Generational Dynamics: Forecasting America's Destiny Generational
Dynamics
 Forecasting America's Destiny ... and the World's

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Web Log - September, 2007

Summary

Sunday news shows: What would we do if we captured Osama bin Laden?

And the Democrats refuse to commit to end Iraq war even by 2013.

Al-Qaeda expert Lawrence Wright provided a kind of "screenplay" scenario for the capture of Osama bin Laden.

One of the most widely asked questions today is: Why haven't we yet caught Osama bin Laden?

Lawrence Wright, author of the Pulitzer Prize winning book, The Looming Tower: Al-Qaeda and the Road to 9/11, provided an answer to that question and another one: What would we do if we captured him? The answers were provided on Face the Nation on Sunday:

Bob Schieffer: Why can't we find Osama bin laden?


Lawrence Wright with Bob Schieffer on <i>Face the Nation</i> <font face=Arial size=-2>(Source: CBS)</font>
Lawrence Wright with Bob Schieffer on Face the Nation (Source: CBS)

Lawrence Wright: It may very well be, Bob, that we more or less HAVE found him. We know that he's in the tribal areas, probably. And yet, we decided not to get him, because going into the tribal areas to actually find him might destabilize Pakistan. At least this is the view of a lot of American policy makers. So in a general way, we have found him. In a specific way, we don't know exactly where he is, probably, but the hunt for bin Laden has essentially stopped at the borders.

Bob Schieffer: If we caught bin laden, what would we do with him?

Lawrence Wright: The CIA asked me that question, because I'm a screenwriter.

They appealed to me for a scenario, and I said I can't write a screenplay for the CIA because I'm a reporter, but I'll tell you what I think, in the form of an op-ed.

First of all, he's the most famous man in the world - he's going to be one of the most famous men in history. So you don't just deal with bin Laden the man. You have to deal with "bin-Laden-ism" and the legacy that he's going to leave for untold generations.

So if you find him, don't kill him, because that's what he wants, and his martyrdom will seal that legacy in amber for all eternity.

But don't bring him to America - not right away. Take him first of all to Kenya where, on August 7, 1998, he set off a bomb in front of the American embassy and killed over 200 people. More than 150 were blinded by the flying glass. Let Osama bin Laden sit in a courtroom in Nairobi and tell 150 blind Africans that he was just striking at a symbol of American power.

Then, after that, take him to Tanzania where, on the same day, he set off another bomb in front of another American embassy killing 11 people, all of the Muslims.

Al-Qaeda excuses that because it was Friday, and "good Muslims" would be in a mosque. It would be a wonderful venue to ask, "What is a good Muslim?"

Then you can have him answer for the Cole bombing, and the 3000 people who died on 9/11, and you could take him so many other places. Just take him one last place. Just take him home to Saudi Arabia, where hundreds of Saudis and ex-pats have died, and try him under Sharia law. And if he's convicted, he'll be taken to a square, a "chop-chop square" in downtown Riyadh. And the Saudi custom is that the executioner goes out and beseeches the crowd, who are composed of the families of the victims of the condemned man to forgive him. And if they can't do that, then the executioner will do his job and bin Laden will be taken and buried in an unmarked Wahhabi graveyard. I think in that way you can begin to roll back some of his legacies."

Wright later added that bin Laden's al-Qaeda has suffered many defeats and is weakened, but worldwide al-Qaeda has been strengthened because of alliances among many terrorist groups.

I would add the following to this, from a Generational Dynamics point of view.

Suicide bombings and other terrorist acts committed by groups loosely related to al-Qaeda are explained by generational factors, as I described in a series of articles following the July 7, 2005, London subway bombings. This was summarized in last December's article on the MI5 chief's speech, saying that the U.K. population contains thousands of Islamic terrorists and sympathizers.

We're seeing that suicide bombers only come from societies that have entered generational Crisis periods, and not before. This indicates that when a society enters a generational Crisis period, the society becomes fundamentally changed, so that the creation of suicide bombers becomes possible. (And as I showed in my analysis on Iraqi Sunnis turning against al-Qaeda in Iraq, there are virtually NO Iraqi suicide bombers, since Iraq is in a generational Awakening era; they all have to be imported from Jordan or Saudi Arabia.)

Further findings, obtained by combining Generational Dynamics research with Robert Pape's study of suicide bombers, published in the book Dying to Win, we find that suicide bombers justify their terrorist acts as "altruistic suicide." Pape found that suicide bombers most likely come from countries occupied by another country, and his research shows that they come overwhelming from countries that have passed through a generational crisis era without having a crisis war. In these countries, the parents have accepted the occupation, albeit bitterly and reluctantly. But their impatient children take it upon themselves to free their parents' generation from this occupation by this unique form of altruistic suicide.

In the case of the London subway bombers, the perpetrators had backgrounds in Pakistan and were bitter about the Kashmir region, disputed between Pakistan and India. They were England-born citizens, but had developed a generational "Hero - Prophet" relationship with radical clerics in Pakistan; that is, the suicide bombers become "heroes" through their altruistic suicide, and they're guided by the Pakistani clerics who assume a kind of spiritual "prophet" role toward the "heroes."

From the point of view of Generational Dynamics, this Prophet/Hero relationship is extremely powerful. This is how crisis wars begin. During generational Crisis eras, young people are confused by the lack of direction in society as a whole, and they turn to these "Prophets," based on the appeal that they can become "Heroes."

So Lawrence Wright is correct when he says that al-Qaeda linked groups are becoming stronger in many countries around the world, as they're fed by foreign fighters linked to countries in generational Crisis eras.

And Wright is TECHNICALLY correct when he said that Osama bin Laden's al-Qaeda has been weakened militarily.

But what I've shown is that the bin Laden's al-Qaeda has been getting increasingly STRONGER in this spiritual "Prophet" sense. Al-Qaeda linked terrorists in many countries may not be working under bin Laden's direct orders, but they're working under the powerful influence of bin Laden's "teachings," as adopted by clerics in Pakistan.

Lawrence Wright's warning not to turn bin Laden into a martyr is certainly correct. A dead, martyred bin Laden would become an even more powerful symbol to these Pakistani "Prophet" clerics.

--------------

Another issue touched on at various times in the Sunday news talk shows is that the leading Democratic candidates for President have refused to commit to end the Iraq war even by 2013.

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Here's an AP news story on this subject:

"The leading Democratic White House hopefuls conceded Wednesday night they cannot guarantee to pull all U.S. combat troops from Iraq by the end of the next presidential term in 2013.

"I think it's hard to project four years from now," said Sen. Barack Obama of Illinois in the opening moments of a campaign debate in the nation's first primary state.

"It is very difficult to know what we're going to be inheriting," added Sen. Hillary Rodham Clinton of New York.

"I cannot make that commitment," said former Sen. John Edwards of North Carolina."

This doesn't surprise me in the least. Here are some of the points that I've been making about Iraq on this web site since 2003:

As I've said many times on this web site in the last few years, my expectation is that we'll still be in Iraq when the Clash of Civilizations world war begins, and we'll withdraw at that time because our forces will be needed elsewhere. (30-Sep-07) Permanent Link
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Alan Greenspan admits that macroeconomic forecasting is a failure

Saying that it's no better today than it was 50 years ago, former Fed chairman Alan Greenspan told Jon Stewart of Comedy Central's Daily Show that forecasting hasn't improved because human nature can't be changed.


Alan Greenspan being interviewed by Jon Stewart <font face=Arial size=-2>(Source: Comedy Central)</font>
Alan Greenspan being interviewed by Jon Stewart (Source: Comedy Central)

Here's my transcript of the final portion of the interview:

"Greenspan: No, actually, what a sound money system does is to stabilize all the elements in it, and reduces the uncertainty that people confront.

And the one thing that all human beings do when they're confronted with uncertainty is pull back, withdraw, disengage. And that means that economic activity, which is really dealing with people, just goes straight down.

And so the key problem is ...

Stewart: It's about perception then. It's about making people believe that the system is sound. ... if the stock market is high, people feel confident and spending, and if it lowers, they feel less confident

Greenspan: I think you have to realize that there are certain aspects of human nature which move exactly the way that you've defined it.

The problem is periodically we all go a little bit euphoric until we get to the point where we are assuming with confidence that everything is terrific, there will be no problems, nothing will ever happen. and then it dawns on us ... no. And we go the other way. [Stewart: Huge fear.]

I was telling my colleagues the other day, I've been dealing with these big mathematical models, forecasting the economy -- and I'm looking at what's going on in the last few weeks and you know if I could figure out a way to determine if people are more fearful, or changing to euphoric, and I had a third way of figuring out which of the two things are working, I don't need any of this other stuff. I could forecast the economy better than any way that I know. The trouble is that we can't figure that out. The same meeting I was talking at, I said that I've been in the forecasting business for 50 years ... more than that actually ... I'll have to think about that ... but in any event, I'm no better than I was, and nobody else is.

Forecasting 50 years ago was as good or as bad as it is today. And the reason is that human nature hasn't changed. We can't improve ourselves.

Stewart: You just bummed the [bleep] out of me."

This is actually quite a remarkable admission, because it makes exactly the point I've been making over and over: Mainstream macroeconomics is a total failure at predicting or explaining anything about the economy.

In my article, "System Dynamics and the Failure of Macroeconomics Theory," I claimed that mainstream macroeconomics hasn't predicted or explained anything that's happened since the dot-com bubble of the 1990s, including the bubble itself. Why did the bubble occur? Why did it happen at exactly that time, instead of ten years earlier or later?

Greenspan is saying a lot more -- that mainstream macroeconomics has been useless for forecasting for his entire 50-year career.

This is no surprise, since nothing that the Fed has done has really made much difference at all, except in the short term. That's pretty obvious, but no one ever says so -- until Alan Greenspan's statement.

So, next time you hear a financial pundit on CNBC, or read one in a newspaper, either praising Ben Bernanke for doing the right thing, or criticizing Bernanke for causing the current crisis, remember that he had nothing to do with it.

Actually, the Fed's ½% interest rate reduction last week evidently continues to have a powerful effect in reducing general investor anxiety and panic. I wouldn't have expected it to be so effective, but investor anxiety appears to have dropped to almost nothing. I don't know anyone who believes that the interest rate reduction has any significant REAL effect on the global economy, but it is having, for the time being, a significant EMOTIONAL effect.

And this brings us to Greenspan's next point: "if I could figure out a way to determine if people are more fearful, or changing to euphoric," then that would be more useful than all the data models and forecasting techniques.

Once again, I can only agree.

From the point of view of Generational Dynamics, the emotions that Greenspan describes -- euphoria and fear -- are exactly the causes of the ups and downs of the stock market that we've been seeing. The dot-com bubble, the credit bubble, the housing bubble, and other bubbles were caused by the generational euphoria among the Boomers and Generation-Xers that occurred when the survivors of the 1930s Great Depression all disappeared. The panic that's been setting in in recent months is when these same Boomers and Xers come to realize that all their assumptions are wrong.

Greenspan's remarks resonate with things that I've been writing on this web site for years. It's a shame that no one will believe him. (27-Sep-07) Permanent Link
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Burma: Growing demonstrations by the "88 Generation" raise fears of new slaughter

At the UN, President Bush announced new sanctions on Burma (Myanmar), as signs grow that the military is preparing to use force.

The last major nationwide demonstrations occurred 19 years ago, starting on August 8, 1988 (8/8/88). Student-led pro-democracy demonstrations at that time were joined by Buddhist monks and many civilians. The demonstrations were crushed when the Burmese army fired on students with machine guns, killing thousands.


Tens of thousands of Buddhist monks demonstrated in Rangoon, forming a sea of red <font face=Arial size=-2>(Source: CNN)</font>
Tens of thousands of Buddhist monks demonstrated in Rangoon, forming a sea of red (Source: CNN)

New demonstrations by the "88 Generation" began last week, triggered by an abrupt government decision to double the price of gasoline.

The new demonstrations have been led by over 100,000 Buddhist monks, in demonstrations across the country, especially in Rangoon (Yangon) and Mandalay. The army has not interfered with them yet, but there are signs that the army is preparing for a confrontation. Many people fear a new mass slaughter, like the one in 1988.

Here's what President Bush said in his UN speech on Tuesday:

"Every civilized nation also has a responsibility to stand up for the people suffering under dictatorship. In Belarus, North Korea, Syria, and Iran, brutal regimes deny their people the fundamental rights enshrined in the Universal Declaration. Americans are outraged by the situation in Burma, where a military junta has imposed a 19-year reign of fear. Basic freedoms of speech, assembly, and worship are severely restricted. Ethnic minorities are persecuted. Forced child labor, human trafficking, and rape are common. The regime is holding more than 1,000 political prisoners -- including Aung San Suu Kyi, whose party was elected overwhelmingly by the Burmese people in 1990.

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The ruling junta remains unyielding, yet the people's desire for freedom is unmistakable. This morning, I'm announcing a series of steps to help bring peaceful change to Burma. The United States will tighten economic sanctions on the leaders of the regime and their financial backers. We will impose an expanded visa ban on those responsible for the most egregious violations of human rights, as well as their family members. We'll continue to support the efforts of humanitarian groups working to alleviate suffering in Burma. And I urge the United Nations and all nations to use their diplomatic and economic leverage to help the Burmese people reclaim their freedom."

The speech references Aung San Suu Kyi, who is a heroine of the 88 Generation, having been a leader in 1988. Suu Kyi has been under house arrest since 1990, and late news stories indicate that the government on Tuesday transferred her from her home to a notorious prison.

From the point of view of Generational Dynamics, Burma is in an Unraveling Era. Large demonstrations of this type are typical in Unraveling Eras, but they fizzle out quickly. For example, think of the "Million Man March" in 1990s America, or the massive demonstrations against Venezuelan President Hugo Chávez in May of this year. Both of these are examples of large Unraveling era demonstrations -- begun enthusiastically, but fizzling out quickly.

The new Burma demonstrations will undoubtedly fizzle out quickly as well, even if the army overreacts. But an overreaction now would set the stage for increasing conflict that would lead to a full scale civil war within 10-15 years.

Brief generational history of Burma

The following is a brief Generational Dynamics history of Burma (Myanmar):


Burma (Myanmar) shares long borders with China, Thailand and India.
Burma (Myanmar) shares long borders with China, Thailand and India.

Crisis war: 1727-1752: Various rebellions against the Toungoo throne at Ava. The crisis war climax occurred when the Ava throne fell in in 1752, after a siege by a combined army of different ethnic groups, ending the Toungoo dynasty.

Crisis war: First Burmese War, 1824-26. British victory. Britain annexes the southern portion of Burma, which becomes part of British India.

Awakening Era war: Second Burmese War, 1852-53. Britain annexed additional territory.

Crisis war: Third Burmese War + civil war, 1886-1891. The war with Britain itself ended with a quick Burmese surrender to Britain, but violent civil war among various ethnic groups continued until 1891.

Awakening: 1920 - A generational split between old and young (presumably between generational "Artists" and "Prophets") members of the Young Men's Buddhist Association. Younger members rename the organization the General Council of Burmese Associations, dedicated to anti-colonialism.

Unraveling war: World War II, 1940-45. Occupation by Japan.

1948: Independence, formation of the Union of Burma.

Note: Aung San, commander of the Burma Independence Army, is considered to be the founding father of Burma. He was assassinated six months before final independence.

Crisis war: 1948-1958: Civil war among ethnic groups, with intervention by Chinese. Climax in 1958 when the army took over power, and turned power over to a civilian government.

The army overthrew the civilian government in 1962, and has remained in power since then.


Aung San Suu Kyi in 2003(?) <font face=Arial size=-2>(Source: CNN)</font>
Aung San Suu Kyi in 2003(?) (Source: CNN)

Awakening Era climax: On 8/8/88, hundreds of thousands of students in the "88 generation," joined by monks and civilians, marched against the military government. Soldiers opened fire on demonstrators with machine guns, resulting in thousands of casualties.

Note: Aung San Suu Kyi, daughter of Aung San, participated in the 1988 demonstrations, calling for democratic government. In 1989, she was placed under house arrest without charge or trial. In 1991, she won the Nobel Peace prize.

Today: As the 20th anniversary of 1988 massacre approaches, there are massive new demonstrations in Burma, led by monks and nuns, but now joined by many ordinary citizens. The tension in Rangoon is great, and the military government is evidently trying to decide whether to let things be, hoping the demonstrations will fizzle, or repeat the violent reprisals of 1988. Since this is an unraveling era, it would seem that the demonstrations will indeed fizzle, unless the army overreacts.

Note: Aung San Suu Kyi is still under house arrest, and is considered a goddess by today's demonstrators. However, late news indicates that she was apparently transferred to a prison on Tuesday. (26-Sep-07) Permanent Link
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Japan's leadership under Yasuo Fukuda reverts to an older generation

After a year of governmental near-paralysis under 53 year old Prime Minister Shinzo Abe, the ruling Liberal Democratic Party has selected 71 year old Yasuo Fukuda as the party's new leader. The Parliament is expected to elect Fukuda as Japan's new Prime minister on Tuesday.

The selection of Fukuda follows the resignation of 53 year old Shinzo Abe, who took office a year earlier as Japan's first Prime Minister born after World War II, in Japan's "Baby Boomer" generation.

Abe had taken office with ambitious plans for economic reform and to increase Japan's role in worldwide diplomatic and military affairs, including plans to beef up Japan's military defense. However, the administration was riddled with scandal, and popularity plummeted.

In other words, Abe's administration followed the typical paradigm, very apparent in the U.S. Congress, of saying a lot of stuff, arguing with a lot of people, but getting nothing done in the end.

By contrast, Fukuda is already exhibiting the qualities of compromise that mark the typical behavior of someone who grew up during the previous crisis war (WW II). The generation of children that grow up during a crisis war, when they're constantly surrounded by the death, destruction and other horrors of a genocidal war, suffer a kind of "generational child abuse." Like any child abuse victim, they grow up to be sensitive and indecisive, which is why William Strauss and Neil Howe, the founding fathers of generational theory, call them "Artists." In America, the Artist generation that grew up during WW II was named the "Silent Generation" during the 1950s, because they never complained about anything.

Recall that on a number of occasions I've contrasted today's U.S. Congress, which is incapable of doing anything except whine and complain, with the 1980s Congress, where the Republicans and the Democrats cooperated with each other to change the Social Security system to make it a sounder system, and then cooperated again to specify new rules to control the budget deficit. That kind of cooperation is completely impossible with the Boomers and Generation-Xers running Congress today.


Yasuo Fukuda bows his head after election victory <font face=Arial size=-2>(Source: Japan Times)</font>
Yasuo Fukuda bows his head after election victory (Source: Japan Times)

Fukuda is following the "Artist" archetype pattern. He has vowed to work for compromise with other party leaders, something that Abe didn't do.

In fact, Fukuda has even replaced younger people in top leadership position in Abe's administration with older generation people (former Minister of Finance Sadakazu Tanigaki, 62, Education Minister Bunmei Ibuki, 69, and former Trade Minister Toshihiro Nikai, 68).

Fukuda has not yet announced specific policies of his new administration, except that he's going to be seeking compromise and reconciliation with other politicians and other nations, including North Korea and China.

However, a nation's policies are not determined by just one man, but by the actions and behaviors of large masses of people. For that reason, Fukuda's more conciliatory approach may accomplish no more than Abe's confrontational approach.

Here's how a Japan Times commentary described the situation:

"New Liberal Democratic Party President Yasuo Fukuda is known as an advocate of relatively conciliatory policies, so after a year with the hawkish Shinzo Abe in power the public may be expecting a major shift in various policy areas, including diplomacy and the Yasukuni Shrine issue.

Political analysts, however, are doubtful there will be much of a drastic change now that Fukuda has been elected head of the LDP and is set to become prime minister on Tuesday.

"What one prime minister wants to do personally and whether or not he will be able to move forward with his policies are two different things," said Takeshi Sasaki, a political science professor at Gakushuin University. "A perfect example of this is Abe himself."

Abe pushed forward his conservative ideas by ramming a controversial bill through the Diet to revise the Fundamental Law of Education to instill patriotism in the classroom, and he stressed his vague but conservative ideology for a "beautiful country." But at the same time, Sasaki pointed out, Abe suppressed much of his hawkish tendencies. ...

Political observers say Fukuda will have difficulty pushing his dovish policies because he is likely to face strong opposition from conservative forces within his own party.

"Fukuda has the motivation (to push dovish policies) . . . but whether he will actually be able to act on his convictions is the issue," Sasaki said. "As long as Abe was able to (control) the LDP's hawks, it was all right — but that is not possible anymore. So Fukuda will be faced with raw" demands from hawkish LDP lawmakers."

So, in terms of results, Fukuda may fare no better than Abe did.

Nonetheless, his exceptionally conciliatory attitude, when contrasted with the much more confrontational approach of Shinzo Abe, marks both men as being typical of their respective generations, one growing up during World War II, and one born after the end of the war. (24-Sep-07) Permanent Link
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Stock markets again are approaching a new all time-high

I've received some criticism for being a bit too negative.

Several readers and correspondents have expressed some scorn, now that the market seems to be "back on track" (as one person put it), headed for new highs.

Let's start by quoting web site reader Bob:

"You are a funny guy since 2006 you predict a crash, it will never happen. After all this mess, the Dow still close to 14 000 nothing can kill this market. It seems obvious...Even the bursting of the housing bubfle and the mortgage mess don't kill that market... What it will take... Why don't you explain that, genius?"

Well actually I've been predicting a crash since 2002, based on the fact that the market is way overpriced by historical standards, and that hasn't changed at all. In 2002 I said it would probably happen in the 2006-2007 time frame, and that's still a pretty good prediction.

One of the standards is price/earnings ratios, and here's the current graph, from my recent article "How to compute the 'real value' of the stock market":


S&P 500 Price/Earnings Ratio (P/E1) 1871-2007
S&P 500 Price/Earnings Ratio (P/E1) 1871-2007

Now, the thing that I don't understand, and have never understood, is how anyone can look at the above graph and not realize instantly that the stock market is going to crash. This graph isn't rocket science; it simply depicts a standard way of measuring the "real" value of the stock market.

The graph doesn't tell you on which day this will occur; it might happen next week, next month or next year. But it does tell you that it will happen soon.

There are a lot of people who used to call me nuts but don't anymore, as the economy has continued to worsen. But one thing I've noticed over the years is that people who do so never address things like the above graph. Does anyone seriously believe that P/E ratios are going to stay well above average forever? No one, including people who call me nuts, has ever made that argument, because it can't be made. The above graph alone is actually very close to a mathematical proof that a crash is coming.

So let's step back now, and see where things stand today.

The Fed / Bank of England reversal

Related Articles

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Alan Greenspan predicts the panic and crash of 2007: He's said this kind of thing before, but this time it's resonating.... (08-Sep-07)
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It's hard to overestimate the impact of this week's monetary loosening by the Fed and Bank of England.

Before Tuesday, the public debate was whether the interest rate cut would be none or 25 basis points (¼%). The 50 basis point (½%) interest rate reduction was much larger than was expected, and represented a sudden and substantial loosening of Fed policy.

The same was true when the UK government agreed to guarantee all Northern Rock bank deposits. The Bank of England then followed up by substantially and unexpectedly loosening the standards for borrowing money from the Bank of England.

Among investors, the euphoria was instantaneous, and lasted through the end of the week. The commercial paper market, which had become frozen, unfroze, partially relieving the credit crunch.

The 50 bp interest rate cut did inject some liquidity into the market and make some additional lending possible, but no one that I've read seriously believes that the 50 bp interest rate reduction is large enough to substantially change the underlying fundamentals that caused the credit crunch, and made other things worse, as we'll discuss in the following paragraphs.

What's going to happen when there's another bout of bad news? There'll be demands for a further Fed rate cut, and this time, any cut, even a 50 bp cut, will not have anything like the same psychological effect.

Fall in the value of the dollar

Just as stock market investors received a psychological boost to push the stock market up higher, currency traders received a psychological boost to push the value of the dollar down.

Here's how one news article described the situation:

"The dollar fell sharply Friday, reaching a record low against the euro and capping a dramatic week for global financial markets that was marked by interest rate cuts, bank bailouts and skyrocketing oil prices.

The level of the dollar - often regarded as a barometer of the U.S. economy's health - dropped to $1.4120 against the euro during business hours in Asia, reaching an all-time low for a second consecutive day.

It also slipped against a number of other major currencies on speculation that the U.S. Federal Reserve would keep cutting interest rates as the world's largest economy weakens.

Sentiment soured for the dollar after Ben Bernanke, chairman of the Federal Reserve, stoked speculation that he might continue to lower rates following this week's aggressive trim of half a percentage point. Bernanke said Thursday that the sell-off in credit markets could make the housing recession more severe."

This makes several things clear: The dollar was weakened by the Fed move, and the world now expects further weakening.

Here's how another news article describes the Saudi view:

"Fears of dollar collapse as Saudis take fright

Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.

Ben Bernanke has placed the dollar in a dangerous situation, say analysts. "This is a very dangerous situation for the dollar," said Hans Redeker, currency chief at BNP Paribas.

"Saudi Arabia has $800bn (£400bn) in their future generation fund, and the entire region has $3,500bn under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States," he said.

The Saudi central bank said today that it would take "appropriate measures" to halt huge capital inflows into the country, but analysts say this policy is unsustainable and will inevitably lead to the collapse of the dollar peg."

Finally, it's worth noting that Canadians are brimming with pride this week because, for the first time in decades, a Canadian dollar is worth just as much as an American dollar.

Europeans suffer "worst jolt" since 9/11

That's the headline in a Financial Times news story about the effects of American's financial turmoil on Europe.

The eurozone "purchasing managers' index," which measures economic activity among both manufacturers and service provides, fell steeply in September, the biggest drop since October 2001.

These problems are being exacerbated now by the fall of the dollar against the euro, which means rise in value of the euro against the dollar, following the Fed's interest rate reduction.

If the "super euro" remains high against the dollar, it means that European exports become a lot more expensive to Americans. This is bad for business in Europe, and there are now concerns that Europe will fall into recession because of the Fed rate cut.

CDOs and other Credit Derivatives

If you've been reading this web site for the last six months, then you know that you know that the economic turmoil has been caused by "collateralized debt obligations" (CDOs) and other credit derivatives.

Without attempting to repeat previous detailed explanations, CDOs and other credit derivatives allow you to make various "bets" related to credit, especially whether certain classes of debt will be repaid or go into default. These got into particular trouble because many CDOs are based on sub-prime mortgage loans.

If you're a very "sophisticated" investor, you might have purchased a CDO that will pay you a regular income provided that the underlying mortgages are not foreclosed. You may have thought it was a "sure bet," because the major ratings agencies told you that these CDOs were AAA investments. But with foreclosures surging in the last few months, these investments have performed badly.

For months, we were told that the "subprime mortgage problem" was completely "contained." But in fact, it's now turning out that CDOs are in the portfolios of all kinds of financial institutions around the world, including banks, pension funds, and so forth.

Here's what Fed Chairman Ben Bernanke said to Congress, just last week:

"Most recently, as I am sure Committee members are well aware, subprime mortgage losses that triggered uncertainty about structured products more generally have reverberated in broader financial markets, raising concern about the consequences for economic activity. As I noted in a speech last month at the economic symposium hosted by the Federal Reserve Bank of Kansas City, the turbulence originated in concerns about subprime mortgages, but the resulting global financial losses have far exceeded even the most pessimistic estimates of the credit losses on these loans. These wider losses reflect, in part, a significant increase in investor uncertainty centered on the difficulty of evaluating the risks for a wide range of structured securities products, which can be opaque or have complex payoffs. Investors also may have become less willing to assume risk. Some increase in premiums that investors require to take risk is probably a healthy development on the whole, as these premiums have been exceptionally low for some time. However, in this episode, the shift in risk attitudes combined with greater credit risk and uncertainty about how to value those risks has created significant market stress. On the positive side of the ledger, past efforts to strengthen capital positions and financial market infrastructure places the global financial system in a relatively strong position to work through this process."

Notice the phrase: "the resulting global financial losses have far exceeded even the most pessimistic estimates of the credit losses on these loans."

Now you may wonder if perhaps the crisis is over. In fact, it's only just beginning.

Many mortgage loan foreclosures are from ARMs (adjustable rate mortgages), where the homeowner signs up for the mortgage with a low monthly payment, based on a low "teaser" interest rate. That teaser rate expires after 1, 2 or 3 years, depending on the terms, and then the interest rate "resets" to a much higher value, and the homeowner's monthly payment can double or even quadruple.

Here's a chart showing ARM reset schedules from the Calculated Risk blog:


Monthly ARM reset schedules, 2007-2009 <font face=Arial size=-2>(Source: Calculated Risk)</font>
Monthly ARM reset schedules, 2007-2009 (Source: Calculated Risk)

As you can see, the great bulk of ARM resets occurs in the next 10 months. So the worst is yet to come.

How bad can it be?

First, you have to remember what's really going on here. There have been global financial crises at regular intervals throughout history. The details have been different each time, but they always have one thing in common: A debauched and perverted use of credit, occurring at exactly the time that the survivors of the previous financial crisis have all died or retired.

If you go back through history, there are of course many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash.

I've quoted this paragraph a couple of times before, but it such a powerful paragraph that I want to repeat it. It describes the the last days of the Tulipomania bubble of the 1630s, as described in Edward Chancellor's 1999 book, Devil Take the Hindmost, a history of financial speculation:

"No actual delivery of tulips took place during the height of the boom in late 1636 and early 1637 as the bulbs remained snug in the ground. A market in tulip futures appeared, known as the windhandel (the wind trade): sellers promised to deliver a bulb of a certain type and weight the following spring, buyers took the right to delivery -- in the meantime, cash settlement could be made for any difference in market price. Most transactions were expedited with personal credit notes which also fell due in the spring when the bulbs would be dug up and delivered. Gaergoedt boasts of having made 60,000 guilders from his tulip speculations but admits that he has only received "other people's writing." By the later stages of the mania the fusion of the windhandel with paper credit created a perfect symmetry of insubstantiality: most transactions were for tulip bulbs that could never be delivered because they didn't exist and were paid for with credit notes that could never be honoured because the money wasn't there." (pp. 16-18)

This last sentence tells you exactly what CDOs and other credit derivatives have become. They're based on leveraged mortgage-based investments that no longer exist in viable form, and were paid for with other credit derivatives that could never be honored because they too were worthless.

So how bad can it be?

Nobody knows for sure, because large financial institutions are now doing everything in their power to cover up the size of their exposure. But here are some figures you should be aware of:

Now, in the case of Bear Stears and other financial institutions, we've seen that some of the credit derivative instruments lost something like 90% of their value when an attempt was made to actually sell them, and they were "marked to market."

But let's suppose that, on the average, when all those credit derivatives are finally "marked to market," the average loss is only 10%. That's an optimistic assumption, but 10% of $750 trillion is $75 trillion!

In other words, even in this optimistic scenario, the amount of money to be pulled out of the world's economies is 1½ times the GDP of the entire world!

Now, for those of you who think that can't happen, remember what Bernanke himself said this week:"the resulting global financial losses have far exceeded even the most pessimistic estimates of the credit losses on these loans."

There is absolutely no evidence to support the belief that the worst has past. In fact, the trends are clearly pointing in the direction that the worst is yet to come.

What happens next?

Let me return to an analogy that I've used before.

Imagine the world economy as a huge mansion, blown up into a huge bubble. For several months now, pieces of that huge mansion have been breaking off and falling into the ravine. Examples of "implosions" are: Bear Stearns' hedge funds, Countrywide Bank, Sentinel Management, and Northern Rock bank in the UK. According to the mortgage lender Implode-o-Meter, the count of major U.S. lending operations that have "imploded" since December is now up to 159.

Maybe the stock market crash would have occurred by now, as it had at this point in the 1929 cycle, but there's something very different today that wasn't true in 1929.

The Fed and other central banks are running around the mansion with hammer and nails, patching things up as fast as they can, trying to keep ahead of things -- and they're being pretty successful at that. Last week's interest rate reduction by the Fed was a particularly big wad of glue and nails.

But it can't work for much longer. The price/earnings graphic near the beginning of this article tells you so. The stock market is overpriced by a factor of 250% or so. Wads of glue can't fix that.

This is the Principle of Maximum Ruin that I've discussed many times in the past. The longer the crash is delayed, the worse it will be. In time, the world's financial officials will see to it that the maximum number of people are ruined to the maximum extent possible.

All the advances in economics and macroeconomics that we've learned since 1929 really haven't done anything useful except provide for new and clever ways of applying glue and nails. But sooner or later, the entire mansion has to collapse and fall into the ravine.

So, to Bob and others, I say to you, take another look at that price/earnings graphic at the beginning of this article, and think about what it's telling you. Is it telling you that "nothing can kill this market," as you claim? Is it telling you that "it's different this time"? If so, then just keep pouring your money into the bubble.

But if it's telling you, as it's telling me, that the P/E index is soon going to start plummeting down below 10, as it has several times in the last century, most recently in 1982, then you'd better take your money and run for the hills.

From the point of view of Generational Dynamics, there's no doubt whatsoever: We're headed for a generational stock market panic and crash. Really, we have different names for things today, but the underlying basics today are no different than they were in 1929. (23-Sep-07) Permanent Link
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Review of recent international stories

France, Pakistan and Israel in the news

I've been focusing on the global economic situation, and have been neglecting a number of important international stories. For the record, here's a summary of some of these stories:

France and Iran

Ever since Nicolas Sarkozy became President, he's become increasingly vocal about Iran's nuclear program, and has indicated (through his foreign minister) that the world should begin to prepare for war with Iran.

Europe as a whole is very schizophrenic about Iran. On the one hand, they don't want to do anything that might be interpreted as supporting United States policy. On the other hand, nuclear missiles launched from Iran won't reach the U.S., but they will reach Europe.

As I wrote in a lengthy analysis of Iran, this kind of bellicose reaction is welcomed by Iranian president Mahmoud Ahmadinejad and by the hardline mullahs. Iran is in a generational Awakening era, and the Iranian people identify with western values, even American values, much to the horror of the hardliners. They see a military conflict, or the threat of one, as the way to unify the nation against the West, as happened during their last generational Crisis era, leading to the Iran/Iraq war of the 1980s.

This is a highly volatile situation, and it's impossible to predict whether, in fact, any military action will take place.

Pakistan and Pervez Musharraf

I've always expressed admiration for Pakistan's President Pervez Musharraf and his Indian counterpart, India's Prime Minister Manmohan Singh. Both Pakistan and India are nuclear powers, but these two leaders have engineered a remarkable détente that has prevented a conflict.

Musharraf, born 1943, and Singh, born 1932, are both survivors of World War II and the subsequent genocidal war between Pakistan and India over Kashmir and Jammu, a dispute that still seethes today, even though the United Nations partitioned the region into Indian and Pakistani regions in 1947.

The disappearance of either Musharraf or Singh would change the situation dramatically, as either one would likely be replaced by someone much younger, and much more confrontational. This is the kind of generational change that leads to new crisis wars.

Musharraf is viewed by many Pakistanis as an American puppet, and now Osama bin Laden has issued a new video declaring war on Musharraf, and calling for his overthrow.

The Pakistanis will have have an election on October 6, and Musharraf's destiny is in doubt at this time.

Sarkozy vs the French Unions

French President Nicolas Sarkozy is in the news for another reason: he's headed for a major confrontation with the labor unions.

President Sarkozy went on television to announce his plan to end the Napoleonic era civil service laws. Infuriated union leaders are threatening crippling strikes.

When Sarkozy won the election in May, he said that he was "going to restore the status of work, authority, standards, respect, merit. I am going to give the place of honour back to the nation and national identity. I am going to give back to the French people pride in France."

He promised to end the 35-hour work week, solve the problem of illegal immigration, and make France a leader in the European Union.

He's been proceeding cautiously, but now he's ready for full-scale political warfare.

From the point of view of Generational Dynamics, he has little chance of succeeding. Think of what's happening in Washington, where the city is practically paralyzed by politicians who are incapable of doing accomplishing anything except arguing. This is because the survivors of the World War II are all gone, and the leaders in Washington are from the Boomer generation born after the war.

The same is happening in France, and in fact in every country that fought World War II as a crisis war. The postwar generation is in charge, and the country is paralyzed, with the leaders unable to do anything but argue.

So it's unlikely that Sarkozy will accomplish anything with his aggressive new initiative although, of course, it will generate a great deal of political furor.

Israel and Gaza

Israel's cabinet has just voted to declare the Gaza strip a "hostile territory," because of the steady stream of Qassam rockets fired into Israel from Gaza.

This means that Israel will impose further restrictions on living conditions in Gaza, including limiting the supply of fuel and electricity, and the transfer of people and goods.

The intent is to make it harder for militants to smuggle weapons into Gaza, but the result will be a further degradation in the standard of living, in a place where the standard of living is already almost the worst in the world.

From the point of view of Generational Dynamics, Gaza and Israel are headed for a new genocidal crisis war, refighting the genocidal war between Palestinians and Israelis that followed the 1948 partitioning of Palestine and the creation of the state of Israel. However, in recent months it's become increasingly likely that a component of this war will be a civil war between Gaza and West Bank Palestinians, with the West Bank allied with Israel, at least for a while. (21-Sep-07) Permanent Link
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US and British central banks shock investors with large monetary loosening

Wall Street markets surge 2.5-3%, the biggest increases since October 15, 2002, following an unexpectedly large lowering of the Fed Funds rate.

European markets spiked 1.5-2%, after the Bank of England changed policies and guaranteed the safety of ALL Northern Rock bank deposits. And as of this writing (evening in US, morning in Asia), Asian markets are up 3%.

Champagne corks are popping again! The party is in full swing! Euphoric investors are ready to go full steam ahead!

In the US, the Fed lowered interest rates by a full ½ point, when only ¼ point was expected. Furthermore, the ½ point reduction applies the both the Fed Funds rate (the rate that banks pay when they borrow money from another bank) and the Fed Discount rate (the rate that banks pay when they borrow money from the Fed).

Thus, the Funds rate went from 5¼% to 4¾%, and the Discount rate went from 5¾% to 5¼%. It is thought that this will reduce the "credit crunch," by providing cheaper money that can be offered for credit.

The size and rapidity of the rate cut was almost completely unexpected, and resulted in the market surge.

Also unexpected was the guarantee, by UK finance chancellor Alistair Darling, that all Northern Rock bank assets would be guaranteed by the government.

In normal times this would be considered a wildly inappropriate move by the government, since it shows such favoritism to one bank, and thereby puts other banks at a disadvantage. However, these are not normal times, as a panicky bank run was spreading throughout Britain.

From the point of view of Generational Dynamics, nothing has changed. This is because the stock market is STILL overpriced by a factor of around 250%.

Equally important, Tuesday's stock market surge is actually a sign of increased panic.

Let's take a look at what happened:


Dow Jones Industrial Index, September 18, 2007
Dow Jones Industrial Index, September 18, 2007

Take a look at what happened at 2:15 pm in the above graph, and then read the following message that I received from an online correspondent:

"Today when the Fed anounced, I experienced a massive system failure in order placement. This is the first time I have seen this. Maybe you were right when you told me that there would be no system access during a major crash. I had 2 isolated systems with their own connections during the outage and both failed to respond.

Luckily for me I was on the correct side of the trade and was not affected much by the outage. But this has scared me. My broker told me that there were multiple firms that all experienced the same problem."

I don't know how widespread this computer failure was, since it hasn't been a media story, but it doesn't surprise me at all.

The above graph shows that at 2:15 pm, when the Fed mades it's announcement, the Dow spiked by 150 points in something like a nanosecond.

It's obvious that large financial firms, with special access to the NY Stock Exchange computers, were able to place buy orders instantly, and get them filled.

But my friend, who is just an ordinary investor, didn't have a prayer. He was so far back in line, that it would have been many hours before he could have placed an order, if that had been necessary.

This is a point that I've made in the past.

There are many people today who are willing to agree that the stock market may be due for a correction, but many of those people believe that they can get out quickly, without losing too much money, if it becomes necessary. Such people have no idea of the dynamics of what's going on.

Here's the next sentence from my online correspondent's message:

"PS: I am very bullish now 70%. I expect new highs in the Dow soon."

What?? Why would anyone believe that there's any significant chance at all that what happened Tuesday means that the market will reach new highs?

What actually happened on Tuesday is what might be called "upward panic." Investor anxiety has been increasing steadily since February. This kind of anxiety leads to panicky decisions -- either in the downward direction (stock market crash) or upward (what happened on Tuesday).

And remember this: On Monday, October 7, 1929, anxious, panicky investors pushed the stock market up +6.32%. That was just two weeks before Black Thursday.

So I would very strongly challenge any assumption that the market is going to keep going up. What happened on Tuesday was not a sign that the party is on again. It's actually a sign of panic among investors, who, for that moment on Tuesday, believed that the Fed saved the world.

But will they still believe on Wednesday that the Fed has saved the world?

We'll have to see, of course, but the huge spike at 2:15 tells me that it's very unlikely. When you have a massive "upward panic" like that, so large that it crashes multiple computer systems, it's not a sign that things are returning to the good 'ol days.

If the Dow can spike up 150 points in a nanosecond on Tuesday, then it can spike down 150 points in a nanosecond on Wednesday. And now, thanks to the message from my online correspondent, we have someone's personal experience to tell you what will happen -- you won't be able to do anything, because the computers will crash. You'll have to just sit there and watch your assets disappear, just as all the people of Salt Lake City, Utah, did in 1929. (19-Sep-07) Permanent Link
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More on the Marketpsych "Fear Index"

By this measure, investor fear has clearly been growing since February.

When I wrote about this subject last week, I hadn't been able to find any historical data on the Marketpsych web site. Now I have.



This graph shows the value of the "fear index" (measured on the left scale) for the last year versus the Nasdaq market index (measured on the right scale). It shows that the market seems to vary inversely with the fear index.

This graph, showing a year's worth of data, clearly indicates that, by this measure, investor "fear" had been falling steadily until February 27, when a 9% collapse in the Shanghai stock market triggered a worldwide "mini-panic." Things settled down after that, but not to the way they were prior to February 27. Investor "fear" was never went back as low as it had been in December and January and, in fact, has been rising steadily since then.

As this graph shows, the "fear index" had fallen to about 4 in January, peaked at 22 in February, but fell back only as far as 10 in May. Since then, it peaked again at 51 in August, and is now hovering around 21, which is near the February peak value.

Before becoming aware of this index, I had previously thought that the August 16 "mini-panic" had been the turning point, and that's why I wrote the essay "The nightmare is finally beginning" at that time.

However, that's clearly not the case. It's now clear that the February 27 event was the triggering event for the rise in investor anxiety, even though the market peak didn't occur until July 19.



The Marketpsych web site does provide a graph that's updated daily, each morning (including Saturday and Sunday), showing the most recent values of the "fear index." The adjoining graph shows the value as of Tuesday morning, along with the preceding three months.

We can guess that the rise in the past few days was triggered by the spreading panic in Britain, as branch offices of Northern Rock continue to be mobbed by depositors wishing to withdraw their money.

And we can guess that the rise on Tuesday morning is related to the anticipation of an expected announcement on Tuesday afternoon of a reduction in the Fed Funds rate.

Incidentally, these two stories have become major international stories in the last few days. In fact, THE major international story on Tuesday appears to be the anticipated Fed announcement, which investors apparently believe will save the world. That alone is a sign of worldwide investor anxiety.

The day to day variations in the fear index really don't mean much, since any bit of news, major or minor, can trigger a small rise or fall. In fact, I suspect that the margin of error on the computation of this index is something like ±3.

What IS important is the long-term trend, and that's become quite clear -- that investor anxiety is continuously increasing.

This contradicts some of the latest remarks by Alan Greenspan, as he seems to have become a rock star in the last few days, and is willing to talk gibberish on almost any economic, political or personal subject.

On the interview on 60 Minutes, broadcast on Sunday, Greenspan said the following, in response to a question by interviewer Leslie Stahl:

Stahl: "Well, what we've already begun to see is not just that housing prices are falling but that it's affecting the job market for anything related to housing, including real estate, including the sales of appliances and furniture."

Greenspan: "But there is an underlying strength in the United States. And, indeed, when you look around the world, even with this extraordinary credit problem, the economies seem to be holding up. But for the moment it does not look sufficiently severe that it will spiral into anything deeper.

"We’re going to get through this particular credit crunch. We always do. This is a human behavior phenomenon, and it will pass. The fever will break and euphoria will start to come back again."

This is a weird point of view. Everybody seems to agree now that there's a housing bubble. Even Greenspan has now admitted that he "didn't get it" about the housing bubble, until it was too late.

So what does it mean when he says, "The fever will break and euphoria will start to come back again"?

Is he abandoning his previous view that "history has not dealt kindly with the aftermath of protracted periods of low risk premiums"?

Who knows?

While I'm on Greenspan, I'd like to comment for a moment on "Fed speak." In his new book (which I haven't seen), Greenspan apparently brags about his use of "Fed speak" to make comments that nobody understands, so that he can get away with saying anything he wants.

What the hell is that all about? I understood everything he was saying, and I've commented on all his major speeches since 2004 on this web site. I showed how he went from self-congratulation to increasing alarm to a total repudiation of his previous reasoning, to dire warnings at the end of 2005. Maybe you have to go to the trouble to read a paragraph two or three times, but if you're willing to go to that trouble, then it's perfectly possible to understand what he's talking about.

This just goes to show how ignorant and sloppy journalists and politicians are. When a journalist or blogger says that he didn't understand Greenspan, what he's really saying is this: "I was too lazy and stupid to bother to figure out what was going on, and I didn't WANT to know what was going on." So you had people like Greg Ip at the Wall Street Journal and Steve Liesman at CNBC who were so stupid and so lazy that now they have to establish a framework of excuses so that they won't be blamed by other people. "Ohhhh, it's not my fault that I'm stupid and lazy; it's Greenspan's fault."

That's like Ben Bernanke's excuse that "It's not the US's fault that we're at astronomic levels of public debt; it's every other country's fault, for having a 'Global Savings Glut.'" Blecch.



Incidentally, I mentioned the February turbulence that caused a 9% drop in the Shanghai stock market bubble in February. There was more turbulence in June.

But nothing seems to stop this bubble (which is what I used to always say sarcastically about the Wall Street bubble, until it finally peaked on July 19.)

The Shanghai index seems to have absolutely no limit, and undoubtedly will keep on getting exponentially higher forever (which is what I used to say about Wall Street). I guess Alan Greenspan would be pleased to see that the "euphoria" hasn't ended in Shanghai.


S&P 500 Price/Earnings Ratio (P/E1) 1871-2007
S&P 500 Price/Earnings Ratio (P/E1) 1871-2007

From the point of view of Generational Dynamics, Wall Street has been in a bubble that began in 1995, as evidenced by the fact that price/earnings ratios have been astronomically since then. The bubble cannot continue forever, and the rapidly rising value of the "fear index" appears to indicate that it won't continue for much longer.

(18-Sep-07) Permanent Link
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Panic appears to be spreading in Britain, as depositors mob Northern Rock

US Treasury Secretary Hank Paulson arrives in London to meet with UK Chancellor Alistair Darling, to discuss the worsening global financial crisis and credit crunch, as spreading panic begins increasingly to threaten markets in Britain and around the world.


Northern Rock customers face long, slow queues to withdraw their deposits in 76 branch offices around Britain. <font face=Arial size=-2>(Source: Guardian)</font>
Northern Rock customers face long, slow queues to withdraw their deposits in 76 branch offices around Britain. (Source: Guardian)

Thursday's bailout of Northern Rock Bank caused long lines on Friday of depositors wishing to withdraw their money.

On Saturday, the lines were even longer and slower at Northern Rock's 76 branch offices. Most customers were elderly, but even so, police had to be called to deal with some "boisterous customers." In one branch, the police dispersed the crowd after the bank promised those present would be assisted first on Monday.

An interesting twist to the Northern Rock story is that, prior to the Bank of England bailout, there were two larger suitors in talks to acquire Northern Rock, Lloyds TSB and Royal Bank of Scotland.

But the Bank of England blocked the potential acquisitions, because they might cause consternation in financial markets. Once that happened, Rock had no choice but to ask the BOE for the bailout, and that DID cause quite a bit of consternation in financial markets.

A month ago, California depositors mobbed Countrywide Bank branch offices to withdraw their deposits, but that event didn't generate anything like the media coverage or widespread concern that the Northern Rock situation has done, particularly in Britain.

From the point of view of Generational Dynamics, this is exactly the kind of panic that we've been watching for. Investors have been getting measurably more anxious and worried since the beginning of 2007, but the Northern Rock appears to be pushing the level of panic up one more notch. (16-Sep-07) Permanent Link
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Alan Greenspan blames the Republicans for the financial crisis

Saying that the Republicans drove the country into ever deeper deficits, former Fed chairman Alan Greenspan criticized "out of control" spending in the Republican Congress, and President Bush's failure to veto those bills.

The comments appear in his new 500 page book, "The Age of Turbulence: Adventures in a New World," to be published on Monday.

Greenspan reserves his highest praise for President Bill Clinton who, he said, maintained "a consistent, disciplined focus on long-term economic growth."

All of this will resonate with the Washington politicians, but I can't help but laugh at it because from the point of view of economics, Greenspan's remarks are total gibberish.

Here's a graph that appeared on the Calculated Risk blog in 2005, showing government income and outlays, but not including Social Security:


Income vs Outlay as %-age of GDP for Federal Government, 1971-2005, not including Social Security <font face=Arial size=-2>(Source: Calculated Risk)</font>
Income vs Outlay as %-age of GDP for Federal Government, 1971-2005, not including Social Security (Source: Calculated Risk)

This graph shows that the deficit has absolutely nothing to do with the Bush administration. Note the following:

So Greenspan's remarks really are TOTAL GIBBERISH.

There's something that I remember very vividly, because I was so shocked by it when it happened in 1996.

In 1996, Clinton gave his "the era of big government is over" speech, and worked with the Republican Congress to end the welfare entitlement because it was too expensive. It was becoming clear that the government was going ever deeper into debt, and it had to stop.

Here's what President Clinton said in his 1996 State of the Union speech:

"We know big government does not have all the answers. We know there's not a program for every problem. We have worked to give the American people a smaller, less bureaucratic government in Washington. And we have to give the American people one that lives within its means.

The era of big government is over. But we cannot go back to the time when our citizens were left to fend for themselves. Instead, we must go forward as one America, one nation working together to meet the challenges we face together. Self-reliance and teamwork are not opposing virtues; we must have both. ...

I say to those who are on welfare, and especially to those who have been trapped on welfare for a long time: For too long our welfare system has undermined the values of family and work, instead of supporting them. The Congress and I are near agreement on sweeping welfare reform. We agree on time limits, tough work requirements, and the toughest possible child support enforcement. But I believe we must also provide child care so that mothers who are required to go to work can do so without worrying about what is happening to their children.

I challenge this Congress to send me a bipartisan welfare reform bill that will really move people from welfare to work and do the right thing by our children. I will sign it immediately.

Let us be candid about this difficult problem. Passing a law, even the best possible law, is only a first step. The next step is to make it work. I challenge people on welfare to make the most of this opportunity for independence. I challenge American businesses to give people on welfare the chance to move into the work force. I applaud the work of religious groups and others who care for the poor. More than anyone else in our society, they know the true difficulty of the task before us, and they are in a position to help. Every one of us should join them. That is the only way we can make real welfare reform a reality in the lives of the American people."

None of that is the shocking part; it's just the usual politics. The shocking part is what happened afterwards.

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Around April or May, news stories said that tax collections were unexpectedly high. Tax receipts kept getting higher and higher, and it was a COMPLETE SURPRISE to everyone, including the administration and Alan Greenspan's Fed. It was not until the END of 1996, when Greenspan gave his "irrational exuberance" speech, that officials became aware that the bubble was on.

So there was a government surplus when the dot-com bubble was on, and there was a deficit when the dot-com bubble burst. This all happened in the Clinton administration. So the Bush administration had absolutely nothing to do with it. That's why Greenspan's remarks are gibberish, although they'll resonate with the usual moronic debates going on in Washington.

Politics has nothing to do with the current financial crisis. As I've written on this web site many times, the current fiscal crisis is caused by the entire Boomer generation and Generation-X, working together to engineer every debauched misuse of credit imaginable. The debauchery is practiced by Republicans and Democrats and independents alike. It has nothing to do with politics. It's because they're in the generations with no personal memory of living through the 1930s Great Depression.

As I've said many times, and discussed at length in "System Dynamics and the Failure of Macroeconomics Theory," mainstream economics has neither explained nor predicted anything since the dot-com bubble began in 1995. In particular, no one has any explanation for why the bubble began in 1995, instead of 1985 or 2005.

The only possible explanation is a generational explanation: The dot-com bubble began when the generations of survivors of the 1930s Great Depression all disappeared in the early 1990s. Their leadership positions were then filled by Boomers and Xers with no personal memory of the 1930s and adopted abusive credit policies that their parents would NEVER have approved.

As I've said before, the survivors of World War II, the GI Generation and the Silent Generation, did great things -- they created the United Nations, World Bank, Green Revolution, World Health Organization, International Monetary Fund, and so forth. They created these organizations and managed them for decades with one purpose in mind: That their children and grandchildren would never have to go through anything so horrible as the Great Depression or World War II.

Throughout their lives, they worked together, even when they were on opposite political sides, to protect America and the world from the excesses that led to the Great Depression and World War II.

In the 1980s, the Republicans and the Democrats cooperated with each other to change the Social Security system to make it a sounder system. After that, they cooperated again to specify new rules to control the budget deficit. And in 1996, as we just discussed, Democratic President Bill Clinton, saying that "the era of big government is over," cooperated with the Republican congress to eliminate the welfare entitlement.


Despicable ad implying that General Petraeus is a traitor. <font face=Arial size=-2>(Source: Moveon.org)</font>
Despicable ad implying that General Petraeus is a traitor. (Source: Moveon.org)

For the last few years, especially since 2004 or so, any kind of political agreement has become completely impossible.

In 2006, when the Republicans controlled Congress, I pointed out that the Congressional calendar was just 97 days for all of 2006, because the Congress was so incompetent that they were going to do nothing.

This year, the Democrats took control of Congress, and it's been nothing but a circus. It started out that the new Congress was so incompetent that they couldn't even vote themselves a pay raise.

It's hard to believe, but the Democrats have been even more incompetent than the Republicans (though not because they're Democrats, but because another year of generational change has gone by).

The poster boy is Senator Joe Biden, who is easily the stupidest person in the Senate, as was clear when he went on Meet the Press in April and said one unbelievably stupid thing after another.

He called Bush "incompetent" because he sent too few troops into Iraq in 2003, but then said that he wants to send just 2,500 US troops into Darfur to stop a civil war against 2.5 million Darfurians. Over and over again, he said things like, "All the troops in the world cannot settle a civil war," referring to the Iraq war which is definitely NOT a civil war, but then wants to stop the Darfur genocide, which IS a huge, massive civil war, with just 2500 troops. This guy's a real idiot.

The despicable Moveon.org ad displayed above, implying that Petraeus is a national traitor, is typical of what passes for intelligence in today's Washington.

Lawrence F. Kaplan, senior editor at the liberal, pro-Democratic opinion magazine, The New Republic, pointed out that Congressional leaders: go out of their way to avoid learning anything; make up any "facts" they want, since they don't know anything; and couldn't care less what happens in Iraq, since they just want votes.

But I don't want to make this a Democratic thing, because the Republicans don't know anything either, as we learn from articles in the Congressional Quarterly. Washington journalists, analysts and politicians have no idea what's going on in Iraq. At the time that those surveys were taken, they didn't know the differences between Sunni and Shi'ite, they didn't know that al-Qaeda is operating in Iraq, and they didn't know that al-Qaeda is a Sunni organization.

Now let's return to Greenspan's opinions.

As I said above, Republicans and Democrats were able to accomplish a number of things since 1945, and I gave several examples from the 1980s and 1990s. They did that through compromise.

Since then, they've been unable to compromise on anything except to blame everyone else for everything.

From the point of view of Generational Dynamics, there's a really vicious process going on right now:

So now we have these two generational forces coming together.

One example is the "Petraeus / betray us" ad displayed earlier, from Moveon.org. The Democratic and Republican leaders in Congress might well be able to come up with a compromise on many issues, but that's impossible, largely because of the power of Moveon.org. Moveon.org is driving Democrats to a destructive political position where they're essentially supporting al-Qaeda against the Americans. Moveon.org itself is driven by Xers who have no fear of this destructive advocacy.

The second example is current financial crisis.

Here's what PIMCO's Bill Gross, head of the world's largest bond fund, said recently:

"During times of market turmoil it helps to simplify and get basic – explain things to a public and even yourself in terms of what can be easily understood. Goodness knows it’s not a piece of cake for anyone over 40 these days to understand the maze of financial structures that now appear to be unwinding. They were created by youthful financial engineers trained to exploit cheap money and leverage who showed no fear and who have, until the last few weeks, never known the sting of the market’s lash. They are wizards of complexity. I, however, having just turned 63, am a professor of simplicity."

Gross's comments show clearly the distinction between Boomers and Xers, and how they created the current mess: Arrogant Boomers are content to let other people take care of things so they can sit back and criticize, and youthful nihilistic Xers show contempt for all caution and have no fear of anything, even their own destruction.

(For those who are even now are planning to write to me, protesting the above, let me say this: The above are generalizations of generational archetypes that are completely true in the aggregate, but are not true of all individuals. If you're an exception, then I congratulate you.)

The remaining question is this: Alan Greenspan was born in 1926, and is a survivor of the 1929 crash and the 1930s Great Depression. Why doesn't he know any better?

The answer is that he does know better, but his own emotions have also gone back and forth. As Fed chairman, he was convinced by the Boomers and Xers that there was nothing to worry about. As I recently described in "Alan Greenspan predicts the panic and crash of 2007," Greenspan has made speeches on both sides. Sometimes he warns of severe danger, and at other times he provides fanciful defenses of his own policies, such as blaming the housing bubble on the 1989 fall of the Berlin Wall. His blaming of the Republicans just advances that pattern.

From the point of view of Generational Dynamics, Alan Greenspan couldn't have changed much of anything anyway. He was just one man facing entire generations of Boomers and Xers. If he'd tried to employ stricter Fed policies to prevent the dot-com or housing bubbles, he would simply have been fired for "harming" the economy. I've often described generational trends as similar to a tsunami, and no one man, not even Alan Greenspan, ever has any hope of stopping a tsunami. (16-Sep-07) Permanent Link
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London Times says "There's no need to panic."

UK's Northern Rock Bank is drawing worldwide attention on Friday, after asking for and receiving a bailout of unspecified size from the Bank of England, acting as lender of last resort, the first such bailout in over 30 years.


Depositors queuing up in front of a Northern Rock branch.  Notice that almost everyone in line appears to be elderly. <font face=Arial size=-2>(Source: BBC)</font>
Depositors queuing up in front of a Northern Rock branch. Notice that almost everyone in line appears to be elderly. (Source: BBC)

Depositors -- especially elderly depositors from the generation that grew up during the Great Depression -- queued up in front at Northern Rock branches across the country. According to the BBC, some just wanted reassurance, while others withdrew their deposits.

European stocks fell on Friday morning at the news. However, as usual, Generational Dynamics is less concerned about the ups and downs of the stock market and more concerned about the level of anxiety exhibited by masses of investors and, in this case, of depositors as well.

The bailout of Northern Rock, which is also a mortgage lender, is considered "shocking" by commentators, because they had assumed that the credit crunch was caused by depraved Americans, and that they were immune to it. It now turns out that Rock followed many of the same depraved schemes, and investors are wondering whether other UK banks and mortgage lenders are going to follow the same path.

There was widespread commentary from newspapers and government officials, telling people not to panic.


Alistair Darling, UK Finance Minister <font face=Arial size=-2>(Source: BBC)</font>
Alistair Darling, UK Finance Minister (Source: BBC)

Alistair Darling, UK Finance Minister, told the BBC:

"Britain has a very strong and stable economy. We also have a very strong and stable banking system. And the reason that Bank of England has provided facilities is because the Governor and I are determined that that should be maintained. We have a Bank of England, that is a lender of last resort, precisely to deal with difficulties like this, to ensure that where there are short-term difficulties in getting money -- and there is a lot of money in the system -- it's just that people are reluctant to lend to each other at the moment -- where you've got that difficulty, the Bank can step in to allow Northern Rock to carry on doing business.

Under the headline "No need to Panic," London Times commentary was as follows:

"With queues of anxious savers forming outside some Northern Rock branches this morning, the No 1 priority for the bank and its regulators is to restore confidence that depositors' money is safe.

Which, by the way, it is.

The Bank of England has made plain that it is ready to provide whatever liquidity is necessary to get the bank through its present difficulties.

Northern Rock may not be one of the four or five banks at the heart of the UK financial system, but it is close enough for it to be unthinkable that it would be allowed to fail its depositors.

So there is no reason for the hundreds of thousands of savers with £24 billion of deposits in Northern Rock to panic."

This "no need to panic" message is repeated in many UK newspapers, and undoubtedly in radio and television news programs.

As we discussed on Thursday, there is evidence that the level of investor anxiety and fear has been growing steadily at least since the beginning of the year.

On Wall Street on Thursday, anxious investors felt euphoric because of their certainty that the Fed will lower interest rates next week, and thus save the world. On Friday, as this is being written shortly before the markets open, stocks are expected to open lower, "with news of U.K. mortgage lender Northern Rock's difficulties reigniting concerns about U.S. banks," according to http://wsj.com. A poorer than expected retail sales report is also raising concern.

This talk of the need to avoid panic is new, and reflects a continually increasing level of anxiety and panic. With the stock market overpriced by a factor of 250%, it can't be too much longer before this level of anxiety translates into action. (14-Sep-07) Permanent Link
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By one measure, investors are getting increasingly anxious and worried

Even though everything seems very calm right now, the levels of investor anxiety and panic have been increasing steadily all year.


The Marketpsych Fear Index versus the Dow Industrials, Jan-Sep 2007 <font face=Arial size=-2>(Source: WSJ)</font>
The Marketpsych Fear Index versus the Dow Industrials, Jan-Sep 2007 (Source: WSJ)

The adjoining graph appeared in a Wall Street Journal article on the emotional roller coaster that investors currently face. "In these markets, everyone's afraid. It's your response to the fear that matters most."

According to the article, people respond from a different part of the brain when in the midst of calm, clear thought. "That area is the prefrontal cortex, ... the "executive" node of the brain that plans and reasons. When we are fearful, blood flows away from the area toward the motor areas of the brain -- the ones that produce a flight-or-fight sensation. This is great if you're confronting a saber-toothed tiger, but not so great if you're mulling your daughter's college fund."

If you look at the above graphic, you'll see that it graphs two sets of values: The DJIA index (in blue), and the "Marketpsych Fear Index" (in gold)." The point of the graph is that the market index was lowest when the "fear index" spiked up, after the February 27 and July 23 "mini-panics."

However, the article never mentions this or anything else about the graphic.

This is very strange about the article. It contains all kinds of fuzzy advice about good investing practices when you feel panicky:

"He recommends two other means of coping with financial fear. The first sounds simple but is essential -- training yourself to recognize fear in the first place. For example, your habit may be to avoid the markets altogether by shunning the newspaper or online stock quotes.

The second approach is to prepare for a busted or volatile market, much like an astronaut rehearsing emergency procedures. This helps neutralize the fear in your decision making, especially in those moments when it seems so easy to succumb.

That's why it might make sense to decide ahead of time your range of responses if your portfolio loses, say, 10% to 20% of its value. Research has shown that, unsurprisingly, retail investors are usually the worst at this, adds [MIT Professor Andrew Lo]."

That's probably good advice, but what we're interested in here is examining the behavior of the market as a whole.

I'm guessing here, but there's little doubt in my mind about why there are no comments about the graph: The news is very bad.


The Marketpsych Fear Index versus the Dow Industrials, Jan-Sep 2007, annotated with trend line <font face=Arial size=-2>(Source: WSJ)</font>
The Marketpsych Fear Index versus the Dow Industrials, Jan-Sep 2007, annotated with trend line (Source: WSJ)

The modified graphic shows the trend line since the beginning of the year, ignoring the two "mini-panics." The transparent red line shows that the "fear index" has been trending upwarding continuously all year, even if you ignore the spikes.

From the point of view of Generational Dynamics, this provides a great deal of interesting new information.

As regular web site readers are aware, I've been conducting a speculative real time experiment, comparing the 1929 and 2007 markets, following their respective market peaks. In 1929, the Dow Industrials peaked on September 3 at 381.17; within 8 weeks, it had fallen 40%. In 2007, the market peaked on July 19 at 14000; 8 weeks have now passed, and the market is 5% below its peak, and may drift even higher. So the comparison seems to have failed.

There IS one major difference between today's market and the 1929 market: The aggressive "injection" of liquidity into the markets. This action has so far prevented a "domino effect," where the collapse of one investment vehicle causes others to collapse. This is serving to extend the period of time over which the financial crisis occurs.

However, this "fear index" study, if valid, indicates that the fundamental basis on which the comparison was made is correct.

Recall that I've said that it isn't the market ups and downs that matter; what matters is the level of fear and anxiety exhibited by masses of investors.

The graph shows that investor anxiety has been growing steadily since January, not just since the July 19 peak, as I had been assuming. It would be very interesting to have data prior to January, but the Marketpsych web site doesn't seem to provide any earlier data.

The WSJ article concludes with these paragraphs:

"Each generation has to go through it and has to emotionally experience it," [says 67-year-old financier Lewis van Amerongen]. "Without that, it's just an academic exercise."

In other words, there is no substitute for having survived other fearful experiences. The best antidote for fear just may be fear itself."

This concept is what this web site and Generational Dynamics are all about. When a generation survives a generational crisis war or a generational financial crisis, they learn how to deal with these crises, and they don't panic.

The generations born after the crisis don't have that experience under their belts, and they DO tend to panic.

As long as the surviving generations are alive, they're society's leaders, and they can control panic. That's why generational crisis wars have never occurred in the 40 year period following the end of one crisis war, and have rarely occurred in the 50 year period following.

Once the surviving generations disappear, the younger generations have no experience and no leadership that helps them deal with panic. This is what leads that next generation into the next crisis war or the next financial crisis.

Assuming that I can ever find anyone who's interested in funding Generational Dynamics research, the "fear index" study hints at a very powerful predictive tool. A "fear index" can be computed for many different things -- not just financial market anxiety, but also anxiety in Palestinians over Israelis, anxiety in Israelis over Palestinians, or anxiety in Americans and Chinese about each other.

Let me just tie this into things I've written about many times in the past:

These examples indicate how the "fear index" can be used in a variety of ways to augment the Generational Dynamics forecasting methodology.

This "fear index" can even be computed for several prior years, by examining news stories and even blogs during previous years.

This kind of study could be a powerful business tool -- by measuring anxiety in specific markets, for example -- and a powerful international relations tool -- by measuring anxiety between potential war enemies.

The "fear index" would be a short-term forecasting tool, of a type that I've previously discussed. As I've indicated in the past, the Generational Dynamics forecasting methodology combines long-term and short-term forecasting methodologies. The long-term forecasting tools provide predictions that are 100% accurate, but within a window of years and sometimes decades. Short-term forecasting methodologies produce predictions in the very near term, but rarely with a probability much above 50%. What I've been doing on this web site for 5 years is developing the forecasting methodology that combines short-term and long-term forecasts into a forecast that has an 80-90% probability of being correct, and with a window of just a few weeks or months.

As I write this, early on Thursday afternoon, the market appears to be surging upwards. The commentary is related to the "certainty" that Fed is going to decrease the Fed funds interest rate when it the Open Market Committee meets next week, and that this decrease will save the world. The expectation is that the Fed will reduce the Fed Funds rate by 25 basis points (¼% interest), from 5¼% to 5% even.

The following graph, appearing on the Minyanville blog, shows the EFFECTIVE Fed Funds rate:


Effective Fed Funds Rate, Jan-Sep 2007 <font face=Arial size=-2>(Source: Minyanville)</font>
Effective Fed Funds Rate, Jan-Sep 2007 (Source: Minyanville)

What's the EFFECTIVE Fed Funds rate?

If you go back to my recent article, "Bernanke's historic experiment takes center stage," I described how the Fed uses "open market operations" to provide INDIRECT control over the interest rate that banks use when lending money to one another. This indirect control is not absolute. As you can see from the above graph, the EFFECTIVE rate was very close to 5.25%, the nominal rate, since January.

However, right after the July 19 market peak, the credit crunch began in earnest, and banks started "hoarding cash," for fear that they'd have cash flow problems. They demanded that the Fed sell them a lot more Treasury bills than usual, since the banks wanted to lend their excess cash to the Fed, rather than to each other. The Fed evidently acquiesced to these demands, sold more Treasury bills than usual. The demand for these bills was very high, and so the price went up, pushing the yields, or interest rates, down. (Prices and yields vary inversely.)

The graph above shows that the Fed Funds rate has been EFFECTIVELY around 5% for much of this period, and so an OFFICIAL lowering of the Fed Feds rate to 5% should not have a great effect.

That's why a Fed Funds rate reduction next week is so widely expected, and it's also why it may not have much of an effect.

But there's nothing rational about what's going on. Investors remember that the party was still in full force (i.e., the bubble was still growing) when the Fed Funds rate was last at 5%, and so they expect it to have the same effect now.

Actually, there are a lot of negative indicators that weren't in play the last time the Fed Funds rate was at 5%: the value of the dollar has fallen to record lows against the euro; unemployment claims have been growing steadily all year; oil prices have surged to $80 a barrel.

And possibly most important, the "Marketpsych Fear Index" has been growing steadily and relentlessly all year, and there's no reason to believe that will change. In fact, it's generational change that's causing the growth, and nothing can change that.

From the point of view of Generational Dynamics, the fundamentals haven't changed from where they've been for several years. A stock market panic and crash MUST occur, because the market overpriced by a factor of 250%. The behavior that the "fear index" captures is the dramatic change, for masses of investors, away from "risk-seeking" or "risk-ignoring" behavior toward "risk-averse" behavior. Unless there's an equally dramatic reversal of investor attitudes and behaviors, it's still likely that this will occur in the next few weeks. (13-Sep-07) Permanent Link
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Japan's Prime Minister Shinzo Abe steps down amid decreasing popularity

Scandals, incompetence, and Japan's schizophrenic attitudes toward fighting terrorism are blamed for the downfall of Prime Minister Shinzo Abe, who took office only a year ago.


Top: Shinzo Abe gives resignation speech.  Bottom: Opposition politicians applaud. <font face=Arial size=-2>(Source: BBC)</font>
Top: Shinzo Abe gives resignation speech. Bottom: Opposition politicians applaud. (Source: BBC)

When Abe took office, he had ambitious plans to increase Japan's role in worldwide diplomatic and military affairs. He began with widely applauded trips to China and South Korea, to reduce tensions with those countries over World War II atrocities, and his approval rating went to 80%.

Abe's most important initiatives were in the military arena, with plans to beef up Japan's military defense, and to amend the post-war pacifist constitution that forbids declarations of war.

When Abe took took office as a young, hawkish Prime Minister, born in the generation following World War II, I expected Japanese-Chinese relations to get worse.

That doesn't appear to have happened -- or maybe it might have happened if Abe's administration hadn't been struck by one scandal after another:

These scandals might well be enough to cause any political leader in any country to resign. In fact, Abe's ruling Liberal Democratic Party (LDP) suffered a major election defeat on July 29, and his personal approval rating is now close to 20%.

But Abe gave an entirely different reason for his resignation:

"[Despite the negative results of the legislative elections,] I had determined that the reforms should not be stopped and that the direction of breaking away from the post-war regime should not be changed. I decided to continue in office. Since then, I have worked as hard as possible, until now. ...

Recently [I said that] the war against terrorism should not be discontinued and that it should be continued by all means. ...

I had the responsibility to persist in this policy with everything in my power. With that thought, I said that I would make every effort and risk my job in order not to discontinue this mission.

I also said I would absolutely not cling to power. Toward this end, I had to make every effort possible.

I also felt that I had to work hard to create the environment, and that I had to give everything I have, and to do everything possible.

[I met with opposition leaders and,] unfortunately, my proposal for the meeting was, in effect, rejected, [and I was criticized] for not following the people's mandate. It is truly regrettable.

I thought about what I should do in order to continue the war against terrorism and concluded that I needed to turn the tide.

Under a new prime minister, the government should aim to continue the fight against terrorism, and to provide a breakthrough in this situation."

The specific issue at hand was a proposal to extend Japan's support for the US-led war in Afghanistan. Under this program, Japan's navy refuels US aircraft in the Indian Ocean.

Some news reports indicate that a deal may have been made, where Abe's opposition will permit this program to continue as long as Abe resigns.

This schizophrenia is strikingly similar to the situation in the United States, where the Congress spends day after day after day investigating real or imagined scandals and makes fatuous demands to end the Iraq war without actually accomplishing anything at all.

In fact, this is the kind of paralysis that's been happening around the world in countries that fought in World War II, including Israel, Korea and Britain.

From the point of view of Generational Dynamics, this kind of paralysis is typical of governments just preceding the start of a new crisis war. The reason is that the survivors of the last crisis war have all retired or died, and the new post-war generation (the Boomers in the United States) have no idea how to govern or how to avoid war. At some point they panic, and a new crisis war begins.

Generational Dynamics predicts that there will be a new Clash of Civilizations world war. It may begin next month, next year or thereafter, but it will occur with 100% certainty. In that war, Japan will be our ally, and China will be our enemy, reversing their World War II roles. (12-Sep-07) Permanent Link
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Pressure is building in Israel for a new invasion of Gaza

Surprisingly, many Palestinians are allying with Israel against Hamas.

Pressure is building in Israel for a major military assault in the Gaza Strip, after Palestinian militants from Islamic Jihad fired rockets into an Israeli army base, injuring 69 soldiers.

There have been a steady stream of these home-made Qassam rockets coming from Gaza into Israel since 2004. These rockets lack any guidance system, so they go wherever they go, within a 5-6 mile range. They rarely cause harm, but this successful strike is causing an already anxious Israeli public to demand that something be done.

However, the demand to "do something" is not new. The Israeli Defense Forces (IDF) have launched hundreds of pinpoint strikes, targeting Hamas and Islamic Jihad leaders, without any effect on the Qassam rockets.

Thus, the IDF is now considering a major assault on Gaza, possibly a complete Israeli re-occupation.

Hamas leaders have responding by going into hiding, after evacuating their security installations, their civilian offices, and even their homes.

Long-time readers of this web site will recall that when the Mideast Roadmap to Peace was announced in May, 2003, calling for side-by-side Palestinian and Israeli states, I predicted that the Roadmap would never succeed, and that the death of Yasser Arafat, when it occurred, would trigger a generational change leading to a new genocidal war between Arabs and Jews. This is based on a Generational Dynamics analysis of the situation following the genocidal war of the late 1940s, when Palestine was partitioned and the state of Israel was created.

Since the death of Arafat in December, 2004, I've been watching carefully to see whether the hatreds necessary for such a war would start building up.

It certainly likely to happen, especially in Gaza, where the median age is 16, guns and other weapons are plentiful, and the standard of living is one of the poorest in the world.

These hatreds HAVE been building up, but not between Palestinians and Israelis, which is what I expected.

Instead, such tensions have been building up between the two major groups of Palestinians, Fatah and Hamas.

I have NOT seen a build-up in hatred between Arabs and Jews. I've mentioned this several times in the past -- that this is the missing ingredient. I particularly noted it in last summer's war between Israel and Hizbollah.

In that war, Israel panicked and went to war in four hours, with no plan and no objective. This behavior is typical of a country in a generational crisis era.

However, here's what DIDN'T happen:


Palestinian Territories <font face=Arial size=-2>(Source: Der Spiegel)</font>
Palestinian Territories (Source: Der Spiegel)

Instead, what we saw instead is a civil war between Fatah and Hamas, and a stunning victory of Hamas over Fatah in Gaza in June.

Last December, I wrote an article attempting a generational breakdown of the major Palestinian groups. Here's a summary:

However, it's now become clear that this breakdown has to be modified.

Palestinian President Mahmoud Abbas and Israeli Prime Minister Ehud Olmert and their ministers have been meeting from time to time, making plans for peace. A recent poll shows that nearly three-quarters of Palestinians now oppose the Hamas takeover of Gaza.

What appears to be happening is that the two younger generations, that I've identified as the "Hamas Generation" and the "Young Guard," respectively, actually each have to be split into two groups, one a group of militants dedicated to the destruction of Israel, and one who considers Israel less evil than the militants wishing to destroy Israel.

But what continues to be the greatest surprise is that the hard-core militants that hate Israel appear to be a fairly small group. This group is centered in Gaza, while the moderate group is centered in the West Bank.

The basic generational prediction has not changed -- a new genocidal war re-fighting the genocidal war of the late 1940s between Palestinians and Jews.

As I always say on this web site, Generational Dynamics tells you where you're going, but doesn't tell you what scenario you'll follow to get there.

It now seems actually possible that the fight will be Israelis + Palestinians versus Palestinians, at least at the beginning. As the war grows, and everyone is forced to choose sides, I would still expect the war to be between Palestinians and Israelis.

If the IDF does indeed purse a major incursion into Gaza, then we may soon see how long these new alliances can last. (12-Sep-07) Permanent Link
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Understanding deflation: Why there's less money in the world today than a month ago.

As the markets continue to fall, the Fed is increasingly in a big bind.

I've received several recent inquiries from web site readers about how there could be less money in the world today than there was a few weeks ago.

Here's how one web site reader put it:

"The only part of your theory that I do not understand is this: I sell my stock in company ABC. I have to put that money in some instrument. The stock is valued at the sell price. Everyone else follows suit in a panic. They all put the money under the mattress or somewhere, The stock continues to decline. The wealth is not disappearing. It is simpling changing hands."

The reader has a point. If you sell your stock, it just means that money goes from one person to another. It doesn't mean that there's less money in the world. So why is there less money in the world?

What we're going to show is how use of credit CREATES new money. What's happening today is a "credit crunch," and the withdrawal of credit actually DESTROYS money.

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First, you have to realize that money doesn't actually exist much any more, at least in physical form. When you put a coin into a vending machine, you're buying something with an actual coin; but it's more likely that you're paying by credit card or by check, and then there's no physical value at all.

Let's start with a silly example. Suppose your bank's computer software has a bug, and it mistakenly adds $10,000 to the balance in your checking account. Well, suddenly you're $10,000 richer, and there $10,000 more money in the world. That's how easy it is. And when the mistake is discovered, you'll be $10,000 poorer and there will be $10,000 less money in the world.

That was a silly example, but let's look at some more realistic examples:

All of these examples have been occurring with increasing frequency, ever since the dot-com bubble began in the mid-1990s.

In fact, each of the above kinds of things have happened trillions of times in the last few years, and really took off in 2003. Those trillions of times created huge amounts of new money, and that new money created the real estate bubble and various other bubbles.

And now, all of the above processes are going in reverse. Where huge amounts of money were being created, huge amounts of money are now being destroyed.

The destruction of the credit bubble is occurring very rapidly right now. One form of credit is "asset backed commercial paper," or ABCP. This is like the IOU that I described in the example above. One business loans money to another business, and receives ABCP back as collateral. If the ABCP was backed by a AAA-rated corporation, then the ABCP itself can be used for other investments.

However, let's go back to the IOU example that I gave above. Suppose the IOU expires after 90 days. Then two things can happen. After 90 days, you will have to pay me back my $100 (with interest), and I'll return the IOU to you; or you'll simply issue a new IOU for another 90 days and keep the $100. (This last is called "rolling over.")

That's how commercial paper works. It can be issued for 30, 60 or 90 days, and when that period is up, the issuer either has to pay up, or else roll the commercial paper debt over into new commercial paper. Usually the rollover option is pretty much automatic.

But that stopped happening a few weeks ago. The commercial paper market has almost been frozen to a standstill. The amount of commercial paper is falling so rapidly that the phrase "crash" applies to it.

Take a look at the following chart, which appeared on Michael ("Mish") Shedlock's blog, and pay particular attention to the thick white line which started skyrocketing in 2004:


Chart showing the evaporation of commercial paper in the last four weeks. <font size=-2>(Source: Bloomberg via Bennet Sedacca)</font>
Chart showing the evaporation of commercial paper in the last four weeks. (Source: Bloomberg via Bennet Sedacca)

If you look at the thick white line, you see that it reached a peak very close to $1.2 trillion a few weeks ago. Since then it's been falling like a stone, and on September 5 it had fallen 20%, to $959 billion.

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That thick white line represents the amount of commercial paper in circulation. And since commercial paper represents money, it shows that the amount of money in the world due to commercial paper has fallen by some $200 billion in the last few weeks.

Is that the end of the commercial paper crunch? Hardly.

According to an analysis in the Sunday Telegraph,

"Britain's biggest banks could be forced to cough up as much as £70bn ($140 billion) over the next 10 days, as the credit crisis that has seized the global financial system sparks a fresh wave of chaos.

Almost 20 per cent of the short-term money market loans issued by European banks are due to mature between September 11 and September 19. Senior bankers fear that they will have to refinance almost all of these debts with funds from their own coffers, putting a further strain on bank balance sheets.

Tens of billions of pounds of these commercial paper loans have already built up in the financial system, because fear-ridden investors no longer want to buy them. Roughly £23bn ($46 billion) of these loans expire on September 17 alone.

Fears of this impending call on bank credit lines are the true reason that lending between banks has ground to a halt, according to senior money market sources.

Banks have been stockpiling cash in preparation for this "double rollover" week, which sees quarterly loans expire alongside shorter term debts - exacerbating a problem that lies at the heart of the credit crisis."

According to a commentary article,

"As we reveal today, an estimated £70bn worth of European commercial paper that has not yet been caught up in the crisis is due to expire between September 11 and 19. Ordinarily, this would present little problem. Companies borrowing money by issuing commercial paper normally expect to "roll over" the loan from one period the next. Just in case the lenders decide not to play ball, most borrowers arrange a backstop funding facility with a major bank.

Except, now, everyone is getting cold feet at the same time. Lenders are worried that some of the borrowers could be contaminated by the subprime mortgage crisis in the US. Until they can find out which ones, they don't want to lend to anyone at all. So the banks who offered backstop lending lines will soon discover just where the buck really stops."

For those web site readers who wrote to me, and to others who have wondered how money could be disappearing from the world, I hope this clears things up.

Money doesn't really exist any more, in the sense of coins or currency. Money today exists only in the form of bits and bytes in computer databases. And those bits and bytes can be changed in a nanosecond to be larger or smaller, creating or destroying money. And today, they're mostly destroying money.

So now you can see the bind that the Fed is in. I recently posted two articles on Bernanke's philosophy for avoiding a new 1930s style Great Depression: "Ben Bernanke's Great Historic Experiment" and "Bernanke's historic experiment takes center stage."

These articles tell of Bernanke's belief that the 1930s Great Depression could have been prevented, and that a new Great Depression can be avoided, by injecting money into the economy.

This is the "deflation" problem. As the amount of money in the world contracts, there's less money available to buy things, and so prices come down. As I've been saying since 2003, my expectation is that the Consumer Price Index will fall 30% by 2010.

Alan Greenspan and Ben Bernanke used to believe that deflation was impossible. After a decade of deflation in Japan, they finally decided that it was possible, but only if the central bank made mistakes. This is why I keep saying that mainstream macroeconomics has been a total failure.

Now we're beginning to see the real reason why deflation occurs, and why it can't be stopped: The problem is that the Fed and other central banks don't have anything like enough money to compensate for the huge contraction in credit that's going on right now.

Above we showed just what's happening with one form of credit, commercial paper, representing about one trillion dollars of debt. There are hundreds of trillions of dollars in derivative instruments of all types out there in the world, and these are going to contract just like commercial paper.

Frequently on this web site I use the analogy of a tsunami: You can't stop a crisis war from coming any more than you can stop a tsunami; all you can do is prepare for it.

The collapse of credit, and the destruction of money, are the tsunami currently on the horizon.

Bernanke had thought he could stop the tsunami by putting up a small barricade on the beach. But the tsunami will wash over that barricade as if it weren't there.

The stock market is another form of credit. You purchase shares in the company with money that the company uses for its expenses. If the commercial paper market can crash, then so can the stock market.

At some point in the not too distant future, this is going to trigger a major panic. If other forms of credit are crashing as quickly as commercial paper is crashing, then it may yet happen by September 21, or shortly after that otherwise. (10-Sep-07) Permanent Link
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Alan Greenspan predicts the panic and crash of 2007

He's said this kind of thing before, but this time it's resonating.

According to an article in the Wall Street Journal, former Fed Chairman Alan Greenspan called today's market conditions in many ways "identical" to those preceding several previous market panics and crashes:

"Former Federal Reserve Chairman Alan Greenspan said the current market turmoil is in many ways "identical" to that which occurred in 1987 and 1998, when the giant hedge fund Long-Term Capital Management nearly collapsed.

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Alan Greenspan predicts the panic and crash of 2007: He's said this kind of thing before, but this time it's resonating.... (08-Sep-07)
Bernanke's historic experiment takes center stage: An assessment of where we are and where we're going.... (27-Aug-07)
How to compute the "real value" of the stock market. : And some additional speculations about stock market crashes. (20-Aug-2007)
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Redemptions of money market funds now fully in doubt: Wednesday is the deadline for 3Q redemption of many hedge fund shares.... (15-Aug-07)
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Alan Greenspan blames the housing bubble on the fall of the Berlin Wall: Meanwhile, the stock market keeps skyrocketing and appears unstoppable to many investors.... (25-Oct-06)
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Alan Greenspan gives another harsh doom and gloom speech: Saying that "the consequences for the U.S. economy of doing nothing could be severe,"... (4-Dec-05)
Ben S. Bernanke: The man without agony : Bernanke and Greenspan are as different as night and day, despite what the pundits say. (29-Oct-2005)
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Greenspan's testimony further repudiates his earlier stock bubble reasoning: The Fed Chairman has now completely reversed his previous position on the stock market bubble... (17-Feb-05)
Alan Greenspan warns that global economic dangers are without historical precedent : In a speech on Friday, Greenspan buried a major change of position in a speech admitting that his assumptions about the economy for the last decade were wrong. (6-Feb-2005)

"The behavior in what we are observing in the last seven weeks is identical in many respects to what we saw in 1998, what we saw in the stock-market crash of 1987, I suspect what we saw in the land-boom collapse of 1837 and certainly [the bank panic of] 1907," Mr. Greenspan told a group of academic economists in Washington, D.C., last night at an event organized by the Brookings Papers on Economic Activity, an academic journal.

Mr. Greenspan, Fed chairman from 1987 to 2005 and now a private consultant, said business expansions are driven by euphoria and contractions by fear. While economists tend to think the same factors drive expansions and contractions, "the expansion phase of the economy is quite different, and fear as a driver, which is going on today, is far more potent than euphoria."

The euphoria in human nature takes over when the economy is expanding for several years, and leads to bubbles, "and these bubbles cannot be defused until the fever breaks," he said.

Bubbles can't be defused through incremental adjustments in interest rates, Mr. Greenspan suggested. The Fed doubled interest rates in 1994-95 and "stopped the nascent stock-market boom," but when stopped, stocks took off again. "We tried to do it again in 1997," when the Fed raised rates a quarter of a percentage point, and "the same phenomenon occurred."

"The human race has never found a way to confront bubbles," he said."

Greenspan certainly knows what this fear is like. Born in 1926, Greenspan grew up during the massive starvation and homelessness of the 1930s Great Depression, during which this kind of fear was rampant.

This isn't the first time that Greenspan warned of a coming financial crisis resulting from the current bubbles, but it appears to be the first time that his warnings have resonated with general investor sentiment. In fact, Greenspan's warnings may be partially responsible for Friday's "mini-panic" that resulted in a 2% fall in Wall Street markets.

I've been following Greenspan's changes in attitude on this web site since 2003, and I summarized what I found in my 2005 article, "Ben S. Bernanke: The man without agony."

In fact, Greenspan's own attitude went from euphoria to fear. In January 2004 he was patting himself on the back for avoiding any major economic harm from the 1990s dot-com bubble:

"There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the [1990s dot-com] bubble's consequences, rather than the bubble itself, has been successful. Despite the stock market plunge, terrorist attacks, corporate scandals and wars in Afghanistan and Iraq, we experienced an exceptionally mild recession, even milder than that of a decade earlier." -- Alan Greenspan to the American Economic Association's annual meeting.

During 2004, his speeches became increasingly anxious, and early in 2005, he completely repudiated his previous reasoning, "because yields and risk spreads have narrowed globally."

His public remarks became increasingly alarming, culminating in his "swan song" speech at the end of August, 2005, the last major speech he gave a Fed chairman.

In that speech he commented favorably on the economy’s flexibility because it encourages investor risk, but warned about the stock market and housing bubbles, and added:

"To some extent, those higher [stock and housing] values may be reflecting the increased flexibility and resilience of our economy. But what [investors] perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums."

This speech, which has been almost completely ignored by the mainstream press and by investors in general, was a warning that now, in 2007, he's repeating explicitly.

Since becoming a private citizen again, Greenspan's speeches have been hot and cold.

Many of his speeches have been fanciful defenses of his own policies. A year ago, he blamed the housing bubble on the fall of the Berlin Wall. And a month ago, he blamed any economic problems on other countries. He essentially repeated Ben Bernanke's claim, first made in 2004, that America's astronomical public debt is not America's fault, but is the fault of "a global savings glut" in other countries.

Greenspan's latest remarks are a return to his 2005 state of alarm, turned up a few notches, and in much more easily understood language. He's well aware by now that a financial crisis is coming, and that he and Ben Bernanke are going to be blamed. You hear this all the time from TV pundits, as in the hysterical rant by CNBC's Jim Cramer. I also see it in the many e-mail messages I get from people who place the entire blame on the two Fed chairmen.

Now, no one has been more critical of Alan Greenspan and Ben Bernanke than I have, but not because they're to blame for the coming financial crisis. I've been critical of them because they keep saying such incredibly stupid things, and because they have no idea what's going on in the world, but instead continue to apply simplistic economic theories that have failed time after time after time.

The current crisis was not caused by Alan Greenspan or Ben Bernanke or other nations' central banks. It was caused because huge masses of people, entire generations of people, used credit abusively after the people in the generation that survived the 1930s Great Depression all disappeared (retired or died), all at once, in the early 1990s.

Neither Greenspan nor Bernanke could have done anything about it, although they'll be blamed. Bernanke will especially be blamed because it's obvious that he's stumbling along with absolutely no idea what's going on. He's a Professor of Economics at Princeton University, but often appears to know less than his freshman students.

The 1930s Great Depression brought about the development of macroeconomic theory, a major enlargement of the previous (micro) economics theory. It is my expectation that this new financial crisis will bring about the development of "dynamic macroeconomic theory," as I described in my article, "System Dynamics and the Failure of Macroeconomics Theory." Whether that knowledge will prevent future bubbles and panics is, however, anyone's guess. (08-Sep-07) Permanent Link
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United Nations warns of social unrest as food prices continue meteoric climb

With world wheat prices now up 60% since January, countries are panicking over fear of impending shortages -- not just of wheat, but of related grains and even meats (since grain is needed to feed cows).

It's been just two weeks since I wrote a lengthy analysis about panic buying following a 30% spike in wheat prices.

Since then, prices have continued upward, and the panic has been taking a different form, as Russia and other wheat-producing countries consider a wheat export ban.

Russia has elections in December, and the politicians are worried about bread prices, and so Russia will probably announce either an export ban or a high export tariff. Ukraine and Indonesia, also large food exporters, are announcing export bans.

These announcements are causing further panic buying in other countries, including Egypt and India.

The demand for food crops for biofuels is increasing.

The result is historically high prices for cereal grains and related foods.

The surging food prices have "the potential for social tension, leading to social reactions and eventually even political problems," according to Jacques Diouf, director-general of the UN’s Food and Agriculture Organisation.

He particularly pointed to Mexico, where mass protests were triggered by rising corn prices.

When I discussed tortilla prices and the situation in Mexico last February, I pointed out that rising prices were causing a lot more problems than just political problems. In particular, it was causing the rise of increasingly violent drug cartels.

The UN's Diouf pointed out that, while food represents about 10-20% of consumer spending in industrialized countries, it represents 65% of in developing nations.

The continuing surge in food prices is extremely ominous. When a man can't afford to feed himself and his family, then he has absolutely nothing to lose by going to war, especially in densely packed developing countries, where there are no other choices. (08-Sep-07) Permanent Link
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Algerian suicide bomber kills 16 and injures 75

President Abdelaziz Bouteflika escaped injury on Thursday when a suicide bomber targeting him was forced to blow himself up before he could approach the President.

It was just 5 months ago, in April, when Northern Africa was in shock after massive terrorist bombings in Algiers and Casablanca.

A group called "al-Qaeda in the Maghreb" (al-Qaeda in Northern Africa), formerly called GSPC (Salafist Group for Preaching and Combat), took responsibility for those attacks. No one has yet claimed responsibility for the new bombing, but the same group is considered likely.

This is part of the pattern we're seeing countries around the world.

Yesterday we reported that Germany foiled a "massive" terrorist attack on US facilities. The captured suspects had been trained by al-Qaeda clerics in Pakistan, and had formed "Hero/Prophet" relationships with those clerics, which is the standard Generational Dynamics paradigm during a crisis era.

If al-Qaeda in the Maghreb claims credit for the new Algerian bombing, we can assume that the same kind of thing happened -- a young man fell under the sway of an al-Qaeda cleric "Prophet," and decided to become a "Hero" by committing altruistic suicide -- killing himself for the good of the "cause."

Al-Qaeda has scored a number of "successes" this way, with suicide bombings in London, Madrid, Iraq, Egypt, and numerous other countries.

Despite these "successes," Osama bin Laden has had numerous failures.

For many Muslims, a suicide bombing in Algeria can hardly be a major success, since Algeria is 99% Sunni Muslim.

Even in Iraq, where suicide bombers are supposedly targeting Americans, by far the most overwhelming numbers of casualties are Muslims.

Bin Laden can count the London and Madrid subway bombings as clear "successes," but Europe is a relatively easy target, because there are so many porous borders.

There is still one and only one "gold standard" target for bin Laden: A new major terrorist attack on American soil, especially something on the anniversary of 9/11. (07-Sep-07) Permanent Link
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Germany foils a "massive" terrorist attack on US facilities

The suspects had amassed 1500 pounds of hydrogen peroxide -- the same chemical used in the London subway suicide bombings in 2005.

The three suspects arrested by German police on Wednesday are aged 22-29. Two are German and one is Turk. They had formed a terror cell called the Islamic Jihad Union in Hamburg in December, 2006, just 9 months ago.

The three were in the final stage of planning "massive" and "imminent" attacks on American targets in all across Germany. The attacks would have been linked to an al-Qaeda celebration of the 9/11 attacks.

"The main motivation of the group in Germany is hatred against American citizens and therefore they had as main targets the American military installations," Jorg Ziercke, president of Germany's Federal Criminal Investigation Office, said. Possible targets might have included Ramstein Air Base and Frankfurt Airport, as well as discos, pubs, airports and other places frequented by Americans.

They had received terror training from al-Qaeda linked clerics in Pakistan. It would be interesting to get more information about this.

The successful July 7, 2005, London subway bombing has been a powerful tool for the Islamist radicals in recruiting young Muslims in England to form terror cells for further terrorist acts.

As I wrote in the article, "MI5 chief: U.K. flooded with Islamic terrorists / sympathizers," from the point of view of Generational Dynamics, many of Britain's young Muslims have set up a "Hero/Prophet" relationship with the radical clerics in Pakistan. This kind of relationship is the visceral basis by means of which new genocidal crisis wars begin. There's an emotional connection between the elder Prophet generation (the idealistic generation born after the last crisis war) and the impatient college age Hero generation (the soldiers who will be fighting the new crisis war).

The initial news reports don't give any details about the German terrorists' relationships with Pakistani clerics, but it appears likely that the same kind of "Hero/Prophet" relationship has developed.

From the point of view of Generational Dynamics, this kind of Hero/Prophet relationship is a standard precursor to the worst kinds of crisis wars. As a country enters a crisis era, approximately 55-60 years after the end of the last crisis war, immigration issues, and xenophobia in general, become important political issues, as is happening today in countries around the world.

At first, this anti-immigrant attitude is diffused and unfocused. But as time goes on, the kids in the younger Hero generation focus on Prophets that best represent their points of view and provide a call for action. The point of view can turn into what might be called "hatred," and the call for action might be called "war."

This happens to every nation to some extent. On this web site we've often discussed the increasing xenophobia between Latinos and Anglos in America, between Europeans and Muslims, between Jews and Arabs, between Pakistanis and Indians, between Chinese and Japanese, between Koreans and Japanese, between Chinese and Americans.

The al-Qaeda cells today are probably the most "advanced" in this process, in that many of them have accepted the call to action, and are preparing for their own wars through terrorist acts and altruistic suicide.

Conflict risk level for next 6-12 months as of: 9-Feb-2006
W. Europe 1 Arab Israeli 3
Russia Caucasus 2 Kashmir 2
China 2 North Korea 2
Financial 3 Bird flu 3
Key: 1=green 1=Low risk 2=yellow 2=Med 3=red 3=High 4=black 4=Active

Here's a possible scenario to show how this works: Right now, American hatred of the Chinese and Chinese hatred of Americans is fairly diffused and unfocused. But suppose there's an international financial crisis, as is expected in the next few weeks. Then the young people in each country will listen to those in the "Prophet" generation who tell them what they want to hear: That the reason that they're starving or homeless is because the wealthy people on the other side (Chinese or Americans, respectively) have purposely harmed them. Once that happens, then demands start getting made, tempers flare, somebody panics, and a war starts.

From the point of view of Generational Dynamics, a new world war is coming with 100% certainty. It might start next week, next month, next year, or thereafter, but it's coming sooner rather than later, and one possible trigger may be a major worldwide financial crisis. (06-Sep-07) Permanent Link
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Investors grow more anxious, as markets continue their fall

Wednesday's comments were by far the gloomiest I've seen.

At 3 pm on Wednesday, the Dow was down by 170 points, or about 1¼%, and 700 points from its July 19 peak. This is not an uncommon occurrence, and normally comments would be in the category of "Oh, what a shame, but it will be back up tomorrow."

But not this time.

The headline on the Wall Street Journal Online site was this:

"STOCK MARKETS STAYED DEEP IN THE RED, underpinned by renewed concerns about weakness in the housing and credit markets."


The lovely CNBC anchor Erin Burnett reports the bad news on Wall Street. <font face=Arial size=-2>(Source: CNBC)</font>
The lovely CNBC anchor Erin Burnett reports the bad news on Wall Street. (Source: CNBC)

Now, this may not seem that significant, but I can't recall seeing any headline so gloomy in many years. Normally, the WSJ site would have something like "The Dow Industrials tumbled 170 points ...."

Someone in the WSJ newsroom didn't feel that "tumbled" was strong enough at 3 pm. But by Wednesday evening the headline was the more sanguine, "The Dow Industrials fell 143.39 ...."

There's more. At 3 pm, if you were listening to CNBC, you were listening to bad news, as the following headlines were displayed on the bottom of the screen, one after another, on the bottom of the screen as the various reporters and pundits spoke:

I just noticed something very amusing.

You'll notice in the above picture, the caption reads, "The lovely CNBC anchor Erin Burnett reports the bad news on Wall Street."


The lovely CNBC anchor Erin Burnett explains why the "big money" is disappointed that the market didn't go lower. (Originally posted on March 5, 2007.) <font face=Arial size=-2>(Source: CNBC)</font>
The lovely CNBC anchor Erin Burnett explains why the "big money" is disappointed that the market didn't go lower. (Originally posted on March 5, 2007.) (Source: CNBC)

I just checked to see - when was the last time that I posted a picture of the lovely Erin Burnett? It turns out that it was in an article entitled "Last week on Wall Street," posted on March 5, 2007. You may recall that the previous week had seen a brief spasm of volatility after the Shanghai stock market fell 9% in one day. But now the spasm was over, and the market was going up again.

The lovely Erin Burnett was asked by another reporter at that time, what do the "big money" investors think of what happened the previous week? Here was the answer she gave:

"The bottom line is that 'big money' wants more selling. They want to see and feel some panic in the market before they feel that it's over. They haven't liked the rally over the last couple of days."

Well, well, well! Let's hope that the "big money" is finally happy now. I would hate for the "big money" to be glum.

New readers of this web site may be wondering why I'm focusing on the gloomy remarks of a few reporters, if the fall in the Dow isn't that significant?

The answer is the same as the one I've given before: The thing that's changed since the market peaked on July 19 is a change in attitude and behavior among great masses of investors from "risk-seeking" or "risk-ignoring" to "risk-averse."

There was no such change when the market spasm occurred on February 27. There is this time.

As regular readers know, we've been conducting a speculative real-time experiment, comparing the 1929 and 2007 markets, following the respective market peaks. This data is taken from my Dow Jones historical page. On September 3, 1929, the market peaked at Dow 381.17. By November 15, it had fallen 40% to 228.73. This year (so far), the market peaked on July 19 at 14000.

The speculative comparison appears to be more and more incorrect. Here's an update:

    1929   % of peak (381.17)
    -------------------------
    Tue 09-03 ( +0.22%) 100%              2007   % of peak (14000)
    Wed 09-04 ( -0.41%)  99%              ------------------------
    Thu 09-05 ( -2.59%)  97%              Thu 07-19 ( +0.59%) 100%
    Fri 09-06 ( +1.76%)  98%              Fri 07-20 ( -1.07%)  98%
    ------------------------              ------------------------
    Mon 09-09 ( -0.36%)  98%              Mon 07-23 ( +0.67%)  99%
    Tue 09-10 ( -2.04%)  96%              Tue 07-24 ( -1.62%)  97%
    Wed 09-11 ( +0.99%)  97%              Wed 07-25 ( +0.50%)  98%
    Thu 09-12 ( -1.23%)  96%              Thu 07-26 ( -2.26%)  96%
    Fri 09-13 ( +0.14%)  96%              Fri 07-27 ( -1.54%)  94%
    ------------------------              ------------------------
    Mon 09-16 ( +1.51%)  97%              Mon 07-30 ( +0.70%)  95%
    Tue 09-17 ( -1.04%)  96%              Tue 07-31 ( -1.10%)  94%
    Wed 09-18 ( +0.65%)  97%              Wed 08-01 ( +1.14%)  95%
    Thu 09-19 ( -0.25%)  97%              Thu 08-02 ( +0.76%)  96%
    Fri 09-20 ( -2.14%)  94%              Fri 08-03 ( -2.09%)  94%
    ------------------------              ------------------------
    Mon 09-23 ( -0.84%)  94%              Mon 08-06 ( +2.18%)  96%
    Tue 09-24 ( -1.78%)  92%              Tue 08-07 ( +0.26%)  96%
    Wed 09-25 ( -0.01%)  92%              Wed 08-08 ( +1.14%)  97%
    Thu 09-26 ( +0.96%)  93%              Thu 08-09 ( -2.83%)  94%
    Fri 09-27 ( -3.11%)  90%              Fri 08-10 ( -0.23%)  94%
    ------------------------              ------------------------
    Mon 09-30 ( -0.41%)  90%              Mon 08-13 ( -0.02%)  94%
    Tue 10-01 ( -0.26%)  89%              Tue 08-14 ( -1.57%)  93%
    Wed 10-02 ( +0.56%)  90%              Wed 08-15 ( -1.29%)  91%
    Thu 10-03 ( -4.22%)  86%              Thu 08-16 ( -0.12%)  91%
    Fri 10-04 ( -1.45%)  85%              Fri 08-17 ( +1.82%)  93%
    ------------------------              ------------------------
    Mon 10-07 ( +6.32%)  90%              Mon 08-20 ( +0.32%)  93%
    Tue 10-08 ( -0.21%)  90%              Tue 08-21 ( -0.23%)  93%
    Wed 10-09 ( +0.48%)  90%              Wed 08-22 ( +1.11%)  94%
    Thu 10-10 ( +1.79%)  92%              Thu 08-23 ( -0.00%)  94%
    Fri 10-11 ( -0.05%)  92%              Fri 08-24 ( +1.08%)  95%
    ------------------------              ------------------------
    Mon 10-14 ( -0.49%)  92%              Mon 08-27 ( -0.42%)  95%
    Tue 10-15 ( -1.06%)  91%              Tue 08-28 ( -2.10%)  93%
    Wed 10-16 ( -3.20%)  88%		  Wed 08-29 ( +1.90%)  94%
    Thu 10-17 ( +1.70%)  89%		  Thu 08-30 ( -0.38%)  94%
    Fri 10-18 ( -2.51%)  87%		  Fri 08-31 ( +0.90%)  95%
    ------------------ -----		  ------------------------
    Mon 10-21 ( -3.71%)  84%		  Tue 09-04 ( +0.68%)  96%
    Tue 10-22 ( +1.75%)  85%		  Wed 09-05 ( -1.07%)  95%
    Wed 10-23 ( -6.33%)  80%
    Thu 10-24 ( -2.09%)  78% Black Thursday
    Fri 10-25 ( +0.58%)  79%
    ------------------------
    Mon 10-28 (-13.47%)  68% Black Monday      September 10
    Tue 10-29 (-11.73%)  60%
    Wed 10-30 (+12.34%)  67%
    Thu 10-31 ( +5.82%)  71%
    Fri 11-01  (Closed)
    -----------------------
    Mon 11-04 ( -5.79%)  67%
    Tue 11-05  (Closed)
    Wed 11-06 ( -9.92%)  60%
    Thu 11-07 ( +2.61%)  62%
    Fri 11-08 ( -0.70%)  62%                   September 21
    ------------------------
    Mon 11-11 ( -6.82%)  57%
    Tue 11-12 ( -4.83%)  55%
    Wed 11-13 ( -5.27%)  52%
    Thu 11-14 ( +9.36%)  57%
    Fri 11-15 ( +5.27%)  60%
    -----------------

We haven't really followed the 1929 pattern. The market has fallen 5%, but was down 15% at a comparable time in 1929. Furthermore, we haven't seen the sharp upward and downward movements we saw in 1929.

If this experiment is right, then the 1929 panic would be repeated sometime in the September 10-21 time frame. It's still possible, but it seems less likely in that time frame.

However, that doesn't mean that no panic is going to occur. Even if nothing happens in the September 10-21 time frame, a panic MUST occur, since the market is overpriced by a factor of 250%. Normally I would say that it might happen next week, next month or next year, but the dramatic change in investor attitudes, as illustrated by the change in tone of the lovely Erin Burnett's reporting, makes it very likely to occur in the next few weeks.

The only thing that could derail this is for masses of investors to go in reverse, returning to "risk-seeking" or "risk-ignoring" behavior. Although I've been surprised by many things in the past, Wednesday's ultra-ultra-gloomy comments would make it the biggest surprise of all. (05-Sep-07) Permanent Link
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Who's most to blame for the problems in the credit market?

A Wall Street Journal poll provides the wrong choices.

The Wall Street Journal poll asks you to select from mortgage lenders, borrowers, ratings agencies, regulators, investment banks and hedge funds.

Here are the results:


Who's most to blame for the problems in the credit market? Poll results: mortgage lenders (45%), borrowers (24%), ratings agencies (8%), regulators (7%), investment banks and hedge funds (16%). <font face=Arial size=-2>(Source: WSJ)</font>
Who's most to blame for the problems in the credit market? Poll results: mortgage lenders (45%), borrowers (24%), ratings agencies (8%), regulators (7%), investment banks and hedge funds (16%). (Source: WSJ)

Unfortunately, the WSJ poll listed the wrong choices. Here's the set of choices that I would have provided, and the approximate percentages:

    Silent Generation       10%
    Baby Boomer Generation  40%
    Generation-X            40%
    Millennial Generation   10%

That's the right way to look at it. (04-Sep-07) Permanent Link
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Financial firms worry about more credit turmoil after Labor Day

The Fed's discount rate actions appear to have been a failure, according to Morgan Stanley analysts Ted Wieseman and David Greenlaw.

The Fed took several steps on August 17 to ease credit problems: It lowered the discount interest rate from 6.25% to 5.75%, to make it easier for banks to borrow funds from the Fed and lend them to other businesses.

Possibly even more important, the Fed is willing to accept asset-backed commercial paper (ABCP) as collateral for the loans from the discount window, even when the assets were based on subprime mortgage loans. This provides a means for banks to get past immediate liquidity problems by being unable to sell expiring commercial paper.

Related Articles

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Understanding deflation: Why there's less money in the world today than a month ago.: As the markets continue to fall, the Fed is increasingly in a big bind.... (10-Sep-07)
Alan Greenspan predicts the panic and crash of 2007: He's said this kind of thing before, but this time it's resonating.... (08-Sep-07)
Bernanke's historic experiment takes center stage: An assessment of where we are and where we're going.... (27-Aug-07)
How to compute the "real value" of the stock market. : And some additional speculations about stock market crashes. (20-Aug-2007)
Ben Bernanke's Great Historic Experiment: Bernanke doesn't believe that bubbles exist. His Fed policy will now test his core beliefs.... (18-Aug-07)
Redemptions of money market funds now fully in doubt: Wednesday is the deadline for 3Q redemption of many hedge fund shares.... (15-Aug-07)
Alan Greenspan defends his Fed policies, as people blame him for the subprime crisis: Greenspan never ceases to amaze, and he did so again on Monday.... (8-Aug-07)
Nouriel Roubini says: "Worry about systemic risk." Whoo hoo!: His arguments show what's wrong with mainstream macroeconomics.... (6-Aug-07)
Robert Shiller compares stock market to 1929: He says the recent fall was caused by "market psychology," but is puzzled why.... (20-Mar-07)
A conundrum: How increases in 'risk aversion' lead to higher stock prices: Maybe because the global financial markets are increasingly "accident-prone."... (12-Mar-07)
Pundits are suddenly talking about (gasp!) "risk aversion": Fearing full-scale panic in the mortgage loan marketplace,... (6-Mar-07)
Alan Greenspan blames the housing bubble on the fall of the Berlin Wall: Meanwhile, the stock market keeps skyrocketing and appears unstoppable to many investors.... (25-Oct-06)
System Dynamics and the Failure of Macroeconomics Theory : Mainstream macroeconomic theory, invented by Maynard Keynes in the 1930s, has failed to predict or explain anything that's happened since the bubble started, including the bubble itself. We need a new "Dynamic Macroeconomics" theory. (25-Oct-2006)
Alan Greenspan gives another harsh doom and gloom speech: Saying that "the consequences for the U.S. economy of doing nothing could be severe,"... (4-Dec-05)
Ben S. Bernanke: The man without agony : Bernanke and Greenspan are as different as night and day, despite what the pundits say. (29-Oct-2005)
Fed Chairman Alan Greenspan says that the deficit is out of control: France's Finance Minister Thierry Breton quoted Greenspan... (25-Sep-05)
Fed Governor Ben Bernanke blames America's sky-high public debt on other nations: I'm normally wary of applying specific generational archetypes to individuals, but Bernanke is acting like a Baby Boomer.... (14-Mar-05)
Greenspan's testimony further repudiates his earlier stock bubble reasoning: The Fed Chairman has now completely reversed his previous position on the stock market bubble... (17-Feb-05)
Alan Greenspan warns that global economic dangers are without historical precedent : In a speech on Friday, Greenspan buried a major change of position in a speech admitting that his assumptions about the economy for the last decade were wrong. (6-Feb-2005)

It now turns out that the Fed has placed tight restrictions on using ABCP as collateral. The result is that the Fed's discount window is too expensive for "economically sensible" banks, according to the Morgan Stanley analysis. "The discount window actions now appear a failure, with apparently no new borrowing in the latest week after purely symbolic borrowing from four financially strong banks with access to cheaper funding in the prior week," according to Morgan Stanley.

As we indicated in my article, "Bernanke's historic experiment takes center stage," we're now at a crucial point in economic history, where Fed chairman Ben Bernanke is putting into practice his core beliefs, acquired on his grandmother's knee as a child in the 1960s: That the 1930s Great Depression could have been avoided, and a future Great Depression can be avoided, by injecting money into the economy.

It now appears that the Fed has failed in its first attempt.

But you should understand exactly what failed, because it's important. It's not that the Fed injected a bunch of money into the economy, and the money didn't have the desired effect. That's not what happened.

What happened is that the Fed failed in its attempt to inject money into the economy. It's almost as if the Fed couldn't give away money. (Is someone from the Fed reading this? If you are, I'll take some money!)

The view that this should have worked is based on macroeconomic theory that was developed in the 1970s and 1980s, and has completely failed in the last 15 years, failing to predict or explain the 1990s dot-com bubble, or anything that's happened since then.

According to mainstream macroeconomic theory, the world's financial state should have been getting better and better, but instead has been getting worse and worse.

And now it's failing to do something that would have been thought to be incredibly simple: Injecting money into the economy. That should be easy, right? Maybe it will work, maybe it won't, but at the very least it should be possible to shovel money out, right? Well, mainstream macroeconomics is even wrong about that simple thing.

Some days, mainstream macroeconomics seems to be wrong about just about everything.

Generational Dynamics looks at things differently, much more dynamically than mainstream models. Mainstream models assume that you can decide policy just by looking at data from the last year. Generational Dynamics says that you really have to look at decades of data.

It is unquestionably clear that something spectacular changed -- on a global scale -- on July 19 and July 23 of this year.

The market, as measured by the Dow Jones Industrial Average, peaked on July 19. After that some kind of "tipping point" clearly occurred, when wild market volatility began on July 23. This signaled a change in the attitudes and behaviors of large masses of investors from "risk-seeking" or "risk-ignoring" to a "risk-averse" pattern. This has been widely reported in the media, though pundits have been saying recently that it's all over now, and things have settled down.

From the point of view of Generational Dynamics, these attitudes towards risk are not formed in one day, or because of one event. They're formed by transitions within entire generations, and the attitudes are formed over long decades.

Once you understand that, then you understand why these simple prophylactic measures by the Fed can't possibly work. There are tens of millions of people in an American generation, and it's doubtful that more than a few dozen are going to be substantially affected by anything the Fed does. Being "risk-ignoring" or "risk-averse" cannot and will not be changed quickly.

There's plenty of reason to believe that deep-seated problems in the economy are getting worse. Market interest rates surged at the end of last week, after institutions became aware of the restrictions on ABCP mentioned several paragraphs up. Many of these institutions have billions of dollars of this commercial paper on their books, theoretically rated AAA. But more and more, institutions realize that in fact they have no idea whatsoever whether their commercial paper has the value they think it has.

So investors and financial institutions are very nervous today. September is usually a bad month for stocks anyway, and they want to know whether this one will be worse than usual. (04-Sep-07) Permanent Link
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Courts reject Bear Stearns hedge funds' bankruptcy claims

And a Former American Home Mortgage branch manager is off to jail.

Ever since Bear Stearns announced that its two major hedge funds are almost worthless, investors have been trying to get their hands on any assets that the hedge funds still own that might have any value. This would be done by forcing the hedge funds into bankruptcy (though the Bear Stearns firm itself would not be bankrupted).

Bear Stearns had hoped to be able to file for bankruptcy in the Cayman Islands, where its hedge funds are officially registered, and thereby prevent investors from selling off the assets.

However, a US bankruptcy judge rejected this claim, saying that "The only adhesive connection with the Cayman Islands that the funds have is the fact that they are registered there."

Related Articles

Macroeconomics
Understanding deflation: Why there's less money in the world today than a month ago.: As the markets continue to fall, the Fed is increasingly in a big bind.... (10-Sep-07)
Alan Greenspan predicts the panic and crash of 2007: He's said this kind of thing before, but this time it's resonating.... (08-Sep-07)
Bernanke's historic experiment takes center stage: An assessment of where we are and where we're going.... (27-Aug-07)
How to compute the "real value" of the stock market. : And some additional speculations about stock market crashes. (20-Aug-2007)
Ben Bernanke's Great Historic Experiment: Bernanke doesn't believe that bubbles exist. His Fed policy will now test his core beliefs.... (18-Aug-07)
Redemptions of money market funds now fully in doubt: Wednesday is the deadline for 3Q redemption of many hedge fund shares.... (15-Aug-07)
Alan Greenspan defends his Fed policies, as people blame him for the subprime crisis: Greenspan never ceases to amaze, and he did so again on Monday.... (8-Aug-07)
Nouriel Roubini says: "Worry about systemic risk." Whoo hoo!: His arguments show what's wrong with mainstream macroeconomics.... (6-Aug-07)
Robert Shiller compares stock market to 1929: He says the recent fall was caused by "market psychology," but is puzzled why.... (20-Mar-07)
A conundrum: How increases in 'risk aversion' lead to higher stock prices: Maybe because the global financial markets are increasingly "accident-prone."... (12-Mar-07)
Pundits are suddenly talking about (gasp!) "risk aversion": Fearing full-scale panic in the mortgage loan marketplace,... (6-Mar-07)
Alan Greenspan blames the housing bubble on the fall of the Berlin Wall: Meanwhile, the stock market keeps skyrocketing and appears unstoppable to many investors.... (25-Oct-06)
System Dynamics and the Failure of Macroeconomics Theory : Mainstream macroeconomic theory, invented by Maynard Keynes in the 1930s, has failed to predict or explain anything that's happened since the bubble started, including the bubble itself. We need a new "Dynamic Macroeconomics" theory. (25-Oct-2006)
Alan Greenspan gives another harsh doom and gloom speech: Saying that "the consequences for the U.S. economy of doing nothing could be severe,"... (4-Dec-05)
Ben S. Bernanke: The man without agony : Bernanke and Greenspan are as different as night and day, despite what the pundits say. (29-Oct-2005)
Fed Chairman Alan Greenspan says that the deficit is out of control: France's Finance Minister Thierry Breton quoted Greenspan... (25-Sep-05)
Fed Governor Ben Bernanke blames America's sky-high public debt on other nations: I'm normally wary of applying specific generational archetypes to individuals, but Bernanke is acting like a Baby Boomer.... (14-Mar-05)
Greenspan's testimony further repudiates his earlier stock bubble reasoning: The Fed Chairman has now completely reversed his previous position on the stock market bubble... (17-Feb-05)
Alan Greenspan warns that global economic dangers are without historical precedent : In a speech on Friday, Greenspan buried a major change of position in a speech admitting that his assumptions about the economy for the last decade were wrong. (6-Feb-2005)

He added, "There are no employees or managers in the Cayman Islands, the investment manager for the funds is located in New York, the administrator that runs the back-office operations of the funds is in the United States along with the funds' books and records, and prior to the commencement of the foreign proceeding, all of the funds' liquid assets were located in the United States."

This is being treated as a technical inside story, but in my opinion it has much broader significance in terms of how the mood of the entire country is changing.

There's an atmosphere of universal suspicion blame that's growing, and will continue to grow.

There are lots of hedge funds and other corporations that are registered in the Cayman Islands in order to avoid the penalties of American laws. Standard interpretations of the bankruptcy laws, as applied to foreign corporations liquidating overseas, may indeed have always been interpreted in the way that Bear Stearns wanted, but attitudes are changing rapidly and laws are being interpreted differently.

This is significant because ALL laws are going to be reinterpreted in an increasingly harsh manner.

The mentality of the Baby Boomer generation and Generation-X can be summarized in the 1960s saying, "If it feels good, do it." This is what led to the 1990s dot-com bubble, it led to the housing bubble, it led to the credit bubble, all based on their debauched abuse of debt and credit.

And as long as everyone was making money in the growing credit bubble, then laws were interpreted liberally. Now that people are losing their homes and their bank accounts, the laws are being interpreted differently because public attitudes are changing.

That's what a former American Home Mortgage branch manager has discovered. Kourosh Partow will pay $240,000 and spend two years in jail for wire fraud. His crime was falsifying documentation to secure "stated income" mortgage loans from mortgage lenders American Home Mortgage and Countrywide Financial.

The phrase "stated income" is used with loans where the borrower states what his income is, but is not required to prove it with documents. It's not as unreasonable as it sounds, since the borrower can be held liable for civil or criminal charges if he misstates his income.

In the case of Partow, the borrowers stated their incomes correctly. It was Partow who changed the amount on the application. In one case, Partow listed the income as $20,000 per month -- "an amount that significantly overstated [the client's] true income."

These things used to be OK, since it got a family into a home of their own, which was the American dream, and that "feels good," so it was OK to do it.

When the bubble was growing, and money was everywhere, anyone could get away with anything. Now that people are losing their homes, they're looking for people to blame.

Many financial crimes are clear violations of the law -- fraud (as in the case of Partow) and embezzlement.

But what's changing is that many crimes that AREN'T clear violations of the law will be prosecuted as if they were. Many of these fall under the general category of "fiduciary responsibility." Thus, if you're a professional with clients that you advise, and it can be shown that your advice was tainted because of some conflict of interest, then you're going to be blamed, and you're going to face criminal and civil charges.

This is what Bear Stearns is discovering. They were counting on the "small print" in laws that allow them to register their hedge funds in the Cayman Islands to escape American laws. Now the laws are changing, and the "small print" no longer applies.

When people are desperate, then they have nothing to lose by blaming someone else. The point is that blaming someone else will become almost universal. And the easiest way to blame someone is to identify a conflict of interest.

Many professionals have fooled themselves by believing that they're because they've been absolved of responsibility by forcing clients to sign agreements.

Have you ever signed on to a web site and had to click a box that says, "I've read the user agreement and agree to its terms"? When you clicked that box, were you telling the truth? Probably not. No one reads these agreements.

So brokers have their clients sign multi-page agreements saying "The client has no right to sue the broker because the client was stupid enough to depend on the broker's advice." I believe that, in time, many of these agreements are going to be struck down, simply nobody ever reads them, and it will be argued that you can't hold a large mass of people responsible for agreements that they were forced to sign, that nobody ever reads, and that they wouldn't understand even if they did read them.

Let's make a list of people who are currently being blamed, or soon will be blamed, and who will be the subject of investigations, civil lawsuits and possible prosecution:

This has all happened before. In fact, the next-to-last international generational financial crisis, the Hamburg crisis of 1857 (panic of 1857), was triggered by a small event -- an employee of the New York branch of the Ohio Life Insurance and Trust Company was found to have embezzled money.

There was a great deal of embezzlement leading up to the last generational financial crisis. I've quoted a portion of this passage before, but it's worth posting the whole thing. John Kenneth Galbraith described what happened -- and what will happen again -- in his 1954 book, The Great Crash - 1929, as follows:

"In many ways the effect of the crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in -- or more precisely not in -- the country's businesses and banks. This inventory -- it should perhaps be called the bezzle -- amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.

The stock market boom and the ensuing crash caused a traumatic exaggeration of these normal relationships. To the normal needs for money, for home, family and dissipation, was added, during the boom, the new and overwhelming requirement for funds to play the market or to meet margin calls. Money was exceptionally plentiful. People were also exceptionally trusting. A bank president who was himself trusting Kreuger, Hopson, and Insull was obviously unlikely to suspect his lifelong friend the cashier. In the late twenties the bezzle grew apace.

Just as the boom accelerated the rate of growth, so the crash enormously advanced the rate of discovery. Within a few days, something close to universal trust turned into something akin to universal suspicion. Audits were ordered. Strained or preoccupied behavior was noticed. Most important, the collapse in stock values made irredeemable the position of the employee who had embezzled to play the market. He now confessed.

After the first week or so of the crash, reports of defaulting employees were a daily occurrence. They were far more common than the suicides. On some days comparatively brief accounts occupied a column or more in the Times. The amounts were large and small, and they were reported from far and wide. ...

Each week during the autumn more such unfortunates were reveled in their misery. Most of them were small men who had taken a flier in the market and then become more deeply involved. Later they had more impressive companions. It was the crash, and the subsequent ruthless contraction of values which, in the end, exposed the speculation by Kreuger, Hopson, and Insull with the money of other people. Should the American economy ever achieve permanent full employment and prosperity, firms should look well to their auditors. One of the uses of depression is the exposure of what auditors fail to find. Bagehot once observed: "Every great crisis reveals the excessive speculations of many houses which no one before suspected." [pp. 132-35]

Galbraith's point was that there were many criminal activities going on before the 1929 crash, but nobody cared, as long as everyone was making money. But once the crash occurred, any irregularity was viewed with suspicion and led to an investigation. These investigations turned up many cases of embezzlement -- people who had "temporarily borrowed" money that wasn't theirs to invest in the stock market, and then got caught in the crash.

It's a time of universal suspicion: "Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks."

The relevance of all this to what's happening today is that, so far, we've only seen the tip of the iceberg of embezzlement and other financial crimes, such as Partow's fraud.

I would tell my web site readers this: This is the time to put your affairs in order.

As I've said before, it's possible that some people reading this have committed crimes, such as embezzlement, thinking that no one would check and they wouldn't be caught. It's true that no one checks as long as everyone's making money, but when things go wrong, everything is checked and double-checked, and criminals are caught.

If you've committed a crime out of desperation, then you should try to find a solution immediately; even if you're going to be bankrupt and homeless, you don't want to be a criminal as well. Don't tell a friend or family member of your crime, because you'll make that person an accessory after the fact. Go talk to a lawyer or confess to a priest immediately, and examine the choices available to you. (02-Sep-07) Permanent Link
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Donations are now being accepted by the Generational Dynamics web site.

A couple of very generous web site readers have asked me if there's any way that they can make a donation for the work that's been done on this web site.

For that reason, I'm now providing a way for anyone who chooses to make a donation. If you click on the "donate" button at the end of any article, you'll be taken to a PayPal page, where you can make a donation by credit card or through your PayPal account.

I thank in advance anyone who chooses to donate.

With or without a donation, I thank all my readers for continuing to come back, making this an increasingly popular web site for people who really want to understand what's going on in the world. The volume of e-mail comments and questions has been increasing a bit, but I'm still keeping up, though sometimes it takes a few days to answer, so as before you're welcome to send me a question or click on the COMMENT link at the top of the page. (02-Sep-07) Permanent Link
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