Risk & Opportunity

A quarterly political and economic newsletter published by Michael Cuddehe

Q3 and 4 '11

Real Change is Coming

The reality of the economic catastrophe that has been created by 30 years of debt creation, laissez-faire globalization and upward redistribution of wealth, is gradually and steadily asserting itself. Our leaders have been doing everything they can think of to first deny, and then delay, delay, delay the inevitable, but big changes are beginning to take shape on every front, and these changes are ultimately going to impact virtually everything.

Domestically, Occupy Wall Street is a gathering storm that is not going to go away. In Europe, the slow moving sovereign debt meltdown is presenting a new drama every day and roiling markets globally. Our own slow moving political meltdown was again demonstrated by the failure of the Super Committee to agree on anything. Geopolitically, the U.S. continues to lose influence around the globe, even as we commit to expand our military “footprint” everywhere, and the pace of realignment is quickening. And in the “from out of left field” category, scientists at CERN have confirmed the measurement of particles traveling faster than light, a development equivalent to the recognition that the world is not flat, or that the Earth is not the center of the universe. What changes in human civilization this might usher in are hard to imagine.

Our chronic economic problems are all being politically driven at this point. There is a desperate need for a reality-based public debate and policy response to the metastasizing crisis. However, any efforts in that direction continue to be stonewalled by Republicans, who are convinced that they will gain in the upcoming election by preventing any improvement in the situation, and who continue to deny any responsibility for the disaster that their policies have created (in fact they continue to promote the very same policies). Feckless Democrats either don’t understand what is happening, or are too cowardly to speak up.

Markets

Markets across the board have been gyrating viciously for months, driven by the Greek (and Spanish, and Italian, and Portuguese, and Irish, and French) sovereign debt crisis, and the indecisiveness of Eurozone policy makers in crafting a solution to the problem.

In the U.S. we are looking at diametrically opposed policy “solutions” to the current economic malaise yielding dramatically different market outcomes. Given the polarized debate and policy options, we are either going to have a Republican sponsored all-out depression, or a Fed sponsored inflationary spiral that could morph into hyperinflation. Obama, as usual, has been trying to split the difference, but as usual that effort has not been working. Instability is increasing. Market participants have no confidence in their positions, and are quick to jump out, and slow to get back in. Price action is even more volatile and unpredictable than usual. I wish I could say otherwise, but I can’t find any reason to think the situation is going to improve any time soon.

Europe

Eurozone policy makers keep trying to buy time with short term fixes, but the banks are broke and need to be recapitalized, or they will go under and take the Euro with them.

When the architects of unified Europe created the Euro, they did not include a mechanism for adjusting the price of debt issued by the various member states according their creditworthiness. For some strange reason, instead of penalizing Germany for affiliating with Greece and other less credit worthy nations, global bond investors have given Greece and the other less credit worthy members a free ride on Germany’s pristine credit rating. As a result, Greece (and others) have been borrowing money for years at the same rate as Germany. It doesn’t take a Ph.D. in economics to figure out that this arrangement will probably not end well.

To simplify a rather complex situation, European banks have bought all of this debt at super low rates (high prices), and now that the bond market is pricing that debt at much higher rates (lower prices), the banks are seriously under water. So the banks need to be bailed out. But the Bundesbank and German taxpayers, who will have to pick up the lion’s share of any bailout and who still retain a vivid national memory of the Weimar era hyperinflation, don’t want any part of it. In fact, the Germans originally went along with the Euro because they were explicitly promised that they would not have to do this very thing. Things have gotten so bad that even Germany was unable to sell out a recent bond offering.

As usual, John Mauldin is a good source of timely information. He has been publishing a series of in-depth articles on the unfolding Euro-disaster in his Outside the Box newsletter. Mauldin also published an especially insightful piece entitled “An Irish Haircut” in his Thoughts From the Frontline newsletter, which delves into how the Irish view their situation.

The bottom line for the Irish is this: if investors are taking a haircut on Greek debt, thus relieving Greek taxpayers, the Irish will demand the same. The Irish are not presently in the streets, but their patience should not be taken for lack of resolve. They will demand it. Extrapolating to the rest of Europe, if the Greeks and the Irish get a haircut, then what of Italy, Spain and Portugal, even France? The situation is simply not resolvable with the half measures that are currently being deployed.

Yves Smith has also been providing extensive coverage of the European crisis and other economic issues on her excellent blog Naked Capitalism. For those intrepid enough to dig into the minutia of this very complex situation, see “Europe’s Plan to End the Debt Crisis – Putting the ‘Con’ in Confidence,” Part I and Part II, by Satyajit Das.

Politics

The Republican Party has been captured by the lunatic fringe of American politics and has become, in the words of Paul Craig Roberts (former Assistant Secretary of the Treasury under Ronald Reagan) “the greatest threat America has ever faced.” I encourage my readers to review Roberts’ 2008 essay at Counterpunch, “The Mother of All Messes,” just as true today if not more so, and my own 2010 op-ed at the Denver Post on the consequences of sending Republicans to Washington, entitled “The Republicans’ Wrecking Ball.”

The Republican “base” is composed of people who cheer for executions and letting the uninsured die, and who hope that our President’s policies fail. Their representatives in Washington are doing everything they can to make sure that the President fails, regardless of the cost to the nation. It hardly needs to be said, but these are profoundly disloyal and un-American sentiments.

The nature of the modern Republican Party is captured by this quote from John Judis, courtesy of Josh Marshall at TPM.

“Over the last four decades, the Republican Party has transformed from a loyal opposition into an insurrectionary party that flouts the law when it is in the majority and threatens disorder when it is the minority.”

The 2012 election season has already begun (heaven help us!). Given his performance and the chronic economic malaise, Obama wouldn’t have a prayer of being re-elected if the Republican Party presidential nomination process had not turned into a freak show. At this point the Republican field gives Obama a pretty good chance. Mitt Romney appears to be the likely nominee. Romney is a political chameleon who changes his position on issues so frequently that it is hard to know what he stands for. Real conservatives hate him and have been offering up a series of lunatic true believers – Michele Bachmann, Rick Perry, Herman Cain, and the latest, Newt Gingrich — in hopes of displacing Romney.

Occupy Wall Street

Occupy Wall Street is the first manifestation of a popular uprising that will eventually sweep away the existing economic paradigm. The 99% have been remarkably indulgent of the fraud (supply side economics, otherwise known as Reaganomics or “voodoo economics”) perpetrated on them for the past 30 years. It appears that we have finally reached the breaking point. Unlike the Tea Party, which from the beginning was the creation of well financed Republican political operators, Occupy Wall Street is a genuine grass roots phenomenon. It’s interesting to note that one of the main criticisms of OWS is that it doesn’t have a political agenda…it’s simply a protest. Critics don’t seem to understand the significance of that reality. A political agenda will inevitably rise out of this protest…in fact it will be more than an agenda, it will be a movement based on the principles of economic justice, commonwealth, and public service. It is not going to be friendly to the status quo or to those who try to hold on to it.

No-one likes to pay taxes. That’s a given. However, any and all efforts to increase taxes, even modestly, on the upper tier (which benefitted so massively from the run-up of debt over the past 30 years), has been assailed by Republicans as class war. Reflecting the growing anger at the intransigence and the fundamental dishonesty of this position, the Economist posted this item on 9/21 entitled “Class War”:

“There is a class war in this country, a war between the subsidy barons, the regulatory arbitrageurs, the patent monopolists and the rest of us. Mr Obama is a class warrior. The trouble is he’s on the wrong side.

During Mr Obama’s reign, the revolving door between Washington and Wall Street has been replaced with an open garage door you can drive a hybrid truck through.”

When the Economist — a very traditional and balanced conservative publication — posts something like this, then you know the ground has shifted. Ironically, Republican intransigence on this matter will go a long way towards generating a real class war.

While the debt-financed party was ongoing the vast majority were only gradually losing purchasing power. Like the frog put in the pot of cold water and then slowly cooked, the majority didn’t realize what was happening to them. Meanwhile, the vastly inflating riches of the upper tier were being financed entirely by debt that would eventually have to be shouldered by the 99%, who are finally beginning to wake up. The so-called conservatives who have been painting Obama as a socialist are going to have to find a new term for the real socialism that is coming.

The following chart illustrates the central issue that is driving Occupy Wall Street. No commentary needed.

And the next chart represents the issue that pushes people over the indignation edge and out to the streets. In 2009 alone, the five highest paid financial executives at bailed out firms received just shy of $100 million in combined compensation, even as their companies were laying off 110,000 people and absorbing over $130 billion in taxpayer subsidies.

Source: Economic Populist

Egregious as it is, however, this chart represents just the tip of the iceberg of what can only be called corporate looting. It doesn’t include the “golden parachute” payments to failed CEO’s such as the $161 million paid to Stanley O’Neil in 2008 after he destroyed Merrill Lynch, or the $100 million paid to Chuck Prince who nearly brought down Citicorp (saved by the taxpayers). And of course none of this touches the billions of dollars paid out in bonuses during the lead up to the meltdown, as the banksters were busy heaping up fuel for the bonfire that would consume our economy for at least a generation. A recent Bloomberg article documents over $7 trillion in Fed loans (read: taxpayer subsidies) to the banks in 2008.

William Cohan posted an excellent article on Bloomberg that identifies the central problem on Wall Street entitled “Ending the Moral Rot on Wall Street.” The following quote sums it up:

“Human beings are pretty simple. They do what they are rewarded to do. On Wall Street, people are rewarded when they take big, short-term risks with other people’s money. Trouble is, they are rewarded not only when the bets pay off, but also when they don’t. There’s probably no practical way to return to the private partnerships that required people to put their net worth on the line, but a way must be found to require bankers, traders and executives to have skin in the game.”

Meanwhile, 46 million Americans are living in poverty, the biggest number ever, over 15% of our people, even as the median corporate CEO has bounced back to pre-2008 levels, and is getting paid 343 times the average wage of their employees, up from 42 times in 1980.

Geopolitics

The global political temperature is rising and the pace of realignment is quickening. Obama is putting the screws to the Pakistanis on their double dealing with the Taliban. This has created political chaos in nuclear Pakistan, and our relentless drone attacks inside Pakistan are feeding the fire. Every incident of civilian casualties from our drone attacks is broadcast far and wide, further inflaming anti-American sentiment throughout the Muslim world. These repeated incidents are destroying what is left of America’s moral authority globally.

The “Arab spring” has created openings for Islamists throughout the Middle East. Israel is now more isolated than ever as Egypt and Turkey have backed away from long term alliances. Iran stubbornly persists in its nuclear program in the face of crippling economic sanctions, while neo-cons lobby for military action against Iran.

At the same time, we are pledging an increased military “footprint” in the Far East to counter China’s growing influence, and in the Middle East to counter Iran. Folks, we simply cannot afford to continue to project military force around the world, unless the world wants to pay us to be the global policeman, which seems highly unlikely. Our fiscal situation is dire, and the entire Western debt based economic model is growing unstable. We have big problems at home and we need to withdraw from empire.

The military industrial complex is about to meet its Waterloo, in the form of the American people, who are increasingly going to start saying “no more foreign military adventures…bring home the troops.” Readers might want to check out Ron Paul’s sensible foreign policy positions. Paul is generally known for his Austrian economic philosophy and more specifically for his opposition to the Fed. Depending on how quickly the metastasizing global financial crisis unravels, however, it is Paul’s foreign policy positions that are most likely to make him a real contender for the Republican nomination. See David Sirota’s piece “Why Young Voters Love Ron Paul.”

Opportunity

See the Economist’s 10/15 cover article “Nowhere to hide: Investing during a crisis.” The lede pretty much covers it…”Investors have had a dreadful time in the recent past. The immediate future looks pretty rotten, too.”

Summary

I still expect that an “all hands on deck” effort to maintain stability going into the election will be successful despite Republicans’ best efforts to create chaos. The wild card is the looming breakdown in Europe. After the election I think we will see the end game, and which way it goes will in large part depend on who wins the election.

Our market risk these days is being driven almost entirely by political developments. As with bear markets, destructive social phenomena often reach their nadir when things are looking hopeless. Several recent developments have given me some hope that the destructive downward spiral in our political process may be starting to bottom out.

The Citizens United decision is becoming a battle ground and focal point around which good government forces can galvanize. Common Cause, Public Citizen and Move to Amend among others have been gaining traction with efforts to overturn this decision. Senator Tom Udall is leading the effort to overturn Citizens United in the Senate, and several Congressmen have offered language for a Constitutional Amendment to overturn this egregious decision.

In another hopeful development, former Colorado Senate Majority Leader Ken Gordon (termed out) has launched a website dedicated to publicizing and supporting candidates who refuse to take special interest money — CleanSlateNow.org. This is a worthy effort that will hopefully gain traction nationally. I encourage my readers to give their support to any and all efforts to eliminate the corrupting influence of big money on our politics.

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