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


Web Log - October, 2007


Wednesday's Fed announcement is the most watched in a long time

As the continuing rapid collapse of the ABX indexes signals a time of great danger, the Fed has never been watched, and speculated about, more obsessively than today.

The Fed Open Market Committee (FOMC) is having its regularly scheduled meeting on Wednesday, and will announce whether it will cut interest rates again.

Investors are overwhelmingly expecting a ¼% interest rate reduction, and many are hoping for a ½% reduction, as happened last month. Last month's ½% reduction caused a great deal of instant drunken euphoria among investors, and most would like to get drunk again.

Lowering interest rates will weaken the dollar as international currency, and it's already the weakest it's been in decades. Leaving interest rates unchanged with bitterly disappoint investors, though it will strengthen the dollar.

One major issue is the surging mortgage crisis, which appears to be getting worse by the day.

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 that I've used before:

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 we've described many times before, these mortgages went through "financial reengineering," slicing and dicing the mortgage loans into tradable securities called Collateralized Debt Obligations (CDOs).

I recently had occasion to be reminded of some of the lyrics from Gilbert & Sullivan 1878 musical play, H.M.S. Pinafore, where the First Lord of the Navy explains how he came to rise to that position:

    As office boy I made such a mark
    That they gave me the post of a junior clerk
    I served the writs with a smile so bland
    And I copied all the letters in a big round hand
    I copied all the letters in a hand so free
    That now I am the Ruler of the Queen's Navy

Well, the financial engineers who created these CDOs created them with a hand so free that even the riskiest of subprime mortgages was somehow converted into the highest-rated AAA CDO securities.

A web site reader has asked me how it's even possible for a high-risk mortgage loan to be converted into a low-risk anything. I won't try to describe the entire process, but I'll give an example of how it works.

Suppose you owe me money, and there's a 25% chance that you won't repay me, which is a pretty high risk loan, which is why I charged you a high rate of interest. Now suppose that 1,000 people owe me money under the same conditions. Then I can expect 750 of the loans to be repaid, and 250 of the loans to default. So I take the 1,000 loans and put them into a pool, and I sell shares in the pool. Actually, I sell two types of shares, low-risk shares and high-risk shares. When people start paying off the loans, the income from the first 600 who pay the amounts owed goes to the investors in the low-risk shares; after that, the remaining income "cascades" to the investors in the high-risk shares. If you've gone through this example, you can see that the low-risk investors should receive the income from 600 people, and the high-risk investors should receive the income from 150 people (750-600=150). But suppose that the 75% figure is wrong? Suppose that only 50% of the loans are repaid? Then the low-risk investors get income from only 500 repayments, and the high-risk investors get nothing.

Prices of ABX-HE series 07-2 for various risk levels on 30-Oct-2007 <font face=Arial size=-2>(Source:</font>
Prices of ABX-HE series 07-2 for various risk levels on 30-Oct-2007 (Source:

That's what the ABX index is for. The mortgages are sliced and diced into credit default swaps and then into CDOs. There are low-risk, AAA-rated securities and there are high-risk BBB-rated securities. The income from the mortgage loan repayments goes first to the AAA securities, and anything left over "cascades" down to lower-rated securities.

As you can see from the adjoining graphs, the low-rated securities (at the bottom) have been falling in value so quickly that they're almost worthless. The high-rate securities at the top have been falling in value as well, because the number of defaults and foreclosures is so much higher than anyone predicted.

This is an incredible situation. It's out of public view because these CDSs and CDOs are so opaque to the general public.

But there are trillions of dollars (notional value) of these things in financial portfolios around the world, and nobody knows how much the damn things are worth -- except that nobody any longer believes that they're worth the trillions of dollars originally claimed.

It was just last week that Merrill Lynch shocked the financial community by writing down $8.4 billion in value of securities that turned out to be almost worthless. And on Tuesday, Switzerland's largest bank, UBS, reported its first quarterly loss in five years because of similar writedowns.

The ratings agencies, Moody's, Fitch and S&P, are re-evaluating the ratings of all the CDOs that were previously rated too high -- which is all of them. Tens of billions of dollars worth of CDOs are being reevaluated downward each week.

The continuing rapid collapse of the ABX index, which is a proxy for the values of these CDOs is a very alarming development, as the collapse may reach a tipping point that causes a domino effect throughout the global financial system.

From the point of view of Generational Dynamics, we're overdue for a generational panic and crash, as I've been saying since 2002, long before the CDO crisis burst forth. It's impossible to predict whether this is the time, but we can be certain that it's a time of great danger.

What does Ben Bernanke think about all this?

As I wrote in my August article, "Bernanke's historic experiment takes center stage," 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. That seems to imply that he'd rather err on the side of reducting interest too much, rather than on the side of not reducing enough. (31-Oct-07) Permanent Link
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Casualties are down sharply in Iraq.

This issue has been a spectacular validation of Generational Dynamics theory.

The number of U.S. military and Iraqi civilian deaths has dropped dramatically.

Related Articles

Iraqi 'Civil War'
Brookings Institution does a full reversal on Iraq war: As Americans withdraw from cities, Brookings admits there's no civil war.... (1-Jul-2009)
Stock markets in Iraq and Iran are surging.: Iran's President Mahmoud Ahmadinejad says "it is the end of capitalism."... (17-Oct-2008)
On "60 Minutes," Bob Woodward makes ridiculous claims about Iraq.: He says the surge succeeded because of some magic new military technique.... (7-Sep-2008)
Iraq's Shiite cleric Moqtada al-Sadr turns from arms to "culture": This follows several Sunni "Tribal Awakenings" to expel al-Qaeda.... (10-Aug-2008)
Obama continues to damage his candidacy with his Iraq policy.: Obama is hurting himself by bobbing and weaving on the success of the "surge."... (27-Jul-2008)
The new Iraqi "civil war" fizzles out, as expected: Radical Shia cleric Moqtada al-Sadr called for a cease-fire on Sunday,... (1-Apr-08)
The Iraq war may be related to the bombing of Hiroshima and Nagasaki.: On the first anniversary of the successful "surge" strategy,... (17-Feb-08)
Casualties are down sharply in Iraq.: This issue has been a spectacular validation of Generational Dynamics theory.... (31-Oct-07)
As Turkey prepares to invade northern Iraq, it's isolating itself internationally: A new "Young Turks revolution" is reestablishing strong Turkish nationalism.... (29-Oct-07)
Washington Post says that al-Qaeda in Iraq is "crippled": Meanwhile, Iraqi citizens' political opposition to America is growing.... (16-Oct-07)
Antiwar Democrats are freaking out over Bush's Vietnam - Iraq war comparison.: The same people who have been comparing Iraq to Vietnam for years... (24-Aug-07)
Iraq: Suicide bombers interrupt celebrations in Baghdad over soccer win: Iraq's stunning 4-3 soccer victory over South Korea in the Asia Cup semi-final... (26-Jul-07)
The al-Askariya Shrine in Samarra, Iraq, is bombed again: Last year's bombing triggered months of vicious sectarian violence in Baghdad,... (14-Jun-07)
Congress votes to fund Iraq war without deadlines: The result shows conflicting anxieties during America's Crisis era.... (24-May-07)
Senator Joe Biden wants to move troops from Iraq to Darfur civil war: Saying on Meet the Press that we should remove troops from Iraqi "civil war,"... (29-Apr-07)
NY Times columnist Thomas Friedman shows ignorance and evasiveness about al-Qaeda in Iraq: In an interview that appeared on CNN on Sunday,... (24-Apr-07)
BBC kills an Iraqi war story because it's "too positive": But a drama showing British troops brutalizing civilians is perfectly fine.... (11-Apr-07)
Tens of thousands of Shi'ites protest against American "occupiers": In what appeared to be a grand, party-like atmosphere,... (10-Apr-07)
Iraqi Sunnis are turning against al-Qaeda in Iraq : This is exactly the kind of thing that generational theory predicts. (1-Apr-2007)
New optimistic poll of Iraqi people barely mentioned on Sunday TV news shows: And Bob Shieffer on CBS's "Face the Nation" asked really dumb questions of Secretary of Defense Robert Gates.... (19-Mar-07)
Robert Gates on "civil war" in Iraq.: Following the release of the Iraq National Intelligence Estimate on Friday,... (2-Feb-07)
News as theatre: NBC announces it will call Iraq war a "civil war": On Monday morning on the "Today Show,"... (29-Nov-06)
President Bush's reference to Vietnam War "Tet Offensive" has journalists in a tizzy: Airhead journalists have completely missed the point, and the real danger.... (20-Oct-06)
Learning-disabled journalists and politicians continue to predict Iraq civil war: Occasionally journalists take a break from their heavy-breathing over Congressional pages,... (8-Oct-06)
General John Abizaid says there'll be no troop cutbacks in Iraq: This is hardly a surprise to me, though not for the reasons most people give.... (19-Sep-06)
Debate over civil war in Iraq rages over semantics: An actual crisis civil war in Iraq is impossible, but it's now embroiled in the November elections,... (23-Aug-06)
Washington becomes hysterical again over an Iraqi 'civil war' : A civil war in Iraq is impossible, as I've said many times, because only one generation has passed since the Iran/Iraq war of the 1980s. Here's some additional historical information. (7-Aug-2006)
Israel's war against Hizbollah and Lebanon forces Muslims to choose sides : The war is part of a larger Shi'ite-Sunni struggle, and a stopgap ceasefire will create a worsening environment leading to a much more chaotic situation within a few months (25-Jul-2006)
Speculations about a stock market panic and crash : Will there be a stock market panic next week, next month, or next year, and will it lead to a crash? We speculate on some possibilities. (31-May-2006)
Journalists have a 'civil war in Iraq' orgy over the weekend: It's hard to remember when news shows had so much sheer non-stop nonsense... (21-Mar-06)
I just heard on CNN International: "The threat of civil war in Iraq is over.": Surprise! Surprise! The press corps was 100% wrong, and I was right.... (28-Feb-06)
Fear of Iraqi civil war nears hysteria: But there is NO CHANCE WHATSOEVER of a civil war.... (24-Feb-06)
Bombing of 1200 year old Shi'ite mosque inflames Iraq to the verge of massive civil war rhetoric: Shi'ites conducted over 90 revenge attacks on Sunni shrines on Wednesday,... (23-Feb-06)
Vitriolic Iraq war politics erupts in Washington: But the basics of the Iraq war haven't changed a bit.... (21-Nov-05)
After President Bush's speech: What next for Iraq?: With growing insurgency violence and flagging public support, what's America's "end strategy" in Iraq?... (1-Jul-05)
Iraqi Sunni and Shi'ite clerics call for restraint: Analysts, pundits and journalists are still predicting civil war, and they're still getting it wrong.... (23-May-05)
The chaotic Iraq election is only two days away: The election is on Sunday, January 30, and no one has a clue what's going to happen.... (28-Jan-05)
Brent Scowcroft predicts an "incipient civil war" for Iraq: Pundits are returning to wishful thinking as the January 30 election approaches... (09-Jan-05)
Can we withdraw from Iraq in 2005?: Suddenly the Washington buzz is that whoever wins - Bush or Kerry - will begin to withdraw American troops from Iraq. We look at two historical examples to predict scenarios. (16-Oct-2004)
Fallujans are getting angry with insurgents: Just a few hours after my posting that al-Zarqawi's most formidable enemy may be the 40-50 year old mothers of Fallujah,... (13-Oct-04)
Al-Sadr's Shi'ite militia fighters turn in their weapons: The war in Iraq took a significant turn this week when the Shi'ite militias agreed to disarm,... (13-Oct-04)
The press is talking about another "uprising" in Iraq. Yawn.: Nothing shows more how clueless the press is about what's going on in Iraq than this constant talk about civil war and uprisings.... (7-Aug-04)
Iraq Today vs 1960s America (Revised): They have much in common: Bombings, assassinations, student demonstrations, violent riots, calls for insurrection and civil war and harsh rhetoric. That's much more than a coincidence. (8-May-2004)
What Iraqi Civil War?: Early in 2003, I predicted that there would be no popular uprising against the Americans, and that there would be no civil war. After the overthrow of Saddam, I said that an Iraqi civil war was impossible. Despite the constant near-hysteria of the politicians, journalists and high-priced analysts, I've been right so far. Here's why. (09-Apr-04)
Anti-Shi'ite Terror Attacks in Iraq, Pakistan: So far, Sunni and Shi'ite leaders in Iraq aren't taking the bait. (2-Mar-04)
Terrorist suicide bombings in Iraq may backfire against terrorists: During an awakening period, terrorist acts cause masses of people to shrink from more violence. (19-Aug-03)

However, nobody is claiming that the problem has been solved. After all, if American forces can "surge," then so can al-Qaeda forces, and they may "surge" to provide a new rise in deaths, even if it's only temporary, in order to gain a public relations victory.

However, casualties have been falling for several months now, so a trend is clear. Sunni insurgent groups have turned against al-Qaeda in Iraq, and are now cooperating with the Americans. Shia groups, including the Mehdi militias, are under ceasefire, by order of Muqtada al-Sadr, and they're now cooperating with the Americans too.

This situation is extremely gratifying to me personally, and is a spectacular validation of Generational Dynamics theory for several reasons:

  • Because I got this prediction exactly right from the beginning, in 2003.
  • Because everybody else got it wrong. Pro-war or anti-war, Republican or Democrat, nobody predicted anything remotely like what I predicted, based on Generational Dynamics theory, and I got it right and they got it wrong.

    You wouldn't BELIEVE the amount of grief and vitriol I've been given over this, even to the point of being called names.

    Since the beginning I've asserted, based on Generational Dynamics theory, that a civil war in Iraq was impossible, and that any such fighting would fizzle out. That's exactly what's happened, and people who claimed otherwise have now been shown to be wrong.

  • Because this is GOOD news. On this web site, I've stated many Generational Dynamics predictions -- on the Mideast, Darfur, China, Burma (Myanmar), Japan, global finance, and so forth -- and they've all come true or are trending true. But all of those are BAD news. The reason that this particular prediction is so spectacular is because it's GOOD news for a change.

I know that I'm going to get more grief for writing this article, but after years of frustration, this situation is really gratifying.

I'll stop there except to thank the ever growing readership of this web site. I'm still keeping up with answering e-mail comments and questions, though it sometimes takes me a few days to get back. If you have any questions or comments, you can use e-mail or one of the little "Comment" forms.

(31-Oct-07) Permanent Link
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Another way to obtain the "real value" of the stock market

Many people claim that you can't tell if you're in a bubble until it's over.

That may have been true prior to the 1900s, before masses of historical data became available.

But today you can usually tell if something is in a bubble by analyzing historical data.

Shanghai stock market has been skyrocketing for the last year. <font face=Arial size=-2>(Source:</font>
Shanghai stock market has been skyrocketing for the last year. (Source:

Sometimes the bubble is so pronounced that you don't need a great deal of data. That's the case with the Shanghai stock market bubble, as shown by the adjoining graph that I referenced two weeks ago in an article, "Wall Street Journal wonders if Shanghai stocks are in a bubble."

However, many analysts would object to my use of the word "obvious," since only 3½ years of data are used, and that's a fair criticism. It's actually pretty easy to "lie with statistics" when using too little data. I've actually seen analyses that attempt to project trends from only 3 or 4 data points. Such attempts are meaningless.

In my article, "How to compute the 'real value' of the stock market," the current value of the stock market is computed by using three different types of historical data: historical earnings, historical growth rates, and historical book values. All three of these methods come to roughly the same result -- the real value of the stock market today is around Dow 5000, meaning that the stock market today is overpriced by a factor of 250% (same as in 1929).

Here's a graph from that article:

Dow Jones Industrial Average, logarithmic scale, 1900 - August 17, 2007.
Dow Jones Industrial Average, logarithmic scale, 1900 - August 17, 2007.

When you want to extrapolate into the future from historical data, then you have to use many data points. The graph above uses over a century of monthly data, over 1200 data points.

When we're talking about generational trends, which repeat in roughly 80 year intervals (the length of a human lifetime), you need at least a century of data. Frankly, I wish I could use three or four centuries of data, but unfortunately no such data exists.

In the above graph, the red line shows the Dow Industrials for each month since 1900. The blue line is obtained by curve-fitting an exponential curve to the Dow Industrials. (The exponential curve appears as a straight line because the y-axis is a logarithmic scale.) Although more analysis is required to be certain, the graph itself is a good visualization of a bubble.

The graph provides a current "real value" of the stock market -- in this case Dow 5268 on August 17, meaning that the stock market is overprices by a factor of over 250% - same as in 1929. (The trend value for each day is given on my Dow Jones historical page. For October 29, the trend value is Dow 5316.)

This method provides an estimate for the stock market as a whole -- at least as measured by the Dow Industrials stock index -- but does not provide information about different stocks.

Thomas Au's "Investment Index"

Thomas P. Au, with the financial services firm R. W. Wentworth, has developed something called the "Investment Index," which he says measures the "real value" of individual stocks.

Au's formula for investment index is very simple:

      IV = (book value per share) + 10 x (dividend per share)

What's interesting about this computation is that it doesn't appear to have anything to do with historical values. That isn't true, however -- the "book value" is a kind of historical value on its own.

Let's look at the two components of IV:

And so, Thomas Au's "investment value" of a share of stock is made up of two components, one of which represents the historic value and the other of which represents the future value.

In an article entitled, "How far down for the Dow," Au uses his IV formula to compute the value of each of the 30 stocks that make up the Dow Jones Industrial Index, and he comes up with the following table:

                    Putting a value on the Dow
                            Book    Divi-   Invest- Price   Premium/
                            Value   dend    ment            Discount
                              ($)     ($)     ($)     ($)     ($)
    AIG                     42.50    0.75    50.00   63.27    26.5%
    Alcoa                   19.20    0.68    26.00   37.44    44.0%
    Altria                   7.50    2.75    35.00   70.50   101.4%
    American Express         9.00    0.60    15.00   57.11   280.7%
    AT&T                    18.00    1.40    32.00   41.37    29.3%
    Boeing                   6.75    1.45    21.25   93.90   341.9%
    Caterpillar             13.00    1.30    26.00   73.57   183.0%
    Citigroup               26.00    2.16    47.60   42.36   -11.0%
    Coca-Cola                8.60    1.34    22.00   58.76   167.1%
    Disney                  16.00    0.35    19.50   33.81    73.4%
    Du Pont                 11.20    1.48    26.00   47.16    81.4%
    ExxonMobil              21.50    1.40    35.50   92.14   159.5%
    General Electric        11.50    1.10    22.50   40.04    78.0%
    General Motors          -7.75    1.00     2.25   37.60  1571.1%
    Hewlett-Packard         15.00    0.32    18.20   51.40   182.4%
    Home Depot              13.75    0.90    22.75   30.76    35.2%
    Honeywell               11.00    1.00    21.00   58.42   178.2%
    IBM                     15.00    1.35    28.50  112.28   294.0%
    Intel                    6.50    0.45    11.00   26.30   139.1%
    Johnson & Johnson       16.00    1.60    32.00   64.23   100.7%
    JPMorgan                36.50    1.50    51.50   45.02   -12.6%
    McDonald's              13.00    1.20    25.00   56.42   125.7%
    Merck                    9.30    1.52    24.50   53.11   116.8%
    Microsoft                4.60    0.40     8.60   30.17   250.8%
    Pfizer                  10.25    1.25    22.75   24.07     5.8%
    Proctor & Gamble        21.50    1.35    35.00   70.80   102.3%
    3M                      14.00    2.00    34.00   86.62   154.8%
    United Technologies     19.90    1.36    33.50   76.00   126.9%
    Verizon                 16.80    1.62    33.00   44.27    34.2%
    Wal-Mart                16.20    0.88    25.00   44.98    79.9%
    Proration factor                                        0.484950838
    Dow                                                     13552.02
    Dow at Investment Value                                  6572.06
    Source: Value Line estimates, author's calculations

Closing prices as of Friday, Oct. 19.

The last two lines of the table tell the story: The Dow was at 13552 on October 19, but the total Investment Value of all of the 30 stocks comes out to 6572.

In my article, "How to compute the 'real value' of the stock market," the three methods that I used came out to a stock market real value around 5000, so Thomas Au's computation comes to a value some 15% higher. I haven't studied Au's method enough to understand why there was this difference, but for the current discussion, the point is moot. A stock market value of Dow 6572 is still much lower than today's bubble value, and means that the stock market is overpriced by a factor of over 200%, still enough to trigger a generational panic and stock market crash.

Interestingly, Thomas Au doesn't seem to believe his own results. I'm referring now to the final statement in the article: "At the time of publication, Au was long Alcoa, Johnson & Johnson and Pfizer, although holdings can change at any time." If Au believed his own results, then he wouldn't be long ANY stocks at the present time. (30-Oct-07) Permanent Link
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As Turkey prepares to invade northern Iraq, it's isolating itself internationally

A new "Young Turks revolution" is reestablishing strong Turkish nationalism.

Turkish officials have been talking for months about sending the army across the border into northern Iraq to root out the PKK Kurd terrorist groups, but it's always been mostly talk and little action.

College-aged student demonstrations Saturday in Ankara calling for a military invasion of Iraq to stop PKK terrorism <font face=Arial size=-2>(Source: CNN)</font>
College-aged student demonstrations Saturday in Ankara calling for a military invasion of Iraq to stop PKK terrorism (Source: CNN)

Although pressure to invade has been building gradually after months of terrorist attacks in Turkey perpetrated by the PKK terrorists operating out of the Qandil mountains in Iraq's Kurdish region in the north. The pressure spiked up sharply last week when PKK terrorists ambushed a Turkish military patrol last Sunday, killing 12 soldiers and capturing eight.

The result was massive protests and street demonstrations by Turkish citizens, especially young Turkish college students, demanding that the army immediately cross the border into Iraq to destroy the PKK hideouts. Even prior to the ambush, Turkey's Parliament had voted overwhelmingly to authorize the government to order military incursions against the PKK bases in Iraq.

Tensions this week have risen much higher, with over 100,000 Turkish soldiers on the border, poised to invade, and the Turkish air force has begun bombing PKK positions in Iraq.

Prime Minister Recep Tayyip Erdogan has increasingly warned that his country will order increased military attacks against the PKK camps in Iraq. The Turkish foreign minister, speaking in Iran, said on Saturday, "Our patience has come to an end. All options are on the table."

Divergence of opinion in Turkey

As I've been watching this situation unfold in the months since the beginning of 2007, it's been clear to me that there's a divergence of opinion within Turkey itself: There are widespread demands from Turkish people to invade Iraq and destroy the PKK camps, but Turkish politicians, lead by Erdogan, have been as conciliatory as possible, conducting an international diplomatic campaign with the Iraq, U.S., Europe, Iran, Russia, and other countries to find a way to end the terrorist attacks without a Turkish invasion.

From the point of view of Generational Dynamics, this divergence represents a split that I've discussed many times in many different contexts.

There are many reasons why a Turkish military incursion into Iraq to destroy the PKK bases is a bad idea. First, almost every nation in the world has said it would be a bad idea. And second, the PKK bases are buried deep in the Qandil mountains in northern Iraq, and a military incursion would most likely fail.

The revolution of the Young Turks

Mideast, showing Israel/Palestine, Muslim countries, and Orthodox Christian countries
Mideast, showing Israel/Palestine, Muslim countries, and Orthodox Christian countries

I've used the adjoining map several times on this web site to emphasize how Israel and the Palestinian terrorities, represented by a tiny red dot in the middle, are surrounded by vast regions of green, representing Muslim nations.

However, the fact that the nations in green are all Muslim nations doesn't mean that they're homogeneous, or that they agree on much of anything.

There are important ethnic differences that often override the common Muslim identity. The people in Turkey are Turks who originally came from central Asia; the people of Iran are Persians; the people on the Arabian peninsula are Arabs.

The last time that most of these Muslim nations were united was in the Ottoman Empire that was formed following the fall of Constantinople (Istanbul, Turkey) in 1453. By the 1600s, the Ottoman Empire was extremely powerful and controlled most Sunni Muslim nations in the region -- though not Shia Iran. The empire only began to fall apart in 1689, when the Ottomans disastrously and humiliatingly lost the War with the Holy League in Europe, as I described in my brief generational history of the Ottoman Empire.

The greatest level of genocidal hatred in all the crisis wars fought by the Ottomans was in the fault line between Islam and Orthdox Christianity. The map above shows Orthodox nations in orange.

The Crimean War of the 1850s was nasty and humiliating to almost all major participants (Turks, Russians, Europeans), and by the 1880s led the Turks to start wondering, "Why do we keep on trying to run an empire with all these different people in it?"

In the late 1800s, a Turkish identity movement had begun to form, promoting Turkish (as opposed to Ottoman) literature and culture. However, the Turkish nationalism movement didn't gain much traction with the public immediately, mainly because for centuries, years the great strength of the Ottoman Empire, and indeed the previous Islamic empires, was that they were all multi-ethnic and the Muslim rulers were really very good at preserving the rights and meeting the needs of their various ethnic minorities.

However, the Turkish identity movement became seriously nationalistic with the Young Turks coup in 1908. This led to an extremely bitter and hugely genocidal war from about 1910-1921, which included these elements:

The final blow came in 1921, when the Ottoman Empire was finally destroyed, and Turkey gave up its Muslim Ottoman identity and adopted a secular Turkish identity, with the intention of becoming recognized as part of Europe, rather than as a Muslim state.

In the following years, new countries were formed out of the pieces of Ottoman Empire, including Iraq, Syria, Lebanon and Jordan (as Transjordan).

Generational crisis wars for any society or country generally come in variable intervals, where one crisis war usually begins roughly 50-80 years following the end of the previous crisis war. The destruction of the Ottoman Empire was a major, devastating crisis war for almost all of the Sunni Muslims in the Mideast. (Incidentally, Iran also had a crisis war, but slightly earlier: The Iranian Constitutional Revolution of 1906-1910.)

So we would expect that all of these countries would have their next crisis wars around the 1970s or 1980s, and in most cases they were pretty much "on schedule" -- the Syria/Lebanon war, the Lebanese civil war, and the Iran/Iraq war.

But two countries, Jordan and Turkey, had different experiences.

Each country, each situation, has to be analyzed for events like unexpected invasions. When two nations on different generational "timelines" go to war with each other, there are a number of possibilities that must be analyzed -- the war may be a crisis or non-crisis war for either side or both sides, for example, or, in some cases, their generational crisis eras become aligned because of the war.

One of the most interesting cases is when a country in a generational Awakening era receives an unexpected genocidal invasion from a country in a generational Crisis era. The first country does everything possible to avoid war, often retreating (if possible), instead of fighting. But if the war is so devastating to this country that the country's inter-generational structure is destroyed -- which often happens in the case of a massive forced relocation of the population -- then the generational timeline for that country "resets" back to the generational Recovery Era (also called the High or Austerity era), just the same as if the preceding war HAD been a crisis war.

That's what happened to the Arabs in Palestine -- the Palestinians -- when there was a massive influx of European Jews fleeing Nazi persecution. The genocidal 1948-1949 genocidal war that followed the partitioning of Palestine and the creation of the state of Israel cause the mass migration of huge numbers of Palestinian Arabs into Jordan, effectively resetting the generational "timeline" of the Palestine and Jordan to a Recovery Era following the war. That's why Israel, the Palestinian territories and Jordan are all entering generational Crisis eras today.

In about 10-15% of the cases, a country has a new crisis war more than 80 years after the end of the preceding crisis war. This is what happened to Turkey -- they're now deep into a crisis era, having not yet had a new crisis war since 1921. (Other countries that are similarly deep into crisis eras include Mexico, Saudi Arabia, and Russia.)

The original vision of a secular Turkey, promulgated by modern Turkey's found, Ataturk, in 1924, was that Turkey would be part of and associated with Europe and the West, rather than with the Mideast.

However, the old battles of World War I keep coming back, leaving Turkey to suffer one indignity after another at the hands of Westerners, including the following:

The Turkish people are more and more realizing that they're going to continue to receive what is, from their point of view, contemptuous treatment by the West.

Increasing xenophobia between Turks and West

Ever since Ataturk established a secular Turkey in 1924, the Turks have maintained an open, friendly attitude toward Europeans and the West. But that has been changing during the past few years.

There's been widespread reporting in the mainstream media that the Turks are becoming more hostile towards Americans because of the Iraq war.

But this is a total misrepresentation of the situation. The Turks have been getting more hostile to almost all major groups outside of Turkey, including Muslim groups.

In fact, among Muslim groups in different countries, the Turks appear to be the most hostile to others.

Here are the results of a recent poll by the Pew Global Attitudes group:

"Recent Pew Global Attitudes surveys show that negative views of the United States are indeed widespread and growing in Turkey. In fact, the United States receives a lower favorability rating (9%) in Turkey than in any of the 47 countries in the 2007 Pew Global Attitudes survey. This is down considerably from a 30% favorability rating in Pew's 2002 poll and from 52% in a 2000 State Department poll. There also has been a correspondingly sharp drop in the favorability rating for the American people (from 32% in 2002 to a mere 13% in 2007).

These negative views are also seen in Turks' opinions on American foreign policy. For example, just 9% of Turks support the U.S.-led war on terror, and only 14% think the U.S. considers the interests of countries like Turkey when making foreign policy decisions. Moreover, according to a 2006 Pew poll, a large majority (64%) of Turks believe that the efforts to establish a stable democratic government in Iraq will fail. This is the largest percentage in any of the 15 countries surveyed in 2006, including four other predominantly Muslim countries (29% in Jordan expressed this view, 25% in Egypt, 16% in Indonesia and 14% in Pakistan). Not surprisingly, in light of these negative views of the U.S. and American foreign policy, 86% of Turks now favor removing U.S. troops from Iraq, according to the 2007 Pew poll.

View of the EU and the West

Negative views also appear to be growing among Turks with respect to the European Union and to Westerners in general. Such negativity toward the EU is likely associated with disillusionment over Turkey's stalled bid to join the union. For instance, the favorability rating for the EU dropped from 58% in 2004 to 27% in 2007.

A combination of all these factors seems to be generating more negative views of Westerners generally. Of the 10 Muslim publics surveyed in the 2006 Pew Global Attitudes poll, for instance, the Turkish public showed the most negative views, on average, toward Westerners. The survey asked Muslims whether they associate people in Western countries such as the U.S. and European nations with a series of negative and positive characteristics, including "arrogant," "greedy," "immoral," "selfish," and "violent," as well as "generous" and "honest." The two positive characteristics were reverse coded to reflect the opposite. For this analysis, a negativity index that ranges from zero (extremely positive) to 7 (extremely negative) was created using this series of questions."

The following poll results, from the Pew study, show that, among all Muslim groups polled, the Turks had the highest negativity to Westerners:

      Average Negativity to Westerners
        Group                   Mean
        ------------------      ----
        Turkey                  5.2
        Indonesia               5.1
        Jordan                  4.8
        Egypt                   4.7
        Pakistan                4.4
        Nigerian Muslims        4.4
        British Muslims         4.2
        German Muslims          3.2
        French Muslims          2.7
        Spanish Muslims         2.7

The following results show the percentage of Turks who have favorable views three religious groups -- Christians, Muslims, Jews. (I wish they had distinguished between Western and Orthodox Christianity. I think it might have made a big difference.)

    Rating of Christians, Muslims and Jews

Percent of Turks with a very or somewhat favorable opinion of ...

Christians Muslims Jews % % % ---------- ------- ---- 2006 16 88 15 2005 21 83 18 2004 31 88 27

The above results are important because they show a significant TREND of decreasingly favorable opinion towards Christians and Jews.

This xenophobia is consistent with Turkey being deep into a generational Crisis era. We see similar xenophobia in other countries as well, though not yet as entrenched as in Turkey.

The next set of results may be surprising at first, but makes plenty of sense in view of the brief history of Turkey provided above.

  Turks Not as Favorable toward Arabs as Other Muslims

Percent with a very or somewhat favorable view of Arabs: Muslim group % ----------------- ---- Nigerian Muslims 90 Spanish Muslims 85 French Muslims 84 Indonesia 84 Pakistan 78 British Muslims 65 Turkey 46 German Muslims 45

Finally, an additional analysis of the same Pew Research data was done to provide a single index of "negativity" of one group to another.

The index is called the "Religious-Cultural Negativity Index," or RCN. On a scale of 0-7, with 0 being least negative and 7 being most negative, it measures the negativity of one group towards another.

Here's how the attitude of Muslim publics toward Westerners is described:

And here is a summary of the poll results:

"The data on Muslim attitudes toward Westerners ... revealed a variety of negative views. In the five majority-Muslim countries, as well as Nigeria, at least 40 percent of Muslims in the survey characterized Westerners as arrogant, violent, greedy, and immoral; meanwhile, relatively few said Westerners were generous or honest.... And Muslims in these countries were particularly likely to say Westerners were selfish—in all six, majorities suggested selfishness was common among people in Europe and the United States. Negative assessments of Westerners were fairly common across all six of these countries, although they were slightly more prevalent in Jordan and Indonesia. European Muslims were consistently less likely to associate negative characteristics with Westerners and were more likely to label them as generous and honest."

      The Religious-Cultural Negativity Index

Negativity of Muslim publics towards Westerners

Muslims Mean RCN ----------------- -------- Turkey 5.2 Indonesia 5.1 Jordan 4.8 Egypt 4.7 Pakistan 4.4 Nigerian Muslims 4.4 German Muslims 3.2 French Muslims 2.7 Spanish Muslims 2.7

As you can see, Turks are more negative toward Westerners than other Muslim groups, and significantly so.

Now we turn the tables, and ask about the negativity of Westerners to Muslims in general.

It turns out that Westerners are significantly LESS negative about Muslims than Muslims are about Westerners.

"The positive qualities from the survey included in our analysis were “generous” and “honest,” while the negative characteristics were “arrogant,” “greedy,” “immoral,” “selfish,” and “violent.” The results showed that many non-Muslims associated negative traits with Muslims.... Majorities of survey respondents in Nigeria, India, Spain, Russia, and Germany saw Muslims as violent. Large numbers, including majorities in India, Nigeria, and Russia, also considered Muslims arrogant. Many also associated selfishness with Muslims, although India was the only country where a majority did so. Non-Muslims were less likely to rate Muslims as greedy or immoral—in France, for instance, only 10 percent said Muslims were greedy, and just 18 percent labeled them as immoral.

Neither of the two positive traits included in our analysis was consistently associated with Muslims.... Still, many did characterize Muslims as honest and generous. Roughly two in three (64 percent) of French, 56 percent of British, and 52 percent of German respondents considered Muslims honest, and majorities in France (63 percent) and Nigeria (55 percent) saw them as generous."

      The Religious-Cultural Negativity Index

Negativity of Westerners towards Muslim publics Non-Muslim publics Mean RCN India 4.4 Russia 4.0 Nigerian non-Muslims 3.7 Spain 3.5 United States 2.9 Germany 2.8 Britain 2.5 France 2.1

A new Young Turks revolution?

The defining characteristic of the Young Turks revolution that began in 1908 was increased nationalism for Turkey. These survey results indicate that a similar process is occurring now, and Turks become increasingly negative and hostile to almost all other groups.

From the point of view of Generational Dynamics, Turkey's central role in Asia Minor means it will play a central role in the coming "Clash of Civilizations" world war. The exact path that Turkey will take cannot be predicted, but a new war between Turkey and the West, especially between Turkey and the Christian Orthodox nations, is coming with absolute certainty. (29-Oct-07) Permanent Link
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Near total collapse of ABX index shows that mortgage problems continue to grow

On a day when the Bank of England warned investors that the stock market is "particularly vulnerable," the ABX-HE index continued to fall like a stone, indicating that the market values of CDOs in many institutions' portfolios are continuing to fall as well.

Prices of ABX-HE series 07-2 for various risk levels on 25-Oct-2007 <font face=Arial size=-2>(Source:</font>
Prices of ABX-HE series 07-2 for various risk levels on 25-Oct-2007 (Source:

This came on the day when the Bank of England issued the semi-annual Financial Stability Report. The report said that the global financial system is at risk of further instability because of "ongoing uncertainties" about credit-market losses, and that both the stock market and commercial real estate values are particularly vulnerable to "further shocks, either in credit markets or from new sources." The gloomy outlook was confirmed in testimony by Chancellor of the Exchequer Alistair Darling.

None of this affected investors, of course. Speaking from the floor of the New York Stock Exchange, CNBC commentator Bob Pisani said that "investors are obsessed with a Fed rate cut next week. That's all they think about. That's all that matters to them."

The ABX-HE indexes are a measure of investor confidence that homeowners are not going to default on their mortgages. The three graphs shown above reflect mortgages that were granted this year, from January 1 to July 1, 2007. The top level graph represents the highest quality prime mortgages, with rating AAA or AA; the middle level graph represents medium risk Alt-A mortgages, with rating A; and the bottom graph represents highest risk subprime mortgages. Indexes at all levels are falling like rocks, and may be headed to zero.

The ABX indexes are proxies for the "market values" of mortgage-backed CDOs in the portfolios of Merrill Lynch and other financial institutions.

Who knows? Maybe one of the reasons that Merrill had to write down $7.9 billion in CDO values, instead of the $4.5 billion they had told us just two weeks ago, is because the ABX indexes fell sharply in the interim.

I like to look at trends, so let's take a look at the trends that have gotten us to the current place:

I wanted to give this summary just to show that the mainstream financial media and pundits will always put the best spin on things. They are, in effect, biased in the direction of keeping the bubble growing as long as possible, even though the larger the bubble, the greater the disaster when it finally bursts completely.

The continued collapse of the ABX index values is really bad news, because it means that the CDOs and other securities in the portfolios of financial institutions are becoming more and more worthless every day.

CNBC commentator David Faber made an interesting point on Thursday. He said that "Merrill Lynch wrote down its high-grade CDOs by 19%, and its [low-grade] CDOs-Squared by 57%." He then compared this to what a small investment firm, Ambex has done. "By contrast, the mark-to-market losses announced by Ambex on its CDO portfolio, which is made up of exactly the same stuff that Merrill had in its portfolio, stand at 2½%."

Faber's comment makes it clear that Ambex has a long way to go in writing down the values of its securities, and by implication so does almost everyone else. Even Merrill, in making its announcement on Wednesday, said that it might have further writedowns on the same securities.

How long can these firms keep this up? How long can they hide the fact that their CDOs are worth far less than they're telling us? How long can they resort to SIVs and M-LECs and Super-SIVs that allow banks to sell worthless securities to each other at inflated prices in order to establish a phony "market value" for the worthless securities?

My instincts tell me that this can't possibly go on much longer, but let's face it, my timing instincts haven't always been the best. But at some point there'll be a "tipping point" and a panic, when it becomes clear that the global financial system is built on top of these near-worthless securities. This panic might occur next week or next month or even next year, but I just can see how it can be prevented much longer.

Let's just review what we do know.

As I showed in my article, "How to compute the 'real value' of the stock market," the stock market is overpriced by a factor of 250%, same as in 1929.

One of the graphs from that article is the following:

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

Now, no one in his right mind can look at this graph and not see immediately that the stock market is going to crash. The P/E ratio will drop below 10, as it did in 1982, for example, and the stock market will fall to Dow 4000 or lower.

From the point of view of Generational Dynamics, we're headed for a generational panic and crash with 100% certainly. (26-Oct-07) Permanent Link
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What did Merrill know, and when did they know it?

Merrill Lynch writes down $8.4 billion in bad security holdings, just two weeks after they had said that the writedown would be only $4.5 billion.

Starting with the Bear Stearns debacle that became public in June, there have been one story after another with the same theme: Banks and other financial institutions are taking every possible step to hide from the public the losses from bad securities (usually mortgage-backed CDOs and other credit derivatives) in their portfolios.

The investment community was shocked on Wednesday to learn that Merrill will take $8.4 billion in write downs for bad securities. That includes CDOs that had a high notional value, but had to be marked down in value by $7.9 billion.

The problem is that it was just two weeks ago that Merrill said that the writedown would be only $4.5 billion.

How could they have made that mistake? I mean, it's one thing if you can't balance your checkbook because you've lost track of a $3.25 payment somewhere, but no one should ever lose track of four billion dollars, especially one of biggest investment banks in the world. A billion here and a billion there, as the saying goes, and pretty soon it adds up to real money.

Merrill is making excuses, of course. "Well, gawrsh, we figured it all out and came to a figure of $4.5 billion two weeks ago. But we did some 'additional analysis' over the last two weeks, and now it's $8.4 billion."

Is Merrill willing to guarantee that there won't be any more writedowns? No, they aren't, although they have "only" $15.3 billion in CDOs left.

And there's the problem. If Merrill made this mistake, aren't other banks likely to be making similar mistakes?

And banks are the experts. If they're making such huge mistakes, what about financial organizations of lesser expertise -- mutual funds, investment trusts, hedge funds, savings banks, pension funds, college endowments, money market funds, insurance companies?

The thing is, as I've said before, what's going on is fraud. People have invested money in funds that may be backed by mortgage-based securities that are worth a lot less than the fund managers claim. That means that the investors stand to lose a great deal of money.

As cynical as I am about what's been going on, I'm still really shocked by how bad it's gotten.

It's incredible to me that you have Treasury Secretary Henry Paulson cooperating with Citibank to set up this M-LEC or "Super-SIV" whose purpose is specifically to allow financial institutions to sell worthless securities to one another at inflated prices, in order to establish the inflated price as a "market value."

For those of you readers who are students of the Bible, I'm sure that you must recognize the kind of debauched, depraved behavior that we're seeing today, although admittedly there were no collateralized debt obligations (CDOs) that we know of in Sodom and Gomorrah.

But it's interesting from a generational point of view, how the "last days" of any society or nation, prior to the start of a new genocidal crisis war, always feature a complete unraveling of all the rules that the society adopted at the end of the preceding crisis war to guarantee that no such war would ever happen again. I know that my 1950s schoolteachers, who often talked about the greed that led to 1929, would be in a state of shocked disbelief at the depraved financial behavior that's the norm today.

I've been predicting since 2002 that we would have a generational panic and stock market crash and a new 1930s style Great Depression, so I'm not surprised that each day we're obviously closer to that result.

But what's really shocking to me is the public displays of depravity and dishonesty. A few years ago I never would have believed that this was possible, and even a few months ago I could not have believed that this behavior could get so bad, and keep getting worse.

The intent of all this depravity is to prevent banks and other financial institutions from having to mark their securities to market, which would mean huge writedowns, such as those from Merrill Lynch.

But those writedowns are happening anyway. The SIVs and the Super-SIVs and the M-LECs can't keep worthless securities at artificially high prices forever. As one institution after another is forced to revalue their assets, pretty soon there may be a domino effect.

As I've said many times, Generational Dynamics tells you what your final destination is, but it doesn't predict how you'll get there. I've been speculating that the worldwide financial crisis could be triggered by a panic on Wall Street or in Shanghai or Hong Kong.

But maybe it will be something quite different: The panicked selling of mutual funds, hedge funds, and other portfolios containing CDOs, before the CDOs have to be marked to market.

At any rate, bubbly investors now have one less hook on which to hang their hats.

In the "bad news is good news" frame of mind, investors have been treating previous writedowns as a good thing. The phrase we've been hearing was that the third quarter was a "kitchen sink" quarter, meaning that financial institutions would get all their writedowns out of the way in the third quarter, so that they could go back to inflating the bubble in the fourth quarter.

This concept is no longer viable. It's now clear that, at best, financial institutions have no idea how big their exposure is and, at worst, they do know, but are fraudulently hiding it from the public.

Either way, bubbly investors are now beginning to realize that the "kitchen sink" concept doesn't work, and that there will be a lot more writedowns in the quarters to come.

And with foreclosures surging and real estate prices falling, it's increasingly clear that much worse is yet to come. (25-Oct-07) Permanent Link
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Investor anxiety is palpably increasing on housing and earnings news

As credit crunch returns, will the Fed save the world again next week?

There's very little left of the bubbly optimism that you used to hear on CNBC. The anchors keep asking the same questions -- of each other and of the pundits they invite as guests: Should investors pay attention to the economy, to earnings, or to the Fed?

From the point of view of Generational Dynamics, we're headed for a new 1930s Great Depression, as I've been saying since 2002, based on the stock market bubble. In 2002 I had no idea how it would unfold, but now we're seeing it.

What's amazing is how the financial community is using one artifice after another, many of them simply fraudulent, to postpone the inevitable, making the situation worse with each new artifice.

That's exactly what happened in 1929, as described by John Kenneth Galbraith in his 1954 book, The Great Crash - 1929, as follows:

"A bubble can easily be punctured. But to incise it with a needle so that it subsides gradually is a task of no small delicacy. Among those who sensed what was happening in early 1929, there was some hope but no confidence that the boom could be made to subside. The real choice was between an immediate and deliberately engineered collapse and a more serious disaster later on. Someone would certainly be blamed for the ultimate collapse when it came. There was no question whatever as to who would be blamed should the boom be deliberately deflated. (For nearly a decade the Federal Reserve authorities had been denying their responsibility for the deflation of 1920-21.) The eventual disaster also had the inestimable advantage of allowing a few more days, weeks, months of life. One may doubt if at any time in early 1929 the problem was ever framed in terms of quite such stark alternatives. But however disguised or evaded, these were the choices which haunted every serious conference on what to do about the market." (p. 25)

This is exactly what's happening today.

I had to laugh on Tuesday morning, listening to Steve Liesman on CNBC talk about the M-LEC or Super-SIV. He said that an unnamed senior Fed official offers conditional support to the Super-SIV, provided that it's completely transparent, and that the securities being sold are at true market prices. So first off we can laugh at the fact that the Fed wants to support the project so much that they're willing to have an unnamed official say so on condition that his name isn't mentioned. Some support.

And what's the nature of the support? It's conditional, and depends on the securities being sold at true market prices, which of course everyone knows they won't be, because the whole purpose of the Super-SIV is to fraudulently sell them at unrealistically inflated prices.

So the Fed gets to eat its cake and have it too. They can support the Super-SIV at the present time, when it's expedient to do so, but only with an unnamed official; and later, when the whole thing blows up, they can say, "Well, yeah, we said it was OK, but ONLY if they sold the securities at market prices. We NEVER meant to support these fraudulent sales."

All these financial officials are covering their asses now, waiting until the inevitable crash occurs, and hoping that SOMEONE ELSE will be blamed. This would be fun to watch, if only the consequences weren't so disastrous. (24-Oct-07) Permanent Link
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Anti-immigrant Swiss People's Party makes large gains in election

Following a pattern of xenophobia that's growing around the world, the Swiss people gave a major election victory to a party that its opponents say is nationalistic and racist.

Anti-immigration election poster, declared "racist" by opponents, depicts white sheep kicking a black sheep away from a Swiss flag, with the caption, "Establish your security."
Anti-immigration election poster, declared "racist" by opponents, depicts white sheep kicking a black sheep away from a Swiss flag, with the caption, "Establish your security."

Based on exit polls, the Swiss People's Party won 29% of the vote in the parliamentary election, making it the largest single party in Parliament.

The Swiss People's Party had campaigned aggressively on an anti-immigrant platform, calling for the forced deportation of any foreign family where any family member is a criminal. The party's campaign featured posters showing white sheep kicking a black sheep away from a Swiss flag.

Similar gains for anti-immigration parties have been made in other European countries.

This is part of the growing xenophobia that's spreading around the world, among countries for which World War II was a crisis war.

From the point of view of Generational Dynamics, this xenophobia leads to a new crisis war. 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 anti-immigrant attitude becomes more explicit and focused, leading to increasing calls 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.

Generational Dynamics predicts that xenophobia and anti-immigrant attitudes will continue to increase in countries around the world, eventually leading to a new "clash of civilizations" world war. (22-Oct-07) Permanent Link
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Benazir Bhutto narrowly escapes death from suicide bombers

Pakistan is adrift and at a crossroads today, as its people wonder where to go next.

We mentioned briefly a couple of days ago that former prime minister Benazir Bhutto was returning from exile to Pakistan, under an agreement with President Pervez Musharraf to share power. Bhutto has been in exile since the 1990s, when she was charged with massive corruption, and chose exile over jail.

Benazir Bhutto, shocked from having narrowly escaped death, is rescued from bombed vehicle on Thursday <font face=Arial size=-2>(Source:</font>
Benazir Bhutto, shocked from having narrowly escaped death, is rescued from bombed vehicle on Thursday (Source:

Benazir Bhutto's return to Pakistan on Thursday was euphoric, as hundreds of thousands of supporters lined the streets along which her caravan traveled from the Karachi airport. The cheers had the atmospherics of a huge party.

The euphoria ended abruptly, however, when two suicide car bombers approached her vehicle and exploded. It was only through the sheerest luck that she was unhurt; she had been fully exposed, waving to the crowds, and only moments before the blasts had she retreated into her vehicle for a brief rest. Even so, her vehicle was badly damaged, and dozens of members of her personal guard were killed as they used their bodies to prevent the suicide bombers from getting closer. Hundreds of onlookers were killed and wounded as well.

Benazir Bhutto, at a press conference on Friday afternoon. <font face=Arial size=-2>(Source: BBC)</font>
Benazir Bhutto, at a press conference on Friday afternoon. (Source: BBC)

At a press conference on Friday, Bhutto blamed al-Qaeda and Taliban militants for the assassination attempt, and declared she would risk her life to restore democracy in Pakistan and prevent an extremist takeover:

"We believe democracy alone can save Pakistan from disintegration and a militant takeover. We are prepared to risk our lives and we are prepared to risk our liberty, but we are not prepared to surrender our great nation to the militants."

These remarks cut very close to the bone for Bhutto.

Benazir's father, Zulfikar Ali Bhutto

Benazir's own father, Zulfikar Ali Bhutto, was President of Pakistan from 1971 to 1973, and Prime Minister from 1973 to 1977. He founded the Pakistan People's Party (PPP) in the 1960s, and governed through some very tumultuous times, especially a humiliating loss in a war with India.

Here's the map of the Indian subcontinent as of 1970:

Indian subcontinent, 1970, highlighting provinces of Waziristan and Balochistan.  East Bengal province, also known as East Pakistan, seceded and became Bangladesh in 1971. <font face=Arial size=-2>(Source: Stearns, Encyclopedia of World History)</font>
Indian subcontinent, 1970, highlighting provinces of Waziristan and Balochistan. East Bengal province, also known as East Pakistan, seceded and became Bangladesh in 1971. (Source: Stearns, Encyclopedia of World History)

The defeat by India was devastating to the Pakistanis. India gained control of much of the disputed provinces of Kashmir and Jammu, and East Pakistan seceded to form a new nation, Bangladesh.

The secession of Bangladesh led to an (Awakening era) secessionist insurgency in Balochistan province, with widespread civil disorder and civil disobedience.

This led to the overthrow of Zulfikar Ali Bhutto's government in 1977, resulting in martial law and a military dictatorship. Bhutto himself was accused and tried for murder and other crimes, which his supporters claim he did not commit. Bhutto was found guilty. He was executed by hanging on April 4, 1979.

Electoral government was restored in 1985, and Benazir Bhutto was elected Prime Minister in 1988. There followed a period of very chaotic government with numerous Prime Ministers. Two of them, Bhutto and Nawaz Sharif, were both exiled from the Pakistan after being found guilty of corruption.

Coup by Army chief Pervez Musharraf

In 1999, a new military coup by Army chief Pervez Musharraf returned some stability to the government. Musharraf and Pakistan had been allied with the Taliban in Afghanistan, but after September 11, 2001, Musharraf turned against al-Qaeda, the Taliban and Islamist extremism. Since then, Musharraf and Pakistan have been allied with the United States in the war against terror.

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Pakistan's President Musharraf faces major crisis : The remarkable détente between India and Pakistan may go down with Musharraf. ... (18-Mar-07)
Al-Qaeda resurging in Afghanistan and Pakistan: Al-Qaeda's greatest threat is to Britain and Europe.... (19-Feb-07)
India claims Pakistan government agency perpetrated the Mumbai railroad bombings: India has promised to show potentially explosive evidence to Pakistan.... (1-Oct-06)
Tensions build as Pakistan cracks down on extremists after London bombings: In Kashmir, a car bomb that kills and wounds dozens, including children,... (21-Jul-05)
"Koran in toilet" rumor is uniting Muslims around the world: From Gaza to Indonesia, Muslims are shouting "Death to America."... (15-May-05)
Pakistan "Black Day" protests fail: Continuing a worldwide trend of increased militarization and police power, President Pervez Musharraf... (02-Jan-05)
China's "sacred responsibility" is to stop Taiwan independence by force: A national defense white paper issued Monday by China threatens... (28-Dec-04)
An eerie parallel between Pakistan and Israel: Pakistani President Pervez Musharraf has proposed a Kashmir peace plan which, like the Mideast "Roadmap to Peace," has no chance of succeeding.... (29-Oct-04)
New Islamic terrorist group claims credit for Bangladesh bombing leading to massive unrest and further violence: Like Pakistan, Bangladesh is overwhelmingly Muslim but still has excellent relations with the U.S.... (25-Aug-04)
Beheadings part of increasing conflict level throughout Mideast: The level of conflict is increasing throughout the Mideast, from Gaza to Pakistan, from Saudi Arabia to Uzbekistan. (23-Jun-2004)
Anti-Shi'ite Terror Attacks in Iraq, Pakistan: So far, Sunni and Shi'ite leaders in Iraq aren't taking the bait. (2-Mar-04)

Musharraf has been very popular with the Pakistani people because of the stability he brought to the government, and because of economic improvements brought about, his opponents claim, by the money provided by the U.S. in return for supporting the war against terror. However, Musharraf's popularity has been plummeting this year, for several reasons:

Benazir Bhutto has been criticizing Musharraf from exile, especially for his 1999 coup, which was reminiscent of the 1977 coup that overthrew her father's government. Her call for a "return to democracy" is made for exactly that reason.

However, Bhutto's popularity is also jeopardized, especially among conservative Muslims, who are opposed to having Bhutto in power because she's liberal, moderate, secular, openly pro-American, and a woman.

Among all the many groups that dislike Bhutto, which one is likely to have perpetrated the assassination attempt?

During her press conference on Friday, she listed four different groups that wanted her dead within hours of her return:

"There was one suicide squad from the Taleban elements, one suicide squad from al-Qaeda, one suicide squad from Pakistani Taleban and a fourth – a group, I believe, from Karachi."

There are certainly sharp disagreements in Pakistan between moderate and hardline Muslims. However, while those disagreements may cause terrorism and low-level violence, it will not cause a crisis war.

Hindu vs Muslim: Partition, independence, genocide

Two months ago, in August, India and Pakistan celebrated 60 years of independence.

And at the same time they commemorated Partition, one of the most genocidal mass migrations in history.

The British, who had ruled the Indian subcontinent for centuries, finally gave in to the demands of the people for independence.

The forced migration of 14 million people and the killing of perhaps a million more makes the 1947 Partition of the Indian subcontinent into two countries, separating Muslims from Hindus, one of the largest mass migrations in history.

It came about because the British, who had ruled the Indian subcontinent for centuries, finally gave into the demands for independence. In order to prevent a civil war, the British partitioned the subcontinent into two portions:

Historically, the defining event of the Indian subcontinent of the last millennium was the 1526 conquest of Delhi in Northern India, climaxing with the Battle of Panipat on April 21, 1526.

Indian subcontinent, showing the disputed regions of Kashmir and Jammu.  Bangladesh used to be the eastern portion of Pakistan.
Indian subcontinent, showing the disputed regions of Kashmir and Jammu. Bangladesh used to be the eastern portion of Pakistan.

The conquest was by the Mongols (the descendants of Genghis Kahn) coming from Persia (Iran), having adopted a form of the Shia Muslim religion. The result was centuries of rule by the Mughals (the Persian name for Mongols).

There are two Mughal emperors of note: Babur, who led the conquest in 1526, and sought to give Muslims a privileged status over Hindus, before dying in 1532; and Akbar, the greatest Mughal emperor, who ruled from 1556 until his death in 1605, and who was greatly tolerant about religion, and encouraged the growth of the Hindu religion along with his own Muslim religion.

These two leaders, Babur and Akbar, represent the opposite poles of Muslim leaders that have defined the lives of the people of the Indian subcontinent for the centuries since then, and continue to do so today.

Tolerant Mughals ruled India through the 1600s, making the Mughal Empire perhaps the greatest empire in the world at the time, with Muslims and Hindus living in relative peace. Hindu persecution began with Aurangzib, who became emperor in 1658. He destroyed Hindu temples, and adopted policies prohibiting exercise of the Hindu religion. The Mughal Empire disintegrated in the 1700s, and in 1764, a major victory brought the subcontinent under British rule.

British rule continued until August, 1947, and Partition. Britain withdrew control of India, and created two nation-states: India with a majority Hindu population, and Pakistan, which was predominantly Muslim.

The plan was that the populations would remain in place, and that the remaining Hindus in Pakistan would live there, as would the remaining Muslims in India. The plan didn't work.

There were mass migrations of some 12 million people, crossing the partition borders, Hindus moving to India and Muslims moving to Pakistan, often leaving everything they owned behind. The ethnic violence killed perhaps a million people. The provinces of Kashmir and Jammu remain chronic sore spots to this day.

The prospects: A new Hindu / Muslim war

From the point of view of Generational Dynamics, the massive ethnic violence and genocide that followed the 1947 Partition will be re-fought in a new crisis war between India and Pakistan, at some time in the not too distant future.

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

In my little "conflict risk" graphic, I've put the Kashmir problem at Level 2 (medium risk of regional war in the next six months). As I've explained, I have great admiration for both 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, and they've pulled back from the continuing seething dispute over Kashmir and Jammu. The question that I'm considering is whether the time has come for me to raise this potential conflict to Level 3 (high risk).

Musharraf, born 1943, and Singh, born 1932, are both survivors of World War II and the subsequent genocidal war fought after Partition and independence. This is exactly the kind of détente that can be expected from people in an "Artist" type, people who grow up during a crisis war. They become adults who, as a group, are more sensitive and more willing to compromise than people in other generations.

When they retire or die, they're replaced by people in the arrogant post-war generations (like our Baby Boomers and Generation-Xers). People in these generations are far more confrontational, and that's been pretty apparent for some time from reading Benazir Bhutto's statements. In particular, Bhutto's statements regarding terrorist activities in Waziristan have been considerably harsher than those of Musharraf, and echo Bhutto's father's attitudes towards the insurgency in Balochistan in the 1970s.

(There was a suicide bombing in southern Balochistan on Saturday. Press reports claim that it was unrelated to the assassination attempt on Bhutto, but that's far from clear. It could well have been perpetrated by the same insurgency that Bhutto's father fought in the 1970s.) (Paragraph added 21-Oct)

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.

The rapidly deteriorating political situation in Pakistan raises the possibility that such a change of leadership could be close; and even if Musharraf and Bhutto do come to a power-sharing arrangement, the political situation may continue to deteriorate anyway, and this could spiral into a confrontation with India.

I'm not the only person that this thought has occurred to; the India news media is expressing increasing concern about the situation in Pakistan. Here's a possible scenario from the Hindustan Times:

"The attacks were not unexpected in Karachi, which is a hotbed of sectarian killings. Intelligence reports even warned that various jehadi groups linked to al-Qaeda and the Taliban were planning to carry out such strikes on Ms Bhutto on her return. The fact that the former premier announced the date and place of her return weeks ago probably gave the perpetrators enough time to prepare. Although no one has yet claimed responsibility for the attacks, many elements in Pakistan are opposed to Ms Bhutto’s possible return to power. She is widely seen as a pro-Western moderate and her open statements supporting US policy in the region obviously put her in the cross-hairs of terrorist outfits. She returns to the political scene at a time when Pervez Musharraf’s grip on the presidency is at its weakest since he seized power in a coup eight years ago. The General’s popularity ratings continue to nosedive even as Opposition parties challenged his re-election as president earlier this month. The loyalty of Pakistan’s powerful military and US patronage appear to be just about the only things going for the embattled president. ...

Ironically, the very forces that the general and Ms Bhutto had created now pose the biggest threat to them. For it was during Ms Bhutto’s second term in office in 1994, when General Musharraf was her Director General of Military Operations, that they projected the Taliban as a force to further Pakistani interests in Afghanistan. But now, any military solution they try out against the radicals would likely trigger more turbulence and invite attacks on the Pakistan army.

As Pakistan drifts, the problem for India is that Islamabad’s military rulers might try to divert attention by indulging in military adventurism. Which means a real danger of increased militancy in Kashmir, more active insurgencies in the North-east and terrorist strikes in the subcontinent."

To this I would add one more scenario. Although there have been a dozen suicide bombings and other terrorist attacks in Pakistan this year alone, they haven't yet galvanized the Pakistani people into political unity. (This is the generational concept of "regeneracy," referring to the regeneracy of national unity that occurs during crisis eras.) It's possible that this particular attack, directed at Bhutto and hence at the heart of Pakistan's democracy, could change the population's behaviors and attitudes to the point where they'll demand that "something must be done." This could cause, to select one of many possible scenarios, a panicked reaction that leads to some kind of inter-tribal warfare, and that too could spread into India. (Paragraph added 21-Oct)

As these scenarios illustrate, the situation in Pakistan is becoming increasingly dangerous, and may be close to spiraling into all-out war. (21-Oct-07) Permanent Link
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WSJ: "When crash means 'buy'"

How mainstream financial media are cheerleaders for the Principle of Maximum Ruin.

As we watch the current financial scene unfold, we see the following message in the financial media: There's really nothing to worry about, but maybe be a little cautious since there have been problems before.

No one wants to go out on a limb and say that there will never be another crash, but the larger message is always the same, that when the stock market dips a few percentage points, then that's a great buying opportunity to take advantage of the next all-time high (which, surely, will only be a couple of weeks away).

In order for a generational financial crisis (like 1929) to be as totally devastating as possible, it's necessary for as many people as possible to believe that a crisis could never happen and, once it's begun, that it will end quickly.

This is the basis for the principle that I've discussed several times on this web site, the Principle of Maximum Ruin: That a generational financial crisis will ruin the maximum number of people to the maximum extent possible.

The mainstream financial media are doing as much as they can to convince people that, while there might something to worry about some day "down the road," there's nothing to worry about now.

These articles are especially plentiful today, as investors commemorate the false panic of Monday, October 19, 1987.

An article in Friday's Wall Street Journal illustrates very well how this works:

"When Crash Means 'Buy' - After Black Monday, Advice to Invest on Dips"

The 1987 crash -- 20 years ago today -- had investors bracing for the worst. When the worst didn't come, those who quickly recognized that the economy and the stock market were far more resilient than they had thought looked smart.

A little more than a year later, the Dow Jones Industrial Average had made back all the ground it had lost, and anyone who bought in the aftermath of the crash could feel justifiably pleased.

"I put all of my 401(k) in the stock market at that time, and it turned out to be one of the few really smart things I've ever done," says ING Investment Management economic adviser James Griffin, who was then an economist for Aetna Life Insurance.

Even after declines this week, at 13888.96 yesterday, the Dow is up nearly eightfold from its close of 1738.74 on Black Monday, Oct. 19, 1987.

As the market has rebounded from every downturn in the 20 years since the crash, individual investors accepted the notion that they should continue to plow money into the stock market even when the picture looks bleak. "Buy on the dips" has become their creed, and standard-issue investment advice. Many saw this summer's credit-market turmoil, which sent stocks down sharply in August, as a buying opportunity. The Dow industrials have rebounded more than 8% since their recent low on Aug. 16 and hit two records just this month.

It is a testament to the dynamism of the economy and stock market, and how skillful policy makers have become when faced with a crisis. At the same time, there is a risk that investors have become too complacent, and that if the day comes that the economy can't bounce back, there will be big losses.

"Probably the largest lesson taken away from 1987 was a belief in the system and the ability of the system to avoid disaster," says John Bollinger, president of Bollinger Capital Management in Manhattan Beach, Calif. "In the long haul, that's probably a lousy lesson for the markets to have learned, because it ultimately sets up for problems down the road." ...

Mr. [James] Griffin, now at ING, says what made him bullish in 1987, when many of his colleagues were not, was the way the Fed, under its newly appointed chairman, Alan Greenspan, responded to the crash. Cutting interest rates stood in contrast to 1929, when the Fed kept rates high. The Fed lowered rates in 1995 after the Mexican peso crisis, in 1998 after the Russian debt crisis, in the aftermath of the Sept. 11, 2001, attacks and, most recently, in response to this summer's turmoil.

Donald Fine, a market analyst at Chase Manhattan Bank in 1987, recalls that after the crash "the recession talk began immediately." But when the economy shrugged off the crash "it said that the economy was considerably more resilient than people thought," says Mr. Fine.

The next recession didn't begin until 1990, making the economic expansion begun in 1982 the longest ever in the U.S. during peacetime. The expansion that followed, which didn't end until 2001, was the longest in history. It's all part of a damping of economic volatility over the past 25 years that some economists dub "The Great Moderation."

One consequence of the Great Moderation has been that companies no longer get rocked as hard by the forces of boom and bust as they did before. That, and policy makers' skill at guiding the economy through crises, has meant buying stocks after selloffs has generally been a good tactic. ...

The real risk, says Mr. Bollinger, is that someday the U.S. economy will run into trouble that defies the ability of the Fed to deal with or, to put it another way, that the success of economy's resilience over the past 25 years has more to do with luck than it does with policy makers' skill."

It isn't just WSJ that's cheerleading for the Principle of Maximum Ruin. Here's part of a Friday morning column on written by financial contributor Rev Shark:

"How You Could Have Managed the '87 Crash"

There is a lot of talk today about the stock market crash that took place 20 years ago. It certainly is important to understand that the market can act so dramatically. Although the 1987 crash was of an almost unimaginable magnitude, it does illustrate that the potential for surprises is always lurking.

However, it is important not to learn the wrong lessons from the crash as well. I would bet that much more has been lost worrying that another giant one-day crash might occur than was actually lost in the 1987 crash. Fear of a crash has caused a lot of people to be overly cautious without must justification. ...

If you used any sort of money management system at all and set stops at reasonable levels, the great likelihood is that you would have been out of almost all your positions before the market crashed 23% on Monday, Oct. 19, 1987.

The lesson here is obvious. Use a money management system, and when stocks are downtrending, don't be too quick to try to catch the turning point. If you keep that in mind, not only would a 1987 crash not cause you too much pain, but it would present a huge opportunity if you stayed patient.

Don't let fear of a crash make you overly cautious. Just make sure you develop a system for cutting losses and stick to it.

This is the typical cheerleading that you read today, along with this silly advice to "set stops at reasonable levels." He's wrong about this on multiple levels.

He's suggesting that you use "sell stop orders" to protect yourself. That means that you instruct your broker (or your online software) to sell your stock as quickly as possible after the price goes below the "stop price."

The first problem is a psychological one. People are told that if the stock market dips, then it's a buying opportunity. Using a sell stop order means you're going to SELL when the market dips. That makes no sense at all.

And second, sell stop orders would have done no good at all on Oct 19, 1987, because the stock exchange was overwhelmed with sell orders and couldn't keep up. A stop sell order would have done you no good.

On days of massive selling, computer systems all over the world will experience failures, because they haven't been designed to handle the huge number of transactions that occur.

Basically, you should assume that, once panic selling begins, it will be several hours, or perhaps an entire day, before you'll be able to execute any orders at all. Remember that everyone will be trying to sell, and you're going to be in line behind a lot of people, many of whom have contacts and a lot more clout than you have.

From the point of view of Generational Dynamics, we're able to see in "real time" how the Principle of Maximum Ruin unfolds. The fact is that few people believe that anything like the Great Depression could ever happen again; most people seem to believe that even a recession could be controlled by the Fed. This could be described as the generational equivalent of "Pride goeth before the fall."

It is 100% certain that we are headed for a major worldwide financial crisis. This will be a generational crisis and, unlike the False Panic of 1987, will continue for years. The stock market fell 40% in 1929, but it kept falling after that, and by 1933 it had fallen to 10% of its peak value. That's the kind of thing that's going to happen again. If you INSIST on adopting a "Buy on the dip" philosophy, then wait until the Dow Industrials dip below 1500, and then it will be time to buy again. (19-Oct-07) Permanent Link
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Investors commemorate the False Panic of Monday, October 19, 1987

The Dow Industrials fell 22% in a single day, the largest one-day drop in history.

But the collapse wasn't sustained. By the end of 1987, the market was rising robustly again, and it recovered completely within 1½ years.

That wasn't true in 1929. On Black Monday in that year, October 28, 1929, the market fell "only" 13%.

The difference, though, was that the market kept falling, and falling, and falling -- for four years! Bit by bit, the market kept falling, until it had tumbled to just 10% of its 1929 peak.

That's how you can tell that the 1987 crash was a "false panic" -- recovery was rapid, as opposed to the "generational panic" of 1929.

It's not surprising that the stock market recovered quickly after the Panic of 1987. The stock market was underpriced in 1987, while today the stock market is overpriced by a factor of 250%, same as in 1929.

John Kenneth Galbraith's 1954 book The Great Crash - 1929, contrasted the 1929 with previous panics:

"A common feature of all these earlier troubles [previous panics] was that having happened they were over. The worst was reasonably recognizable as such. The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune." (p. 108)

That's the situation we're in today. One of the reasons that almost no one is concerned about a possible crash today is because there is general belief that once it happens, the troubles will be over. However, from the point of view of Generational Dynamics, we're now overdue for a new generational crash, and it will be very long-lasting, like the crash of 1929.

If you examine the articles that are being written about the Panic of 1987, you'll see that nobody has any idea why the Panic of 1987 occurred, and why it occurred then instead of, say in 1980 or 1990.

This is a similar problem to the question of why the 1990s dot-com bubble occurred at the time it did. You can look at all the macroeconomics research and you'll discover that no one has a clue. It's as if it occurred by magic. From the point of view of Generational Dynamics, and from the point of view of ordinary common sense, it's perfectly obvious why the bubble began in the mid-1990s. It began in the 1990s because that's exactly the time when the people from the generation who survived the Great Depression all disappeared (retired or died), all at once, leaving behind the Boomers and the Xers who were debauched in using debt and credit.

Generational change after 58 years

The Panic of 1987 occurred at that time for a related reason. 1987 was 58 years past the crash of 1929, and generational research has found a number of examples where a huge disaster occurs, and a "false panic" occurs 58 years later.

Anyone who was 4 years old or older in 1929 had some personal memory of the panic of 1929. Thus, in 1987, people who were 62 years old or older are the only ones now remembering anything about the 1929 panic. (Paragraph corrected on 22-Oct)

Thus, the 1987 panic appears to have occurred at a time of a significant generational change. Whatever latent fears that still existed about a recurrence of the 1929 panic were focused on this moment, as those who remembered the 1929 were quickly disappearing, and were replaced by those who didn't remember it.

Another example was the "swine flu" panic in 1976. The public became hysterical over the possibility of a new flu pandemic. Responding to public demands, the government prepared millions of doses of swine flu vaccine. The pandemic amounted to nothing, and the whole thing was a political fiasco.

This was a false panic that occurred exactly 58 years after the Spanish Flu epidemic of 1918. It appears to be the same kind of thing as the false panic on Wall Street in 1987. Up to that point, people were afraid of a recurrence of the 1918 epidemic. The 1976 panic was a political fiasco that reversed the public mood, and left the public with no further fear of a flu epidemic. That's why the public today has no fear of a bird flu pandemic.

The Panic of 1914

The Panic of 1914 was another "false panic," and it has many similarities to the Panic of 1987. In particular, it occurred 58 years after the previous generational crash, the Panic of 1857 (also known as the Hamburg crisis of 1857).

The Dow Industrials actually fell 24.39% on November 11, 1914, but it's not counted as a one-day fall because the market had just reopened after a hiatus caused by the outbreak of the Great War (World War I).

The Panic of 1914 was important in United States history, because it transformed the US into the major monetary superpower in the world.

Here's how it's described by William L. Silber in When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America's Monetary Supremacy:

"The Great War threatened the United States with financial disaster. During the last week of July 1914, Europeans began to liquidate their Wall Street investments and transfer gold to Europe to pay for the war. Foreign investors owned more than 20 percent of American railroad securities, the largest category of securities traded on the New York Stock Exchange. Under the gold standard, they could demand the precious metal in exchange for the proceeds of their stock sales. The biggest gold outflow in a generation imperiled America’s ability to repay its debts abroad. Fear that the United States would abandon the gold standard pushed the dollar to unprecedented depths on world markets.

The European assault on American finance brought danger and opportunity. In 1914 the United States was a debtor nation with a history of financial crises. Failure to meet its foreign obligations could sink American dreams of world monetary leadership. If it passed the test, however, the United States could jump to the head of the class.

Less than three weeks after the outbreak of the European conflict, Woodrow Wilson reviewed a road map for America’s march to world financial supremacy. Henry Lee Higginson, an investment banker in Boston, wrote to the president on August 20, 1914, that "England has been the exchange place of the world, because of living up to every engagement, and because the power grew with the business. Today we can take this place if we choose; but courage, willingness to part with what we don’t need at once, real character, and the living up to all our debts promptly will give us this power; and nothing else will. I repeat that it is our chance to take first place." Wilson sent Higginson’s letter to Treasury Secretary William G. McAdoo with the following covering message: “Here is a letter which is no doubt worth your reading whether you think the suggestions are practicable or not." ...

How did the summer of 1914 change history?

A suspension of the gold standard in 1914 would have been a setback to American dreams of international financial leadership. The Panic of 1907 had already damaged U.S. credibility. A panic in 1914 would have been the second act in an American financial tragedy. Alexander Noyes, the contemporary business editor of the New York Times, appropriately highlighted the drama: "It is not too much to say that as a matter of financial history, the United States stood during those two or three weeks of August at the parting of the ways." Suspending the gold standard would have relegated the dollar to second-class status, and sterling would have remained the undisputed money of choice for international finance. ...

[Treasury Secretary William G.] McAdoo succeeded in August 1914 because he did not hesitate to bludgeon the crisis with a sledgehammer. He wielded powerful weapons— suspending stock trading for four months and flooding the country with emergency currency—that could have injured America. His exit plan, stimulating agricultural exports with the Bureau of War Risk Insurance, avoided lasting damage to the economy. McAdoo could apply massive force because he had implemented a plan to restore normal functions. Failure to include a strategy for withdrawal either promotes toothless emergency weapons, like a placebo to treat a serious disease, or imposes unnecessary costs. ...

McAdoo’s imprint—decisive leadership combined with a road map for crisis control—turned a potential financial disaster into a monetary triumph."

This description illustrates another major parallel between the two false panics (1914 and 1987): Treasury Secretary William G. McAdoo established his reputation as major financial leader in 1914, just as Alan Greenspan established a similar reputation in 1987, as I described in "System Dynamics and the Failure of Macroeconomics Theory."

As quoted above, John Kenneth Galbraith wrote, "A common feature of all these earlier troubles [previous panics] was that having happened they were over. The worst was reasonably recognizable as such."

This is a very significant statement because it hints at the process that occurs, leading from one generational crash to the next, from 1857 to 1929, and from 1929 to today.

The Panics of 1914 and 1987 served the same purpose: They occur 58 years after the preceding crash, at a time of significant generational change from the last people who have any personal memory of the previous crash. And they serve to convince the younger generations that there's nothing to fear, that the economic and policy problems that caused the previous crash have all been solved, and that there's nothing left to fear.

From the point of view of Generational Dynamics, the False Panics of 1914 and 1987 are important events. In particular, the False Panic of 1987 has led to the debauched use of debt and credit that we've been seeing for the last few years, and that will lead to the coming generational crash and new 1930s style Great Depression. (19-Oct-07) Permanent Link
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Review of recent international stories

France, Turkey and Pakistan in the news

It's time again for a summary of all the important international stories that I've been neglecting while I've been focusing on the deteriorating financial situation.

Incidentally, there's a potentially big financial story coming up, possibly as early as Thursday morning. Remember when I used to write a lot about the ABX credit derivatives. They fell sharply early in the year, leading to the Bear Stearns hedge fund collapse, and credit crisis. The ABX index stabilized over the summer.

However, it now turns out that ABX has been crashing like mad in the last few days. This may have repercussions very soon. And investors are nervous as hell anyway, because Friday is the 20th anniversary of the False Panic of 1987. Take care.

France: Sarkozy facing massive strikes on Thursday

Recall that when Nicolas Sarkozy won the election for President in May, he announced a very ambitious program to make France great again. The heart of his program was to eliminate the 35 hour restriction on the work week, and to eliminate some special pension regimes.

Well, the labor unions aren't happy, and they're anxious to prove to everyone that they're more powerful than Sarkozy is. The major confrontation begins on Thursday. 90% of all scheduled train service across France will be canceled. Other public service workers will be striking as well.

From the point of view of Generational Dynamics, France is becoming politically paralyzed. The same thing is happening in America, where the Congress can't get anything done. The same thing is happening in Japan, China, Israel, and other countries that fought in WW II as a crisis war.

This happens when the postwar generation (i.e., the Baby Boomer generation in this case) comes to power. Not having lived through a previous crisis war, they don't know how to govern, and so the government becomes paralyzed.

Let's see if Sarko can get anything done after this confrontation with the unions.

France: Sarkozy's wife dumps him

French President Nicolas Sarkozy and wife, former model Cécilia Sarkozy <font face=Arial size=-2>(Source:</font>
French President Nicolas Sarkozy and wife, former model Cécilia Sarkozy (Source:

French President Nicolas Sarkozy has one more distraction: His wife is having an affair and is about to file for divorce.

But, ummmm, she may have a problem: Article 67 of the French Constitution says the following:

"The President of the Republic bears no legal responsibility for his acts carried out as President, with exceptions [these include high treason]. During his mandate the President may not be required to testify or become the object of any legal action before any jurisdiction or French administrative authority. He may not be the subject of investigation or prosecution."

So he can't become the object of any legal action including, presumably, a divorce action.

Vive la France!

Congress backs off on Turkish genocide vote

The plan had been to pass a non-binding resolution of Congress declaring that Turkey had committed the genocide of millions of Armenians in 1915, during World War I.

From the point of view of Generational Dynamics, I would certainly call it a "genocide," but then some would also call the WW I Battle of the Somme a genocide, where over a million British soldiers were killed, 20,000 on one day alone: July 1, 1916.

The Fire: Germany Under Bombardment, 1940-45
The Fire: Germany Under Bombardment, 1940-45

And then there are a number of Germans who would like to declare the Allied bombing of Dresden in WW II a "genocide."

So this game of identifying old genocides can be a dangerous one, and can backfire.

The Administration has been applying a lot of pressure to Congress to drop the measure, as it would infuriate the Turks, who are an important ally in the war in Iraq. And incidentally, this isn't a party line issue, as there are proponents among both Democrats and Republicans. But the pressure seems to be working, as many former proponents are now expressing the view that this isn't the time to insult an important ally.

Benazir Bhutto returns to Pakistan amid political chaos

President Pervez Musharraf may or may not still be President of Pakistan. He won the election a couple of weeks ago, but the decision won't be final until the Supreme Court decides that he was eligible to run for president in the first place.

Benazir Bhutto <font face=Arial size=-2>(Source:</font>
Benazir Bhutto (Source:

In the midst of all this, former premier Benazir Bhutto is returning from exile on Thursday, under an agreement with Musharraf that he'll be President and she'll be Prime Minister. Bhutto has been in exile since the 1990s, when she was charged with massive corruption, and chose exile over jail. Her return now is begin greeted by millions of supporters, although it's not clear how long that support will last.

At a press conference in Dubai on Wednesday, Bhutto said: "Tomorrow (Thursday) at this time we will be on board the plane for Karachi, which is a day that I and all the people in Pakistan who love democracy and who believe in fundamental human rights have been waiting for. Pakistan’s future is at stake and I am going to Pakistan with a mission to see a peaceful transition to democracy. My return heralds for the people of Pakistan the turn of the wheel from dictatorship to democracy, from exploitation to empowerment, from violence to peace."

She said she wanted to create for the people of Pakistan a country "where they have opportunities for employment, economic well-being, the primacy of civilian rule and a society free of extremism."

Now, from the point of view of Generational Dynamics, it's the last few words that are the most significant.

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.

With Bhutto coming into the picture, that may actually happen. When she says that she wants "a society free of extremism," she's referring to the freedom from the extremism of hardline Muslim radicals who have been setting off suicide bombs across the country. The most spectacular confrontation occurred in July, when over 106 died in an assault on a radical mosque in Islamabad, just down the street from Musharraf's office.

Even more serious is that radical al-Qaeda terrorists control what is practically a country within a country, in the lawless Waziristan region of northwest Pakistan. This region, on the border between Pakistan and Afghanistan, is probably where Osama bin Laden is living these days.

According to a a new report in the LA Times, this region is becoming increasingly powerful and dangerous, and is the principal supplier of trained terrorists to Europe.

This is something that I've written about a number of times. Young men who are citizens of European countries, but whose parents emigrated from Pakistan, are turning to al-Qaeda clerics on the Pakistan/Afghanistan border, starting with an internet relationship. From the point of view of Generational Dynamics, the young men adopt a "Hero/Prophet" relationship with the clerics, and usually travel to Pakistan for terrorist training. With the clerics acting as "Prophets," the young men decide to become "Heroes" by committing altruistic suicide -- killing themselves for the good of the cause.

Musharraf has not been successful in stopping this activity in Waziristan, but the situation hasn't exploded either.

Benazir Bhutto was born in 1953 and is like America's Baby Boomers -- arrogant, narcissistic, and unable to govern. If she comes to power, she will be much more confrontational with extremists than Musharraf, and will make more mistakes, and the situation could spiral out of control into civil war in Pakistan. (18-Oct-07) Permanent Link
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Wall Street Journal wonders if Shanghai stocks are in a bubble

But it's OK if they are, because stock market crashes are GOOD for you!

Shanghai stock market has been skyrocketing for the last year. <font face=Arial size=-2>(Source:</font>
Shanghai stock market has been skyrocketing for the last year. (Source:

I just can't stop laughing at this. There's this big page one Wall Street Journal article on Tuesday.

It says: "Big unknowns loom over the market, starting with whether China is in a bubble that's in danger of popping."

What does it take to get WSJ to declare something a bubble?

But it gets much, much worse:

"But there is strong evidence that even if the boom ends with a crash, China's investing frenzy will also leave behind much lasting good, because it is helping build a modern, market-driven financial system. ...

The Issue: China's booming stock market has raised concerns it is a bubble that could burst.

Silver Lining: China is seeing development of a class of investors that is helping make the economy more market driven.

Stateside Perspective: While Wall Street investors are concerned about how a reversal in stocks might dent China's economy, some American firms are benefiting in the boom. ...

After the 1929 stock-market crash helped plunge the U.S. into the Great Depression, economist John Maynard Keynes chided those who said the downturn was a just outcome for excesses in prior years. "While some part of the investment which was going on in the world at large was doubtless ill judged and unfruitful, there can, I think, be no doubt that the world was enormously enriched," he wrote."

You know, Dear Reader, I often quote some politician who says something that's so unbelievably stupid that you can't help but laugh. But these are the world's "most respected" financial journalists, writing on page one of WSJ, telling us that they can't tell us if it's a bubble, but if it is, then the crash will be good for us.

These journalists are children who have no idea what they're talking about.

Of course the Shanghai stock market is in a bubble -- a HUGE bubble. Anyone can see that from the above graph. Of course it's going to crash. Bubbles always do. And of course crashes inflict an enormous amount of horror, in the form of mass starvation and homelessness.

Here's a graph from my 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

And of course Wall Street is also in a bubble, as anyone can see from the above graph. And of course it's going to crash. Bubbles always do.

But don't worry, folks. A crash is GOOD for you!

The WSJ argument is a little more subtle than that. They argue that major advances occur during stock market bubbles that wouldn't occur otherwise. It's kind of vague what advances the article is referring to, but let's take some guesses.

Let's imagine what someone might argue was the benefit of the most recent bubble, that began in 1995. We can talk about all sorts of advances in the computer field -- the Internet, the iPod, and so forth.

Would those have occurred without the bubble? Of course they would have.

Look at the advances that occurred since the 1950s. There were mainframe computers, minicomputers, desktop computers, local area networks, wide area networks, and .... the Internet, which was actually invented in the 1960s.

The article says that you need a crash to have a "modern market-driven financial system." But what good is that if you're still going to have crashes anyway?

A bubble and crash aren't good for anyone, and they don't produce anything that wouldn't have been produced otherwise.

Just read my article, "The bubble that broke the world," to get the idea.

But it's nice to know that WSJ is good for a hearty laugh every now and then.

Well, here's a little more comedy for your viewing enjoyment, The Bubble Man:

(17-Oct-07) Permanent Link
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Washington Post says that al-Qaeda in Iraq is "crippled"

Meanwhile, Iraqi citizens' political opposition to America is growing.

According to the Washington Post article:

"The U.S. military believes it has dealt devastating and perhaps irreversible blows to al-Qaeda in Iraq in recent months, leading some generals to advocate a declaration of victory over the group, which the Bush administration has long described as the most lethal U.S. adversary in Iraq.

But as the White House and its military commanders plan the next phase of the war, other officials have cautioned against taking what they see as a premature step that could create strategic and political difficulties for the United States. Such a declaration could fuel criticism that the Iraq conflict has become a civil war in which U.S. combat forces should not be involved. At the same time, the intelligence community, and some in the military itself, worry about underestimating an enemy that has shown great resilience in the past."

There's no doubt that the American military has scored very significant achievements over al-Qaeda in Iraq since the "surge" began, but it's far from a victory, as the article continues:

"There is widespread agreement that AQI [al-Qaeda in Iraq] has suffered major blows over the past three months. Among the indicators cited is a sharp drop in suicide bombings, the group's signature attack, from more than 60 in January to around 30 a month since July. Captures and interrogations of AQI leaders over the summer had what a senior military intelligence official called a "cascade effect," leading to other killings and captures. The flow of foreign fighters through Syria into Iraq has also diminished, although officials are unsure of the reason and are concerned that the broader al-Qaeda network may be diverting new recruits to Afghanistan and elsewhere."

It certainly would be a political disaster to declare any kind of victory. The next day, al-Qaeda in Iraq would find a way to blow something up with a suicide car bomber, and the press would have a field day condemning America again.

That point was made over the weekend, as Sunday talk shows and the mainstream press have been breathlessly reporting on a speech by former General Ricardo Sanchez, who once was the commander of the American forces in Iraq. What we've been hearing all weekend is this:

"Lieutenant General Ricardo Sanchez has delivered one of the most damning assessments of US policy in Iraq, becoming the most senior war commander to do so. "There is no question that America is living a nightmare with no end in sight," he told reporters in Arlington, Virginia. ...

Even without naming names, Gen Sanchez's analysis of the mishandling of the occupation of Iraq, delivered on Friday, was piercing. "From a catastrophically flawed, unrealistically optimistic war plan to the administration's latest surge strategy, this administration has failed to employ and synchronise its political, economic and military power," he said."

The above has been quoted hundreds of times on television news shows, and in thousands of news articles. But it wasn't until I checked out articles by Fox News that I found out that Sanchez ALSO spoke as follows:

"In his speech to the Military Reporters and Editors Association in Washington, D.C., on Friday, Sanchez made many accusations, including blaming reporters for "unscrupulous reporting, solely focused on supporting an agenda and preconceived notions of the U.S. military."

Without naming a specific company, Sanchez said "parent media organizations" have political agendas that direct the news coverage of the war and in some cases put U.S. service members in deadly situations.

"What is clear to me is that you are perpetuating the corrosive partisan politics that is destroying our country and killing our service members who are at war. My assessment is that your profession, to some, has strayed from these ethical standards and allowed external agendas to manipulate what the American public sees on TV, reads in newspapers and what they see on the Web," Sanchez said."

For some reason, reporters at BBC, CNN, NBC and other mainstream news organizations "forgot" to put that part in.

However, with the number of suiciding bombings in Iraq reduced significantly, I have noticed one big change in the mainstream news coverage. It used to be, as I complained frequently, that every mainstream newscast led every day with the same story: The latest suicide bombing in Iraq. It was perfectly obvious that al-Qaeda in Iraq was using suicide bombings as a public relations tools, and was scheduling one each day to match the news cycles. The mainstream news producers were stupidly doing the bidding for al-Qaeda by obediently covering its "press events."

Well, that doesn't seem to happen any more. I don't if it's because the number of suiciding bombings has gone down, or if it's because the mainstream news producers have gotten smarter. Since I doubt the latter, I assume that the former is true.

But if we now look at what's happening in Iraq itself, we see that the following:

Both of these precisely parallel the Generational Dynamics predictions that I've been making on this web site since 2003, and have repeated many times.

One of my first major predictions was the August 19, 2003, article on Iraq, where I wrote the following:

"Today's massive car bombing of the hotel used as United Nations headquarters in Baghdad is just the most recent of terrorist bombings in Iraq in recent days -- including two bombings of an important oil pipeline last weekend and the car bombing of the Jordanian Embassy in Baghdad on August 7.

Many analysts believe that this increasing level of terrorist violence is part of a guerrilla war being directed against American interests, and sponsored by a combination Saddam's Baathists and al Qaeda. The obvious intent of the terrorists is to, well, terrorize the public and generate a massive civil war against the American occupiers.

In fact, Generational Dynamics indicates that something quite different may happen.

The effect of terrorist acts on a nation often depends most on where the nation is on the generational timeline. Terrorist acts can indeed incite massive war, but usually only when the nation is in, or about to enter, a "crisis" period. (In fact, that could be the effect of another massive bombing that occurred today in Jerusalem, a region which is entering a crisis period.)

But Iraq has already had its crisis period -- during the Iran/Iraq war, the Gulf War and the subsequent internal rebellion, running from 1980 to 1991.

Today, Iraq is in an "awakening" period, and the easiest way to understand that is to compare it to America's own awakening period during the 1960s and 70s. Awakening periods are characterized by riots and demonstrations motivated by a generation gap. In other words: During an awakening period, there are a lot of college kids making a lot of noise to rebel against their parents.

That's why you're seeing massive riots and demonstrations among the Shi'ites in southern Iraq, but you're not seeing massive violence against the American occupiers. There's no "Tet offensive" and no Vietnam-like "quagmire" in the cards for the Americans.

Terrorist acts during this period can thus have the effect of backfiring against the terrorist. The young people taking part in massive demonstrations and riots sometimes take a deep breath and say, "Whoa! This is farther than we wanted to go." The result is that public opinion begins to turn against the terrorists rather than (in this case) the Americans.

That's not to say there aren't dangers, and here we'll point out two major ones:

First, the terrorist attacks may continue and get worse. Terrorism is more a political technique rather than a military technique. Al Qaeda may succeed in increasing the level of terrorist attacks in order to influence American public opinion.

And second, the terrorist acts may presage a larger regional war involving the Palestinian Arabs and the al Qaeda against Americans in Iraq. Iraq is in an awakening period, but the Palestine region is just about to enter a crisis period. Some analysts claim that the terrorist acts are being perpetrated by Palestinian Arabs and "Mujahadeen" being paid thousands of dollars each, funded by Saddam and Osama bin Laden, arriving from Syria and Saudi Arabia.

The really dangerous scenario is that large numbers of Palestinian and "mujahadeen" terrorists will be motivated by identity group relationships to move into Iraq as a theatre of war against the Americans. That isn't happening now, but it's one of several possible scenarios that may unfold in the Mideast region during the next few months and years."

I can't even imagine a better analysis and prediction, given the information available to me on August 19, 2003. And I gave a full analysis in an April, 2007, article.

Now, you can go to analysts like Stratfor or Brookings or Cato or anyone else, and you will not find an analysis that comes anywhere close to what I wrote in 2003. Even today, analysts are still getting it wrong. They just don't learn, because they're too bound up in politics.

I have no politics. I'm neither Republican nor Democrat. I'm neither Liberal nor Conservative. I just use the Generational Dynamics forecasting methodology, which I began to develop in 2003 and I first described at length in 2004, and have described further many times since then.

Using this methodology, I've made predictions about the Mideast, Iraq, Iran, Darfur, Lebanon, Burma, China, and many other countries, and every one of those predictions has either come true or is trending true.

Since 2002 I've also been predicting that we're headed for a new 1930s style Great Depression. For years people scoffed at me, but few people have been scoffing in the last few months.

I'll repeat a challenge I've made before: Show me any web site, anywhere in the world, that has anything close to the predictive success of this one. I know that none exists because I've looked for one.

If you'd like to get the latest political assessment, go to Stratfor or Brookings or Cato or one of the mainstream analysts. If you want to know what's going on in the world, this is the only web site that will tell you. (16-Oct-07) Permanent Link
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Big banks discuss mind-boggling "M-LEC" superfund to bail themselves out.

Citigroup, JPMorgan and Bank of America, with US Treasury help, prolong the coverup.

As we've been saying, financial firms have been increasingly using deceptive or fraudulent practices to avoid having to sell the securities that they manage. Why? Because they got investors to pour money into funds backed by these securities by valuating the securities at notional prices that can't be sustained in the marketplace. Many of these securities are CDOs and other credit derivatives based on sub-prime mortgage loans that now have very high default rates.

The firms have been using a variety of practices to avoid selling these securities. Practices include: refusing to reveal prices of assets to investors; hiding at-risk securities in separate "black-box" corporations known as SIVs (structured investment vehicles); negotiating deceptive or fraudulent sweetheart deals with other financial firms to establish artificial "market values" for assets.

For these firms, a sale of these securities must be avoided at all costs.

And now, huge new deceptions based on the mother of all SIVs are about to be announced. And it's been endored by US Treasury Secretary Henry Paulson, so it MUST be ok.

We won't know all the details until the announcement, possibly on Monday, but it goes something like this: Citibank doesn't dare sell any of its vast holdings of questionable securities in an open market, because that might show them to be nearly worthless. Also, Citibank can't buy the securities from itself, because that wouldn't make sense (as if anything else does).

Soooooooooooo, Citibank (actually Citigroup), in conjuction with JP Morgan and Bank of America, is going to set up a ... wait for it! ... a Master-Liquidity Enhancement Conduit, or M-LEC.

These three firms will put $100 billion dollars into the M-LEC. Most of the money will come from Citibank; the other two firms will sit back and collect fat fees. Citibank will be able to sell its questionable securities to the M-LEC at whatever notional price it wants.

It's still Citibank's money buying Citibank's questionable securities, but since the money is laundered through the M-LEC, it's an "open market" sale. So Citibank can thus establish a "market price" for its questionable securities.

Both the American and British governments have been encouraging additional banks to participate in the M-LEC, but there have been no further announcements.

Why are these governments endorsing this deception? Because they fear another major credit crunch, like the one that almost brought down Wall Street in August.

To me, this appears to be a move of total desperation. And a new week begins. (15-Oct-07) Permanent Link
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How do you compute the "fair value" of a security?

FASB Statement 157 doesn't help much because it ignores history.

For ten years, we've been increasingly in a world where investors have poured their money into securities that have no obvious value.

And, as each day goes by in the current liquidity crisis, it's more and more apparent that financial firms are scrambling to hide losses through deceptive or fraudulent practices. These losses come from having sold investments in CDOs and other structured credit securities at wildly optimistic prices that can no longer be sustained in the marketplace. In some cases, such as at Bear Stearns, the securities turn out to be almost totally worthless.

The practices include: refusing to reveal prices of assets to investors; hiding at-risk securities in separate "black-box" corporations known as SIVs (structured investment vehicles); deceptive or fraudulent sweetheart deals with other financial firms to establish artificial "market values" for assets.

The Financial Accounting Standards Board (FASB) has tried to help out by issuing a new accounting rule, Statement 157, to take effect on November 15, on how to determine the "fair value" of the securities that now turn out to be overvalued.

Unfortunately, I don't see that Statement 157 provides any help at all, for two reasons.

But first, let's summarize Statement 157. The actual statement can be found on the the FASB web site (or full text PDF file.)

The gold standard for the fair value of a security is its price on an open market: "The definition of fair value retains the exchange price notion in earlier definitions of fair value. This Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability."

However, this method for determining fair value is useless if there's no open market for securities being valuated. (And many of the deceptive and fraudulent practices being used by financial firms today are tricks to avoid an open market valuation.)

The FASB statement provides three different types of valuation. Here's a summary of the three methods, as provided by the Wall Street Journal, in decreasing order of "precision":

As I said, there are two problems with this new accounting rule.

The first problem is that it doesn't change anything; it simply encodes the practices that have caused the current problems. Except to handle some technical issues, there really isn't much point of issuing Statement 157.

The second problem is that it exalts market-based valuation methods, without recognizing the possibility of an asset bubble.

In particular, it doesn't even recognize bubble-independent historical earnings-based valuation methods.

Now, regular readers of this web site will immediately recognize that this is the sort of thing that I've been railing about here for years. In my article, "How to compute the 'real value' of the stock market," the current value of the stock market is computed by three different methods: historical earnings, historical growth rates, and historical book values. All three of these methods come to roughly the same result -- the real value of the stock market today is around Dow 5000, meaning that the stock market today is overpriced by a factor of 250%.

I'm not saying that FASB should prescribe historical methods as the preferred valuation method. What I'm saying is that FASB should give SOME RECOGNITION to historical methods. For example, a rule might specify the following: If market methods and historical methods differ by, say, more than 25%, then you must provide a justification for why the market price isn't a bubble price. (If the market price is lower, as would happen during a period of deflation, you'd have to justify the lower price in the same way.)

I like to joke that most people today seem to believe that the world was created ten or twenty years ago, and nothing that happened before that has any relevance to today.

That's the reason why Generational Dynamics has worked over and over through the centuries. People think that "old data" and "old events" are too old to matter. So when the same thing happens again, people panic and turn a crisis into a disaster. I doubt that a new FASB rule requiring some recognition of history would make any real difference, but it certainly couldn't hurt. (14-Oct-07) Permanent Link
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Financial firms increasingly hide losses through deceptive or fraudulent practices

According to an article in Friday's Wall Street Journal, banks and other organizations are going to extraordinary lengths to hide the real values of mortgage-backed securities (MBSs) in their asset portfolios.

Techniques include: refusing to reveal prices of assets to investors; hiding at-risk securities in separate "black-box" corporations known as SIVs (structured investment vehicles); deceptive or fraudulent sweetheart deals with other financial firms to establish artificial "market values" for assets.

In addition, some of these techniques appear to have been designed to illegally avoid tax consequences on certain kinds of income. On Friday, the IRS announced an inquiry into a particular kind of SIV known as "remics" (real estate mortgage investment conduits). A financial firm transfers its mortgage-backed securities to a remic, which can then sell slices of the MBSs to investors. The IRS is examining whether financial firms controlling these remics are underreporting the income they earn.

The use of SIVs is the latest twist to come under scrutiny following the "Bear Stearns disaster" that became public in June. At that time, Stearns bailed out its defaulting hedge funds rather than have to sell some of the assets in their portfolios.

These assets were collateralized debt obligations (CDOs), a kind of synthetic security created by slicing and dicing mortgage loans at various risk levels. Stearns had given these synthetic securities a certain value, or notional price, based on computer programs designed to valuate these kinds of synthetic securities. Unfortunately, no one was willing to purchase the CDOs at the notional prices that the Stearns computer programs had computed.

Finally, in mid-July, the firm announced that its hedge funds were almost totally worthless.

This led, in August, to the "liquidity crunch" or "credit crunch" and the worldwide banking crisis. Companies around the world were no longer able to sell "asset-backed commercial paper" (ABCP), where the assets were CDOs, because investors had no way of knowing whether the notional prices had any validity.

Various central banks -- the Fed, the Bank of England, the European Central Bank -- provided a temporary solution by shocking investors with a large monetary loosening, much more generous than investors had expected. They lowered interest rates (by a full ½ point in the US), and perhaps even more important, the central banks accepted some of this asset-back commercial paper as collateral for central bank loans.

However, the commercial paper crisis is far from over. The Fed itself said as much in the Open Market Committee meeting minutes, published last week, which said, "Given existing commitments to customers and the increased resistance of investors to purchasing some securitized products, banks might need to take a large volume of assets onto their balance sheets over coming weeks, including leveraged loans, asset-backed commercial paper, and some types of mortgages."

What the Fed is referring to is the fact that market exigencies are forcing one institution after another to place their mortgage-backed securities on the market, to test what prices they can sell for.

This is an ongoing process. In the past month, eight major financial firms -- UBS, Merrill Lynch & Co., Citigroup Inc., Deutsche Bank AG, Morgan Stanley, Goldman Sachs, Lehman Brothers Holdings Inc., and Bear Stearns Cos. -- have written down $20 billion in asset values. There's a lot more to come.

How big is the problem? In times past, an investment portfolio might have contained stocks that trade on the stock market, the WSJ reports that substantially more than 50% of the assets in most portfolios are now securities that DON'T trade on exchanges.

In order to prevent a market for these securities from developers, financial firms are refusing to providing pricing information to investors in the overwhelming majority of cases.

The article provides the following "Percentage of investors who reported problems getting price quotes this summer in various markets:"

	Corporate bonds                         62%
	Commerical mortgage-backed securities   63%
	High-yield bonds                        65%
	Mortgage-backed securities              66%
	Leveraged loans                         69%
	Collateralized loan obligations         78%
	Asset-back securities                   82%
	CDOs / Structured credit                83%

Besides refusing to divulge prices, financial firms are resorting to other methods to "protect" themselves at the expense of the public:

I'm not a lawyer but these practices sure look like fraud to me. If a firm uses deceptive practices to claim unrealistically high asset values in sales to investors, then the investor is being defrauded.

What we're seeing are two growing trends, both of which I've described several times before:

First, the size of the problem is growing. Investors, mutual funds, investment trusts, hedge funds, savings banks, pension funds, college endowments, money market funds, insurance companies, and so forth have all invested HUGELY in securities that have no credible value.

And second, the net is spreading for people who are going to be blamed for the coming financial crisis. When everyone was making money, no one cared about a little cheating or a little fraud or a little embezzlement. But once people start losing money, the desire for revenge will be enormous, and repercussions will be felt in every corner of the world.

In the meantime, here are your Sunday comics:

Stocks at all time highs! <font face=Arial size=-2>(Source:</font>
Stocks at all time highs! (Source:

(14-Oct-07) Permanent Link
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Madonna switches record labels, accelerating a return to a new Big Band Era

Madonna is leaving Warner Music, her long time record label, for Live Nation, the concert promoter behind the Live 8 events. The switch happened after Warner refused to match the $120 million ten-year deal offered by Live Nation.

The switch from Warner Music to Live Nation is more than just a label switch. It's a symbolic of the music business' rapid change from making money by recorded music (records, CDs, etc.) to making money principally from live performances.

As I wrote in my 2003 article, "Return of the Big Band Era," we're rapidly approaching a time, around the mid to late 2010s, when it will be possible to have a computer with a disk file containing every song ever recorded. And with network bandwidths and disk sizes increasing exponentially every year, it will be possible to download hundreds of new recordings every day.

Basically, there will no longer be any technical limitation to listening to recorded music. The only real limitation will be the quaint fact that a normal human being isn't capable of listening to more than a few songs a day.

What this means is that the big money in the music industry will come from live performances -- just as was the case when bobby soxers -- teenage girls -- mobbed venues where Frank Sinatra was crooning. Five years from now, there may be little money to be made from sales of a Madonna recording, but there may be huge amounts to be made from a live Madonna concert playing live to a worldwide concert over the internet.

Few people seem to understand what the Big Band Era of the 1930s was all about. It came about because of the Big Depression of the 1930s. A bandleader could afford to hire a big band of 10-20 instruments because out-of-work musicians were willing to work for a dollar a week -- and happy to have the opportunity. It was only after the economy recovered in the mid-1940s that the big bands disappeared.

Also, few people seem to understand the KIND of music that was played in the 1930s, 40s and 50s. The view is almost of demented robots who could only understand the simplest music possible, not the complex music that sophisticated people listen to today.

One song that became very popular after the war was an old Al Jolson song with the following lyrics:

    When the red red robin
    Comes bob bob bobbin' along, along
    There'll be no more sobbin'
    When he starts throbbin' his old sweet song

Wake up, wake up you sleepy head Get up, get up get out of bed Cheer up, cheer up the sun is red Live, love, laugh and be happy

What if I've been blue Now I'm running through fields of flowers Rain may glisten But still I listen for hours and hours

I'm just a kid again Doing what I did again Singing a song When the red red robin comes bob bob bobbin' along, along

It's hard to believe that this is anything but a silly children's song, but in fact that was a very popular song among adults for a number of years after the war.

The 1930s and 1940s were times of enormous hardship. Starvation and homelessness were all around. And then people learned of their loved ones being tortured and maimed by the Bataan Death March in 1942, or mowed down blades of grass on the beaches of Normandy in 1944. Today we have scandals when someone Cindy Sheehan loses her son in the Iraq war. Imagine how women must have felt when the news filtered back that tens of thousands of their sons, their husbands, their brothers and their fathers had all been tortured or killed in Europe or Asia?

People did not want complex music during this period. They went down to the local dance hall to listen to the Big Bands play simple, carefree music that would take their minds off of what was going on in the world.

Actually, Big Band music really WAS very complex and sophisticated in another way, because it conveyed sexuality without the need for explicitness that came into vogue in later decades. The songs were light and carefree, with lyrics that are sometimes absolutely hilarious if you stop to listen to them.

Here are the lyrics to a couple of Big Band Era songs:


I double dare you to sit over here. I double dare you to lend me your ear. Take off your high hat, and let's get friendly. Don't be a scare cat, Say what-d'ya care, can't you take dare?

I double dare you to kiss me and then, I double dare you to kiss me again. And if that look in your eye means what I'm thinking of I double dare you to fall in love with me, I double dare you.


I stand at your gate and the song that I sing is of moonlight. I stand and I wait for the touch of your hand in the June night. The roses are sighing a Moonlight Serenade.

The stars are aglow and tonight how their light sets me dreaming. My love, do you know that your eyes are like stars brightly beaming? I bring you and sing you a Moonlight Serenade.

Let us stray till break of day In love's valley of dreams. Just you and I, a summer sky, A heavenly breeze kissing the trees.

So don't let me wait, come to me tenderly in the June night. I stand at your gate and I sing you a song in the moonlight, A love song, my darling, a Moonlight Serenade.

Incidentally, who's greatest pop star of the 20th century? The Beatles? Naaaaah. It's Frank Sinatra.

After the war ended, people were still traumatized for the rest of their lives by what had happened. As philosopher Hannah Arendt wrote in 1949, reflecting the mood of America at that time, "Two world wars in one generation, separated by an uninterrupted chain of local wars and revolutions, followed by no peace treaty for the vanquished and no respite for the victor, have ended in the anticipation of a third World War between the two remaining world powers. This moment of anticipation is like the calm that settles after all hopes have died. ... Never has our future been more unpredictable, never have we depended so much on political forces that cannot be trusted to follow the rules of common sense and self-interest -- forces that look like sheer insanity, if judged by the standards of other centuries."

So now go back and reread the lyrics of "Red Red Robin," and you'll see that it's a very touching song with a message: "The war is over. It's time to start living again."

The song was still being sung on television as late as 1957, as shown by the following TV clip, where Ethel Merman and Perry Como sing the song with a comic twist:

The music of the era reflected the attitudes of the people of the era.

People today think of the early 1950s as a time of ultra-conformity and oppression of women. Nothing could be further from the truth.

During the 1930s, families became homeless and were forced into the streets. During the war, tens of millions of women lost their husbands to the war, and women who would have liked to stay home and take care of the kids were forced to take "Rosie the Riveter" jobs that they hated, but took them anyway out of patriotism.

By the time the 1950s came around, the "American way of life" meant that every woman could have a husband, a couple of kids, and a nice home (with a nice picket fence), and women wouldn't be forced to work unless they wanted to. 1950s women didn't want their daughters to suffer as they had, and they considered it to be a gift to their daughters that they handed them a country where all that was possible.

Songs like "Red Red Robin" were appreciated by the survivors of WW II, but was not appreciated by those born after the war, in the Baby Boomer generation.

The Boomers rebelled against their parents and their music. 1960s women's libbers humiliated their mothers by rejecting their message. They were mad at their mothers for telling them to wear girdles and not to have sex before marriage. They burned their bras in rebellion against their mothers. But women were never discriminated against.

As we look back over the whole period, we see that the carefree music of the 1930s and 40s gave way to the sweet, romantic music of the 1950s, which gave way to the Boomer's rebellious music of the 1960s, which gave way to the Generation-Xer's nihilistic music of the 1990s.

Now Madonna is leading the way as we enter a new 1930s style Great Depression. Once again, live performances will be the important things. Once again, there'll be Big Band Era. It'll be called something else, of course, but it'll be based on the same economics as the 1930s: With lots of people unemployed, live performances by groups of musicians will become popular again, and we may even see huge audiences of teenage girls squealing with delight at some new hot young crooner. (12-Oct-07) Permanent Link
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American Prospect's Robert Kuttner compares 2007 to 1929

His comparison is clearly generational, but he fails to notice it.

I can't prove it, but it seems to me that more and more people are comparing what's happening today to what happened in the 1929 crash. It just seems to me that I hear "1929" mention pretty frequently now.

A web site reader alerted me to the article "The Alarming Parallels Between 1929 and 2007," containing recent testimony to the Congressional House Committee on Financial Services by The American Prospect co-editor Robert Kuttner. The author has a book coming out in a few weeks on the subject.

He summarizes similarities between "the systemic risks of the 1920s and many of the modern practices" as follows: excessive leveraging, misrepresentation, insider conflicts of interest, non-transparency, and the triumph of engineered euphoria over evidence.

Generally, his comparison are very similar to those that I discussed in my article, "The bubble that broke the world." So I'll only expand on those similarities that present new information.

He gives the following similarities:

  1. Creation of asset bubbles. "The most basic and alarming parallel is the creation of asset bubbles, in which the purveyors of securities use very high leverage; the securities are sold to the public or to specialized funds with underlying collateral of uncertain value; and financial middlemen extract exorbitant returns at the expense of the real economy. This was the essence of the abuse of public utilities stock pyramids in the 1920s, where multi-layered holding companies allowed securities to be watered down, to the point where the real collateral was worth just a few cents on the dollar, and returns were diverted from operating companies and ratepayers. This only became exposed when the bubble burst. As Warren Buffett famously put it, you never know who is swimming naked until the tide goes out."

  2. Securitization of credit. "Some people think this is a recent innovation, but in fact it was the core technique that made possible the dangerous practices of the 1920. Banks would originate and repackage highly speculative loans, market them as securities through their retail networks, using the prestigious brand name of the bank -- e.g. Morgan or Chase -- as a proxy for the soundness of the security. It was this practice, and the ensuing collapse when so much of the paper went bad, that led Congress to enact the Glass-Steagall Act, requiring bankers to decide either to be commercial banks -- part of the monetary system, closely supervised and subject to reserve requirements, given deposit insurance, and access to the Fed's discount window; or investment banks that were not government guaranteed, but that were soon subjected to an extensive disclosure regime under the SEC."

    In "The bubble that broke the world," we quoted examples of foreign bonds -- bonds issued by dozens of other countries -- that American investors purchased, receiving only a promise to redeem the bonds several decades later.

    There are two major "advantages" to the securitization of credit: First, it separates the creditor from the debtor. The creditor lends money by purchasing a security; he has no idea who will use the money, or how the money will be used. And second, the sale of securities is handled by middlemen who have no reason to be cautious, since the money being loaned is not his own. The middlemen collect their fat commissions and are on their way.

    Today, of course, the securitization of credit has been raised to a monstrous level, with $750 trillion of CDOs and other credit derivatives in the portfolios of organizations around the world.

    Kuttner points out that since the repeal of Glass-Steagall, there is no longer any distinction between the banking system and the general economy:

    "Since repeal of Glass Steagall in 1999, after more than a decade of de facto inroads, super-banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s -- lending to speculators, packaging and securitizing credits and then selling them off, wholesale or retail, and extracting fees at every step along the way. And, much of this paper is even more opaque to bank examiners than its counterparts were in the 1920s. Much of it isn't paper at all, and the whole process is supercharged by computers and automated formulas. An independent source of instability is that while these credit derivatives are said to increase liquidity and serve as shock absorbers, in fact their bets are often in the same direction -- assuming perpetually rising asset prices -- so in a credit crisis they can act as net de-stabilizers."

    Kuttner makes an interesting new point at the end of the above paragraph: That all these credit derivatives are based on the assumption that the stock market will keep going up forever. The stock market never goes up forever, and once it starts going down, the market for credit derivatives starts crashing as a unit.

  3. Excessive use of leverage.

    "A third parallel is the excessive use of leverage. In the 1920s, not only were there pervasive stock-watering schemes, but there was no limit on margin. If you thought the market was just going up forever, you could borrow most of the cost of your investment, via loans conveniently provided by your stockbroker. It worked well on the upside. When it didn't work so well on the downside, Congress subsequently imposed margin limits. But anybody who knows anything about derivatives or hedge funds knows that margin limits are for little people. High rollers, with credit derivatives, can use leverage at ratios of ten to one, or a hundred to one, limited only by their self confidence and taste for risk. Private equity, which might be better named private debt, gets its astronomically high rate of return on equity capital, through the use of borrowed money. The equity is fairly small. As in the 1920s, the game continues only as long as asset prices continue to inflate; and all the leverage contributes to the asset inflation, conveniently creating higher priced collateral against which to borrow even more money."

  4. Corruption of the gatekeepers.

    "The fourth parallel is the corruption of the gatekeepers. In the 1920s, the corrupted insiders were brokers running stock pools and bankers as purveyors of watered stock. 1990s, it was accountants, auditors and stock analysts, who were supposedly agents of investors, but who turned out to be confederates of corporate executives. You can give this an antiseptic academic term and call it a failure of agency, but a better phrase is conflicts of interest. In this decade, it remains to be seen whether the bond rating agencies were corrupted by conflicts of interest, or merely incompetent. The core structural conflict is that the rating agencies are paid by the firms that issue the bonds. Who gets the business -- the rating agencies with tough standards or generous ones? Are ratings for sale? And what, really, is the technical basis for their ratings? All of this is opaque, and unregulated, and only now being investigated by Congress and the SEC."

  5. Failure of regulation to keep up with financial innovation.

    "Yet another parallel is the failure of regulation to keep up with financial innovation that is either far too risky to justify the benefit to the real economy, or just plain corrupt, or both. In the 1920s, many of these securities were utterly opaque. Ferdinand Pecora, in his 1939 memoirs describing the pyramid schemes of public utility holding companies, the most notorious of which was controlled by the Insull family, opined that the pyramid structure was not even fully understood by Mr. Insull. The same could be said of many of today's derivatives on which technical traders make their fortunes.

    "By contrast, in the traditional banking system a bank examiner could look at a bank's loan portfolio, see that loans were backed by collateral and verify that they were performing. If they were not, the bank was made to increase its reserves. Today's examiner is not able to value a lot of the paper held by banks, and must rely on the banks' own models, which clearly failed to predict what happened in the case of sub-prime. The largest banking conglomerates are subjected to consolidated regulation, but the jurisdiction is fragmented, and at best the regulatory agencies can only make educated guesses about whether balance sheets are strong enough to withstand pressures when novel and exotic instruments create market conditions that cannot be anticipated by models."

  6. Universal conviction that markets are self-regulating.

    "A last parallel is ideological -- the nearly universal conviction, 80 years ago and today, that markets are so perfectly self-regulating that government's main job is to protect property rights, and otherwise just get out of the way."

    This is an interesting one.

What's disappointing about Kuttner's testimony is that he completely misses the generational aspects, even though they're completely obvious.

"Beginning in the late 1970s, the beneficial effect of financial regulations has either been deliberately weakened by public policy, or has been overwhelmed by innovations not anticipated by the New Deal regulatory schema. New-Deal-era has become a term of abuse. Who needs New Deal protections in an Internet age?"

He goes on to list one thing after another that changed after the 1970s.

He even says:

"My perception as a financial journalist is that regulation is so out of fashion these days that it narrows the legislative imagination, since politics necessarily is the art of the possible and your immediate task is to find remedies that actually stand a chance of enactment. There is a vicious circle -- a self-fulfilling prophecy -- in which remedies that currently are legislatively unthinkable are not given serious thought. Mr. Chairman, you are performing an immense public service by broadening the scope of inquiry beyond the immediate crisis and immediate legislation."

It never occurs to him ask why this has happened -- why it happens more and more as the people in the generation that survived the 1920s and 1930s die out, leaving behind younger leaders with no personal memories of the horrors of the Great Depression. If that thought ever crosses his mind, then he might have realized that the features of the 1920s occurred when the generation of people who survived the Panic of 1857 died out, and he might have understood WHY "regulation is so out of fashion these days."

As I've said many times on this web site, with respect to many different subject areas, people are completely blind to generational issues, no matter how obvious they are, and this is pretty obvious. Apparently human beings come with some sort of mental block that prevents them, most of the time, from even allowing a generational trend to enter their minds.

Kuttner concludes as follows:

"The fact is that the economic fundamentals are sound -- if you look at the real economy of factories and farms, and internet entrepreneurs, and retailing innovation and scientific research laboratories. It is the financial economy that is dangerously unsound. And as every student of economic history knows, depressions, ever since the South Sea bubble, originate in excesses in the financial economy, and go on to ruin the real economy.

It remains to be seen whether we have dodged the bullet for now. If markets do calm down, and lower interest bail out excesses once again, then we have bought precious time. The worst thing of all would be to conclude that markets self corrected once again, and let the bubble economy continue to fester. Congress has a window in which restore prudential regulation, and we should use that window before the next crisis turns out to be a mortal one."

I'm not even sure what he means by this. A huge number of factory jobs have fled to China, and a huge number of service jobs have fled to India. It's hard to see why it's appropriate to simply call this "sound."

If Kuttner understood even the simplest generational theory, then he'd know that "dodging a bullet for now" doesn't mean that things get better, since generational changes always continue. The depraved use of credit that Kuttner has documented will only get worse as there are additional generational changes, and new regulations will have no greater success than the old ones did. His idea to "restore prudential regulation" is just part of the universal self-delusion that the entire world is suffering from in 2007, just as it did in 1929. (11-Oct-07) Permanent Link
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IMF sharply cuts US economic growth estimate

But all that matters to investors is that the Fed is less concerned than before about inflation.

Please read the new article I just posted: "The bubble that broke the world."

It compares what's happening today to what happened in the 1920s. I was able to make some specific new predictions about the scenario that I expect to unfold in the next couple of years, especially in our relationship with China.

On September 18, the Fed shocked investors by announcing a ½ point interest cut, twice as much as had been expected.

Since then, believing that the Fed had saved the world, investors have pushed the Wall Street markets up to new historic highs.

On Tuesday, the Fed released the minutes from the committee meeting that it held on September 18 at which the ½ point decision was made. It's called the "Fed Open Market Committee," and it releases the minutes of its meetings several weeks after each meeting is held.

The minutes contain some pretty negative stuff, such as "consumer sentiment turned down in August" and and the "housing sector remained exceptionally weak." But none of that matters.

All that matters is that "with incoming inflation data to the favorable side, the easing of policy seemed unlikely to affect adversely the outlook for inflation."

Even this comment on inflation was part of a larger sentence: "With economic growth likely to run below its potential for a while and with incoming inflation data to the favorable side, the easing of policy seemed unlikely to affect adversely the outlook for inflation."

So there's the usual craziness. Economic growth is slowing -- which means that corporate earnings will go down, which SHOULD mean that stock prices should go down.

But in the continuing bizarre, upside-down world of the investor, bad news is good news. Why? Because bad news means that the Fed might lower interest rates again, and everyone knows that lowering interest rates will save the world again, and any time the world needs saving.

In fact, the signs of an economic downturn are growing. The International Monetary Fund (IMF) is expected to report on Wednesday that the US economic forecast is down sharply.

And Rodrigo Rato, outgoing managing director of the International Monetary Fund, has warned that the credit squeeze was a "serious crisis" that was not over yet and would curtail growth worldwide.

As I read through the book that I quoted in "The bubble that broke the world," I was struck by two things. First, how total, absolute and universal the self-delusion was in the 1920s among investors, financiers, journalists and politicians. And second, how all the same elements of universal self-delusion that occurred in the 1920s are recurring with full force today.

How on earth, with all the bad economic news coming out, could investors possibly think that this is good news because the Fed might lower interest rates again, and that the stock market bubble, which is already astronomically large, should be blown even larger?

Almost every day, investors act en masse to do something which, by "normal" standards, if absolutely insane. What happened on Tuesday is just one more example. (9-Oct-07) Permanent Link
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Students at Tehran University risk protest against Ahmadinejad

When Iranian President Mahmoud Ahmadinejad spoke at Columbia University last month, the Columbia University president, Lee Bollinger introduced him by criticizing his denial of the Holocaust. "This makes you quite simply ridiculous. Mr President, you are exhibiting all the signs of a petty and cruel dictator," said Bollinger.

These comments by Bollinger were criticized in the Arab and in the Iranian press.

However, the criticisms never really rang true. Generally speaking, Arabs (who are Sunni Muslims) don't really like Ahmadinejad, who is Persian, who is fanatically Shia Muslim, and who has made it clear that he wants Iran to have hegemony over the entire Muslim Mideast, including the Arabian peninsula.

Iranians, on the other hand, don't much like Ahmadinejad anymore either, since the economy has been deteriorating, and because Ahmadinejad has infuriated many people with oppressive policies, such as arresting women whose headscarves don't cover enough of their heads.

Tehran University students demonstrating and protesting against Ahmadinejad <font face=Arial size=-2>(Source:</font>
Tehran University students demonstrating and protesting against Ahmadinejad (Source:

The dislike is especially true of students, as would be expected from the point of view of Generational Dynamics. Iran is in a generational Awakening era, since only one generation has passed since the genocidal Iran/Iraq crisis war of the 1980s. Today's college-age generation is the first generation born after the war, and they are as rebellious against President Ahmadinejad today as American college students rebelled against Presidents Kennedy, Johnson and Nixon in the 1960s and 1970s.

So in that sense, it's not surprising that hundreds of students at Tehran University held anti-Ahmadinejad demonstrations on Monday, chanting: "Death to the dictator."

There were similar protests in December, 2006, by students at Amir Kabir Technical University, but those students were severely punished.

Thus, new protests occur rarely. But this kind of "generation gap" is a standard feature of generational Awakening eras, and so student protests always occur, and will continue to increase.

As I wrote in my July analysis of Iran and Ahmadinejad, Iran is a very dangerous wild card in international politics. One the one hand, young people are increasingly willing to demonstrate and protest against the older generation, the generation that lived through the 1980s war.

On the other hand, Ahmadinejad and the older generation clerics, who took part in the 1979 Iranian revolution, are increasingly alarmed by these protests and demonstrations, and they (mistakenly) see a potential military conflict with the west as a way to unite the country once more.

The easiest way to understand this conflict is to think of President Kennedy's situation in the early 1960s. As a World War II survivor, Kennedy was determined to prevent a world war against Communism, which is why he authorized military actions against Cuba and Vietnam. But growing student protests led to political problems in Kennedy's, Johnson's and Nixon's administrations.

Like Kennedy, Ahmadinejad came into power at the beginning of his country's Awakening era. The internal protests and demonstrations may force Ahmadinejad to overreact, and in some scenarios that could lead to war. (8-Oct-07) Permanent Link
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President Jimmy Carter has near-altercation in Darfur

Generationally, Darfur is ten years ahead of Burma.

Former President Jimmy Carter got into a shouting match with Sudanese security forces who blocked him from visiting with Darfur refugees.

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"You can't go! It's not on the program!" said Omar, the security chief.

"We're going anyway! You don't have the power to stop me!" said Carter.

In the end, the Sudanese did block his visit, and Carter was forced to leave.

Carter is on a fact-finding mission to Darfur with an entourage of "Elders," including billionaire businessman Richard Branson and Graca Machel, the wife of former South African President Nelson Mandela, and South Africa's Archbishop Desmond Tutu.

From the point of view of Generational Dynamics, this whole effort by Carter is pretty silly. From time to time, various political figures -- Jimmy Carter, Jesse Jackson, Jane Fonda -- take trips to foreign countries, proclaiming that if we all just talk together, then we can get along. These trips are almost always just political side shows and, as far as I know, none of these trips has ever accomplished anything real.

On this web site, whenever I describe these major world events, I always emphasize that they're being caused by attitudes and behaviors of large masses of people, entire generations of people, and that no politician can ever hope to have an effect.

That's certainly true of the Darfur war, as I've described repeatedly on this web site, starting with my first Darfur article, "Darfur genocide: The UN is completely irrelevant."

In fact, not only has the U.N. not halted the Darfur genocide, but the situation seems to get worse almost on a daily basis.

In a recent article, I summarized the recent generational history of Darfur, correcting some common misstatements in the mainstream media.

The most important confusions in the mainstream media are the names given to the various group. So here's a summary of the major groups, and how their names have changed since the 1970s:

The "West," as represented mostly by the U.N., the U.S., and Europe, with no understanding of what a generational crisis war is, have been extremely naïve in it's portrayal of what's been going on.

Here are some mistakes that Western politicians and journalists make all the time:

Actually, the situation is becoming increasingly complex and increasingly unstable.

A big sign of this occurred early this week when a large group of 'rebels' launched a genocidal attack on a group African Union "peacekeepers."

Western groups are totally perplexed by this. The "rebels" are supposed to be good guys, and they shouldn't be massacring "peacekeepers." The West's entire world view of the Darfur war is totally screwed up now.

But the situation is even worse than that. According to a new analysis on, both the "Arab" side and the "black rebel" side have split into warring ethnic groups. Here's a one-paragraph extract from the analysis, to give you a flavor:

"The black rebel movement was split from the beginning between the Sudan Liberation Movement/Army (S.L.M./A.) and the Justice and Equality Movement (J.E.M.). The S.L.M./A. had the backing of the Fur, the largest of the black Muslim tribes in Darfur, through the leadership of Abdul Wahid al-Nur, as well as significant backing from the Zaghawa and Masalit tribes. Led by Khalil Ibrahim, the J.E.M. was a smaller, mostly Zaghawa operation made up of Islamists who were purged from the government in 1999. The group then received backing from the Chadian government and aligned itself with a separate rebel movement in Sudan's northeast, thus receiving support from Eritrea as well."

It's hard to know what the Western media and politicians are going to make of all this, once they get it figured out, assuming that they ever get it figured out.

From the point of view of Generational Dynamics, here's what's going on: The regeneracy was triggered on February 26, 2003, as described above. The word "regeneracy" is used because this is the point where an identity group's unity is "regenerated," for the first time since the end of the previous crisis war. Initially, it was just the Africans versus the Arabs, but as the years have passed and the war has become more and more genocidal, both of these sides have splintered further, and regeneracies of individual tribal and ethnic loyalties have also occurred.

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We've been discussing the situation in Burma (Myanmar) during the last couple of weeks.

Here's the question: Why is the Burmese government so violent with protesting / demonstrating citizens?

Are Burmese government officials all such psychopaths that they get enjoyment out of seeing blood pouring out of the heads of harmless monks after being hit with clubs? When someone applies for a job in the Burmese government, do they give him a battery of psychological tests, and reject him if he isn't totally sadistic?

If you want to understand how Generational Dynamics works, you have to be able to understand the minds of people who commit acts that seem to be monstrous. The fact is, if you're unable to understand why Hitler and his lieutenants felt that was they were doing was perfectly reasonable and necessary, then you also can't understand why President Roosevelt felt that what he was doing was perfectly reasonable and necessary.

And everything is always driven by the previous crisis war. The survivors of a crisis war spend their entire lives doing everything possible to make sure that their own children will never have to suffer anything so horrible.

In America's case, when WW II ended, the survivors believed (incorrectly) that the war could have been prevented if they'd stopped Hitler in 1935. After the war, the survivors adopted the 'Truman Doctrine,' making America the "Policemen of the World." That's why we found the Korean and Vietnam wars, and why we're in Iraq today.

In "Burma: Growing demonstrations by the "88 Generation" raise fears of new slaughter," I summarized the previous crisis wars for Burma, and they were mostly dominated by ethnic civil wars. Burma's last crisis war was the civil war ending in 1958. That was an extremely bloody, genocidal war among Burmese ethnic groups, and today's Burmese government is determined that it shouldn't happen again.

Furthermore, the Burmese officials look a few thousand miles to the west, and they see what's happening in Darfur today: a growing civil war among Sudan's ethnic groups.

The Burmese officials actually LIVED through a multi-ethnic war like the one going in on Darfur, and they know very well that no "peacekeeping mission" is going to stop the Darfur war.

People like Jimmy Carter, as well as US, UN and European officials must look like total buffoons to Burmese officials. I can just imagine them saying to one another, "Those guys must be idiots to think that they can just go to Darfur and talk to a few people, and end a multi-ethnic civil war involving millions of people."

So the Burmese officials believe that they have no choice. The protests and demonstrations HAVE to be stopped AT ALL COSTS, to prevent a recurrence of the 1950s genocidal crisis civil war, even if it means killing some monks. In fact, in the disturbed minds of the Burmese officials, it's either kill a few monks or allow a mass genocide. If YOU had to make that choice, which choice would YOU make?

In fact, Burma is about ten years behind Darfur.

Ten years ago, Darfar was in a generational Unraveling era. At that time, the Janjaweed militia were merely a police force in Darfur, and there was nothing more than low-level violence.

Burma is still in a generational Unraveling era today, which is why the the protests and demonstrations fizzled out -- and why they would have fizzled out anyway, even if the government hadn't resorted to violence. If Burmese officials had understood that, then they would have known that no violence was necessary at this time.

And if Jimmy Carter and other "peacekeeping officials" understood what a crisis war is, then they might stop tilting at windmills. (5-Oct-07) Permanent Link
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The effects of the Fed's August 17 discount rate cut

Without the interest rate cut, things might be very different today.

It was on early morning, August 17, that I posted my essay, "The nightmare is finally beginning." I had reached the conclusion that the masses of investors had had a dramatic change of attitude that was so overwhelming that we would see a generational crash within a few weeks.

I set up a "real time experiment," comparing the day by day changes in the Dow Industrials to corresponding days in 1929, to see if we would have a generational crash in the same time frame. That didn't happen, as we now know. But even without following exactly the same schedule as 1929, it remains still true that something dramatic had changed on August 17.

Apparently I'm not the only person who's reached that conclusion.

Here's what PIMCO's Bill Gross, head of the world's largest bond fund, wrote in his October market commentary:

"I and other PIMCO professionals were attempting to describe to high-ranking Treasury and Fed officials the near-frozen commercial-paper markets and the draining confidence of bond and stock investors worldwide. It was Thursday, August 16. Stocks had closed down 210 points and were expected to open hundreds of points lower on Friday. The country’s largest mortgage originator, Countrywide Financial, was rumored to be in liquidation mode (it survived that crisis). This was to be Ben Bernanke’s first test, an opportunity to prove that he and his board of governors knew “something” as opposed to “nothing.” Pass the test he did, cutting the discount rate the next morning and calming markets in ensuing weeks. When Bernanke’s Fed met officially on September 18, it acted again and joined a convoy of global central bankers maneuvering to restore a semblance of normalcy to credit and equity markets. So far, so good."

Note that, according to Gross, the market was expected to open several hundred points lower on Friday. This, in fact, is what I was expecting.

In other words, Gross was talking to Washington officials at the same time, and telling them his own version of "the nightmare is just beginning."

Let's take a look at the table that was in my August 17 posting. This table measured the 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, the market had peaked on July 19 at 14000.

The table that I posted compares 1929 and 2007, following the respective peaks:

    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%
    Mon 10-07 ( +6.32%)  90%
    Tue 10-08 ( -0.21%)  90%
    Wed 10-09 ( +0.48%)  90%
    Thu 10-10 ( +1.79%)  92%
    Fri 10-11 ( -0.05%)  92%
    Mon 10-14 ( -0.49%)  92%
    Tue 10-15 ( -1.06%)  91%
    Wed 10-16 ( -3.20%)  88%
    Thu 10-17 ( +1.70%)  89%
    Fri 10-18 ( -2.51%)  87%
    ------------------ -----
    Mon 10-21 ( -3.71%)  84%
    Tue 10-22 ( +1.75%)  85%
    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
    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%
    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%

The table stops at 8/17. As it turns out, the next line was:

                                   Fri 08-17 ( +1.82%)  93%

That is, the Dow Industrians gained 1.82%, after the Fed announced the discount rate cut.

If the Fed hadn't announced the discount rate cut then, according to Gross, the market was expected to fall several hundred points, let's say, -4%.

This would have matched what happened in 1929: On Thursday, October 3, the market fell -4.22%.

So, if Gross is correct, then we would indeed have been following the 1929 path, and the generational crash might well have occurred already, by September 21.

Gross adds that the basic problems that the problems that led to the near-meltdown on August 17 "remain to be disproved." He continues,

"The modern financial complex has morphed into something unrecognizable to many astute market veterans and academics. [Fed Chairman Ben] Bernanke’s fellow governors and [Treasury Secretary] Hank Paulson’s staff at the Treasury spread their roots during an era in which traditional banking activity – lending out deposits backed by a certain level of reserves – was the accepted vehicle for liquidity creation. Remember those old economics textbooks that told you how a $1 deposit at your neighborhood bank could be multiplied by five or six times in a magical act of reserve banking? It still can, but financial innovation has done an end run around the banks. Derivatives and structures with three- and four-letter abbreviations – CDOs, CLOs, ABCP, CPDOs, SIVs (the world awaits investment banking’s next creation; perhaps IOU?) – can now take a “depositor’s” dollar and multiply it ten or 20 times. Reserve banking, and the Federal Reserve that regulates the system, appear anemic in comparison."

This is the point that I've made many times. Only I believe the use of CDOs have created leverage by a factor much higher than 10 or 20.

He continues:

"I’m sure that Bernanke, Paulson, and their cohorts understand this, but it isn’t yet clear how much they appreciate it. Alan Greenspan admits in his newly published book that he didn’t appreciate until recently the impact adjustable-rate mortgages and their subprime character, accompanied in some cases by outright fraud, would have on the housing market. If the Fed was so slow to grasp the role that subprime mortgages played in the housing boom and bust, do the Fed and the Treasury of today totally comprehend what happens when the nonbanking private system suddenly stops flooding the market with credit? Do they recognize that such a shutdown puts spending for housing and business investment at risk, and job growth as well? The Fed will have to adapt its monetary policy, and the Bush Treasury will have to adjust its fiscal policy to this brazen new world dominated more and more by private rather than public policies and proclivities. To overcome private-market caution, the Fed may need to put on a bold face marked by even more decisive cuts in short-term rates. To prevent a housing-market slump from metastasizing into a cancerous self-feeding tumor, Treasury Secretary Paulson will have to coordinate policies that lend a helping hand to homeowners in distress."

I agree with what Gross says, except for his evident belief that it's still possible to do something to prevent a global economic meltdown.

Nothing has really changed since I wrote my August 17 essay, "The nightmare is finally beginning."

What these financial officials don't understand is that they have things backwards. They believe that a series of accidents -- the housing bubble, the distress of a couple of banks -- is the CAUSE of the investor anxiety and panic. They believe that if they can take a few confidence-building steps, and convince people that the banks are OK, then investor anxiety and panic will return back to "normal."

But that's backwards. The panic and anxiety is CAUSED by generational changes -- the people in the generations that survived the 1930s Great Depression have all disappeared, replaced by Boomers and Gen-Xers who have no idea what's going on, and are panicking as a result.

The generational panic and anxiety that had been growing silently among Boomers and Xers finally metastasized into action on August 17. The shot of heroin that the Fed provided with interest rate reductions has produced the desired euphoria, but that euphoria can't last much longer.

Something very significant happened on August 17, even if the comparison with 1929 didn't precisely occur. The issue is NOT the ups and downs of the stock market; the issue is the dramatic increase in panic and anxiety among investors. That's not going to change. It's still true that the generational panic I've described might occur next week, next month, next year or even later, it's still my expectation that we'll see it within the next few weeks. (3-Oct-07) Permanent Link
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Bad news is good news again, as Dow hits a new high

Here's how the pundits explain it.

Monday started off ominously.

Those were ominous warning signs. But no matter. The Dow Industrials skyrocketed by 191 points on Monday, to close at an all time history high, 14,087, eclipsing the 14,000 point high that it reached on July 19.

Here's how CNBC commentator Bob Pisani described the situation as of 1 pm, when the Dow was already at a new intraday high:

"It sounded like bad news from Citigroup and UBS, but the market treated it this morning -- and the comments in the trade press were very clear -- "Get the bad news out now." They took the right approach. ...

Doesn't sound like good news, but the market said, look, they're getting everything out. The losses are very conservative. That is they're taking significant losses. They're trying to anticipate that it may even be worse, and they're trying to move ahead. The market loves that, and you'll notice that the stocks are on the up side here. ...

What seemed like bad news is actually being turned on its head. ... They're getting all the dirty laundry out right now."

And here's what Richard Bove, financial strategist at Punk, Ziegel & Co., said at about 8 am:

"I think it's pretty clear. ... It's because people simply don't believe that there is a crisis of this nature out there.

They believe that the Federal Reserve can solve any problem whatsoever. I mean the Federal Reserve's ability to print money and to throw that money around and solve any crisis that could arise in the financial system is so great that people simply don't believe that this is meaningful."

This has my head spinning. We've moved back into this crazy, bizarre world where up is down and good is bad. If UBS AG had posted a large profit, investors would have been ebullient about the high earnings, and would have pushed the market up to new highs.

But UBS AG posted a big loss, and investors are STILL ebullient. Why? Because UBS is taking significant losses, anticipating that things may even get worse, and they're staying ahead of it. Aaaaahhhhhhhhhhhhh!!!!

In the 1950s, my teachers would tell us about how gullible and clueless the investors were prior to the 1929 crash, and I never understood how it was possible. Now I do. What's going on today is absolutely mind-boggling. The average investor appears to be as dumb as a stump. And to think that they've pushed the stock market bubble up to a new high is almost too incredible to be believed.

Do you want to know how these guys -- these investors and their advisors -- make their decisions, reach their conclusions? Here's an example, by Morgan Stanley's David Miles, in a posting on Morgan Stanley's global economics forum:

"Our main tool for judging medium and longer-term trends in inflation is a five-equation model that allows us to determine the long-run steady state levels for key macroeconomic variables. Part of this model incorporates a Bank of England reaction function such that short-term interest rates are consistent with a path for inflation that stabilises around the target. The other elements in the model reflect wage pressures, consumer spending, unemployment and oil prices – driving factors behind inflation pressures and therefore central to Bank of England interest rate decisions. For the short term (up to one year) central outlook and risk analysis we take into account a wide range of information, including the likely path of utility prices, oil prices, pressures on food prices, house prices and council taxes.

At each stage, we consider risks: in the long run, whether the economy could converge to a different activity level; in the medium term, analysis of shocks that could affect the medium-term path; in the short run, current inflationary pressures that can affect the near-term path. Fortunately, all three approaches currently give a relatively consistent picture."

Can you believe this? He has a "five-equation model" to predict inflation for the next year.

He probably has another "five-equation model" that tells him where the stock market will be next year, and another "five-equation model" that tells him what mood his wife will be in that evening.

I would like to hear from anyone who reads this web site who believes that a "five-equation model" can be used to predict almost anything. Just write to me and let me know.

These guys have no idea what they're talking about. If you listen to the weather forecasts on the radio in the morning, they'll probably be accurate for the entire day. If you listen to stock market forecasts in the morning, there's a good chance they'll be wrong by 11 am.

Even retrospective explanations are bizarre. An evening business report might say, "Stocks went up today on the news that oil prices were falling." Then, the next evening, it'll be, "Stocks went up today as investors were unfazed by rising oil prices."

Before I go on, let me mention that last night when I wrote the article, "IMF questions the globe's continuing financial stability," I made a couple of mistakes in my description of how CDSs and CDOs are created. I thank a couple of sharp-eyed web site readers for correcting me, and the article itself has now been corrected.

However, it really hit me last night how REALLY crazy all this. There's a joke that no one who knew how sausage was made would ever eat sausage.

Well, who the hell would ever buy a CDO? Only a maniac would, especially when you know how they're made. You take high-risk subprime mortgages and merge them into a big blob, break up the big blob into small shares, and the high risk mortgages magically turn into low-risk CDOs. Actually, you still have have some high-risk CDOs left over, and you make another big blob, do the same thing, and magically convert THOSE into low-risk CDOs-squared.

Is anyone really dumb enough to invest in one of those? That's INSANE.

And yet, here we are. Investors, mutual funds, investment trusts, hedge funds, savings banks, pension funds, college endowments, money market funds, insurance companies, and so forth -- they all invested HUGELY in CDOs.

There are 750 TRILLION DOLLARS of these and other credit derivatives in the portfolios of these organizations. And it's all leveraged, based on JUST 10 TRILLION DOLLARS worth of contracts. Man, that's leveraging! And the worldwide annual GDP -- the total sum of all the goods and services produced in the whole world, is ONLY 45 TRILLION DOLLARS.

But that's no problem. All we need is a "five-equation model." It'll tell us that everything is fine. So stop worrying! Be happy!

I never thought that investors would be dumb enough to push the stock market bubble even higher than it was on July 19, but that goes to show how wrong a guy can be. I can hardly wait to see what happens next. (2-Oct-07) Permanent Link
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Burma (Myanmar) demonstrations fizzle after violent government response

Thousands of troops are exerting a massive stranglehold on the streets of Rangoon (Yangon) on Monday, as the street protests have died out.

It's thought that hundreds of activists and citizens have been shot dead or burned alive in government crematoriums. Thousands of Buddhist monks, who led the protests to begin with, have been rounded up and detained. Some have been found floating face down in rivers. Horror stories abound.

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In an odd coincidence, Sylvester Stallone has witnessed some of the genocide that was going on in Burma even before the recent protests began.

Stallone returned eight days ago from shooting his new movie "John Rambo," filmed on a river separating Thailand and Burma.

"I witnessed the aftermath—survivors with legs cut off and all kinds of land mine injuries, maggot-infested wounds and ears cut off. We saw many elephants with blown off legs. We hear about Vietnam and Cambodia and this was more horrific," Stallone told The Associated Press in a telephone interview Monday. "This is a hellhole beyond your wildest dreams," Stallone said. "All the trails are mined. The only way into Burma is up the river." Stallone said that he plans to incorporate the real-life genocide into the movie during editing.

Ironically, the army need not have resorted to violence to end the protests. As I wrote a week ago in my article, "Burma: Growing demonstrations by the '88 Generation' raise fears of new slaughter," Burma is in a generational Unraveling era.

Burma's last crisis war ended in 1958. Following the end of a crisis war, a country or society goes through a series of "generational eras," as the generations change and fight one another. The greatest conflict is between the generations that lived through and survived the crisis war, and those born after the war ended. This "generation gap" generates the behaviors that are characteristic of each era. The Awakening era, which begins 15-20 years after the crisis war ends, is characterized by strident political battles between survivor and post-war generations. The Unraveling era, which begins around 40 years after the crisis war ends, is a time when all the "lessons learned" from the last crisis war unravel. About 60 years after the crisis war ends, when the survivors of the last crisis war all die or retire, a new generational Crisis era begins.

During a generational Unraveling era, large protests and demonstrations occur, but they always fizzle out quickly, as I explained last week. So if the army had simply waited a few days, they would have gotten what they wanted without violence.

This is a perfect example of how an understanding of Generational Dynamics can aid policy makers. If the Burmese government officials had understood what a generational Unraveling era is, then they would have known not to start spraying civilians with machine gun fire.

There's a lot of wishful thinking going on in the world about Burma. For example, Carl Bildt, Minister for Foreign Affairs for Sweden, wrote an article entitled, "Rotten regime will not be long-lived." In this article, he says:

"Regimes like that in present-day Burma never last forever, and in our increasingly open world these enclaves of isolation are being placed under ever greater pressure.

Human rights are justly regarded as universal; modern IT technology does not respect old borders, and the accelerating process of globalisation is gradually opening up even the most closed of societies.

The only thing we can say with absolute certainty about present-day Burma is that the current regime will sooner or later belong in the past. We would like to be able to say when and how this will happen - and we would like for it to happen now, through the open dialogue that not least the monks are calling for in their protest."

Unfortunately, Sweden's foreign affairs minister doesn't understand a generational Unraveling era either. If he did, he'd know that the current regime is certain to survive for many years. Burma will enter a generational Crisis era again in the late 2010s. Around that time, there will be a new civil war, and almost certainly the current regime will be overthrown.

There's nothing magic or psychic about these conclusions. Students of generational theory have identified hundreds of similar situations throughout history where exactly the same thing happens over and over.

Let's take a brief look at some other news stories that we've covered on this web log:

Every one of these examples has domestic policy implications for the countries involved, and foreign policy implications for the United States and other countries. Generational Dynamics can serve as a powerful tool by governments in determining matters of state and war. (2-Oct-07) Permanent Link
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International Monetary Fund (IMF) questions the globe's continuing financial stability

Saying that the "global financial system is enduring an important test," the IMF is warning that the global financial system has been getting increasingly unstable for at least several months, and that this trend is continuing.

Let's look at some excerpts from the executive summary of the International Monetary Fund's October, 2007, Global Financial Stability Report (GFSR):

"Since the April 2007 Global Financial Stability Report (GFSR), global financial stability has endured an important test. Credit and market risks have risen and markets have become more volatile. Markets are recognizing the extent to which credit discipline has deteriorated in recent years—most notably in the U.S. nonprime mortgage and leveraged loan markets, but also in other related credit markets. This has prompted a retrenchment from some risky assets and deleveraging, causing a widening of credit spreads in riskier asset classes and more volatile bond and equity markets. The absence of prices and secondary markets for some structured credit products, and concerns about the location and size of potential losses, has led to disruptions in some money markets and funding difficulties for a number of financial institutions, as some counterparties have been reluctant to extend credit to those thought to hold lower quality, illiquid assets. The resulting disruption has required extraordinary liquidity injections by a number of central banks to facilitate the orderly functioning of these markets."

This refers to the tremendous volatility and investor anxiety that occurred in August. The report indicates August events are a great threat to global financial stability, and most of the report is about what happened in August and how to keep it from happening again.

"The potential consequences of this episode should not be underestimated and the adjustment process is likely to be protracted. Credit conditions may not normalize soon, and some of the practices that have developed in the structured credit markets will have to change. At the same time, the global economy entered this turbulent period exhibiting solid growth, especially in emerging market countries."

The report does not predict a 1930s style Great Depression, as I do, but says that the problems will continue for a long time, and will get worse.

The report says that "some of the practices that have developed in the structured credit markets will have to change," but as we'll see, any significant change is unlikely.

"Systemically important financial institutions began this episode with adequate capital to manage the likely level of credit losses. So far, despite the significant ongoing correction in financial markets, global growth remains solid, though some slowdown could be expected. Downside risks have increased significantly and even if those risks fail to materialize, the implications of this period of turbulence will be significant and far reaching. Eventually, lessons for both the private sector and the regulatory and supervisory arenas will have to be drawn in order to strengthen the financial system against future strains."

"Systemically important financial institutions" refer to major financial institutions, such as large banks, insurance companies, and investment firms around the world. This makes the point that it's not just a few small town savings banks that are in trouble.

"The threat to financial stability increased as the uncertainty became manifest in the money markets that provide short-term financing (especially commercial paper markets). At the center of the turmoil is a funding mismatch whereby medium-term, illiquid, and hard-to-value assets, such as structured credit securities, were being funded by very short-term money market securities—often asset-backed commercial paper."

This "funding mismatch" is the problem that exploded. Here's an example of what can happen:

"The market illiquidity and the difficulty in valuing the complex, structured products held as assets has compounded the risks of the funding mismatch. Thus, while potentially helping protect the financial system from concentrations of credit risk in banks, the dispersal of structured credit products has substantially increased uncertainty about the extent of the risks and where they are ultimately held."

The creation of these "complex, structured products" is the most bizarre financial development of the modern age. Let's continue with the above example:

And so, returning now to the paragraph above from the IMF report, the phrase "market illiquidity" refers to the fact that there's rarely a market for these CDOs; "difficulty in valuing" refers to the computer models, and the difficulty in relating notional values to market values; and "increased uncertainty about the extent of the risks" refers to the fact that no one has the vaguest idea what's going to happen when these "marked to model" CDOs have to be re-valued, because they've been sold.

"This funding mismatch was undertaken by a significant number of conduits and special purpose vehicles that had assumed they could hold their illiquid assets to maturity. Many have been associated with regulated banks, and to a large extent their funding strategies were backed by contingent liquidity lines from those banks. When doubts about the quality of some of the underlying assets emerged and the high ratings were perceived as less reliable, prices of the assets fell, the rollover of associated asset-backed commercial paper became very difficult, and funding began to be squeezed. As a consequence, what had been contingent, off-balance sheet liabilities for regulated banks threatened to move "on balance sheet."

This describes the credit crisis that began in August. These CDOs were everywhere, and there was no institution really had any way of knowing how exposed it was, let alone how exposed other institutions are.

What's the total value of all the credit derivatives in the world?

The IMF's Global Financial Stability Report provides an answer.

Click on the "Statistical Appendix," and open the PDF file. Go to page 136, and look at the "TOTAL" line in table 4. Expand that single line into a table by itself, and you get the following:

    Table 4. Global Over-the-Counter Derivatives Markets: Notional
    Amounts and Gross Market Values of Outstanding Contracts

(In billions of U.S. dollars)

Date Notional amounts Gross Market Values ----------- ---------------- ------------------- 31-Dec-2004 257,894 9,377 30-Jun-2005 281,493 10,605 31-Dec-2005 297,670 9,749 30-Jun-2006 369,507 9,936 31-Dec-2006 415,183 9,695

FOOTNOTE: All figures are adjusted for double-counting. Notional amounts outstanding have been adjusted by halving positions vis-à-vis other reporting dealers. Gross market values have been calculated as the sum of the total gross positive market value of contracts and the absolute value of the gross negative market value of contracts with non-reporting counterparties.

According to this table, credit derivatives have been growing quickly since 2004. Today, the total notional values of credit derivatives is $415 trillion.

This $415 trillion of credit derivatives is built on top of only $9 trillion in contract market values. And the total GDP of the entire world is only $45 trillion.

Incidentally, Ron Insana on CNBC has lately been quoting an up to date figure of $750 trillion. This is considerably larger than the December figure quoted by the IMF report, but it wouldn't be a surprise, because the use of credit derivatives accelerated during 2007.

Whether it's $415 trillion or $750 trillion, we're talking about a bubble so huge that it almost can't be imagined. I've been talking for years about the whole world being a giant financial bubble, but as this $750 trillion sized bubble sinks in, it's shocking even to me, after all this time. The world is headed for a financial disaster of almost unimaginable proportions.

A web site reader has called my attention an article by Jon Markman about credit derivative expert Satyajit Das. The article describes how we got into the current situation, and what's going to happen next. Here are some excerpts:

"Das is pretty droll for a math whiz, but his message is dead serious. He thinks we're on the verge of a bear market of epic proportions.

The cause: Massive levels of debt underlying the world economy system are about to unwind in a profound and persistent way. ... [He] foresees hard times as an optimistic era of too much liquidity, too much leverage and too much financial engineering slowly and inevitably deflates. ...

[He] points a finger at three parties: regulators who stood by as U.S. banks developed ingenious but dangerous ways of shifting trillions of dollars of credit risk off their balance sheets and into the hands of unsophisticated foreign investors; hedge and pension fund managers who gorged on high-yield debt instruments they didn't understand; and financial engineers who built towers of "securitized" debt with math models that were fundamentally flawed.

"Defaulting middle-class U.S. homeowners are blamed, but they are merely a pawn in the game," he says. "Those loans were invented so that hedge funds would have high-yield debt to buy."

The liquidity factory

Das' view sounds cynical, but it makes sense if you stop thinking about mortgages as a way for people to finance houses and think about them instead as a way for lenders to generate cash flow and create collateral during an era of a flat interest-rate curve. Although subprime U.S. loans seem like small change in the context of the multitrillion-dollar debt market, it turns out these high-yield instruments were an important part of the machine that Das calls the global "liquidity factory." Just like a small amount of gasoline can power an entire truck given the right combination of spark plugs, pistons and transmission, subprime loans became the fuel that underlays derivative securities many, many times their size.

Here's how it worked: In olden days, like 10 years ago, banks wrote and funded their own loans. In the new game, Das points out, banks "originate" loans, "warehouse" them on their balance sheet for a brief time, then "distribute" them to investors by packaging them into derivatives called collateralized debt obligations, or CDOs, and similar instruments. In this scheme, banks don't need to tie up as much capital, so they can put more money out on loan.

The more loans that were sold, the more they could use as collateral for more loans, so credit standards were lowered to get more paper out the door -- a task that was accelerated in recent years via fly-by-night brokers now accused of predatory lending practices.

Buyers of these credit risks in CDO form were insurance companies, pension funds and hedge-fund managers from Bonn to Beijing. Because money was readily available at low interest rates in Japan and the United States, these managers leveraged up their bets by buying the CDOs with borrowed funds.

So if you follow the bouncing ball, borrowed money bought borrowed money. And then because they had the blessing of credit-ratings agencies relying on mathematical models suggesting that they would rarely default, these CDOs were in turn used as collateral to do more borrowing.

In this way, Das points out, credit risk moved from banks, where it was regulated and observable, to places where it was less regulated and difficult to identify.

Turning $1 into $20

The liquidity factory was self-perpetuating and seemingly unstoppable. As assets bought with borrowed money rose in value, players could borrow more money against them, and it thus seemed logical to borrow even more to increase returns. Bankers figured out how to strip money out of existing assets to do so, much as a homeowner might strip equity from his house to buy another house.

These triple-borrowed assets were then in turn increasingly used as collateral for commercial paper -- the short-term borrowings of banks and corporations -- which was purchased by supposedly low-risk money market funds.

According to Das' figures, up to 53% of the $2.2 trillion commercial paper in the U.S. market is now asset-backed, with about 50% of that in mortgages.

When you add it all up, according to Das' research, a single dollar of "real" capital supports $20 to $30 of loans. This spiral of borrowing on an increasingly thin base of real assets, writ large and in nearly infinite variety, ultimately created a world in which derivatives outstanding earlier this year stood at $485 trillion -- or eight times total global gross domestic product of $60 trillion.

Without a central governmental authority keeping tabs on these cross-border flows and ensuring a standard of record-keeping and quality, investors increasingly didn't know what they were buying or what any given security was really worth.

A painful unwinding

Now here is where the U.S. mortgage holder shows up again. As subprime loan default rates doubled, in contravention of what the models forecast, the CDOs those mortgages backed began to collapse. Because they were so hard to value, banks and funds started looking at all CDOs and other paper backed by mortgages with suspicion, and refused to accept them as collateral for the sort of short-term borrowing that underpins today's money markets.

Through late last month, according to Das, as much as $300 billion in leveraged finance loans had been "orphaned," which means that they can't be sold off or used as collateral.

One of the wonders of leverage is that it amplifies losses on the way down just as it amplifies gains on the way up. The more an asset that is bought with borrowed money falls in value, the more you have to sell other stuff to fulfill the loan-to-value covenants. It's a vicious cycle. In this context, banks' objective was to prevent customers from selling their derivates at a discount because they would then have to mark down the value of all the other assets in the debt chain, an event that would lead to the need to make margin calls on customers already thin on cash.

Now it may seem hard to believe, but much of the past few years' advance in the stock market was underwritten by CDO-type instruments which go under the heading of "structured finance." I'm talking about private-equity takeovers, leveraged buyouts and corporate stock buybacks -- the works.

So to the extent that the structured finance market is coming undone, not only will those pillars of strength for equities be knocked away, but many recent deals that were predicated on the easy availability of money will likely also go bust, Das says.

That is why he considers the current market volatility much more profound than a simple "correction" in prices. He sees it as a gigantic liquidity bubble unwinding -- a process that can take a long, long time."

That's a pretty good description of what's been going on and what's coming, and says the same thing that I've been saying for a long time.

When Satyajit Das was asked, using a baseball analogy, which "inning" the credit crisis was in, he said that we're only just starting to play the national anthem. In other words, we're barely at the beginning of a crisis that will go on for many, many years.

As I'm writing this on Sunday evening, Zurich-based banking giant UBS AG is expected on Monday to announce its first quarterly loss since 2002. The loss is expected to amount to $516 million. But more than that, they're forced to revalue their fixed-income assets from "notional value" to something closer to "market value," as described earlier. The result: A $2.5 billion loss of value. (1-Oct correction)

This kind of thing is going to keep on happening to one institution after another, until that $750 trillion bubble is fully deflated. It will not be pretty. (1-Oct-07) Permanent Link
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