econotech

8/14 Speculators Take Global Economy Hostage, Central Bankers’ Liquidity Concession, With Nothing in Return, Interest Cuts Next?—Part 1

2007-08-14T11:17:00.000-07:00

August 14 (Econotech FHPN) – This is the first of a two-part article, which I have broken up due to length. I will post the second part in the next day or two, please look for Part 2, hopefully on the sites you visit that very kindly post or link to my articles, or on my web site link. This first part is under 6,000 words, the second under 4,000. Thanks. -- econotech

Please NOTE well: All bold emphases added in the many quotes from mainstream media throughout this article are by me, NOT in the original. Btw, if I've seemed to put bold emphases on too many superlatives, it's simply to try to accurately convey the highly unusual environment financial markets are currently in. -- econotech

“The calmer tone in global markets yesterday will encourage Federal Reserve policymakers to believe they are striking the right balance in response to credit market upheavals: stepping up liquidity support aggressively when needed, but holding fire on interest rates. But with further credit bombshells likely, there is every possibility that the coming days will see renewed turmoil and fresh pressure on the U.S. central bank to cut rates.” FT, Aug 14, “Fed weighs economic impact of market turmoil,” Krishna Guha

“Central banks worldwide have injected at least $323.3 billion in the past 48 hours …the Fed said in a statement that amounted to a promise to do whatever was necessary to keep markets from seizing up. Such statements from the Fed are unusual, with the last having come after the September 11, 2001, terror attacks, and reflect the seriousness that policy-makers view the current disorder in markets. Before the September 11 attacks, the Fed had not offered reassurance on its willingness to provide liquidity since October 20, 1987 -- the day after Black Monday.” Reuters, Aug 10

“in times of crisis it [the central bank] should provide unlimited amounts of liquidity to ensure the smooth functioning of the payment system … When, as happened last week, they dump large amounts of liquidity in the system, they also allow banks that did foolish things to get off the hook. And many banks did foolish things … More drastic reforms will be necessary. Banks have increasingly been involved in activities outside the supervisory and regulatory framework. They have done so by offloading part of their riskier activities to hedge funds. Banks that engage in such activities should not expect to enjoy the automatic insurance provided by central banks without accepting that there is a price to pay for this. The price is that these hedge fund activities are brought back into the same framework of supervision and regulation as the other banking activities. This will not be easy, because it involves a difficult exercise of international co-operation.” FT, Aug 13, op-ed, “Banking bail-out sows seeds of future crises,” Paul de Grauwe

“Among today's big fears: that commercial and investment banks, thinking they have used derivatives to lay off the risk of defaults, will discover they effectively bought insurance from hedge funds whose financial survival depends on credit from those same commercial and investment banks; that big firms are exposed to troubled markets in ways they don't realize or haven't disclosed; or that players with heavy borrowing will have to dump their holdings and make everything worse … Some Fed officials worry a rate cut now might suggest the bank is focused on the markets rather than on the economy. Others see a growing economic justification for easing. Some analysts suspect Mr. Bernanke, who has been in office for 18 months, will be reluctant to cut rates in order to expunge belief in the "Greenspan put" -- Wall Street's term for the perceived readiness of his predecessor to cut rates and bail investors out of bad decisions.” WSJ, Aug 13, front page article, Greg Ip, Deborah Solomon and David Wessel

“the Great Unwind of the global credit pyramid still has further to go … there's a 21st century version of a run on the bank, and the central banks have had to step in to do their prime duty of supplying liquidity when the market won't [the conventional view—econotech] … well before the real economy feels much impact from the current financial dislocations.” Barron’s Online, Aug 9, “Even After $1 Trillion Goes Poof, It Ain’t Over,” Randall W. Forsyth

“All cosy assumptions have suddenly been called into question …Central banks should only bail out traders who made bad bets if the financial infrastructure is truly in danger [still a conventional view—econotech] …[the Fed] offering funds to banks and saying it would accept mortgage bonds as collateral. This step is more extreme than first appears. The Fed used public money to take risk, in the form of high-quality, but stricken mortgage securities off banks’ hands – at least for the short term,” FT, Aug 10, “Financial plumber must stem the panic,” John Authers

“the question haunting the markets yesterday … is what on earth has triggered this sudden €94.8bn [ECB liquidity injection] move? One explanation - and the one alarming many traders - is that there is something truly nasty lurking out there in relation to credit losses that only the ECB knows about. If so, let us all pray that it does not involve any of the big dealer banks. However, another explanation - and let us hope this is the correct one [prayer and hope are not the most effective solutions—econotech] - is that the ECB is engaged in a subtle war of psychology with the commercial paper market.” FT, Aug 10, “Has the bank seen something nasty on the horizon?” Gillian Tett

“What’s been happening in financial markets over the past few days is something that truly scares monetary economists: liquidity has dried up … This could turn out to be nothing more than a brief scare. At worst, however, it could cause a chain reaction of debt defaults … And here’s the truly scary thing about liquidity crises: it’s very hard for policy makers to do anything about them … when liquidity dries up, the normal tools of policy lose much of their effectiveness. Reducing the cost of money doesn’t do much for borrowers if nobody is willing to make loans. Ensuring that banks have plenty of cash doesn’t do much if the cash stays in the banks’ vaults … Let’s hope, then, that this crisis blows over as quickly as that of 1998. But I wouldn’t count on it." [Dr. Krugman is a great economist, but hope is not a strategy—econotech] NYT op-ed, Aug 10, “Very Scary Things,” Paul Krugman

“Friday’s action by the Fed marked the abandonment of its “business as usual” stance. It told dealers it would re-enter the market as often as necessary, and – in a highly unusual move – accepted high-quality mortgage-backed securities as collateral for the entire $38bn of funds. This amounts to the most extensive liquidity support operation undertaken by the US central bank since the 9/11 terrorist attacks and follows similar steps by the European Central Bank and Japanese central bank in the past two days.” FT, Aug 11, front page lead article

“The level of funds markedly exceeded the ECB's only previous major intervention - on the day after 9/11 when it lent €69bn followed by €40bn over subsequent days. Even more striking was its one-day pledge to meet 100 per cent of all funding requests from financial institutions … The ECB did not offer any detailed explanation for its move, which caught markets by surprise” FT, Aug 10

“Fallout from the intensifying credit crisis stretched from a French bank to the largest home-mortgage lender in the U.S., triggering unusual central-bank interventions and driving the Dow Jones Industrial Average to its second-worst drop this year. The troubles demonstrated both the global reach of the crisis and its impact on a widening circle of markets and companies.” WSJ, Aug 10, front-page article

“Federal Reserve Chairman Ben S. Bernanke was wrong. So were U.S. Treasury Secretary Henry Paulson and Merrill Lynch & Co. Chief Executive Officer Stanley O'Neal. The subprime mortgage industry's problems were contained, they all said. It turns out that the turmoil was contagious.” Bloomberg, Aug 10, “Bernanke Was Wrong: Subprime Contagion Is Spreading,” Bob Ivry

“"Like everyone else, [central banks] face uncertainty about the future (most of which is shared uncertainty), but, unlike almost anyone else, they must maintain an aura of wisdom, of being in control, almost as if they did know (a lot) more about the future than the rest of us," writes Ethan Harris, chief economist at Lehman Brothers. "They do not."”, thestreet.com, Aug 10, “Bernanke’s Bind: No Easy Answers,” Liz Rappoport

Financial Markets’ and Officials’ Panicky Fear of Lurking “Unknown Unknowns” and “Black Swans”

The title of my last article on July 26 link, “Speculators’ Liquidity-Leverage Russian Roulette with Economy” may have seemed a little over the top to some at the time, that is, before this past Thursday and Friday, Aug 9-10. As of Aug 14, the day this new article is being posted, that may no longer seem to be case for the title of that article and this one.

During that 48-hour period at the end of last week, global central bankers injected around $300 billion of liquidity into the banking system, promising unlimited short-term funds, even taking mortgage-backed securities as collateral, extremely unusual moves that evidently only have had two precedents, 9/11 and the Oct 1987 crash, when the U.S. market fell more than 20% in a single day.

So, why did the central bankers concede to speculators’ pressure, yet again? (I believe that using "speculators'", at huge financial institutions, is a more accurate and realistic way of putting it than the much more common euphemism, "market pressure.")

If you consider that the rampant fear and surprisingly drastic actions occurred, even though global financial markets haven’t even begun to really crash, yet, let alone a recession begin to take hold, then isn’t that some indication of the seriousness, potentially, of what may really be at stake, right now?

Like Dr. de Grauwe, a well-regarded international economist whom I quote above, I have no problem with central banks basically “doing their duty,” so to speak, by providing liquidity to try to keep the global financial system from freezing up or melting down, pick your metaphor.

To not do so would be irresponsible to the global economy and populations that rely upon a smoothly functioning financial system for their essential daily and future well-being.

But as Dr. de Grauwe's above quote somewhat suggests, there needs to be a significant cost to the global speculators of the recent largesse from central bankers, who, in principle, are very high public servants who have been trusted with the awesome responsibility of nations' money supply and credit, most especially in this age of fiat currencies.

And that cost to the speculators is to rein in, ASAP, their ridiculous speculative, selfish antics that are now putting the global economy, and the well-being of billions of innocent people, at risk, yet once again (as Asia, with nearly 4 billion people, fully knows from its earlier run-in with the global speculators in the so-called Asian financial crisis of 1997-98, known in Asia as the IMF crisis).

Very powerful speculators have gained the privilege of stewardship of the global monetary/financial system. So be it, that’s current reality. But that reality needs to be changed, as the current credit market dislocations have made clear, yet again.

The global financial system is in another mess, yet again, simply because global speculators, yet again, pushed their search for high yields and excess returns way too far, and because global monetary officials, yet again, facilitated it with E-Z money and allowing them to run amuck.

(Recall the many previous speculators’ bubbles, and then remember the old saying, “fool me once, shame on you, fool me twice, shame on me.”)

Most importantly, it NEVER had to come to the current situation in the first place. It did, yet again, due to a very basic, ancient human foibles, excessive power, greed, hubris--the global speculators’ simply never know when enough is enough, rather they always want more, more, more, with a take no prisoners attitude to get it.

(Exhibit A is the Citigroup CEO quote about dancing to the liquidity beat with which I led off my July 26 article link. Exhibit B is Jim Cramer’s now infamous tirade on national tv berating Fed governors on behalf of his Wall Street contacts, which I take up later in part two of this article.)

Given such poor performance on the part of both global speculators and monetary officials--and I hope it should be clear by now on my web site link that, while so many seem to focus so much of their ire just on the latter, both are to blame, the structured credit-addicted (CDO's, CLO's, etc) prime culprits and huge beneficiaries of the current system are the global speculators, monetary officials are their "enablers," justifiably held accountable for not living up to their public responsibilities--one of their speculative own might adolescently say on tv, “You’re fired!”

With the global economy still in good shape, perhaps we should be more tolerant than that, for now, since many of them really are extremely talented and/or powerful, who perhaps may still surprise and do great good in better allocating global capital, if provided with the right economic incentives, ones that encourage innovation and production, not absurdly excessive, destabilizing speculation.

So for now, let’s as adults, say to them, shape up, or ship out.

Because we don’t want nor need you, if you can’t control your adolescent absurdly excessive “risk-taking” behavior, which repeatedly puts the global financial system and economy at completely unacceptable risk, mainly for your own selfish gain. More on this later.

My Investment Suggestion Continues to be Hedge Until If/When See Some All Clear Signs

Turning to my investment suggestion, as I’ve said in my June 21 link and July 26 link articles, I continue to believe that it is best to be hedged, however and as much as each individual prefers, since the basic investment problem continues to simply remain that no one knows how bad things might get, as was clearly demonstrated, yet again, the past week.

Practically, as I will show in a few charts later in this article, equity markets have greatly increased in volatility, but they have NOT yet corrected significantly, this has not even been a normal correction, by historical standards, so far.

So, investors are currently being offered the worst possible combination, very significant risks from increasing volatility, which is still on average below the average level of the late 1990s, but with nowhere near low enough prices to compensate for such risk.

To make that currently unfavorable reward-risk ratio better, either equity prices need to decline significantly further, and/or volatility needs to significantly dampen down.

Or a new bubble, tech redux (watch the price action of a few leading tech stocks for clues), energy (an obvious secular uptrend) or some others, needs to emerge to justify current valuations and volatility, which at the moment seems unlikely.

One of the more glaring anomalies in global financial markets has been the continuing huge disconnect, over many months now, between the increasing turbulence in the credit markets and the so far modest correction in the equity markets. One is wrong.

The flight-to-quality 40 bp decline in 10-year bond yields over the past month has helped equity valuation models.

As noted in my July 26 article link, on June 30 I sent out an e-mail saying, “I now feel that there is greater than a 50% chance of a significant correction in the stock market in the 3rd qtr. By significant, I mean at least 5-10%, but it could be much more.”

Given how fear already has swept through the global credit markets last week, clearly the probability of the more worse case scenarios is now higher at the moment.

Most mainstream pundits and mainstream media, as good as its coverage of the unfolding credit crises consistently has been for months (I am very grateful for the hard work of many mainstream journalists and columnists, reflected in the large number of quotes in this article), have yet to really emphasize critical potential risks.

One significant exception continues to be noted global portfolio manager Dr. Marc Faber, who is on Barron’s semi-annual roundtable, and who expertly talks about the U.S. entering a recession and bear market in the upcoming months in these two Bloomberg interviews on Aug 13 link and Aug 10 link, both of which I STRONGLY urge readers to listen to.

For those who have the time, I also highly recommend this considerably longer Bloomberg interview with Dr. Nouriel Roubini on Aug 14 link (and Roubini's and Setser's blogs at their rgemonitor.com, also recommended in my last article).

But before discussing very serious potential market and economic risks in the next section, let me close this section with the most basic, if seemingly utopian, message of my web site link, whose tag line is “Finance Innovators, not Speculators”:

If global leaders and people use the current unfolding financial markets’ situation to summon their wisdom and courage to try to just “think the unthinkable,” starting with how to change an increasingly dysfunctional global financial/monetary system, also how to restructure taxes to promote productive economic activity rather than rampant speculation based on uneconomical paper capital gains, remove onerous business restrictions (starting with SOX), reform education, fix the health care mess, etc. …

then the ongoing awesome changes in the global real economy and all areas of science and technology should, without doubt, create an unprecedented era of world peace, just prosperity, creativity, artistic beauty, far surpassing any civilization in human history (and fairly dealing with issues such as global warming, energy, water, demographics, health, etc.).

Why This Time Potentially Could Be Much Worse than LTCM Oct 1998

“Today's turmoil is creating obvious comparisons to 1998. Then, a financial crisis at first crippled emerging Asian economies without threatening the U.S. or other Western economies. But when Russia devalued its currency and defaulted on foreign debts in August, it sent a shock wave through global markets ... hedge fund Long Term Capital Management imploded. Trading in numerous markets came to a near halt. The New York Fed organized a rescue of LTCM, and the Fed cut interest rates by three-quarters of a percentage point between late September and mid-November. The U.S. escaped recession. Whether today's credit crisis looks as bad is a subject of intense dispute. "In 1998, a lot of big boys were really scared," said a former government official and veteran of '98. "Right now a lot of the big boys are saying, 'How can I profit from this?' That feels a little different … But comparisons are difficult. The greatest stresses today are in markets that were far less important in 1998. Their evolution since then has made it much harder for regulators or Wall Street CEOs to know precisely where the risks lurk.” WSJ, Aug 13, front-page article, Greg Ip, Deborah Solomon and David Wessel

“Each time the buy-out funds checked in with Morgan Stanley, Cadbury's adviser, the bank ratcheted up the interest rate on the debt package, according to people close to the matter. For the private equity titans, this unusual behaviour was a confirmation of their worst fears: the world had fundamentally changed, and not in their favour … That moment could be etched into the memory of buy-out executives for years to come. Just days after Chuck Prince, Citigroup's chief executive, had confidently proclaimed that he was "still dancing" to the tune of the buy-out boom, the music stopped and the self-proclaimed "golden age" of private equity came to an end. Indeed, since the end of July, discussions about large private equity takeovers have virtually ground to a halt, say Wall Street bankers.” FT, Aug 14, “Not dancing anymore. How the music stopped for buy-out buccaneers,” James Politi and Francesco Guerrera

“Blackstone has warned of a slowdown in large private equity takeovers due to the upheaval in credit markets. But the US buy-out group said the new environment could help boost returns over the long term. Tony James, Blackstone president, said that the meltdown in the financing markets for risky debt would in the short term hit performance by reducing fees and delaying asset sales … Mr James suggested that in the changed environment Blackstone would be pursuing different kinds of transactions - smaller buy-outs, public equity investments, and buying debt of pending deals at a discount.” FT, Aug 14

“Blackstone Group LP, manager of the world's largest private-equity fund, said second-quarter earnings more than tripled as revenue at its four main units increased during a record year for leveraged buyouts.” Bloomberg, Aug 13

“Wal-Mart Stores Inc., the world's largest retailer, said second-quarter profit rose less than analysts anticipated and lowered its earnings forecast … ``U.S. consumers continue to be under difficult pressure economically,'' [CEO] Scott said on the call. ``It is no secret that many customers are running out of money toward the end of the month.” … Consumer spending, which makes up about 70 percent of the economy, slowed to a 1.3 percent annual growth rate in the second quarter, the weakest since 2005.” Bloomberg, Aug 14

“[Wal-Mart CEO] Mr. Scott said. "The paycheck cycle is, in fact, more pronounced now than it ever has been."” WSJ, Aug 14

“Home Depot on Tuesday reported weak second-quarter earnings, confirming its earlier outlook, and said it expected grim market conditions to continue into 2008 … Sales in stores that were open for at least a year fell by 5.2 per cent. The worst depression in the housing market in 16 years continues to present a “tough selling environment” for the home improvement retailer, chairman and chief executive Frank Blake said. “We believe the housing and home improvement markets will remain soft into 2008.”” FT, Aug 14

“The lending landscape has changed dramatically … Even if months of absurdly easy credit are simply giving way to a more realistic but stable view of risk, clearing the backlog will take time … Demoralising subprime-related headlines are also likely to recur as disclosures of real or paper losses at investment funds and banks dribble out over the coming months … If buy-out firms cannot borrow as aggressively they will pay less for public companies, eroding the premium built into stock prices. Meanwhile, if companies find borrowing tougher, they will indulge in fewer share buy-backs and special dividends, further disappointing equity investors. Tougher lending criteria could also force more of them into bankruptcy. Decent global economic growth could help offset much of this. However, a serious credit crunch could crimp growth by squeezing commercial activity.” FT, Aug 12, “Investor should prepare for more of the same at best,” Tony Jackson

“U.S. banks increasingly tightened loan conditions on sub-prime and non-traditional mortgages in recent months and became more cautious about prime mortgages, syndicated loans and commercial real estate, according to a survey by the Federal Reserve … The survey was conducted just before the global credit crunch intensified.” FT, Aug 14

“UBS AG, Europe's largest bank, fell to the lowest in a year on the Zurich exchange after acknowledging that ``turbulent'' markets may reduce profit for the rest of the year.” … UBS has overtaken Morgan Stanley as this year's top underwriter of share sales, according to data compiled by Bloomberg.” Bloomberg, Aug 14

“The 14 percent rally in Chinese stocks in the past two weeks has created some of the largest companies in the world by market capitalization and defied a global rout that wiped more than $3.3 trillion from equities worldwide. The gains helped Industrial & Commercial Bank of China Ltd. attain a market value that exceeds all but two U.S. companies … ICBC's Shanghai-listed shares trade at 39 times reported earnings, almost four times Citigroup's multiple of 11. Shares in China's CSI 300 Index trade at 50 times profit, while those in the Standard & Poor's 500 Index trade at 17 times … The CSI 300 has more than tripled in the past year … Trading by individual investors accounts for about 60 percent of market volume … Investors in China have opened about 33 million brokerage accounts already this year, more than six times the total for 2006. Daily turnover on the nation's two stock markets soared more than fivefold.” Bloomberg, Aug 14, “China’s Stocks, World’s Costliest, Defy Global Slump,” Darren Boey and Zhang Shidong

“What makes China's worst inflation scare in a decade doubly dangerous is its deceptively harmless appearance. Many analysts are inclined to write it off as a temporary food shortage, when it actually stems from a serious money glut. The annual inflation rate zoomed to 5.6 percent last month, the highest in more than 10 years … Just as loose global monetary conditions have caused energy prices to run away in recent years, surplus liquidity in China -- the deluge of money entering the country through its record trade surplus -- is now showing up in food costs, which account for a third of the Chinese consumption basket … money supply, which grew 18.5 percent in July, the fastest pace in more than a year.” Bloomberg, Aug 14, “Blame Money, Not Pigs, for China’s Price Scare,” Andy Mukherjee

“The spurt in inflation comes at a sensitive time in China’s political calendar, ahead of the five-yearly Communist party congress in October, when stability is at a premium. Outbreaks of inflation have triggered political upheaval in the past.” FT, Aug 14

“Final reckoning only days away for Musharraf. Time is running out for Pakistan’s president to secure his political future and avoid a constitutional crisis,” FT, Aug 14

“Poland’s ruling coalition crumbles,” FT, Aug 14

So, why could this get a lot worse than LTCM in Oct 1998?

Back then the Fed could arrange a Wall Street bailout of one hedge fund, a very easily identifiable locus of risk, and Greenspan could quickly cut rates three times (thereby re-affirming the infamous “Greenspan put,” perhaps soon to be called the Bernanke-Trichet put, once again creating even more “moral hazard,” i.e. speculators are assured that, heads I win, tails I still win, hence you lose.)

The current situation is NOT comparable, and is, potentially, far worse. And the prospect of a global financial meltdown, as bad and unfortunate as that would be, potentially might just be the tip of the iceberg.

That’s because, very unfortunately, the underlying strength of the basic financial and economic structure of the U.S., in particular, is now far weaker than in the late 1990s, yet very few in positions of power yet want to admit to it (through sheer denial, almost all of the American elite, who should know better by now, still maintain that the U.S. remains the omnipotent, ubiquitous sole superpower, for those interested in this issue, see my 17,000 word Oct 27, 2006 article link, "Global Strategic Bargain: Positive Reality Therapy for America's Critical "States of Denial"").

This situation has been reversed in “emerging markets,” which are in far better shape now than back then, though that probably will NOT protect them from a global financial meltdown, as Marc Faber notes in the two video links in the section just above, should it occur.

In the late 1990s tech bubble, financial market problems were concentrated in usually risk-averse, unleveraged mutual funds then uncharacteristically gobbling up obscenely over-priced IPO’s, and economic problems in capital spending in the corporate sector, which suffered a sharp downturn in the 2001-02 recession, while consumer spending growth did not go negative.

Now, as the mainstream media likes to point out, the corporate sector has record high profit margins and still good earnings growth (up over 10% in the second quarter, which would be normal at a cyclical peak), and huge amounts of cash (according to Goldman, non-financials in the S&P 500 have $800 billion in cash, 10% of their assets), which it seems to have no better productive use for than economically dubious m&a and stock buybacks, both of which will likely recede from their record levels.

In the current situation, potentially severe problems are now dangerously concentrated, though globally dispersed, in the banking and highly leveraged speculative finance sectors, i.e. hedge and private equity funds and commercial and i-banks, all now much larger, increasingly indistinguishable, and financially cancerous, and in the consumer sector, which has been heavily dependent on its real estate asset “paper wealth effect,” due to the stagnation of real incomes in the 2000s.

Households did accumulate enormous "paper wealth" in the 2000s, but much of that is concentrated in the upper percentiles, especially at the very top, the huge winners in the current system, much of their winnings coming from lightly taxed speculative capital gains. For average income/wealth households, with real estate prices now declining, and real-world prices rising, consumer spending has been under pressure.

Additional factors usually neglected by the mainstream media that are critically different than in LTCM Oct 1998 and the late 1990s tech bubble include the following: the U.S. has a far larger current account deficit and external debt; a very weak dollar; a budget deficit dependent on cyclically high corporate profits and especially huge capital gains, both of which may peak; high energy, food, health care and other prices; worrisome slowing productivity (the rapid rise in productivity in the late 1990s was the underlying basis of the tech bubble); and just around the corner, huge unfunded pension/health care liabilities.

In addition, much of the world thinks that the U.S.is currently losing two wars and U.S. global standing is very low, as repeatedly shown in polls.

In fact, there has been a dramatic shift in relative economic strength between 1997-98 and now. Back then, Asian nations had current account deficits and currencies under attack.

Asians, now holders of trillions of depreciating U.S. dollars (left click on chart to enlarge, courtesy of St. Louis Fed) do not fondly remember U.S. actions protecting American speculators at the expense of Asian living standards in the 1997-98 so-called Asian financial crisis, which some Asians call the IMF crisis and identify with the U.S.

In addition, obviously the global geopolitical situation today is also far worse than in LTCM Oct 1998, not only Iraq and Afghanistan, but also very worrisome in Pakistan, a nuclear power, Iran and elsewhere.

All these potentially destabilizing factors, which especially when taken together are far worse than during LTCM Oct 1998, if for no other reason than they now are now afflicting the U.S., not the more peripheral "emerging markets" as back then, are usually being ignored right now by both financial markets and the mainstream.

But without being alarmist, for most countries, all these factors taken together usually would be the symptoms of an upcoming major financial/economic/political crisis.

Since the dollar is still the world’s major reserve currency and the U.S. is by far the dominant military power, that very unfortunate potential outcome has been continually avoided, to the puzzlement of many mainstream economists and other academics, as the rest of the world continues to finance, for now, America’s spending spree, both consumer and military.

(I won't go into here the esoterics of financial, not physical, "dark matter" and what economists affiliated with Deutsche Bank cleverly but inaccurately labeled Bretton Woods II back in 2003.)

The Big Positive Difference This Time

Perhaps the main reason, or rationalization, for sweeping the potential very large risks under the rug, at the moment, is the one very obvious, extremely huge positive that many others, and myself on my web site link, have consistently noted, namely extremely strong global economic growth, especially in Asia.

My ultra-simplistic working assumption has been that the U.S. real estate and lbo bubbles were so absurd and so huge, i.e., that it was economically impossible for the Fed to give away essentially free money (negative real interest rates) for so long without creating huge potential problems, therefore that the subsequent credit market problems must be quite large, hence the subsequent pain probably has significantly further to go. Kudos and thanks to others who have analyzed this far more thoroughly than I have, and it is now almost consensus opinion.

But, on the other hand, as I’ve also repeatedly said, we've also never lived in an era where so much of the world is now in the market economy, and I believe the ongoing long-term positive benefits of that truly historical change are likely to be continually underestimated also, especially by those in the west.

Real estate and credit market problems have become major daily news in the U.S. The huge positive gains from a market economy in China, India, and elsewhere seem quite remote to the very busy daily lives of most Americans, but these gains continue, day in and day out, rapidly, cumulatively greatly improving the lives of hundreds of millions of people over time.

Asian growth obviously has continued to be extremely strong, even as the U.S. has slowed. E.g. the IMF recently raised its forecast of global growth in 2007 from 4.9% to 5.2%, even while it cut its forecast for the U.S. Whether or not that will continue to be the case if the U.S. goes into an actual recession is still an open question in my mind.

China, which grew 11.9% in the second quarter, will contribute more to global growth this year than the U.S. On the negative side, China’s consumer prices have just increased 5.6% in July, well above estimates of 4.6% and the highest rate in more than ten years, from 4.4% in June.

Regardless of the strength of Asian economic growth, a global flight from risk will most likely have a strong negative impact on emerging stock markets, which like others has continued to hold up remarkably well so far and thus remain over-extended and overbought on a long-term basis, as I’ve shown in charts several times in the past month or two.

China’s mainland stock markets of course continue to seem to be in a world of their own, extremely over-extended, and thus remain another potential source of global financial risk and instability.

Financial Markets’ Sharply Higher Volatility without Low Enough Prices to Attract Buyers

I will break the main flow of this article with this section, to briefly show a few key charts.

Note well, this article is posted Tues, Aug 14, the charts in this section were from e-mails sent out last week, Aug 6-10, I did not have time to update them for this article, but I believe the points they illustrate hopefully are still valid.

Left click on the charts to enlarge.

This 5-year weekly chart of the S&P 500 (as of Friday, Aug 10) shows that so far the correction has NOT been very severe, though it has broken the uptrend from July 2006 (purple line).

In the short-term, the S&P 500 is oversold, shown in the bottom indicator, "stochastic momentum index," and thus "normally" due for a bounce, though the current financial environment is obviously no longer normal.

Longer-term, this correction would have further to go just to get down well into the bottom of the regression channels, the parallel lines (the red one is 2 std dev from the middle regression line), bringing the "true strength index" trend indicator down to 0 or below.

Going down toward the bottom of the regression channels would create real equity market fear and concern, and perhaps at some point more Fed intervention to try to trigger a massive short-covering rally (something Greenspan did with the LTCM crisis in Oct 1998, but which led to all sorts of "moral hazard" problems later).

More so than the S&P 500, most world stock market indexes were so far above-trend and overbought at the peak on July 19, that even a normal modest correction has not brought them down to very attractive entry points so far. I have shown these charts, especially of EEM, the emerging markets etf, a number of times in previous articles on my web site link, so will not do so here.

Greatly compounding the practical investment problems (as Goldman's and other "quant" funds can well attest to) has been the surge in volatility. As shown in this chart (from Tues, Aug 7), VIX (black line), the widely followed S&P volatility index, has been trending sharply upward, and is now significantly higher than it was at the previous peak in May-June 2006.

Yet for the etfs shown, EEM emerging markets (red) and QQQQ Nasdaq 100 (blue), the percentage price declines in that earlier 2006 correction were significantly larger than they have been now.

In other words, to repeat what I said earlier, equity investors are now facing the worst combination of greatly increased volatility without low enough prices to make the added volatility risk worth taking.

This next chart (from Mon, Aug 6) shows the percent change in three etfs, XHB (black) homebuilder, SPY(blue) S&P 500, and QQQQ (red) Nasdaq 100.

The main point of this chart is that all three were highly correlated up until Feb 2007. Since then, until the past few weeks, SPY and QQQQ ignored the increasing troubles in the real estate sector so clearly reflected in the rapidly declining price of XHB.

Finally, this last chart (from Wed, Aug 8), shows the normal "retracement" bounce of XLF, the financial sector etf, during the seemingly highly manipulated rally Mon-Tues, Aug 6-7. of last week (such as floating rumors of FNM and FRE buying subprime mortgages, similar to the July 12 rally that hyped Wal-Mart sales a day before weak consumer spending was reported), which failed Wed, Aug 8 afternoon, leading to the sharp decline Thurs, Aug 9, when the central bankers threw open their liqudity spigots.

Thanks very much for reading such a long article, I greatly appreciate it. Part 2 to follow in a day or two. -- econotech

7/26 Speculators' Liquidity-Leverage Russian Roulette with Economy; Real Cap Gains Tax Scandal

2007-07-26T10:03:00.000-07:00

July 26 (Econotech FHPN) --

"The point is that these innovations have externalities for the entire financial system that are hard to measure but dominate their apparent value. Rather than adding complexity and then trying to manage its consequences with regulation, we should rein in the sources of complexity at the outset. Linked to the need to reduce market complexity is the need to relax tight coupling … A less disruptive course of action is to reduce the amount of leverage that comes as a result of liquidity, since this is ultimately the culprit that high liquidity and speed of execution breeds. The externalities to high leverage are greater than they appear, because on most days everything runs smoothly. But as we have seen time and again, in the instances where it really matters the liquidity that is supposed to justify the leverage will disappear with a resulting spiral into crisis. Simpler financial instruments and less leverage make up a painfully obvious prescription for fixing the design of our markets." Richard Bookstaber, "A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation," 2007, Wiley, pg 260. [bold emphasis added by econotech]

"Chuck Prince yesterday dismissed fears that the music was about to stop for the cheap credit-fuelled buy-out boom, declaring that Citigroup was "still dancing". The Citigroup chief executive told the Financial Times that the party would end at some point but there was so much liquidity at the moment it would not be disrupted by the turmoil in the US subprime mortgage market. He also denied that Citigroup, one of the biggest providers of finance to private equity deals, was pulling back, in spite of problems with some financings. "When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing" … "The depth of the pools of liquidity is so much larger than it used to be that a disruptive event now needs to be much more disruptive than it used to be.” … "At some point, the disruptive event will be so significant that instead of liquidity filling in, the liquidity will go the other way. I don't think we're at that point."” FT, July 10, front page [bold emphasis added by econotech]

This article is mainly about whether to practically deal with an increasingly risky current investment environment, via hedging, as a follow-up on previous articles.

The Bookstaber quote above addresses the far larger issue of the safety of the current financial system, and what could be done to increase it. I strongly recommend the new one-hour interview with Bookstaber at financialsense.com link. Dr. Bookstaber's (MIT economics Ph.D.) practical knowledge of derivatives and credit markets has been earned since the early 1980s as a "financial engineer" and "quant" at Morgan Stanley, Salomon Bros, and a hedge fund.

As for the above quote from Citigroup's CEO Prince, I will comment in the next to last section of this article on his "it's not my fault, the liquidity made me do it" rationalization for continuing the credit bubble. For now, I will just ask, is the almost adolescent yet high-stakes game of liquidity-leverage Russian roulette or chicken, or musical chairs to adapt Prince's dance metaphor, any way to finance a modern global economy, who do you think benefits from doing so, and who will lose if/when the music stops?

If you've seen this movie before, it might feel like watching a car wreck in seeming slow motion, you cringe, but can't stop it from happening. But you can, the current rules of finance are not the same as the immutable laws of physics. E.g., capital gains taxes which encourage the ongoing orgy of speculation can be changed, as I discuss in the third from last section. The last section talks about my web site's link new tag line, "FINANCE INNOVATORS, NOT SPECULATORS, For Just Global Development, To Restore America's Purpose and Values."

What to Do If/When Liquidity-Leverage Music Winds Down

With a sell-off in U.S. stock markets July 24, I would like to give an update today (July 26) to my June 21 article, “”Goldilocks” 65 Basis Pts Higher” link, specifically the last section titled “If and When to Hedge?” where I wrote:

"As I've tried to imply earlier in this article and in recent previous ones, while I have consistently presented "the long-term uptrend is your friend" view on my web site since the middle of the sharp global sell-off May-June 2006 (starting with my June 2, 2006 article link), now might be one of those times to consider incurring the costs of hedging your bets, in some way to some extent, depending on your preferences. Again, in terms of timing a hedge strategy, July, like most first months of each quarter, tends to be seasonally stronger, after negative earnings news comes out in the previous month."

I have not given specific investment suggestions on my web site link, that is NOT its intent nor purpose. But by hedge, I meant exactly that, hedge, perhaps with puts, or however else one is most comfortable (including simply raising cash, lowering beta, using stop losses, buying precious metals, etc). Or, perhaps even easier, consider using calls (similar to going long both securities and puts), to limit downside risk and avoid the difficult task of trying to match-up hedges with longs (rising volatility is making the use of options more costly).

I tried to be a little more specific in a private e-mail distribution on June 30:

“To get right to the bottom line, I now feel that there is greater than a 50% chance of a significant correction in the stock market in the 3rd qtr. By significant, I mean at least 5-10%, but it could be much more … for the very little that it's worth, my guess is that the stock market might be okay through around July 20, as money continues to flow into large cap and tech stocks during the upcoming 2nd qtr earnings season. Then I think the period of maximum risk begins, from around July 20 thru to about Oct 10.”

Will July 20 mentioned above turn out to be a, or even "the," top? It simply doesn't matter, it was just a sheer guess. So far, July 19 has been the closing high in the S&P 500, and money did flow into tech and large cap stocks during the July earnings season, producing a rally stronger than I expected (I had previously written of this shift into large caps and tech a couple of times, e.g. on May 31 "Brief Update" link).

Regardless, do I still have the same concern about a significant market correction in the third quarter? Yes, I would again suggest that investors consider hedging to protect their gains. I discuss a couple of caveats in later sections.

Btw, I simply can NOT suggest such actions as going net short on my web site, so please don't read anything into my failure to do so, should the 2002-07 bull market look like it is sharply correcting.

How Far Will Credit Market Problems Go?

The basic investment problem that I've highlighted before remains that no one really knows how far the very obvious excesses that have been concentrated in the credit markets in the 2002-07 bull market are going to play out.

But so far all the news has been bad, and it keeps getting worse day after day, with the subprime woes spilling over into higher rated mortgage securities, and into the absurd economic misallocations of the lbo and m&a deals, which finally belatedly are having some difficulty getting funded in the capital markets.

Under these circumstances, it is simply financially prudent to try to protect one's investments as best as possible.

However, until just the past few days, there has been a huge disconnect between what is going on in the credit and equity markets, with the latter seemingly almost willfully and deliberately ignorant of the problems in the former.

This is even more true of rising geopolitical risks, not only in Iraq, but especially in Pakistan, Afghanistan, Iran, and elsewhere, which global financial markets continue to almost completely ignore, other than through the price of oil and precious metals.

Unfortunately, as I’ve written several times already, e.g. on June 7 link and June 21 link, even most professional equity investors are woefully in the dark on the day-to-day working reality of credit, derivatives and structured finance markets, which are deliberately very non-transparent, even to government regulators, to their unease.

(Btw, I was tempted to post extensive quotes on these credit market issues, I have a 16,000 word file on them just from the past month alone, but I simply don’t have the time to do news summaries on my web site.

I would STRONGLY recommend that any equity investor interested in following credit market issues, which are particularly critical right now, regularly read Bloomberg at http://www.bloomberg.com/ and subscribe to the Financial Times, which are very good news sources on them. Randall Forsyth at Barron's Online has also been doing a good job lately covering credit market issues. Nouriel Roubini's and Brad Setser's blogs at rgemonitor.com have done a good job on the first half economic weakness. There are also others certainly worth following especially right now, see my links list.)

Precious Metals, Dollar, Oil Indicate Increasing Desperation to Contain Credit Market Damage

The recent action of the dollar, precious metals and oil, along with the ongoing very rapid expansion of key monetary aggregates globally, seem to indicate that the financial powers that be are becoming increasingly desperate in their efforts to contain the damage in the credit markets.

Suffice to say, every investor should be very aware that precious metals, the dollar and oil are at critical levels, decisive breaking of which would reflect increasing major risks in the global economic/financial environment, so please continue to follow these markets very carefully.

Btw, Bernanke's recent speech about "anchoring" inflation expectations seems rather futile in a world in which the major reserve currency, the dollar, isn't anchored to anything real. One look at charts of the dollar index against major currencies from 1973 to the present (see chart below, left click once to enlarge, courtesy of St. Louis Federal Reserve) and gold would seem to indicate that. Again, is this any way to run a global monetary system, for lack of a better term?

I do not have more to say for now about gold, the dollar, and energy, especially oil, markets which are extensively covered by others more knowledgeable than myself on these issues, including on the sites that kindly repost my articles and I have listed in my links section, so I will defer to them on these topics for the moment. But deferring does not mean minimizing the importance of these issues.

Equity Market's Suspect July Rally

In the equity markets, particularly suspect in the July rally was the seemingly manipulated short-covering strong gain, on relatively light volume, on Thurs, July 12, early in the day attributed to better-than-expected same-store sales from Wal-Mart, and a large m&a deal, Rio Tinto’s takeover of Alcan.

Needless to say, yet another mega-deal was hardly new news in a record-breaking year for m&a, nor is consumers’ dealing with rising energy and food costs trying to stretch their budget by shopping at discount stores necessarily good news.

In fact, the very next day, Friday the 13th, came a report of very weak consumer spending in June, yet of course in the bull market media frenzy that did not reverse the previous day’s gains. Lost in the mass media hype is that most of the increase in second-quarter GDP will be from a large inventory swing, secondarily from the external account, with consumer spending still expected to be below trend.

As for the other most common rationalization for the July rally, earnings so far have been coming in up about 8%, again better than the reduced expectations, again same old game. This seemed to be enough to spur a small tech-bubble redux, with lower but still nose-bleed p/e's in a few crowd favorites such as RIMM, AAPL, and AMZN that I've previously mentioned in another article.

It's Not Only About Your Father's S&P, Dow and Nasdaq Anymore

My first caveat regarding a significant market correction in the third quarter is that, while the S&P 500 is usually the benchmark index for American investors, it is far from the leading one in the 2002-07 bull market.

As I've said before, that prize goes to emerging markets, which are up 4 times as much as the S&P, and equities and commodities in energy, materials, precious metals, etc.

All these markets play off the same theme of strong global economic growth (with precious metals also reflecting other issues) that has been unprecedented in history, in terms of speed, scale and scope. As a result, U.S. financial markets are no longer as dominant as they once were.

So, in trying to determine the trends and risks of global financial markets, we need to look at other leading markets, not just the large cap U.S. S&P 500, Dow Industrials and Transports, Nasdaq 100, etc. (on which many excellent traditional technical analysts still seem fixated).

EEM, the emerging market etf, and OIH, the oil service etf, are still in strong long-term uptrends. But, as I've been writing for the past few months on my web site link , these uptrends are extremely over-extended at the current time, and thus susceptible to sharp declines.

E.g., here is a 4-year daily chart of EEM that I've shown before, courtesy of prophet.net (left click to enlarge), indicating that it has just started to pull back from being 2 standard deviations above its linear regression trendline, it is currently down nearly -6% intraday today (July 26), while EFA, the developed markets etf, is down -3.6% mid-day.

(I didn't use a log vertical scale since this greatly curves the regression lines, so EEM's current strength is somewhat visually exaggerated compared with earlier due to the linear scale, e.g., its recent 10 point move from 130 to 140 is far less in percent terms than the earlier 10 point move from 40 to 50 four years ago).

Let me be crystal clear that looking at these other leading markets is NOT meant to minimize the importance of developments in the U.S.--everything is connected nowadays, both in the real world and the financial one.

As I've indicated before link, up until the past few days, huge credit market risks have been counter-balanced to some extent by huge real global economic growth, though that balance is rapidly turning into global risk aversion.

E.g., China grew 12% in the 2nd quarter (China's mainland stock markets have just come back to their previous highs, and are very highly valued and frothy). The world has never seen anything like this growth before, again in terms of speed, scale and scope, though it of course has seen many previous examples of excess speculation.

Why I Try to Stay Aligned with the Long-term Trends, Except When They Change :-)

As for my second caveat regarding the prospects of a significant market pullback in the third quarter, as my phrase “the long term uptrend is your friend” above clearly implies, I do not place too much faith in trying to forecast, or guess, critical turnings points in financial markets, for various reasons that I’ve described elsewhere on my web site.

Suffice to say here that the economic/financial environment has changed so much in the past decade that I have great difficulty extrapolating prior experience, statistical patterns, rules-of-thumbs, theories, hypotheses, sheer guesses, etc.

(The Bank for International Settlements says something similar in its recent "Annual Report": “the combination of developments is so extraordinary that it must raise questions about the source and, closely related, the sustainability of all this good fortune. A variety of hypotheses have been suggested to explain subsets of these phenomena, but each falls short of explaining them all.”)

Given that, I am content with trying to merely recognize major trend changes early enough as they happen to matter. For most individual investors, that is more than good enough. Larger, slower institutions must invest on the basis of their forecast.

(Btw, on the efficacy of forecasting financial markets, I recommend the views of portfolio manager and economics Ph.D. John Hussman. I would especially note his July 16 “Weekly Market Comment,” “A Who’s Who of Awful Times to Invest,” link which does an excellent job indicating the risks of this type of market environment.)

A Real Capital Gains Tax Scandal

Recently there has been a little political concern raised over very low taxation of the huge gains of private equity fund owners, though their lobbyists quickly quashed it. The issue raised was whether their gains should be taxed as capital gains or income.

Of course it should be the latter, but that misses the key point. The very low capital gains tax rate has not done what it was sold to do, i.e. increase investment in productive economic activity, that investment has been low by historical standards in this economic cycle.

Rather, low capital gains taxes, including real estate, have clearly done what they could be expected to do, produce enormous speculative financial capital gains, mainly for the benefit of the ultra-wealthy. That is what the U.S. tax and monetary systems and economy are geared toward doing.

Obviously capital gains that reflect expected real future cash flows from expected real future economic activity should be strongly encouraged and very lightly taxed (and onerous regulations removed, starting with Sarbanes-Oxley, I felt strongly enough about this to post "Sarbox counterproductive" twice, on March 8, 2006 link and April 10, 2006 link.)

The same is true, probably even more so, for real income, which also should be taxed at very low rates, because real income must come from the production and sale of real goods and services.

Whereas, in contrast, capital gains can often be manufactured out of pure Wall Street financial fantasies and speculation, purely in fanciful spreadsheet projections and the click of an electronic trade in cyberspace.

Today, much capital gains, again most especially of the ultra-wealthy, are from mere paper shuffling of assets and virtually unlimited credit creation, with very little, if any, link to real productive economic activity.

(Btw, mainstream economists don't seem to be willing to look at these financial speculative capital gains as probably the main source of growing income and wealth inequality in the U.S., instead focusing on differences in education which doesn't explain the rising disparity in favor of those at the very, very top vs other very well-educated people.)

I think any honest person who has ever worked in a hedge or private equity fund or i-bank would know how completely economically absurd many of their deals really are, and the fact that they are driven by pure greed, plain and simple. This is not how markets' "invisible hand" is supposed to work. Most mainstream economists, especially academic ones who haven't worked in speculative markets, just don’t seem to know this, much less the politicians.

Paul Krugman, an honest and extremely capable mainstream economist (e.g. a 1991 winner of the highly prestigious John Bates Clark Medal), came close to hitting the capital gains tax nail on the head in a recent NYT column on this issue:

“There's a larger question one could ask: should we even be giving preferential tax treatment to true capital gains? I'd say no, because there's very little evidence that taxing capital gains as ordinary income would actually hurt the economy. Meanwhile, the low tax rate on capital gains is one main reason the truly rich often pay lower tax rates than the middle class. A couple of weeks ago, Warren Buffett pointed out that he pays an average federal income tax rate of 17.7 percent, while his receptionist pays about 30 percent. But even those who disagree with me on the larger point, who think the special treatment of capital gains is justified, should be able to agree that treating the income of fund managers differently from the way we treat the income of everyone else who works for a living makes no sense. And that's why it's very disheartening to read that prominent Democratic senators are taking seriously the claims of fund managers that making them pay taxes like regular people would discourage risk-taking.” NYT, July 13, Paul Krugman, op-ed, “An Unjustified Privilege” [bold emphasis added by econotech]

But even Dr. Krugman, who has been extremely outspoken in going after the U.S. political elite on Iraq and other issues, so far has been unwilling to do the same with its speculative financial elite. In general, most well-meaning and very capable economists still show great deference to the financial, as opposed to political, elite

What Citigroup's CEO Didn't Say

While Krugman at least honestly raises the critical capital gains tax issue, compare this with the quote from Citigroup's CEO at the front of this article.

Citigroup’s Prince failed to make two critical points, first that the global hyper-speculators are dancing to music of their own making, to use his metaphor, through their infinite credit creation schemes. I.e, liquidity is not some external, exogenous, force of nature, it’s created by the global hyper-speculators’ own daily decisions and actions.

The second, even more critical point, that Prince obviously won’t say is that this liquidity-driven global financial system is mainly intended to benefit its mega players, and is a completely economically absurd way to allocate savings and capital in a global economy.

Again, what this monetary/financial regime, for lack of a better word, is very good at is creating capital gains out of thin air, which mainly accrue to the ultra-wealthy, hence the unending stream of absurd deals that do just that.

What this economic regime isn’t very good at right now is rationally allocating investments that actually produce significant gains in real income, again which should have very little if any tax, by meeting the real needs of the vast majority of the world’s population, not the Madison Ave.-induced fantasies of a tiny, increasingly superficial ultra-elite.

Sooner or later, this massive global mis-allocation of capital for the benefit of a very small group of global hyper-speculators will change, hopefully positively, but if not, then with negative consequences.

That has always been the case throughout history, when an entrenched elite doesn’t do the right thing, bad things invariably follow in reaction, in terms of conflicts and ideologies, which the elite then use to rally people against.

Let’s hope history doesn’t sorrily repeat itself yet again.

The Meaning of My New Tag Line: "FINANCE INNOVATORS, NOT SPECULATORS, For Just Global Development, To Restore America's Purpose and Values"

I've shortened the tag line on my web site link, still keeping the capitalized main theme, it now reads, "FINANCE INNOVATORS, NOT SPECULATORS, For Just Global Development, To Restore America's Purpose and Values"

This reflects my belief that the leading front in global history is the amazing economic development going on in many parts of the globe, while the U.S. government is bogged down in a debilitating, in many ways, rear-guard battle in the war in Iraq. (I view global history in terms of the leading nations moving forward human progress and global development, or unfortunately not, in any given era.)

I believe it’s very unfortunate that the U.S., and many Americans, seems so pre-occupied with other things, including a huge capital gains fueled consumption binge of unprecedented proportions among its elites, to not have time to truly understand and appreciate the march of global progress in many parts of the world right now, which the U.S. previously had led for much of the past century, resulting in its much higher former global standing.

I also believe that the current U.S. failure to provide such global leadership, especially the U.S. financial elite’s focus on its own ill-gotten speculative gains, has greatly eroded America’s historical purpose and values. (For some suggested changes in U.S. policies, please see my Oct 27, 2006 article, "Global Strategic Bargain: Positive Reality Therapy for America's Critical "States of Denial,"" link.)

As for the U.S. tech elite, it's nice that Apple is selling a lot of iPods, iPhones, and Mac's, Amazon a lot of stuff, and Google a lot of ads. But Steve Jobs, the once hip computer revolutionary, and Silicon Valley, the once awesome center of American innovation, have increasingly gone the way of Madison Avenue and Hollywood (though Yahoo recently switching CEO's was a small step in the other direction).

Hopefully the U.S., and its tech elite (I have little hope for the financial elite, perhaps those around the Rubin/Summers wing of the Democratic Party in the Hamilton Project will belatedly surprise me) will once again rejoin the global march of progress. If so, the U.S. might begin by once again starting to pay its way, instead of sucking in the world's savings much needed for economic development elsewhere.

After more than three decades of the U.S. becoming the world's credit junkie, to start to change would require difficult but nevertheless doable reforms in the world monetary and financial regime, again for want of a better word. It would be much easier to make the much-needed global economic adjustments while things are still going relatively well.

But with the speculative finance elite dominating the U.S. economy, and the leading candidates of both parties seemingly in their hip pockets (with Clinton and Obama particularly good at getting money from hedge and private equity funds, i-banks and Hollywood), I personally don't have much optimism about that occurring any time soon. I hope I'm wrong.

6/28 Global Financial Markets' Bipolar Disorder Even Greater than Usual

2007-06-28T14:56:00.000-07:00

June 28 (Econotech FHPN)--Is it just me, or do global financial markets currently seem to have even greater bipolar disorder than usual?

The past few months I have been increasingly highlighting global financial markets' risks, while also noting more recently that momentum investors have been shifting into U.S. large cap and tech stocks, which in general have been laggards in the 2002-07 cycle.

Exhibits A and B just from today, compare these two stories below. First the lead story on Yahoo!Finance this afternoon; before the price rise, RIMM's trailing p/e was already 50, according to Yahoo!Finance:

"Research in Motion's 1Q Earnings Jump
Thursday June 28, 5:06 pm ET
By Rob Gillies, Associated Press Writer
Research in Motion Says 1Q Earnings Grew 73 Percent on Increased Sales; Shares Soar 14 Percent

NEW YORK (AP) -- Shares of Research In Motion surged more than 14 percent in after-hours trading Thursday after the BlackBerry maker said its first-quarter earnings grew 73 percent on increased sales and subscriber additions."

Now second, the lead front page story in this morning's "Financial Times," one of the world's most authoritative financial news sources:

"Axed deals reflect concerns over credit
By Lina Saigol and Joanna Chung in London and Richard Beales in New York
Published: June 28 2007 03:00

Companies are pulling financing deals across the globe, in one of the clearest signs yet that investors' worries about rising interest rates and US subprime mortgages could be infecting other areas of the credit world and driving up the cost of corporate borrowing ... The bonds and loan deals were pulled after investors refused to buy them under the proposed terms, demanding higher premiums and more protection. Stephen Green, chairman of HSBC, yesterday ... In an interview with the Financial Times, he said he was "worried by the degree of leverage in some big ticket transactions nowadays" and felt that "something is going to end in tears". He also warned that losses could be higher because the parcelling out of risk to so many parties across the financial system could make it more difficult to arrange a rescue - a comment that highlighted widespread and growing unease among senior banking executives ... Many investors are now reassessing risk, which could force up the cost of doing deals and cause a sharp slowdown in private equity activity. Investors appear to be rejecting deals involving the riskiest structures ... Amitabh Arora, New York-based head of interest rate strategies at Lehman Brothers, said: "The bigger risk now is that it calls into question CDOs as a financing vehicle in the corporate credit market.""

6/26 Emerging Markets Volatility, Regional Banks Negative Alpha Just Two More Warning Signs

2007-06-26T15:04:00.000-07:00

June 26 (Econotech FHPN)--Due to my ongoing concerns about the global financial markets at the current time, I've been posting more frequently the past month than I feel comfortable doing. I hope that I am not becoming too short-term oriented as a result.

Emerging markets have been a clear focus of public equity market speculation in the 2002-07 cycle (there's much larger speculation in private equity, structured finance and derivative markets). In this respect, EEM, MSCI emerging market etf, is the QQQQ, Nasdaq 100, of this cycle.

Perhaps with the critical difference that EEM's p/e is now actually over an order of magnitude lower than Nasdaq's in March 2000 (I know that seems difficult to believe in retrospect, especially given how "efficient" developed financial markets' are claimed to be).

I showed in my last June 21 article (“”Goldilocks” 65 Basis Pts Higher," link) that EEM is now 2 standard deviations over its 4-year linear regression trend. Much shorter-term, over the past month since May 23, EEM has started to exhibit greater volatility.

You can see that on the attached 60-day, 60 min chart, courtesy of prophet.net (left click once to enlarge).

Before May 23, EEM prices hugged the center green regression line. After May 23, these prices have been yo-yo-ing up and down. You also can see the same thing in the "true strength index" panel, with the greater oscillations around the 0 line.

To me, this chart is an early warning sign, for the following reason. Over this short-term period, reward, in this case the rate of price change, essentially the slope of the regression line, hasn't changed. Yet risk, indicated by the greater volatility (larger standard deviation of prices), is increasing.

So, EEM most recently is generating the same return, but now at higher risk. I.e., risk-adjusted return is going down, especially when you add in the additional factor of the higher hurdle of rising l-t interest rates.

Perhaps this declining risk-adjusted return may seem a somewhat subtle change if one is mainly focused on return. But I believe that when a market starts giving the same return for higher risk, it's time to start taking notice.

To be crystal clear, I am NOT predicting here imminent meaningful declines in the emerging markets, though I think the risks of that have been increasing. E.g, perhaps July might have its typical seasonal bounce, with declines to then follow.

But to continue the analogy from my June 7 article (“Equity Markets Flying Without Instruments Into a Non-Linear Storm”, link), I do think there are subsurface cracks in the ice.

In that article, I showed a chart of XBD, the broker-dealer index, with a negative alpha (risk-adjusted return) since July 2006, saying that didn't seem like a good sign for a global financial economy seemingly run for and by the Goldman Sachs’ and Blackstones’ of the world.

I-bank stocks have been weaker since I posted that due to concerns about the Bear Stearns hedge fund situation (see my June 21 ""Goldilocks"" article link).

Here is a 4-year weekly chart of another financial sector, RKH, regional bank etf, courtesy of prophet.net (left click one to enlarge).

Similar to XBD, RKH’s alpha is negative, in the latter case at the lowest level of the past four years.

It’s a little difficult to see, but RKH is now below its 40-week moving average (purple line) and right near the bottom (2 std deviations) of its linear regression channel. Both served as support in Oct 2005, failure to do so again would be significant this time.

So the signs, “Warning Thin Ice,” continue to add up. Perhaps the darkest hour is just before dawn. Wall Street is probably hoping for the usual first month of the quarter bounce in July during earnings reporting season.

But perhaps these increasing warning signs mean there may be more darkness to come. That’s why I’ve recently suggested considering hedging one’s bets in the most appropriate manner for each investor.

I think most people naturally would prefer not to hear such warnings and suggestions, and I'd prefer not to give them. But no one likes losing money either, so perhaps, at selected times, it may be worth running the risk to one's credibility by making them.

6/21 "Goldilocks" 65 Basis Pts Higher; Public Equity Mkts Lopsided Info Disadvantage; Emerging Mkts 2 Std Dev Above Trend; Laggard Large Cap/Tech Rise

2007-06-21T09:35:00.000-07:00

June 21—(Econotech FHPN)

"Last month, Enhanced Leverage reported that its value fell 6.75% in April after the [hedge] fund's bets on the mortgage market went wrong. Two weeks later, it put the loss at 18%, spooking already-nervous investors and creditors and sending many of them running for the exits. The huge revision at least in part reflected conversations Bear Stearns hedge-fund managers had with bond dealers, three of which told them in late April that some of the funds' assets were worth less than the values stated on the funds' books ... "No one in the subprime business wants to ask the question of whether they need to re-mark all the assets. That would open the floodgates," said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago. "Everyone is trying to stop the problem, but they should face up to it. The assets may all be mispriced."" “Two Big Funds At Bear Stearns Face Shutdown,” WSJ, June 20, front page

"The giant market for securities backed by US subprime mortgages was thrown into turmoil on Wednesday as lenders struggled to sell more than $1bn of assets seized from two Bear Stearns hedge funds that suffered heavy losses on subprime bets. The complex securities being auctioned are rarely traded and early attempts to sell the collateral met with mixed results. The prospect of the “fire sale” knocked down prices for similar mortgage-backed assets and sent a key derivative index for the market to record lows. The rout highlights the risks investors take when they buy illiquid and hard-to-value securities. Fire sales in times of stress can trigger dramatic changes in pricing in such markets, perhaps leading other holders of assets to mark their values down and triggering demands for additional collateral from lenders." FT, June 21, front-page

"``It's a blood bath,'' said Mark Kiesel, [EVP of Pimco], the manager of $668 billion in bond funds. ``We're talking about a two- to three-year downturn that will take a whole host of characters with it, from job creation to consumer confidence. Eventually it will take the stock market and corporate profit.'' … ``When all these people see their mortgage payment and it's up 40 or 50 percent, they're going to say, `We can't stay in this house,''' Pimco's Kiesel said. ``And there are millions of people in this situation.'' … The recent increase in mortgage rates is the biggest spike since 2004. The change means buyers can afford 8 percent less house than they could five weeks ago, Kiesel said. ``Prices are going lower,'' he said." Bloomberg, June 20

Mario Gabelli: "My major concern about deals is no different than my major concern about the stock market: There is so much leverage, and the use of derivatives has built in so much leverage below the surface." Barron's "2007 Midyear Roundtable," June 18 [the key phrase here for what follows is "below the surface"]

Can Public Fund Managers Accurately Assess Private Fund Risks?

The first two quotes above are from WSJ and FT front-page articles on problems at two Bear Stearns' private hedge funds, High Grade Structured Credit Strategies Enhanced Leverage Fund and High Grade Structured Credit Strategies Fund.

The problems at these two private hedge funds is indicative of some of the financial impact of the ongoing fiasco in the subprime mortgage market, which I won't go into in this article, as it has been extensively covered everywhere else.

My focus here is on how this hedge funds' story also highlights the difficulty that public market equity investors in this 2002-07 cycle will continue to have in accurately gauging key risks in several critical areas dominated by private funds, leveraged debt and structured finance deals and derivatives.

(Btw, sorry for my article's long title, I wanted to convey all the ground covered in it. This article intersperses more pragmatic investing-oriented sections, often with charts, with ones on more "big picture" issues, as does my web site in general, so if a particular section doesn't interest you, please skip further down, thanks.)

Given that these two private hedge funds' managers themselves did not accurately know the prices (let alone values) of these structured finance assets (and Bear Stearns is considered to be one of the most knowledgeable i-banks in the mortgage markets), as indicated in the two quotes above, honestly highlighted by Tavakoli, a well-regarded expert, then what fair, honest chance does any outsider public equity investor, no matter how diligent and well-informed, have of knowing about the risks of what may happen to these two structured finance funds, and what may be their likely impact on global financial markets?

Probably virtually zero chance of accurately knowing, and that's exactly my point. And that point is not limited to whether these two particular funds may or may not work out, and what impact that may or may not have, as important as that might become.

I want to emphasize the more general point that most public equity market investors, including mutual and pension fund professionals, have no real idea what may happen not only in the case of these two particular Bear Stearns' funds, but also much more broadly no real way of accurately assessing the riskiness of potential, yet still unknown, situations in the leveraged debt, structured finance and derivatives markets, now and into the future.

And now making this public equity market information disadvantage considerably worse, the risks of playing that lopsided information game have been significantly increasing with rising 10-year rates the past few months, which is making it more difficult to even price some of the more esoteric private securities, as mentioned in the quotes above, let alone assess their real future economic value.

To re-iterate the analogy about unseen sub-surface cracks in the ice of bullish investor psychology from my June 7 article, "Equity Markets Fliying Without Instruments Into a Non-Linear Storm," link, public equity market investors and fund managers simply have no way of being intimately familiar with the working details and hence actual risks of various critical markets, most of which are dominated by private players, especially leveraged debt and structured finance deals and derivatives, in the 2002-07 cycle. (Another key sector in this cycle, emerging markets, is also very difficult for U.S.-based equity investors to adequately assess.)

It's not that well-informed public equity market managers are not very aware of these opaque private markets and issues, many have diligently, professionally stayed on top of them, in general outline.

And these issues are well covered in the mainstream media, as indicated by the front-page quotes leading off this article, and on many informative web sites, including those I’ve provided links to on my web site (right below the long list of my own articles in the “Links” section on my web site link , with special thanks to those that post and link to my articles and site).

Nevertheless, whatever public knowledge is available is almost always from an outsider perspective into mostly private, and often deliberately opaque, markets. (Global central bankers and financial regulators are often in a similar informationally disadvantaged situation, and along with multinational economic organizations, have been saying so for years now.)

Unfortunately for public market equity investors, these more opaque private markets are where the main financial action is in the 2002-07 global boom, one key way in which this cycle is significantly different than the tech bubble of the late 1990s.

Back in that earlier bubble, when private hedge fund LTCM ran into huge trouble in Sep-Oct 1998, briefly freezing up global financial markets, the Fed stepped in with interest rate cuts and organized a Wall Street bail-out of LTCM, then the main action quickly shifted back to the enormous speculation in the public equity markets in 1999, with Nasdaq up over 80% in a huge torrent of legal but nevertheless essentially negligently, if not even fraudulently, mispriced IPO's, with the role of private hedge funds far smaller in aggregate than today.

In that bubble, which of course ultimately worked out extremely poorly for most public equity market investors in the deep bear market of 2000-02, public equity fund managers knew all the critical working details of the IPO deals they were involved in, even though they tended to get caught up in the hype and lunacy, for obvious self-gain and/or self-delusion.

But public fund managers were at a huge information disadvantage to the private venture capitalists and i-banks feeding the IPO's into the public markets, an inherent information disadvantage that private equity firms once again fully intend to take huge advantage of in this cycle when they go to sell back their LBO's into the public markets, more on this in a section below.

So, to sum up, a not insignificant risk for public market equity investors right now that I continue to believe is underappreciated is that most of them, including professional mangers of mutual and pension funds, less so in private hedge funds that are involved in many private equity and structured finance deals, are assuming a level of safety for which their daily working knowledge simply is not adequate to assume, and thus are probably overly complacent.

As I've said, public equity market investors are not unaware of the risks in their lack of working knowledge of these leveraged debt and structured finance deals, but because they do not know the deal details, most, including public market mutual and pension fund managers, seem to assume that these deals must be okay, simply because nothing has happened so far, until proven otherwise, in which case it might be too late.

For a structured finance professional's assessment of the Bear Stearns' hedge fund situation, see this June 20 video interview of Andrew Brenner on Bloomberg link.

U.S. Equity Market Valuation Now 20% Less Attractive than Three Months Ago

By my back-of-the-envelope calculation, just plugging a few numbers into the ultra-simple “Fed” valuation model, the S&P 500 is about 20% less attractive today than it was just three months ago in early March (as of June 20, the 10-year bond yield was about 12% lower back in early March, and the S&P 500 price, hence p/e, was about 10% lower back then, assuming consensus 2007 estimates haven’t moved up too significantly since then, though first quarter earnings were signficantly better than previously drastically reduced expectations).

Yet so far, global financial markets don’t seem to care very much. If one wanted to explain or rationalize this, then perhaps you could say markets may just be about 20% less undervalued now than they were then, though based on both cyclically and secularly extremely high earnings and profit margins, and still historically low long-term interest rates, with it still being too early to tell if that critical secular disinflationary downtrend line since the 1980s has been decisively broken.

(The recent move up in long-term rates was due mainly to an increase in the extremely low term premium, since estimtates of both long-term real growth and long-term inflation have barely moved, though many have questioned the accuracy, even legitimacy, of the still relatively low inflation data from the government.)

The still consensus belief is that the combination of strong global economic growth and high liquidity continues to create a best possible “Goldilocks” investment environment, especially for record-setting m&a and lbo deals and emerging markets. "Goldilocks" is perhaps a little less attractive with 10-year bond yields 65 basis point higher than three months ago.

To be sure, there is no shortage of hand-wringing over this Goldilocks view. One can constantly read of all the various concerns of mainstream investors, economists, regulators, journalists, etc. consistently in Bloomberg and FT articles, let alone the more dire ones of the Net denizens.

Needless to say, one of the key sectors on everyone's radar screen remains the residential real estate market, which has just had yet another leg down of bad news, mainstream views of this recent news are discussed in these two video interviews on Bloomberg on June 18, link and link.

Here is a chart of XHB, the homebuilder etf, courtesy of prophet.net (left click once to enlarge).

XHB tracks the changing sentiment regarding the outlook for the U.S. housing market. The small upturn in sentiment in the second-half of 2006 topped out in early Feb with renewed concerns about sub-prime lending woes. XHB is now at its previous April 2007 low, breaking that and going toward the lows of last summer 2006 would be a poor indicator not only for this critical sector, but obviously also for the overall U.S. economy.

And of course, the converse would be that if XHB were to hold here at the April lows, that might become a double bottom and a higher low from 2006, thus indicating that perhaps the worst, in terms of expectations, is over for the homebuilding sector.

But so far none of these highly articulated concerns have dented global markets very much, other than throwing small periodic scares that the global hyper-speculators still quickly shrug off.

Despite far lower equity valuations, this is now getting to feel just a little similar to 1999-early 2000, perhaps not accidentally, though once again, the main excesses this time around are in the global credit, not equity, markets, valuations in the latter are far below the earlier bubble, while credit spreads remain at or near historically record low levels, even after the recent rise in long-term rates.

I recall reading around five years ago about a study, by Ned Davis research I believe, that said that since 1950, the S&P 500 has averaged a 50% increase from its low in the second-year of the 4-year political cycle to its high in the third year.

At that time, Nasdaq had gone up up over 80% in 1999, it later went up 50% in 2003. So far this time around, as if on schedule, the S&P 500 is up 25% from its closing low of 1224 in June 2006.

Unfortunate Evolution of Global Financial Markets: Transfer of Risk to the Public for Private Gain

"Blackstone IPO seven times subscribed amid overseas demand," FT, June 21, lead headline

Today's FT lead headline on the Blackstone IPO runs opposite one that says, "Subprime sector hit by $1 bn assets sale," so while the latter sector remains in the outhouse, the private equity sector is clearly enjoying penthouse status.

Perhaps one of the key features in many aspects of the current global economic and financial landscape is the transfer of risks to the public for private gain. One sees that in the corporate sector, with "at will" employment contracts, outsourcing, pension and healthcare looting, etc., and may soon see it politically with respect to Social Security, Medicare, Medicaid, etc.

One can view much of what is going in the financial markets in a similar way of public risk transfer for private gain, most especially with rampant, record-setting private equity deals. As I say, they call it "private" equity for a very good reason.

Of course there is absolutely nothing wrong with private capital, per se. In fact, one can make a very plausible argument that private capital may be inherently far less manic and irrational than public markets (can you picture Jim Cramer at Blackstone?)

That is perhaps because, with private capital, crucial confidential corporate business information can be readily shared between the financial sector and corporate officers, which simply can't be efficiently done in U.S. public markets, and is now completely illegal with the so-called level playing field.

(This more efficient transfer of confidential corporate information also characterizes Asian and European bank-based financial systems and their more industrial customer base, systems which have had other drawbacks--alas, there is no perfect system.)

But there are at least two glaring issues with the current private equity boom/bubble.

First, and more relevant here, currently private equity has increasingly become essentially a legalized con game (hence my term ROLLL, return on leverage legal looting), in which the inevitable sucker to be played almost always is fully expected and projected to be the public investor and public corporations, which have incredibly far less inside information and financial incentives than the private equity side when the expected transfer of assets, at wildly overly inflated prices, is made back to the public.

I'm ignoring the inherent enormous information disadvantage, huge financial incentives, and obvious legal conflicts of interest in any LBO with senior corporate management participation, in which management essentially forsakes its legal fiduciary responsibility, in order to trade against public equity and bond holders.

(Private equity supporters attempt to cover up these various inherently unfair con games by claiming that pension funds are increasingly beneficiaries of the con. That's like saying private equity robs Peter, the public, to pay Paul, themselves, then gives a little back to Peter. Same, btw, with private equity philanthropic giving.)

A second glaring problem with the current version of private equity, as I've said several times before, especially in my long Dec 19 article on "World Needs Better "Face of American Capitalism" than Private Equity" link, is that it focuses mainly on sheer financial leverage and hence excessive short-term corporate cost cutting, at the expense of longer-term investments in innovation.

That cost-cutting focus may have made some sense in the 1980s LBOs, but at this point it is the exact opposite of what is necessary for corporate incentives, since corporate America have been cutting to the bone under various guises and banners--total quality management, restructuring, reinventing, lean production, outsourcing, offshoring, six sigma, i.e. repackaged tqm, lean six sigma, etc.--for well over twenty years now.

Not that there's anything wrong with these efforts, per se, especially in terms of improving quality of products and services, and hopefully customer focus, though that they tend to more internally oriented. Rather it's simply that the emphasis needs to be on innovation and growth, and especially with products and services that address the still glaring unmet needs of the vast majority of the global population.

To put the private equity legalized con game in human nature terms, the basic thing wrong with current private equity excesses ironically may not be that much different than the very same thing that inevitably undermined what private equity would claim to be its polar opposite, socialism and all other utopian schemes, namely rampant human greed and excessive power that is unchecked by any publicly accountable strong enough countervailing power.

Btw, the same has probably been true in the political arena. Due to the current lack of effective, sufficient countervailing power, both market and political, neither private equity excesses and more generally global hyper-speculation, nor current political policies seem to have much chance of changing in the near future, but that's a whole other story (for those interested, see my 17,000 word Oct 27 article, "Global Strategic Bargin: Positive Reality Therapy for America's Critical "States of Denial," link).

Global Emerging Markets Currently 2 Standard Deviations Above 4-Year Trend

As I've said in my most recent articles (e.g. on May 31 link), to me most key charts still look very over-extended, even though they haven't wanted to go down, as of yet. This view obviously presents a dilemma, the specific nature of which and how to address it (try to hedge risks perhaps trying to time entry and exit points to keep hedging costs reasonable, ignore rising risks, lighten up, lower beta, etc) depends on one’s own particular investment positions and outlook, financial situation, risk aversion, etc. (hence I don’t give investment advice on my web site link).

Anyway, I’ll discuss once again EEM, the MSCI emerging market etf, since emerging markets have clearly been the market leader in the 2002-07 cycle. With EEM outperforming the S&P 500 and Nasdaq 100 by 4 to 1 over the past four years, it’s difficult for me to see how this cycle can end without this chart eventually rolling over. This is a four-year weekly chart of EEM, as of June 20 close, courtesy of prophet.net, except without my usual log scale (as I will explain shortly), left click to enlarge.

The key message on the chart is that EEM still seems to be very over-extended, using simple linear regression analysis. The center green parallel line is a linear regression line generated statistically.

(I use regressions because, if you get the endpoints right, which is the key to accurately depicting a trend using this approach, then simple regression trendlines are fairly “objective” (ignoring the issue of which regression technique to choose) and thus helps to minimize the all too human condition to see and draw trendlines that one wants to see, per my comments on investors bull/bear “cognitive dissonance," in "A Tale of Two Cognitions, Bull and Bear" on June 4 link).

The parallel red lines on this chart are 2 standard deviations away from the center trend line, the parallel green ones 1 sd, and the blue ones 1.5 sd. (These parallel lines excessively curve on a log scale chart due to EEM's very large percent price change, about 240%, over the past four years.)

Two sd’s indicates that 95% of the observations fall between the red lines (assuming a bell-shaped normal probability distribution).

EEM is now at the red line, 2 sd's above trend. I chose that color to indicate a clear warning, i.e. that if this trendline is correct, and that is the key if, then there would seem to be a rather low probability of strong gains from this level, prior to, at minimum, a sideways consolidation, or maybe worse a sharp pullback, as occurred in May-June 2006, or perhaps then becoming the beginning of something worse over time.

Is such a pullback statistically pre-ordained? Of course not.

E.g., we could easily imagine or draw other plausible steeper trendlines, such as one connecting the previous major high in April 2004 and April 2006, which would make EEM seem less overbought (I haven’t done so to avoid overly cluttering this chart for presentation purposes). Or if EEM were to continue strongly up, it would have the effect, over time, of simply steepening the slope of the regression channels, making the up move look more reasonable, in retrospect.

Nevertheless, to me, at this moment, this regression line is the best fit look I have, coming off the March-April 2003 (Iraq invasion) lows, and so the odds seeme to be stacked against a strong up EEM move from here. The same picture emerges using different timeframes, and also using other leading indexes, etfs, etc., though U.S. major indexes are generally less overextended, as I discuss regarding QQQQ, the Nasdaq 100, below. The U.S. market hasn't wanted to go down in seasonally weak May-June, and it's soon to enter seasonally better July and August.

Going back to the 4-year cycle numbers I mentioned earlier, could global equity markets go much higher? Perhaps could global markets be in an era not only of serial multiple asset bubbles, which many observers now readily concede, but bubbles of such magnitude that the 1998-2000 equity market "innovation/productivity" tech bubble was not just a once in a lifetime experience, but rather one of a series of seemingly once-in-a-lifetime bubbles (as already was the case with the follow-on global real estate "re-rating" bubble)? E.g., could the emerging markets boom just continue right off the charts, so to speak?

Of course, China's white-hot equity markets are on everyone's radar screen nowadays, so here is a chart of the Shanghai composite, courtesy of stockcharts.com (left click to enlarge). Obviously this index is once again at an important point, namely whether, after its recent sharp pullback to once again its 50-day moving average, it can take out its previous high, as it quickly did after the smaller pullbacks in Feb and April of this year.

It is extremely difficult, perhaps impossible, to guess the top in any parabolic market like this. Do you think it is likely for most American equity investors, including professionals, to do so for a huge country across a huge ocean that they have very little understanding of?

Too harsh? How many American investors even know the names of the leaders of China and India, let alone how much steel China is currently producing--the overwhelming majority would be shocked by the answer in comparison to the U.S. In fact, I use these questions as everyday litmus tests, and no one gets them right, just like no one came even remotely close to guessing Nasdaq's p/e at its all-time peak, for many more years to come, in March 2000.

Btw, to shift gears, there are several good independent analysts who have done excellent work for a long time, often combining fundamental and technical data from a huge number of data series into their numerous models, among them the above-mentioned Ned Davis, Steve Leuthold, John Hussman, Jim Stack, etc. E.g., here’s a June 18 Bloomberg interview link with Leuthold that is representative of the views of those who do so much hard work, in his case he's recently reduced his equity asset allocation.

Update on Nascent Shift into U.S. Large Cap and Tech Stocks

For both momentum investors and die-hard U.S. large cap and tech stock ones, the latter haven't had too much to cheer about in the 2002-07 cycle, there is some ongoing rotation into these stocks, as I noted in my May 31 "Brief Update on U.S. Materials, Retail, Large Cap/Tech ETF Trends link. Another indicator of the same nascent speculative sentiment shift is that the long-term alphas, risk-adjusted excess return, of the semiconductor index and etf (SOX, SMH) are just now turning back to positive.

QQQQ, the Nasdaq 100 etf, is only 1 sd above its lackluster 4-year trendline, as shown in the 4-year weekly chart below, courtesy of prophet.net (left click to enlarge), encouraging the current buy-the-laggard mentality for tech sector stocks. Also note in the bottom panel that QQQQ alpha has just turned positive.

Cyclical GARP-type tech bulls have lately started bidding up such stocks as Micron (MU), a commodity play hence usually a good indicator of increasing tech sector speculative sentiment (some also like it as a longer term play on video bandwidth secular growth), while growth bulls continue to love such much more highly valued tech stocks as AAPL, GOOG, RIMM, AMZN, and smaller ones like RVBD (an emerging leader in WAN optimization).

Here is a 60-day, 60-minute chart, as of the June 20 close, of QQQQ, the Nasdaq 100 etf, courtesy of prophet.net, left click once to enlarge. Due to the length of this article, I'll keep my description of this chart briefer than usual.

QQQQ has been in modest uptrend the past two months, consolidating the sharper gains off its March lows. After breaking down to the bottom red line, it had its almost requisite short-covering bounce last week, but so far only back to the center green trendline, which is also near the purple trendline connecting recent tops, both now around 48, before turning down June 20 afternoon, again about on schedule. For the uptrend to continue, 48 eventually needs to be taken out.

If and When to Hedge?

As I've tried to imply earlier in this article and in recent previous ones, while I have consistently presented "the long-term uptrend is your friend" view on my web site since the middle of the sharp global sell-off May-June 2006 (starting with my June 2, 2006 article link), now might be one of those times to consider incurring the costs of hedging your bets, in some way to some extent, depending on your preferences. Again, in terms of timing a hedge strategy, July, like most first months of each quarter, tends to seasonally stronger, after negative earnings news comes out in the previous month.

Why consider hedging at all at this time? Perhaps one reason is the one I led off with in my June 7 article link and this one, i.e. one of the key differences in this 2002-07 cycle is the opacity, often deliberate, of critical markets to public market equity investors, including professionals, and that rising long-term rates have now made these information gaps considerably more risky to continue to ignore.

To finish up, here are a few quotes, in alphabetical order, without my editorial comment from this week’s mid-year Barron’s roundtable update (I may add a few more quotes from the second part of this roundtable later today):

Scott Black: "the index, at current levels, sells for 17.6 times earnings. The market is about 10% overvalued. That doesn't mean it can't go up ... Another problem is the casino mentality of many market players. Between the hedge funds trading in and out and the private-equity people chasing stocks at very inflated multiples of price to enterprise value ... And there seems to be no fear ... [what could break this cycle?] You almost need to have a hedge fund blow up, or a couple of private-equity deals go south. The private-equity business is more of a fee-gathering business now than an investment-performance business."

Marc Faber: "A lot of money flows into the pockets of affluent people ... The economy of the middle class and the workers is not doing particularly well. The U.S. stock market, like all other asset markets, is in cuckoo land. We have bubbles everywhere, which hasn't happened before ... those markets have become correlated with the U.S., so if the S&P goes down 5%-10%, nothing much will go up. If the S&P drops 10%, emerging markets easily could drop 20% or more ... The S&P either will really begin to correct, or continue to move up, perhaps until August, and, like in 1987, have a very sharp setback in the second half ... And it's not just hedge funds. The whole system is geared to taking a lot of money out of the pockets of clients. Where are the customers' planes?"

Mario Gabelli: "We are no longer at the dawn of the fourth major takeover boom since the 1950s. But we are certainly not at the sunset. We are probably just starting the mid-afternoon. When does the stress-testing come? In 2009 or '10. Deals with covenant-lite provisions can cover two years of economic challenges. At the end someone will overpay, there will be an episode of insider trading, or something. A lot of garbage will surface."

Bill Gross: "Corporate bonds for the most part, and high-yields, and certainly subprime debt are moving into a vulnerable period, unless the economy really snaps back to its good old healthy self. We don't see that happening."

Art Samberg: "The S&P 500 is up about 7%, or 15% on an annualized basis. That's too much, so I'm sure we'll get hit over the head soon. Adjustable-rate mortgages really started resetting in May and the resets peak around January, so housing-market troubles could impact the stock market in the second half. There will be another consumer scare between here and the end of the year. We'll get some kind of a correction. But the big drivers are corporate profitability and all the money sloshing around. Not much has changed since January."

Felix Zulauf: "We had a mild and short correction in late spring, and likely will get a sharper one in the third quarter. But this is not going to be the end of the bull market. It will shake out a lot of investors, and then the market will go up again. Eventually, the difference between a 7% earnings yield and a 5% bond yield will be arbitraged away through all sorts of merger and acquisition activity, corporate buybacks, private-equity deals and such."

And from Greenspan from the previous week on Bloomberg, again without editorial comment:

"Referring to historically low premiums on emerging-market debt, Greenspan said ``it ain't going to continue that way. And indeed, all the spreads you are looking at, including your spreads relative to the 10-year, are going to start to open up and the 10-year is going to be moving as well.'' ``So I'd suggest someone out there is not going to be as happy as we are today,'' Greenspan said" Bloomberg, June 12

6/7 Equity Markets Flying Without Instruments Into a Non-Linear Storm?

2007-06-07T15:18:00.000-07:00

June 7 (Econotech FHPN)--At the risk of writing too frequently, I think the current investment environment merits more rapid updates than I usually do.

Two Potentially Critical Blind Spots For Global Equity Investors--They Call It "Private" Equity for a Reason

I would like to make two key points that I think are not as widely understood as need to be right now.

First, at certain critical inflection points, there is not a linear, one-to-one relationship between rising interest rates and rising market risk. Rather at some point, rising interest rates might more rapidly move global markets downward, I used the analogy of cracked ice (investor psychology) giving way in my June 4 article link.

I.e., if interest rates continue to rise, especially with the 10-year bond yield now over 5%, things may get rather more risky rather more quickly than overly complacent global financial markets still currently expect, again especially due to the fact that global markets are so highly dependent in the 2002-07 cycle on very leveraged m&a and lbo deals and emerging market debt, and because of the weak state of the mortgage market, especially with upcoming ARMs upward resets.

(See section on "volatility shock" in my April 13 "When Leading Fund Mgr Talks, Do People Listen," link, one of three "heads-up" articles with similar titles that started with my April 4, "When Citibank Chief Exec Talks, Do People Listen," link.)

Second, another critical point that I would like to re-emphasize is the lack of transparency for American equity investors, including professional, of both the leveraged debt markets and debt and equity emerging markets.

Again using the analogy of subsurface cracks in the ice, almost all equity investors, professionals and gurus included, simply are not well-equipped to see leveraged debt and emerging market cracks in the ice of global investor and business psychology, that’s one of the key things that makes the 2002-07 investment cycle so different.

To put it as bluntly as possible, most professional equity investors, even very incredibly successful ones, have very little actual, real-time working knowledge of what is really happening in these two critical markets, leveraged debt and emerging markets, and may be very surprised by events in them.

Despite Market Uptrend, Alpha Weakening for Key Sectors

I’ve previously noted that alpha, risk-adjusted excess return, of EEM, the MSCI emerging markets etf, has been coming down to near zero, and how this might trigger a flight of momentum money should the bullish psychology on/off switch suddenly flip. (See my May 24 "When Greenspan Talks, Do People Still Listen?" link)

Similarly, here is 4-year weekly chart of another critical sector, $XBD, U.S. broker-dealer stocks, courtesy of prophet.net (left click once to enlarge for better viewing).

Note that its alpha, bottom panel, is negative. Since the global economy now often seems to be run by and for the benefit of the Goldman Sachs’ of the world, this negative alpha wouldn't seem to bode too well, and rising interest rates usually doesn't help the record-setting deal flow that drives this sector.

If Current Uptrend Might Be in Jeopardy, Which Timeframe Are We Talking About?

Whenever Wall Street, the mainsream media, experts, etc talk about uptrends, they almost always fail to make clear which timeframe they are talking about.

Right now there are at least three, nested "current uptrends," from most to least important: the long-term, from the Oct 2002/Mar 2003 lows; the intermediate-term, from the Jun-Jul 2006 lows; and the short-term, from the Feb 27 2007 lows.

The practical investment/trading problem is that no one knows, of course, if the short-term uptrend ends, whether it will stop there, and that the intermediate and longer-term ones will not in turn subsequently end.

For the past month or so, key markets have been at the top or even above their regression channels in several different timeframes on my charts, e.g., as I've previously shown with XLB, the materials sector etf, a key beneficiary of the huge growth in emerging markets. (See my May 31 "Brief Update," link)

That overextended, increasingly risky situation needs to be taken into account right now, though I consistently have given the benefit of the doubt to the current uptrends staying intact until clearly broken, and even though global liquidity and a record-setting global m&a deal binge have been propping up global markets.

6/4 A Tale of Two Cognitions, Bull and Bear

2007-06-04T10:27:00.000-07:00

June 4 (Econotech FHPN)--I added the last phrase to the quote below from my May 31 article link to help make the point in today's first section.

“Financial Leverage May Boost Global Economic Growth,” Bloomberg headline, June 4, 2007

“The global economy, led by China, India and other emerging markets, is in arguably its strongest five-year boom in history, in terms of sheer scale, scope and speed, and unfortunately also of financial leveraged speculation.” Econotech, May 31, 2007

“It was the best of times, it was the worst of times.” “Tale of Two Cities,” Charles Dickens, 1859

Unprecedented Both Global Growth and Speculation May Cause Cognitive Dissonance for Market Analysts

“Basically, cognitive dissonance is a state of tension that occurs whenever an individual simultaneously holds two cognitions (ideas, attitudes, beliefs, opinions) that are psychologically inconsistent. Stated differently, two cognitions are dissonant if, when considered alone, the opposite of one follows from the other. Because the occurrence of cognitive dissonance is unpleasant, people are motivated to reduce it;” “The Social Animal, 8th ed,” pg 182, Elliot Aronson, 1999 [bold emphasis in original]

In the 2002-07 global market cycle, both the global real economy and global leveraged speculation are very strong, in fact both are at record levels.

Perhaps to unconsciously minimize cognitive dissonance, permabulls (Wall Street) constantly emphasize the former, the unprecedented growth of the global economy, while permabears (common on the Internet) continually analyze the latter, the unsustainability of huge global speculation using debt.

However, both are different views or frames of the same seamless overall reality, and thus need to be simultaneously kept in mind in order to optimize investment results.

Two Monday Morning "Heads-Up" Charts, China's Shanghai Composite and U.S. 10-year Treasury Bond Prices

In the attached chart (left click once for better viewing), courtesy of stockcharts.com, since China's stock market peaked on May 29, the more well-known Shanghai Composite is now down -15.3%, the newer CSI 300 -15.7% The index closed on its 50-day moving average for the first time since the beginning of Sep 2006.

So far global markets have shrugged off this equity market correction in China, the strongest global equity market this year. Global equity markets are making new highs, as if money is flowing out of China into the U.S., Germany (the strongest developed equity market this year), Japan (the latter two showing somewhat less anemic economic growth than has been the norm until recently), and elsewhere.

Wall Street has offered up the usual rationalizations for this lack of concern, such as China's stock market is small, its correction is overdue and won't impact China’s economy, the U.S. economy is re-accelerating after a weak first quarter, corporate profit growth remains strong, etc.

These are all plausible sounding, except if/when a correction in China or elsewhere were to become more serious. Then you may hear a different set of stories. For now, it's too early to dismiss China’s ongoing correction as something not to be concerned about more globally.

Second, the rise in U.S. 10-year bond yield to approaching 5% is starting to get a little worrisome for stocks, see attached Treasury bond price chart, courtesy of stockcharts.com, left click once to expand for better viewing.

To use an out-of-season metaphor, this rise in yields, decline in Treasury bond prices, can create small subsurface cracks in the global markets’ ice (i.e. support levels of bullish psychology) that can widen and give way, with a loud bang, more suddenly than may seem obvious right now on the surface, especially given the huge amount of leveraged deals which are driving global markets, and the fragility of the real estate mortgage market, especially with ARMs resets.

Challenge to Private Equity: Innovation, Not Cost-Cutting, Drives Economic Growth, Living Standards, Asset Values

“"We're in two different industries," says Ted Schlein, a venture capitalist at the Silicon Valley firm Kleiner Perkins. "We recruit. We help companies sell product. We do business development. [Private equity] is not an industry that can talk about creating ten million jobs."” “Raising taxes on VCs,” Adam Lashinsky, Fortune magazine, May 16

I have my own long-standing criticisms of overly opportunistic venture capital as the major focus in the U.S. of a business model for innovation, but I agree with the above vc quote with respect to private equity.

Huge confusion is caused by the fact that Wall Street and the mainstream media, in their self-interest, would have you believe that immense leveraged financial speculation, especially by private equity, is helping to drive the global economy, e.g. the Bloomberg headline at the beginning of this article which makes very explicit the implicit assumption of much mainstrean financial coverage.

One "enlightened" form of this argument, sometimes favored by economists and vc/technology types, is that financial speculative excesses, bubbles, are a necessary evil, so to speak, a small price to pay in order to incentivize and drive innovation and strong economic growth.

Rather, I believe that the exact opposite is the more accurate view, that not only are huge financial speculative excesses unnecessary and harmful, but also that the immense growth in the global real economy, led by China and India, is what is allowing huge global speculation, what I consistently call return on leveraged legal looting (ROLLL), to essentially skim off record unearned speculative income. (For elaboration, see my long Dec 19 article, "World Needs Better "Face of American Capitalism" than Private Equity," link.)

The paper “wealth effect” on economic growth of rampant asset/debt bubbles, concentrated at the very top of the income/wealth pyramid, can only support cancerous or parasitic speculation to some limit, though no one seems to have any idea how long that may be.

In the economists' infamous "long run," ROLLL can not support global valuations that are currently based on an extended future period of strong, low-inflation growth. E.g., there is a very large but still only finite number of m&a restructurings that can be done that emphasize cost-cutting, outsourcing, layoffs, speed-up, health care and pension looting, etc., let alone that make business and economic, or even financial and political, sense.

A couple of decades ago, economists finally figured out what entrepreneurs have always instinctively known, i.e. that innovation and real productivity (not working more hours for less money, since 1972 real median weekly earnings are down -15% in an unprecedented shift in American history) is what drives long-term growth in the real economy, living standards and asset valuations. (Hence my web site's tag line, "Finance Innovators, Not Speculators" link.)

Unless and until private equity, which is on pace to smash last year's record, makes the case that it is driving innovation and real productivity, it is an exercise in unjustly enriching a very few, including the corporate CEO’s who have unavoidable legal conflicts of interest in making buy-out deals on their own behalf, and even worse, tremendously distorting incentives for the allocation of scarce corporate resources, especially human talent, and developing markets capital (which is funding unprecedented U.S. current account deficits driven by paper "wealth effects").

In other words, concretely, what innovative, useful products, services, processes, etc., is private equity creating better than had been done before? I've never read or heard of one, so far.

5/31 Brief Update on U.S. Materials, Retail, Large Cap/Tech ETF Trends

2007-05-31T11:12:00.000-07:00

May 31 (Econotech FHPN)--Like last week's article (May 24, "When Greenspan Talks, Do People Still Listen?" link) , this short update simply consists of three e-mails I sent out this morning.

Materials Sector Overextended on Unprecedented Global Boom and M&A

The global economy, led by China, India and other emerging markets, is in arguably its strongest five-year boom in history, in terms of sheer scale, scope and speed, and unfortunately also of financial leveraged speculation. The U.S. equity sectors that have benefited most are energy, materials and industrial. Attached is an update of the 4-year weekly chart of XLB, the materials sector etf, that I last e-mailed on May 4, left click once on it to enlarge for better viewing.

In my May 4 e-mail I wrote: "the XLB is now at the top of the regression channel (three parallel blue lines, which curve slightly on a log scale) for each timeframe shown [with just one exception of five separate charts of XLB from long-term to very short-term timeframes] ... in the past, XLB's strong uptrend has tended to pause and consoldiate when it reaches the top of these regression channels. There is some potential upside left ... of about another 1 1/2 points, about 3.8%, which I would not rule out, given the current worldwide stock momentum."

That was when XLB was 39.23, it's now at 40.93. I.e. it is even more overextended or overbought at this point, e.g. one indication being the "stochastic momentum index" in the bottom panel. Obviously no one knows when the strong uptrend in the materials sector from its July 2006 lows (red trendline) will start to consolidate, but the odds of that happening usually continue to increase the higher this etf goes above its long-term regression channel (the parallel blue lines).

Nascent Defensive Market Shift Into U.S. Large Caps and Tech?

A possible nascent, defensive market shift into U.S. large cap stocks, including tech, continues. During most of the 2002-07 bull market, international, especially emerging market, and U.S. small cap stocks both dominated U.S. large cap and U.S. tech (the darlings of the previous cycle).

However, since the beginning of 2007, the 200-day moving average (ma) of SPY (S&P 500) relative to IWM (Russell 2000) has had its first sustained, albeit small, rise, meaning the long downtrend of U.S. large to small caps may, emphasis on may, be finally starting to change in favor of large caps. A similar picture is only just beginning now with respect to QQQQ (Nasdaq 100) relative to IWM, with this 200-day ma just now turning up in May.

The 200-day ma of SPY relative to EEM (emerging markets) flattened out in late 2006-early 2007. This followed a very large decline of about -40% in the SPY to EEM relative strength the prior two years. Since late March, the 200-day ma of SPY to EEM has slightly declined again.

The value of SPY relative to EEM made a potential double bottom in April, the first bottom at the same relative level being in May 2006, just before a brief strong rally in SPY relative strength as EEM sharply corrected down in May-June 2006.

A similar thing may happen if China's small correction this week were to deepen and/or spread to other emerging markets, sending money back into the perceived short-term safety of the heavily indebted U.S. economy and weak dollar.

Also as I noted in my last week's comment link, the alpha, risk-adjusted excess return, of EEM is now around zero, it just turned slightly positive again this week (alpha takes into account factors that relative strength does not, and also is more amenable to most fundamental analysts).

After the typical strong move in U.S. tech stocks in the first year of the 2002-07 bull market, I am usually somewhat skeptical of the long-term staying power of any U.S. tech rally in this cycle, viewing them as either seasonal (fourth quarter) and/or a potential sign of impending short-term consolidation of the far more powerful moves in the true market leading sectors in this cycle, such as international (both emerging market and non-U.S. developed), energy, materials and industrial, etc.

Shop ‘Til They Drop U.S. Retail Stocks

The health of the U.S. economy usually means American consumers shopping 'til they drop (using E-Z credit provided by East Asian manufacturing and Mideast oil producing nations), no matter what else might seem to be going wrong (e.g. this week a correction in China's frothy equity markets that global markets have shrugged off so far).

Attached is a 4-year weekly chart, courtesy of Prophet.net, of RTH, the retail stock etf, that reflects this ongoing American shopping binge, left click on it once to enlarge for better viewing. RTH broke out of a long sideways consolidation (two parallel red lines) in the beginning of 2007, and is now threatening to break out above its recent resistance (short purple horizontal line).

Btw, this does not mean that U.S. retail stocks have been a preferred place to park investment capital, since they have had negative alpha, risk-adjusted excess return (relative to the S&P 500 and U.S. interest rates), for most of the time since Sep 2005 (bottom panel), let alone greatly underperforming stocks and sectors exposed to the huge emerging market uptrend.

But it does indicate that, for now at least, investors in U.S. retail stocks still seem to think the American economy will be fine into the second half of 2007, as indicated by RTH's still intact strong uptrend since July 2006 (rising brown trendline, and rising red 200-day moving average).

5/24 When Greenspan Talks, Do People Still Listen?

2007-05-24T11:12:00.000-07:00

May 24 (Econotech FHPN)--Rather than a longer article on “big picture” issues with extended supporting quotes from the mainstream media, for timeliness this shorter piece simply consists of three quick e-mails I sent out this morning on the current state of global equity markets.

“Greenspan Worried Shanghai Will Burst, Fears "Dramatic Contraction"”

As most of you know, Investor's Business Daily, IBD, is a newspaper read by many equity investors/traders. Its front-page right-hand lead large headline this morning says, "China Syndrome? Greenspan Worried Shanghai Will Burst, Fears "Dramatic Contraction"" The text goes on to say: ""China’s stock boom “is clearly unsustainable,” Greenspan told a Madrid, Spain, conference via satellite. “There is going to be a dramatic contraction at some point.”"

U.S. stocks sold off just a little after Greenspan's remarks, but, for now, complacency continues to rule the global financial markets. It's easy to slough off Greenspan's warning as just another in a recently increasing chorus from financial leaders about growing risks in global markets. E.g., in its "The Big Picture" daily market analysis on the front page just below its story on his comments, IBD says: "Greenspan may still influence the Street, but he hasn’t been a great market timer."

In my articles since the May 2006 sell-off (starting with June 2 "Did May's Sharp Global Market Sell-off Signal a Major Trend Change?" link), I consistently have stated my opinion of a global "market in confirmed rally," to use IBD's current view. For the past week or two, global markets have been consolidating their large gains off their Feb 27 sell-off.

That said, this probably is not the best time for complacency about global risks, expressed in terms of glib attitudes about market timing prowess.

Again, I reiterate that many clear warnings about global financial risks, including the China stock market and private equity/m&a debt bubble, increasingly have been given by financial leaders in recent weeks (starting around my April 4 article, "When Citibank Chief Exec Talks" link). These are usually buried in stories in the Financial Times and Bloomberg, so you may not be fully aware of them. E.g. the May 23 Financial Times had a long full page good summary article on page 11 by their two market analysts titled, "Snapping point? As markets approach all time highs, some think they are starting to look overstretched."

I simply call these serious warnings to your attention and suggest that you might give them your consideration with respect to protecting your investment capital.

In addition to the ongoing U.S. housing recession (see my April 13 article, "When Leading Fund Mgr Talks," link), two other big shoes that everyone is waiting to hear if/when they drop is a botched private equity or m&a deal, both on pace to smash last year's huge totals, and another sharp one-day China sell-off that wasn't almost immediately greeted by even more manic buying, as have the last two in Feb and April (not to rule out something similar in India and other emerging markets).

A seasoned investment pro, Doug Kass, wrote May 22 on TheStreet.com's Street Insight, that the chairman of Blackstone, a leading private equity firm, "Stephen Schwarzman is likely to top-tick the private-equity market in his sale of a $3 billion minority stake to the Chinese government and a $4.75 billion stake to individual and institutional investors."

The proverbial “ringing of the bell” at a major m&a market top (UAL aborted lbo in 1989, AOL-Time Warner merger in 2000) won't be clear until retrospectively. Trying to protect against, let alone calling, tops of such huge uptrends as emerging markets and private equity, or bubbles, depending on your bias, is obviously very difficult,

This is especially true this time around, because both China's and other emerging markets and private equity debt and derivative/structured finance deals are much more opaque, deliberately so in the case of the latter (including to regulators), to the vast majority of American equity investors, including professional, than the U.S. housing and tech bubbles, which they lived through and had intimate working knowledge of.

That may make it more difficult for them to tell whether it really is “different this time.”

Finally, I would note that the "alpha," risk-adjusted excess return (relative to the S&P 500 and U.S. interest rates), of the EEM, emerging market (MSCI) etf, is now back to zero. The alpha of this etf/index was extraordinarily and consistently positive from Sep 2004 to May 2006. That has been much less true since the sell-off of the latter date.

The price momentum of EEM also looks like it might be topping on a longer-term weekly chart. So, if there currently is no longer positive alpha in emerging markets, then why take the risk of the momentum indicators rolling over, why not protect the enormous gains many investors have in emerging markets?

That might seem to be the question that could be forming, even if unconsciously, in the minds of momentum investors who have piled into the emerging markets. If that thought, or gut feeling, crystalizes into action, then a sharp correction might ensue, as it did last May-June.

Starting with Goldman on May 10, a few leading i-banks have now expressed their opinion that a correction in China's extremely frothy equity markets is overdue.

Nasdaq 100 Short-term Momentum Waning?

Attached is a 60-day, 60-min chart, courtesy of Prophet.net, of QQQQ, the Nasdaq 100 etf (reflecting U.S. tech stocks). Left click on the chart to expand for better viewing.

This is a short-term chart, I often send out 4-year weekly charts. I chose short-term this time because this timeframe shows the rally since the one-day Feb 27 global sell-off, and chose the Nasdaq 100 because it gets so much speculative money (etfs of emerging market, international developed market, energy, material, and industrial stocks are the market leaders, and retail, homebuilder, and financial stock etfs are also critical).

QQQQ has been moving sideways to slightly upwards since around 4/30, the longest stretch of consolidation on this chart. It has just today broken through the bottom of its regression channel (blue lines). It has done so without going to the top of the channel, unlike on the two previous occasions, but rather stopped at mid-channel. Also, it has not been generating as much positive trend momentum, shown by the "true strength index," as it did in April. (For those who care about the extremely short term, QQQQ is now "oversold," shown by the "stochastic momentum index" at a low.)

These may be little warning signs that QQQQ momentum may be slowing. I repeat, “may.” If you step back and look at the long-term charts of the key sectors I mentioned above, which I'm not showing here, it's too early to "call a top" in their etfs.

But especially given how over-extended global financial markets are in every timeframe -- five years from the Oct 2002 lows, since the Jun-Jul 2006 lows, and from the Feb 27 2007 lows -- it is currently very prudent to be on watch for any and all signs of little momentum shifts right now. E.g., short term, equity markets usually rally into holiday weekends, such as next week's Memorial Day, failure to do so would also be another little red flag.

Industrial Metals Prices Decline

Attached is 3-year daily chart of the Goldman Sachs industrial metals price index, courtesy of StockCharts.com (prices of the metals, not the stocks of companies that produce them). Left click on the chart to expand for better viewing.

These industrial metals prices are highly sensitive to both real changes in actual global cyclical industrial production, and to speculative capital flows betting on such future changes. Because of their cyclical and speculative sensitivity, it is helpful for equity investors to keep an eye on this industrial metals price index.

Since the beginning of May, there has been a minor sell-off in industrial metals prices, but without a corresponding correction in global equity markets. In contrast, in early May 2006, a simultaneous sell-off began in global industrial metals and global equity markets. That sharp sell-off followed a far more manic run-up in industrial metals prices preceding it. Right now, the China equity market is in a huge run up, and other global equity indexes are making new highs.

The recent rally in industrial metals prices has short-term "support" around 500, right around the 50-day moving average (blue line at 495). If this support is broken, then that is another red flag of a potential negative shift in momentum in global markets.

Conversely, if industrial metals prices hold above key support, especially its 200-day moving average (red line), and then continue their rally of the upside "break-out" in early April 2007 from its nearly 1-year sideways consolidation, then that is further confirmation that "this time is different" and that we are in some sort of "new era" of extended global prosperity (if not peace), led by the huge booms in China, India, and other emerging markets.

Also of course bearing close watching is the dollar, which has had a little short-term bounce back to its 50-day moving average, just above critical long-term support, and gold for inflation/deflation hints.

4/13 When Leading Fund Mgr Talks, Do People Listen: “biggest housing price decline since the Great Depression”

2007-04-13T14:00:00.000-07:00

Apr 13 (Econotech FHPN)--“The one thing they [investors] shouldn’t go anywhere near is a CDO or residential mortgage-backed securities rated triple-A by Moody’s and S&P because these securities are going to get downgraded by the hundreds of billions because they are secured by sub-prime and Alt-A mortgages where there’s going to be massive defaults … most of them appear to have been sold to hedge funds and foreigners and pension funds. Interviewer: Who owns them? Heebner: No one wants to talk about it … They [hedge funds] buy a pool of mortgages that yield 8%, and they borrow against the yen and pay 3% [a yen carry trade], and they lever it ten to one, and so you have a lucrative profit. The hedge fund that you’re running, the manager gets 20% of the gain. So even if you go a year before you go broke in the hedge fund, you get rich until the thing gets shut down. So there’s a huge incentive to gamble recklessly here in the hedge fund business … They [largest investment banks] created, they invented this machine. They’re the ones that came up with the idea of securitization. They know the products are toxic. I don’t think they’re going to suffer losses. They simply passed them on to everybody else ... The only impact [on the i-banks] this will have when it shuts down is that the profits flow from it will get less … So, they know the product is toxic; they’re not going to get caught [financially]. Interviewer: And basically you think they’ve disposed of all the risk. They created it, they made their fees, and they got rid of the risk. Heebner: That’s right.” Kenneth Heebner, manager, CGM Realty Fund, Bloomberg video, Apr 12, my transcription

“They [investment banks] know the [mortgage securities] product is toxic; they're not going to get caught,” Kenneth Heebner, Co-Founder, Capital Growth Management

Heebner, a very experienced mutual fund manager, is one of the tiny handful of the absolute best out of many thousands. According to the Bloomberg video, his CGM Realty Fund had a 5-year cagr of 30%. CGM as a whole manages more than $6 billion, so this is real money, not economists’ forecasts.

I.e., when Heebner talks, serious financial people listen. He’s not a permabear. In fact, despite his strong views on the residential real estate market that I quote in the next section below, he said he currently doesn’t think this will lead to a U.S. recession.

“Heebner, manager of the top-performing real-estate fund over the past decade … co-founded Capital Growth Management in 1990 … known for making concentrated investments in a few industries. He sold homebuilders after owning them from 2001 to 2005, record years for home sales. He bet against technology and telephone stocks in 2000, correctly timing their collapse.” Bloomberg , Apr 12

On April 4 I posted an article titled “When Citibank Chief Exec Talks, Do People Listen: ‘A market correction is coming, this time for real’” link. Likewise, Heebner also has very important comments on real estate prices, which follow in the next section.

I chose to lead with the above quote because I wanted to focus first on the issue of the hyper-speculative nature of global capital markets, who wins, who loses, a major theme of my web site link. That issue is also taken up below with respect to private equity.

Heebner says that the creators of the “toxic” mortgage products, the largest investment banks, i.e. the Goldmans and Lehmans of the world, will not be the losers. They almost never are. Their motto for the rest of the world could be the proverbial, "Heads I win, tails you lose."

"would estimate that housing prices in '07 will decline at least 20% in a lot of markets from where they are today ,” Kenneth Heebner, Co-Founder, Capital Growth Management

"I think it’s not only sub-prime, I think the Alt-A mortgages are going to default on a huge scale also … As we get a large amount of these two and half trillion of mortgages going into default … You’re going to see foreclosed houses dumped onto an already weak market where homebuilders are struggling to sell their spec houses. And so the price declines that have started will continue and maybe even accelerate in some of the hotter markets. I would estimate that housing prices in '07 will decline at least 20% in a lot of markets from where they are today … What you’re going to see is the biggest housing price decline since the Great Depression … The consequence of this is going to be a big decline in housing prices … … housing prices in the inflated markets, that’s California, Arizona, Nevada, Florida, and parts of the northeast, they have to decline a lot before it’s attractive to buy rather than rent … They’re [mortgage losses] going to dwarf those [Resolution Trust – S & L crisis of the early 190s] losses … It could easily approach a trillion dollars. That dwarfs anything that has happened. Enron was a hundred billion dollar loss, this is going to be far greater than that.” Kenneth Heebner, manager, CGM Realty Fund, Bloomberg video, Apr 12, my transcription

“a new Bloomberg/Los Angeles Times poll … Most Americans remain sanguine about home prices, the poll showed, with more than half expecting homes in their neighborhood to hold their value over the next six months. Twice as many respondents said home prices will increase as those who predicted a decline. A majority said slowing home sales nationwide will hurt the economy.” Bloomberg, Apr 11

Here's the link to the full Heebner Bloomberg video, a short ad appears first, and at times it has been unavailable.

“The overarching question is why public companies can't do the same things [as private equity] to create the most value,” Michael Mauboussin, Legg Mason strategist

In addition to mortgage-backed securities, CDO’s, etc, that Heebner discusses above, private equity and m&a continue to be key issues in the global financial markets, with m&a reaching $1 trillion in the first quarter, a record on pace to top last year’s nearly $4 trillion.

Here is a recent comment on private equity from Michael Mauboussin, the highly regarded strategist for Legg Mason (e.g., see reviews of his books on Amazon at link and link):

“The overarching question is why public companies can't do the same things [as private equity] to create the most value. That hasn't been satisfactorily answered by many executives. If there are ways to create value, why aren't they doing those as public companies? Why do they need to be private? Those are concerns that should weigh on public shareholders … That's the right word: incentive. Two things in particular make these transactions attractive to an executive. First, often the ownership stake or equity stake of the executives can rise quite a bit. They're more leveraged to the success of the operation, so they stand to do better financially. Second, there may be corporate actions, asset sales, downsizing or other capital allocation decisions that managers may feel are truly in the best interests of the value creation for the company, but there's a perception that making those moves as a public company would be unpopular. That's a perception, not a reality, but perception is important. So when you go to an executive and say the prospects are for you to have more skin in the game and do very well financially if this works out, and to have more latitude to make tough decisions, that's the one-two combination that draws executives.” Legg Mason strategist Michael Mauboussin, printed interview, MarketWatch, Apr 4

Mauboussin’s points seem somewhat similar, though more polite, than those I made in my Dec 19 article, “World Needs Better ‘Face of American Capitalism’ than Private Equity, Goldman Sachs” link. In short, private equity is a leading symptom of massive under-investment in real innovation and productive capital:

“my main criticism of private equity and the rest of the global hyper-speculators, such as hedge funds and investment banks like Goldman Sachs (mainly a very large hedge and private equity fund), is the economically unproductive ways in which they “earn” their extraordinarily high returns on leveraged legal looting (ROLLL) … If all this shareholder value enhancing was supposedly done by CEOs already, then after two decades of it, what could possibly be the role of private equity in now supposedly greatly providing even more of the same? However, if public companies haven’t enhanced shareholder value by such draconian actions and now need to be wholesale taken over by private equity, then the whole system of “free capital markets” and corporate governance that the ex-Goldman Sachs U.S. officials mentioned above are trying to persuade China and the rest of the world to adopt was perpetrated for the benefit of the very few who have become unfathomably rich. Even if the day of reckoning of the current immense wave of private equity deals were continued to be postponed another year or two, this unproductive use of capital already has greatly distorted global capital market flows, corporate incentives, and thus corporate allocation of scarce and critical resources, especially all-important human talent.”

“Income inequality grew significantly in 2005, with the top 1 percent of Americans … receiving their largest share of national income since 1928, analysis of newly released tax data shows … The new data also shows that the top 300,000 Americans collectively enjoyed almost as much income as the bottom 150 million Americans.” NYT, Mar 29

I doubt this enormous concentration of income and wealth in the top 1/10th of 1 percent can be adequately explained by educational levels without significantly accounting for the effects of unprecedented unproductive global hyperspeculation.

Of course, love him or hate him, Jim Cramer can be counted on to be brutally frank and honest, more so than any other recognized name on Wall Street. Here’s his recent take on private equity:

"They [private equity firm Cerebus Capital Management] have to break the union. The key strategy behind everything they’re doing is to crush the unions. That has to happen … the Goodyear model is the model for Cerebus … Cerebus is a very smart company. The lynchpin of the strategy, I believe, is to break the union … I’m pro-union, I’m against manipulation." Jim Cramer, "Wall Street Confidential" video, Mar 29, my transcription, on Cerebus' strategy in the U.S. auto sector.

This is a very old story, several decades old, that’s almost finished, union busting came into vogue at least as early as one of Pres Reagan’s very first acts as president in breaking the air traffic controllers strike (emulating the City of London's Margaret Thatcher).

Very Brief Update on Global Financial Markets: Risk of "Volatility Shock"

In my Apr 4 article link, I noted: “each [global major index] etf has rebounded from the decline that started at the end of Feb and is now nearing or at its previous high. Should they take out those highs, especially EEM [emerging markets], perhaps in another manic run along with rising commodities like last April, this might then trigger another sharp decline, like last May-June.”

For now, that scenario seems to playing out, especially in the continued enormous speculation in China’s equity markets, now up more than 50% this year, and any commodity that feeds into China’s economy. I also noted the recent loss in relative strength in India’s equity market as a possible cause for concern, and that also continues.

I also noted there that updated data plugged, by a major investment bank, into a leading economic indicator developed by a Fed researcher, while not yet signaling recession, was well on the way to doing so. Since 1962, on six of the seven occasions when it has reached the March level, it then went on to continue moving up through the signal threshold and correctly forecast a recession (when the indicator was at this level in early 1984, the threshold was reached but not breached, hence the indicator has correctly forecast 6 of 6 recessions, with no false signals).

I would like to add two things regarding this. First, as I’ve discussed elsewhere (e.g. the section "Why I Like Charts and Leading Indicators" in my Sep 26 article, "Global Markets Hope 'Mid-Cycle' 'Soft Landing,'" link) while I greatly prefer leading economic indicators to economic model forecasts, since the latter usually miss the turns, I much prefer charts to both, trying as best I can to stay aligned with their main trends, as I’ve mentioned several times before.

Second, I have a great deal of respect for the work of perhaps the top provider of leading economic indicators, Economic Cycle Research Institute (link). While ECRI stopped posting a chart of its Weekly Leading Index (WLI) on its web site a few years ago, it still does post media comments, such as follows:

“”We’re hitting bottom on the economic growth and we should expect more positive surprises as the year progresses,” said Lakshman Achuthan, managing director at the Economic Cycle Research Institute … Achuthan says it’s normal to have “a lot of confusion” during this time. “We don’t have any recession here, I think those fears are largely being laid to rest by a lot of the data coming out,” he said. “But we’re still having of [sic] what seems to be a cyclical bottoming in the growth rate in the economy, and when you’re at a turning point like that, you’re going to get mixed data.”” CNBC, Apr 9

Just look at how confused Wall Street is as it flip-flops almost daily, indicated by futures contracts, on its what is the Fed going to do guessing game. My advice for a "big picture" is to follow leading indicators (e.g. Conference Board and OECD provide others), but most especially key longer-term market charts as closely as you can.

And critically, especially in periods like this with extremely low but slightly increasing financial market volatility, do NOT underestimate the very real possibility of financial “volatility shocks” mentioned here by the IMF, which markets and forecasters always underestimate (in part due to human psychological nature, part to huge vested interests), but which can do great damage to capital preservation:

“Against the backdrop of continued global growth, none of the individually identified risks by themselves threaten financial stability. However, with volatility across asset classes close to historic lows and spreads on a variety of credit instruments tight, investors may not have adequately factored in the possibility that a “volatility shock” may be amplified given the increased linkages across products and markets. Institutions may well be acting in accordance with their own incentives, but collectively their behavior may cause a buildup of investment positions in certain markets, possibly resulting in a disorderly correction when conditions change. For instance, the rapid growth of some innovative instruments, the rise in leverage in parts of the financial system, and the growth of carry trades suggest that market participants are expecting a continuation of the low volatility environment and that a sustained rise in volatility could perturb a wide range of markets” “Summary” section, “Global Financial Stability” semi-annual report, April 2007, IMF

What Private Equity, I-Banks and Hedge Funds Taketh Away, Can Philanthropy Give Back?

“Wealthy philanthropists have the potential to do more than the Group of Eight leading nations to lift Africa out of poverty, according to Jeff Sachs, special adviser to the United Nations secretary-general … "There are 950 billionaires whose wealth is estimated at $3.5 trillion [$3,500bn]. An annual 5 per cent 'foundation' payout would be $175bn per year - that would do it. Then we don't need the G8 but 950 people on the Forbes list," said Mr Sachs. "Maybe private philanthropists will champion solutions to individual problems rather than the G8," he said. He was speaking as the OECD reported last week that aid from rich countries to Africa remained static last year even though G8 leaders promised in 2005 to spend $50bn more each year to 2010 on aid, with half the rise going to sub-Saharan Africa. The so-called Gleneagles commitments were championed by Tony Blair, the prime minister, and Gordon Brown, the chancellor.” Lead article, FT, Apr 9

I have enormous respect for the almost super-human efforts of Sachs in this area, along with incredible philanthropy such as that of the Gates’ and Buffet. That said, my take on this in my April 4 article, “When Citibank Chief Exec Talks,” link:

“Rajan [ex IMF economic counselor] does make a key point that I have tried to make far less well several times on my web site, i.e. low interest rates are not mainly the result of a so-called “savings glut,” a la Bernanke, but rather also due to under-investment (I would argue massively so) in real productive assets, in my formulation to meet the needs of most of the world’s population, resulting in what Rajan calls a “financing glut,” what I consistently label global hyperspeculation. And, btw, the unprecedented amount of philanthropy directed at these needs by Gates, Buffett, etc, which is incredibly worthwhile and extremely admirable, is not enough, what I would argue is that what the philanthropists consider to be a "market failure" itself ultimately must be directly addressed as such and changed.”

Once Again, Whither China?

Since Goldman Sachs and other i-banks, private equity, hedge funds, etc, have long ago captured the global capital markets in the "developed" world, that battle is mainly being fought in "emerging" markets, most particularly China:

“Carlyle Group's bid to buy part of Chongqing City Commercial Bank will be rejected as China stiffens opposition to buyout firms, especially in the $5.6 trillion banking industry, three people familiar with the matter said …The regulator is also mulling plans to make it harder for private equity companies to purchase stakes in banks. It is the latest setback in China for Washington-based Carlyle, which was forced last month to scale back a planned takeover of Xugong Group Construction Machinery Co. The Chinese government is concerned that buyout firms seek short-term profits and don't improve companies they buy enough, the people said.” Bloomberg, April 4.

As I put it in my Dec 19 “World Needs Better “Face of American Capitalism” link:

“China is in the midst of a multi-year effort to try to reform its financial system. The U.S., led by ex-Goldman chief Treasury Secretary Paulson, is strongly trying to influence it in the direction of the American-Anglo “free market” model, rather than perhaps the more traditional Asian one of state dominated banking systems that produced remarkable results in the industrial rise first of Japan then later S. Korea, both under authoritarian regimes. China going from the huge problems of its own state-dominated banking system to the Wall St-City of London hyper-speculative “free capital markets” model would be somewhat like jumping from the frying pan into the fire, but that limited choice is the way the issue is always framed.”

And in my “Whither China?” section of my Oct 27 article “Global Strategic Bargain” link:

“Thus, with very limited domestic and international opposition, that basically leaves China and Russia left standing in the way of total global domination by the hyper-speculators, two states which the U.S. government can not currently strongly influence, to the obvious chagrin and anger of those pushing U.S. hegemony in the current hyper-speculative version of globalization (there is a good version), hence the trotting out of Paulson's and Rice's current “soft cop” approach to China. The U.S. is not really interested in “free trade," it no longer has much that countries like China seem to want to buy, except Boeings and soybeans, since as noted above U.S. industry has long since been hollowed out, as opposed to Japan's and the EU's, which are more slowly getting there, to their great dismay. Rather, what the U.S. mainly wants from China, and everywhere else, is unlimited capital mobility for its mega- global financial institutions, so it can ROLLL (again, return on leveraged legal looting) over them as they have the rest of the world. Both China and Russia seem aware of this, and their elites are playing a fascinating game with the global hyper speculators … One of the most important areas to focus on is control of the financial sector. Huge Western financial institutions have made significant investments on very favorable terms in China’s four main banks, but China is clearly reticent to give up too much control of its key financial institutions and its nascent capital markets, as with Citigroup's efforts to take a stake in Guangdong Development Bank … As it did with its industrial state-owned enterprises, China is using the club of foreign competition to do much of the politically unattractive dirty work, so to speak, to shake up its four large banks and the financial sector. In the long term, the Goldman’s will ultimately need China far more than China needs the Goldman’s. China is at the center of East Asian production networks that generate real savings/capital, which the U.S. currently does not. It is critical that China continue to channel its capital where it is needed, into China’s internal development, not into very low-yielding U.S. securities, it holds $1 trillion in foreign exchange reserves, that are just being printed up in massive amounts to control and confiscate real wealth. “

4/4 When Citibank Chief Exec Talks, Do People Listen: “A market correction is coming, this time for real”

2007-04-04T10:48:00.000-07:00

Apr 4 (Econotech FHPN)--“much of the good news has come as a result of extraordinary levels of liquidity pouring into opportunities around the globe. To a large extent this is due to the Federal Reserve's expansionary monetary policies early in the decade and the US administration's fiscal stimulus. The yen carry trade has also facilitated the buoyant expansion of investments and leverage evident everywhere today. The low spreads, the tremendous build-up of liquidity, the reach for yield and the lack of differentiation among borrowers have stimulated both dynamic growth and some real concerns. Pockets of excess are becoming harder to ignore … As lenders and investors inevitably become more discriminating, liquidity will recede and a number of problems will surface … I believe that over the next 12 months a market correction will occur and this time it will be a real correction … Market developments in the past few weeks should be seen as a warning … what is clear to me is that in the next year a material correction in the markets will occur … Today, hedge funds, private equity and those involved in credit derivatives play important, and as yet largely untested, roles. The primary worry of many who make or regulate the market is not inflation or growth or interest rates, but instead the coming adjustment and the possible destabilising effect these new players could have on the functioning of international markets as liquidity recedes.” “A market correction is coming, this time for real,” Mar 29, "Financial Times" op-ed, by William Rhodes, senior vice-chairman of Citigroup, and chairman, president and chief executive of Citibank [bold emphasis added]

Is the Global Bull Market Still Intact, or Should I Sell Now?

This is the chief executive of Citibank, one of the world's largest, saying "in the next year a material correction in the markets will occur." Not some blogger, permabear, the IMF, or Morgan Stanley's Stephen Roach. (Just kidding on the last one, I greatly respect Roach's intellectual integrity, honesty, and professional courage.)

Given such authority, Rhodes' article certainly got the attention of those to whom I've shown it, followed by the understandable practical question, so, should I sell now? That’s always a difficult question, especially for longer term investors.

My web site link does not focus on and does NOT intend to give investment advice. Given that constraint, this is how I can reply here.

Throughout this 2002-07 bull market cycle, two simple basic assumptions of mine have been that, first, global market uptrends, though perhaps now increasingly vulnerable, remain still intact until clearly broken (e.g. I made that point in a number of articles in 2006, starting in my June 2 article, "Did May's Sharp Global Market Sell-off Signal a Major Trend Change," link that noted at the time that the uptrend still seemed intact), and second, that usually a major change in trend occurs with a change in market leadership.

The sharp correction last May-June was triggered by concern about rising inflation, currently market concern is about slowing U.S. growth combined with stubborn inflation. In both instances, the rising prices of gold and industrial commodities have been a good inflation concern indicator, so I watch them for clues. For signs of sluggish growth, I focus on such things as the homebuilding, retail and other cyclical stock indexes and etfs. I will discuss a few key charts later in this article.

Shorter term, meaning the next six months or so, based upon a current update of a very accurate recession predictor model developed by a Fed researcher, which I will post here if I can figure out how to cut and paste it (for the original model, see Jonathan Wright, “The Yield Curve and Predicting Recessions,” Feb 2006, pdf link), I believe that global markets are currently underestimating the chances of a U.S. recession. E.g., recently reported weakness in durable goods orders did not bode well for those hoping for U.S. capital spending strength, in case the resilient American consumer should, finally, falter.

The big risk, of course, is that should the economy, and thus job and income growth, perform worse than consensus currently expects, then real estate markets and their fragile psychology will get a much larger shock than the subprime-arm reset forecasts of 1-2 million foreclosures anticipate, and more neighborhoods will start to feel a palpable physical "contagion" of unsold and abandoned homes.

Worse yet, should the economy ever fall into that sinkhole, then it is hard to see another asset class of the same size and importance as real estate that could be massively reflated to pull it out. Off the top of my head, only a huge revamping of the economy for more efficient, cleaner energy production and consumption might do the trick. And/or perhaps an even much larger increase in military production.

Longer term, after of course the all-important preservation of inflation-adjusted capital, an important objective for many U.S. investors is to try to become diversified internationally and stay that way, since most of the growth in the world is in the emerging markets. The difficulty at this time is that emerging markets have already had huge moves, and can be very volatile to the downside, as most recently shown last May-June and this late Feb and early March.

Since this bull market has been led by emerging markets, in line with one of my key assumptions mentioned above, I closely watch EEM, the emerging markets etf, for clues. In the first quarter it became more volatile and range-bound in a consolidation of huge previous gains in the fourth quarter of 2006. Increased volatility without increased returns is always a warning flag that catches my attention very quickly.

EEM has now recovered to its previous high following the “Shanghai” sell-off that started in late Feb link . If it doesn't break out to meaningful new highs soon, then I would guess markets might become more concerned about this key uptrend.

India and some eastern European countries have nascent over-heating inflation and/or current account issues that have typically derailed emerging markets in the past. India is a key growth story, including from a U.S. geopolitical perspective. Its stock index has been lagging recently following the recent correction, and thus bears close watching as a possible negative catalyst for the broad emerging market asset class.

While China doesn't have these same economic issues, its stock market remains very extended, making new highs after a couple of very short declines earlier this year. Investors seem to remain convinced that China’s government won’t take away the proverbial “punch bowl” before the party (pun intended) congress this fall and next year’s Olympics. Despite recent top-level official Chinese policy statements in favor of more balanced, equitable, energy efficient, environmentally sensitive growth, the risks that come with a very strong export-led investment boom continue.

Comparison of Key Global Stock Market Indexes

The following points are based on the 4-year daily chart right below, courtesy of prophet.net (left click once on it to expand), comparing etfs based on five key market indices, three domestic, SPY (black, S&P 500), QQQQ (blue, Nasdaq 100), IWM (red, Russell 2000); and two international, EFA (green, MSCI World ex US, i.e. developed markets) and EEM (purple, MSCI emerging markets).

First, all five etfs are still in uptrends according to the most basic definition of higher highs and higher lows. I've drawn in two straight uptrend lines (in brown) just to help visualize this.

Again, until these indexes seem to flatten out, break their uptrend lines, and turn down, the most basic technical rule of thumb is to give the benefit of the doubt to the ongoing uptrends continuing, as I mentioned above, but with a very large caveat, which I will state shortly.

Second, the two international etfs have greatly outperformed the two large cap domestic ones, with only U.S. small caps being in the same league.

EEM, the emerging market etf, has increased about 260% in the past four years, outperforming both SPY and QQQQ by about 4 times. And that is just the broadest index, many national emerging markets have gone up far more, not to mention the even larger gains in individual international stocks.

Third, each etf has rebounded from the decline that started at the end of Feb and is now nearing or at its previous high.

Should they take out those highs, especially EEM, perhaps in another manic run along with rising commodities like last April, this might then trigger another sharp decline, like last May-June.

Here's the very important caveat re market uptrends. Conversely, failure to signficantly take out these recent highs might lead, at minimum, to continued volatility until the global economic/financial picture hopefully becomes clearer.

Or there is a "real," using Rhodes' term, possibility that this failure would mark the onset of a major market correction that he discusses above in the opening quote. Or even, at maximum, perhaps something currently unthinkable by most but quite worse, given the huge leverage and complacency in the global financial system.

I apologize to those wanting a more definitive answer. I don't have it, I don't believe anyone does when it comes to market timing, and even if I did, I couldn't share it here, sorry.

Basic Fundamental Issues in the Current Market Environment

What are some of the key issues currently in the fundamental economic/financial picture?

Here are five of them, leaving out geopolitical stuff, which daily swings between continued poor news and some slightly encouraging positive progress (see my Feb 28 article, link "Is U.S. Slightly Inching Toward My Oct 'Global Strategic Bargain'"? and my long article last Oct 27, "Global Strategic Bargain," link).

First, the impact of the global real estate boom/bubble. This factor has dominated the U.S. financial media, so I won't dwell on it here, with the surprises continuing to be negative in recent weeks and months.

The S&P homebuilder stock index shown below, a 3-year daily chart courtesy of stockcharts.com (left click once on it to expand), which peaked in July 2005 along with the housing market, is now well below its falling 200-day moving average (red line), testing its previous lows. Needless to say, failure to hold those lows might get the market's attention, I would guess.

Second, emerging market economic growth. Right now this is still a positive factor, once again being revised upward recently in China and developing Asia, to around 7.6% for 2007 (e.g., see Table 1.1.1. on page 8 of the new Asian Development Bank "Outlook 2007", I was not able to cut and paste it, the full 388 page report is here, sometimes a long download link) and one which financial markets have some difficulty accurately assessing because clearly this is now a much different global economy.

E.g., using the IMF's purchasing power parity weights, China accounted for 31% of world economic growth in 2005 (I don't have 2006), India 10%, and East Europe 9%, for a total of 50%, vs U.S. 15%, Eurozone 4% and Japan 4%. That is a dramatically different world than the one most American portfolio managers have spent their careers in.

In the most recent week, U.S. domestic steel production is running at a 100 million ton annual rate. China's is 475 million tons. Leaving aside economic and energy efficiency issues, there is an almost insatiable demand from China and other emerging markets for raw materials, energy, etc. Furthermore, light sweet crude oil has been getting much harder to find for more than four decades now (helping uranium stocks, which have been one of the biggest winners since 2000).

Even Europe is getting in on the act recently. According to the lead story in the Apr 3 FT headlined “European bourses eclipse US markets by value,” “the last time Europe eclipsed the US in market capitalization was likely to have been before the first world war.”

Btw, as a very broad generalization, most American fund managers, especially private equity and hedge, under 50 simply have no practical conception of an industrializing, or even an industrial, global economy, it's completely alien to their professional experience and deeply entrenched personal biases, which not surprisingly tend to view economic wealth creation through the distorted lens of massively unproductive paper asset inflation.

Third, private equity and m&a deals. While I consider these to be, both economically and morally (two sides of the same issue), incredibly wasteful high ROLLL (return on leveraged legal looting, see my previous articles, e.g. Dec 19 "World Needs Better 'Face of American Capitalism' than Private Equity," link), global financial markets view them as a huge positive factor. Global m&a deals reached $1 trillion in the first quarter, a record, and there seems to be no sign of slowing down.

Fourth, ultra-low long-term interest rates and credit spreads continue. This has been the support of everything above, global real estate, private equity and m&a deals, emerging market and all other valuation issues, etc. The failure to come to grips with this has been a major problem for bears.

Fifth, earnings growth. This very important fundamental factor often almost seems a secondary issue in the media compared with some of the others I just mentioned. In the U.S.., consensus earnings growth estimates are now projected in the mid-low single digits in the first and second quarters, after a string of 14 consecutive quarters of double-digit growth. Moreover, recently all S&P 500 earnings growth has been accounted for by the financial sector (again ROLLL, return on leveraged legal looting).

It is the global capital market's focus on ROLLL in this cycle, rather than on anemic real productive spending for global development that has been the big missed opportunity (see my recent Mar 5 article, link, "Potential Larger Implications of Volatile Financial Markets").

U.S.-Centric and Global World Views

Rhodes says in his op-ed quoted in my intro to this article, “During the last big adjustment that started in July 1997 in Thailand and spread to a number of Asian economies including South Korea, followed by Russia in 1998 - and led ultimately to the bail-out of Long Term Capital Management, the US hedge fund - a number of today's large market operators were not yet in the mix.”

This comment may strike many American investors as anomalous, since Rhodes skips over the huge 2000-2002 bear market, in which many lost a great deal of money, with the S&P 500 declining -48% and Nasdaq -78% (it is still more than 50% below the peak).

I don't know why Rhodes omitted this. Regardless, most Americans simply have no idea how devastating the so-called Asian financial crisis that Rhodes alludes to was to those countries, and the sea change in their view of western financial institutions that resulted from it, nor how close the global financial system came to a meltdown in the Sep-Oct 1998 LTCM hedge fund fiasco.

That is mainly because at the time the U.S. mass media was pre-occupied with the GOP impeachment of Pres Clinton over lying about sex during that critical period, all Clinton, all the time, for or against.

Now the roles of the two major parties have been reversed, and the issues discussed often more substantive. Now it's all Bush, all the time, for or against. Nevertheless, for the rest of the world, the key issues seemingly do not revolve predominantly around Iraq, Iran, Israel/Palestine, etc., as important as they may be, almost to the exclusion of everything else, as one might believe from the American mass media news.

For the developing nations, the issues seem to revolve more around the ones discussed in Rhodes’ article. Major financial players intensely focused on where the growth is in the global economy know that.

As a parallel to the current media pre-occupation with Iraq and Iran, as I’ve mentioned before, back in the early 1970s, the American mass media and hence public was pre-occupied with getting out of Vietnam and Watergate. Meanwhile, the “Bretton Woods” monetary system was dramatically changed with huge historic consequences that all but a microscopic handful of financial experts were aware of at the time.

By focusing so exclusively on what is happening in the Middle East, a critical region to be sure, the American mass media is subordinating the story of perhaps the greatest economic transformation, in terms of sheer scale, scope, and speed, in human history going on in China, India and elsewhere. And the American public is missing out on some tremendously uplifting Asian success stories, compared to the steady stream of depressing news coming out of the Middle East.

On "Charlie Rose" on PBS, a show I greatly enjoy, the Israel-Palestine conflict, a century-old tragedy which now directly impacts about 10-15 million people including Palestinian refugees, gets far more coverage than China and India, with a combined 2.4 billion, around 200 times as many.

If the tv show “Are You Smarter Than a Fifth Grader” were simply to ask for the names of the current leaders of China and India, which together soon will comprise almost 40% of the world’s population, out of 100 Americans, excluding Asian Americans, global business people and academics, how many would know? In comparison, how many urban middle-class in China and India, with incomes still far below the U.S average, could name the American leaders?

Again, my point is NOT to minimize issues critical to U.S. national security nor the strategic importance of the Middle East, but rather to place them in the context of the profound historic changes in the global economy. Perhaps looking back a few decades from now, that will be clearer.

A Few Closing Quotes With Ideas that May Be Linked

I will close with a few more recent quotes, with minimal comment, that I may take up in a future article.

“Carlyle Group's bid to buy part of Chongqing City Commercial Bank will be rejected as China stiffens opposition to buyout firms, especially in the $5.6 trillion banking industry, three people familiar with the matter said …The regulator is also mulling plans to make it harder for private equity companies to purchase stakes in banks. It is the latest setback in China for Washington-based Carlyle, which was forced last month to scale back a planned takeover of Xugong Group Construction Machinery Co. The Chinese government is concerned that buyout firms seek short-term profits and don't improve companies they buy enough, the people said.” Bloomberg, April 4.

"They [private equity firm Cerebus Capital Management] have to break the union. The key strategy behind everything they’re doing is to crush the unions. That has to happen … the Goodyear model is the model for Cerebus … Cerebus is a very smart company. The lynchpin of the strategy, I believe, is to break the union … I’m pro-union, I’m against manipulation." Jim Cramer, "Wall Street Confidential" video, Mar 29, my transcription, on Cerebus' strategy in the U.S. auto sector.

“Income inequality grew significantly in 2005, with the top 1 percent of Americans — those with incomes that year of more than $348,000 — receiving their largest share of national income since 1928, analysis of newly released tax data shows … While total reported income in the United States increased almost 9 percent in 2005, the most recent year for which such [tax] data is available, average incomes for those in the bottom 90 percent dipped slightly compared with the year before, dropping $172, or 0.6 percent. The gains went largely to the top 1 percent, whose incomes rose to an average of more than $1.1 million each, an increase of more than $139,000, or about 14 percent. The new data also shows that the top 300,000 Americans collectively enjoyed almost as much income as the bottom 150 million Americans. Per person, the top group received 440 times as much as the average person in the bottom half earned, nearly doubling the gap from 1980 … The disparities may be even greater for another reason. The Internal Revenue Service estimates that it is able to accurately tax 99 percent of wage income but that it captures only about 70 percent of business and investment income, most of which flows to upper-income individuals, because not everybody accurately reports such figures. ” NYT, Mar 29

"Venture capitalists in Silicon Valley have been searching for the next big thing in high-tech for years, but now many have switched to greener pursuits -- finding technology to help cut global warming." Reuters, Apr 3.

A little pet peeve of mine is Wall Street's labelling of "technology" to mean a very narrow, if important, sub-segment, information and communication tech. E.g., if you look at "Full Coverage: Technology," in the widely used Yahoo! News, that's all you see link.

This is not to pick on Yahoo! News, which I use a great deal. And I'm using Google's blogger.com to write this. Rather, it's just to point out a mindset that is endemic on Wall Street. That's why Wall Street and Silicon Valley often think the answers to global development and poverty are cell phones, laptops and entertainment downloading.

“Almost half, or 48 percent, [of Americans in a new Newsweek poll] said they reject the scientific theory of evolution, while 34 percent of college graduates said they accept the Biblical account of creation as fact.” Bloomberg, Mar 31 (Please don't read this as anti-religious, it is NOT intended that way, but rather as pro-science.)

“Sales for a top-selling classical recording in the West number merely in the thousands instead of the tens of thousands 25 years ago. More profoundly, classical music executives say that the art form is being increasingly marginalized in a sea of popular culture and new media. Fewer young American listeners find their way to classical music, largely because of the lack of the music education that was widespread in public schools two generations ago. As a result many orchestras and opera houses struggle to fill halls. China, with an estimated 30 million piano students and 10 million violin students, is on an opposite trajectory. Comprehensive tests to enter the top conservatories now attract nearly 200,000 students a year, compared with a few thousand annually in the 1980s, according to the Chinese Musicians Association.” NYT, Apr 3

3/5 Potential Larger Implications of Volatile Financial Markets, "Financing Glut" and Real "Investment Restraint"

2007-03-05T12:48:00.000-08:00

Mar 5 (Econotech FHPN)--“Overall investment restraint is the real macroeconomic conundrum”--Raghuram Rajan, former IMF Director of Research, now at University of Chicago

To keep this reasonably short, I am not going to recap the highlights of what happened in global financial markets last week, nor try to guess their short-term directions, there is plenty of that of widely varying quality all over the web, so I keep my thoughts on such subjects to my private e-mails (for a very small sample, see my Feb 27 post link).

One and Done Re-Rating of Global Real Estate Assets

Rather, I would like to focus on one simple but critical point. In this 2002-07 business and financial cycle, the U.S. and global economy probably has used up its “one-off” reprieve from the previous recession, namely through a massive “re-rating” of global residential real estate on the basis of a huge shift downward in global long-term interest rates, term premium, and credit risk spreads

Whatever the trajectory of global real estate prices going forward, it would seem likely that this unprecedented “re-rating” is one and done, that asset class can’t get significantly re-re-rated yet again, at least further upwards (although NYC real estate is still going up since it is based on the huge bonuses generated by the hyperspeculative financial, not real, economy).

This real estate asset re-rating was a one-time adjustment, essentially based on compressing decades of suppressed economic development of the majority of the global population into a very tiny 5-10 year window of unprecedented change, and projecting that high-growth, low-inflation historic shift out into the future. Even though this rapid global development trend is likely to continue, with ups and downs, that one-time historic step function is probably now by-and-large over.

The Good News Is That Time For Economic Re-Adjustment Was Bought

The good news is that this bought the U.S. and global economy five more years of prosperity, on the basis of a massive creation of paper asset “wealth,” especially in home equity (and also thus non-income “savings,” as incorrectly redefined from the traditional GDP measures, by some conservative economists), especially for the upper 20% of the population, that “trickled down” into very robust U.S. consumer spending and import demand from, and investment in, the rest of the global economy.

(Briefly, here is aggregate statistical data on household “wealth creation” from the last release—the next quarter will come out March 8—of the Fed’s “Flow of Funds Accounts,” Z.1. From Table B.100 Balance Sheet of Households and Nonprofit Organizations, pg 102. All percent changes are from the end of 2001 to end of third quarter 2006.

Household real estate assets (line 4), home mortgages (line 32), and owners’ equity (line 49) grew 11.0%, 13.1%, and 9.3% CAGR over this time frame. All other assets (lines 1 minus 4), liabilities (lines 30 minus 32), and net worth (lines 41-49) grew 5.6%, 5.5%, and 5.6% CAGR.

I.e., real estate assets, liabilities and net worth grew roughly twice as fast as that of everything else the past five years.)

The Bad News Is That Time Has Probably Now Been Squandered

The bad news is that those five years of breathing room now have been squandered, and it’s probably too late to change that.

By squandered breathing room I am not referring to the failure during the recovery and expansion to address key looming fiscal issues related to the impending “baby boomer” retirement demographic shifts that are frequently focused on by establishment economists, though that is very important.

Rather, I mean the failure to shift global real productive investment away from the inward satisfying of the U.S. domestic consumption boom, outward toward beginning to address the huge development needs of the vast majority of the world’s population.

Unfortunately, the critical opportunity to massively shift global capital investment into more productive uses has been wasted in a veritable orgy of many trillions of dollars of unproductive private equity and other M&A deals that have done virtually nothing except line the pockets of those engaged in their return on leveraged legal looting (ROLLL, see my Dec 19 "World Needs Better "Face of American Capitalism," link).

The U.S. economy continues to be structurally changed to satisfy this booming home-equity “wealth creation” internal domestic demand, not to satisfy the export market for the development of the rest of the world, hence the huge U.S. current account deficits. A good example of this has been the huge shift in focus of Silicon Valley from corporate productivity tools to ad-based media business models, following the huge success of Google.

Businesses and people in literally every other country in the world wake up every working day trying to figure out what to sell the rest of the world in order to earn their keep. It seems very difficult for many Americans to think this way anymore, since "E-Z credit" financing of the U.S. external deficits has been so easy and painless.

What Will End the 35-Year Decline in U.S. Real Wages?

With a long-term trend of stagnating real wages, should the worse come to pass and last week turns out to be the harbinger of a decline into a global slowdown or recession, the U.S. in particular will need to live off its home equity, so to speak, built up over the past five years, provided it doesn’t substantially fall. As a result, muddling through may be the best that one can hope for if the U.S. and global economy were to enter a recession.

The massive expansion of actually productive real investment may have been the only thing that could have eventually slowly begun to reverse the -15% decline in U.S. weekly real earnings since 1972.

(For data, see 2007 “Economic Report of the President,” Table B-47, Hours and earnings in private nonagricultural industries on pg 286. In the column “Average weekly earnings, total private,” in 1982 dollars, 1972 was 331.59. Dec 2006, the last date provided, was 282.75, a -14.7% decline. The average in 2002 was 278.83 and in 2006 it was 278.66, i.e. no growth. The only even very modest growth since 1972 occurred from 1996 to 2000, when the data rose 6.2%, a 1.5% CAGR.)

Despite the very minor recent late cycle rise in real earnings, I’m not sure why that long-term trend decline will be reversed. To compensate for stagnant wages, household income was increased through women increasingly entering the labor force, but that gain has long since run its course. So, without some sort of renewed asset inflation paper wealth creation, it is hard to see what will sustain aggregate demand if a sharper slowdown were to occur.

"The mismatch between unabated global desired savings and lower realized investment ... has led to a financing glut"--Raghuram Rajan, former IMF Economic Counselor

To buttress my point about the massive mis-allocation of investment from productive to speculative purposes, let me please try to invoke the authority of no less than the former Economic Counselor of the IMF, Raghuram Rajan, who has just returned to his former home at that bastion of “free market” capitalism, the University of Chicago (its business school, not economics department). Of course he doesn’t exactly say what I just did about ROLLL, no self-respecting eminent economist would put it this way.

But Rajan does make a key point that I have tried to make far less well several times on my web site, i.e. low interest rates are not mainly the result of a so-called “savings glut,” a la Bernanke, but rather also due to under-investment (I would argue massively so) in real productive assets, in my formulation to meet the needs of most of the world’s population, resulting in what Rajan calls a “financing glut,” what I consistently label global hyperspeculation.

(And, btw, the unprecedented amount of philanthropy directed at these needs by Gates, Buffett, etc, which is incredibly worthwhile and extremely admirable, is not enough, what I would argue is that what the philanthropists consider to be a "market failure" itself ultimately must be directly addressed as such and changed).

The following is from the Dec 1, 2006 remarks by Rajan, at the time the Economic Counselor and Director of Research of the IMF, to the G-30 meeting in NYC titled, “Is There a Global Shortage of Fixed Assets?” The full text can be found at this link.

I am reprinting extended excerpts of Rajan's remarks below, relying upon the following usage policy from the IMF web site, “The IMF freely authorizes downloading and/or reprinting files from its website for any non-commercial use,” since my web site is completely non-commercial.

Here is the customary disclaimer made by Rajan in footnote 1: “The following reflect my views only and are not meant to represent the views of the International Monetary Fund, its management, and its board.”

Now, in Rajan’s own words:

"Is There a Global Shortage of Fixed Assets?" by Raghuram Rajan

"…The intent is to provoke discussion rather than to claim I have all the answers …

I will argue that underlying these seeming anomalies [in the pricing of financial assets] may be a global shortage of creditworthy hard real assets relative to desired savings. This has resulted in a financing glut that is particularly pronounced in debt markets. Of course, I cannot prove this is what is going on, but it does fit the facts reasonably well. Moreover the implications are quite important for policy.

Let me draw on three global ingredients to build the case for my hypothesis. The first is a widespread surge in productivity across the world. The second is a desired savings rate that continues to be high, particularly supported by corporations, but also by emerging market governments. The third, and perhaps least well understood, is global nominal investment in physical assets that has yet to return to past levels (as a share of GDP) despite the higher productivity and available savings …

Given strong productivity growth and an unabated desire to save, it is therefore surprising that actual corporate physical investment has not kept pace. After all, if productivity growth is strong as is the desire to save, investment should be both profitable and easily financed. Yet investment is only slowly returning to the levels reached in the last decade, and I would conjecture, probably below the quantities that might be warranted by the tremendous growth experienced over the last few years.

To my mind, overall investment restraint is the real macroeconomic conundrum (Bernanke (2005) offered an early discussion of the phenomenon, though based on work at the Fund, I believe the problem of the excess of desired savings over realized investment is better described as investment restraint rather than a savings glut). [bold emphasis in this paragraph added by econotech] …

To summarize, I have argued the world has experienced strong productivity growth, and desired savings that continue to remain high, but actual investment, after plunging at the turn of the century, despite rapid rates of growth recently, is yet to recover fully. Let me now turn to the consequences.

The mismatch between unabated global desired savings and lower realized investment, between the amounts available for finance and the flow of hard assets to absorb it, has led to a financing glut.

Let me now argue that the glut is likely to be particularly pronounced in debt like instruments, and this is partly responsible for low long term real interest rates the world over lower. [bold emphasis added by econotech in the above two paragraphs] …

There are a number of implications. First, given financial markets are integrated, the glut has spilt over into markets for existing real and financial assets—real estate, high-risk credit, private equity, art, commodities, etc—pushing prices higher. [unless where otherwise noted, this and the bold highlights that follow were made in the original by Rajan] …

Second, while uncertainty may hamper cross-border corporate investment, no such uncertainty hampers domestic investment in non-traded goods such as real estate …

Third, different financial systems have different abilities to take advantage of the global hunger for savings instruments. The United States financial system is particularly adept at creating instruments the market wants. For instance, the recent phenomenon of large leveraged buyouts may simply be the financial system catering to a market that is desperate for debt. [bold emphasis added to the second sentence by econotech]

Finally, given this discussion, I would suggest that the easy financing conditions the world over are not primarily because of the accommodative policy followed by the G-3 central banks in recent years, though clearly monetary policy can add or subtract at the margin by affecting liquidity conditions and carry trades.

Indeed, monetary authorities face a particular dilemma. If they raise policy rates they could reduce investment in sectors sensitive to short rates or liquidity, increasing the financing glut, pushing long term interest rates even lower, and increasing the possible mis-pricing in other asset markets. … If on the other hand, monetary authorities allow the environment to be excessively accommodative, they allow inflationary pressures to build, even while the liquidity glut adds to the financing glut. [bold emphasis added in this paragraph by econotech]

Let me conclude. Current conditions are unlikely to be permanent. Indeed, investment does seem to be picking up steadily. My hope is that as a better balance between desired savings and realized investment is achieved over time—long term interest rates will move up steadily, certain pumped up asset markets will deflate slowly, exchange rates will adjust, and global imbalances will narrow, without major blow-ups … We also know adjustments, either on the real or financial side, rarely take place as smoothly as hoped for. Appropriate caution is warranted. Thank you."

Paulson’s Latest China Trip, Japan’s “Mr. Yen” on U.S.-China Deal

“On his trip next week, Paulson will meet with Vice Premier Wu Yi. The secretary will hold meetings in Shanghai, China's financial capital, with financial sector leaders and give a speech on Chinese financial market reforms. The administration is trying to convince the Chinese to open their financial markets to greater participation by U.S. companies.” (UK Guardian, Mar 2)

Americans should be aware of Paulson’s agenda with China (I'm sure China is, e.g. see my section on "Whither China" in my Oct 27 "Global Strategic Bargain," link).

Eisuke Sakakibara is Japan’s former Vice Minister of Finance for International Affairs, where he gained visibility as “Mr. Yen” during the Asian financial crisis of 1997-98. He is a strong proponent of Japan’s system and interests, e.g. Japan floated the idea of an Asian Fund during that crisis which was immediately snuffed out by the Rubin-Summers U.S. Treasury Department. An economics Ph.D., he is now at Waseda University.

In his remarks to Tokyo’s Foreign Correspondents’ Club of Japan on Mar 2 (link to the Bloomberg audio), Sakakibara says, “We really do not know the magnitude of the carry trade” (my transciption, at 8:26 mark). Then, deep in the Q&A period, he drops one of his outspoken comments (often delivered with a hearty laugh):

“Well I think Mr. Paulsen [U.S. Treasury Secretary] and Governor Zhou [head of China’s central bank] seem to have a struck a deal that China would stick to a gradual appreciation of the renminbi. Wen Jiabao [Premier of China’s State Council, like his predecessor in that position, Zhu Rongii, CPC Politiburo Standing Committee member most responsible for economic policy] has said that, in June of I think 2006, that China would stick to the gradualism, and China would not lose control of forex market either. And I think the deal is that China would gradually appreciate the currency but at the same time China would open the financial markets, particularly for U.S. investment bankers. So I think as long as that deal is there, I would not expect the renminbi to have a very rapid appreciation in the coming year or so.” (my transcipition at 1:00:31 mark)

Needless to say, China would not be pleased with this characterization, rightfully so, especially when coming from a former high Japanese official. My point in posting it is simply that Americans should better understand what the real U.S. agenda is for China and for American jobs.

Paulson is mainly concerned about the extraordinarily lucrative jobs of his former colleagues at Goldman Sachs and other U.S. hyper-speculative giants, not primarily with American manufacturing jobs. That war was lost long ago, in the first Reagan administration.

America and China should also realize the risks of a Goldman-led U.S. economy (e.g., almost the entire increase in S&P 500 earnings is now coming from the financial sector). “Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.” (Bloomberg, Mar 2)

Glenn Hubbard, a Harvard Ph.D. economist, was chairman of the Council Economic Advisors in the Bush administration and was reportedly interested in replacing Greenspan as Fed Chairman, the post Bernanke got (a hilarious, light-hearted video spoof link of this by the Columbia b-school follies, where Hubbard is dean, was widely circulated on Wall Street last year).

Hubbard recently addressed the Stanford Institute for Economic Policy Research. He tells a little story:

“I once showed a picture to President Bush of declining work in a sector. And he said yeah, I’m sick of the manufacturing jobs we’re losing. I said Mr. President, I just showed you agriculture, 1900 to 1940, and do you want to put all those people back on the farm?” (my transcription, 32:30 mark)

Left unsaid was that earlier era was one of rapidly rising real wages and productivity. This historically anomalous era is one of rapidly rising productivity, but as I mentioned earlier, declining real wages since 1972 (I won’t get into the distinction between compensation and wages here, it doesn’t really change the unprecedented in American history negative trend in real wages).

Book recommendations: Corporate America has responded to the distorted “market signals” I think inherent in Rajan’s above analysis by meeting U.S. domestic demand from the home equity “wealth creation.”

There are several very well-meaning books, usually by professors at leading b-schools and consultants, that attempt to re-orient this corporate focus outward toward more sustainable global economic development.

All are excellent, but I think all suffer from the same limitation of not realizing that the necessary re-ordering of corporate investment, especially away from the wasteful paper-shuffling of assets by private equity and other M&A deals, depends on the need to re-prioritize the incentives coming from global capital markets, which have been captured by the global hyper-speculator hedge and private equity funds and investment banks (the same thing).

Perhaps the two most well-known books of this genre are “The Fortune at the Bottom of the Pyramid,” (2004) by C.K. Prahalad and “Capitalism at the Crossroads,” (2005) by Stuart L Hart, and also “The 86 Percent Solution,” (2005) by Vijay Mahajan and Kamini Banga; “Green to Gold,” (2006) by Daniel C. Esty and Andrew S. Winston.

A related genre looks at the lessons from increasingly world-class firms from the emerging markets themselves, see “The Emerging Markets Century,” (2007) by Antoine W. van Agtmael and “Made in China,” (2005) by Donald N. Sull.

A larger but also important genre is on the impact of China and India (now called Chindia by Wall Street), e.g. two very enjoyable reads by two former and current FT journalists, “China Shakes the World,” (2006) by James Kynge, and “In Spite of the Gods,” (2007), by Edward Luce.

While not related to these genres, yet another b-school academic, Phil Rosenzweig, who acknowledges Sull, has just published a very healthy and skeptical antidote to the most standard of all business genres, what makes a company great, “The Halo Effect” (2007). Also see “Hard Facts, Dangerous Half-Truths” (2006) by Jeffrey Pfeffer and Robert I. Sutton.

And speaking of b-school academics, about twenty-five years ago marketing profs, including Theodore Levitt and Philip Kotler, began their campaign to shift the mind of America’s business leaders outward to markets and customers.

Unfortunately, that shift has now focused so heavily on the home equity-based demands of the U.S. consumer, rather than those of the global economy. A sympathetic description of the consumer's never-ending obsession with “trading up” and “trading down” is “Treasure Hunt” (2006) by Michael J. Silverstein.

For my book recommendations on the Middle East and oil, see the last section my Feb 28 article link, to which I would add to that list “The J Curve” (2006) by Ian Bremmer (his curve is more like a swoosh). The J curve, from international economics, was also adapted by yet another management author in “Managing the Dynamics of Change,” (2006) by Jerald M. Jellison, one of the better books on corporte change management; on the same subject, also see "Built to Change," (2006) by Edward Lawler, Chris Worley, Jerry Porras.

The basic idea in all these applications is that with change, often things get worse (the bottom of the J, think Iraq) before they get better (coming up the right side of J), so if you don't want backsliding (in your company, for example), you better figure out strategy, tactics and concrete ways to deal with the inevitable resistance (again, think of Iraq).

Bremmer applies the idea to changing nations. This is also a good idea to keep in mind when dealing with the inevitable adjustments of global economic imbalances, financial markets, etc.

2/28 Is U.S. Slightly Inching Toward My Oct "Global Strategic Bargain"? First N. Korea, now Iran?

2007-02-28T07:08:00.000-08:00

Feb 28 (Econotech FHPN)--An AP story this morning says, "While Syria said Wednesday it would send an aide to a Baghdad-organized conference of Iraq's neighbors that the United States plans to attend, Iran said it was considering whether to take part."

Following the U.S. preliminary deal with N. Korea, for which the U.S. strongly praised China's leadership, does this latest news perhaps also indicate a Rice faction of the U.S. government very slowly, very slightly inching in the direction that I wrote about in Oct after the N. Korea nuclear test in "Global Strategic Bargain: Positive Reality Therapy for America’s Critical "States of Denial""? link.

Would you please be the judge of that? My long Oct article's opening section said:

"N. Korea’s nuclear test, the ongoing deep morass in Iraq, Afghanistan, very high and very volatile energy prices, among many other things, indicate two critical facts about the state of the world today which should by now be crystal clear to anyone not in a deep “state of denial” (to borrow what I consider to be the inaccurate title of Bob Woodward’s new book, explained at the end of this article).

First, the U.S. can, and should, not attempt to police and remake the whole world unilaterally. Second, leading nations need to more rationally, fairly share access to energy, to help create more just, sustainable global economic development.

With a rather belated recognition and acceptance of this glaring reality by the world’s leaders, I believe that there would be the possibility of a new global strategic bargain between, most importantly, the U.S. and China, with the EU, Japan, Russia, India, Saudi Arabia and others also playing critical roles. It would not have to be negotiated nor presented as such, I would prefer gradual but steadfast diplomacy with this bargain in mind ...

The essence of a possible global strategic bargain is that the U.S. will greatly scale back its so far unsuccessful efforts at regime change in the “Axis of Evil,” to remake the Middle East, Northeast Asia, etc, and rather share influence in critical regions with major powers, including regional ones.

In the case of the Middle East, this would modify a sixty-year U.S. policy of hegemonic domination of by far the most important source of oil. In the case of East Asia, it would simply accept the reality of China as a leading power with its own strong interests and influence, and try to make the best of it.

In return for this change in current U.S. policy, the other major powers, especially China, the EU and Russia, will fully, unreservedly commit to do all that they can to help stop nuclear weapons proliferation, starting with N. Korea, while the world transitions over the next decades to more sustainable sources of inexpensive, clean energy.

I have long believed, and my web site’s tag line, “finance innovators, not speculators” reflects this, that the most important struggle in the world today is not Bush/Cheney’s “war on terror.” It is about who will control the “commanding heights” of the global economy in the 21st century, via its monetary/financial and energy systems.

These global production and financial networks need to be closely linked as part of this new global strategic bargain, in which the U.S. will once again earn its way, rather than relying upon much of the world’s development capital. The “war on terror” and nuclear non-proliferation will naturally be part of global economic development and security, there can not be global prosperity without global peace and security."

Book Recommendations: For a few good, mainstream, recent books on the Middle East and oil, I recommend:

"Hidden Iran," by Ray Takeyh (a Council on Foreign Relations, CFR, author who presently has had a little PBS tv air time; a short, indispensable must-read if one wants to actually understand the real Iran at the present juncture, not some cynical politically motivated cartoon caricature, U.S. policy toward Iran, and vice versa; the average American would be stunned by the nuanced picture presented here, especially of the importance of Iran's cooperation with the U.S. against the Taliban in Afghanistan immediately after 9/11 and the efforts of the Iranian reformist faction then in power to start a dialogue with the U.S., and how the U.S. rebuff and "Axis of Evil" labeling helped strengthen the current hardliner faction return to power, since he/she NEVER sees or hears it in the mainstream mass media and from the two major political parties, to their huge discredit); "The Shia Revival," by Vali Nasr (a CFR affiliated author);

"Israel-Palestine," by Alan Dowty (the best short, even-handed historical treatment of many I've read on a subject which is often, if understandably, very emotional and highly politicized, including in the U.S.; though not the explicit themes of the book, with a little reflection, the average American can come to see in the material presented how both sides have seemingly justified claims, and how both sides have been historical underdogs, which Americans usually typically instinctually favor for basic human fairness and decency, Israel especially from 1948 to 1967, when the Arabs were united to reject and destroy it, and the Palestinians especially since 1967 when Israel occupied the West Bank, particularly since Israel's West Bank settler and occupation policies greatly impacted its internal domestic politics and global moral standing);

"Thicker than Oil," by Rachel Bronson (about U.S.-Saudi Arabia relations by another CFR author); "Saudi Arabia in the Balance," ed by Paul Aarts, Gerd Nonneman (only for those really serious about this subject, a longer, more academic book than the others here and slightly less up-to-date, I advise skipping the extensive footnotes on many pages; I'm sorry to say that, like other books I've read on this country, I found it a depressing but necessary read to face reality);

"A Thousand Barrels a Second," by Peter Tertzakian (one of the better of the many books I've read on oil, especially the many excellent charts, such as Figure 4.14 Total Volume of New Oil Discoveries Worldwide: By Year, 1900-2004, and Figure 4.16 Hubbert Type Peak Oil Production Analysis: Global Production History and Best Fit Bell Curve, which give in a few brief seconds a crystal clear visual summary of what the world is facing re oil that would shock the average American, who has never seen such data, again to the enormous discredit of the mainstream mass media and two major political parties, and thus has no idea of its impact on U.S policy, Cheney has known for many years what these charts show (not the subject of this book); the book's author accepts the "Hubbert Peak" analysis specifically for light, sweet crude but then tends to downplay it; he got poor editorial advice to spend too many pages in the beginning of the book on whale oil); and "The Age of Oil," by Leonardo Maugeri.

2/27 Recent Comments on China Stock Market and Global Speculation

2007-02-27T14:28:00.000-08:00

Feb 27 (Econotech FHPN)-- In its first year, my "blog" website has evolved into a format of infrequent long pieces on "big picture" themes. Because of today's events in the global financial markets, I am making an exception to this format by posting a few recent e-mails to some close friends on the markets and global situation. These are posted as written to friends, as fast as possible, there was no attempt to back up, fill out, or qualify my thoughts, as I do in my long articles, so I sincerely apologize if I have inadvertently offended anyone in my haste. (I also don't use capitalization to speed my typing). This post is an exception, I don't intend to become a frequent blogger, I'm sorry for that, but presently only hope for your valuable time for more substantive articles on critical, and I fear dire, topics when I have the chance. Thank you very much.

Sent: Thursday, February 22, 2007 2:14 AM
Subject: Shanghai A shares index up 81% since Sep 1

u.s.-centric investors/traders should be aware that this index is at the "bleeding edge" of global speculation at the present time, up 81% since sep 1, and that since the beginning of 2007, it has become much more volatile on a daily basis. the index has put in a marginal new high. i think it makes sense to monitor it very closely right now to see whether this might be the beginning of a topping pattern after having gone nearly vertical from mid-nov to mid-jan.

it closed at 3125 at the previous peak on 1/24/07. it closed at 3148 on 2/16/07, and has been closed the past days for chinese new year. this is up from an intra-day low of 2668 on 2/06, following the first sell-off since this huge leg of the uptrend began sep 1 at 1743. if it fell 36% down to 2,000, it would be where it was on 11/15/06.

china stocks have 10% daily limits, i don't know whether that could contribute to the steepness of a potential decline, as i believe has sometimes happened in u.s. futures markets when they hit daily limits on the opening during a precipitous slide.

tonight the nikkei 225 broke 18,000 for the first time in six years, as the "free money" 0.5% interest rate global speculative orgy continues.

Sent: Tuesday, February 27, 2007 12:12 AM
Subject: shanghai a shares down -9% tonight

shanghai a shares are down -9% tonight, the most in ten years. last week i sent out an e-mail noting the increased volatility and marginal new highs in china's stock market. i got no replies, perhaps it did not go out correctly, so i will repeat what i said, that this more volatile market action has made it a key time to monitor china's stock market for signs of topping for those interested, and also that since that market has been at the "bleeding edge" of global equity speculation, especially since mid-nov, its increased volatility might come to have broader implications (especially in a global financial environment extremely risk complacent at the current time). these are always long shots, but in light of the decline in shanghai a shares tonight, i would once again repeat that suggestion, not a prediction, just a heads-up for anyone interested in monitoring this.

Sent: Tuesday, February 27, 2007 2:17 AM
Subject: p.s. very scary world once again

btw, for what it's worth, if you've been following what's going on in pakistan/afghanistan with al queda/taliban lately, including cheney's trip, the world is becoming very scary very quickly once again, yet financial markets just don't seem to care.

Sent: Tuesday, February 13, 2007 1:25 PM
Subject: QQQQ

the attached chart is a 4-year weekly chart of the qqqq, nasdaq 100 etf. since i haven't seen the following ultra-simplistic observation in print, i want to make it here. i believe the nasdaq 100 usually tops out right around the beginning of the year, after its usual 4q fun-and-games, silly season, bonus-enhancing rally. this is shown by the first three short vertical red lines that i have drawn. you can also see it by looking at the peaks in the true strength index below the chart. if this pattern continues to hold, either a qqqq decline commences soon, as in the first two red-line tops, or the qqqq goes sideways until may, which is the other usual area for a tech top ("sell in may and go away"), as in the third red-line top. this belief in the good probability of a qqqq top is one of the reasons why i "took profits" in my paper model portfolio last wed.

Sent: Tuesday, February 27, 2007 9:57 AM
Subject: reply to a question on implications of china's -9% stock market decline last night

here is an expansion of my reply to someone who asked me this morning, "i'm unclear as to what might be the broader implications?...what are the long shots?" in response to the e-mail i sent out on china's -9% stock market decline last night:

btw, just curious, but did you get my brief e-mail on the timeliness of watching for possible topping action in china last week?

by "long shots," i'm simply referring to "calling a top" in a very over-extended market such as china's, which i am not in the business or ego game of attempting to do, merely monitoring things to see if it does in fact seem to break down, in line with my investment philosophy that i've tried to articulate to you the past year or two.

some possible broad implications are first, that cyclical bull markets, such as the global one since oct 2002, almost by definition don't end until the big uptrend in the stock leadership groups, and key financial/economic phenomena, of that particular cycle finally gets over-extended and starts to break down under the burden of too much unjustifiable risk taking.

china and emerging markets more generally are one of, if not the, key such groups in this particular cycle (financial stocks being another, tech obviously in the last in the late 1990s), so if they finally decisively break down, which would likely take a while, then this bull market cycle is likely over, needs to go through a correction, even bear market.

despite the sharp correction last may-june, that trend breakdown did not happen, which is why i said a number of times on my blog site since early june last year that the global bull market still seemed to me to be intact. it then went through what might have, in retrospect, culminated in a "blowoff" upside stage in china recently (and also in private equity deals, btw, the latest record deals might be another proverbial "ringing of the bell" at a major top).

another broad implication is that if china's decline yesterday is an indication of a beginning of an increase in global risk aversion, then this ultimately might have very broad, profound and unforeseeable negative implications, simply because such risk aversion has been virtually non-existent, with a recent exception of the u .s. subprime real estate mortgage market.

in such an environment, all sorts of unexpected "negative surprises" whose potential were previously simply swept under the rug can seemingly come out of nowhere and begin to accelerate a downward, reinforcing spiral of increasing risk aversion, again not forecasting that, but that's just how it could happen. i.e., when it rains, it pours.

e.g., just like most u.s.-centric investors/traders really don't viscerally appreciate the recent degree of speculation in china since it's not something they deal with, perhaps even much more importantly, they have virtually no idea of the impact of the "yen carry trade," despite repeated references in the financial press to financing global speculation using the ultra-low interest rate currency of japan.

of course, the standard counter-argument to all this has been that modern financial products have dispersed risks so broadly that there are no critical weak points whose failure could cause systemic problems. which may be why there has been so much global risk taking, the previous financial circuit breakers and fuse boxes don't get tripped very early.

another possible implication is the most obvious, if china starts to falter a bit, then that is probably a sign that the global economy will slow down somewhat in the second half of 2007.

if any or all of these implications start to gain any credibility, there is often an initial "flight to safety" reaction which tends to benefit less risky assets, often perceived to be u.s. dollar based. so it would also be interesting to watch if this is the reaction again if this plays out a little more.

of course, china's market decline just might just be one-night blip in a global speculative orgy. as all the players know, china's five-year party congress this fall and olympics next year has made investors in china extremely confident that the game won't be over anytime soon. so it's a little more interesting now.

also, i sent out a second e-mail late last night noting increased geopolitical risks, mentioning pakistan/afghanistan. i.e., things could also surprise in many hot spots, in either direction. e.g., it's quite possible that the new draft iraq oil law announced yesterday gives the oil multinationals exactly what cheney/halliburton crowd have wanted for nearly two decades now (it may have been written by them), i need to read more about it first.

i.e., global events and markets just might be entering a more surprising, fluid phase, of which the china decline last night is a harbinger of unexpected things to come. so once again, heads-up. or down, depending on your proclivity.

in closing, i want to re-emphasize that i don't try to "call tops," i don't play that game. i simply try to tune into the increase in volatility as a possible indication of an unfavorable changing risk-reward ratio. in the past, i've found that taking more risk for the same or less reward is generally not a good strategy/tactic. then again, that's just my personal preference, and those of you who know me should factor that in, of course.

Sent: Tuesday, February 27, 2007 12:35 PM
Subject: p.s. global real estate bubble

p.s. in an earlier e-mail today, i emphasized the international aspects, especially the stupendous changes in emerging markets, in part because of my strong bias that in historical perspective those will be seen as the seminal change of this era

that said, i did not mean to in any way understress the importance in this particular economic/financial cycle of global real estate speculation. it's just that for u.s.-centric investors, whom i was sending this e-mail to, that issue continues to be beaten to death, it is extremely well-known, whereas many of them often don't see as clearly the stuff coming from overseas.

(also, i have yet to see a fully satisfactory explanation of the ultra-low long-term interest rates that have underpinned the real estate bubble for so long, though i have my views, based on under-real-investment, not so-called "excess" global savings, given the huge unmet basic needs of most of the world's population).

very few u.s.-centric investors/traders, let alone the general public, see these international risks as clearly as they do the domestic ones, such as the real estate bubble, understandably so, especially given the mass media. so that is what i have tried to alert them to. many, many others are doing a great job on real estate and other issues, so for me to emphasize it would be redundant.

of course, emerging markets and global real estate are completely interlinked. ultra-simplistically, it is the enormous improvements in global productivity derived from shifting hundreds of millions of essentially peasants into the modern industrial/urban globalized economy (similar to what happened in the u.s. national economy following the civil war from the 1860s to the 1920s), that is the driving force, so to speak, that supports the enormous wasteful speculation in the global markets.

just like most of the twentieth century's growth, especially from 1945 to 1971, rested on the foundation of essentially "free" hydrocarbon energy created by nature tens of millions of years ago to be finally tapped, for the past two decades, especially since the end of the cold war, the recruitment of essentially hundreds of millions of "free" labor has been the "free energy" increasingly driving the global economy, employing up until now a lot of the technology of the advanced sectors.

hence my focus on that process, for what it's worth.

(btw, as an historical footnote, i view the accelerated development of "emerging markets," home of most of the world's population, as the continuation of the key seminal change since the end of ww ii, initially called decolonization or anti-imperialism by leftists, not the cold war per se, which i view as a u.s.-centric perspective.

in that light, i sometimes tend to view communism, despite its origins, not so much as a european authoritarian political philosophy, the so-called left version of the right's fascism, but rather, based on where it actually took political power on the eurasian mainland in russia and china, as a very distorted and unfortunate historical abreaction to the very negative effects on global development of the western capitalism of that earlier era in the first half of the 20th century.

imho, it didn't have to be so, and decades of tragedies, such as the vietnam war, the great leap forward and cultural revolution in china, etc, could have and should have been avoided, especially if the u.s. had played the european decolonization game following ww ii totally differently, rather than subsuming it under the cold war on communism prism as ww ii drew to a close.

unfortunately, again imho, the same thing is playing out yet again in yet another permuation, under the guise of the war on terrorism or radical islamic fundamentalism, whatever bush/cheney wants to label it. too bad, but it seems being susceptible to this exaggerated good guy/bad guy stuff is just human nature. it was just a lot less dangerous when the "wmd" were swords and spears instead of nuclear bombs and missles.)

12/19 World Needs Better “Face of American Capitalism” than Private Equity, Goldman Sachs, Media “Freak Show”

2006-12-19T14:10:00.000-08:00

Dec 19 (Econotech FHPN) – Thanks very much and happy holidays to my readers this past year, I greatly appreciate your time and interest; the web sites that have been extremely kind to post my articles; Google for freely hosting http://econotech.blogspot.com/ ; and the friends without whom I would have never started putting my articles on the web. I also express my appreciation for mainstream journalists whose reporting I heavily rely upon, in a non-mainstream way.

Private Equity New “Face of American Capitalism”
Private Equity Is Unfair, Wastes Capital, Distorts Corporate Resource Allocation
Da Boyz Simply Never Know When Enough is Enough
Why Are Management Buy-Outs Even Legal?
Private Equity Is a Bad Global Financial Model for Industrializing Nations
Some Extraordinarily Good News for the Holidays …
… And Some Very Bad News
Weakening Dollar, Déjà Vu All Over Again, and Again, and Again

Private Equity New “Face of American Capitalism”

I apologize for starting this article with far more quotes than usual, they make some critical, almost self-evident, points from credible sources.

“in the United States, private equity has grown enormously over the last few years. In fact, today, I think, private equity is perhaps the face of American capitalism. In the old days - 1950s, 1940s, 1930s - large corporations that would trade on the New York Stock Exchange might be seen as the face of American capitalism. Companies like US Steel or IBM or General Motors. Those are still very good companies in many cases, but I don’t think they are seen as the face of American capitalism. Today I think the face of American capitalism is the large private equity firms that are buying companies, improving them, adding value for shareholders and returning very good returns for their investors … I think China is probably the single most attractive market over the next five to 10 years for private equity … predictions. First, that there will be a $50bn buyout done within the next year. Two: that there will be a $100bn buyout done within the next two years.” (David Rubenstein, Co-Founder and Managing Director, The Carlyle Group, one of the very largest private equity firms, “View from the Top” interview, FT, Dec 7)

“there are at least two sets of rules -- one for the rich and well-connected, another for the middle class, the Wall Street proletariat … The upper class is now serviced by a vast and growing industry, loosely called Private Equity. The job of the private-equity investor is -- again, speaking loosely -- to exploit the idiocy of the ordinary investor, and the corporate executives and mutual-fund managers who purport to serve him … the relationship between the upper class and the proles more explicitly parasitical than it usually is … the smartest, best-connected money has separated itself from the rest of the stock market, and has gone into the business of trading against that market. It seeks to buy from the stock market cheap, and sell to the stock market dear, and if you need evidence that this is possible you need only look to the returns on private equity, which have been running three times the returns of the public stock market.” (Michael Lewis, Bloomberg, Dec 11, author of “Liar’s Poker,” “The New New Thing”)

“A surfeit of liquidity in the financial markets is tempting bankers to underwrite and finance deals that may come back to haunt them, a top banker at Goldman Sachs said. Eugene Leouzon, the chief underwriting officer for Europe and Asia who sits on the investment bank's global credit committee, said the current conditions were unparalleled in his experience of investment banking. Leouzon, who approves new loans and debt deals to fund mergers and acquisitions. "The things we are seeing being done, both on the investment grade side and the non-investment grade side, are I would say borderline stupid." "There is just too much capital going after too little by way of deals." But Leouzon said the outlook was for a strong level of new deals going forward, led by lending money to fund leveraged buyouts and cash mergers and acquisitions … Competition among bankers chasing big bonuses is also likely to keep the pressure on doing deals.” (Reuters, Nov 16)

“Goldman Sachs reported earnings yesterday that left jaws agape on Wall Street. Quarterly profits soared 93 percent. The bank earned nearly as much per share in 2006 as it had in the last two years combined, both of which were also record years … the bank is paying roughly $623,418 for every employee [about 26,000]. Rainmakers in investment banking can expect to see $20 million to $25 million each while traders who booked big profits will take home up to $50 million apiece. In 1997, investment banking and trading and principal investments produced roughly the same revenue. In 2006, trading and principal investments [essentially Goldman’s own hedge and private equity funds] produced almost 70 percent of the total net revenue.” (NYT, Dec 13)

“Goldman Sachs's William Dudley to head the [NY Fed] market's group. former Goldman executives control or influence the oversight of key aspects of the US financial system and hold prominent positions throughout the Bush White House. They include: Hank Paulson, the Treasury secretary and former Goldman chief executive; Reuben Jeffrey, a former Goldman managing partner who is the chief regulator of commodity futures and options trading; Joshua Bolten, White House chief of staff who served as a Goldman executive director; Robert Steel, the former Goldman vice-chairman who advises Mr Paulson on domestic finance; and Randall Fort, the ex-Goldman director of global security who advises Condoleezza Rice. Bush's working group on financial markets is composed of Mr Paulson, Mr Jeffrey, [Bernanke and Cox] - would be Mr Bush's first port of call in the event of a financial crisis. Mr Dudley would also play a crucial role in stabilising the markets in the event of a meltdown … Goldman represented the biggest single donor base to the Democratic party ahead of this year's mid-term elections. Jon Corzine, the New Jersey governor, and Robert Rubin, the former [Clinton] Treasury secretary, are Goldman alumni.” (FT, Dec 4) [also, Gerald Corrigan, former president of the New York Fed, is currently a Managing Director of Goldman]

“yesterday deals worth nearly $90bn were announced around the world … adding to the $3,500bn of takeovers agreed so far this year. This has made 2006 the busiest year on record for M&A globally, exceeding the volumes of the internet bubble of the late 1990s … While most observers are expecting favourable conditions for dealmaking to remain next year, there are concerns the market may be overheating, as it did in 1999 and 2000. Worries centre on large amounts of debt being piled on to companies by private equity groups, with critics believing a string of bankruptcies is inevitable.” (FT, Dec 19)

“Private equity funds are playing much the same role as Santa Claus in the equity market rally. Yesterday brought another four huge private equity buy-outs … Many in the market assume that there is an effective "private equity put" - named after options that allow you to sell at a fixed price. If things go badly, your company becomes a target. If it catches on to a wave of the moment, buy-out funds will pay more. Either way there is a "put" … Knowing there is a private equity put reduces the perception of risk for everyone.” (John Authers, FT, Dec 19)

“Heavy debt-raising has continued into the traditional winter slowdown, making this December among the busiest in recent memory for US capital markets. The unseasonable frenzy of deals stems from huge investor appetite for credit-related exposure. It has also raised concerns that debt levels could in some cases be dangerously high.” (FT, Dec 18)

“Private-equity firms accounted for more than a third of all deals involving U.S. targets in 2006.” (MarketWatch, Dec 18)

“That's not just a record in dollar terms but is more than twice the amount of private equity deals for all of 2005 … "There's an endless appetite for credit now, and that's kind of scary," said one high-yield investment manager. "It's all liquidity-driven.” (CNNMoney, Dec 18)

“Private equity firms accounted for 22 percent of global M&A volume in the first nine months of the year, hitting a record $570.1 billion in deals. That's up from around 5 percent a few years ago.” (Reuters, Dec 16)

“U.S. firms could raise $225 billion in private-equity funds this year, soaring over 2000's $177.8 billion … Investments in private-equity firms returned 22.5 percent during the 12 months ended June 30, compared with a 6.6 percent return from the S&P 500. Over the past 10 years, private-equity investments have returned 11.4 percent per year, compared with 6.6 percent per year by the S&P 500. Over the last 20 years, the comparison is 14.2 percent for private equity vs. 9.8 percent for the S&P. ” (Dallas Morning News, Dec 13)

“This year, the average gain for an IPO of company owned by buyout firms is just 1%, compared to a healthy 30% return for all other U.S. company IPOs … This year buyout-sponsored IPOs account for 42% of the total dollars raised in the market for new stock offerings … In the past, private-equity firms typically held onto an investment for several years trying to make the business more efficient before looking to cash out. But now private-equity firms are paying themselves hefty dividends and looking to cash out just months after taking over a company.” (thestreet.com, Nov 27)

“Billionaire investor Wilbur Ross last week said ``it's inevitable that we will see higher default rates'' after announcing a plan to help invest $685 million in bankrupt companies for a group formed by New York-based Goldman.” (Bloomberg, Nov 14)

“A group of 12 securities industry associations … said they have adequate procedures in place to guard against improper trading in the unregulated market for credit derivatives and other markets including loans that are privately negotiated between banks and investors. They will ``educate'' and ``inform'' members about how to handle information that hasn't been publicly disclosed that could influence markets.” (Bloomberg, Dec 13)

“Greenspan [said] "I expect that the dollar will continue to drift downwards until there will be a change in the U.S. balance of payments." "There has been some evidence that OPEC nations are beginning to switch their reserves out of dollars and into euro and yen." ” (Reuters, Dec 11)

“The recent weakness in the U.S. dollar is sending tremors through a popular practice in foreign-exchange trading, raising the potential for further instability in global currency markets. known as the carry trade: Investors borrow money in a country in which interest rates are near zero, such as Japan, and invest it in a country like New Zealand, where interest rates hover above 7%. The trade works best when currencies involved remain relatively stable -- sharp currency moves can wipe out gains from the difference in interest rates.” (WSJ, Dec 13)

“Bonuses for bankers who arrange structured credit rose 15 to 20 percent on average this year, beating increases of 10 to 15 percent for credit-default swap traders.” (Bloomberg, Dec 12)

“The bonuses at Goldman and elsewhere on Wall Street are expected to give the New York area’s economy a substantial boost, particularly in sales of high-end residential real estate, luxury cars and other pricey goods.” (NYT, Dec 13)

“unit labor costs in the nonfarm business sector rose at an annualized rate of 2.3% in the third quarter [and] fell at a 2.4% rate during the second quarter [both below the rate of inflation].” (WSJ, Dec 6)

“[Bernanke] said labor costs ``have been rising more quickly of late,'' and there is a ``worrisome possibility'' employers will pass on costs to consumers, causing inflation to accelerate. Wages as a share of value added in the private sector fell to 50.5 percent last quarter, the lowest since World War II.” (Bloomberg, Dec 7)

“Executive-pay consultants, about to lose their anonymity as the result of a new federal [SEC] rule, are asking the companies they advise to shield them from lawsuits by shareholders angry over lavish pay packages for corporate executives.” (Bloomberg, Nov 15)

“In 2000, the top 1 percent of the world's population -- some 37 million adults with a net worth of at least $515,000 -- accounted for about 40 percent of the world's total net worth. The bottom half of the population [over 3.2 billion people] owned merely 1.1 percent [in total] of the globe's wealth. ” (NYT, Dec 6)

“The [media] Freak Show is new. Its incentives for divisiveness are embedded deeply in political and media culture. These incentives—for publicity, for influence, for money, for votes—favor more extreme and uncompromising positions, provoking the ruthless tearing down of adversaries … The Freak Show is the enemy of ideas. But ideas are also the enemy of the Freak Show … The cumulative effect of these incentives and the actions they inspire is a political system constantly staggering toward the irrational … Its incentives breed division even when the underlying issues are of minimal relevance. It obscures legitimate debate behind clouds of accusation and spite.” (“The Way to Win, Taking the White House in 2008,” new book by Mark Halperin, political director ABC News, John F. Harris, national political editor “Washington Post”)

Private Equity Is Unfair, Wastes Capital, Distorts Corporate Resource Allocation

In addition to the inequitable nature of private equity deals highlighted by the Lewis’ quote above, my main criticism of private equity and the rest of the global hyper-speculators, such as hedge funds and investment banks like Goldman Sachs (mainly a very large hedge and private equity fund), is the economically unproductive ways in which they “earn” their extraordinarily high returns on leveraged legal looting (ROLLL) (see the section with that title along with several others in my 18-section Oct 27 article, “Global Strategic Bargain: Positive Reality Therapy for America’s Critical “States of Denial,” link)

In the case of private equity buy-outs, this is done by leveraging and cosmetically re-packaging companies to then sell them back to the public markets, adding very little real value, especially in the form of innovative new products and services.

Leveraged buy-outs were rationalized back in the 1980s as necessary to shake-up an admittedly then sclerotic and complacent corporate America.

But since that time, supposedly “efficient” and “free” capital markets have supposedly incentivized CEOs, via exorbitant stock options, to “enhance shareholder value,” via layoffs, outsourcing, pension and benefits cuts, wage suppression, working condition changes, etc. As a result, corporate profit margins are at all-time highs, while the percent of employee compensation is at an all-time low.

If all this shareholder value enhancing was supposedly done by CEOs already, then after two decades of it, what could possibly be the role of private equity in now supposedly greatly providing even more of the same?

However, if public companies haven’t enhanced shareholder value by such draconian actions and now need to be wholesale taken over by private equity, then the whole system of “free capital markets” and corporate governance that the ex-Goldman Sachs U.S. officials mentioned above are trying to persuade China and the rest of the world to adopt was perpetrated for the benefit of the very few who have become unfathomably rich.

Even if the day of reckoning of the current immense wave of private equity deals were continued to be postponed another year or two, this unproductive use of capital already has greatly distorted global capital market flows, corporate incentives, and thus corporate allocation of scarce and critical resources, especially all-important human talent.

“all the wheeling and dealing stems from lots of money sloshing around the global markets, as interest rates remain low … That suggests many deals are financial bets, not strategic business moves, perhaps reducing their chance for success.” (WSJ, Nov 22)

In reality, private equity buy-outs have become essentially what I have called return on leveraged legal looting (ROLLL). It is not unique in that, but simply one manifestation of many types of global hyper-speculation with the same purpose, to greatly enrich the very few by ROLLLing the rest of the world’s population.

In that, the global hyper-speculators, which would include their corporate CEO collaborators, have already exceeded beyond their wildest dreams. For them, it is a very happy holiday, every day of the year.

“When it comes to wealth, one in every 325 [American] households had a net worth of $10 million or more in 2004, more than four times as many as in 1989 … the winners include numerous partners in recently formed hedge funds and private equity firms … Seventy-five percent of the chief executives in a sample had a net worth in 2004 of more than $25 million mainly from stock and options. That was up from 31 percent for the same sample in 1989, adjusted for inflation.” (NYT, Nov 27)

The massive unproductive use of debt in the current private equity buy-out boom is similar to but larger than the unproductive use of equity by another form of private equity, venture capital, in the huge tech equity bubble of the late 1990s, which eventually resulted in an $8 trillion loss in equity value.

In both cases, private equity depends, as Lewis says, on the “idiocy” of the mutual and pension funds (and also hedge funds, whose returns are much lower than private equity, with a far smaller dispersion of results between best and worst, both indicating much more competition among hedge funds in the public market than exists among the small, exclusive private equity “deal clubs”).

“What is worrying institutional investors is that [private equity] funds are coming back to them too quickly for money … The value of private equity-backed buyouts this year doubled to $602.4 billion from last year, on 1,912 deals. At the same time, the value of their exits is down 23 percent to $176.8 billion. The number of exits, which include selling to other buyers or public offerings, is down 24 percent to 698 … buyout firms used to take four to five years to spend their funds. institutional investors had money going out and money coming in. Right now, the money is mainly going out. Indeed, so many big funds are spending money so fast that it’s sucking demand from investors.” (Reuters, Dec 16)

It was much easier for the public to eventually, albeit far too late, see the unproductive use of capital in the tech equity bubble, when in retrospect after the bubble collapsed all those previously highly praised “business models” were finally recognized for what they really were, essentially legalized fraud, though virtually no hyper-speculative perpetrators did time for them, unlike some corporate essentially co-conspirators. Corporate America politically paid for the sins of Wall Street with Sarbanes-Oxley, which then further drove corporate CEOs into the arms of the private equity buyout firms.

However, it is virtually impossible for all but the financial and corporate elite to see a similar unproductive use of capital at work in the deliberately less transparent current buy-out debt bubble, and in the deliberately even more opaque derivatives/structured finance markets, so non-transparent and over-extended that even the regulators, usually compliant yes-men for Wall Street and the City of London, have increasingly expressed their concern.

Da Boyz Simply Never Know When Enough is Enough

Like the current version of Britney Spears, all sorts of hyper-speculation which started out as once relatively harmless, perhaps sometime even good, ideas have been pushed way too far, as is usually the case, simply due to that age-old malady of the elite that is unfortunately hard-wired into parts of the human brain, obsession with greed, power, status (and Freud would add sex).

In the case of derivatives and structured finance, their legitimate role in risk management, often extolled by Greenspan, has been turned into a veritable orgy of paper speculation on a scale many times the global economy that is hard to grasp by anyone, including the regulators.

“The use of derivatives grew at the fastest pace in eight years during the first half of 2006, boosting earnings at securities firms. The face value of derivatives jumped 24 percent to $370 trillion, according to the BIS. It was the biggest percentage rise since the bank began keeping records in 1998.” (Bloomberg, Nov 17)

In both types of private equity, buy-outs and venture capital, the original intent was perhaps actually somewhat justified. Especially with venture capital, the tech equity bubble story was very easy to sell the public, because it was initially true.

Venture capital did play an indispensable role in financing risk-taking innovation making America and the world more productive and creating great new products and services, often tied to the Internet (though the key role of government in its initial development was usually omitted in the telling by the later commercializers).

The private equity buy-out story has a lot less sex appeal, hence the public has been kept largely unaware of it. How can you put a positive economic spin on these stories?

“Clayton Dubilier & Rice, Carlyle Group and Merrill Lynch put up $2.3 billion of the $15 billion they paid for Hertz in December [2005]. The owners have received a dividend of $1 billion and plan to get another payout of about $420 million. Coupled with the group's remaining 72 percent stake valued at $3.46 billion, the owners more than doubled their investment. shaved cash and cash equivalents almost in half. net income slumped 77 percent. Total debt increased 32 percent to $14 billion. Interest expense almost doubled to $672.6 million.” (Bloomberg, Nov 16)

“After Weetabix Ltd., the maker of Britain's best-selling breakfast cereal, fired 7 percent of its workers and canceled the employee bus service to free up cash for debt from a leveraged buyout, the company borrowed 130 million pounds ($249 million) so it could enrich owner Lion Capital.” (Bloomberg, Nov 1)

“Kohlberg Kravis Roberts and Carlyle Group, the manager of the biggest U.S. buyout fund, are among 13 private equity firms accused in a class-action lawsuit of rigging the market to take companies private. `Investors in the target company are deprived of the full economic value of their holdings and `squeezed out' at artificially low valuations,’ the suit says. The U.S. Justice Department launched an informal antitrust investigation into allegations that private-equity firms collaborated on leveraged buyouts, according to a person familiar with the matter.” (Bloomberg, Nov 15)

In the case of both the venture capital equity bubble and now the buy-out debt one, the first and most obvious deals are usually the best, and often provide huge real economic value. E.g., with venture capital, Yahoo, Amazon, eBay and Google have greatly helped change the world.

But as with all the ridiculous IPO's that were funded in addition to the healthy ones, with the "plausible denial" excuse that one couldn't tell the difference, the current buy-out mavens simply don’t know when to stop, or rather they know, but simply can’t help themselves, like all obsessive-compulsive addicts.

I maintained at the time and since that every "professional" involved probably knew, on some level, that the huge number of stupid business plans going public in 1999 were essentially legalized frauds, but that didn’t stop the vc’s and investment banks from shoveling out, to their enormous self-benefit, many hundreds of them that year to the public, nor Lewis’s “idiot” funds from buying them, much to their investors’ later loss, anger and chagrin.

The same thing is happening today. So if investment bankers at Goldman Sachs admit that these deals are “borderline stupid,” from a quote in the lead section, then why are they still being done in record number and size?

Duh?! Despite academic fairy tales of “efficient” and “free” capital markets to justify this supposedly “rational” behavior, it really doesn’t take an economics ph.d. to see that private equity and all the other global hyper-speculators are obsessively driven by their “need” for yet another mega-home, another yacht, another private jet, another luxury car, another private school, another vacation, another facelift, another plaything, another “experience,” another trophy wife, another mistress, another another.

To constantly grasp for more of everything, the global hyper-speculators just keep “pushing the envelope,” with each deal becoming more unjustifiable and ridiculous than the next.

With the paper dollar adrift from real value since 1971 and absolutely no financial “adult supervision” in the credit and derivative/structured finance markets and central banks reining in those out-of-control adolescent emotions, these waves of deal-making and speculation play out until economies, nations and their ordinary citizens eventually really do get unjustifiably hurt, one way or another.

In the process, the well-educated and perhaps even once well-meaning (especially in the case of venture capital) perpetrators have lost all sense of perspective and culpability (see the section titled "Self-Described 'Schmucks' of the Financial World" in my Oct 27 article, "Global Strategic Bargain," link).

Why Are Management Buy-Outs Even Legal?

With corporate profit margins already at all-time highs, and the share of employee compensation at all-time lows, the last thing corporate America probably needs is even more incentives, either to avoid or participate in buy-outs, to do even more of the same.

Are the private equity owners going to actually spend out of their own pockets on development of great new products and services, capital investment, employment, etc.?

Again, duh?! Of course not, they wouldn’t know how (they’re not actually as smart and capable as they claim), even if they wanted to, which they don’t.

They are simply going to leverage with even more debt, loot the companies they buy, pay themselves a huge cash dividend, then flip the sucked-out leveraged company back to the public.

As I mentioned earlier, the impact on corporate decision-making to avoid this fate is one of the biggest negatives of private equity. Since this was well expressed in the following quote, I’m repeating it from the section titled "Return on Leveraged Legal Looting (ROLLL)" from my Oct 27 article, “Global Strategic Bargain” link:

"Cheap credit is everywhere … the most avid consumers of leveraged loans have been private equity groups. Many corporate executives sniff at what they see as financial engineering, especially when private equity groups quickly sell their investment or lock in their returns by floating a portfolio company on the stock market. It is even harder for a CFO to announce that he is planning to trash his employer’s credit rating just for the sake of returning capital to investors. The current situation has created an arbitrage that is being exploited by private equity groups at the expense of public shareholders. Either defaults begin to rise and corporate credit conditions tighten again, limiting the scope for buy-outs, or companies will inevitably conclude that they should be more aggressive in their borrowing." (Peter Thal Larsen, FT, Sep 26)

The very largest private equity funds and investment banks belong to an oligopolistic "deal club" dominated by a very small handful of firms that make far higher returns than others in their hyper-speculative “industry,” including hedge funds.

Unlike corporate investment, which generates innovative new products and services and jobs, these hyper-speculative entities do very little economically and socially useful.

Unlike another form of private equity, venture capital, there is not even the pretense of buyout funds investing for progress. It is simply legal looting for the sake of a very small group.

Thus, it is not unreasonable to ask why is this looting activity even legal. Ben Stein asked that question, specifically with respect to management buy-outs, I’ll repeat the quote again from the ROLLL section from my previous article, “Global Strategic Bargain” link.

"[management buyouts] should simply not be allowed at all as a matter of law … they buy the assets on the cheap and sell them off for their own management benefit, or they manage the company differently for the benefit of themselves and their buyout partners … breaching that fiduciary duty … management is seeking to pay the least it can get away with for the assets of the public holders, while the public holders want the most they can get. irreconcilable conflict of interest … lack of full disclosure … [buyout] memos are not disclosed to the stockholders or to the market generally … insider trading. what is a management buyout other than trading on inside knowledge?" (Ben Stein, NYT, Sep 3)

This is now a global issue:

“Management buy-outs are fraught with conflicts of interest anywhere. In Japan, MBOs take these risks to even higher levels - as shareholders are learning to their cost. The actions of some Japanese management teams, and the private-equity funds bankrolling them, are notable … Minorities [shareholders] are effectively being bought cheaply. Worse, from investors' perspective, their options when faced with an inferior offer are severely constrained.” (Lex, FT, Dec 4)

One powerful group is trying to protect itself.

“Bondholders worldwide are suffering a double whammy this year because more than 80 companies controlled by LBO firms have borrowed at the expense of workers and debt investors just so they can pay themselves dividends … The payments have helped the [buyout] firms recoup 86 percent of their investments within two years.” (Bloomberg, Nov 1)

“The world's biggest bondholders are determined to make an example of Henry Kravis. Pacific Investment Management Co. and Advantus Capital Management, frustrated by the sudden losses caused by leveraged buyouts, are forcing companies to guarantee immediate payment of principal whenever the borrower is acquired by Kohlberg Kravis Roberts, Blackstone Group or any of the dozens of LBO firms that have ravaged the corporate bond market.” (Bloomberg, Nov 7)

Private Equity Is a Bad Global Financial Model for Industrializing Nations

I have a final criticism of private equity. The combination of its capital market distortions and inequity has made private equity a terrible “business model” and “brand image” of the current version of Wall Street-City of London hyper-speculative financial capitalism for those regions of the world that might learn from a better model, most especially China, India and the Middle East.

“the aims of foreign policy go far beyond the misnamed ‘war on terror’ … Equally important are maintenance of a prosperous world economy, management of the rise of new great powers, economic development, not least in the Islamic world, and management of the global commons … The victories over communism were not secured through force of arms, but through the attractions of the west’s prosperity, freedom and democracy … The right way ahead … should go via the power of US example rather than its military power and via its ability to give a lead rather than unilateral dictation. The great US policymakers of the 20th century understood that well.” (Martin Wolf, FT, Nov 28)

Wolf is the well-regarded chief economics writer of the FT. Without minimizing the importance of the use of military power when justified in legitimate self-defense, I fully agree with his emphasis on the critical role of economic development and America’s example. Btw, the division in academic international relations theory between "high" (national security) and "low" (economics) politics has always been silly since the real-world of course makes no such distinctions.

If the 20th was “America’s century” and the 21st may eventually become China’s, how China develops should be of major importance to Americans, yet they are being very badly misled on the China issue, by the “Freak Show” media and both Republicans and Democrats (such as Pelosi, Schumer, etc).

China saw Asia's devastating first-hand experience in the so-called Asian financial crisis of 1997-98 and perhaps fully understands that the current American-Anglo version of so-called “free market” capitalism is designed solely for the benefit of the global hyper-speculators, and it may only play along with them so long as doing so is perceived to be to in its self-interests.

This major, permanent shift in Asian perceptions, both elite and popular, of Wall Street-City of London hyper-speculative "free market" global capitalism was totally lost on most Americans, with the exception of a few such as Nobel economist Stiglitz, then at the World Bank, due to the “Freak Show” media pre-occupation with Clinton’s sex life in his 1998 impeachment (ex-Goldman chief Rubin was Clinton's Treasury Secretary at the time, economist Summers his key aide).

China is in the midst of a multi-year effort to try to reform its financial system. The U.S., led by ex-Goldman chief Treasury Secretary Paulson, is strongly trying to influence it in the direction of the American-Anglo “free market” model, rather than perhaps the more traditional Asian one of state dominated banking systems that produced remarkable results in the industrial rise first of Japan then later S. Korea, both under authoritarian regimes.

China going from the huge problems of its own state-dominated banking system to the Wall St-City of London hyper-speculative “free capital markets” model would be somewhat like jumping from the frying pan into the fire, but that limited choice is the way the issue is always framed. (For more on this, see the section titled "Whither China?" in my Oct 27 article, "Global Strategic Bargain," link.)

“Some bankers have expressed dismay at bureaucratic hurdles and funding requirements, which analysts have said are designed to soften the impact of foreign competition on inefficient and often largely insolvent local [China] banks. Some [global] banks have protested local incorporation will complicate global operations. But Beijing has insisted it is necessary for consistent oversight and in line with global practice.” (FT, Nov 15)

“Reform of China's banking sector has only just begun. Despite pouring more than $18 billion into minority stakes in Chinese banks over the last few years, foreigners haven't made much headway in changing their partners' outdated lending practices … it's in the [Communist] Party's interest that banks like Citi succeed.” (editorial, WSJ, Nov 22)

I would make a similar argument with respect to the Middle East. The very real problems caused by millennia-old feuds over religious identities are not going to be solved until more practical issues are also addressed, such as the lack of good jobs and education for unemployed youth, and clean water.

But rather than trying to address such issues, burgeoning massive Arab oil wealth is currently trying to build up its own version of Wall Street-City of London hedge and private equity funds and financial centers. This is simply not going to help the solve the ethnic, religious and sectarian violence in that region.

To help solve the many often seemingly intractable global issues, including global warming, the world needs to see a better “face of American capitalism,” a more progressive, technology-based industrial renaissance, seriously addressing the needs of global urban and rural development, clean sustainable energy, universal quality health care and education, etc., etc.

Right now, the distorted U.S. financial system and economy is so far away from addressing these needs, due to its free ride of massive credit creation on the basis of the paper dollar, and the prospects of that changing look so remote, that ultimately China, India (new U.S. nuclear deal notwithstanding) and the rest of Asia, with or without U.S. ally Japan, along with Russia and other countries, will simply keep moving further away from the U.S. into their own economic development bloc.

Some Extraordinarily Good News for the Holidays …

This being the holiday season and my not wanting to completely appear to be Ebenezer Scrooge, I want to very briefly counter-balance this “bah humbug” tale of Wall Street greed with some very obvious yet extraordinarily good news.

For example, despite the tech equity bubble, not because of it, the Internet already really is one of the greatest communication and social innovations, ever, in terms of sheer global scale and scope, spurring unfathomable amounts of world-class creative collaboration that is changing the world greatly for the better. Bioscience really is in the middle of one of the most potentially awe-inspiring and beneficial scientific and technological revolutions, ever.

While most Americans would agree with this, they don’t share my view that the “peaceful development” of China, India, Russia and some other major countries really is one of, and potentially the, most unprecedented, positive economic and social transformations, ever, again especially in terms of sheer scale and scope.

Failure to understand these profound changes in the global economy is one of the main reasons economic, political and social critics and doomsayers and investment bears (often concerned with avoiding the very real “this time is different” trap) have tended to get things wrong so far in the 21st century.

Those who have tended to make this mistake also often intensely dislike Greenspan, an authority figure, who far better than most more clearly understood, starting in 1996, the positive impact on controlling inflation of two successive massive global positive “supply shocks,” first of the Internet in the latter half of the 1990s and then China’s unprecedented growth in global manufacturing following its WTO accession in 2001. Nonetheless, Greenspan of course did get monetary/credit policy wrong, for which eventually a price will be paid.

… And Some Very Bad News

All of human history has shown over the long run not to bet against human creativity and progress. But all of human history has also shown that it is just as unwise to bet against the negative aspects of excessive human greed and power. Human progress is not pre-ordained, nor does it go in a straight line.

"Establishment" supporters and apologists and investment bulls and cheerleaders tend to make this mistake. They tend to conflate and confuse the extremely positive trends in the real economy, such as those mentioned above, with another extremely negative trend, the complete hijacking by private equity and hedge funds, investment banks and all the rest of the hyper-speculators of the global financial system, solely for their own selfish benefit.

The hyper-speculator practitioners and their apologists would have you believe that they represent “free capital markets” and are one of the prime causes of global peace and prosperity and the extremely positive real economy trends that I mentioned above.

Whereas the exact opposite is actually true. These so-called “free capital markets” are actually oligopolistic control of the world’s financial system by a handful of extremely powerful firms, whose domination of a virtually unlimited supply of global credit, supported by compliant supposedly “independent” central banks, enables them to earn inordinately excessive returns on leverage legal looting (ROLLL) and thus expropriate the real wealth of the real economy for a very select few.

The true innovators in the Internet felt that the financial shenanigans of Wall Street were the sideshow. Google’s founders clearly felt that way during its own IPO after the bubble collapsed.

But to Wall Street, the Internet and all other real wealth-producing innovations is the sideshow. Wall Street could care less about the actual, real-world benefits of the Internet, or of bioscience, or China's stunning development for that matter, viewing each as simply the next “new, new thing” to exploit solely to line its own pockets.

Wall Street readily moved on without skipping a beat from the Internet bubble as soon as it collapsed to the real estate bubble, leaving the investors and denizens of the previous hot arena to pick up the pieces. Btw, venture capital private equity has modestly picked up the pace to a little over $30 billion this year (dwarfed by buy-out deals). Unfortunately, one area of focus is Web 2.0 ad-based narcissistic social networking, not what the world needs more of.

The stakes are so high in real estate and in China that Wall Street and the Fed will first try to do everything they can to try to prevent a true crash in the former and to heavily penetrate the financial system in the latter. But make no mistake about where Wall Street’s ultimate loyalty will always solely lie, its own pocketbook, it has no national loyalty.

Weakening Dollar, Déjà Vu All Over Again, and Again, and Again

The first quote in the beginning of this article about private equity being the new “face of American capitalism” from the co-founder of the Carlyle Group (which, btw, Bush Sr. has been associated with) shows the same level of hubris as Bush/Cheney, and although it is far more “reality based,” such arrogance may eventually suffer a similar setback.

But for the moment, while Bush/Cheney are under pressure, private equity has been very safely flying under the radar screen of the vast majority of Americans, who barely know it exits, let alone what it is doing and the effects it is having.

One of the main points in Lewis’s article quoted in the first section is that the American middle-class seems so surprisingly complacent about being fleeced by private equity. He writes:

“One of the miracles of Wall Street is its ability to create a class system without class resentment … There is, you might think, a war waiting to happen between the Haves and the Have-Mores. And yet no one much complains … from time to time … the proles take to the streets with their pitchforks and torches. But they don't seem to be disturbed by the inequality inherent in the financial markets in good times … the investment lower class is surprisingly docile ... But it's going to be hard to keep them distracted … Trust me. The ordinary investor is now and forever cast in the role of the peasant at the king's banquet. He's so happy to have any food at all that he fails to notice that bone between his teeth isn't the meal. It's the scraps.” (Michael Lewis, Bloomberg, Dec 11)

I’ve mentioned in the past the many “déjà vu” similarities between the current global economic/political situation and the one in the early 1970s (Middle East wars, rising oil prices, and increasing terrorism being a few of them).

One of the most obvious is that back then, while the antiwar left and liberals were pre-occupied with the Vietnam War and Nixon’s impeachment, virtually no one outside a very small circle of financial insiders really understood the profound ramifications when the post World War II “Bretton Woods” monetary/financial system was changed by a stroke of a pen on August 15, 1971 during the severe, protracted dollar crisis of that era.

That change led to the current financial/economic system and its problems that the world is currently facing. It was no accident that from the very next year, 1972, the strong post WW II rise in average weekly real (inflation-adjusted) earnings of American workers stopped dead in its tracks, and have declined -17% since then, a profound break with the previous three hundred-plus years of American history, while income and wealth inequality have reached an all-time high.

A similar thing is happening today, this time with Iraq replacing Vietnam. While public debate in the “Freak Show” media and opinion polls are completely dominated by and divided over that issue, virtually nothing is being said about the profound transformations in the global financial system, changes which may eventually lead to various crises, as was experienced in the 1970s.

E.g., the potential of a dollar crisis somewhere down the road is very slowly ebbing into the news once again, driven by the continued explosive growth in non-productive debt for their benefit by the global hyper-speculators.

“Rubin, Treasury secretary under Clinton, and former Fed Chairman Volcker said foreign investors probably won't keep increasing dollar holdings, raising the risk of a slump in the currency. ``It seems almost inconceivable that this will continue indefinitely,'' Rubin, who now chairs Citigroup's executive committee, said. ``It's incredible people have gone on so long holding dollars,'' Volcker said.” (Bloomberg, Nov 15)

“Fed Dallas President Fisher clashed with United Arab Emirates Central Bank Governor Sultan al-Suwaidi, who said the euro will overtake the dollar by 2015'' (Bloomberg, Nov 17)

“comments from Wu Xiaoling, deputy governor of the People’s Bank of China, indicating her unease at the rapid build-up of $1,000bn of reserves in China. She said Asian foreign exchange reserves were at risk from the dollar’s fall.” (FT, Nov 24)

There is always the possibility, as is analyzed by many on the web sites that post my articles, that the financial system itself may either implode (deflate) or explode (inflate) under the weight of increasingly unproductive debt creation by the global hyper-speculators.

Even if that day of reckoning continues to be postponed, then at minimum the tremendous increase in global inequality, both between and within nations, will tend to continue to produce more social and political tension.

Because of America’s historical social/political “exceptionalism,” greatly aided by the benefit of incurring its unprecedented debts in its own currency, significant political, economic and social reform, e.g. to the education and health care systems, probably will not happen in the U.S. But that simply means that these rising tensions will keep getting pushed abroad.

Very unfortunately, the “Freak Show” of both old and new media continually exploits the fact that the world’s population has always been divided, currently to the immense benefit of a globalized elite, by overly zealous nationalism, religious fanaticism, racial and ethnic hatred, and other modern if anachronistic manifestations of ancient clan/tribal identities deeply hard-wired into the human brain.

This makes it much easier for U.S. workers, and Democratic party leaders, to get angry at China than at the CEO of the global corporation that moved the factory there in response to the incentives of the global hyper-speculators (whose predecessor moved it to the American south from the north many decades before that for essentially the same reasons, in that era to exploit regional divisions in the national population).

“Democrats are returning to power on Capitol Hill just as two powerful wings of the party, labor and Wall Street, are colliding over economic issues. The dispute over trade and budget policies prompted a high- level private meeting earlier this month between AFL-CIO President John Sweeney and former Treasury Secretary Robert Rubin, who is now chairman of the executive committee at New York-based Citigroup.” (Bloomberg, Nov 22)

Contrary to popular opinion, Wall Street has always been a “powerful wing” of the Democratic party. But Rubin is not FDR, his "Hamilton Project" notwithstanding; Sweeney is not a labor leader of the 1930s; Pelosi gets her wealth from her real-estate developer husband; and it’s no accident that Hillary Clinton moved to become one of the Democratic senators from Wall Street, the other being Schumer, the most important Democratic fund-raiser in the mid-term election (along with Bill Clinton's Democratic Leadership Council protege Rep. Rahm Emanuel).

For more on “Any Hope for the Dismal State of Politics in America,” see the final section with that title in my Oct 27 article, “Global Strategic Bargain” link.

Until some political party, and as I said in that section I honestly don’t care which it is, eventually comes up with the 21st century version of a “New Deal” for globalization, the “Freak Show” will dominate American politics and hence the world will remain at great risk of being drawn into yet more wars in the coming year, with the Democrats being just as, if not more, inclined to do so as Bush/Cheney, especially in parts of the Middle East.

Once again, thanks very much to all those who have read my often overly long articles this year and best of luck in 2007. econotech http://econotech.blogspot.com/

10/27 Global Strategic Bargain: Positive Reality Therapy for America’s Critical “States of Denial” (full version)

2006-10-27T16:45:00.000-07:00

October 27 – (Econotech FHPN) (Nov 1: I have revised this article to include a new section, further material on leveraged buyouts in several sections, and other additions/revisions, noted in the list of sections below.

This article consists of the following 18 sections (revised order) of approx. 17,100 words. It can be accessed for printing at link. The first eight sections of approx. 6,200 words can be separately accessed at link. For further details, especially on the critical subject of hedge and private equity funds and investment banks, there is an extensive set of news summaries for the past month from the mainstream media posted on Oct 24 link.)

* A New Global Strategic Bargain of Energy and National Security -- Revisions Added
* Time to Reconsider Worldview Based on U.S. as Hegemonic Sole Superpower
* "Sensible Center" Historic American Political Realignment Needed -- Revisions Added
* Attempt to Explain America's Massive Denial of Basic Economic Reality -- Revisions Added
* It's the Hyper-Speculative Global Financial Markets -- Revisions Added
* Return on Leveraged Legal Looting (ROLLL)-- New Material Added
* Self-Described "Schmucks" of the Financial World -- New Material Added
* Historical Context for a New Global Strategic Bargain

* World More Dangerous With Loss of U.S. Power and Domestic Political Stalemate
* What Would Happen Politically If the Housing Bubble Really Collapsed?
* Billions of People Without Clean Water, Basic Sanitation, etc.
* Equity Markets Keep Rising, Regardless of Short-term Rate Expectations
* No Domestic Opposition to Global Hyper-Speculators -- New Material Added
* Europe and Japan Offer Little Opposition to Global Hyper-Speculators
* Whither China?
* Whither Russia?
* Time to Regain America's Moral Authority, Credibility and Trust -- New Section Added
* Any Hope for the Dismal State of Politics in America? -- Revisions Added

“North Korea's declared nuclear bomb test program will increase the incentives for other nations to go nuclear, will endanger security in the region and could ultimately result in nuclear terrorism … demonstrates the total failure of the Bush administration's policy toward that country. For almost six years this policy has been a strange combination of harsh rhetoric and inaction.” (William J. Perry, Secretary of Defense from 1994 to 1997, later Clinton’s Special Adviser on North Korea, WP, Oct 11)

“the Bush administration sees diplomacy as something to be engaged in with another country as a reward for that country's good behavior. They seem not to see diplomacy as a tool to be used with antagonistic countries or parties, that might bring about an improvement in the behavior of such entities, and a resolution to the issues that trouble us. Thus we do not talk to Iran, Syria, Hizballah or North Korea. We only talk to our friends -- a huge mistake.” ("Bush's Blunder in North Korea," by Donald Gregg, was a CIA official since 1951 and a liaison to President Carter's NSC and, National Security Adviser to VP George Bush and U.S. ambassador to South Korea from 1989 to 1993, now chairman of the board of the Korea Society, WP, Oct 9)

“[North Korea’s] test appears to represent a stunning failure for the Bush administration's stated goal of blocking the spread of weapons of mass destruction, the foundation of its security policy." (WSJ, Oct 9)

“the American era in the region has ended … Much more likely is the emergence of a new Middle East that will cause great harm to itself and the world … What brought it to an end? Topping the list is the Bush administration's decision to attack Iraq and its conduct of the operation and resulting occupation … Other factors include the demise of the Middle East peace process, a failure by traditional Arab regimes to counter the appeal of radical Islamism, and globalization.” (Richard Haass, Director of Policy Planning in Powell’s State Dept, now President of the Council on Foreign Relations, FT, Oct 17)

“With the Middle East immersed in its worst crisis for years, we call for urgent international action towards a comprehensive settlement of the Arab-Israeli conflict. The outlines of what is needed are well known.” (Newspaper ad signed by numerous famous former global leaders, FT, Oct 4)

“Israeli officials and politicians across the political spectrum are convinced Iran represents an existential threat … Saudi Arabia, in what was considered a dramatic move several years ago, offered to get much of the Arab world to recognize Israel in exchange for a withdrawal from all territory Israel occupied during the 1967 war. Israel rejected the idea.” (WSJ, Oct 3)

“Senate Majority Leader Frist said Monday that the Afghan war against Taliban guerrillas can never be won militarily and urged support for efforts to bring "people who call themselves Taliban" and their allies into the government. [Frist] said he learned from briefings that Taliban fighters were too numerous and had too much popular support to be defeated on the battlefield. "It sounds to me ... that the Taliban is everywhere."” (AP, Oct 2)

A New Global Strategic Bargain of Energy and National Security

N. Korea’s nuclear test, the ongoing deep morass in Iraq, Afghanistan, very high and very volatile energy prices, among many other things, indicate two critical facts about the state of the world today which should by now be crystal clear to anyone not in a deep “state of denial” (to borrow what I consider to be the inaccurate title of Bob Woodward’s new book, explained at the end of this article).

First, the U.S. can, and should, not attempt to police and remake the whole world unilaterally. Second, leading nations need to more rationally, fairly share access to energy, to help create more just, sustainable global economic development.

With a rather belated recognition and acceptance of this glaring reality by the world’s leaders, I believe that there would be the possibility of a new global strategic bargain between, most importantly, the U.S. and China, with the EU, Japan, Russia, India, Saudi Arabia and others also playing critical roles. It would not have to be negotiated nor presented as such, I would prefer gradual but steadfast diplomacy with this bargain in mind.

Bluntly put, the U.S. can not ask, let alone try to pressure or cajole, major powers such as China, the EU and Russia, to act on America’s behalf against its own designated enemies, e.g. N. Korea and Iran, which these other powers may not necessarily wish to confront to the same extent as the U.S. does right now, without offering something very significant, beyond its market access and appreciation, to these major powers in return.

“Because of North Korea's track record as an eager exporter of weaponry, some experts are more worried about the government in Pyongyang spreading nuclear technology to other "rogue" nations than about the possibility of it launching a nuclear attack … most experts said the country would probably refrain from doing so." (LAT, Oct 21)

“Whether the NPT survives this combined assault depends on how the big powers rise to the challenge: by co-operating to press both regimes to abandon their nuclear exploits and uphold the rules, or by competing in the wider struggle for regional influence … North Korea is dangerous, but isolated. An Iran with nuclear weapons, says one senior Bush administration official, would be a “game-changer”.” (Economist, Oct 19)

“Ms. Rice's immediate challenge is to get real cooperation from North Korea's neighbors. Yet she appeared to make little progress on that front during her Asia trip, which ended Saturday.” (WSJ, Oct 21)

“As Rice left China today for Russia, her goal of uniting Northeast Asia in a strong, unambiguous punitive stance against North Korea remained elusive … Rice sought Friday to lower expectations … Beijing believes that if it is identified too closely with a U.S. hard-line stance, it loses the opportunity to broker a solution in the future, with the international prestige that entails.” (LAT, Oct 21)

The essence of a possible global strategic bargain is that the U.S. will greatly scale back its so far unsuccessful efforts at regime change in the “Axis of Evil,” to remake the Middle East, Northeast Asia, etc, and rather share influence in critical regions with major powers, including regional ones.

In the case of the Middle East, this would modify a sixty-year U.S. policy of hegemonic domination of by far the most important source of oil. In the case of East Asia, it would simply accept the reality of China as a leading power with its own strong interests and influence, and try to make the best of it.

In return for this change in current U.S. policy, the other major powers, especially China, the EU and Russia, will fully, unreservedly commit to do all that they can to help stop nuclear weapons proliferation, starting with N. Korea, while the world transitions over the next decades to more sustainable sources of inexpensive, clean energy.

I have long believed, and my web site’s tag line, “finance innovators, not speculators” reflects this, that the most important struggle in the world today is not Bush/Cheney’s “war on terror.” It is about who will control the “commanding heights” of the global economy in the 21st century, via its monetary/financial and energy systems.

These global production and financial networks need to be closely linked as part of this new global strategic bargain, in which the U.S. will once again earn its way, rather than relying upon much of the world’s development capital. The “war on terror” and nuclear non-proliferation will naturally be part of global economic development and security, there can not be global prosperity without global peace and security.

“Global leaders must find a way to unravel lop-sided trade and investment flows or risk a slump in the U.S. dollar that would create havoc for the world economy, ADB Chief Economist Ali said. An international agreement along the lines of the 1985 Plaza Accord ``on a bigger scale'' is needed to unwind the imbalances that have resulted in the U.S. current account deficit swelling to a record $805 billion.” (Bloomberg, Oct 3)

Whether or not this "Plaza II" suggestion is a way to go I'll leave to the true international economic and monetary experts, the unbiased ones that is. I believe that, as I wrote in my Sep 26 article link:

“Reforming the monetary/financial system to make the U.S. earn its way once again, as it had proudly done for two centuries, would profoundly change everything, including the low image of the U.S. in the world and the social/political mass culture of this nation. Wouldn't U.S. corporate innovation become focused on what the rest of the world really needs? And wouldn't Americans be proud in doing so? Wouldn't that be a more positive image and vision for the world?”

Frankly, by running such unprecedented current account deficits, which draw upon the world’s savings that could otherwise go towards global economic development, and by its less than 5% of the world's population consuming about 25% of the world’s oil, the U.S. has lost much moral authority in the eyes of the rest of the world (along with other reasons).

The U.S. asking the rest of the world to do its bidding is like a credit junkie telling his card companies what to do. Likewise with energy, how could the U.S. with a straight face tell China, with 20% of the world's population, and others which nations are politically correct enough for it to cut energy deals with?

Not only is the U.S. heavily dependent on East Asia, and the Arab Persian Gulf, for financing its massive twin deficits. It is also heavily dependent on the former, most especially China, for its supply chains and productions networks.

Indeed, it may not be completely far-fetched to say that East Asia and the Arab Persian Gulf are essentially helping to finance, via the twin deficits, U.S. military presence and operations in regions whose stability is of paramount importance to those major powers with their own strong interests (and influence) in those regions and in stable economic development.

This is an unprecedented situation for a country purportedly trying to dominate the world as the hegemonic sole superpower, and is clearly not a sustainable strategic position. Rather, it means that the U.S. and its creditors and producers will need to cooperate ever more closely in the future, especially on key issues involving energy security and nuclear proliferation.

The sooner U.S. leaders accept and act on that basic reality of the U.S. strategic situation, the better off the nation and world will be.

Time to Reconsider Worldview Based on U.S. as Hegemonic Sole Superpower

Most, perhaps all, in the U.S. foreign policy “establishment” would balk at this bargain, especially when it comes to sharing U.S. power in the Middle East.

One of the biggest “states of denial” that extends clear across the ideological spectrum of the U.S. elite, from Kissingerian “realists” to neocon “idealist” Jacobins, is that the U.S. is the world’s unquestioned, unchallenged superpower or hegemon (sometimes called hyper- or uber-power in Europe), its current global dominance greater than even the Roman and other (in)famous empires of the past.

Since the breakup of the Soviet Union, I have never read, heard or seen even a single solitary public dissent (what is said in private I’m obviously not privy too) from a leading economic, foreign policy and national security expert, of any ideological persuasion, from this characterization of the U.S. as unprecedented, virtually unlimited superpower, regardless of how strongly critical various members of the elite may be of important aspects of U.S. foreign/military policy at any given moment.

Yet it is precisely this hubristic delusion of America’s unprecedented, unlimited, and unchecked power on the part of Bush, Cheney, Rumsfeld and the neocon’s that has now gotten the U.S. into the huge mess described by leading bipartisan former government officials and mainstream "establishment" experts quoted at the very beginning of this article.

The harsh reality is that the U.S. of today has nowhere near the economic, industrial, technological and most especially financial power in the world that it did in 1945, when an ailing FDR met with Saudi Arabia’s first monarch, Ibn Saud, on a Navy ship in Egypt to seal the foundation "oil for security" deal of the postwar era between the two nations, nor even in 1980, as U.S. industrial descent was already picking up steam just before the disastrous precipitous decline in Reagan's first term, when the “Carter Doctrine” of unchallenged U.S. control of the Persian Gulf was explicitly declared.

The accelerating decline in key economic parameters of U.S. power, military excluded where the U.S. almost outspends the rest of the world combined, since that time has become so glaringly obvious by now that it seems to me it takes almost deliberately willful blindness on the part of the U.S. elite to continue not to see the evidence and deny it. How can one read any leading news publication without noticing what is happening to the underpinnings of U.S. power? One could find many quotes any week from the mainstream media like the following recent ones:

“During the past five years America has accounted for only 13% of global real GDP growth, using purchasing-power parity (PPP) weights. Asia has accounted for over half of the world's growth since 2001. Even in current dollar terms, Asia's 21% contribution exceeded America's 19%.” (Economist, Oct 19)

“IBM has moved its global procurement headquarters to southern China from New York to ``capitalize on emerging market opportunities.'' IBM spends 30 percent of its $40 billion annual procurement in Asia. This is the first time the company is moving the headquarters of one of its biggest divisions to China … The move ``places us closer to the core of the technology supply chain.”” (Bloomberg, Oct 12)

“Azim Premji, chairman of Wipro, the Indian outsourcing group, has warned that the US faces a more acute skills shortage in information technology than India, blaming failings in America’s education system and restrictive immigration policies. “Math is not considered as important, and students are not getting a premium when they graduate as engineers,” he said.” (FT, Oct 26)

“Global trading in futures and options contracts on lending rates, currencies and stock indexes increased to $484 trillion from $429 trillion in the first quarter, the Basel, Switzerland- based BIS said in a quarterly review.” (Bloomberg, Sep 11) To put the last quote in context, U.S. current dollar annual GDP is $13.3 trillion.

As best I can tell, it seems that the U.S. elite actually believes that Wall Street, along with its City of London ally, dominating this orgy of global derivatives trading and structured finance is THE viable basis of U.S. economic power.

"Sensible Center" Historic American Political Realignment Needed

For many years now, the current U.S. political party alignment has proven to be incredibly dysfunctional. E.g., the two critical issues of Iran and N. Korea have been barely mentioned by either party in the current election, yet both will be sure to have major consequences following it.

To head off the possibility of increasing internal and international conflicts based on genuine frustration and anger, a new historical political realignment is needed.

A critically needed political realignment can be done simply by combining the moderate, progressive, centrist majority of the two major parties into whichever party decides to come to its senses first (don’t hold your breath), rather than allowing the "sensible center" majority to continue to remain divided, frustrated and trapped in two separate parties, due to the heavy influence in both parties of their extreme wings.

Such an obvious realignment would leave the anti-evolution right of the ultra-cynical Rove and the ultra-liberal left of Hollywood in their own self-made minority camps. My choice of adjectives to characterize the extremes is an attempt to distinguish between sensible views of the right and left, and those of the extremes.

The vast majority of Americans doesn’t believe either extreme has a self-proclaimed monopoly on morality and ethics, and understandably is tired of the extremes’ attempting to impose their small minority, personal views in Rove's highly cynically orchestrated "culture wars."

This is not to deny the critical and vital importance of morality, ethics, religion, lifestyles, etc. in American lives and culture. My site emphasizes the critical link between morality and ethics and finance, economics and business.

Rather, it is simply to draw some boundaries which, until the advent of Rove's ultra-cynical "negative" "attack" politics, were usually respected between private views and deliberately contrived and manipulated public divisiveness. I think it would be a mistake to get down in the mud and fight Rove's "culture wars" on his divide-and-conquer terrain, as some seem to advise doing.

A progressive "sensible center" majority realignment would produce a durable, powerful, ethical coalition of business people and labor force focused on innovation for real, sustainable, fair wealth creation, hopefully relegating Rove’s “culture wars” to history’s trashbin, and pre-empting any ridiculous charges of "soft on terror" and "class war" also.

It seems increasingly likely that, barring a huge pre-November election surprise, Rove’s pipedream of a durable realignment may go up in smoke, not so much because of Foley or Iraq, but rather because it was based on a very negative, inherently unstable coalition of the anti-evolution right and “conservatives” who didn’t want to pay taxes but did want pork-barrel, not “free market,” handouts and subsidies, to the point of corruption.

A new progressive realignment would be historically similar to the Republican industrial ascendancy in the 1896 election and the Democratic social safety net one in 1932, less similar to the racial “wedge issue” Republican "Southern strategy" realignment in 1972, the clear precursor to the even more dismal negative politics of Rove in this era.

(Rove's lifestyle-religious-oriented wedge issues of "guns, gays, and God" were preceded by racially-oriented ones of busing, urban crime and affirmative action, both sets of issues were very deliberately used to break up the FDR "New Deal" coalition.)

These major political realignments seem to occur every 30-40 years, along with significant economic/financial crisis.

Perhaps it was no historical accident that the creation of Lincoln’s Republican party, which was based on promoting northern industrial capitalism, came with the great crisis of the Civil War; McKinley’s Republican industrial capital consolidation with the major economic/financial crisis in the 1890s; FDR’s Democratic “New Deal” with the 1930’s “Great” Depression; and Nixon’s 1972 Republican racial “Southern strategy” with the 1971-73 collapse of the Bretton Woods post WW II monetary system and the end of the era of ultra-cheap oil with the assertion of the OPEC cartel's power.

Attempt to Explain America’s Massive Denial of Basic Economic Reality

For years I have found it almost impossible to believe that elite policy-makers could seriously think that the U.S. is performing a great service for the rest of the world by being the global “shopper of last resort.”

The only explanations for this massive denial of basic economic reality by both elites and the average American that I have been able to come up with over the years are the following, I’m sure I’ve missed other crucial ones.

First, the CEOs of U.S. global corporations no longer have significant incentives, most especially financial, for national self-interest, so the U.S. skill gap, decline of industrial competitiveness, etc. simply doesn’t matter too much to them. Even the corporations of those few well-meaning leading CEO’s who consistently warn about such dangers to the U.S., such as IBM’s Palmisano and Intel’s Grove and Barrett, must constantly shift their resources and efforts to outside the U.S.

Fifty years ago American industrial CEO’s actually believed that “what is good for General Motors is good for America,” as GM’s CEO and Secretary of Defense "Engine Charlie" Wilson said in 1955, so for example, a perceived lag in science and math education, especially following Sputnik in 1957, was actively addressed.

This is no longer the case today. What is good for any major global corporation is now good for its CEO stock options and hedge funds, which inevitably has meant massive outsourcing offshore, not building up U.S. domestic capabilities.

That is a major change in mindset, and until the rules of the game are changed to alter it, there is very little hope that the growing problems of the U.S. can and will be altered, because there is not the power, money and incentive to do so in corporate America.

Second, the U.S. has become a nation of middle-class homeowners who are doubling as inadvertent (mostly) speculators, especially in real estate, whose economic self-interest in their home equity makes it virtually impossible for them to tell, or even be aware of, the difference between real economic wealth creation and the paper version. (I've written about this several times, starting with my Feb 14 article, "Mommy, Where Do McMansions Come From?" link,
also see the section below titled "What Would Happen Politically If the Housing Bubble Really Collapsed?")

As I've previously mentioned a number of times, the same applies to their political leaders and pundits, especially in the liberal “blue states,” where real estate speculation has been most egregious.

Their financial self-interest makes it all but impossible for them to see how U.S. economic policies are negatively affecting the rest of the world they usually sincerely would like to help, because it seems almost impossible to honestly understand the huge negative impact of the rest of the world funding the U.S. massive twin deficits, when one is sitting on huge real estate capital gains resulting from those twin deficits and the policies that helped create them.

Again, this is particularly difficult for liberal leaders, pundits, advisors, even economists, to come to grips with (not to single them out, there's plenty of blame to go around), but until they do, the prospects of truly meaningful change is very limited, if not impossible.

Btw, one big negative side effect of the real estate bubble is the even greater huge disparities in public education systems funded by local property taxes, which makes a mockery of the chance at equal opportunity in this country that both liberals and conservatives supposedly embrace as a core value (see my Feb 12 article, "Home-Equity ATM of Blue-State Liberals and Inequitable Funding of American Education" link).

Third, somewhat related, the average American doesn't know a great deal about subjects that have rapidly become in just the past few years critical to his future, such as China, derivatives/structured finance, the Middle East, N. Korea, etc., etc., , in part due to the abysmal oligopolistic state of the mainstream mass media and two major political parties.

It’s one thing if decades ago voters, let alone the highest government officials, didn’t know much about the differences between Sunni and Shia, Iraq and Iran, it’s quite another for that to be the case when the U.S. now has a declared national security strategy of pre-emptive/preventive undeclared, in the Constitutional sense (which doesn't seem to bother the "strict constructionist" faction on the Supreme Court), war all over the globe.

Fourth, key parts of the technology elite in the U.S., which I've long considered perhaps its "last best hope," as reflected in my site's name, "econotech," now actually seems to believe that the 24/7 narcissistic obsessive social networking of MySpace, YouTube, etc., combined with relentless massive media advertising and branding, is the economic and technological equivalent of developing leading edge advanced industrial capital goods, new genuinely high-tech sources of cheap, sustainable energy, and affordable, good quality basic consumer goods and services to help raise desperately low global living standards.

Again, the financial self-interest of massive stock options, usually to unjustified excess, even backdated at times, and IPO’s seems to have something to do with this Silicon Valley shift to the fantasy worlds of Hollywood and Madison Ave. in the real estate bubble consumer boom of the 2000s, from the emphasis on tools for corporate and individual productivity in the 1990s (see my Feb 27 article, "The New, Old Thing: Silicon Valley, Hollywood, Madison Ave.," link).

I guess what all four reasons boil down to, in the final analysis, is that if humans can get a "free lunch," which the U.S. has been able to do since 1971 with its paper dollar, then it is simply hard-wired in their nature to take it, and then make up all sorts of plausible-sounding reasons, at least to oneself most importantly, and hopefully to one's close family and friends, for why that's not what they're actually doing.

Modern academic psychology has shown the amazing power of humans to delude themselves in this way many times in small lab experiments, so why should it be any different on the scale of the global economy?

It’s the Hyper-Speculative Global Financial Markets

James Carville said after the 1992 elections, "It's the economy, stupid," often attributed to Bill Clinton. I've updated that slogan for this era, leaving off the "stupid."

Perhaps one of the most fundamental of America’s states of denial is the simple failure to admit the obvious, i.e., that the U.S. economy and government is now mainly one of, by, and for hyper-speculators, not the people.

A simple way of trying to show this is that Wall Street’s estimate before third-quarter results started coming in was that “the financial industry will account for 48 percent of the S&P 500's third-quarter growth, according to Thomson.” (Bloomberg, Oct 16)

The other nine sectors of the economy together add up to the other half. This probably understates the role of finance in the U.S. economy, as many large non-financial corporations make significant profits from their financial activities.

Regardless of the exact percentage after all the results have been reported, finance now occupies the “commanding heights” of the U.S. economy after a thirty-plus year transformation.

The same conclusion is shown looking at tax receipts. Bush closed the budget gap this year because of much greater than expected capital gains taxes. Payroll tax receipts increased far less.

For more details on the dominance of the hyper-speculators in the global economy, please see examples of the "wall of liquidity" in the section below titled "Equity Markets Keep Rising ... ", and especially the first section on hedge and private equity funds and investment banks in my Oct 24 news summaries link. Here are a couple of examples from the section below:

“U.S. leveraged-buyout activity is on pace for a record. 371 leveraged buyouts worth about $124.6 billion have closed in the first nine months, a 50% increase from the $83.1 billion in deals for the same time period a year ago … The total for deals announced but not yet closed this year is a whopping $238.7 billion across 405 deals, up from $111 billion across 317 deals at this time last year.”(WSJ, Oct 9)

“Takeovers involving European companies have climbed to $1.26 trillion this year from $819 billion in the same period a year ago … Finance has been the most active, with $341 billion of deals involving banks and insurance companies … Private-equity firms record $160 billion they have raised this year.” (Bloomberg, Oct 9)

Bottom line, the U.S. is not a service, information or any other fad term economy, but rather a hyper-speculative one.

It is also very self-delusional and even arrogant, not surprisingly for those who don't like advanced math and science, to label the hyper-speculators, and those who do very well-paid professions in their service in some way, as somehow more creative than those designing, engineering and manufacturing the actual products and services we use. Scientists and engineers, like true artists, are very creative.

Return on Leveraged Legal Looting (ROLLL)

Global finance now means what I have labeled ROLLL, return on leveraged legal looting, by hedge and private equity funds and the largest investment and commercial banks, usually in private, deliberately opaque non-transparent, even to the regulators, transactions, and usually at the expense of the public in one way or another, which has long since superceded the emphasis on “shareholder value.” E.g.,

"Cheap credit is everywhere … the most avid consumers of leveraged loans have been private equity groups. Many corporate executives sniff at what they see as financial engineering, especially when private equity groups quickly sell their investment or lock in their returns by floating a portfolio company on the stock market. It is even harder for a CFO to announce that he is planning to trash his employer’s credit rating just for the sake of returning capital to investors. The current situation has created an arbitrage that is being exploited by private equity groups at the expense of public shareholders. Either defaults begin to rise and corporate credit conditions tighten again, limiting the scope for buy-outs, or companies will inevitably conclude that they should be more aggressive in their borrowing." (Peter Thal Larsen, FT, Sep 26)

"As dozens of collateralized loan obligations (CLO) structures have set up shop, buy-out groups have been issuing waves of leveraged loans into this pool of demand. Investment bankers have also been creating tailor-made instruments for buy-out groups. These instruments have been gobbled up so eagerly by hedge funds and other investors that the price of raising funds has fallen to extraordinarily low levels. many buy-out firms have started to raise cash to pay themselves dividends … if big corporations are not willing to leverage themselves up, they could fall victim to hostile bids from private equity groups themselves." (Gillian Tett, FT, Sep 26)

Much of modern finance, based on innumerable arbitrage games, doesn’t create real economic wealth, as most corporations do through innovation, but rather simply redistributes it to the super-wealthy, via their control and use of the credit system with which to expropriate real wealth. Calling this looting financial innovation doesn’t change its essential nature.

"[management buyouts] should simply not be allowed at all as a matter of law … they buy the assets on the cheap and sell them off for their own management benefit, or they manage the company differently for the benefit of themselves and their buyout partners … breaching that fiduciary duty … management is seeking to pay the least it can get away with for the assets of the public holders, while the public holders want the most they can get. irreconcilable conflict of interest … lack of full disclosure … [buyout] memos are not disclosed to the stockholders or to the market generally … insider trading. what is a management buyout other than trading on inside knowledge?" (Ben Stein, NYT, Sep 3)

ROLLL has been based on a few obvious one-time tricks, some of which may not be repeatable, at least on the same scale, such as the global real estate bubble. Unfortunately, by the time that becomes more obvious to most people, whatever breathing room these tricks have bought the U.S. over the past decades to begin to transition to a much more healthy U.S. economy will have disappeared.

Here's a timely example of hyper-speculators’ big gains. I discuss in a section below on China how long it might continue to play along with the Goldman's of the world.

“The first-day stock gains give Goldman Sachs, the world's most profitable securities firm, a paper gain of $4.9 billion on its investment. Goldman paid almost $2.58 billion in April for 16.48 billion shares of ICBC for itself and its employee- and client-owned private-equity funds.” (Bloomberg, Oct 27)

“[Goldman’s] China bonanza is the result of more than 70 visits by former Goldman Chief Executive Officer Paulson, who became U.S. Treasury Secretary last June.” (Bloomberg, Oct 23)

“Goldman will announce on Oct. 25 its new class of partners, who will join the 287 who currently hold that title. Last year, that group shared more than $2 billion, or about 20% of the total compensation Goldman paid. That averages out to about $7 million per partner. Goldman's partners also are offered opportunities to invest beside the firm when it buys stakes in other companies, which can be lucrative.” (WSJ, Oct 13)

Politically, splitting actually economically innovative corporations, and countries for that matter, those that create real products and services, away from control by global hyper-speculators, in the case of corporations via CEO stock options and buy-outs, will be critical. The purpose of the changes proposed in this article is to encourage everyone to get very wealthy the “old-fashioned way,” by actually creating something of economic value, not as the hyper-speculators have done.

"Private-equity firms have notched seven of the 10 largest leveraged buyouts of all time this year … [CEOs] are both buying and selling the company … fraught with potential conflicts of interest. "Every private-equity firm markets itself to its potential investors on the basis of its access to deals, preferably exclusive access to deals" without competitive bidding, says a merger-and-acquisition lawyer … little that is more important to a private-equity firm than courting the management. offer management … as much as a 10% stake … when the company is recapitalized or goes public, the executives often get windfalls valued at hundreds of millions of dollars." (WSJ, Sep 8)

Good business is a very morally uplifting endeavor, it's all about creatively meeting the needs of customers with innovative ways of providing products and services. Good business is thus the essence of creativity and connection, the two things that psychologists have shown are the keys to personal happiness. Therefore, we want as many people as possible to be involved in business in a creative and connected way, so that they will be as happy and fulfilled as possible by "doing well by doing good."

“Former NYSE chairman Grasso must return tens of millions of dollars in compensation to the exchange, a New York state judge ruled on Thursday. Mr Spitzer filed a high profile law suit in 2004 arguing that the $139.5m in salary, bonus and benefits paid to Mr Grasso in 2003 for his eight years as NYSE chairman violated New York law requiring that compensation for executives at not-for-profit organisations be “reasonable” and “commensurate with services performed.”” (FT, Oct 19)

I only mention Grasso’s case because, if I recall correctly, in a recent tv interview perhaps the most celebrated, respected CEO of the prior two decades defended him, before the verdict, on the grounds that no executive would turn down huge sums of money if legitimately offered by its board.

But are these offers really legitimate, even when perfectly legal most of the time? Buffett recently said of current corporate morality: “many perpetrators of corporate scandals acted because they felt others were doing it.” (FT, Oct 10)

Corporate morality is not going to change by hiring more moral CEO’s and MBAs with ethics classes. It is critical to break the systemic link of corporate America, the repository of crucial talent, know-how and technology, that is tethering it in its now more than two-decade alliance with the global hyper-speculators. (See my April 10 article, "SOX counterproductive; Corp America responds to distorted incentives," link.}

Self-Described “Schmucks” of the Financial World

The larger ROLLL becomes, the worse off America’s and the global future ultimately will be, as capital/savings is siphoned off in pure hyper-speculative activity solely designed to line the pockets of the super-wealthy, with no useful or redeeming economic value whatsoever, rather than being rationally invested to raise global living standards.

Who are these hyper-speculators, and what drives them? A revealing self-description was in the lead article on page one of the Sept 30 WSJ:

“Mr. Tepper, 49 years old, is head of Appaloosa Management, a $4.5 billion hedge fund that owns 9.3% of Delphi's stock. Mr. Tepper has gotten rich investing in America's broken companies and declining industries … Mr. Tepper says he is not causing economic pain -- he is just capitalizing on it … Delphi wants to close many plants and lay off thousands of people. It also intends to cut wages and benefits … On [Tepper’s] desk sit three plastic pigs. He jokes that he rolls them for guidance on difficult trades. If all three snouts point down, in the eating position, it's a signal to buy. "The media says that hedge funds are the new masters of the universe," he chuckles. "We're just a bunch of schmucks."” (WSJ, Sep 30)

Tepper’s amorality is not an aberration, it is the norm. The world’s financial system is being run by people who make the 1987 character played by Michael Douglas, Gordon “Greed is Good” Gekko, seem benign (despite their philanthropic activities of returning some of the legal looting).

“After Weetabix, the maker of Britain's best-selling breakfast cereal, fired 7 percent of its workers and canceled the employee bus service to free up cash for debt from a leveraged buyout, [it] borrowed $249 million so it could enrich owner Lion Capital. This year more than 80 companies controlled by LBO firms have borrowed at the expense of workers and debt investors just so they can pay themselves dividends … The payments have helped the firms recoup 86 percent of their investments within two years … Weetabix will pay annual interest of 13 percent for the next decade because of the dividend to Lion Capital. That's almost double the cost on loans it used earlier this year to refinance debt from its 2004 buyout. Interest costs like those may force the company to cut more expenses … Robin Smith, a spokesman for Weetabix, declined to comment. Lion Capital spokeswoman Mani Pillai also had no comment.” (Bloomberg, Nov 1)

There is now a whole MBA army of Gekko’s on financial steroids and with very little adult supervision whatsoever, a key point as to who might possibly restrain these “masters of the universe,” that I will get back to shortly.

Historical Context for a New Global Strategic Bargain

At the risk of seeming even more hubristic and self-deluded than the elite that I've just criticized, such a global bargain as the one I sketched above would be of the same historic importance for long-lasting peace and prosperity in the 21st century as the creation of the post WW II Bretton Woods institutions and economic reconstruction along with security alliances.

Sixty years ago, the latter without the former could very well have ended up in yet a third round of the 20th century’s extended “Thirty Years’ War,” with even many more tens of millions dead, this time in nuclear holocausts. Everything possible must be done ASAP to avoid going down that path toward international anarchy today.

This global strategic bargain should have been attempted thirty years ago during the huge energy, monetary, foreign policy and political crises of the 1970s. If it had, perhaps a great deal of unnecessary pain and suffering could have been avoided, and a huge amount of global development achieved.

But global leadership on all sides, trapped in a Cold War mindset, clearly was nowhere close to being up to the task back then. Hopefully this time around they will be, better late than never, although as a result the U.S. has already unnecessarily squandered huge amounts of historically earned goodwill and prestige, “soft power” if you prefer, or "political capital" as Bush might put it.

World More Dangerous With Loss of U.S. Power and Domestic Political Stalemate

And make no mistake about it, this is a huge loss, even if Wall Street currently doesn’t seem to care.

E.g., I recently saw a Bloomberg tv interview with Jesper Koll, Merrill Lynch’s chief Japan economist who has been there for two decades, in which he quickly brushed aside any concern whatsoever about the recent N. Korean nuclear test.

Not to single out Koll, he seemed a nice enough guy and is a good market economist, but this is extremely short-sighted, to say the least (as if that would be unexpected from Wall Street).

Financial markets globally remain extremely complacent about the potential dangers ahead, as market players are already spending their huge year-end bonuses, counting on the ongoing global rally to continue (see my Sep 26 article, "Global Markets Hope ..." link). E.g.,

“The Chicago Board Options Exchange volatility index, or VIX, dropped 0.27, or 2.5%, to 10.63 -- its lowest closing level since late 2005.” (WSJ, Oct 21)

Barring a major late turnaround and/or last minute surprise, come November, there may be a huge political stalemate in D.C.

“A last-minute "October surprise" -- a dramatic news event that shakes up the U.S. election -- could be a big wild card in the final three weeks of the fight for control of Congress. With Democrats threatening to sweep Republicans out of power in Congress in the November 7 elections, a late-breaking foreign crisis, terrorist attack or a new scandal could change the debate and shape the ultimate outcome.” (Reuters, Oct 17)

Wall Street thinks that such a stalemate will be okay:

“Investors are banking that a Democratic victory will mean political stalemate with President George W. Bush rather than passage of an anti-business agenda.” (Bloomberg, Oct 24)

But it very well might make the world, already teetering on the brink of war in many volatile areas, an even far more dangerous place.

With the possibility of tremendous political warfare in Washington, the loss of U.S. global power and prestige, right now dangerously palpable, could become even worse, and with it the prospects for global stability.

That risk doesn't influence how I feel about the absolute necessity for huge change in the political situation, in fact it only makes the need for such change that much more imperative, as I try to argue in the final section of this article.

But it does mean that the nation's leaders should be very much aware of what happened in the 1970s under wounded Nixon and weak Ford and Carter, and the effects of a relentlessly hounded Clinton in the 1990s.

And also remember what happened with the worldwide collapse of the elite’s moral authority associated with the Vietnam War and the year 1968, not only in the U.S. and Europe, but also in the enormously devastating “Cultural Revolution” in China.

No one wants to relive those times of upheaval, and we’re far way from that right now, but the negative international surprises keep coming. Very few expected Israel to do what it did to Lebanon this summer. Nor for N. Korea to test a device so soon, even though:

“North Korea's leadership is under severe economic pressure. Financial sanctions imposed by the US in September last year appear to have had a tougher than expected effect. (FT, Oct 5)

What’s next? Will Gaza explode, with unforeseen consequences, perhaps for Egypt? More unrest in Eastern Europe, whose current account deficits might make them somewhat vulnerable to another markets contagion effect if things start to get out of hand, as happend in East Asia in 1997?

“Police in Budapest charged at protesters to end a day of riots on the 50th anniversary of Hungary's anti-communist uprising. The violence extended a month of pressure on Prime Minister Gyurcsany to resign.” (Bloomberg, Oct 24)

“The average monthly wage in Hungary was 847 euros ($1,067) at the end of last year, a third of the 2,542-euro average in Germany. The frustrations in Budapest mirror those of people around Eastern Europe as governments from Estonia to Slovakia struggle to fulfill promises that capitalism would bring a better life. Gyurcsany's Socialists were the first Hungarian party to win a second consecutive term since the fall of communism when it won re-election in April. Czechs, Poles and Slovaks have all replaced the parties that led them into the EU two years ago.” (Bloomberg, Oct 20)

“Attempts at forming stable governments in some of the 10 nations that joined the EU in 2004 have foundered as voters cast their ballots for a growing number of parties and as politicians struggle to forge coalitions with a common goal. Alliances have shattered as political leaders seek to implement budget cuts demanded by the EU without breaking campaign spending promises.” (Bloomberg, Oct 3)

My point is that the loss of U.S. prestige and status globally, combined with the tensions inherent in an inequitable hyper-speculative version of globalization, have created potential tinderboxes all over the world, with not necessarily completely foreseeable but still very serious risks.

Unfortunately, when the structural foundations of stability are steadily weakned, reality has a nasty habit of intervening into situations based upon massive denial and delusion. As the ancient Romans and other erstwhile empires found out to their everlasting chagrin.

No one can predict how with any certainty. But one thing is obvious so far, unanticipated geopolitical surprises have become more frequent, and Wall Street doesn't seem to care in the least, as the good times continue to roll. For now.

What Would Happen Politically If the Housing Bubble Really Collapsed?

“Is this what a housing bust looks like? New home prices fell last month by the largest amount in 35 years and owners are being warned to brace for further declines, especially in formerly hot markets. After years of increases, some buyers say prices are still out of their range. The Commerce Department reported that the median price for a new home sold in September was $217,100, a decline of 9.7 percent from September 2005. That was the lowest median home price in two years and the sharpest year-over-year decline since December 1970, providing dramatic evidence of the slowdown in the once-booming housing market.” (AP, Oct 27)

“The decline in home prices after a five year real-estate boom will cause the economy to slow and force the Fed to lower rates to avoid a recession, McCulley wrote on Pimco's Web site on Oct. 19. ``To think otherwise after a bubble is to not understand bubbles.''” (Bloomberg, Oct 23)

"Moody's Economy.com projects that the median sales price for an existing home will decline in 2007 by 3.6 percent, which would be the first decline for an entire year in home prices since the Great Depression of the 1930s. 133 of the nation's 379 metropolitan areas would suffer price declines. account for nearly one-half of the value of the nation's stock of single-family homes … the rebound in prices is not expected to occur quickly." (AP, Oct 3)

“The ABX index, which measures the risk of owning bonds backed by home-loans to people with poor credit, rose 30 percent since Aug. 9 to the highest since January. There are more than $500 billion of such notes outstanding. The increase in the index shows traders expect mortgage delinquencies and foreclosures to increase at a time when the number of homes for sale is at a 13-year high. The percentage of home-loan payments more than 60 days delinquent rose to 7.23 percent in July from 5.9 percent a year earlier, the fastest rate of increase since 1998.” (Bloomberg, Oct 23)

""Since the start of 2005, the inventory of unsold new homes has climbed 29 percent, while the stock of unsold existing homes is up a staggering 82 percent'' … cancellations are rising, and they aren't being captured in the aggregate statistics because of the way the survey is designed. Hence, sales are being overstated and inventories understated. " (Caroline Baum, Bloomberg, Sep 29)

““I don’t think that the [housing market] boom came from a 1 per cent Fed funds rate or from the Fed’s easing. It came from the collapse of the Berlin Wall,” Mr Greenspan told a private audience in Canada on Friday … the collapse of Communism in eastern Europe and the shift towards more market-based economies in China and other parts of the developing world brought “billions of cheap labourers onto the scene”. This, he said, “brought disinflation and lowered inflation risk premiums and long-term interest rates, creating a decline in real interest rates and equity-risk premiums.” In consequence, “the real market value of assets increased faster than GDP.”” (FT, Oct 9)

""The rate of [real estate] decline is going to dramatically slow,'' Greenspan told an audience of insurance-industry executives in White Sulphur Springs, West Virginia. ``We are beginning to see some evidence that all the data are not going south,'' he said, citing statistics on mortgage applications." (Bloomberg, Oct 10)

If Greenspan fully believed his explanation of what he calls the “boom,” then why did he lower interest rates to 1% in the first place and keep them there so long?

It wasn’t just the “billions of cheap labourers onto the scene” that was key, it was the decisions to transfer to that labor by stateless multinationals advanced technology and management, developed over decades by innovative individuals standing on the shoulders of their societies’ progress, now expropriated for the benefits of the very few at the very top running those multinationals, via their stock options, and the financial hyper-speculators driving them to do so.

But I digress. The key point to be made for the purpose of this discussion is the potential political problem arising from the American middle-class not understanding and accepting what Greenspan said above.

Five or ten years ago, if you had told the American middle-class that their homes would be worth what they are today, you would have been considered insane. Everyone knew such valuations would be completely absurd based on all their prior experience, not only with their own home prices, but also with decades of stagnation of their own real incomes.

Yet today, the American middle-class very strongly believes that these previously insane valuations are normal, and more importantly politically, that they somehow earned their massive increase in home equity.

They have no real idea how it happened, magically perhaps, they don’t particularly care. They don’t fully understand the role of East Asia that Greenspan mentioned above, because no leader has ever clearly told them, no one has explained to them the so-called "Bretton Woods II" marriage of convenience between the spending Americans and the saving Chinese, implicitly agreed to by "independent" central bankers in the U.S. and CCP leaders in China.

Nor do they fully appreciate how they've benefited from massive government tax breaks of a couple hundred billion dollars per year on mortgage interest and capital gains, the latter enacted clearly to pump a bubble, huge government mortgage security subsidies, government supply restricting zoning and land use regulations, etc., all of which was not in the news report on Greenspan that I quoted above.

If the middle-class homeowners thought about it at all, they might think their huge home equity gains was the “free market” at work, and since they took the "risk," they deserve the huge capital gains, even the small number who weren't fully honest.

“the use of liar loans has become epidemic. In 2005, mortgages underwritten with minimal documentation sometimes accounted for as much as 50 percent of subprime mortgages. almost 60 percent of the stated-income amounts are exaggerated by more than 50 percent.” (sfgate.com, Oct 6)

Regardless, they know possession is nine-tenths of the law, so it's their hard-earned home equity, period, end of story. They’ve even spent a good chunk of it, via home equity extraction, which has continued even through rising rates, though at a slower pace, down from about $800 billion a year to less than $500 billion. But there’s still far more of that new paper wealth left.

The Fed is doing everything it can to maintain this mass delusion about real estate values, otherwise they would be far lower, while keeping inflationary pressures under control, at least until after the Nov election.

But what if this truly massive social “state of denial” was ever threatened, what would be the consequences? Who would be blamed? Who would the middle class lash out at, as it historically has been prone to do when its living standards are very seriously threatened? Who would pay the price, be the target, for their sublimated anger?

For three decades, as their real incomes stagnated (average real weekly earnings are still -17% below the level of 1972) working and middle class people’s lives were spindled, folded and mutilated on the premise and promise, by both political parties and the mass media, that what came to be called "globalization" would somehow ultimately pay off for them.

It did, finally, but in an unanticipated way, not through better new jobs , 1996-2000 was the only period of modestly rising real wages since 1972, but rather through the by far largest speculative bubbles in history, first in the equity markets, then more importantly in real estate in the 2000s.

Social science research gives clues as to who would be targeted should the real estate bubble significantly deflate (see the end of the Social – U.S. and Political – U.S. sections of the 10/24 news summaries link).

Billions of People Without Clean Water, Basic Sanitation, etc.

Two generations with Gordon Gekko’s amoral attitude are now endemic to global financial markets.The global economy essentially consists of billions of very poor people going nowhere fast, while global stock markets and all other speculative activity make all-time highs.

“more than 1 billion people were without clean water in 2004 … 2.6 billion people worldwide without access to proper sanitation.” (Reuters, Sep 28)

“President-elect Calderón recently admitted that violence has escalated out of the control of the authorities in several states and in Mexico City … Big investors appear to shrug off the violence, as they have the disputes after Mr Calderón's election. "It's not a concern," said Damian Fraser, chief Latin America strategist of UBS Warburg. As Mr Fraser spoke last week, the IPC index of the Mexico Stock Exchange set fresh records.” (FT, Oct 4)

“Maoist guerrillas are active in a quarter of the country's 602 administrative districts. Transport infrastructure is woefully inadequate. Nor is there a coherent energy policy … average age is 23 and there are 300m children aged between six and 16 poised to enter the workforce - but education is poor and jobs are scarce … only 35m Indians [out of 1.1 billion] - less than 7 per cent of the workforce - are employed in the formal economy and 21m of those work for the government.” (Victor Mallet, FT, Oct 19)

But “India will have at least 50 property- related initial public offerings in the next year as the real- estate industry booms” (Bloomberg, Oct 3)

“The world's ecosystem is being degraded by humans at an unsustainable rate that risks causing ``irreversible damage'' to the planet, the conservation group WWF said. ``by 2050 humanity will demand resources at double the rate at which the Earth can generate them.'' "At this level of ecological deficit, exhaustion of ecological assets and large-scale ecosystem collapse become increasingly likely.'' Almost half of the ecological footprint is due to emissions from fossil fuels. ``Humanity is no longer living off nature's interest, but drawing down its capital,'' WWF said.” (Bloomberg, Oct 24)

And almost as if to celebrate the stock market bull markets?

“the video of a Merrill Lynch [private] banker having a sexual encounter on a Spanish beach with an ex-girlfriend of Brazilian soccer star Ronaldo … has crashed computers on trading floors in Sao Paulo and Rio de Janeiro.” (Bloomberg, Sep 29)

Equity Markets Keep Rising, Regardless of Short-term Rate Expectations

Before continuing with the main themes of this article, the following section gives my patient investment readers a brief update on financial markets, which I will cover in more detail once again in future articles.

The prospects of short-term rates going down was a key rationale often cited for both the stock and bond markets strongly rallying in the third quarter following a sharp May-June correction, even though each market was betting on a diametrically opposite economic forecast, as noted in my Sept 26 article, “Global Markets Hope … ,” link.

Since then, a few key data releases and Fed speeches convinced financial markets that the Fed was not going to cut rates anytime soon.

“Federal Reserve officials may leave interest rates alone until the middle of next year, confident of ``moderate'' economic growth and abating inflation pressures. Futures traders anticipate the Fed's benchmark lending rate will stay at 5.25 percent through May." (Bloomberg, Oct 26)

The result? Of course global equity markets continued to go up anyway, while the U.S. bond market has had a small correction of its previous very strong advance.

I.e., in an equity bull market, it doesn’t matter what the rationale of the day is, s-t rates expected to go down, s-t rates expected to stay flat, all news is okay, including bad news, especially with decent earnings reports.

“[S&P 500] has risen 4 percent in October, which would be the biggest monthly gain since December 2003. As of yesterday, with about half the companies in the S&P 500 reporting earnings, 73 percent have posted profits that exceeded analyst forecasts, while 12.5 percent reported results that trailed estimates.” (Bloomberg, Oct 26)

“The MSCI Asia-Pacific Index set for its highest close since May 18. The measure last rose for six straight days in the period ended Jan. 31. U.S. stocks advanced, sending the Standard & Poor's 500 Index to its longest winning streak since March.” (Bloomberg, Oct 26)

“The Shanghai Composite Index, which tracks performances in the bigger of two Chinese stock exchanges, rose 53 percent this year, the sixth-best performer out of 80 global indexes tracked by Bloomberg.” (Bloomberg, Oct 13)

“The DJ Stoxx 600 [Europe] Index at the highest since February 2001. Stocks have risen 17 percent from their low on June 13 as takeovers, a three-month retreat in oil prices and better-than- expected earnings bolstered prospects for profit growth and underpinned stock values.” (Bloomberg, Oct 21)

“Lead rose 2.7 percent in London, earlier touching the highest ever. Nickel climbed 1.2 percent to the highest since at least 1987.” (Bloomberg, Oct 13)

“Shares of Nippon Building Fund Inc., Japan's biggest real estate trust, reached a record last week as land prices and rents soared.” (Bloomberg, Oct 12)

Consider what would have been the equity market’s reaction had N. Korea detonated a nuclear advice during its sharp decline in May-June. Yet rising global geopolitical risks do not register at the current time, with equity market volatility (VIX) once again extremely low.

The most basic reality of the global financial markets continues to be, as the FT said Sep 26, “Cheap credit is everywhere … the most avid consumers of leveraged loans have been private equity groups.”

“U.S. leveraged-buyout activity is on pace for a record. 371 leveraged buyouts worth about $124.6 billion have closed in the first nine months, a 50% increase from the $83.1 billion in deals for the same time period a year ago … The total for deals announced but not yet closed this year is a whopping $238.7 billion across 405 deals, up from $111 billion across 317 deals at this time last year.”(WSJ, Oct 9)

“Takeovers involving European companies have climbed to $1.26 trillion this year from $819 billion in the same period a year ago … Finance has been the most active, with $341 billion of deals involving banks and insurance companies … Private-equity firms record $160 billion they have raised this year.” (Bloomberg, Oct 9)

China’s ICBC $19.11 billion IPO received more than $500 billion in orders. “"I am staggered by the wall of liquidity that exists in the capital markets right now," says Steven Barg, UBS AG's head of equity capital markets for Asia.” (WSJ, Oct 21)

“Asian hedge funds starting operations increased to 215 in 2005 from 95 in 2002.” (Bloomberg, Oct 27)

“Assets at commodity hedge funds rose 87 percent to $22.5 billion in the past year and may grow to $30 billion in 2007. The number of funds increased to 95 from 70 a year ago.” (Bloomberg, Oct 23)

“Since 1999, the amount of money invested in commodities by pension funds, mutual funds and endowments has soared almost 17- fold, to $100 billion from $6 billion. Hedge funds, commercial banks and Wall Street firms, meantime, have poured about $50 billion into the market.” (Bloomberg, Oct 10)

“the sea of cash flooding the Gulf [Arab oil producers] these days has produced an explosion of investment companies. New names spring up almost every week. Arab companies' acquisitions abroad are announced with as much frequency … Gulf oil producers' current account surplus will increase 37 per cent this year to $227bn. (FT, Oct 19)

Here's a few things to worry about:

“U.S. stocks fell on Friday [Oct 27] as a report showing third-quarter U.S. economic growth was the weakest in more than three years raised concerns about the outlook for corporate profits. The market pulled back after two weeks of gains. The government said GDP expanded at a 1.6 percent annual rate -- much slower than the 2.2 percent rate economists had expected and down from a 2.6 percent rate in the second quarter. Stocks showed little reaction to a report from the University of Michigan that its consumer sentiment index rose to a stronger-than-expected reading of 93.6 in October, up from 85.4 in the previous month.” (AP, Oct 27)

“The Fed's [staff] number-crunchers threw out previous conclusions about how fast the economy can grow without fueling inflation. They concluded that the speed limit is lower than previously thought. The implication: Unless the economy slows more than the Fed now expects, the central bank may have to resume raising interest rates sooner rather than later to control inflation. In effect, policy makers were told last month that time is running out for inflation to fall.” (Bloomberg, Oct 23)

“The Conference Board index of leading indicators edged up just 0.1% to 137.7 in September, but noted that consumer expectations have improved. The index fell by a revised 0.2% in August. "The economy has slowed but the evidence to date doesn't suggest it will stall or go into a recession." "To the contrary, the economy retains considerable strength," given the rise in stock prices and drop in energy prices. employment remains robust and inflation relatively low.” (WSJ, Oct 20)

“The Institute for Supply Management's manufacturing index dropped to 52.9, the lowest since May 2005.” (Bloomberg, Oct 2)

“Caterpillar shares had the biggest drop in 19 years. Sales of construction equipment will be less than the company anticipated as a housing slump triggers a period of slack economic growth.” (Bloomberg, Oct 20)

“[Investor] Sentiment has reached a level of extreme optimism, according to an indicator compiled by Ned Davis Research.” (Bloomberg, Oct 9)

“For the year ending August 31, "86.8 per cent of the $118.56bn in equity flows has headed overseas."” (FT, Oct 4)

“Gulf oil producers will continue buying dollar-based assets with their windfall revenues, but not all the money will flow into the US, according to [the IMF]. Gulf oil producers will record current account surpluses of $239bn this year, rising to $259bn in 2007.” (FT, Oct 10)

“In 2006, fuel exporters expected to generate a $505 billion surplus, vs. $462 billion from Asian nations … oil-exporting countries have recently taken the lead in buying U.S. bonds and Treasury bills … If they tumble to $50 per barrel, the boom in petrodollar purchases of U.S. securities could evaporate.” (BW, Oct 9)

“the possibility of a disorderly unwinding of the external deficits … The rest of the world may no longer need further increases in the US external deficit. But it would not want to see it contract too brutally or too quickly either. If US domestic demand weakened, however, a big correction of the external deficit is exactly what most Americans would want, since that would be preferable for them to a domestic recession. They would wish to export their slowdown.” (Martin Wolf, FT, Sep 28)

But until that seemingly inevitable but much-delayed day of reckoning, for now the huge global “wall of liquidity,” actually a tsunami, has prevailed. Until I give an updated market/chart review in a future article, I will close this section by just repeating what I wrote Sep 26 link:

“as I have written a number of times since June 2 link when global financial markets were sharply declining, equity markets still remain in their now 4-year bull market, judged on the most simplistic trend criteria (e.g. MSCI World (ex US) and the NYSE are currently well above their rising 200-day moving averages), indicating the equity markets’ recent diminution of concern over the prospects of a successful "soft landing"”

No Domestic Opposition to Global Hyper-Speculators

But this is not about the hyper-speculators' personal morality. It’s not about somehow replacing the current hyper-speculators with more ethical ones, as if that could be done. It’s about a monetary/financial system that is being run to benefit a very tiny group of global hyper-speculators. And in the final analysis, it is all about political/economic/military power.

The U.S. is not going to significantly rein in the global hyper-speculators, one of whom is currently Treasury Secretary. Perhaps there may be a little more policing at the margin to make sure the speculative orgy doesn’t get out of control and finally wake someone up, but it won’t amount to much.

“Top US policymakers believe fresh regulation of hedge funds may be needed to avoid a catastrophic hedge fund failure and that relying on banks and other counterparties to manage their exposure to the booming industry may no longer be enough. The development marks a shift in thinking on hedge fund oversight since a US court in June struck down a rule that hedge fund managers register with the SEC … One focus of concern was that hedge funds had access to financing from multiple prime brokers … official said. “The real concern is the transmission mechanism of the failure of a hedge fund into entities of a size that really are of systemic consequence.”” (FT, Oct 15)

“Hedge funds present a risk to the financial markets and tighter regulations are needed, a majority of private economists said in a new WSJ.com survey … little is known about their borrowing. Banks have been aggressive in extending credit, sometimes requiring little or no collateral on loans … Geithner, president of the NY Fed, recently called upon regulators to examine whether banks and securities dealers are requiring sufficient collateral from hedge funds … Thomsen, the SEC's director of enforcement, said the agency will be monitoring hedge funds through their relationships with broker dealers, and those ties will face more scrutiny.” (WSJ, Oct 13)

“Snow, the former U.S. Treasury secretary named chairman of Cerberus Capital Management this month, said investors, not policy makers, are the best regulators of hedge funds. Snow said he came to favor a ``lighter'' touch for hedge funds because the $1.3 trillion industry was too big for the government to monitor effectively … Senate Finance Committee Chairman Grassley told Snow's replacement, Paulson, that hedge funds pose too big a risk to the U.S. pension system, and asked the Treasury to find ways to boost transparency in the funds. the SEC is focused on insider trading by hedge funds ahead of corporate merger announcements, Chairman Cox said. Snow, who had amassed personal wealth of about $100 million when he joined the Bush administration, said joining a private equity fund seemed a natural evolution.” (Bloomberg, Oct 31)

The “enlightened capitalist” factions that for years now have expressed deep concern about the direction of the global economy and financial markets, e.g. those around Rubin, Volcker, Peterson, etc., have no political leverage to push for more significant reforms (e.g. Rubin supported Kerry), except perhaps via the Clintons (the same is true in foreign policy). That’s because the domestic political power to fundamentally change the speculative system was destroyed decades ago, with the U.S. labor movement.

The “enlightened capitalists” heavily contributed to this destruction, e.g. Carter’s Volcker ultra-high interest rate-ultra strong dollar policy “hollowed out” the U.S. “rust belt” in Reagan’s first term; Clinton’s Rubin Nafta-WTO “free trade”-strong dollar policy formally institutionalized the decades-old shift (first to the anti-union south) of U.S. industrial capacity abroad; with Bush Jr. delivering the final U.S. industrial deathblow in his first term, a truly bipartisan effort over the decades, with this final result:

“Wal-Mart is pushing to create a cheaper, more flexible work force by capping wages, using more part-time workers and scheduling more workers on nights and weekends … workers assert that the company is making changes with an eye to forcing out longtime higher-wage workers. Investment analysts and store managers say Wal-Mart executives have told them the company wants to transform its work force to 40 percent part-time from 20 percent. Wal-Mart denies it has a goal of 40 percent part-time workers, although company officials say that part-timers now make up 25 percent to 30 percent of workers, up from 20 percent last October. Wall Street analysts praising the new approach to managing its workers … A big area of discrepancy between what Wal-Mart says and what the workers say is whether the company has a policy of “open availability.”” (NYT, Oct 2)

“Wal-Mart Stores Inc. is paying a former advisor to President Clinton at least $3 million over the next two years to direct a rapid-response team to handle mounting criticism of the world's largest retailer.” (LAT, Aug 30)

Not all that surprising, considering that Hillary Clinton was on Wal-Mart's board for six years.

Europe and Japan Offer Little Opposition to Global Hyper-Speculators

Since being defeated in WW II, the continental Europeans have consistently abdicated in the fight with Wall Street and its City of London ally, as has Japan. The BoJ usually seems to be just another branch of the Federal Reserve supplying virtually limitless liquidity to the global hyper-speculators via “yen carry trades,” that isn’t going to change under Abe, who will institute much harsher fiscal austerity than Koizumi.

Japan actually got uncharacteristically a little bold with the U.S. during the 1997-98 “Asian” financial crisis, proposing an Asian Monetary Fund, for which it was promptly slapped down and put in its place by the Treasury Dept of Rubin/Summers. Japan, especially "Elvis" Koizumi, hasn’t uttered a peep since that the U.S. doesn’t like.

The rest of East Asia learned its lessons the very hard way from that 1997-98 experience regarding the ultra-tight relationships between global “hot money,” the IMF, and the U.S. government, something Mexico and the rest of Latin America had learned long before in crises throughout the 1980s and 1990s, and as a result East Asia has accumulated a $2.4 trillion “war chest” of foreign exchange reserves, and entered into the Chiang Mai Initiative of swap networks.

As for Europe:

“Germany was also expecting opposition from the UK to its [renewed] plan to examine the risk posed by the activities of hedge funds. "We tried to get hedge funds on to the [G8] agenda in 2005 but we hit a brick wall from Britain and the US," the official said.” (FT, Oct 19)

“Productivity may be about to do for [the ECB’s] Trichet what it did for Greenspan … European workers are catching up to their American counterparts after lagging behind for most of the past decade. One sign of the times: Last month's agreement between Volkswagen AG, Europe's largest carmaker, and union leaders to extend the workweek [4.2 hours] without additional pay.” (Bloomberg, Oct 16)

That’s “productivity” and “catching up” from the viewpoint of the global hyper-speculators, but not in any sane economic sense, not that they would care about the difference.

Whither China?

Thus, with very limited domestic and international opposition, that basically leaves China and Russia left standing in the way of total global domination by the hyper-speculators, two states which the U.S. government can not currently strongly influence, to the obvious chagrin and anger of those pushing U.S. hegemony in the current hyper-speculative version of globalization (there is a good version), hence the trotting out of Paulson's and Rice's current “soft cop” approach to China.

The U.S. is not really interested in “free trade," it no longer has much that countries like China seem to want to buy, except Boeings and soybeans, since as noted above U.S. industry has long since been hollowed out, as opposed to Japan's and the EU's, which are more slowly getting there, to their great dismay.

Rather, what the U.S. mainly wants from China, and everywhere else, is unlimited capital mobility for its mega- global financial institutions, so it can ROLLL (again, return on leveraged legal looting) over them as they have the rest of the world. Both China and Russia seem aware of this, and their elites are playing a fascinating game with the global hyper speculators.

For the past decade, China has been the prime beneficiary of “globalization,” but that is mainly due to China’s efforts and also somewhat to multinational foreign direct investment, the good kind, of $60 billion per year, not to the global hyper-speculators, who want that to change. Now a little-noticed battle is gearing up for control of China's economy, especially its financial sector, as I’ve mentioned in an earlier article.

“there is a growing perception that foreign companies have done too well from their investments. The Party leadership has publicly accused a few of capturing "excessive" market shares, acquiring too many stakes in China's strategic industries, and buying state assets at bargain prices. Above all, there seems to be a concern that overseas investors own too much of the technology crucial to China's economic development … The main focus is on making it more difficult for foreign companies to operate in China … China is also attempting to build "national champions" … China's economic nationalism is a marginal adjustment to, rather than a fundamental repudiation of, Beijing's broader embrace of globalization.” (Harry Harding, Eurasia Group, WSJ, Oct 24)

“Carlyle Group agreed to reduce the size of a planned investment in a Chinese company in an effort to close a deal that has stirred government and public concern about foreign inroads into China's economy … Increasing numbers of Chinese officials and scholars have been speaking out against the strong market position some foreign companies have achieved in China.” (WSJ, Oct 18)

“Buyout firms should give up on taking control of companies in Asia because of rising nationalism and sensitivity toward overseas investments, said Hsu Ta-lin, chairman and founder of H&Q Asia Pacific … ``It's increasingly hard to buy control of companies in Asia and I do think negative control is probably a way to it,'' said Frank Tang, managing director of Temasek Holdings Pte, Singapore's state-owned investment company.” (Bloomberg, Oct 11)

“The U.S. may file new complaints with the WTO because China is showing signs of ``backtracking'' on its pledge to allow foreign investments and cut subsidies, the top U.S. trade official said. China is favoring domestic producers including steel producers and hasn't done enough to crack down on intellectual property violations.” (Bloomberg, Oct 13)

One of the most important areas to focus on is control of the financial sector. Huge Western financial institutions have made significant investments on very favorable terms in China’s four main banks, but China is clearly reticent to give up too much control of its key financial institutions and its nascent capital markets, as with Citigroup's efforts to take a stake in Guangdong Development Bank.

“overseas firms that invested $17 billion in China's four biggest publicly traded banks in the past two years. The mainland lenders have handed investors $10 billion in gains since they first sold shares in Hong Kong last year.” (Bloomberg, Oct 9)

As it did with its industrial state-owned enterprises, China is using the club of foreign competition to do much of the politically unattractive dirty work, so to speak, to shake up its four large banks and the financial sector.

“China is pushing its biggest banks to sell shares to the public so that tougher international accounting rules, tighter stock market regulation and scrutiny of overseas investors will help improve corporate governance and management.” (Bloomberg, Oct 27)

In the long term, the Goldman’s will ultimately need China far more than China needs the Goldman’s. China is at the center of East Asian production networks that generate real savings/capital, which the U.S. currently does not.

It is critical that China continue to channel its capital where it is needed, into China’s internal development, not into very low-yielding U.S. securities, it holds $1 trillion in foreign exchange reserves, that are just being printed up in massive amounts to control and confiscate real wealth. E.g.,

“an engineering project is attempting to divert billions of tons of water from China's flood-prone south to the Yellow River and the cities that rely on it. [China] has one-quarter of the per capita water resources of the world average; in Beijing, it is one-thirtieth. Some 136 cities face severe shortages. More than 300 million people, almost a quarter of the population, lack access to clean drinking water, as more than half of major waterways are badly polluted. The entire project, which could take decades to complete at an estimated cost of more than $60 billion, would build three canals. Many worry that funneling water north fails to address problems of waste and inefficiency.” (WSJ, Oct 20)

(Of course the same need for massive internal investment holds true for India and all the rest of the developing nations. “Last week [Prime Minister] Singh doubled the estimate of investment needed in India's roads, ports and other infrastructure to $320 billion by 2012 to accelerate economic growth to as much as 10 percent from the 8.1 percent expansion in the past three years.” (Bloomberg, Oct 13))

A couple of recent examples of China’s growing commercial and geopolitical clout:

“China International Trust & Investment Corp. will pay $1.9 billion to buy the Kazakhstan oil assets of Canada's Nations Energy Co. The acquisition follows China National Petroleum Corp.'s $4.2 billion purchase of PetroKazakhstan Inc. last year. China is beating India and the U.S. in bids for Central Asia's oil. Kazakhstan's reserves are twice as big as those of the North Sea.” (Bloomberg, Oct 26)

“China's economic planners have approved the construction of a natural-gas pipeline from the country's northwest to its south to transport gas imported from Turkmenistan. will be more than double the capacity of the existing West-East pipeline … part of Beijing's plans for as many as six natural-gas pipelines crisscrossing the country.” (WSJ, Sep 28)

“Airbus SAS won an order from China for 150 A320 aircraft. [Airbus] will also set up a final assembly plant for the A320 in the northeastern Chinese city of Tianjin China will also sign a letter of intent for 20 A350 aircraft, which Airbus is redesigning to compete with Boeing Co.'s 787 model.” (Bloomberg, Oct 26)

The profitability of China’s companies is a hotly debated issue, as is its susceptibility to a U.S. economic slowdown, I don’t have space to go into the latter here. E.g.,

“profits of [China’s] industrial companies have soared by an average of 36% a year since 1999. The average pre-tax return on equity by state-owned firms increased from 2% in 1998 to 13% in 2005; private companies' return went up from 7% to 16%. most corporate investment is now financed out of companies' own cashflows and only one-third from outside sources. [return on capital] has risen steadily since the late 1990s. A fifth of all industrial firms (and a third of state-owned enterprises) continue to lose money.” (Economist, Oct 19)

“Profits at Chinese industrial companies increased 29.6 percent in the first nine months from a year earlier. Higher earnings may ease concerns about overcapacity, causing the government to refrain from taking additional steps to curb investment.” (Bloomberg, Oct 24)

“The largest SOEs are reporting burgeoning profits and financing new investments themselves, but they are the exceptions: in 2005, the 10 largest accounted for more than 53 per cent of total SOE revenues and the 165 SOEs owned by the central government for more than 70 per cent of profits. The implication is that banks' exposures are likely to be greater to the thousands of smaller government-dominated firms whose profits appear to be much less certain.” (Dobson and Kashyap, FT, Oct 19)

Things in China are not very clear, at least not to me sitting on my duff in the U.S., so I’m really not sure how power between the Party, both central and local, capitalists, both industrial and financial, and military will play out.

“China said its top statistician, Qiu Xiaohua, was fired because he was linked to misuse of Shanghai's state pension fund, a scandal that has already brought down the city's party chief Chen Liangyu … At least 16 billion yuan of China's national social security fund, valued at more than 1.8 trillion yuan in 2005, has been embezzled since 1998, the official Xinhua News Agency said on Sept. 15.” (Bloomberg, Oct 19)

To just sketch out a little background on China’s power relationships, China’s pragmatists, led by Deng, asserted control over the Maoists (“Gang of Four”) in 1976-80 after Mao’s death, and implemented market opening reforms. Deng then re-asserted his initiatives in his 1992 “Southern Tour” over more conservative, old-line leftist comrades (e.g. Chen Yun, one of the "Eight Immortals," for you few sinologists) who wanted to pull back after Tiananmen in 1989. Zhu’s WTO accession in 2001 and Jiang’s “Three Represents” finalized that ideological political victory over the older leftists.

Hu’s and Wen’s recent emphasis on a “harmonious society” is a nod toward concerns about growing inequality, pollution, corruption, etc. E.g.,

“China's government said it will double social security coverage to at least 1 billion people by 2020. The party will build more low-cost houses. China's annual urban unemployment rate surged to a record 8.4 percent at the end of 2005.” (Bloomberg, Oct 12)

“[In China] to qualify for the top 500 today a person must be worth at least $100m compared with a cut-off of $6m for a top 50 listing eight years ago … China's richest mostly live in Guangdong or Zhejiang provinces, and are often active in real estate or manufacturing … there are no information technology entrepreneurs in Hurun's top 10 for the first time since 2003.” (FT, Oct 11)

“[China’s] luxury-goods market is growing as much as 60 percent a year … an estimated 300,000 U.S.-dollar millionaires in China … About 200 million Chinese live on less than $1 a day.” (Bloomberg, Oct 16)

“China estimates that the economic cost from China's industrial pollution reached $64 billion in 2004, or about 3% GDP. The cleanup cost of that mess in 2004 alone would have cost another $36 billion. China actually spent about a third of that amount two years ago. China would need a one-off investment of $135 billion to install the latest pollution-control technology. That's about 7% of China's economic output. from 2006 to 2010, China will commit $175 billion to clean up industrial pollution. some 20% of the population lives in "severely polluted" areas, 70% of the country's rivers and lakes are in grim shape. local environmental regulators owe their allegiance to local Communist Party officials.” (BW, Sep 28)

“China's securities regulator said shareholders must return any fund that may have been misused by the year's end or they will face ``legal responsibilities.'' Up to 102 Chinese publicly traded companies, or 7 percent of the 1,400 listed, have had 25.4 billion yuan ($3.2 billion) of funds misappropriated by their parents or affiliates.” (Bloomberg, Oct 13)

For additional recent details than I don't have space for, please see the China and also India sections of my Oct 24 news summary link.

Whither Russia?

As for Russia, Putin continues to flex his energy muscle. Note, this is the only secion of this article consisting solely of news summaries, all the others are mainly my analysis.

“Energy is at the heart of EU-Russian ties, with oil and gas making up more than 60 percent of Russian exports to Europe … Putin today also rejected calls to introduce investment rules modelled on the EU's free-market principles. The EU is pushing for an energy agreement with Russia, saying a free-market framework would bring in foreign capital to upgrade Russia's energy production.” (Bloomberg, Oct 20)

“near Sakhalin Island, culminating a $17 billion project led by Exxon Mobil and local partner OAO Rosneft. About 350 miles to the south, at the tip of the island, engineers for a $22 billion venture led by Royal Dutch Shell. The Shell project has no Russian partners. The attack on Shell is more about OAO Gazprom's attempt to get a piece of the project than protecting wildlife, analysts say. Sakhalin contains the equivalent of 45 billion barrels of oil, equal to the North Sea's reserves, Shell estimates. About 30 percent of Russia's energy exports will flow to Asia by 2020, up from 3 percent today, President Putin said.” (Bloomberg, Oct 19)

“Analysts said Gazprom's decision on Shtokman was almost certainly linked to frustration at what Moscow saw as US foot-dragging on the WTO deal and a broader increase in perceived US hostility towards Russia. While the Kremlin has denied linking the two issues, most observers believe they became heavily entangled this summer … the explanation from Alexei Miller, Gazprom's chief executive, that the shortlisted foreign partners had not offered suitable assets in exchange, might contain some truth … many previous deals had turned out to be highly unfavourable to Russia.” (FT, Oct 11)

“Gazprom said yesterday it would develop Russia's massive Shtokman natural gas field alone - and switch eventual output from the US to Europe - dashing the hopes of foreign companies vying for stakes in the $20bn project … The announcement highlights the Kremlin's determination that Russian companies should take the lead in developing the country's oil and gas. It follows pressure on the Royal Dutch Shell-led Sakhalin-2 project, and signs that state-controlled Gazprom wants to buy out private Russian shareholders of TNK-BP, the Anglo-Russian joint venture. The news is a particular setback for the US.” (FT, Oct 10)

"OAO Russian Railways, the state-run monopoly led by Putin confidant Vladimir Yakunin, is planning to complete a rail line crossing the North Korean-Russian border. While the project doesn't violate UN sanctions on North Korea, it shows Putin's drive to expand Russian influence. Despite delays over financing and feasibility, Russian Railways is keeping the $2.5-billion project alive. Yakunin traveled to Seoul to press South Korea to guarantee the freight that would make the Eurasian rail link economically viable. A pipeline with Sakhalin gas that would follow the path of the railway into North Korea has been under consideration by OAO Gazprom." (Bloomberg, Oct 25)

“OAO Russian Railways, the country's rail monopoly, plans to raise billions of dollars selling shares in the company or its units by 2010. Sales last year surged 55 percent. The company transports 40 percent of Russia's freight.” (Bloomberg, Oct 23)

Time to Regain America's Moral Authority, Credibility and Trust

To regain its moral authority, credibility and trust, at home and abroad, U.S. leaders must start to once again not only "talk the talk" but also "walk the walk."

Specifically, they can not in good faith and conscience ask people, including some of their own and others, and nations to make huge sacrifices and do things that they themselves are not willing to do.

That is the moral code of a fair leader and just warrior. Any leader, political, corporate, military, etc., who does not follow it will be discredited and not taken seriously today.

E.g., look at corporate CEO's who go on about how we're all in this together, then accept huge stock option grants, sometimes backdated, from controlled boards, institute mass layoffs, and renege on contractual wages, working conditions and benefits.

This is perfectly legal, especially under threat of outsourcing/offshoring or bankruptcy protection, but no worker respects these putative corporate leaders, and never will again.

Granted, most corporate leaders honestly anguish over the hard decisions they have to make, and the decisions seem to be forced on them by the cold, hard economic realities of the current version of globalization.

That's why this hyper-speculative version needs to be changed ASAP. Because in the end, the corporate leaders do make those hard decisions, incentivized by their stock options to do so.

They come out on top, and most learn to live with it, quite well of course, rationalizing it in one way or another as due to their hard work and effort in increasing "shareholder value."

U.S. elites, financial, corporate, foreign policy and others, must once again operate according to the best American traditions of plain speaking AND fair dealing.

For far too long now, they haven't always done so. That must change ASAP, before this nation loses whatever moral authority, credibility and trust it still has left, at home and abroad.

Any Hope for the Dismal State of American Politics?

“Two leading Republican senators [Lugar and Specter] joined Democrats on Sunday in calling for direct talks with North Korea aimed at easing a nuclear standoff. Sen. Biden said Japan, Russia, China and South Korea have privately urged the U.S. to allow direct talks with the North. Lugar and Specter joined Biden in calling for direct talks with Iran.” (AP, Oct 22)

“Leading Republicans and the Bush administration yesterday projected a deepening sense of American disarray over Iraq, as they argued with each other over the current state of affairs and the way forward. Several senators took issue with the administration's policies in Iraq, distancing themselves from the White House in the run-up to next month's mid-term elections to Congress.” (FT, Oct 23)

“Former Secretary of State Baker said he agreed with Republican Senator Warner that Iraqi leaders have two to three months to demonstrate concrete evidence of progress … Baker's comments and the remarks made last week by Warner are adding to the pressure on the president to change his strategy in Iraq.” (Bloomberg, Oct 8)

Let me say at the very outset of this final section, I have NOT written this article in overt support of either major party, and most definitely NOT to give election advice. I have no favorite dogs in the fight, although my biases should be obvious. Please keep that very clearly in mind as you read the following.

Key Republican and Democratic senators are increasingly publicly voicing their dissatisfaction with the current direction of the country, especially with respect to Bush/Cheney/Rumsfeld policies on Iraq. It’s not yet anywhere close to the level of Fulbright in the 1960s and Church in the 1970s, but this will probably intensify after the election, unless there is a miraculous change.

My hope is that rather than descending into an intense partisan battle between the extreme wings of the two parties, the moderate centrists in both parties will eventually unite to take control of the situation. If the former occurs, and especially if the Bush/Cheney administration is greatly weakened, then the chances for global instability rapidly escalating will probably significantly increase.

That said, my personal hope is that sensible bipartisan politicians in D.C. do whatever is necessary to rein in Cheney, in particular, before it really is too late and irreversible damage to the U.S. is done.

It is a huge mistake to under-estimate Cheney’s determination and capabilities, and also that of Rove.

Both have shown, over and over again, that unless one really finishes them off politically, once and for all, they will always come back, just like the Terminator, even more determined to push through their divisive, radical agendas. Cheney’s pushing through the Military Commission Act through Congress was just the latest example.

“Officials said Mr. Cheney’s staff and its bureaucratic allies were closely involved in guiding the talks with Republican senators. Their adversaries in the administration had to scramble just to keep up with details of the bargaining. “Basically, they were left to get back whatever they could from Congress,” one senior administration official said of the Cheney group. “And they did.”” (NYT, Oct 1)

Cheney’s and Rove’s relenteless, unremitting pursuit of their very clear agenda is why I mentioned earlier that I don’t agree with the implication of the title of Woodward’s book, “State of Denial.” Cheney and Rove are most definitely not in a state of denial, while anyone who believes so most definitely is.

Cheney has known exactly what he wants to do with military policy (I hesitate to call it foreign policy at this point) since the 1970s, when he determined that a weakened presidency was disastrous for America. He controlled the personnel process in the formation of the Bush Administration to re-shape the basic nature of American government and military/foreign policy.

Likewise for Rove, his dream of a permanent Republican realignment dominance using his ultra-cynical wedge issues of “guns, gays and God” has been crystal clear for a very long time, at least by the time he started implementing it back when he got Bush elected governor of Texas.

To many, the Bush Administration has exhibited remarkable incompetence and hubris. Personally the thing that has always bothered me the most has been its obvious unwillingness to be upfront with the American public, especially about its clear intentions. I won't speculate why it chose this route, perhaps it sincerely felt it had to do so.

Bush's style of governing has always been obvious, and can be easily seen in Woodward’s two previous books on the Bush Administration prior to “State of Denial,” and in a number of other recent well-researched books by respected mainstream journalists.

But to me at least, calling any of this “denial” is letting Bush/Cheney et al off the hook with an easy psychological label, as pop psychologists have done for Americans for decades.

As for the Democrats, for years now they have repeatedly folded under the relentless onslaught of Rove and Cheney, greatly aided by the oligopolistic electronic mass media, which is a huge, perhaps insurmountable, obstacle to true democracy and rational discourse in the U.S.

Thus the Democrats have ended up being far too often unwillingly, sometimes even unwittingly, complicit in the Bush/Cheney resulting massive loss of America’s standing in the eyes of the world and its assault on Constitutional rights at home.

Frankly, there is no other term for the Democrats’ abysmal performance as an opposition party than national disgrace. They have been the Chicago Cubs of politics, except I hardly consider the Democrats lovable losers, given the serious consequences of their inability and/or unwillingness to often offer effective opposition, for the good of the country, to Bush/Cheney.

Because of my disappointment in their performance, I am probably being even harder on the Democats than on Bush/Cheney, the latter have always been just exactly who they are, as I fully expected. But at least the Democrats have not sunk to the level of Rove, whose ultra-cynical, extremely divisive and negative political strategies and tactics are often almost beneath contempt, and have done great harm to this nation, both at home and abroad.

There may be some reading this who view it as an attack on the Republicans. Nothing could be further from my intention. Bush/Cheney do not represent traditional Republican values and policies of prudent, limited government at home and abroad, but rather essentially the exact opposite, to the great detriment of the party and nation.

“the Bush team goal is to accumulate just enough power to use the energies and passions of the base to effect ideological change in the nation’s laws and institutions, even if — sometimes especially if -- those changes might be at odds with majority public opinion … Democrats chosen alternative -- in which they swallow their true beliefs on important national issues -- demoralizes their own base … the core of their enunciated message — both vowing to stop the president’s right-wing policies and blurring their differences with Republicans on highly charged issues -- has in recent elections been a recipe for defeat … uninspiring to both the Democrats’ base and the center.” (Mark Halperin, political director of ABC News, NYT, Oct 1)

Many feel that this mid-term election is the final chance for the Democrats to put up or shut up.

“Boiled down to a line, Roveism says that Republicans can win by mobilising and motivating their core supporters. The 2004 election seemed to prove the theory right. My skeptical reaction is that we have not yet had the true test of Mr Rove’s strategy – one that tells us whether it can deliver for Republicans in less propitious circumstances and without a blundering Democratic opponent. But on November 7, we will get it.” (Jacob Weisberg, editor of Slate.com, FT, Oct 18)

“As the Democratic strategist James Carville [said] in August, “If we can’t win in this environment, we have to question the whole premise of the party.”” (NYT, Oct 1)

Personally, I felt that question was already on the table with the inept Gore campaign in 2000, and most especially with the lamentably inept campaign of Kerry in 2004.

Like millions of other American voters at the time, I was very dissatisfied in the 1980s with the direction of the country, the capture of the Democrats by its ultra-liberal wing in the 1970s, and thus its failure to at least try to protect the average working American from the already decade-long assault on its jobs and living standards, finally offering little more than discredited "re-training" schemes.

That Democratic failure to stand up for their base is what really created the white blue-collar "Reagan Democrats" in the pivotal battleground states in the industrial midwest, destroying the FDR "New Deal" coalition, and gave Rove his openings to wage "culture wars," especially in the south.

The gutting of the industrial unions, along with the waning of the civil rights movement, removed two powerful forces through which the concerns of ordinary people could be organized and focused. Instead the population became increasingly fragmented and atomized (e.g., see the work of Robert Putnam), with each family pre-occupied with individually trying to survive the decline in real wages, benefits cuts, less power over working conditions, etc.

Rove and his allies, on the other hand, were able to recruit and mobilize highly motivated political foot-soldiers from one of the few social institutions that was rapidly growing, the Christian right churches.

(As mentioned earlier, Rove's lifestyle-religious-oriented wedge issues of "guns, gays, and God" were preceded by racially-oriented ones of busing, urban crime and affirmative action, both sets of issues were very deliberately used to break up the FDR "New Deal" coalition.)

Now in the 2000s, the political pendulum has swung way too far in the other direction, and I have become even more dissatisfied with the direction of the country and the capture of the Republicans by its extreme right-wing,

Perhaps like a lot of other Americans, I am tired of this swinging back and forth between two unappealing extremes. As I tried to sketch out earlier in this article, I think the time has come for another massive, historic realignment of the political parties in America, so that the "sensible center" majority vote can once again take control of the U.S. government.

I honestly don’t care how this realignment comes about, as I said, I have no favorite dog in the fight, and under whose banner it would occur, call it Republocrat if you like, just so that it finally happens.

But I just don’t see yet how it will.

Politics, like life, is all about power, money and status (Freud would add sex). Ideas are nice, that’s why I write these articles, but ideas are meaningless without the power and money to do something about them. For there to be a major political realignment, there needs to be a huge source of power behind it and money to fund it.

As I said earlier, I think the Democrats desperately need to break the financial control of their party by the Hollywood left and the Wall Street hyper-speculators, who are now heavily contributing to them again, via Schumer and the Clintons. The Republicans are clearly captured by mega-corporate America, especially oil and gas and military industries.

So where is the money and power to come from to fight a major realignment battle? The unions are moribund.

Many in the technology elite have extremely good intentions and a huge amount of money to do something about them. Microsoft’s Gates and Google’s Page and Brin are just a couple of the most obvious examples. Moreover, unlike the Wall Street hyper-speculators and the Hollywood fantasy crowd, the technology elite is strongly connected to the real economy and is deeply committed to global progress.

Obviously I am very biased in favor of the technology elite, my web site’s name, "econotech," clearly indicates that. That is why I have been so disappointed with the direction of Silicon Valley since the collapse of the 1990s TMT equity bubble.

It has dramatically moved away from being the Valley of Intel's Grove, Moore, and Noyce, physical scientists and electronics engineers, great American heroes whose innovations positively affected everything in modern life, and of Oracle's Ellison and Cisco's Chambers, great American business leaders who helped to dramatically improve corporate productivity, to one that is now dominated by media and advertising, by the popular fantasy culture mentality of Hollywood and Madison Ave.

It would have been far better for the U.S. if the bi-coastal technology elite, some with midwest roots, had allied with the midwest industrial elite in the 1980s, when both were under relentless assault from Japan, where such an alliance still exists, as in other advanced industrial nations such as Germany, which is one reason they can still make big-screen tv’s and great cars.

Unfortunately, that didn’t happen, and now the once-proud and globally dominant American midwest industrial elite is a tiny shell of what it was fifty years ago when GM's "Engine Charlie" Wilson made the quote I noted earlier about "what's good for General Motors is good for the country," along with the blue-collar industrial unions such as the UAW, both prey to “vulture capitalists” like Tepper who described himself above as “not causing economic pain -- just capitalizing on it.”

A couple of decades ago, a younger Steve Jobs once asked his prospective CEO and future nemesis, do you want to spend your life selling sugar water, soda pop? Nearly half of Apple’s revenues are now dependent on music, mostly pop pop. Purely coincidentally, the stock of Google of Mountain View, which just acquired YouTube, is once again hitting new highs, while that of Peoria's Caterpillar just had a sharp drop.

At this point, I wouldn’t be surprised to open Yahoo’s home page one day to see a headline in small text in the news section such as “Another War Breaks Out in Middle East” buried underneath a banner headline for a video, “Next 15-Minute of Fame.”

If too harsh, I’m sorry. I really hope I’m wrong, and that the Internet, like television over fifty years ago, really does live up to its hope, hype, promise and potential of making the world a much more informed and better place, as Google's founders have always worked for.

“Politicians with profiles that get the most traffic know that on MySpace, it is important to do as the under-30 crowd does: make public what is personal -- and don't skimp on the trivial.” (WSJ, Oct 14)

I judge good intentions by the bottom-line results.

In 2004, a President was re-elected with the strong support of Rove’s political base, many of whom did not know the most simple, basic facts regarding the President's stated reasons for going to war in Iraq long after the truth had become known, as repeatedly shown in polls to this day. Presumably some of these voters had broad-band Internet access to find out the truth buried in the blogosphere, along with their car's talk radio.

If a stronger nation invades a weaker one in a so-called "pre-emptive" war, then it, its government, and its citizens, have a legal and moral duty, especially to the armed forces it puts in great danger and to the people of the invaded nation whose lives will be greatly impacted, to know the reasons why it is doing so, what to reasonably expect, including worst case scenarios, and what needs to be done to minimize them.

Now look at the results after that 2004 re-election:

“early September poll of 1,150 found: Almost four in five Iraqis say the U.S. military force in Iraq provokes more violence than it prevents. About 61 percent approved of the attacks [on U.S. forces] — up from 47 percent in January. A solid majority of Shiite and Sunni Arabs approved of the attacks. The increase came mostly among Shiite Iraqis … The State Department has also conducted its own poll, found that two-thirds of Iraqis in Baghdad favor an immediate withdrawal of U.S. forces.” (AP, Sep 28)

“More than 2,660 Iraqi civilians were killed in the capital in September amid a wave of sectarian killings and insurgent attacks, an increase of 400 over the month before, according to figures from the Iraqi Health Ministry. The increase came despite an intensified U.S.-Iraqi sweep of Baghdad that was launched in mid-August to try to put down the wave of violence that has swept over the capital.” (AP, Oct 11)

So until I see otherwise, I will remain highly skeptical about positive political change in this country, from either major party.

Despite all I’ve said above, please don’t forget to vote, it’s our right, privilege and duty.

Who knows, perhaps some day a political statesman-entrepreneur with Lincolnesque courage and compassion eventually will come along to do what historically needs to be done. I hope so, but as they say, hope is not a strategy.

For those patient enough to get to the end of this very long article, I will go back to reviewing and analyzing the financial markets in a future article.

And thanks very much, I greatly appreciate your time and interest.