A REPORT FROM THE WALL
2,112 days--and counting--of global shaking, destabilizing change, dysfunctional math, widespread volatility, and soft anarchy
For recent subscribers, the thesis of this newsletter is to explore the remarkable uniqueness of our era. Something different is happening on our generational shift, yet seldom do people realize the historic when they are living through it. The staggering rapidity of change, the dysfunctional math, and the increasingly vertical curves are all alarming. We are caught in an acceleration trap and can't seem to find our way out. History is not playing by the rules. We've navigated ourselves off the map and are making it up as we go.
As usual, we see both positive and negative developments. Having said that, because of the suddenness, drama, and volatility implicit in this thesis, we are well served to pay particular attention to the dangers that might lie ahead.
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Beginning with positive news, the auto industry has picked up impressive speed (at least until very recent slowing). Real estate finally seems to be gaining some traction, although uneven. Corporate profits continue their impressive gains. Gas prices are finally down a bit.
Unfortunately, the news is mixed. We have positive job creation and economic growth (about 2%), for which we are grateful. Both, however, are anemic and not nearly what we expected this far into the recovery. The stock market, after a wild and frightening ride last August and September, rose substantially for the next seven months with the Dow up 2300. Since May 1, however, it has fallen 760, largely due to fears regarding Eurozone contagion.
JP Morgan Chase is the largest US bank and one of the few to survive the recession in healthy shape. Its sterling reputation took an embarrassing hit, however, when the bank announced a $2 billion loss (possibly as high as $4 billion) due to "egregious mistakes" in a failed hedging strategy involving credit default swaps. CEO Jamie Dimon, regarded as the smartest person in any room and the most respected banker in the nation, admitted "the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored." It was largely run out of the London office by Bruno Michel Iksil who once claimed he could "walk on water." The irony: Dimon, once thought next in line for Treasure Secretary, lobbied repeatedly against increasing government regulation of risky bank activity.
Only four months after California Governor Jerry Brown said there would be a state deficit of $9.2 billion, he was forced to revise it to $16 billion. Failing tax increases, schools, universities, and social services will need to make deeper cuts in what one observer called anti-Christmas.
Facebook went public with its stock in the third-largest IPO ever offered, impressive for a company only started in 2004, now with 900 million participants and worth $100 billion. A record 570 million stocks changed hands on the Friday debut. Then came the rain on the parade, nothing but criticism for the botched event: the initial price was too high, the number of shares offered too many, critical investment information was withheld, the social network site will prove a fad, and the revenue-generating model will fail. There are multiple class-action lawsuits already filed. For its part, NASDAQ was plagued with chaos and glitches the entire day, a "complete cosmic catastrophe," including a 20-minute delay initiating trading caused by a "millisecond systems blip due to the largest IPO auction in the history of mankind." In disgust, Facebook is considering leaving NASDAQ.
The Patient Protection and Affordable Care Act, otherwise known as Obamacare, is awaiting its fate at the hands of the Supreme Court. Six hours of oral argument took place March 26-28 with the Justices voting soon thereafter. All that remains is for the decision to be written and then issued some Monday in June. The bill is a massive 2,800 pages and 400,000 words and deals with the most complex and expensive domestic issue this country has ever faced. If the Justices find the PPACA unconstitutional, there are two options: portions might be retained to go forward or else the entire bill scrapped. We desperately need effective healthcare reform that bends the $2.6 trillion cost curve. This current act, however, has been besieged by controversy from the beginning: how the vote itself was conducted, the question if it is a back-door single payer, the fear it will increase the cost of healthcare, the lawsuits filed by the states regarding the constitutionality of an individual mandate to buy insurance, and also the twelve lawsuits filed by 43 Catholic institutions in protest of clauses violating their religious liberties and conscience rights.
As impressive as the above list of epic issues appears, it is still our long-term debt problems that dominate my thinking.
- Our rapidly-rising national debt of $15.7 trillion, nearly 104% of GDP
- The astounding $1.3 trillion federal deficits for each of the years 2009, 2010, 2011, 2012
- Our total national debt at $57 trillion
- The unfunded mandates of $117 trillion: Social Security ($15 trillion), prescription drug costs ($20 trillion), Medicare ($82 trillion)
- The ignored debt commission report (Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform) presented December 2010, then shelved
- The Senate not submitting a budget for 3½ years
- The President's budget voted down 99-0, again
- The contagion we face from a highly unstable Eurozone situation
- Another shut-down-the-government debt ceiling vote scheduled at the end of this year
Nouriel Roubini calls himself a global nomad: born of Iranian Jews, lived in Turkey and Israel, educated in Italy and Harvard, worked at Yale, IMF, Federal Reserve, World Bank, Council of Economic Advisers, US Treasury. He now teaches at New York University's School of Business and is chairman of Roubini Global Economics. Impressively, he was spot-on in his predictions of the real estate collapse and subsequent severe global recession.
For more than a year, Roubini has sounded alarm bells regarding our "2013 fiscal cliff."
Many things are expiring at year end. All the tax cuts on income, on dividends, on capital gains, on estates. There's an expiration of the payroll tax (cut). There is a reduction or expiration of transfer payments to state and local governments, to unemployment benefits. There is the expiration of infrastructure spending, and then there are the automatic cuts on discretionary spending, which came about because we failed to reach an agreement for reducing the budget deficit. The point is, all this is expiring at year end, and the hole will be $600 billion, or about 4% of GDP, and then we plunge into a nasty recession. Now, some items may be continued (if the Republicans and Democrats can agree to extend) but a realistic assessment is a fiscal drag. Even if the cliff is not a free fall because some items won't expire in an agreement, there will still be the beginnings of a fiscal drag, because you reduce disposable income by raising taxes, and (by) cutting transfer payments, you reduce aggregate demand by reducing government spending.
The thing I most appreciate about Roubini is his absolute fearlessness, a total intellectual freedom to be ruthlessly honest. In addition, he is a brilliant integrator of trends. Regarding 2013, he predicts a recession but no stock market collapse, along with a warning that political and economic courage will be essential.
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On the global economic front, the Eurozone debacle remains the most dangerous story, with Greece still making the jazziest headlines. The already-limping country has suffered additional downgrades with their banks and sovereign credit ratings, has shortages of food and medicine, can barely keep the lights on, has a 21% unemployment rate, and is fatigued by severe austerity. Greek frustration was expressed in May 6th elections when the austerity parties failed to win a majority to continue painful belt-tightening. Opportunity to form coalition governments failed, forcing another election June 17. Do they vote for despair (austerity) or devastation (exiting the Eurozone)? If they default on debt payments, there will be consequences. To receive bailouts from other nations, particularly the Germans, they must play by the rules. If not, they must leave the Eurozone. That seems increasingly likely. But abandoning the Euro and reverting to the Drachma will cause collateral damage all over the place, even the US.
Roubini calls the Eurozone a "slow-moving train wreck." A Brussels think tank says the governments and banks of the struggling peripheral economies are locked in a "dance of death." A French asset manager says a Greek exit would be a Pandora's box: "It's a disaster that would leave the door open to other disasters." The second largest French bank estimates a Greek exit could result in more than $1.1 trillion loan and currency losses in the US and Europe.
Most feared by leaders is a run on banks in any of the involved countries. Once trust and credibility go, the race to remove funds becomes crowd psychology gone wild. Watch out below.
The situation in Spain has worsened significantly, making it, for some, even more worrisome than Greece. Their banking and real estate sectors are in severe distress and unemployment remains at depression levels of 24.1% (youth 51%). Moody's downgrading of 16 Spanish banks was not a surprise. Italy, too, received a Moody's downgrade of 26 banks.
The French elections thrashed Sarkozy out of office and sent Francois Hollande to Palais de l'Elysee, the first socialist party candidate to occupy the presidency in seventeen years. He, too, is opposed to austerity and prefers growth (who doesn't?). Meanwhile, German Chancellor Angela Merkel's party has suffered repeated regional defeats from a populace that resents their hard-earned money backstopping loans to irresponsible countries. In other words, other than a similarity in anger and frustration, the German mood is the precise opposite that of the French and Greek mood.
Taken together, the situation is so tightly coupled it could easily spiral beyond anyone's control and lead to deposit flight risk.
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If global economic distress centers on the Eurozone, in the broader geopolitical world, distress still points to the Middle East. With sanctions biting deeply, Iran has been forced back to the negotiating table in Istanbul, then Baghdad (next Moscow). The two sides remain far apart over Iranian nuclear aspirations and IAEA inspections. But with their backs to the wall and with full-blown sanctions coming on-line the end of June, Tehran is at least pretending to play ball. A recent UN report reveals continuous expansion of Iranian capacity in the underground bunker facility at Fordo. This tiny village of 700 near the holy city of Qom was discovered in 2009 to secretly house extensive nuclear installations buried into a mountain. Recent inspections there discovered hundreds of additional newly-installed centrifuges representing the undeniable progress of Iran in its nuclear ambitions.
Several items are of concern:
- Iran continues to insist on a "right" to enrich uranium when no such right exists within the Nuclear Non-Proliferation Treaty. If a country requires 20% enriched uranium for medical isotopes, other nuclear countries such as the US or Russia supply it as needed.
- The new centrifuges continue to advance Iran's capacity. The Fordo facility now has 500-700 compared to their previous 300. The Natanz facility has 9,330 compared to 9,156 in February.
- Iran doubled their supply of low-enriched uranium since February, after tripling it in the three months preceding February.
- There is much more low-enriched uranium than would be needed for medical isotopes, yet the six world powers have failed to persuade Tehran to freeze its 20% enrichment program.
- A few traces of uranium were found to be 27% enriched, which Iran says was a technical issue but, by definition, is highly enriched. (slightly-enriched uranium is 2-3.5%; low-enriched uranium is up to 20%; highly-enriched uranium is above 20%. Bomb making requires 85-90%)
- Satellite photos show possible "sanitation" of a suspected nuclear facility which the IAEA is seeking to inspect at the Parchin military complex. Indications from different sources point to high-explosives tests conducted there in a specially designed chamber.
- According to the Institute for Science and International Security, a US think tank, Iran now has enough 3.5% enriched uranium hexafluoride, that if further refined, would be sufficient for five nuclear weapons.
Israel, for its part, is not buying Iran's "deceive and delay" strategy. Talk accomplishes nothing in Netanyahu's mind except giving time to the Persians and false hope to the West. Only severe sanctions, credible threats, and military power can thwart Iran's plans. And, of course, cyber warfare weapons such as the newly discovered and massively complex Flame infecting Iranian computers.
In a shocking move, Netanyahu suddenly aborted his plan for new September elections through which he would have won four more years as prime minister. Instead, on May 8th, he joined forces with the opposition Kadima party to form a unity government. This gives him a supermajority but only guarantees him 18 months of secure leadership. Why would he trade four years of power for 18 months? The US administration fears it is all about Iran. Netanyahu has now consolidated power sufficiently to attack Iran prior to the November US elections. He is fearful that Obama, if reelected, will prove antagonistic to any military attack on Iran in his second term. The presidential issue aside, on May 9, the US House of Representatives voted 411-2 to pass the United States-Israel Enhanced Security Cooperation Act of 2012.
And then there are Syria and Egypt. Syrian President Assad has now killed 10,000 of his people in a 14-month brutal and protracted battle. Massacres are common, including children. The Syrian opposition has reached Damascus, killing 55 in a series of explosions. Assad's inner circle has been threatened. Syria reported to the UN that al Qaeda and the Muslim Brotherhood have joined the battle against them, with fighting now reaching across into Lebanon as well. The Syrian National Council head told a Saudi paper that the opposition has no intention of normalizing relations with Israel after they displace Assad. For its part, Israel is also worried about Syria's extensive biological and chemical stockpiles falling into the hands of someone insane enough to use them against the Jews.
The chaotic elections in Egypt add distress to not only Israel but also Egyptian students, women, intellectuals and Coptic Christians. Ah, the Arab Spring and what might have been...
- Be alert
- Be sober
- Be frugal
- Be content
- Do not lose heart
- Do not be afraid
- Live ready
- Thank God every day for the privilege of living in such interesting times.