of the post for a reason. That reason? "Group think" is most definitely is flaw of human nature. Be it the current crop of professionals on Wall Street that appear to have no grounding in reality, their black box trading systems that are fundamentally flawed, politicians who seem to believe pollsters and gaming voters are more important than genuine leadership or even economists who base the foundation of much work on unreliable or outdated theses.

As if it weren't predictable, the markets gyrated higher yesterday. That trade has been a no brainer for years. Right on time at exactly 2:15pm. No time to analyze any of the Fed's statement. Pure gamesmanship. Just hit the buy button. As if any of the problems facing the economy were somehow magically fixed by lowering interest rates. Lowering interest rates while oil is up 800%, gold up 300% and industrial commodities up hundreds to thousands of percentage points off the their late 1990s lows. Anyone care to see how many times we have seen this from a historical perspective? Now, the Fed obviously has to do something in some attempt to instill confidence in the financial system but what if I told you there was nothing anyone could do and the outcome to this cycle was likely framed by events unfolding ten years ago. Framed meaning macro factors not the specific events unfolding today. Would you believe it? That all of the nail biting, analysis and mind power working out whether the Fed will be successful accomplishes nothing? The answer from most would be one of emphatic disbelief. Why? Group think? Too frightening for many to believe their future cannot be controlled? Fear of some unknown force at work? Faith in science and by implication the Fed? A belief in part of their core value system is broken? Just something to ponder.

A quick perusal of some stocks I watch shows US Steel up nearly 2,000% on an annualized basis from yesterday's action. That's sustainable now isn't it? (My absolutely favorite stock I recommended to a friend over three years ago as my top pick for him to replace his left over dead beat bubble technology stocks. US Steel was up over 1,000% this cycle. He never listened. Still got those dead beat technology stocks Mister?)

More group think? We've talked about how many on Wall Street were actually bearish in 2000. Today? Same. How many technology executives bought their own cooking into the technology bubble? John Chambers, the CEO of Cisco surely did. His quotations at the bubble peak were, "The brightest people in the world didn't see it coming". "It" being the technology bubble crash and subsequent crash in his business. Chambers and Cisco paid dearly for being blind sided with massive inventory write downs, over hiring and a total miscalculation of future business opportunity.Today? The media quotes Chamber's bullishness as a reason to believe the global economy is in great shape. How foolish is that? More group think and conclusions from an unreliable historical data point.

And as for the ratings agencies, who was willing to stand up before we got to a crisis and give an honest assessment of this credit garbage being passed around? Not one. How many financial firms of any ilk were willing to do so? None. Why? Group think? Because they would have been ostracized? Do you know the few executives on Wall Street who were publicly bearish in 1999 and 2000 were generally relieved of their duties? Or lost billions because clients wanted in on "the game"? How does being honest help financial firms acquire more of those wonderful management fees? Well, here's one nugget you should always believe: When everyone agrees, no one is thinking. S&P, the blue chip Wall Street firm is no different than the rest of them. How unfortunate. Here's the title to three articles from the same source:

Commercial Paper Boom to Continue: Study - February of 2007
Commercial Paper to Remain Strong: S&P - May of 2007
Report: Commercial Paper Takes High Dive - August of 2007

It's quite amazing to me that almost every single investment mind is as bullish today as they were in June. A recent study of investment advisers was very bullish. What were they most bullish of? Oil stocks. Mark that.

posted by TimingLogic at 9:30 AM

Monday, September 17, 2007

The Skyscraper Indicator And The Global Economic Boom

This week we see the United Arab Emirates announcing the world's tallest building, the Burj Dubai. I've watched from afar in astonishment as Dubai builds and builds and builds. Build it and they will come? Real estate mania beyond comparison; man made islands, underwater hotels, building after building for a city of only 1.5 million people. The numbers are staggering. Dubai is building enough office space for half of the world to relocate there. All in a region of volatility and government directed spending as opposed to investment based on market demands. Sound familiar? Sounds like China which ironically is also polishing off its latest skyscraper, a 101 story building. A sign of irrational exuberance? If Dubai is building anything, it's a huge mess in my estimation. A better use for its oil profits would have been education, civil rights reforms, market based reforms and democratic institutions. In other words, investments leading to sustainable growth and increased stability. Not more cement ponds.

The Skyscraper indicator is an obscure and anecdotal indicator coined post the 1929 crash. Before the Great Depression the U.S. had started construction on the Empire State Building, the Chrysler Building and a few others at the peak of the U.S.'s irrational exuberance.

This data point has led economic peaks since in many countries including Malaysia, Taiwan and even the United Arab Emirates. Middle Eastern markets are already experiencing their stock market crashes or the first phase of them as we talked about last year. And while not the tallest buildings, real estate booms also preceded massive busts in Thailand and Japan. What does this mean for the global real estate boom seen in Russia, Europe, China, the U.S., Australia, Asia, the Middle East, etc?

While the indicator is interesting and a potential sign of irrational expectations of a given economy at a point in time, what I find most interesting is the unprecedented amount of massive new structures around the globe that has been erected over the last ten years as well as what is being planned on a go forward basis. And where are many concentrated? Asia. Does this point to a decade long rounding peak for the global economy or a hiatus from the perceived "unstoppable" globalization? Or does this point to the rise of Asia and the demise of Europe, the U.S. and western culture? Or does it really mean anything? Time will tell but I would point out that while the indicator is anecdotal in nature, there is some validity to be concerned about the global economic build out as I have discussed for more obvious reasons.

Exchange rate dynamics and high commodity prices are surely not sustainable wealth creators. Why this is so difficult for people to understand is beyond me. Human nature 101; why do today what you can put off till tomorrow? Repressive regime 101; why give people true free market and democratic reforms when you can give them just enough of an illusion?

This begs a question. Does temporary wealth created under unsustainable circumstances historically lead to liberalization and democratic reform? Or does democratic reform and liberalization lead to sustainable economic growth? Any historians, psychologists or sociologists reading this? I'm quite confident of the answer for a man eminently more wise than us shared the answer over two thousand years ago.

"I tell you that virtue is not given by money, but that from virtue comes money and every other good of man, public as well as private."

Unless emerging economies undertake serious and lasting reforms, much of their wealth is simply perceived and likely temporary.
posted by TimingLogic at 8:20 AM

Thursday, September 13, 2007

Finally A Dollar Bull

It seems the whole world is bearish on the dollar. I don't worry about short or intermediate term moves in currency but as this cycle comes to a close, I believe the dollar will likely strengthen against most global currencies. It's not a position I am wedded to but unlike the crowd, I see no compelling fundamental argument for a sell off. In the long run fundamentals do matter for those who were beginning to wonder. I haven't read any commentary from someone bearish on equities yet bullish on the dollar as I am so I guess I'm odd man out. But, today the head of currency strategies at Calyon in London gives a counter argument as to why he believes the dollar will likely strengthen over time.

If for no other reason, let me give you something to think about. Every asset in the world is highly correlated and rising this cycle. There are very few exceptions. One is the dollar. As a value investor, (the most successful investing approach over a long time horizon) one should always give analysis and thought to buying what everyone hates and selling what everyone loves. If there is one asset that is universally hated, it would have to be the dollar. Simple enough. People are too conditioned to expect the dollar to fall without actually thinking. Most likely reason is recent precedence. The dollar fell precipitously when the Fed cut rates in 2001. Because it was correlated with rate cuts, there seems to be an almost universal belief that rate cuts always lead to a weaker dollar. In other words, lower interest rates leads to easier money which leads to inflation which leads to lower buying power for the dollar. Those articles of faith can be true at certain times but I would argue there are many times when such a broad statement is not the most important fundamental factor. As an example, what if lower rates means lower inflation, tighter money and higher purchasing power for the dollar?

Update Friday September 14th: I was asked a question as to what this means for gold. I am still neutral to bearish on gold as I commented a month or so ago. But, there is a scenario no one is talking about that might unfold. Could the dollar stabilize or rise yet gold continue to move significantly higher? Possibly. While that may seem counter intuitive, a scenario could unfold where the dollar strengthens against other currencies yet the value of all currencies falls in real terms. In other words, an attempt to relieve imbalances via monetary creation by global central bankers could lead to an oversupply of currency and some unknown loss of intrinsic value of most or all currencies versus gold. Do I expect this? Not at this point in time. But, we need to monitor events as they unfold as this is not a normal business cycle.
posted by TimingLogic at 10:17 AM

Wednesday, September 12, 2007

Time To Hire The Fact Checkers?

I'm thinking of hiring FCU to determine the truth about the banking crisis we see unfolding. A worthwhile endeavor? You be the judge.

If you are a sucker for great comedy, you need to bookmark They do short takes on popular TV shows as well as short comedic clips sent in by others. This is hilarious. Especially if you love Bill Murray.

FCU with Bill Murray
posted by TimingLogic at 7:21 PM

Tuesday, September 11, 2007

Shanghai Index And The People's Bank of China Update

I thought I'd continue the China theme over the past week as I believe a Shanghai market crash, protectionism and nationalism are all very large risk factors to global stability and confidence. Factors not being taken into account by the investment community or multi-national corporations as many shovel significant monetary investments into China without any regard for risk. In the last fifty two weeks the Shanghai Index is now up about 240% and we are fast approaching another key resistance level in the index. Has there ever been such a rapidly rising bubble in the last few hundred years? I remain very negative on the emerging markets supplying China as an investment theme. As we've discussed before, tis better to buy European, Japanese, U.S., Canadian and Australian investments benefiting from exports to China.

Today we see inflation out of China is out of control and has reached a ten year high. We can therefore expect the People's Bank of China to institute its fifth rate increase in 2007 some time soon. In addition, late last week China upped the banking reserve requirements again in an attempt to gain some control over the banking system and astonishing credit creation rates. This is the seventh such move in 2007 if that is possible to believe. The last time the US changed reserve requirements? The 1980 credit crunch. So, what will burst the bubble? I see two possible leading candidates. One, the global supply chain backs up and it starts a severe inventory correction out of China and two, the PBC will bust it as the Federal Reserve did in 1929. Therefore, I vote for history repeating itself with some potential twist. I don't believe the global supply chain will move fast enough to be the exogenous shock starting China's asset decline but being that their boom is heavily focused in the industrial economy, the outcome has the potential to be catastrophic and exacerbated by a significant and lengthy inventory correction, massive business washouts and by a nearly nonexistent consumer economy to cushion an industrial crash.

The global supply chain has a significant lag effect and it is circular. In other words, it starts in the U.S. and ends in the U.S. with global production ramped up to serve America's perceived never ending demand. If you want to read more on that and the ramifications for a supply chain bust, I would encourage you to go back and read The Illusion of Wealth I posted in July of last year.

posted by TimingLogic at 9:09 AM

Friday, September 07, 2007

This Is Likely Do Or Die For The Bulls

With today's weak unemployment report, the markets are at the most telling test of this bull market. The media reports the employment data is unexpected? I've said for a year that my models say a recession is a foregone conclusion and it's a matter of when not if. The S&P, where smart money roams, is pointing to a possible bear market ABC pattern. Failure for the market to rally above the August highs before another down leg points to a high probability of new lows. As an aside, I also believe it is highly probable the 2000-2003 correction and the 2003-2007 move up are likely larger A and B patterns respectively. Therefore, another lengthy and serious declining C wave should be expected unless the market proves otherwise.

Enjoy the weekend! By the way, a little hint. Major pre-market dumps are seldom rewarded.
posted by TimingLogic at 9:15 AM

Thursday, September 06, 2007

A Tribute To A Legend: Luciano Pavarotti

Let's end the week on a high note and take a moment to remember a man who made millions smile and made the world a better place. There are very few living legends. Pavarotti is one of them. He'll be missed.

posted by TimingLogic at 11:47 PM

Wednesday, September 05, 2007

News Highlights From Yesterday And Today

posted by TimingLogic at 11:30 AM

Monday, September 03, 2007

Volatility And The Threat To Globalization

"Democracy is the worst form of government except for all others"
--Winston Churchill

"With all the imperfections of our present government, it is without comparison the best existing or that ever did exist"
--Thomas Jefferson

"The attitude of the state towards capital would be comparatively simple and clear. Its only object would be to make sure capital remained subservient to the state."
--Adolph Hitler in support of capitalism

Let's take a break from the markets and talk a little about global economics and very unstable fundamental dynamics. It's no secret I am very bearish on the China story. Okay, that might be putting it mildly based on some of my prior posts. It seems the whole world believe(d) China will inherit the world's economic mantle. The first repressive state to lead the free economic world in vitality? I don't think so. Japan is still the dominant economic power in Asia and I see no reason for that to change. Ever. Ever means until a transformational set of events unfold to support another position. To compare the two economies is rather ludicrous. As time passes, many are waking up to some sense of reality yet I still see unfounded trend following projections and irrational exuberance from organizations that should know better including McKinsey and Goldman. There are simply too many unknowns and unprovens to make such assumptions.

It is amazing to me how many people today loosely interchange the terms democracy and capitalism. I firmly believe in the ideals of both democracy and capitalism. But only when used in the same sentence. When China is compared to the Soviet Union or other repressive regimes, many foolishly come to the aid of China as a capitalist society. It seems to me that most defenders I see are business leaders investing in China. How quickly we discount reality in the name of profits. History is littered with repression intertwined with some form of capitalism. We don't need to go back a thousand years for comparisons. We need only go back half a century to look at the repressive fascist regimes of Italy, Japan and Germany. Did global business leaders also profit from these regimes until events unfolded leading to the most catastrophic of human circumstances? What about the repressive acts of slavery or imperialism conducted by capitalist nations? How capitalism is confused with democracy, and by inference freedom, is beyond me. Honestly, I sometimes wonder how democracy in action can be confused with freedom. But, since the beginning of time no one has come up with a better idea than democracy. Look at what democracy has accomplished over the ages; personal freedoms, civil rights, economic opportunity for all people and on and on. It's not perfect but it's fluid, generally driven by the people and long term changes are most typically for the better. Those of us who live in a free society are very fortunate.

I do believe strongly in generally fair and free trade with China. It may be one possible approach of coaxing a repressive regime forward is by liberalization of trade and normalized relations. So far, that really hasn't happened. Many freedom and rights based groups believe the Chinese government has actually moved towards increased control and reduced rights over the last decade. So, when does one conclude liberalization might never happen? That increasing economic power might actually become a threat to global freedom as happened just a handful of decades ago? Is humanity more civilized than a few decades ago? Has man's desire to control his fellow man diminished? Is concentration of power without oversight something we no longer fear?

I believe volatility is not confined to asset markets but rather symptomatic. War, social turmoil, political upheaval, economic instability, environmental volatility and a multitude of other imbalances are the driver behind market volatility. What drives those events? Randomness? Unknown factors? Sun spot cycles? I do believe volatility is cyclical and that we are entering a new cycle of volatility. That's for another day. On that topic I will say science has crowded out anything not understood or explained through rationalization as invalid in today's world. A completely erroneous assumption in my estimation. It's amazing that thought leaders from cultures many millennia ago understood more about the importance of esoteric factors than we do today. We have become slaves to empirical data. The same empirical data that led almost everyone to believe this was a Goldilocks environment as recently as a month ago. That worked now didn't it? On one hand humanity has progressed beyond imagination but on the other hand much of humanity has lost touch with the esoteric, spiritual or mystical universe. That denial of our natural psyche and basic instinct, in my estimation, is a key contributor to the rise in fundamentalism across the globe. Or put another way, a rise in volatility.

One volatility factor I fear greatly is nationalism. Nationalism can be the foundations for very dangerous events. National pride is fine for the Olympics. But, since the beginning of time it has also been used by global politicians and those wielding power to stir up animus conditions leading to violence and even world war. Now I am hardly predicting global war. As I've said repeatedly I am bullish on the global economy after we get through the outcomes associated with this cycle. But, as I've said, that is not a quick stock market correction and the world is right as rain again. Regarding nationalism, the good news is that multiculturalism, intertwined economies and the spread of liberalization and democracy makes it more difficult for extreme nationalism to develop. As more and more of the world embraces democracy, there is less opportunity for such seeds to develop into major crisis. The bad news is monoculturalism and repressive societies still represent much of the world's population. Therefore, any pull back from globalization could cause unforeseen political tensions and consequences. As we've discussed, the world is ripe for a bout of nationalism, protectionism and alot of other -isms associated with volatility.

I still believe it is reasonable odds that China's government (Is China still communist or are we seeing the emergence of a fascist state?) will collapse within the next five to ten years. Or that tremendous upheaval will develop. That may appear bizarre with China's economy seemingly running on all cylinders (it's actually out of control in my estimation) but if one thinks through to an end state in this bout of globalization, it's really quite plausible. Maybe the most plausible outcome. Make no mistake, China will see increased social unrest without democratic reform because this cycle will end badly for China. China's bureaucracy, be it communist or fascist, is a repressive regime seeking to protect its interest before the interests of the Chinese people and recent actions reinforce that fact. Case in point:
  1. China's currency manipulation drains the wealth of the Chinese population while serving leadership's need to create millions and millions of jobs of any quality to maintain civil obedience.
  2. The world's largest polluter is poisoning its own people at the expense of growth at all costs to maintain control and obedience.
  3. Projects approved through bribery and corruption result in massive over investment in many sectors deemed priority by the communist leadership as opposed to letting the people or market demands determine investment and educational needs.
  4. Nearly 100,000 documented human rights abuses annually including the fact that people who chose to exercise their liberties still generally receive no due process. While there may appear to be a modicum of freedom, there is really no intrinsic freedom of expression, religion, thought or press in any repressive society.
  5. Up to one third of the economy is an illegal pirating, patent and copyright abuse machine generating nearly 70% of the world's counterfeit goods. Goods that compromise the very safety of the world community while flouting intellectual property rights laws that cost legitimate businesses revenue, profits and jobs.
  6. A massive reliance on exports for growth because creating a consumer empowered economy would require political reform and democratic ideals. Or as I said before, it would work every communist official out of a job. When have we ever seen repressive regimes freely call for a new constitution and elected leadership? We can't get politicians to willfully leave their posts of power in democratic countries let alone a society without elections.
Recently, it seems much of the world is reawakening to the fact that China is a communist country. Should the global economy slip into a serious recession, it won't take long for the world's leaders to focus on this fact with laser precision. China's subsidized exports and the prospect of global unemployment would make China's manipulative policies a top issue in many economies. Now, it appears China is attempting its domestic game of manipulation on the global community. First there were quoted Chinese officials stating the government may dump their U.S. dollar reserves should the U.S. too aggressively pursue fair trade policy. Then there were quoted officials stating that would not happen. I can assure you that neither statement was likely a mistake but rather calculated political posturing. Ad hominem remarks in a society with a mind controlling ministry of propaganda are highly unlikely. I believe this was a major miscalculation that ultimately will fuel further instability within the globalization paradigm.

As we've discussed, China would be incredibly foolish to unload dollars on the markets. For, as in any situation where one "dumps" an asset, it would be at the seller's loss. They would do so at a significant discount and the rest of the world would pick up very liquid dollar denominated assets at fire sale prices. Even if the U.S. government had to buy them back at a profit. Let's get some context here. The $1 trillion+ of dollars held by China is not exactly going to leave the market for dollar denominated assets in disarray. PIMCO alone manages nearly that much in bonds. There are $10 trillion of U.S. corporate assets held overseas. In the next fifty years, the U.S. Federal government alone will collect north of $200 trillion in taxes and the U.S. economy will likely have a cumulative GDP of quadrillions of dollars barring a global blow up of unprecedented proportions. Ditto with Europe and other nations capable of sopping up discounted dollar denominated assets. This is a major miscalculation in the world of political chess as it exposes the Chinese government as an unstable threat rather than a stable trading partner for all democracies.

Is China's miscalculation a sign of future concern? Disagreements are common and healthy amongst democratic societies. But, what are we to expect when disagreements arise between repressive states that are seeking control through manipulation and democratic states? Is China clearly showing the world to expect more of the same unreliable and dangerous behavior and more unfulfilled promises of fair trade policies and domestic reforms? As a reminder, many countries around the globe are growing uneasy with Chinese trade policies. That includes those benefiting as well as competing emerging economies. While the U.S. and any other country ultimately has no one to blame but themselves for trade imbalances, China will ultimately have no one to blame but themselves if the U.S., in tandem or unilaterally, acts to rectify unfair trade imbalances using their own set of rules. To date, the U.S. has asked that China allow more float in its currency as the rest of the top economic trading partners do. Even when it is not advantageous to domestic policy of these countries. Not that such an action would likely accomplish anything other than sooth the political winds that are blowing. Given that the majority in China still make less than $2 a day as outlined at a recent Asian summit coupled with the fact that Chinese policy doesn't appear in any hurry to change, the trade gap is not going to be rectified by additional currency float. But, the point is China appears unfazed regarding fair trade policy with the U.S. or any other nation. And, their subsidized policies make it difficult for other developing nations to effectively trade and institute policies of wealth creation for their citizens. China's trade policy represents an involuntary dive to the bottom of the barrel for the global work force. I'm not sure how such a policy is constructive. That is, unless one believes capital trumping labor is constructive as many economists do. I totally disagree with that theory. And you'll get a chance to witness that fact first hand soon enough.

China clearly underestimates the prospective backlash developing across the globe unless they adopt more liberalized reform. Many citizen in the industrialized world already believe China is usurping their wealth and their jobs. This is more of a function of domestic policies and social factors in my estimation. But, convincing anyone who has lost their job of this fact while globalizing companies and their executives are printing profits is not high odds. Add in China's exports of counterfeit drugs, automobile parts, industrial supplies, aviation parts, fasteners, medicines, pet food, medical supplies, toys, consumer products, software, autos and foods that have killed people around the globe and we are one medical disaster away from an international trade crisis. Recently, nearly 400 people in Panama died from ingesting cough syrup with counterfeit Chinese diethylene glycol labeled as glycerin. If that happens in Japan, Europe, Australia, Canada, America or any other industrialized democracy, the world could quickly reach levels of international crisis not seen in decades.

How many people in China have died throughout the years because of such corruption and counterfeit action supported by corrupt government officials? People in China are ingesting much of the same counterfeit product shipped around the globe. Thousands? Tens of thousands? More? We will never know because China is not a transparent society. The issues regarding food safety, counterfeit merchandise and poisonous medical supplies are nothing new. Twenty years ago engineered aviation fasteners were being counterfeited in China and making their way into the U.S. commercial aviation market. One doesn't want to be three miles in the air when an engineered fastener fails because it is a below specification counterfeit. As an aside, it's not an irony that China's airlines hold the title as the world's most unsafe as measured by deaths. Flying to China? Thank you, I'll fly Singapore Airlines.

Here's the dilemma that simply has no solution. Capitalism without democracy is simply bourgeoisie corruption and repression run amok. As the world's great minds of freedom have told us time and again throughout the ages, unchecked concentration of power always leads to calamity. Capitalism generally works in a democracy because of the natural governance and checks of a free society. Transparency, freedom of speech, freedom of thought, freedom of expression, freedom of the press and civil liberty are checks and balances to widespread abuse. Corruption is rooted out for fear of legal recourse, being sacked by shareholders, losing customers, bankruptcy or worse. Poisons in foods are stopped immediately for fear of death, loss of customers, legal liability, bankruptcy, etc. Democratic government oversight is generally successful because the government are stewards of the people and elected by the people to protect the people. In other words, capitalism, while far from perfect, works in a democracy because an open society with a rule of law has self correcting oversight. Communism is based on corruption, cronyism, suppression of the press, suppression of rights, suppression of freedom, lack of transparency and protection of an elitist culture with a jack boot on the neck of society. Hence, there is no oversight or self correcting governance. The problem with counterfeit goods coming out of China is not the people but the system; the repressive state. We don't know how this will be resolved but the history of corruption is much longer than reported. It has been going on since the communist power mongers found out they could profit from it.

China's attempted manipulation and the use of "stick" diplomacy on a benign economic issue of trade shows an underlying abusive behavior that obviously works as a tool to keep order in its own police state. Within the last few days the communist government has released some type of documentary meant to convince its people and the world that its products are safe. Again, another form of mind control which has effectively been used on the people of China will not work with a free world. Democratic countries adhering to their own quality standards are capable of producing quality products in China. Chinese companies adhering to traditional Chinese and free market values are also producing quality goods. But time and again the communist system has shown the ugly head of corruption. To date, I believe governments have been slow to move because multi-national corporations have lobbied democratic officials in attempts to protect their vested interests. Yet, in the end countries will act on behalf of their citizens and not multi-national corporations. There is absolutely no way China can continue the massive job creation needed to quell civil unrest without democratic reforms. The export driven model of growth is simply not sustainable. The U.S., Europe or other large economies are not going to watch their trade deficits swell ad infinitum. Where is China's transformative legislation to drive domestic reforms? I am extremely dubious that it will ever come. Of course, there are many outcomes; a pull back in globalization and a return to an even more repressive China as communist officials fear loss of control; or nationalism inflamed by leadership should restrictive trade barriers arise. The only question is when, how and whether this will happen peacefully or otherwise. In a world of increasing volatility, let's hope a peaceful movement towards democracy unfolds.
posted by TimingLogic at 11:21 AM