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


Web Log - June, 2008


Pakistan is paralyzed as Tehrik-e-Taliban advances in NorthWest

Pakistan army abandons negotiations for war to prevent imminent takeover of Peshawar

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Pakistan has become increasingly paralyzed in the months since Pakistan's president Pervez Musharraf was forced to give up much of his power last fall, leading to elections in January that ended his monolithic leadership. In its place is a fragmented government with multiple power centers. Leadership has been replaced by incessant bickering, just as it has in the United States Congress and in many countries around the world.

From the point of view of Generational Dynamics, this is precisely what was to be expected. In America, the post-WW II Baby Boomer generation never learned any leadership or governing skills, having spent the 60s and 70s protesting and rioting against their parents. Today they're the senior management in political, business and educational institutions across the country, and are unable now to develop the new skills necessary to lead. The middle managers in Generation-X, frustrated by the lack of Boomer leadership, are taking matters into their own hands. But they lack the experience and wisdom of the Boomers, and are much more likely to handle complex situations with simple solutions that backfire, sometimes leading to disaster.

In Pakistan, since Musharaff was forced to resign his role as commander in chief of Pakistan's armed forces, the military and the intelligence services (ISI) have become essentially independent units within Pakistan, pursuing their own policies, often maintaining secrecy from civilian government officials.

Official map of Pakistan, with the addition of the FATA (Federally Administered Tribal Areas), highlighting Swat Valley <font face=Arial size=-2>(Source:</font>
Official map of Pakistan, with the addition of the FATA (Federally Administered Tribal Areas), highlighting Swat Valley (Source:

This became apparent last week when it was revealed that in February the military and the ISI had negotiated a secret peace agreement with Sunni militants in Pakistan's tribal regions that border Afghanistan.

This foolish policy has backfired. A terrorist group, Tehrik-e-Taliban (Taliban in Pakistan), led by Baitullah Mehsud, has used the time to gain strength in the region surrounding Peshawar, threatening complete takeover of the city.

This could lead to complete control of the Northwest Frontier Province (NWFP), and to an ethnic civil war between the Pashtuns, centered in NWFP, and the Punjabis, centered in Punjab province.

(For further information on the history of the 1947 Partition and the relationships between Pakistan's ethnic groups, see "Tense Pakistani president Musharaff calls for elections" from last year.)

For the United States and NATO forces fighting in Afghanistan, the increasing strength of the Taliban poses significant problems. The resurgence of Taliban strength in Afghanistan means that much of the country is no longer under control of the government, headed by President Hamid Karzai.

Furthermore, since Afghanistan is land-locked, the assault on Peshawar threatens the major route for resupplying the NATO forces. This supply route runs from the port of Karachi to the outskirts of Peshawar and through the Khyber Pass to the battlefields of Afghanistan.

The strategy pursued by the military and ISI has now changed. The peace agreement with the Taliban has ended, and on Saturday Pakistan's army began attacking the militants around Peshawar. That battle is ongoing.

In a separate but possibly related story, thousands of Muslim separatists in Indian Kashmir have been protesting since Monday against India's plan to transfer some land to a Hindu shrine. These protests have led to violence and clashes with police.

Kashmir is an predominantly Muslim area, but has been disputed by both Pakistan and India since the UN partitioned it in 1947 into Pakistani and Indian regions. Pakistan claims the entire region, and points out the partition was supposed to be temporary, and that the UN Security Council mandated an election in 1951 to permit Kashmiri self-determination. That election has never been held, and there have been constant clashes between Indian forces and Kashmiri separatists who want the entire province to be part of Pakistan.

So Pakistan is in a continually deteriorating situation. The government is split into factions and paralyzed, while significant external problems with militants are growing. Pakistan may be close to civil war, and that would inevitably lead to war (and then nuclear war) with India.

From the point of view of Generational Dynamics, a re-fighting of the massive, bloody genocidal war that followed Partition in 1947 is coming with absolute certainty. Exactly what will trigger this war cannot be predicted, but the increasingly militancy that's facing a paralyzed Pakistani government illuminates a number of different scenarios. (29-Jun-2008) Permanent Link
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Wall Street markets plunge 3% on Thursday as corporate earnings show continued weakness

Traders are hoping for a "mini-panic." Be careful what you wish for.

Ten days ago, the Royal Bank of Scotland issued global stock crash alert, saying, "A very nasty period is soon to be upon us - be prepared."

The nasty period appeared to have already begun on Thursday, as the Wall Street markets fell to their lowest levels since September, 2006. The month is now on track to be the worst June since the Great Depression.

David Buik, BGC Partners, London <font face=Arial size=-2>(Source: BBC)</font>
David Buik, BGC Partners, London (Source: BBC)

Financial analysts were generally very negative about the outlook early Friday morning.

David Buik, of BGC Partners in London said:

"The trouble is that we're now six weeks without a single solitary piece of good news. And if you have a plethora of bad news... -- we're talking about inflation, lowering corporate results, the cost of oil, the banks throwing rocks at each other, uncertainty about their stability, are there going to be more writedowns, lower growth endorsed today in the UK by the fact GDP came in lower than we expected at 0.3% -- then investors get really frightened. And when they're frightened, they just back off."

There was none of the usual crazy optimism that's been so prevalent in the past. In the past, we frequently heard, "It's good news that things are so bad, because that means the worst is over, and the market will go up again." Everyone is now very grim, and this is a marked change.

On Friday morning, CNBC's Carl Quintanilla interviewed stock traders Ben Lichtenstein of and Jim Iuorio of TJM Institutional Services:

Ben Lichtenstein: "Unfortunately this is not good for John Q Public. I think we have a long way to go. I think that the panic selling has yet to come in. I think this is a bad news situation, the fundamentals are still very negative."

Jim Iuorio: "Things are so strong negatively now.... Yesterday, there really was no huge panic at any one time. As traders, what we look for is that sort of capitulation with people crawling all over each other to get to the exits to signal the short-term bottom, and we didn't really see that. It was kind of an orderly break, even though it went on through the whole day.

CNBC's Carl Quintanilla (left) interviews stock traders Ben Lichtenstein (middle),, and Jim Iuorio, TJM Institutional Services <font face=Arial size=-2>(Source: CNBC)</font>
CNBC's Carl Quintanilla (left) interviews stock traders Ben Lichtenstein (middle),, and Jim Iuorio, TJM Institutional Services (Source: CNBC)

It was just people concluding that it was either going to trade sideways or negatively. Throughout the day, traders were getting out. ... We haven't gotten to that big level yet, where everyone's going to be pounding out."

Lichtenstein: "I really feel that the market still has a ways to go. Rather than seeing the pressure of a high energy selloff, we're seeing the lack of a buyer right now. And that is concerning to me. I think that the markets are going to go a little bit further till we clean it out and then head back up."

Iuorio: "There's a certain feel that happens -- it's unmistakable -- when everybody really feels so distraught that everyone heads out at the same time and the market gaps lower -- moves lower real quickly. And that's when traders come in and that's when traders come in and think, "They've blinked." Now it's time to come in and we establish a short-term bottom. And we haven't seen it yet, but we could real soon."

What's interesting about this is the desire and expectation of what might be called a "mini-panic." We can try to match up this desire with what happened just prior to the 1929 crash. If we look at my Dow Jones historical page, we can see what happened before the 1929 crash, some of which is extracted here:

    1929: Daily change in Dow Industrials
    Mon 10-07 ( +6.32%)
    Tue 10-08 ( -0.21%)
    Wed 10-09 ( +0.48%)
    Thu 10-10 ( +1.79%)
    Fri 10-11 ( -0.05%)
    Mon 10-14 ( -0.49%)
    Tue 10-15 ( -1.06%)
    Wed 10-16 ( -3.20%)
    Thu 10-17 ( +1.70%)
    Fri 10-18 ( -2.51%)
    Mon 10-21 ( -3.71%)
    Tue 10-22 ( +1.75%)
    Wed 10-23 ( -6.33%)
    Thu 10-24 ( -2.09%) Black Thursday
    Fri 10-25 ( +0.58%)
    Mon 10-28 (-13.47%) Black Monday
    Tue 10-29 (-11.73%)
    Wed 10-30 (+12.34%)
    Thu 10-31 ( +5.82%)
    Fri 11-01  (Closed)
    Mon 11-04 ( -5.79%)
    Tue 11-05  (Closed)
    Wed 11-06 ( -9.92%)
    Thu 11-07 ( +2.61%)
    Fri 11-08 ( -0.70%)
    Mon 11-11 ( -6.82%)
    Tue 11-12 ( -4.83%)
    Wed 11-13 ( -5.27%)
    Thu 11-14 ( +9.36%)
    Fri 11-15 ( +5.27%)

Let's imagine that in 1929 there were traders just like Lichtenstein and Iuorio, waiting for a "mini-panic," which would mean a market bottom and a time to buy. What happened on 10/23/1929 would fit the bill -- a sudden 6.33% market plunge. They might have taken that as the mini-panic they were looking for.

Black Thursday came next. That was a very tumultuous day, with wide swings up and down. Lichtenstein and Iuorio would have been expecting an up market, so they would been on the "buy" side. Meanwhile, the great unwashed masses, who didn't have such a sophisticated understanding of why a mini-panic was such good news, were on the "sell" side, and really sold off on Black Monday and Tuesday.

By that time, Lichtenstein and Iuorio and others like them would have been convinced that things couldn't POSSIBLY get any worse, so they pushed the market back up 18% by the end of the week. Unfortunately for them, the market didn't start going up again to new bubble heights, and kept falling until 1933, at which time it had fallen 90% from it's 1929 high.

So these statements by Lichtenstein and Iuorio give us further insight into what's going on, and why any coming stock market crash is going to be accompanied by wild up and down swings that will fool a lot of people, leading to the Principle of Maximum Ruin -- the maximum number of people will be ruined to the maximum possible extent.

The real problem is that the basic math hasn't changed, as I began describing in 2002, and summarized last year in "How to compute the 'real value' of the stock market." The stock market is overpriced by a factor of well over 200%, and by the Law of Mean Reversion, a crash must occur.

Even if you ignore the possibility of a crash, a stock market rally is almost impossible right now, because corporate earnings and earnings estimates have been falling. Price/earnings ratios (also called valuations) are being pushed to stratospheric levels again, whether or not there's a crash. See: "Stock markets plunge on unemployment and historic oil price spike" and: "Price/earnings stock index continues to surge higher and higher."

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate. (27-Jun-2008) Permanent Link
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Boston area, Thur, June 26: "Generational Issues in Managing IT Projects"

***** CORRECTION: JUNE 26 (THURSDAY THIS WEEK). Invitation to attend a talk on GenX and Boomers in software development projects

I'll be giving a talk on this subject on Thursday at 6 pm. Web site readers in the area are invited to attend.

The talk is titled "Generational Issues in Managing IT Projects," and I intend to focus on issues of software development project risks and project ethics. I'll be emphasizing many of the issues that I discuss on this web site.

If you're interested, the official announcement is below.

Meeting: Boston Tech Professionals Group: Next Meeting Thursday, June 26, 6 pm

Speaker: John J. Xenakis

Topic: "Generational Issues in Managing IT Projects"

John Xenakis has been a successful IT consultant since the 1980s, and has had almost 100 clients. He also writes for his web site, . He's seen IT project disasters caused by generational differences, and he'll give some specific examples.

John will also discuss how to address and bridge the gulf between Boomers and Gen-Xers in very positive, cooperative ways, by helping each person understand the other's view of the workplace and the world. This is an essential practice for any manager who wants to significantly reduce the risk of a project failure.

Red Sox Tickets:

A raffle will be held to win a set of 3 Red Sox tickets. Bring a business card or a slip of paper to toss in to the jar to be eligible for the raffle.

The game up for grabs is Monday July 28 at 7:15 PM - Sox vs. Angels


There are now 395 of us connected through the Boston Tech Professionals Network.

Next Meeting: Our next group meeting is Thursday, June 26th starting at 6:00 PM.

230 Third Ave, 1st Floor Atrium Waltham MA 02451

RSVP for this Event

Note: Third Ave is right off exit 27A of 128. Building 230 is the Schwartz Communications building (visible from 128), formerly the Microsoft building, a quarter of a mile past the Waltham Westin Hotel.

Plenty of free parking is available in the parking garage built in to the building.

I'll get pizza and drinks from Bertuccis, so plan to have dinner here.


If you have a colleague who would benefit from the group, please forward them the invitation link:

You may attend even if you forget to RSVP. (24-Jun-2008) Permanent Link
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Questions from readers on finance and investing

On fraud, the FDIC, China, and other subjects.

Normally I try to work the responses to the most common reader comments and questions into regular web log articles, but there have been a spate of financial and related questions lately, so it's time to devote an article to them.

Almost every journalist, pundit, analyst, and advisor has some financial stake in today's market, and their answers to financial advice questions are influenced by what is most likely to make money for themselves. I have nothing at stake except my own credibility, so my answers will be a lot more cautious than answers by others.

The stench of corruption

"I have been working in the financial sector since 1970 but I have never seen before (not even at Drexel Burnham in the late 1980s) the kind of extremely questionable practices, cover-ups, fraudulent behavior, and lack of transparency (coming so shortly after Enron blew up) by financial firms, the government and its agencies. In fact, if I weren't an incorrigible optimist who believes that what hasn't killed me yet (motorcycles, drinking and smoking heavily and ...) makes me stronger I would fall into a deep depression at the sight of the current financial environment and the government's lies."

The stench of corruption and fraud is beyond belief. I would never have believed it possible, even a few years ago.

I don't get depressed either. I just get more and more furious at the utter stupidity of these people. See: "'Operation Malicious Mortgage' indicts 406 people including Bear Stearns execs"

Are you bullish on America?

"[You wrote in a recent article:] "And I'm still bullish on America. I'm underweight emerging markets, and I'm overweight US stocks."

How can you rectify this statement with predicting a 3% probablity of a major crash each week? I think you are correct in foreseeing a tragic market in the next year. If you are overweight US stocks you should evaluate your reasoning for that."

Thanks for pointing out the lack of clarity in this passage. I changed the text so that it's clearer that the sentences you're quoting do not represent my view.

If I owned stock after all I'd written on my web site, I wouldn't have any credibility whatsoever. Hell, I wouldn't even have credibility with myself. To be clear: I own no stocks.

On the other hand, I'm QUITE bullish on America doing well during the coming financial crisis and Clash of Civilizations world war.

"If you must own stocks right now I recommend ..."

When the crash happens, even the "good" stocks will fail. That's because investors having to meet margin calls will need to sell even their "good" stocks to get cash.

It's been a year since the credit crisis started

"It`s been one year that the credit crisis started and still no crash....Do you think you are wrong? No depression...Why is it taking that long...No event a bear market...The dow is down 12% from a all time high...Does look tome like 1929...What do you think?"

The Fed has been very skillful in postponing a crash through narrowly targeted injections of liquidity -- something that wasn't understood or considered in 1929. There would have been a crash in October of last year, if not for the aggressive actions of the Fed.

And in March of this year, a Bear Stearns bankruptcy would have caused a worldwide crash if the Fed hadn't made a historic intervention. There's no doubt about this - Ben Bernanke said so in testifying before Congress.

Meanwhile, the underlying problems have been worsening, because the credit and real estate bubbles have continued to lead, pulling trillions of dollars out of the financial system. It's like high blood pressure being a "hidden killer" -- it's invisible until one day it kills you.

As for the stock market, it HAS to continue falling because corporate earnings and earnings estimates have been falling. What people who keep hoping for a rally don't understand is that price/earnings ratios (also called valuations) are already being pushed to stratospheric levels again, and that can't be sustained even if you ignore the possibility of a crash. See: "Stock markets plunge on unemployment and historic oil price spike" and: "Price/earnings stock index continues to surge higher and higher."

As regular readers know, every week or two I post the table of S&P 500 average corporate earnings estimates, based on figures from CNBC Earnings Central supplied by Thomson Reuters.

Here's the latest table for second quarter earnings:

  Date    2Q Earnings estimate as of that date
  ------- ------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%

As keeps happening, quarter after quarter, initial rosy earnings estimates are proven wrong, as actual numbers come out, and the estimates keep getting worse, week after week after week.

The basic mathematics hasn't changed in the six years that I've been running this site. The stock market is overpriced by a factor of well over 200%, and by the Law of Mean Reversion, a crash must occur. See: "How to compute the 'real value' of the stock market."

What's the best place to live?

"Firstly, thanks for the regular and insightful articles. I appreciate the effort you put into this website and it's given me many things to think about. A question if you've got time: I belong to the 'GenX' age group, am an American living in Asia (China) and am wondering where might be the safest place for me to consider settling down within the next few years. Do you think my fears of returning to the US are exaggerated? Might there be a somewhat safer place to call 'home'?"

Thanks for the compliments. I've been asked this question several times before, and I wish that I could answer it, but there's really no way to tell what regions of the world will be safer than others. My guess is that the less populated areas will be safer than more populated areas. I suppose that some place in the middle of Siberia might be pretty safe. On the other hand, a farm in the middle of Kansas might be pretty safe too.

The problem with China is that it's so densely populated and so economically and socially unstable, that it must be very hard to find a safe place there. See: "China is 'unsteady, unbalanced, uncoordinated and unsustainable.'"

One thing that I strongly suggest is that you obtain enough supplies -- dried or canned food, water, medicines, etc. -- so that you and your family can live without leaving your home for a few weeks. This is useful in preparing for a flood, a war, or a bird flu pandemic.

On the American Red Cross web site, you'll see instructions for preparing your own survival kit. You can also purchase a ready-made survival kit from the Red Cross store. Costs: $30-70.

"Thank you for your reply. I am working in the hospitality industry here in China. Would you have any idea regarding a timeline as to if/when Sino US relations could sour to the point of making it unpleasant/unsafe to continue to live in this country."

It's impossible to predict this, and you can show this using the concepts of Chaos Theory. Can you predict when the next hurricane will occur? You've probably heard about the "butterfly effect" that says that when a butterfly flaps its wings in China it might (or might not) cause a chain reaction that leads to a hurricane in North America. The same is true of starting a generational Crisis war. Someone in Washington or Tokyo or Taipai might say something (or fail to say something) that causes some kind of chain reaction of events that leads to war. All we can say for certain is that the probability of war increases with each passing day.

"One last question: if widespread conflict erupts do you think the US would reinstate the draft in order to fill the military's ranks?"

I think that this is almost an absolute certainty.

Why are the Chinese buying US dollars?

"[According to one blogger,] the Chinese printing presses are running like mad, selling Yuan (Renmimbi) to buy dollars. This suppressed the value of the Yuan, kept Chinese exports flowing and allowed China to maintain its currency peg. These policies are also causing the Chinese economy to overheat, and a significant factor behind the rise in commodity prices.

I'm pretty sure I have seen the same kind of analysis from you but I don't understand some of basic principles, if they are even correct: Why would the Chinese be buying US dollars when the value of our dollar is going to complete shit?"

Here's a better way of saying it: What the Chinese do is turn out huge amounts of manufactured goods, which they sell to the US to get US dollars. Since the US is a debtor country, China then uses its surplus dollars to purchase Treasury bonds. That's why China has almost a trillion dollars worth of Treasuries in its vaults.

"2) How and why would China choose to suppress the value of it's dollar by buying ours just to keep exports flowing and how exactly would that "peg" China's currency to ours?"

For many years, the Chinese pegged the yuan to the dollar (8.2 yuan to the dollar) at a fixed conversion rate. That way, they could keep the yuan from appreciating as the dollar got weaker, and they could keep selling their manufactured goods to the US at low prices.

This created a major frenzy in Washington in 2004-05, because politicians were blaming the Chinese for the loss of manufacturing jobs in America. Congress was threatening sanctions on China unless China let the yuan appreciate. Finally they did, in 2006 I think. See: "Stock market frenzy follows Washington yuan-bashing" and: "US dollar weakness and China's growing economic strength dominate World Economic Forum."

"I get that China might choose to do something sort of shifty to increase it's exports, perhaps, but in the net sum gain I don't see how they are benefiting here. I don't understand why they would make those choices given that they could just chose to not buy us dollars, let their currency float, and perhaps fair just as well or better against our currency. What (do you think) I am missing here?"

China's economic bubble depends on selling lots of stuff to the US. If China revalued the yuan too much, then Chinese goods would become more expensive in the US, which means we'd import less, which would cause a recession in China.

This kind of stuff is typical of a generational Unraveling and Crisis era, when everything goes crazy economically. That certainly happened in the US with the dot-com bubble, then the housing and credit bubbles. The craziness is the same but the symptoms are different depending on whether you're a creditor or debtor nation.

Take another look at this for a perspective on what the US was like when it was a creditor nation: "The bubble that broke the world."

Right now, China's stock markets are crashing big time, and there are plenty of good reasons to believe that China will have some sort of financial crisis once the Olympics games end. See: "Shanghai China stock market and Baltic Dry Index are crashing sharply."

Whether that will be a small financial crisis or a large one remains to be seen.

Are FDIC-insured accounts safe?

"So anyway, I have a modest sum of cash lying around and I'd like to be able to feed and house my family within the foreseeable future. Is there a single investment available on this planet that is not as fickle as Wall Street and Washington DC?"

The only investment I'd suggest are short-term Treasuries and FDIC-insured certificates of deposit (CDs). Or cash.

"I was wondering if you think having money in savings, even FDIC insured accounts is safe. If the financial meltdown is severe enough, will the government be able to pay to recover all those funds?"

Not completely, as I wrote about last year: "Is your bank deposit protected by the FDIC?" Basically, if a major banking crisis occurred, then the FDIC would run out of money.

The question is how long you want to leave your money in the bank. My guess is that there'll still be time to get it, once the banks start failing, but not a lot of time, so you should be prepared to move quickly. Also, larger accounts are likely to be frozen before smaller accounts.

"In addition, I quite frankly don't trust guarantees from the FDIC nor treasury, especially with the t-bill cycle circumvented by more reliable currencies."

Once the crisis begins, there's no guarantee that promises made before that time will be honored. See: "Questions and answers about the 'credit crunch'" and: "Will hyper-inflation make the dollar worthless (like the Weimar republic)?"

Where to put money so it's safe is a big problem. Putting it into a bank risks losing in case of bank failure. Keeping it in your home risks robbery. Keeping it in a safe in your home risks the possibility that in a major emergency you won't have time to get to the safe. Obviously, the best solution depends on each person's circumstances.

Does ending the gold standard create a new paradigm?

"I was looking at the DOW Jones chart you have demonstrated being way above the long term mean. One thing I was wondering if that since the dollar was removed from the gold standard in 1971, if stock prices have been overinflated significantly due to inflation, i.e. the change in 1971 have led to a new paradigm. And when inflation is taken into account, maybe the prices aren't really so far above trend.

For example, you can see that gold prices were steady until 1971 also. Perhaps stock prices have been growing more exponentially because of inflation? Is there any possibility to this?"

There really isn't. Gold is just another commodity, so ending the gold standard wouldn't have affected much beyond the commodities markets. As far as stocks are concerned, ending the gold standard probably affected the share prices for manufacturers of jewelry and dental supplies, but I don't think it would affect much more. Also, please note that inflation was taken into account in all my long-term trend charts.

What if the Bear Stearns crisis had happened on a Monday?

"Just a couple thoughts I'm having after this strange week. It seems like stocks are inching higher in the face of bad news until they crash. To paraphrase Galbraith, people think the worst is reasonably over, so those beliefs lead to a rising market which tends to reinforce the view that the worst is reasonably over until the catalyst comes."

I actually think that things are happening in a different order than they happened in 1929.

In 1929, there was a panic, but then a post-crash three-year period with a continuing bear market. I believe that we've already entered what corresponds to the post-crash period, with the actual panic delayed.

I'm reasonably certain that the panic would have occurred last October if it hadn't been for such aggressive Fed intervention. And I KNOW it would have occurred in March if the Fed hadn't intervened so aggressively to save Bear Stearns.

In fact, if I understand you correctly, I think you're saying the same thing, when you refer to Galbraith's remark, which applied to the 1929 post-crash period.

"That's exactly how I see it. In fact, I remarked to the mailman (when he mentioned that he was thinking about buying back into the market with his retirement money) that having the weekend to patch up Bear Stearns probably made the difference between whether a panic would have already occurred or whether it will occur later. If Bear Stearns had collapsed on Monday, Tuesday, Wednesday, or Thursday instead of Friday, there would not have been enough time to patch it up and a panic would have occurred. I agree there will still be a panic after this secondary high is complete, whenever that is. After this panic occurs, the vast majority will think the worst is over and buy (or hold) stocks. But the worst will not be over and stocks will continue to decline for a number of years. You know, after the 1929 crash, the low in the Dow Jones was 198 in November and the Dow made a substantial recovery to 294 in April of 1930. Therefore, those who know their market history will probably try to buy a post crash low. It's my guess that there will be no recovery after this upcoming crash and stocks will move lower for years. That is how Maximum Ruin will be accomplished this time."

What you're saying makes a lot of sense. (23-Jun-2008) Permanent Link
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Israel conducts mock attack on Iran

The rumor mill is predicting a real attack.

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Israel conducted a large-scale military exercise in the Mediterranean earlier this month.

Israel sent 100 fighters 900 miles over the Mediterranean sea, along with refuelling planes and helicopters. In a real attack on Iran's Natanz nuclear plant, the 100 fighters would fly 900 miles in the opposite direction.

Ever since the Iraq ground invasion in 2003, there have been constant rumors that an American or Israeli attack on Iran is imminent. These rumors have often been led by Seymour Hersh, who believes that the American armed forces are like Nazis, and who has been making a career out of reporting that such-and-such an Administration official told him that there's an Iranian attack plan in the works. Over the years, I've received quite a few web site reader questions expressing concern about an imminent attack on Iran.

The concerns have never made sense. The "logic" was that President Bush got up one morning and decided to invade Iraq, and therefore he might get up one morning and decide to invade Iran. Actually the 2003 Iraq ground invasion was debated publicly for over a year, in Congress, the United Nation, and in foreign capitals. No such debate has been going on over Iran, so any comparison is vacuous.

So is it different this time? Should we take the new rumors about an Israeli bombing of Iran seriously this time?

The Pentagon says no. The exercise is "sabre-rattling," to scare Iran. "If the Israelis were serious about it, no one would know about it until after it has happened," said an official.

As I explained recently in my comparative strategy of Iran and China, and earlier in "Iran's President Ahmadinejad is facing a growing 'generation gap,'" Iran's increasingly unpopular government is using the nuclear issue to try to gain domestic support. The idea is that if Iran can provoke some kind of military action by the West against Iran, then the Iranians will be unified as they were in the 1979 Islamic revolution.

From the point of view of Generational Dynamics, this strategy is doomed to fail. In 1979, Iran was in a generational Crisis era, and the Islamic revolution DID unify the country. Today, Iran is in a generational Awakening era, and the Iranian people, especially young Iranians, would be much more likely to blame Ahmadinejad for having provoked the attack.

Having said all that, the situation between Israel and Iran is very dangerous.

Israeli Prime Minister Ehud Olmert is far too unpopular and mired in personal scandals to attempt to lead a war that would follow the bombing of Iran. And the mess he made of the 2006 war against Hizbollah in Lebanon gives him no credibility with the Israeli people. An unprovoked attack against Iran would be an act of desperation.

Iran's President Mahmoud Ahmadinejad is, by contrast, a near-total madman. His fundamentalist belief in the Mahdaviat -- the belief that the Shia Mahdi is coming soon to save mankind -- combined with his determination to provoke the West, make him a potentially lethal wild card.

The possibility exists that Ahmadinejad will do something so stupid and so provocative that even Olmert will believe he has no choice but to retaliate.

However, nothing like that appears to be imminent right now.

(21-Jun-2008) Permanent Link
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'Operation Malicious Mortgage' indicts 406 people including Bear Stearns execs

All kinds of fraud by all kinds of people.

In June of last year, Bear Stearns was forced to bail out two hedge funds that were close to default. The hedge funds had taken investors' money and used the money to invest in CDOs (collateralized debt obligations) that had large nominal values, but which nobody was willing to buy. Investors wanting to withdraw cash from the hedge funds were causing problems, since the hedge fund managers couldn't sell the CDOs to obtain cash.

A month later, Bear Stearns announced that its hedge funds were almost worthless, causing their investors to lose billions of dollars.

According to an FBI press release (or get the entire indictment (PDF) here), there was criminal activity involved.

Two senior Bear Stearns hedge fund managers, Ralph Cioffi and Mathew Tannin, are being charged with conspiracy, securities fraud and wire fraud. Cioffi is also charged with insider trading.

According to the FBI, the managers believed in March 2007 that the funds were in risk of collapse, but lied to investors to keep them from withdrawing cash. The evidence also indicates that that they lied about the level of their own personal investments in the hedge funds.

In a separate action called "Operation Malicious Mortgage," 66 people were arrested and 406 defendants were charged, in 144 mortgage fraud cases across the country. Approximately $1.4 billion in losses were inflicted by these mortgage fraud schemes. The people charged included real-estate developers, brokers, agents, appraisers, lenders, lawyers and "straw buyers."

Three types of mortgage fraud were targeted:

In addition, there are many more to come, according to FBI director Robert Mueller.

I would note that these investigations aren't targeting the many homebuyers who lied on their mortgage loan applications to obtain a mortgage that they would never be able to make the payments on.

Circumstantial evidence becomes hard evidence

As I've said many times, there's no doubt that massive fraud has occurred on Wall Street because of the circumstantial evidence.

The banks, ratings agencies and bond insurers who all colluded to give AAA ratings to near-worthless CDOs and other mortgage-backed securities might claim that they didn't realize what would happen in 2002, or 2003, or 2004, or 2005, or perhaps even 2006. But there can be no question that they knew, or should have known, in 2007 that their valuation models were broken. And yet, the rate of abuses actually INCREASED in 2007.

In fact, I would argue that by the time 2007 came around, financial professionals no longer even cared about their investors or about honesty or about who got screwed. If you look at all the actions and statements by financial executives in 2007, vastly many of which have turned out to be disastrously wrong, you can see that they all had one and only one purpose: Preserving their fat bonuses, fees and commissions, irrespective of honesty or professionalism.

There's one very interesting thing about the Bear Stearns indictments: The use of the date March, 2007. It's possible that March, 2007, will be recognized as a major turning point, the time after which no investment banker or financial engineer could credibly claim that these mortgage-backed investments were still viable. Once March, 2007, had passed, every one of these professionals knew, or should have known, that these investments were in trouble, and any positive statements after that date might be considered as potentially fraudulent.

The ubiquity of fraud

The breadth and depth of this fraud identified by the FBI indictment is breathtaking. It's not just a single company, like Enron, nor a narrow range of companies, like the S&L scandal. This has been happening in all financial and real estate services companies, from workers at the bottom to senior managers at the top.

Furthermore, after the Enron scandal, Congress passed the Sarbanes-Oxley Act, which provided the most far-reaching reforms of business practices since the 1930s. This act was supposed to make it harder for companies to lie to investors, but as it turned out, it had no effect whatsoever on the breadth and depth of mortgage fraud. This goes to the heart of Generational Dynamics: Political decisions really have nothing to do with the major great events of the world. It's generational changes that propel history, and politicians can do no more than stand by and watch.

As I've been saying for years on this web site, this can only be explained generationally. This ubiquity of fraud would not have been possible even ten years ago, and is made possible by the lethal combination of the stupidity, blindness and easy corruptibility of Boomers, combined with the nihilism and destructiveness of Generation-Xers.

I would describe the generational situation in terms of "3 C's":

The result is a fourth C - Catastrophe - as we're seeing now in the collapse of the world's global financial system, resulting in massive homelessness, bankruptcies and starvation, and a spur to the coming Clash of Civilizations world war.

(Incidentally, I'm developing an article about the same generational 3 C's when applied to the IT/software development industry. There's no reason why this generational ubiquity of fraud should apply to just one industry.)

So what happens next? To answer that, I'm going to repeat a passage about what happened in 1929. John Kenneth Galbraith described what happened -- and what will happen again -- in his 1954 book, The Great Crash - 1929, as follows:

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

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

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

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

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

And so, what happened in the 1920s has also been happening in the 2000s.

After all, it's been clear since 2004 that we're in a housing bubble -- I said so on this site. There have also been numerous stories in the press about nefarious mortgage practices, but nobody cared much as long as everyone was making money.

But now the social culture is reversing dramatically. Most people don't realize what's going on, unless they read the above excerpt by Galbraith and absorb its consequences. Things are going to get increasingly vicious. Everyone's accounts are going to be examined and audited in detail. Things that were previously ignored will be exposed. People who got away with fraud or embezzlement will be found out after all. Financial advisors who protected themselves while collecting fees and commissions from clients for making bad investments will be come after with baseball bats and shovels.

What we're seeing now is a cultural shift that will last for generations. Boomers will continue bickering with everyone until they die, but Gen-Xers whose nihilism backfired will become increasingly bitter, as the younger Millennial generation begins to take over. It's the cycle of life being repeated, as it has many times before. (20-Jun-2008) Permanent Link
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Royal Bank of Scotland issues global stock crash alert

"A very nasty period is soon to be upon us - be prepared," says the RBS research report to investors, according to an article in Wednesday's Telegraph.

The report advises clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyzes the major central banks. It warns that the S&P 500 index is likely to fall more than 300 points to around 1050 by September, as "all the chickens come home to roost."

This would correspond roughly to a fall of 3000 points in the Dow Jones Industrial Average, to around 9000.

The RBS report also warns that the contagion will spread across Europe and emerging markets.

The report was written by Bob Janjuah, the bank's credit strategist.

"I do not think I can be much blunter. If you have to be in credit, focus on quality, short durations, non-cyclical defensive names. Cash is the key safe haven. This is about not losing your money, and not losing your job," according to Janjuah, whose grim warnings last year about the credit crisis proved all too accurate.

Janjuah's conclusions are based on highly technical considerations, but an article by James Montier of Société Générale, appearing in John Mauldin's newsletter, does a comparison of today's financial marketplace to that of 1929.

This article also draws lessons from the huge Japanese real estate bubble of the 1980s, and the subsequent real estate and stock market crash of the 1990s.

You may recall that real estate prices were in a huge bubble in Japan in the 1980s. The bubble was so huge that the total nominal value of real estate in Tokyo alone, at the height of the bubble, was greater than the value of all real estate in the U.S. at the time.

The following graph from Mauldin's report shows the path of Japanese real estate prices following the crash:

Changes in Japan's land prices (% growth or decline) following 1990 crash (red line) <font size=-2>(Source: Mauldin)</font>
Changes in Japan's land prices (% growth or decline) following 1990 crash (red line) (Source: Mauldin)

As you can see, following the 1990 stock market crash, Japanese real estate prices kept falling sharply for 16 years, only starting to increase again in 2006. I noted this in an article last year: "Japan's real estate crash may finally end after 16 years."

Interestingly, the RBS research was pretty much ignored on the BBC and other mainstream media, except for the Telegraph.

However, an analysis by Financial Times finds broad agreement with the findings, though not with the timing:

"Mr Janjuah’s peers at other European banks agreed it was inevitable that credit markets would deteriorate later in the year, potentially quite dramatically, when large companies started to default on their debt. However, most said that RBS was a touch aggressive in forecasting that turmoil would strike as soon as August.

“[The predictions] are pretty much in line with what we’d expect,” said one strategist, “though we’re not so sure about the timeframe.” He said many struggling companies would be able to limp along into 2009 before falling apart."

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

These are called "generational crashes" because they occur every 70-80 years, just as the generation of people who lived through the last one have all disappeared, and the younger generations have resumed the same dangerous credit securitization practices that led to the previous generational crash. After each of these generational crashes, the survivors impose new rules or laws to make sure that it never happens again. As soon as those survivors are dead, the new generations ignore the rules, thinking that they're just for "old people," and a new generational crash occurs.

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate. (18-Jun-2008) Permanent Link
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Chad and Sudan may be close to a declaration of war

The peace agreement signed in March seems to be falling apart.

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Anti-government rebel forces in Chad an army post and several towns in eastern Chad, near the border with Darfur. According to a Chad government statement,

"After despatching columns of mercenaries to Chad and failing to secure strategic areas, the Sudanese army took matters in its own hands today and attacked Ade, backed up by helicopters.

By openly engaging their troops and air force, Khartoum has finally thrown off its mask, [and Chad's] response will be sterner than Sudan is expecting."

Sudan and neighboring countries.  Sudan has three major regions: Northern Sudan, Southern Sudan, and Darfur (Western Sudan)
Sudan and neighboring countries. Sudan has three major regions: Northern Sudan, Southern Sudan, and Darfur (Western Sudan)

I've described the history of the Darfur war several times, and why the United Nations will be unable to stop it until it's run its course.

It became the focus of international attention in 2004, when millions of Darfur refugees poured across the border into camps in Chad. As the Darfur war spread into Chad, it began to include anti-Chad rebel groups.

Chad and Sudan signed a peace agreement in March, much to the relief of international officials.

The peace agreement lasted until a month ago, when some Darfur rebels staged a dramatic attack on Khartoum, as I described last month. The Sudan government blamed Chad for instigating that attack, and ended diplomatic relations with Chad. In response, Chad closed the border with Sudan. (I'm not sure what "closing the border" means here, since it's a very long unpatrolled border that anyone can cross at any time.)

Now the heat is rising one step farther, as Chad accuses Sudan of instigating and supporting the rebel attacks in Chad and threatens a counterattack.

Up until now, the Darfur war has been isolated within black Africa (also called sub-Saharan Africa), with no danger of spreading into the wider Western world. A war between Chad and Sudan might spread into Libya and/or Egypt, and from there into the Mideast. There's no way of predicting what event will trigger the Clash of Civilizations world war, but a war between Chad and Sudan could possibly become such a trigger.

(18-Jun-2008) Permanent Link
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Europe in 'chaos' as Ireland rejects Lisbon Treaty

The Europeans don't seem to have a clue about what's going on.

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European Union leaders appeared to be in a panicked state of emotional denial on Friday, as it became clear that the Irish voters had rejected the Lisbon Treaty by a referendum vote of 53.4% to 46.6%.

European Commission President José Manuel Barroso said:

"We recognise the Irish vote but ratification from the other member states has to continue. The treaty is still alive, Our position is very clear. Eighteen member states have already ratified the Lisbon Treaty while one rejected it. We must now continue with the ratification process in the other member states while continuing in a collective way to find a solution on how to move forward."

The problem with this idea is that the Lisbon Treaty was already a big political stunt, and what Barroso is saying is, in effect, "Let's look for another political stunt."

As I wrote two weeks ago, the Lisbon Treaty ratification effort is an attempt to get around the rejection of the EU Constitution by France and the Netherlands in two referendums in 2005. The EU politicians decided to draw up a new version of the Constitution, the "Lisbon Treaty," and have it ratified by the legislatures of the 27 member states, instead of asking the hoi polloi what they think.

This political stunt has now failed because Ireland's constitution required a referendum, and because the referendum has now been held and delivered a "No." So Barroso is essentially look for a new political stunt to bypass the Irish vote.

As I wrote last time, my own analysis of the 2005 French referendum vote indicates that the vote is divided along generational lines, with WW II survivors more often voting "yes," and post-WW II generations voting "no." Since the WW II survivors are dying out, there is going to be less and less support for an EU Constitution - or for its replacement, the Lisbon Treaty.

In fact, that's true in Ireland. The Irish voted in 1991 on the "Nice Treaty," a preliminary to the Constitution, and they voted it down. However, the referendum had a very low turnout, so that held another vote in 1992, and this time the vote was "yes," with a very high turnout. That's why some people are suggesting that the Irish might vote again.

But that won't work this time. In last week's Ireland vote, the turnout was very high in the "no" vote, indicating that the mood of the electorate has shifted since 2002 -- and that's because WW II survivors have been dying off.

EU politicians are saying some desperate things.

The German foreign minister says, "Of course we have to take the Irish referendum seriously. But a few million Irish cannot decide on behalf of 495 million Europeans."

To this, the British foreign secretary said, "There is no question of bulldozing or bamboozling or ignoring the Irish vote. The rules are absolutely clear. If all 27 countries do not pass the Lisbon Treaty it cannot pass into law." He added that a "two tier" Europe - with some countries pressing ahead with greater integration and others being left behind - was not "in our interests or going to happen."

This appears to be the first signs of bitter recriminations, such as those that followed followed the 2005 French referendum vote.

If you want to see what's wrong with this whole thing, just take a look at what a member of Malta's parliament said:

"It is bad news for Europe and bad news for Malta as we now stand to lose our sixth seat in the European Parliament.

There is no question that the Irish 'no' vote puts the entire ratification process in trouble. Perhaps the time has come for countries who want to take European integration forward to be able to do so without being held hostage by recalcitrant countries.

Member states who did not want to go along should be free to do so but why should they be able to stop all the rest from moving on.

Perhaps it is time for them to decide whether they want to stay in the European Union."

Here we again see the bitter recriminations building, but note the first sentence: "[W]e now stand to lose our sixth seat in the European Parliament."

Everybody in Europe is measuring this by asking "What am I going to get out of it?" Whether it's farm subsidies or parliamentary power, no one particularly cares about the EU as a whole. It's always "Me, me, me." That's true in the U.S. and other countries as well, as political bickering takes the form of selfish concerns.

When the United States was formed out of the Revolutionary War crisis, a lot of compromises were made, but everyone was desperate for a solution, rather than risk another war with Britain. If America had to vote today on the U.S. Constitution, it would never pass. Certainly Senator Obama would object to many things in it, and would never vote for it.

When Europeans signed the "Treaty of Rome" in 1957, giving birth to the precursor of the "United States of Europe," everyone was desperate to avoid another massive war on European soil.

Today it's just "gimme what I want," with no sense of the importance of the European Union as a whole, and what strategic role it will play in the world.

That's why these people are babbling such idiocy. They don't know what's going on in their own population, so they're pulling stunts to avoid having to let them vote, and then they make ridiculous statements. It would be fantastic to see a European say something credible about where the world is going. Instead, they sit in their easy chairs, enjoy their 35-hour work week, complain about the "Anglo-Saxon model," make pompous statements about "global warming" but do nothing about it, and make pompous statements about the wars in Iraq and Afghanistan, but never live up to their own commitments. No wonder they can't get anything ratified.

I'll just describe one analysis of the Ireland vote, as a further illustration of how up-in-the-clouds these people are.

Exit poll results from 1992 and 2005 French referendums on European Union
Exit poll results from 1992 and 2005 French referendums on European Union

This is an analysis by economist Kevin O'Rourke, appearing on Nouriel Roubini's economics blog.

The adjoining graphic is taken from O'Rourke's posting. The table shown actually uses the same exit poll figures that I used in my 2005 analysis.

Here are the figures that break the "No" vote down by age:

|      |  1992 Maastricht     |      2005 EU        |
|      |    Treaty Vote       |  Constitution Vote  |
| Age  |        "No"          |         "No"        |
|18-24 |         49           |          56         |
|25-34 |         52           |          55         |
|35-44 |         49           |          61         |
|45-59 |         47           |          62         |
|60-69 |         45           |          44         |
|70-   |         **           |          42         |

Now, suppose you take that same table, and fill in the years of birth and generations:

|      |  1992 Maastricht     |      2005 EU        |
|      |    Treaty Vote       |  Constitution Vote  |
| Age  |   Birth    Gen  "No" |   Birth    Gen  "No"|
|18-24 | 1968-1974 GenXer 49  | 1981-1987 Millie 56 |
|25-34 | 1958-1967 GenXer 52  | 1971-1980 GenXer 55 |
|35-44 | 1948-1957 Boomer 49  | 1961-1970 GenXer 61 |
|45-59 | 1933-1947 Silent 47  | 1946-1960 Boomer 62 |
|60-69 | 1923-1932 Silent 45  | 1936-1945 Silent 44 |
|70-   |     -1922 GI     **  |     -1935 Silent 42 |

When you look at it this way, it's perfectly clear what's going on. Between 1992 and 2005, the Gen-Xers and Boomers became far more negative about the EU, while the Silents (WW II survivors) became more positive.

And yet economist Kevin O'Rourke doesn't even look at any of this. This is what I always complain about on this web site, because it drives me crazy. It's what I was complaining about a month ago with respect to the genius economists at Princeton If these high-paid economists at least looked at generational breakdowns, and explained why they disagreed with their importance, then I would be shocked. But this is evidently way too abstract for them to consider. It's just mind-boggling.

So instead, O'Rourke writes mindless stuff about politics, poverty and class, which is the only way these economists can think. He looks ONLY at the "Profession" section of the exit poll figures, and tries to base a political analysis on them. After a lengthy analysis, he finally says, "My claim is simply that economic interests were one factor among many, and should not be ignored." Well, what about generational differences? Why are those being ignored?

Anyway, the defeat of the Lisbon Treaty in Ireland, and the politicians' reactions to it, show that Europeans are nowhere near ready to accept the compromises require to form a union similar to the United States. Once there's a new major European war, as part of the Clash of Civilizations world war, then the Europeans will finally be desperate enough to enact a real Constitution. (16-Jun-2008) Permanent Link
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Shanghai China stock market and Baltic Dry Index are crashing sharply

Developing country economies all appear to be collapsing.

Shanghai stock market index, for two years ending June 11, 2008 <font size=-2>(Source: MarketWatch)</font>
Shanghai stock market index, for two years ending June 11, 2008 (Source: MarketWatch)

Shanghai's Stock Exchange index has fallen to new 14 month lows, as can be seen from this graph.

Investors held a public protest outside the stock exchange building on Thursday, representing millions of individual investors who have lost their life savings. One slogan compares the stock market crash to the earthquake carnage: "More than 100 million investors have been buried in the ruins of the stock market by the earthquake in China's capital markets. Most of them are dying."

I last mentioned the crashing Shanghai stock market in an April 22 posting, but amazingly, it's never even mentioned in the news. Nonetheless, it's a major catastrophe for China.

I've mentioned many times that there's a good chance the China is going to fall off a cliff economically, once the Beijing Olympics games end in August, without knowing whether it's going to be a small cliff or a large cliff. But with the Shanghai market in full-scale crash mode, the evidence is mounting more and more that it's more likely to be a large cliff.

There's very little news being reported about China for the past several weeks, thanks to the devastating earthquake carnage. The earthquake remains a continuing story, thanks to this incredibly dramatic "quake lake" story: the rubble from earthquake landslides blocked water flows, forming an enormous lake that threatened millions of people with drowning if the rubble broke free. It's only been in the last week that Chinese engineers managed to clear the largest quake lake by creating a small channel through the rubble by means of anti-tank weapons.

These incredibly dramatic stories have swamped all other news coverage coming out of China, even Olympics coverage. And yet, the earthquake can only have increased the damage to the Chinese economy related to the stock market.

Baltic Dry Index, for 200 days ending June 12, 2008 <font size=-2>(Source:</font>
Baltic Dry Index, for 200 days ending June 12, 2008 (Source:

Another sign of devastating economic changes in China, this time with a broader global significance, is the crash of the Baltic Dry Index, as illustrated by the adjoining graph. The BDI is a measure of the price of shipping dry goods around the world, and its recent bubble prices have correlated to the bubble growth of the Chinese economy, which has been importing all kinds of raw materials from around the world.

According to a published analysis:

"Cantor Fitzgerald analyst Natasha Boyden said in an interview the significant drop was the result of Chinese iron ore importers working through their stock piles of the commodity instead of bringing more into the country. With the huge demand for iron ore, steel and other commodities carried by drybulk ships soaring, Boyden said Chinese importers turned to their own supplies as ports clogged and drybulk rates skyrocketed.

But Fitzgerald noted that the Chinese only have about three to four weeks worth of iron ore stockpiled. After its resources are used up, Boyden said drybulk ships will again be in high demand to deliver goods to the country.

"This (pull back) is merely temporary," she said. "Painful, but temporary."

JPMorgan analyst Jonathan Chappell said in a client note that he expects the Baltic Dry Index to continue to fall through the third quarter, as the typically slow period will be compounded by an expected lull in trading around the Beijing Olympics and further draw downs of existing inventory by Chinese steelmakers."

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These analyses support my own view that the Chinese economy will be falling off a cliff after the Olympics games. In fact, this fall in the BDI appears to indicate that Chinese manufacturers are already severely cutting back, as the frenzied building activity in preparation for the Olympics is already coming to an end.

According to an analyst interview on CNBC on Thursday afternoon, all the emerging market countries are having serious economic troubles, led by the BRIC (Brazil, Russia, India, China) countries.

According to Peter Stock, President & CEO, Stock Investment Management:

"For some time we've discussed the cracks in the emerging markets story here, starting with Iceland, Vietnam, China. And the latest appears to be Russia. They're running with a 15% inflation rate now, the ruble appears to be breaking out of a band that it's been in for some time in order to combat that inflation. Russia's been the recipient of a lot of hot money flows, as a beneficiary of the carry trade. That story is starting to pop up on my screen.

This week we had the Dong [the Vietnam currency] devalued in Vietnam, stocks down 25 out of 26 days, India raised rates for the first time in 15 months, China stocks remain in a swoon. It's interesting, you know, nobody's really talking about that too much - the stock market's off there about 10% in the past week. Last time that happened, everybody headed for the hills.

[In response to the question: What's the worst case scenario?] I use a pressure cooker analogy. All these emerging economies -- one by one they're being thrown into it. The pressure's building, but unfortunately there's no policy release valve here. The central banks, for whatever reason, are not acting quickly and decisively enough, and appear to have no sign of willingness to do it.

So that raises the risk to me of a crisis occurring in one of these countries -- I'm not quite sure which one -- but I have my guesses -- the obvious choice would be a Vietnam or somebody like that. Then we go to the knock-on effect. I was front-row center for the Asian contagion back in 1997, and frankly I don't want to see that again.

The BRIC wall -- the bricks, one by one are coming down here -- they accounted for half of global growth last year. I'd avoid the asset classes generally for emerging markets, and specifically the BRICs. I mentioned DUG [the exchange-traded fund that bets against oil] before - a good way to short oil. Oil's obviously been a big beneficiary of global growth coming out of these areas. And I'm still bullish on America. I'm underweight emerging markets, and I'm overweight US stocks."

The above comment by Peter Stock describes what he sees is a dangerous, growing problem in emerging markets outside the US, although he sees no particular danger on Wall Street.

I keep talking about "tipping points" on this web site -- spiking oil prices, spiking food prices. In fact, the above interview on CNBC was followed immediately by another story -- the disastrous summer corn crop, raising world corn prices to yet another historic high.

What Peter Stock is describing is tipping points that are being reached in all the emerging market countries. What he doesn't understand is that, unlike what happened in 1997, a collapse in emerging markets will also cause a collapse on Wall Street.

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate. (13-Jun-2008) Permanent Link
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Retail sales surge in May

Americans are still spending every penny they can get hold of.

Economists were surprised on Thursday when Commerce Dept. figures showed that retail sales in May were much higher than expected.

Spending went up across every category -- electronics, appliances, clothing, health care, food or general merchandise and sales rose. People even ate out more.

For several months, economists have been saying that consumers would stop buying. Consumers have been maxing out on credit and have been using money from second mortgages on their homes. As those sources are tapped out, consumers should stop spending, according to economists.

Well, the tax rebate checks started going out in May, and economists are attributing the spurt in retail sales to that. Previously, economists had wondered whether consumers would spend their tax rebates or use them to pay off some of their debt, but that question has now apparently been answered.

And yet, economists are still puzzled, because retail spending had begun increasing prior to the time that the tax rebate checks were sent out. But apparently we even have an answer to that.

According to JP Morgan analyst Tom Lee, there's another possible reason why consumer spending increased:

"The record wave of foreclosures darkening the U.S. housing market may actually be boosting consumer spending....

Many owners are stuck with mortgages that exceed the value of their homes after a double-digit national home price slump in the last two years. Conventional wisdom says owners who are unable to refinance or sell their homes are cash-starved and sharply curbing spending.

But Lee said that as an increasing number of "under water" homeowners return their keys to lenders and walk away from their mortgages and properties the reverse is true.

"In a perverse way, people who are leaving homes are actually helping the consumer spending picture," Lee told the Reuters Investment Outlook Summit on New York.

"If you were under water in a mortgage, and then you walked away, you literally stop paying the mortgage so your actual disposable income goes up," he said."

This is another one of those moments when all I can do is shake my head in disbelief.

At any rate, American consumers are apparently determined to tap every penny they can get their hands on.

This is exactly the complete opposite of the behavior of people who survived the Great Depression. For the most part, those survivors spent their lives saving every penny they could. Today, people are spending every penny they can.

People should be saving every penny. "Instead, there is gaiety and gladness, killing of cattle and slaughtering of sheep, eating of meat and drinking of wine: "Let us eat and drink [and be merry], for tomorrow we die." [Isaiah 22:13]

This shows how the generational cycle works. Once a financial crisis occurs, and we reenter a new 1930s style Great Depression, then people will be furious with themselves for not having saved just a small part of the money they're throwing away today, and they'll change their behavior to save every penny for the rest of their lives. (13-Jun-2008) Permanent Link
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South Korea's government in crisis over beef imports from U.S.

Hundreds of thousands of Koreans held candlelight demonstrations in Seoul on Tuesday, the largest yet of the protests that began a month ago.

Hundreds of thousands of Koreans hold candlelight demonstrations in Seoul <font face=Arial size=-2>(Source: Seoul Times)</font>
Hundreds of thousands of Koreans hold candlelight demonstrations in Seoul (Source: Seoul Times)

The demonstration was dubbed "1 Million-People Candle-Light March" by the organizers, and commemorated the "June 10th Uprising" that occurred on June 10, 1987, when the people staged massive riots and brought down the military government in favor of new elections.

The demonstrations were triggered shortly after Korea's new President, Lee Myung-Bak, took office on February 25. Lee's approval ratings were quite high, as he prepared to meet with George Bush at Camp David on April 19.

Then the roof fell in. Just before the meeting, Lee agreed to lift a five-year-old ban on American beef imports, first imposed in 2003 after a single case of mad cow disease was discovered in the United States.

The demonstrations began on May 2, when hundreds of uniformed schoolgirls held candles in downtown Seoul. The demonstrations kept growing, and by this week, they became so huge that Lee's cabinet offered to resign, putting the entire government into crisis.

The puzzling question is: What the heck is going on? Apparently no one seriously believes that they'll get mad cow disease from American beef, inasmuch as Americans eat American beef all the time. And anyway, even if Korea imports American beef, no one has to buy it or eat it.

The demonstrations don't even seem to be particularly anti-American. As one person commented online, "This is why you never see any anti-US slogans in these protests. The issue is really about Lee Myung Bak and his policies."

So what are these huge demonstrations all about? No one seems to be really certain.

From euphoria to panic

Generational Dynamics studies the attitudes and behaviors of large masses of people, entire generations of people. Any mass change in behavior or attitudes always attracts my attention for study, and that includes episodes of mass euphoria and mass panic. This incident appears to include both.

Consider the following description from a news story:

"The scenes Tuesday illuminated the dramatic shift in President Lee's political fortunes. When he was elected last December, South Koreans hailed him as a long-awaited leader who could salvage their country's alliance with the United States, which was strained under Lee's left-leaning predecessor, Roh Moo Hyun. ...

Aging South Koreans who fought alongside U.S. troops in the Korean War in the early 1950s, took to the streets in joy. They trusted Lee to save the country from what they called "leftist, anti-U.S. and pro-North Korean elements," such as Roh.

On the eve of the meeting with Bush, Seoul agreed to lift a five-year-old ban on American beef imports, first imposed in 2003 after a case of mad cow disease was discovered in the United States. The gesture demonstrated Lee's eagerness to rebuild ties with Washington.

He apparently did not anticipate the reaction at home, especially among younger South Koreans, who had been watching him coldly.

"What he did was little different from an ancient Korean king offering tribute to a Chinese emperor," said Kim Sook Yi, a 35-year-old homemaker who joined the Tuesday protest. "This time we give a tribute to Washington? It's humiliating, bad for education for Korean children."

The demonstrations that began on May 2, when hundreds of uniformed schoolgirls held candles in downtown Seoul, quickly snowballed. By this week, they became so huge that Lee's cabinet offered to resign.

To many South Koreans, the beef dispute was not entirely about health or science. Nor is it entirely about economics; U.S. beef is half the price of Korean. Rather, it is the latest test of whether their leaders can resist pressure from superpowers like the United States, even if that pressure is legitimate, as is the case in the beef dispute. South Korea had promised to lift the ban once the World Organization for Animal Health ruled American beef fit for consummation, as it did in September.

South Korea has built the world's 13th largest economy largely through exports. Still, in a country that has been invaded by bigger neighbors throughout its history, people harbor a deep suspicion about big powers, even allies like the United States.

Koreans in their 40s remember a childhood song handed down from their fathers and grandfathers: "Don't be cheated by the Soviets. Don't trust the Americans. Or the Japanese will rise again." Koreans still chafe at the fact that the United States and the Soviet Union divided Korea into the Communist North and the pro-U.S. South after liberating it from Japanese colonial rule at the end of World War II.

Whether a South Korean leader can navigate such nationalistic sentiment can make or break his career."

None of this makes much sense in rational terms, but it does describe massive changes in generational attitudes:

This is a somewhat contradictory set of reactions to something that really isn't that much of a big deal. Even if it was the first time in a long time that a Korean head of state visited the American president, it still doesn't deserve this kind of extremely emotional reaction on all sides.

The 58 year hypothesis

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The street demonstrations are commemorating the 21st anniversary of 1987 student uprising, as we said, but they're commemorating something else as well:

It was 58 years ago in June, 1950, when the North Koreans attacked Seoul. The world was shocked when the Russian-supplied North Korean People's Army swept south and overwhelmed both South Korean and U.S. forces stationed there, killing and imprisoning many civilians and causing massive starvation.

I've discussed the "58 year hypothesis" several times on this web site. Briefly, it goes as follows: If a disastrous national event occurs, it particularly traumatizes the 5-10 year old children, who remember its horrors for the rest of their lives. 58 years later, when that group reaches age 63-68, and are in senior management positions throughout the country, they cause a panic, often a "false panic."

I don't claim to know exactly how it works, or how the various generational interactions occur, but I do know that I now have sufficiently many very clear examples of such panics that the 58-year hypothesis has to be taken seriously. Some examples include the 1987 stock market panic (58 years after the 1929 crash), the 1976 swine flu fiasco (58 years after the 1918 Spanish flu pandemic), and Israel's 2006 panicked war on Hizbollah (58 years after the 1949 genocidal war between Jews and Arabs). There are a number of other examples as well. What all of these examples have in common is an almost totally irrational panic, triggered by some relatively unimportant event.

What's going on today in Seoul seems to fit the 58-year hypothesis. The dancing in the streets is odd, the over-reaction to lifting the beef imports is odd, and the concern about the American betrayal is odd. All of these concerns relate strongly to the June, 1950, North Korean invasion. Even the beef issue relates to the starvation that occurred in 1950.

For those interested in historical research, the 58 year hypothesis is a potential source of many, many thesis topics. For those inclined to such research, be sure to observe the methodological proscriptions regarding "cherry-picking" that I discussed in a previous article.

Future of South Korea

As we approach the Clash of Civilizations world war, we've been trying, on this web site, to identify which countries will be among the American "Allies," and which countries will comprise the enemy "Axis." We do this by looking at long-term trends in attitudes and behaviors of the masses of people in each country.

Among the likely Allies we have Taiwan, Japan, India, Russia, Israel and Britain. I still consider Iran a likely Western ally for reasons I've stated before. Among the likely Axis countries, we'll have China, Pakistan, Bangladesh, Indonesia, Malaysia, and other Sunni Muslim countries.

But what about South Korea? It's easy to identify trends in the other countries, but it's very hard for South Korea.

This is a country with major conflicting loyalties:

This makes it very difficult to detect a trend one way or the other for South Korea. If the people were forced to choose one side or the other in a war, which side would it be? Based on the information I have today, I don't see a clear direction, and it may actually still be dependent on chaotic events that cannot be predicted. For example, some incident involving Japan might push them towards China, while a North Korean attack might push them toward the West. (12-Jun-2008) Permanent Link
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Ben Bernanke is still the "Man without Agony"

What was he thinking?

In 2005, I wrote something called "Ben S. Bernanke: The man without agony." I contrasted Fed chairman Alan Greenspan with the man who would soon replace him.

I included numerous quotes from both men to contrast Bernanke's "What me worry?" attitude toward economic bubbles with Greenspan's genuine agony over the fact that his gut is telling him that we're headed for a major financial crisis.

So I guess it shouldn't be too surprising that, in a speech given on Monday in Boston, Fed chairman Ben Bernanke said the following:

"Before turning to those issues, however, I would like to provide a brief update on the outlook for the economy and policy, beginning with the prospects for growth. Despite the unwelcome rise in the unemployment rate that was reported last week, the recent incoming data, taken as a whole, have affected the outlook for economic activity and employment only modestly. Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."

This statement is so Pollyannaish that even the normally bubbly anchors on CNBC were incredulous.

Keith Hennessey, director of the National Economic Council, also assistant to the president for economic policy <font face=Arial size=-2>(Source: CNBC)</font>
Keith Hennessey, director of the National Economic Council, also assistant to the president for economic policy (Source: CNBC)

On Tuesday morning, Keith Hennessey, director of the national economic council, was a guest on CNBC and, as an Administration member, he supported Bernanke's statement. He was asked to defend the statement, given that, "Oil's up another 30% from where it was, we've got Lehman Brothers, and hard to get a mortgage credit tightness." His response:

"We always put a lot of stock in what Ben says. Obviously the President has plenty of confidence in Ben. We also think that he's right on the substance of it.

The downside risks do seem to be a little smaller than they were a few months ago. ...

Part of it though is that more time is passed, and we haven't had significant big negative surprises, we haven't had big shocks like we had back in March. Obviously the Lehman news was not good. You've had gradual price increases in oil.

But the more the time goes on and you don't have big negative shocks, the more confidence gradually accumulates."

This statement reminds me of the old joke: A man jumps off a 50-story building. As he passes a window on the 20th floor, someone yells at him: "How are you doing?" His response: "Everything's fine so far!" (11-Jun-2008) Permanent Link
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Lehman Brothers shocks Wall Street with more unexpected asset writedowns

And there may be a smoking gun showing that UBS AG committed fraud.

Lehman Brothers was another investment bank that kept assuring us that they'd been particularly clever in avoiding investments in CDOs and other securities that later turned out to be worthless.

After Bear Stearns, Wall Street's smallest investment firm, imploded in March because of investor panic, and the Fed had to step in and prevent disaster. The historic Fed intervention prevented major worldwide financial meltdown and crisis, as I explained last month. This is not speculation -- Fed chairman Ben Bernanke said as much in testimony before Congress.

Don't they make a lovely couple?  Hedge fund manager David Einhorn and Lehman CFO Erin Callan. <font face=Arial size=-2>(Source: NY Times and Lehman)</font>
Don't they make a lovely couple? Hedge fund manager David Einhorn and Lehman CFO Erin Callan. (Source: NY Times and Lehman)

Since the Bear Stearns implosion, attention immediately began to turn to the next smallest investment firm, Lehman Brothers.

It turned into a personality battle of sorts. David Einhorn, who runs the Greenlight Capital hedge fund, was loudly claiming that Lehman was not valuing the assets on its books, and was not disclosing all the risks. On the other side was Lehman CFO Erin Callan, who has been out front reassuring investors that Lehman was OK.

In April, speculation got so bad that Lehman CEO Richard Fuld sought to calm things by stating, "The worst of the impact on the financial-services industry is behind us."

And so Wall Street was shocked, shocked on Monday, when a Lehman press release (PDF) announced:

"NEW YORK, June 9, 2008 – Lehman Brothers Holdings Inc. (ticker symbol: LEH) announced today that continued challenging market conditions will result in an expected net loss of approximately $2.8 billion ... for the second quarter ended May 31, 2008....

Net revenues for the second quarter of fiscal 2008 reflect negative mark to market adjustments and principal trading losses, net of gains on certain debt liabilities. Additionally, the Firm incurred losses on hedges this quarter, as gains from some hedging activity were more than offset by other hedging losses. ...

Chairman and Chief Executive Officer Richard S. Fuld, Jr. said, “I am very disappointed in this quarter's results. Notwithstanding the solid underlying performance of our client franchise, we had our first-ever quarterly loss as a public company. However, with our strengthened balance sheet and the improvement in the financial markets since March, we are well-positioned to serve our clients and execute our strategy.”"

The loss included a $4.1 billion asset writedown, mostly from CDOs and other residential mortgage backed securities.

This is a preliminary announcement, with the actual earnings announcement scheduled for June 16. Pundits are congratulating Lehman for warning investors early, so they won't be surprised on June 16.

But there's little doubt that Lehman was forced to make this announcement. Investors were getting increasingly nervous, the stock price was falling significantly, and there was increasing fear of a Bear Stearns-type panic.

It's the same old story: Richard Fuld and Erin Callan materially misrepresented the values of their assets for several months. Take your pick: Either they were lying, or they had no idea what the values of those assets are.

Either way, it means that nothing that any financial institution says these days can be trusted.

As we posted in April, Lehman has $200 billion of Level-2 assets and $42 billion of Level-3 assets on its books. These are the CDO and CDS type assets that can't be market to market because there is no market.

(For those interested in the math behind the creation of CDOs from CDSs, see "A primer on financial engineering and structured finance." For a discussion of credit default swap (CDS) counterparty risk, see "Brilliant Nobel Prize winners in Economics blame credit bubble on 'the news.'")

With Monday's announcement, Lehman has written down a total of $8 billion in assets of the $242 billion potential. In Monday's press release, the company made no claim whatsoever that the writedowns are over, and it can be assumed that they have a long way to go.

However, there's some uncertainty about this because Lehman also announced that it had sold off $130 billion in assets. If those assets turn out to be from the $242 billion in Level-2 and Level-3 assets, then Lehman may indeed dig itself out of this hole, albeit as a much smaller company.

A smoking gun for UBS AG?

As I've said often, there's no doubt that massive fraud occurred on Wall Street around the creation of the CDOs and other mortgage-backed securities. The circumstantial evidence is overwhelming. The Wall Street firms might claim that they didn't realize what would happen in 2002, or 2003, or 2004, or 2005, or perhaps even 2006, but there can be no question that they knew, or should have known, in 2007 that their valuation models were broken. And yet, the rate of abuses actually INCREASED in 2007.

Now we may have an actual smoking gun, in the form of a letter indicating that UBS warned some investors of problems, but not others.

The problem was not with CDOs, but with the hare-brained auction rate securities (ARSs) scheme, which has created more trillions of dollars in worthless securities.

The letter indicates that UBS knew that the ARSs were in trouble as early as December, but kept selling them to investors as late as February.

Effect of Ambac/MBIA downgrades will be widespread

Meredith Whitney, director of equity research at Oppenheimer
Meredith Whitney, director of equity research at Oppenheimer

I've frequently quoted Oppenheimer's Meredith Whitney as the best and most honest of the Wall Street analysts. And now, a prediction that she made in February is closer to coming true.

Part of the magic that allowed investment banks to turn CDOs and other nearly worthless mortgage backed securities into "risk-free" AAA rated securities was the "monoline" bond rating agencies, If you're an investment bank issuing questionable bonds, then you buy insurance from an insurer who promises to pay off the bonds if the issuer defaults. That way the bonds are "doubly-protected" -- either the bond will pay off or the insurance will pay off -- thus magically earning an AAA rating.

The three largest bond insurers are MBIA Inc., Ambac Financial Group Inc., and Financial Guaranty Insurance Co. (FGIC). Like any insurance company, they're supposed to evaluate the risk of guaranteeing insurance payouts, and then refuse to provide insurance if the risk is too high. These bond insurers didn't do that. Instead, they ignored the risk and charged fat fees to insure questionable securities without questioning them. This is essentially fraud.

Once the massive writedowns of securities began last Fall, it became pretty clear that the bond insurers had insured many bonds that were turning out to be worthless and shouldn't have been insured. This meant that the bond insurers themselves were on the road to bankruptcy, since they wouldn't be able to pay off all the insurance claims when the CDOs defaulted.

That fact threw into doubt the AAA ratings on corporate debt of the bond insurers themselves. (Keep straight that there are two different things here: The ratings on the bond insurers' own corporate debt, and the ratings on the CDOs that they insure.)

The ratings agencies (Moody's, S&P, Fitch) have been playing a game, stalling as long as possible, keeping the ratings on CDOs and bond insurers' debt at AAA. This is fraudulent, but it's OK because the government is openly encouraging this kind of fraud.

In February, Meredith Whitney predicted that Citibank, UBS and other banks would lose billions of dollars more when the bond insurers lost their own AAA ratings.

This part of the game-playing now seems to be coming to an end. Fitch has already downgraded MBIA and Ambac. Last week on Wednesday, Moody's indicated that a downgrade was near. And on Thursday, June 5, Standard & Poor's downgraded the ratings on MBIA and Ambac, the two largest bond insurers.

According to S&P:

"In our view, the impact of the downgrades on the structured finance market is wide spread... [W]e expect the deterioration of the creditworthiness and the resulting downgrades of MBIA and Ambac, with recent downgrades of other monoline bond insurers, to add to the pressures on certain broker-dealers' and banks' financial performance."

Meredith Whitney was more specific. In a note to investors on Monday, she wrote that Citibank, Merrill Lynch, and UBS AG alone will suffer $10 billion in additional writedowns.

However, the downgrades are expected to cause more widespread "collateral damage." Hundreds of billions of dollars (notional value) of CDOs and other mortgage-backed securities received AAA ratings only because of insurance by MBIA and Ambac. All of these ratings are now in jeopardy, and we can expected substantially more writedowns from other institutions.

The thing to understand from all this is that the credit bubble that was created in the early 2000s continues to leak faster and faster, and the deflationary spiral is growing.

As was shown in the case of Bear Stearns, all of these investments are interlocked in hedge funds, investment funds, and so forth. At some point, a multi-billion dollar loss is going to trigger a chain reaction and massive financial meltdown, as almost happened with Bear Stearns.

And once again, the point is that there's no one left on Wall Street who has any credibility at all. The ratings agencies stalled for months before doing what they had to do, essentially committing fraud in the process. That's the norm today on Wall Street, as everyone covers up to avoid the inevitable.

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate. (10-Jun-2008) Permanent Link
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Stock markets plunge on unemployment and historic oil price spike

Are we near some kind of tipping point?

The world's financial markets became extremely volatile last week, with the greatest volatility occurring on Friday.

Economic indicators worsen <font face=Arial size=-2>(Source:</font>
Economic indicators worsen (Source:

As the adjoining graphic shows:

Add to these statistics the following that I've discussed frequently:

With these dramatic moves beyond historical trend values, there's good reason to wonder if we're reaching some kind of tipping point. Let's explore that concept.

Stein's Law and the Tipping Point

Back in 2002-04, when I was alone in the wilderness predicting a stock market crash and a new 1930s style Great Depression, people who stumbled on this site simply thought I was a nutcase. An argument that was made to me frequently was the following: If you're wrong, you'll never admit it, because all you have to do is claim that the stock market crash simply hasn't happened yet.

Actually that was never true. My conclusions were based on long-term trends that I described last year in "How to compute the 'real value' of the stock market." As I told people in 2003, I would be perfectly happy to admit I was wrong if America's public debt started falling, or if the balance of trade deficit started falling. Since both of these have continued to grow exponentially, I haven't had any reason to change my mind.

The argument that I'm using is based on a semi-humorous law formulated by the late economist Herb Stein:

Stein's Law: If something cannot go on forever, then it won't.

In other words, if something isn't done to deflate the credit bubble gradually, then it must stop growing for some other reason -- namely a crash.

I've been using the phrase "tipping point" a lot in recent months when referring to the meteoric rise in food prices. Rice prices have tripled since January (though they've come down a little from their highs in the last couple of weeks), and the price of food in general has doubled in the last year. With more and more millions of people foraging through garbage dumps just to find enough food to stay alive, this situation cannot continue. (See Stein's Law.)

The commodities bubble

Commodities like oil, wheat, rice and gold are definitely in a bubble. That's easy to prove just by comparing today's prices to the long term historical price trend for each of them.

But there are two distinct kinds of bubbles:

When evaluating these, not all commodities are the same. It's easy to hoard gold, since it takes up so little space, and so it's quite possible that the current gold bubble is caused purely by speculation.

But it's much harder to hoard food, and almost impossible to hoard oil.

In 2004, I posted the article, "Bear Stearns predicts oil prices will fall by almost half." At that time, oil was at $50/barrel, and Bear Stearns (may it rest in peace) was predicting a fall to $25/barrel:

"[Bear Stearns'] reasoning is as follows: During the last year, concerns about oil supplies have caused companies to increase their own private inventories of oil. Indeed, U.S. commercial inventories of crude oil are 5% above last year's level, according to the Wall Street Journal.

Therefore, the Stearns reasoning continues, this almost panic-like stocking up of oil inventories has created an "oil bubble." Once the inventory build-up ends, according to Stearns' research, the actual market fundamentals support only a $25 per barrel price. Prices close to $25 would be maintained even if a terrorist act caused a temporary supply shock, because of the large inventories of oil on hand."

Well, the Bear Stearns prediction certainly didn't come to pass, did it?

I've heard similar claims when oil went to $60 per barrel, then $70 per barrel, then $80 per barrel, but they've never turned out to be true.

There are people today claiming that speculators are hoarding oil, and that without speculators the price would fall to $90, $80 or even $50 per barrel. The problem with that argument is that the hoarded oil would have to be sitting somewhere, perhaps in a thousand huge tankers, and there's no evidence of such hoarding. You can't hoard oil the way you can hoard gold.

The same argument applies to rice, wheat, and other staples. It might be possible for some speculator to rent some huge warehouses and store grain in them, but these price surges have been going on for a couple of years now, and if that were happening then it would have been widely reported in the news by now.

I think it's quite possible that Friday's spike in oil prices was caused by panic buying, and I think it's quite possible that some part of the price of oil -- say $10-20 per barrel -- might be caused by panic buying or speculation. In that case, the price of oil would be about $115-120 per barrel without speculators, still very high. A similar statement could be made about wheat and rice prices.

I can't prove this, but my intuition tells me that some sort of tipping point has been reached -- perhaps a structural limit in the markets that can't be cured in the short run. It might be that all easily available land is used up, or perhaps the worldwide transportation and shipping infrastructure is so overloaded that it's locked up in some way, and can no longer expand in the short run. I think that we're seeing the Law of Diminishing Returns in action. In "normal" times, these situations would be self-correcting in a few months, but some long-term structural limitation is keeping the supply/demand mismatch from clearing up.

The problem apparently is that demand appears to be increasing faster than the supply can increase and faster than the markets can adjust. China and India put hundreds (or is it thousands?) of new cars on the roads every week, and these cars suck up gasoline. China puts two new power plants on line every week. Power plants use coal, but use of oil-based energy is going to increase along with the power plants.

In the case of food, we can be more certain of what's going on because we have published statistics.

On the supply side, a United Nations food summit was held in Rome last week and officials announced that resolving the food crisis would cost $30 billion per year, essentially to spawn a new "Green Revolution", like the one that was launched in 1948. That Green Revolution didn't produce results for almost 20 years, and even if the $30 billion per year could be found, the new Green Revolution wouldn't produce results for at least ten years.

More meat-eating in developing nations <font face=Arial size=-2>(Source:</font>
More meat-eating in developing nations (Source:

On the demand side, there's the diversion of wheat for ethanol, but more important is the fact that people in developing countries are eating more meat. Feeding grain to a cow and then feeding the meat to a human uses up considerably more grain than just feeding the grain directly to the human. And there are close to 4 billion people in China and India alone who are "moving up the food chain" and consuming more meat, milk and maize.

And so, it seems much more likely than not that these price surges, that have been going on for years already, are going to continue. In the case of food, the United Nations has said as much.

This leads us back to:

Stein's Law: If something cannot go on forever, then it won't.

What does Stein's Law mean if the oil and food bubbles cannot be deflated slowly by policy in the short run? It means:

The only question that's left is the timing. The recent spikes in oil and food prices seem very compelling. Things cannot continue this way much longer, although the exact timing cannot be predicted.

Safe deposit boxes

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Just to repeat what I've said many times before: The global financial system is in a deflationary spiral, which means that the amount of money (i.e., the US dollar) in the world is decreasing every day, and the value of this money is therefore increasing. We will see deflation and NOT hyperinflation, as some people are predicting. Thus, for most people, the best investment today is cash or short-term T-bills or FDIC-insured bank certificates of deposit.

Gold is in a price bubble, and makes a very poor investment. Buying gold today costs roughly $900 per ounce plus fees and commissions, and the historical trend value of gold is $300-500 per ounce, which is the amount your gold will be worth after the bubble bursts.

However, if you DO own gold, then you have a problem with how to store it. For example, you can hide it at work or in your home, or you can hide it in a bank safe deposit bank.

A recent blog posting by Michael "Mish" Shedlock is entitled "How safe is my gold?" and describes problems with storing gold in bank safe deposit boxes - that the contents are vulnerable to seizure by government officials.

The article quotes an ABC news investigative article entitled, "Not-So-Safe-Deposit Boxes: States Seize Citizens' Property to Balance Their Budgets," and a a Telegraph article titled "Safety deposit box raids yield £1bn of drugs, cash and guns." Both of these articles describe recent government raids of safe deposit boxes of perfectly innocent people.

If any web site readers have thoughts about how to handle this safety deposit box problem, send them along and I'll post them.

The earnings game begins for the second quarter

Regular readers know that every week or two I post the table of S&P 500 average corporate earnings estimates, based on figures from CNBC Earnings Central supplied by Thomson Reuters. What this table shows is that analysts' earnings estimates can't be trusted.

Here's the final version for first quarter earnings:

  Date    1Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct 23:             +10.0%
  Jan  1:              +5.7%
  Feb  6:              +2.6%
  Feb 29:              -1.1%
  Mar  7:              -4.3%
  Mar 14:              -7.8%
  Mar 21:              -7.9%
  Mar 28:              -9.3%
  Apr  4:             -12.2%
  Apr 11:             -14.1%
  Apr 18:             -14.6%
  Apr 25:             -14.1%
  May  2:             -15.0%
  May  9:             -17.4%
  May 16:             -17.5%
  May 23:             -17.5%
  May 30:             -17.5%

On January 1, at the beginning of Q1, analysts were saying that Q1 earnings would be 5.7% higher than Q1 of last year. Those estimates fell, week after week, and the final results are that earnings were 17.5% lower than Q1 of last year.

Now the earnings estimates for the second quarter are becoming available, and we're starting to play the same game. Here's the table so far:

  Date    2Q Earnings estimate as of that date
  ------- ------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%
  Jun  6:              -7.3%

Analysts started out a little more realistic this time. The first day of the second quarter was April 1, and on that day analysts' estimates were for 2% earnings negative growth.

By this past Friday, June 6, the earnings estimates had fallen to a 7.3% negative growth.

This continued fall in earnings estimates means that either price/earnings ratios will continue to rise into even higher bubble levels, or else the stock market will continue its downward path.

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate. (8-Jun-2008) Permanent Link
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American aid ships are ordered to leave Burma's (Myanmar's) waters

Military junta is using cyclone devastation as cover for violent campaign against Karen minority.

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After more than one month after Cyclone Nargis struck Burma, the U.S. has given up trying to provide aid. The American aid ships, loaded with food, medicines, blankets, tents, and other supplies, have been ordered to sail away from Burma, after repeated failures to gain permission to deliver the aid to cyclone victims.

In a letter from Nobel laureates sent two weeks ago, the Myanmar junta is accused of crimes against humanity. The letter also called on the West to provide aid by force, without waiting any longer for permission:

"By refusing aid, the Burmese regime has effectively declared war on its own population and is committing crimes against humanity. The UK, United States, and France have the capacity to respond immediately. Please use your ships, helicopters, and all other tools within your capacity to immediately deliver humanitarian aid to the people of Burma. We must wait no longer for permission from China and Burma's military regime. The time to save 1.5 million lives is now."

Now there are new charges of crimes against humanity for a different reason: The military junta is conducting a violent and brutal campaign, including killing and torture against the Karen ethnic group, according to Amnesty International. The junta has forcibly relocated almost 150,000 Karen people after burning their villages and destroying their crops.

This apparently answers the question of why the junta has been refusing to allow foreign aid workers to enter the country. The after-effects of Cyclone Nargis are being used as a cover-up for the violence against the Karens.

Unfortunately, the situation in Burma is going to get even worse.

Burma's Irrawady Delta - satellite view prior to Cyclone Nargis <font face=Arial size=-2>(Source: CNN)</font>
Burma's Irrawady Delta - satellite view prior to Cyclone Nargis (Source: CNN)

The adjacent map shows the Irrawady delta as it appeared in a satellite shot prior to the arrival of Cyclone Nargis. The region indicated by the weatherperson shows large near-white areas. These were the rice paddies, the rice bowl, where the nation's food was grown. These areas were all flooded and washed away by the cyclone.

Burma has been running a rice surplus for two years, and was planning to export rice this year. That's in the past. The rice harvest has been lost. In addition, the livestock and equipment that were used to plant and harvest rice have also been lost.

Food used to be plentiful in Burma, but now people are going to starve, with little relief in sight.

From the point of view of Generational Dynamics, this is going to have a HUGE impact on Burma, something that will be a great shock to the military junta, who have completely misread the situation.

As I wrote last September in "Burma: Growing demonstrations by the '88 Generation' raise fears of new slaughter," Burma is in a generational Unraveling era, its last Crisis war having been an ethnic civil war climaxing in 1958. Large demonstrations are typical in Unraveling Eras, but they fizzle out quickly, as happened last September. I said at that time that a new crisis war would not occur at that time, but would probably occur within ten years or so, as the survivors of the previous crisis war disappear.

However, from the point of view of generational theory, the most significant question is whether all of these psychotic actions by the junta will speed up the timeline. This might happen, for example, if the cyclone disproportionately killed older people, in the generation of survivors of the civil war that ended in 1958.

The junta fears a repeat of the bloody, genocidal crisis civil war of the 1950s. What they don't understand is that the actions they're taking might actually speed up the schedule for a new crisis civil war.

What is certain is that the Burmese people are infuriated by what's happening. They are fully aware of the crimes that the junta has committed, including the fact that aid ships from Europe and the U.S. are leaving, taking away all the supplies they brought with them. Whenever the civil war returns, as it must, the junta will learn that their use of violence and torture to suppress rebellion has failed, and that there will be a great deal of revenge-taking against the junta and their supporters. (5-Jun-2008) Permanent Link
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Questions for readers: Managing Boomers vs Generation-X in the workplace.

Also an ethics question: When do you tell the boss that the project is crashing and burning?

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Later this month, I'm giving a talk to a user group on "Generational issues in managing IT projects." I specifically want to focus on issues between Boomers and Gen-Xers. The title refers to "IT projects" (i.e., software development projects), but the generational issues should apply to any group of professionals in any field.

Here's the way I currently see it:

As I described in "Software development projects for Moody's, Digimarc, Y2K, DEC further illuminate Gen-X nihilism," I consider this difference in view to be the highest risk factor in a development project, if management does not address it.

So how does management address it?

I'm looking for real-life anecdotes, as well as opinions and viewpoints on the general problem. Needless to say, anything of yours that I use will be stripped of any personal identifying information.

A separate but related issue is an ethical question I've recently been posing to several people. This is based on personal experience.

In the 1990s, I was working under contract on a project at Fidelity to develop telemarketing software. There were five of us working on the project, each of us developing a different piece. My piece was portfolio rebalancing -- the user interface where the client would specify what percentage of his money was to go into each asset class, and the back end algorithmic software that would generate the buy/sell orders to bring his portfolio into balance. The other four people were working on other pieces.

The idea is that we'd each spend three months working on our pieces, and then we'd put them all together to have a complete working system.

(As an aside, this is a common mistake that software development managers make. They divide a software development project up into components, assign people to work on each component, and assume that the components will all work together at the end. This is a VERY common mistake, and it's the main reason for that old saying, "The first 95% of the project takes the first 95% of the time, and the last 5% of the project takes the remaining 95% of the time.")

So I went in on a Sunday, and spent a couple of hours doing a little mini-QA project. (QA = quality assurance.) I tested out each component, and I tried to get them to work together. I identified 82 different bugs and issues, some trivial, some major. I put them all into a memo, stating my opinion that the project would slip 3-6 months. On Monday, I gave the memo to my supervisor, who gave it to his manager.

Well, the s--t hit the fan. The manager was absolutely off-the-wall furious at me, and was screaming at me in his office. A couple of weeks later I was fired, and a couple of months later the entire project crashed and burned -- not at all to my surprise. A few months after that, I ran into a consultant who had left the project before I did. He told me that he had quit the project because he, too, realized it was headed for disaster.

My point of view is that I was a consultant working for a boss whose project was going to crash and burn, and that as a consultant I had a moral and professional obligation to tell him that. I still feel that way today, although of course I now realize that my view is typical of the sense of "moral superiority" that many Boomers have.

Still, what other choice did I have? I've asked several people about this, and one said that it would have been better for me to resign and not tell anyone, just as the other consultant did. The reasoning, I guess, is that it's not up to the consultant to disturb the client's plan, even if it's wrong. At least I think that's the reasoning. And also, when the last Shuttle disaster occurred, there were stories coming out of Nasa employees who had warned of problems but who had been ignored or fired.

Anyway, so I'm asking you readers this question as well: What should I have done? More generally, when should a consultant or employee tell his boss that the project is headed for disaster? What should he do if he's afraid that he'll be fired just for saying so? And what should a manager do when an employee gives him that news? In your answers, does it make a difference if you're talking about a telemarketing application program versus a project where lives are at stake?

As in the previous question, I'm looking for philosophical opinions and rants as well as real-life anecdotes. Anything I use will have personal identifying information removed. You can write to me at , or else use the "Comment" link at the top of every page. (5-Jun-2008) Permanent Link
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A clearer explanation of credit default swaps.

How credit default swaps (CDSs) present a systemic risk to the global financial system is explained in a recent article by economics journalist Martin Hutchinson, writing for The Bear's Lair.

You should read the entire article, but I'll just comment on a couple of things about it.

"Under a CDS, one bank promises to pay another bank money if a particular debt obligation of a third party borrower defaults. The precise definition of “default”, the mechanism for calculating the amount of money payable and the extent to which the deal relates to general debts of the third party or to one particular obligation all vary between CDS, as do the maturity and amount. There is thus no easy mechanism whereby a liquid securities market could be created in CDS, since the differing terms of each transaction tend to make them un-substitutable."

The point is that each CDS is a unique contract between two people (two banks). Since these contracts aren't standardized, it's impossible to be sure that any two of them have the same value. Thus, they're not like stock shares in a corporate, where each share is equal in value to any other. Therefore, it's difficult or impossible to determine the values of an CDSs in an institution's portfolio.

(For those interested in the math behind the creation of CDOs from CDSs, see "A primer on financial engineering and structured finance." For a discussion of credit default swap (CDS) counterparty risk, see "Brilliant Nobel Prize winners in Economics blame credit bubble on 'the news.'")

"[In] a severe credit crisis, the potential losses on credit derivatives may indeed approach ... 10% of $62.3 trillion or $6.23 trillion, several times the capital base of the entire US banking system, more than the current total of Federal government debt outstanding and about 40% of a year’s US Gross Domestic Product. That would make a credit derivatives crash far larger in monetary terms and somewhat larger in terms of the economy than the Japanese banking problems of the 1990s, which caused 13 years of recession in that country."

This is the crucial point. There are $62.3 trillion of these CDSs out there. A 10% failure would not be surprising in case of a severe credit crisis, and it would have catastrophic effects.

The most amusing paragraph is this one:

"It is clear what has led to the tottering and bloated nature of the credit derivatives market: the perverse incentives of Wall Street. Senior traders are rewarded with “drop dead money” – amounts that enable them to leave the business at any time, financially secure for life, with only the distant threat of long-term imprisonment to deter them. Since the financial services industry also works excessive hours, allowing little time for reflection and intellectual stimulation, a high proportion of its inmates become possessed with a monomaniacal urge to accumulate the cherished “drop dead money.”

This is the contradiction. If senior traders faced even the "distant threat of long-term imprisonment," then what they did is already illegal, and it doesn't make any difference whether new laws and regulations are implemented.

It never dawns on anyone to ask why so many people -- in every organization, at every level -- committed some kind of fraud for their own personal gain, or at least condoned such fraud. People in my parents' generation would not have done this.

The housing bubble was caused by massive fraud throughout the entire financial and real estate industries, from top to bottom, whether it was homeowners lying on their applications, construction firms colluding with appraisers and brokers to get kickbacks by over-valuing homes, lenders who resold mortgages without checking any of the claims, lenders who adopted predatory lending practices, granting loans to people with no hope of making payments, investment banks that securitized loans based on the assumption that real estate prices would rise forever, ratings firms and monoline insurers that took fat fees to lie about these potentially worthless securities.

The only possible explanation for such ubiquitous debauchery is generational. There's no other way that it could have reached every corner of every financial and real estate organization except in the contemptuous attitudes of nihilistic Generation-Xers, perpetrating fraud right under the noses of their stupid Boomer bosses, who condone the crimes because they also gain. This lethal combination of Gen-X nihilism, combined with Boomer stupidity is what got us where we are.

Here's an investigative story from the The Milwaukee Journal Sentinel, a case study in "liar loan" fraud in which one person after another commits fraud:

"As housing prices were rising year after year, lenders across the country had eased underwriting standards. As a result, many homebuyers were able to secure high-interest loans without disclosing such basic information as their employment, income or assets. The real estate boom stalled, and many subprime borrowers found themselves unable to refinance or sell their homes.

In Medellin's case, the deal wouldn't have been possible without the motley collection of individuals and firms eager to get a piece of the 8.75% loan and the fees that went with it."

The article goes into a great deal of detail, but the bottom line is this: There isn't a single person in the story who had any moral or ethical standards. It was one crook after another.

I've gotten several e-mail messages in the last couple of weeks asking me why I sometimes sound so "angry." I was asked, "Why are you so angry today?"

Anyway, the reason I was "so angry" that day is because I'm angry every day. The stench of corruption and fraud is overwhelming, and the coming disaster will be the worst in history. After writing this web site for six years, I don't know how I could be anything BUT angry.

What I've discovered in the last couple of years has shocked me beyond belief. The depth of financial debauchery is staggering. If someone had told me even 2-3 years ago what I would find, I wouldn't have believed it possible. I can hardly believe it's possible now, but there's no doubt about it.

In Hannah Arendt's study of the Nazi Germany in the book, The Origins of Totalitarianism (p. 335), she describes the enormous level of corruption at the time, and how it was reflected in Bertolt Brecht's play, The Three-Penny Opera [Dreigroschenoper], which presented gangsters as respectable businessmen and respectable businessmen as gangsters. The theme song for the play was "Erst kommt das Fressen, dann kommt die Moral," best translated as "First comes gluttony, then comes morality."

Today, financial institutions are openly avoiding providing realistic market values for their CDO and CDS assets, and they're continuing to defraud investors and the public. All we can do is hope that the "distant threat of long-term imprisonment" turns into an immediate threat, since we're in the same place today as Germany was in the 1930s: there's no difference between respectable businessmen and gangsters. (4-Jun-2008) Permanent Link
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Ireland may block Lisbon treaty for new European Union in June 12 vote

Those opposed to ratification appear to be gaining ground, according to some news reports.

Here's the latest polling data:

    How would you vote in the referendum on the Lisbon Treaty?
    |         | May 21 | May 7 | Apr. 23 |
    |Yes      | 41%    | 38%   | 35%     |
    |No       | 33%    | 28%   | 31%     |
    |Not sure | 26%    | 34%   | 34%     |
    Source: Red C / Sunday Business Post

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The "Yes" vote is still ahead of the "No" vote by 41% to 33%, but politicians are concerned that the "No" vote is increasing faster, and that over one quarter of the polled voters still answer "Not sure."

(When one choice in a poll is "politically correct" and the other isn't, there's an inclination for those favoring the second choice to say "Not sure," rather than admit they favor the choice that's not "politically correct.")

The rejection of the Lisbon Treaty would be yet another major blow to the entire "EU project" that was almost completely derailed in May, 2005, when voters in France and the Netherlands voted "No" to ratifying the proposed EU constitution. The Lisbon Treaty is an attempt to accomplish, with a treaty, the main elements of the Constitution that EU politicians believe are necessary for functioning of the EU government.

That voting "Yes" is the politically correct choice is apparent by the fact that all mainstream media outlets are evidently in the tank for it.

Here's how Germany's Der Spiegel describes the situation:

"The future of the European Union now hangs on how the voters in this small country on the far western edge of Europe vote on June 12. And with less than two weeks to go to polling day, the referendum debate has been hijacked by issues that have little to do with the Lisbon Treaty. While many have accused the campaign against the treaty of being aggressive, populist and misleading, the reality is that it has also been pretty successful."

You can see from the wording how Ireland is described disdainfully as "this small country on the far western edge of Europe," and how the treaty's opponents are described as "aggressive, populist and misleading."

An article in Times Online doesn't take sides, but describes the negative effects of a "No" vote:

"Several politicians stand to be big losers if Ireland votes “no”. Angela Merkel, the German Chancellor, has staked her reputation on reviving the failed constitution. The French President Nicolas Sarkozy is due to preside over the appointment of the EU president and foreign minister when his country assumes the rotating presidency for six months in July. A “no” vote would potentially wreck his cherished EU presidency — including plans to enhance European defence capabilities.

Perhaps the man with most to lose is José Manuel Barroso, the European Commission President, whose claims to a second term rest on implementation of the Lisbon treaty."

The rocky road to an EU government

Once upon a time, in the early 2000s, the "European Union project" and the EU Constitution seemed like sure things. Everyone was in favor of them, because they would create a unified country, just as the United States had been unified in 1789 by its Constitution (assuming that you forget about what happened in 1861).

The French referendum in May 2005 changed all that and shocked everyone, when voters rejected the proposed EU constitution.

June 2005: Jean-Claude Juncker, Tony Blair, Jacques Chirac
June 2005: Jean-Claude Juncker, Tony Blair, Jacques Chirac

At an acrimonious European summit meeting in June 2005, British Prime Minister Tony Blair, Luxembourg Prime Minister Jean-Claude Juncker and French President Jacques Chirac exchanged vitriolic accusations over how the EU budget, especially the agricultural subsidies, were to be divided among the EU members. Six months later, Tony Blair caved, and only that way could an interim EU budget agreement be reached.

These events completely derailed the "EU project" plans, and sent EU leaders back to the meeting rooms to figure out what to do next.

They initially decided on an education campaign so that voters would accept the EU constitution next time.

The generational factor

European politicians, journalists and analysts are completely oblivious to the generational factors controlling the "European project," even though the generational factors are so obvious that you'd have to be blind to miss them.

During the run-up to the 2005 French referendum, young people were quoted as worrying that low-paid East European workers would come to France and take all the jobs; the symbol adopted by opponents of the constitution was the low-paid Polish plumber who comes to France and steals a job away from a well-paid French plumber.

But there was a different kind of opinion expressed by an elderly French voter to a BBC reporter: "My grandfather fought in World War I. My father fought in World Wars I and II. I fought in World War II. And now, for 60 years, my children and grandchildren have lived in peace. That's a good enough reason to me to vote 'yes' on the Constitution."

Last year, a news report quoted a 50-year old man as saying, "My parents had experienced two wars before (the EU was founded). My father lost his brother. I have the opportunity to live in peace here."

These quotes show anecdotally what the generational differences are. Those who favor the EU project, usually older generations, see it as a way of preserving peace; those who oppose it, usually younger generations, see it as costing them money and jobs.

I've never seen a published analysis that acknowledged this obvious fact, or its obvious consequence: That the EU project is becoming less and less popular, as generations that survived World War II disappear.

Breakdown of French vote by income, May 2005 <font size=-2>(Source: WSJ)</font>
Breakdown of French vote by income, May 2005 (Source: WSJ)

All the published analyses focus on income and class. Why did poor people vote this way, and rich people vote that way? Why did upper and lower classes differ? Magazine articles can go on for pages discussing this stuff, and then reach sanctimonius conclusions about why the upper classes are preying on the lower class. The adjoining graphic, published on page 1 of the Wall Street Journal just after the vote, is typical.

This is all total, utter nonsense. It's totally meaningless.

Many people go through periods in life when they're doing well financially, and other times when they're in trouble financially. But do their major political opinions change as their incomes go up or down? I don't know anyone who's like that.

What DOES matter, as I've shown over and over and over and over on this web site, is that whether you're rich or poor, upper or lower class, it matters much less than what generation you were born into.

That's certainly true of attitudes towards the EU project, as I showed in my own analysis of the French referendum vote. I was able to find an age-based breakdown of the referendum exit polls, as well as the results of the 1992 vote on the Maastricht treaty.

When you look at the age-based votes, you immediately see that the split is between those who born during or before World War II versus those born after. Older generations voted in favor of the constitution (because they believe that it will bring peace), and younger generations voted against it (because they believe it would cost them money).

And that also explains the income graphic displayed above: Older people make more money than younger people, and that's why people with higher incomes are more likely to vote "Yes."

How stupid do all these politicians, journalists and analysts have to be not to see something so obvious?

And once you realize what's going on, you also realize that the Constitution is not going to be ratified by the people of Europe. The more time goes on, the more opposition will grow, since there will be more people from post-war generations. It's hardly more complicated than that.

The Parliamentary work-around

When Nicolas Sarkozy took office as President of France in May of last year, he immediately flew off to Berlin to meet German Chancellor Angela Merkel, to begin work on one of his campaign promises: To lead the effort to develop a "mini-treaty" that will provide some of the changes that Constitution would have provided, but few enough changes so that a new referendum can be avoided altogether.

It's a great idea: If the people refuse to vote in favor of what you want, then find a way to get what you want without letting the people vote.

The elements of the Constitution would be reworked into a treaty, and the treaty would be ratified by the various parliaments of the 27 EU member countries. Sarkozy hoped to get it all done by June of last year.

That didn't happen, of course. Things moved more slowly in many countries' legislatures. Only 14 EU nations' parliaments have ratified the agreement to date, and it's hoped that 12 more will do so by the end of this year.

That leaves Ireland. Sarkozy's grand plan may founder because Ireland's Constitution does not permit simple parliamentary ratification of this treaty. A referendum is required, and it's scheduled for next week on Thursday, June 12.

The issues

One theme that I keep coming back to on this web site is that, in country after country that fought World War II as a crisis war, the governments are becoming increasingly paralyzed.

Whether it's South Africa, France, America, Japan, China, Europe or Israel, the government is unable to do anything because of internal bickering.

This current situation with the Lisbon Treaty is a good example of why it happens.

After a crisis war, the survivors are all unified in their determination that nothing so horrible should ever happen again. Very often, this determination is stated as President Truman did in 1947 in his Truman Doctrine as a money issue: that no matter how much it costs to prevent another crisis war the cost is far less than the cost of the crisis war itself. This is part of the debate today over the Iraq war, as its cost is measured against the cost of a full-scale world war.

About 60 years after the Crisis war ends, the generations of survivors are almost all gone, and the post-war generations have no such determination. They're worried more about costs than in preventing a new world war. Since the old generation leaders can't handle these attitudes, they become paralyzed.

The full text of Lisbon treaty is available online, if you care to read it. But if you do, you'll be one of the very few who have done so. It's long, it's boring, and it's just a laundry list of stuff.

That's why the Lisbon treaty is in trouble, according to a letter to the editor:

"We are hearing quite a few arguments against the Lisbon Treaty -- such as the loss of our commissioner for at least five out of 15 years, the primacy clause, and so on.

I have noticed that every time any 'Yes' campaigner is challenged on any of the concerns raised, they simply deny that these issues are a problem or contend that they don't exist at all.

[Ireland's foreign affairs minister Micheál] Martin especially has become particularly fond of the phrase "That is simply not true".

I also notice that no concise reason for voting 'Yes' is being communicated to the public, nor is any evidence being offered to back up Government denials.

As a citizen, I believe it would be grossly irresponsible of me to vote 'Yes' because a politician says it is "Good for Ireland, Good for Europe".

Why is it good for Ireland?"

Since almost nobody has read the Lisbon Treaty, and few people know what it's about, it's an easy target for various kinds of accusations:

Each of these issues has a response that begins with "That is simply not true," as the above letter-writer describes, but the problem is that there's no comparable list of benefits to Ireland if the treaty is ratified. The question, "Why is it good for Ireland?" has never clearly been answered.

Thus, the New York Times reports in its Sunday paper, "European Bloc at Standstill Pending Vote in Ireland":

"Referendums are always dangerous, and almost all countries decided not to have one on the Lisbon Treaty, which requires the approval of all 27 member nations of the European Union to come into force. But the Irish did not shy away, and the prospect of how they might vote has caused jitters across many capitals. ...

And with opinion polls showing much of the Irish electorate undecided, the possibility that the Lisbon Treaty may be rejected has sent unfamiliar tremors of fear through the ranks of Europe’s top bureaucrats, who rarely have to trouble with voters.

This has brought a kind of unacknowledged but collective halt on anything controversial, particularly if it might upset Irish sensibilities."

The future of the European Union

I always like to say that great ideas are born and developed during Awakening eras, and are either implemented or killed off by Crisis wars, and that's certainly true of the European Union project.

England, France and Germany have had numerous bloody genocidal wars with one another over the centuries, especially since 1066, and the vitriolic arguments that occurred in the June, 2005, EU summit meeting showed that the bitter feelings between France and "Anglo-Saxon society" still exist.

It was on March 25, 1957, that the "Treaty of Rome" was signed, giving birth to the precursor of the "United States of Europe." The objective was specifically to prevent yet another European war.

The European Union will almost certainly come into existence as a powerful, unified nation, but not before there's another crisis war. The younger generations today are too worried about costs, and not worried enough about the next world war. All that will change when the world war actually occurs, and tens or hundreds of millions of Europeans are exterminated, as has happened so many times before. After that, people will be willing to listen to reason.

From the point of view of Generational Dynamics, the outcome of an election depends on chaotic events that can't be predicted, and so it's impossible to predict the outcome of the June 12 Irish referendum on the Lisbon Treaty. But the trend is so clear that we can at least say that history is on the side of rejecting the treaty, and that even if the treaty is ratified, a lot of it will never be implemented. (2-Jun-2008) Permanent Link
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"Lost tribe" found in Amazon forest on border of Peru and Brazil

Aerial photos show them aiming bows and arrows at small plane taking the photos.

Lost Brazilian tribe preparing for battle with small airplane photographing them <font face=Arial size=-2>(Source: CNN)</font>
Lost Brazilian tribe preparing for battle with small airplane photographing them (Source: CNN)

A Brazilian government agency has released photographs of a "lost tribe," an indigenous tribe thought to have had no contact with the outside world.

The group releasing the photos advocates for the rights of "uncontacted people" to remain uncontacted. They released the photos in order to protect the people from intrusion.

"These pictures are further evidence that uncontacted tribes really do exist," said the group's director. "The world needs to wake up to this, and ensure that their territory is protected in accordance with international law. Otherwise, they will soon be made extinct."

From the point of view of Generational Dynamics, the interesting question is this: Why were the tribe members preparing for war against the airplane?

Lost tribes have generational timelines, just like everyone else. They have crisis wars, just like everyone else.

Maybe one day, centuries ago, a few people from this tribe went off and built a camp in another valley, essentially creating a second tribe. Maybe both tribes grew larger and larger, they had to compete for resources, they had a genocidal crisis war, and one exterminated the other. That's what happened in mfecane in South Africa, for example.

So what generational era is this lost tribe in? Recovery era? Awakening era? Unraveling era? Are they in the middle of a crisis war? Did they just finish such a war in the last few years?

Why are there so few people in the pictures? Are they the only survivors of a recent genocidal war with the tribe from the next valley? And by the way, where did they learn about bows and arrows?

In trying to guess where they might be on the generational timeline, it's not hard to imagine a scenario that might work in any generational era. For example, maybe their wives heard the plane flying around, and demanded that the men go out and defend their families.

My guess, based on the sparseness of the population and their readiness for warfare, is that they're the survivors of a crisis war in the last ten years, and that it substantially reduced their population.

And that brings us to the issue of all the hand-wringing about not disturbing this lost tribe.

Why not? Why shouldn't we intrude? Since they have bows and arrows, they obviously have wars and war wounds, as well as various illnesses, and don't we as human beings have a moral obligation to them to provide them with modern medicine?

And hunting for food must be awfully dangerous, with the snakes, spiders and stuff in the Amazon rain forest. If we provided them with a McDonald's, then they could just eat there rather than having to risk their lives to feed their familes.

And if we built a shopping center for the tribe, then the wives could go shopping, which would make them happy, and then the wives would make the husbands happy, so they wouldn't have to have as many wars. Isn't that our moral obligation as human beings? Isn't that better than letting them remain "uncontacted"?

Anyway, here's an Al-Jazeera video of a news story on the lost tribe:

(1-Jun-2008) Permanent Link
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