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

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Web Log - August, 2008

Summary

Presidential election debate continues to focus on 1960s issues

21st century issues are being totally ignored, so far.

I love irony, and so I'm absolutely thrilled about the choice of Alaska governor Sarah Palin as the Republican Vice Presidential candidate:


Sarah Palin in photoshopped <i>Vogue</i> magazine cover <font face=Arial size=-2>(Source: Kodiak Konfidential blog)</font>
Sarah Palin in photoshopped Vogue magazine cover (Source: Kodiak Konfidential blog)

To me, as a person who dislikes politicians and was expecting to find the campaign increasingly boring, this is all hilarious and extremely enjoyable. I expect it to remain enjoyable until Palin gets boring or until she starts making gaffes and flames out.

All the issues being argued about in this election are from the 1960s generational Awakening era: feminism (women's lib), racism, generational change. Even the Iraq war as an issue is a reflection of the antiwar / Vietnam War debate.

(For information about generational Awakening eras, see "Basics of Generational Dynamics." For more information about the 1960s, see "Iraq Today vs 1960s America.")

There isn't a single bit of this that's at all relevant to what's coming. What's important today are things like the gathering storm in the Caucasus, the meltdown of the country of Pakistan, and the accelerating financial deflationary spiral. A crisis in any one of these areas would be enough to instantly remove feminism, racism, and Iraq from the public discussion, and there will be crises in all three areas.

Does it make any difference who's elected? It's hard to see how. It's true that Palin and Obama have little real experience. And it's true that I've called Biden the stupidest man in the Senate, with good reason: He wanted to stop the Iraq "surge," and send 2200 American troops into Darfur. And it's true that McCain has the most experience that's relevant to the first two of the three issues listed above.

But these potential crises are all completely new, and unlike anything that very few people alive today have ever seen before. There is nothing in past experience that could prepare any of the candidates for any of these crises, and so there's no predictable effect that the election of either candidate could have on the outcome of these crises.

Just as today's major political issues were leftovers from the 1960s Awakening era, the major political issues of the 1960s were leftovers from the WW II 1940s crisis era. The big issue in the 1960 election was over how the US should respond to a Chinese attack on the Taiwanese islands of Quemoy and Matsu. John Kennedy won in 1960, but got into trouble on 1940s-type Crisis era issues -- the Bay of Pigs disaster in Cuba, the Cuban missile crisis, the Vietnam war. The Administrations of Kennedy, Johnson and Nixon all foundered because they failed to recognize and deal with the new 1960s Awakening era issues -- women's lib, racism, antiwar, etc. It didn't matter which of Kennedy, Johnson or Nixon was elected -- they all made similar mistakes, because none of them had any experience with the new issues.

The same will be true today, no matter whether Obama, McCain, Palin or Biden is President. They're all focused on the 1960s issues, and none of them has a clue how to deal with the new Crisis era issues that are right around the corner. Any one of them will make many major mistakes, just as President Lincoln did in the Civil War, and Franklin Roosevelt did in WW II. However, the good news is that our enemies will also make many major mistakes, and at least we have the hope that they'll make worse mistakes than we will. (31-Aug-2008) Permanent Link
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China rebuffs Russia over Georgia invasion.

What could the Russians possibly have been thinking?

A couple of days ago I saw a news article with the title, "Medvedev Seeks Support From China, Allies on Georgia." My immediate reaction was that Medvedev will get support on the Georgia invasion from China when pigs fly.

The Chinese Communist Party (CCP) is the most paranoid group of politicians on earth. They're afraid of secessionist movements by the Tibetans in Tibet, by the Muslim Uighurs in Xinjiang, and by the Taiwanese. They're also afraid of rebellions by their own people.

There was never a snowflake's chance in hell that China would support the Russians in declaring the independence of the two Georgian provinces, of Abkhazia and South Ossetia.


Shanghai Cooperation Organization group meeting in Dushanbe, capital of Tajikistan. <font face=Arial size=-2>(Source: Xinhua)</font>
Shanghai Cooperation Organization group meeting in Dushanbe, capital of Tajikistan. (Source: Xinhua)

The Russians had hoped that a meeting of leaders of several Asian countries of the Shanghai Cooperation Organisation (SCO) would side with Russians against the West. After all, it was to oppose Nato and the west that the SCO was formed.

After the meeting ended, Russian President Dmitry Medvedev claimed victory by saying, "We are sure that the position of SCO members will get an appropriate international response. I hope it will serve as a serious signal for those who try to turn black into white and justify the bloody adventure of the Georgian leadership."

Actually, the meeting was a significant political rebuff of Russia.

The statement issued by the SCO insisted on the need to preserve "the unity of a state and its territorial integrity," and that "placing the emphasis exclusively on the use of force has no prospects and hinders a comprehensive settlement of local conflicts.

A web site reader wrote to me:

"I'm a British student living in Belgium. I have been reading through your website and the draft of your new book with great interest and I think you've more or less convinced me; however I have one big problem with your prediction of a clash of civilizations world war. In light of all its conflicts with the EU and the US in the years since 1991, its growing ties to China and its massive historical and cultural differences with Europe and the West; is it not more likely that in any upcoming world war Russia will be against us? I've looked down the list of weblogs and couldn't find anything describing why they would be on our side."

The differences between Russia and the West have always been purely political. There is no visceral hatred or xenophobia between the West and Russians. The Russians particularly love the Europeans.

Here's a graphic that I created several years ago. It's a tiny bit out of date but it illustrates the points we want to make:


Major Crisis Wars
Major Crisis Wars

This graphic shows some of the major crisis wars of the last millennium. North America is the column on the left, Western Europe is the column in the middle, and Eastern Europe is the column on the right.

In the column on the right, you'll notice that I have three wars displayed in grey: "Great Northern War v Sweden," "Napoleon invades Russia," and "Hitler invades Russia." These are the three great wars where Europeans invaded Russia. All three of those wars were non-crisis wars for the Russians, but occurred during major crisis wars for the Europeans (the War of the Spanish Succession, the Napoleonic Wars, and World War II, respectively). And Russia won all three of those wars in pretty much the same way: Let the invading enemy go deep into Russia, where the frigid Russian defeated the invaders. There was never a genocidal Russian attack on Europe. As I said, Russians love Europeans.

Russians do not love the Chinese. Ever since Genghis Khan and the Mongols swept through Western Asia in the 1200's, the Russians and their Asian neighbors have not gotten along. The Mongols conquered Turkey, the Caucasus, and much of Russia before being driven back. Mongol descendants influenced or became part of the cultures of several Sunni Muslim populations in the Mideast, as well as in China itself. The Mongol invasions targeted the Russians and Hindus alike, and so the Russians and Indians are viscerally allies against the Mongol progeny in Pakistan and China.

Most people believe that China and Russia love each other because they both had Communist Revolutions. Actually, they had different kinds of Communist Revolutions and they didn't support one another. The only thing they had in common was that their leaders, Josef Stalin and Mao Zedong, join Adolf Hitler as the three most bloodthirsty, genocidal psychopaths of the 20th century.

In fact, take a look at the 1960s CIA intelligence report on the Sino-Soviet split. Many people in the intelligence field believed that China and Russia were close to thermonuclear war at that time.

Of course, generational theory tells us that couldn't really have happened, since neither country was in a generational Crisis era at that time.

But BOTH countries are in generational Crisis eras today. Either of their populations would happily exterminate the other's. They get along politically only because they both wish to oppose the United States and the West politically, but when they're forced to choose, they'll choose to fight each other. (29-Aug-2008) Permanent Link
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Moscow Times: "Russia Adds 2 New Countries to Its Map"

Relations between Russia and the West became colder on Tuesday, when Russian President Dmitry Medvedev announced that he had signed a decree recognizing the breakaway Georgian regions of South Ossetia and Abkhazia as independent states.


Russian President Dmitry Medvedev, announcing that he had signed the decree <font face=Arial size=-2>(Source: Moscow Times)</font>
Russian President Dmitry Medvedev, announcing that he had signed the decree (Source: Moscow Times)

Medvedev said that it was necessary to protect the indigenous Ossetians and Abkhazians from "genocide" by the Georgians. "This is not an easy decision, but this is the only chance to save people's lives," Medvedev said.

President George W. Bush demanded that Russia reverse its "irresponsible decision." Similar statements came from several European leaders.

It's startling how quickly relations between Russia and the West have deteriorated, in just three weeks.

What's become clear in these three weeks is that there isn't much visceral hatred between Georgians and Russians. The Georgians are furious that the Russians are occupying Georgian territory, but there's no genocidal fury between these two ethnic groups.

What's also become clear, however, is that there is plenty of genocidal fury between Georgians and Ossetians. These two ethnic groups really hate each other, and either of them would gladly exterminate the other.

The Russians see their role as keeping the Georgians and Ossetians from killing each other, causing a war that would ignite the entire Caucasus. The Russians still have a collective memory of the massive civil wars of the 1920 that slaughtered tens of millions of people. To the Russians, the Georgians and Ossetians are beginning to replay those events. Thus the Russians see the need to play peacekeeper, keeping their troops within Georgia proper, and now declaring South Ossetia (and Abkhazia) to be separate nations.

For the West, the collective memory is very different -- of Hitler, World War II, and Stalin. To the West, Russia is replaying those events.

These collective memories don't come from politicians. They come from hundreds of millions of people in the Russia and the West. It's these collective memories from hundreds of millions of people that are driving events in the Caucasus. That's why it makes no difference how much political pressure the Russians and the West put on each other; it's like trying to close a gate to stop a tsunami.


Troubled areas in Caucasus region - including Dagestan, North Ossetia and Chechnya in Russia, and breakaway regions of Abkhazia and South Ossetia in Georgia
Troubled areas in Caucasus region - including Dagestan, North Ossetia and Chechnya in Russia, and breakaway regions of Abkhazia and South Ossetia in Georgia

If you enjoy ridiculous political machinations, then you'll love the current debate of so-called "international law" on this issue.

In February, the West allowed Kosovo to secede from Serbia. The Russians were strongly opposed, citing "territorial integrity" of Serbia, while the West called it a "special case."

Now the positions are reversed. It's the West that's citing "territorial integrity" of Georgia, while the Russians are calling this a "special case." So-called "international law" is just about the silliest stuff around.

But this business of secessionist provinces is extremely serious stuff. Remember that the American Civil War, an extremely bloody and genocidal war, began when the South moved to secede from the United States in 1861.

There are several regions shown in the Caucasus map above that are secessionist problems. Chechnya, Ingushetia and Dagestan have Muslim separatist movements that would like to see those provinces secede from Russia. Nagorno-Karabakh in Azerbaijan is an Armenian enclave that the Armenians would like to see secede.

In India, you have Kashmir, where there is a strong independence movement among the Muslims. There's Tibet in China, there's Xinjiang in China, and let's not forget possibly the most explosive one of all -- Taiwan wants to secede from China.

Any of these situations could ignite a larger war, just as the secession of the South launched the American Civil War.

This is the stuff of generational Crisis wars. As long as there were people around who remembered the horrors of WW II, the populations were willing to live happily, and avoid making trouble by trying to secede. But now, with most of the world entering a generational Crisis era, and with few WW II survivors still around, it's time for people to learn their lessons again, as the world lurches toward the Clash of Civilizations world war. (27-Aug-2008) Permanent Link
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Pakistan's government coalition dissolves following dispute over Taliban

As fighting rages in Pakistan's tribal areas, the coalition formed by the two parties that forced the resignation of former President Pervez Musharraf has collapsed.

The collapse came after the government banned the Taliban group, Tehreek-e-Taleban Pakistan (TTP), that claimed responsibility for the massive suicide bombing attack last Thursday at a large munitions factory near Islamabad, the nation's capital.

It's not clear whether the "ban" will have any actual effect on TTP, or whether it's simply symbolic.

But, as expected, last Thursday's terrorist attack has had a powerful effect on Pakistani politicians and people, and is becoming a "regeneracy" event.

(For information about the term "regeneracy," see "Basics of Generational Dynamics.")


Bajaur in Pakistan's  Federally Administered Tribal Areas (FATA) in the scene of increasing warfare between the Taliban and Pakistan's army <font face=Arial size=-2>(Source: cfr.org)</font>
Bajaur in Pakistan's Federally Administered Tribal Areas (FATA) in the scene of increasing warfare between the Taliban and Pakistan's army (Source: cfr.org)

Parliamentary leader Asif Zardari, widowed husband of the assassinated Benazir Bhutto, and head of the Pakistan People's Party (PPP), has acted indecisively toward the Taliban until now. Pakistan's army, was entirely on its own in fighting a massive battle in the Bajaur region of the tribal areas. Now the army is gaining political support from Zardari, and this is a big change.

Nawaz Sharif, head of the Pakistan Muslim League-Nawaz (PML-N) party, split with Zardari shortly thereafter, blaming the split on "unkept promises" by Zardari. However, as I've pointed out in the past, Sharif is one of the group that tends to blame the terrorist violence on Musharraf's relationship with America, fighting the war on terror. Thus, it seems most likely to me that the differences in attitude toward the Taliban are the main cause of the split, after Thursday's terrorist attack.

Recall that Zardari is Shia Muslim, and that the father of his slain wife, Benazir Bhutto, was one of the leading Shia figures in the early days of Pakistan's independence. Sharif is Sunni Muslim, as are the Taliban.

The Pakistan government is disintegrating right before our eyes, at a time of maximum danger, when a major war is going on in Bajaur, and rioting is increasing in Kashmir. As the regeneracy advances, the days of easy compromise have ended, and positions on all sides will continue to harden. (26-Aug-2008) Permanent Link
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Money supply contracts dramatically, as credit markets continue to seize up.

Former IMF chief: Worst of global financial crisis is yet to come.

I'm grateful to several web site readers this week who sent me references to different articles and blog entries all saying the same thing: That the amount of money in the world has been contracting sharply in the last few months.

There have been three closely related stories in the past week:


UK housing price index from mortgage lender Halifax <font face=Arial size=-2>(Source: Telegraph)</font>
UK housing price index from mortgage lender Halifax (Source: Telegraph)

These three news stories are all related to the same thing: That the global financial system is in a deflationary spiral, and there is less money in the world each day than there was the day before. One web site reader put it this way: "Seems like deflation is right around the corner despite persistent hysteria about inflation among the general population."

Related Articles

Deflation vs Inflation
The spectre of deflation forces a historic change in economic theory: Economists are shocked that the fight against inflation is over.... (8-Nov-2008)
What's coming next: Understanding the deflationary spiral: Why are the dollar and the yen getting stronger, while the euro is getting weaker?... (27-Oct-2008)
Roubini: The situation is "sheer panic," as hundreds of hedge funds are going bust: Policy makers may need to close markets for one or two weeks.... (24-Oct-2008)
There's never before been a day like this on Wall Street.: Possible exception: One of the days just before or after the 1929 crash.... (11-Oct-2008)
Ben Bernanke's Great Historic Experiment is at the brink: Desperation sets in as credit markets continue to seize up.... (25-Sep-2008)
Government promises to buy bad debt to end the credit crisis: Stock markets stage huge comeback as giddy investors pile in.... (19-Sep-2008)
Web site readers express sadness, anxiety and anger: It's beginning to sink in.... (18-Sep-2008)
Another stunning and historic bailout: Fannie Mae and Freddie Mac: Giddy investors are popping the champagne corks.... (9-Sep-2008)
Long-term negative market trends asserting themselves strongly: Stock and commodities prices plummet as worldwide foreclosures and recessions worsen.... (5-Sep-2008)
Money supply contracts dramatically, as credit markets continue to seize up.: Former IMF chief: Worst of global financial crisis is yet to come.... (24-Aug-2008)
As commodities plummet worldwide, the meaning is unclear.: We speculate on some possibilities.... (11-Aug-2008)
Alan Greenspan calls this a "once in a century" liquidity crisis.: Says that the "big surprise" is the "impressive" American economy... (3-Aug-2008)
More questions from readers on finance and investing: Anxious readers wonder what's going on, what to do next.... (18-Jul-2008)
Pundits and analysts are baffled by the market's performance: They have some interesting fantasies, as well.... (10-Jul-2008)
Questions from readers on finance and investing: On fraud, the FDIC, China, and other subjects.... (23-Jun-2008)
Royal Bank of Scotland issues global stock crash alert: "A very nasty period is soon to be upon us - be prepared,"... (18-Jun-2008)
Ben Bernanke is still the "Man without Agony": What was he thinking?... (11-Jun-2008)
A clearer explanation of credit default swaps.: How credit default swaps (CDSs) present a systemic risk to the global financial system... (4-Jun-2008)
WSJ's page one story on Bernanke's Princeton "Bubble Laboratory" is almost incoherent: So is Thursday's speech on bubbles by Fed Governor Frederic S. Mishkin.... (18-May-2008)
Brilliant Nobel Prize winners in Economics blame credit bubble on "the news": Meanwhile, the deflationary spiral is in progress, but hyperinflation is not.... (27-Apr-08)
Investment bank UBS is now "writing down" clients' auction rate securities: From individual investors to tech firms, people are losing their money.... (29-Mar-08)
Both consumer and commercial credit is disappearing as deflationary spiral accelerates: Wall Street markets plummet 3% on Tuesday, as service sector contracts sharply.... (6-Feb-08)
Will hyper-inflation make the dollar worthless (like the Weimar republic)?: I've gotten this question several times this week from web site readers,... (21-Dec-07)
Questions and answers about the "credit crunch": What's going on, and what you can do about it.... (6-Dec-07)
Understanding deflation: Why there's less money in the world today than a month ago.: As the markets continue to fall, the Fed is increasingly in a big bind.... (10-Sep-07)
Bernanke's historic experiment takes center stage: An assessment of where we are and where we're going.... (27-Aug-07)
Ben Bernanke's Great Historic Experiment: Bernanke doesn't believe that bubbles exist. His Fed policy will now test his core beliefs.... (18-Aug-07)
Japan's real estate crash may finally end after 16 years: To see where America is going, look what happened in Japan.... (20-Feb-07)
This week's financial data points to trend back toward deflation.: Several inflationary indicators are down for June... (17-Jul-04)

For those who wish to understand this better, please refer to the accompanying list of "related articles." A good place to start is "Understanding deflation: Why there's less money in the world today than a month ago."

The collapse of M3 since February is one of the most dramatic pieces of evidence yet of the deflationary spiral.

There's also plenty of anecdotal evidence about the worsening credit squeeze. I recently spoke to an accountant who told me that American Express has frozen the long-time accounts of three of her clients. American Express is cutting off credit to its own customers.

M3 has become somewhat controversial, since the Federal Reserve announced in 2005 that it was discontinuing the computation and reporting of M3. This has led to a number of conspiracy theories that the Fed was hiding information from the public for dire reasons, even though several private firms are now making their own M3 computations available to the public. See http://shadowstats.com for a current chart.

I look at the M3 question a little differently than most.

When I was studying economics in the 1970s, I learned that M1, M2 and M3 meant the following:

"M1 = Money that can be spent immediately. Includes cash, checking accounts, and NOW accounts.

M2 = M1 + assets invested for the short term. These assets include money-market accounts and money-market mutual funds.

M3 = M2 + big deposits. Big deposits include institutional money-market funds and agreements among banks."

These definitions made sense in the 1970s when I was studying them, as did concepts like the velocity of money. But when you're in a credit bubble, as has been the case since 2002, they make no sense at all.

For example, money in money market funds is counted in M2 and M3. What about money in other kinds of funds that are "just as good" as money market funds -- like funds backed by auction rate securities or CDOs? What about funds backed by credit default swaps (CDSs) or other credit derivatives?

Back in the 70s, when I was learning this stuff, there were clear boundaries between different kinds of money. There were few credit cards around, and most credit was clearly defined.

Today, there's no way in practice to distinguish between money and credit. Money "created" by credit can be spent in exactly the same way as printed money. If a bank has money provided by the Fed's discount window, and another bank has money provided by depositors, then it's money either way, and can be loaned to borrowers to spend.

Money created by the alchemy of CDOs or credit derivatives is still money. You can't buy groceries with a CDO security, but you can use the security as collateral for a loan of money that you can use to buy groceries. And with $700 trillion in credit derivatives in the world, there's no longer any real meaning to M3.

And so I don't view the Fed's discontinuance of publishing M3 figures as a major international conspiracy to fool the public. I view it as acquiescing to the obvious -- that M3 has no real meaning in a credit bubble. Once the credit bubble has dissipated over the next few years, then measuring M3 will make sense again, and the Fed will probably start doing it again.

A web site reader asks the following about the recent news about the collapse of M3:

"This plays well into your thesis I suspect. I don't doubt that history repeats itself but what is interesting to me is how it is playing out right now. As a test of the robustness of your theory, what is the next thing to happen when the gov't bails out freddie/fannie (which seems inevitable)? At some point I figure the dollar value deflates (even more) as the balance of financial power shifts elsewhere and the central bank has to raise interest rates just to pay its enormous debt."

If I could reliably predict the "next thing to happen," I wouldn't tell you guys -- I'd just use the information to become millionaire.

The best list of "next things to happen" was provided by Nouriel Roubini's "12 steps to financial disaster" in the current financial crisis. I summarized Roubini's 12 steps in an article last April. However, Roubini doesn't always get it right. He didn't get the housing bubble until 2006, even though it was obvious (and was discussed on this web site) in 2004. By 2005, Alan Greenspan was mentioning it, but Roubini and other mainstream economists ignored it.

This web site uses generational theory to make predictions based on long-term trends. I was telling people in 2002 that we would be entering a new 1930s-style Great Depression, and at that time I didn't know what a "collateralized debt obligation" or an "auction rate security" was. All I knew was that the stock market was overpriced by a factor of over 200%, and that generational theory showed we were overdue for a major stock market crisis.

(For an explanation of why the stock market is overpriced, see "How to compute the 'real value' of the stock market." For an explanation of why the credit bubble didn't create massive inflation, see the discussion of the "crusty old bureacracy theory" in "Greenspan to increase interest aggressively.")

What we're seeing today is that the the world financial system is now careening toward the fulfillment of the predictions made in 2002. This had to happen. It could not be either caused nor prevented by Alan Greenspan, George Bush, or anyone else. It was caused by a lethal combination of incompetent Boomers and nihilistic Gen-Xers: The Gen-Xers created the financial instruments necessary for the fraudulent activities leading to the credit bubble, and Boomers who were supposed to be managing the Gen-Xers instead encouraged the fraudulent activities so that they could all make money.

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. (24-Aug-2008) Permanent Link
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Pakistan government crisis deepens, following Musharraf's resignation

The government is completely rudderless as suicide bombers shock the country.

(My computer went down this week, leaving me way behind on a lot of stuff -- both articles and e-mail. I hope to catch up in the next few days.)

The fantasy among Pakistani people has been and continues to be that all of Pakistan's troubles were caused by President Pervez Musharraf's relationship with the United States in fighting the war against the Taliban in Afghanistan. And so, the fantasy continued, as soon as Musharraf was gone from the Presidency, Pakistan's troubles would disappear. It would be change you can believe in, no matter who replaced Musharraf.

Unfortunately, the Taliban aren't cooperating.


Bajaur in Pakistan's  Federally Administered Tribal Areas (FATA) in the scene of increasing warfare between the Taliban and Pakistan's army <font face=Arial size=-2>(Source: cfr.org)</font>
Bajaur in Pakistan's Federally Administered Tribal Areas (FATA) in the scene of increasing warfare between the Taliban and Pakistan's army (Source: cfr.org)

There have been several major terrorist attacks in Pakistan since Monday. The latest occurred on Thursday, in the town of Wah, just outside of Islamabad, Pakistan's capital. Two suicide bombers simultaneously attacked two separate entrances of a large manufacturer of munitions at shift change time. 70 people were killed.

Earlier in the week, on Tuesday, a suicide bomber in the Swat Valley in NorthWest Frontier Province (NWFP) killed 59 people in a hospital emergency room, in an attack on Shiites. (The Taliban are Sunni extremists, allied with al-Qaeda.)

At the end of the week, on Saturday, four people were killed in two suicide bombings, again in the Swat valley.

The Taliban have claimed responsibility for these attacks, saying that it's in retaliation for the Pakistan army's military campaign against the Taliban in the tribal regions.

According to BBC reporter Owen Bennett-Jones, the entire country is in denial about what's going on. He describes a period of increasing danger to the entire country, including new terrorist bombings, but the people don't talk about it, the politicians don't talk about it, and the media don't talk about it. The coalition government, having control of the Parliament, and now having driven Musharraf out of office, don't want to deal with the violence at all. According to Bennett-Jones, the coalition government is simply telling the army to do what it wants. The army is coming back and complaining that the politicians have to do their part by educating the public about what's going on.

In fact, political opinion in Pakistan appears to be split on the Taliban/al-Qaeda question. Some groups, including both the protesting lawyers and many Urdu-language newspapers, are openly supporting al-Qaeda and the Taliban against the Pakistani government.

In fact, the reinstatement of the country's Supreme Court justice, who was suspended by Musharraf early last year, remains a major source of political haggling in the coalition government in Parliament.

So, with Parliament haggling over political trivia while the NWFT burns with suicide bombings and warfare, I'm always reminded at times like this of how when the Muslims were approaching the center of Constantinople for the final conquest of the Byzantine Empire in 1453, the people of the Senate were having a lengthy political debate about whether angels were male or female.

At any rate, the Parliamentary coalition appears to be falling apart. The victory of Musharraf's opposition in February caused a great deal of euphoria, as it was believed that the new government would negotiate with the Taliban and al-Qaeda and bring an end to the violence. Instead, violence has been steadily increasing. Then it was hoped that the resignation of Musharraf would end the violence, but the events of the last week seemed to have dashed those hopes.

The two coalition leaders are:

Zardari and Sharif hate each other, but they've been united in their mutual hatred for Musharraf. But now that they've brought down Musharraf, their differences have become more important, and this is hindering their ability to name a candidate to replace Musharraf as President.

As leader of the PPP, the party with the largest representation in the government, Zardari is the logical choice. However, Sharif doesn't want to give Zardari the full level of power that Musharraf had, and wants Zardari to accept the presidency with less power. A long-time correspondent of mine from Pakistan put it as follows:

"Just to add to your knowledge, a new president will most likely be some one from Pakistan People Party (the ruling Bhutto party headed by Asif Ali Zardari). You are right in saying the new president will be some one younger and/or less knowlegeble/competent than the existing one. BUT the reason obviously will be Zardari's urge to maintain his control without himself becoming the president (Zardari has a very poor image even among PPP supporters). Yes the country, now, indeed seems to be in trouble. Iam afraid your predictions months back are proving right. I dont know if I should congratulate you on that."

However, late Saturday, the news is that Zardari is agreeing to run for President, although the details of the agreement with Sharif are not yet known.

It may be that the events of the last week have brought Pakistan close to a full regeneracy.

Recall that, in generational theory, the "regeneracy" is an event or series of event that end the political bickering and unify the country behind the leader. In a country where there are fault lines between different ethnic or religious groups, the regeneracy solidifies the unity of each of the groups. It's called the "regeneracy" because civic unity is "regenerated" for the first time since the end of the previous crisis war.

(For information about the term "regeneracy," see "Basics of Generational Dynamics.")

Among the Pakistani people, February's euphoria has now been shattered, and more and more people are beginning to understand that their country and their way of life is coming under attack. This switch from euphoria to anxiety or panic among masses of people tends to make people take extreme positions, and that can lead to a regeneracy.

In fact, this does appear to be happening, according to an editorial in the Lahore-based Daily Times:

"Editorial: ‘Mind-forming’ effect of terrorism


"Two suicide attacks kill 70 ..." -- Sabir Nazar <font face=Arial size=-2>(Source: Daily Times)</font>
"Two suicide attacks kill 70 ..." -- Sabir Nazar (Source: Daily Times)

Two suicide bombers blew themselves up outside Pakistan’s main army munitions factory at Wah on Thursday, killing 70 workers in “the deadliest attack on a military installation in the country’s history”. The Tehreek-e Taliban Pakistan (TTP) owned the attack, its leader Maulvi Umar saying, “Our bombers carried out today’s attack. It is in reaction to military operations in Swat and Bajaur. Similar attacks will be carried out in other cities of Pakistan including Lahore, Islamabad and Rawalpindi”.

Prime Minister Yousaf Raza Gilani’s reaction was that Pakistan had to “take the war on terror to extremists’ doorsteps because it cannot be won on the defensive”. Mr Rehman Malik, adviser to the prime minister on security, said, “Some foreign hands might be involved in terror activities in DI Khan, Kurram Agency and Swat”. On the other hand, the leader of Jama’at-e Islami, Qazi Hussain Ahmad, asked the government to “pull out troops” from the Tribal Areas and bring “relief” to the displaced persons of Bajaur, Kurram and Waziristan.

Many Urdu newspapers have begun to reverse the incidence of mobilisation in the Tribal Areas. Instead of saying that troops have been sent to the Tribal Areas in response to terrorism, they editorialise that suicide-bombing trouble in the big cities has started after the troops were sent into the Tribal Areas. Thereafter, some have squarely placed the blame on the policy of following the “American diktat” in a negation of Pakistan’s sovereignty. Most TV anchors on Thursday night followed the same cue. On Thursday too, protesting lawyers in Lahore were seen holding placards bearing pro-Al Qaeda slogans for the first time since their protests for an “independent judiciary” began.

Clearly, the Pakistani mind is changing under pressure from the Al Qaeda strategy of suicide bombing. In the same week, Al Qaeda struck. ...

The Pakistani mind is turning pro-Al Qaeda in the same measure as it is turning against the government in Pakistan. The fundamental reason is the inability of the state to protect its citizens and assert its writ on its territory. Past military strategies have caused the state power to decline in relation to those that it allowed to wage jihad. Unless the state fights back with all the means at its disposal and defeats the terrorists, it will be seriously endangered. And the final shock will come, not from Al Qaeda, but from the economy which is slowly giving up the function of sustaining Pakistan’s population."

Thus, from the point of view of Generational Dynamics, we could be seeing a major shift of public opinion in Pakistan. This could be the reason why Zardari suddenly agreed to run for the Presidency, but it also could mean that violent fault lines are close to some kind of explosion.

Meanwhile, in the India-controlled portion of Kashmir, tens of thousands of Muslims in a new generation of young Kashmiris are now demonstrating violently against the Indian government, demanding independence from India. As of today, these growing demonstrations are India's problem. But with events moving so quickly, something could happen at any time to make them Pakistan's problem.

There's a tough contest going on these days between Pakistan and the Caucasus over which is the most dangerous region in the world. Today, with things in Georgia seeming to be settling down for the time being, Pakistan is once again the winner. (23-Aug-2008) Permanent Link
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Price/earnings ratios continue to surge as corporate earnings plummet

Second quarter earnings were disastrous.

As regular readers know, 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 final table for second quarter earnings:

  Date    2Q Earnings growth estimate as of that date
  ------- -------------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%   Start of quarter
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%   End of quarter
  Jul  3:             -12.4%
  Jul  8:             -13.0%
  Jul 11:             -14.7%
  Jul 18:             -17.1%
  Jul 25:             -17.9%
  Aug  1:             -20.4%
  Aug  8:             -22.1%
  Aug 15:             -22.0%

You can see that, as the second quarter earnings season ends, and actual earnings are available, earnings are 22% lower than they were last year. We should start to have third quarter earnings estimates next week.

A fall in earnings estimates means an increase of price/earnings ratios estimates. Here's the Friday's version of the graphic that appears on the bottom of the home page of this web site:


S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 15-Aug-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 15-Aug-2008. (Source: MarketGauge ® by DataView, LLC)

As you can see, P/E ratios (also called "valuations") have returned to really astronomical heights.

We're now "celebrating" the one-year anniversary of the worldwide global credit crisis.

As a measure of that celebration, here's an interesting graph from a blog at the Federal Reserve Bank of Atlanta:


Libor - OIS spread, January 2007 to August 2008
Libor - OIS spread, January 2007 to August 2008

LIBOR is the London InterBank Offered rate. It represents the interest rates that banks charge one another for 30 or 90 day loans.

The OIS is the Overnight Index Swap rate, and it represents the interest rates that banks charge each other for overnight loans.

The difference (or "spread") between LIBOR and OIS measures the willingness of banks to loan money to one another for more than overnight. If I don't trust you, then I might still risk loaning you money overnight, but for any longer period I'd charge a much higher interest rate. The size of that interest rate is a measure of my distrust.

Prior to August, 2007, the Libor-OIS spread was pretty much flat at 6 basis points (or a 0.06% interest rate difference). With the credit crunch, the spread skyrocketed, reaching 110 basis points (1.10% interest rate difference) on December 4. Now it's still much higher than historical rates, meaning that the credit crunch is far from over.

That shouldn't be surprising, because continually have to write down more and more worthless assets. According to one analysis:

"Banks' losses from the U.S. subprime crisis and the ensuing credit crunch crossed the $500 billion mark as writedowns spread to more asset types.

The writedowns and credit losses at more than 100 of the world's biggest banks and securities firms rose after UBS AG reported second-quarter earnings [on August 12], which included $6 billion of charges on subprime-related assets."

The following table shows the asset writedowns and credit losses as well as the capital raised in response. All numbers are in billions of U.S. dollars. Check out your favorite bank:

        Firm               Writedown & Loss      Capital Raised
        Citigroup                 55.1               49.1
        Merrill Lynch             51.8               29.9
        UBS                       44.2               28.3
        HSBC                      27.4                3.9
        Wachovia                  22.5               11
        Bank of America           21.2               20.7
        IKB Deutsche              15.3               12.6
        Royal Bank of Scotland    14.9               24.3
        Washington Mutual         14.8               12.1
        Morgan Stanley            14.4                5.6
        JPMorgan Chase            14.3                7.9
        Deutsche Bank             10.8                3.2
        Credit Suisse             10.5                2.7
        Wells Fargo               10                  4.1
        Barclays                   9.1               18.6
        Lehman Brothers            8.2               13.9
        Credit Agricole            8                  8.8
        Fortis                     7.4                7.2
        HBOS                       7.1                7.6
        Societe Generale           6.8                9.8
        Bayerische Landesbank      6.4                -
        Canadian Imperial (CIBC)   6.3                2.8
        Mizuho Financial Group     5.9                  -
        ING Groep                  5.8                4.8
        National City              5.4                8.9
        Lloyds TSB                 5                  4.9
        IndyMac                    4.9                -
        WestLB                     4.7                7.5
        Dresdner                   4.1                -
        BNP Paribas                4                  -
        LB Baden-Wuerttemberg      3.8                -
        Goldman Sachs              3.8                0.6
        E*Trade                    3.6                2.4
        Nomura Holdings            3.3                1.1
        Natixis                    3.3                6.7
        Bear Stearns               3.2                -
        HSH Nordbank               2.8                1.9
        Landesbank Sachsen         2.6                -
        UniCredit                  2.6                -
        Commerzbank                2.4                -
        ABN Amro                   2.3                -
        DZ Bank                    2                  -
        Bank of China              2                  -
        Fifth Third                1.9                2.6
        Rabobank                   1.7                -
        Bank Hapoalim              1.7                2.4
        Mitsubishi UFJ             1.6                1.5
        Royal Bank of Canada       1.5                -
        Marshall & Ilsley          1.4                -
        Alliance & Leicester       1.4                -
        U.S. Bancorp               1.3                -
        Dexia                      1.2                -
        Caisse d'Epargne           1.2                -
        Keycorp                    1.2                1.7
        Sovereign Bancorp          1                  1.9
        Hypo Real Estate           1                  -
        Gulf International         1                  1
        Sumitomo Mitsui            0.9                4.9
        Sumitomo Trust             0.7                1
        DBS Group                  0.2                1.1
        Other European banks       7.2                2.3
        Other Asian banks          4.6                7.8
        Other U.S. banks           2.9                1.9
        Other Canadian banks       1.8                -
                                   ____              ____
        TOTAL                    501.1              352.9

As one online correspondent wrote, "I would compare the current economy to a house of cards. Cards are being yanked out from the bottom-it won't be much longer before the whole thing collapses."

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. (19-Aug-2008) Permanent Link
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A possible new alignment in Europe and Central Asia

Russian language blogs provide a complex and threatening picture.

I'm grateful to a web site reader for sending me the following message, that I received just as I was finishing up my article, "The gathering storm in the Caucasus":

"Reading through Russian language blogs (with some very well informed participants), I have a feeling [that they expect] some kind of overhaul in South Europe - Caucasus region - Middle East politics. The main idea is to minimize US and NATO influence by bringing together Turkey, Russia and Iran as major players. Turkey military, traditionally West leaning and anti-Islamic being promised to keep upper hand in new nationalist, moderately religious, economically independent state, which doesn't have to bow to EU anymore. Iran and Russia providing energy for industry and markets for goods.

Whoever joins this union is accepted. Others, especially financially and politically dependent on US and EU, will be crippled by sanctions (energy supply infractions). All these new pro-western. pro-liberal elites in the former USSR and Eastern Europe are considered the main targets of Russian foreign policies. With a serious economic crisis unfolding, the West going to be less prone to back these small countries with funding.

First, Slovakia, Bulgaria, Serbia and Hungary will take different approach. Others will follow or fall (Estonia and Latvia, but not Lithuania). The Kurds, probably, will gain independence in North Iraq, but not US-oriented. Israel will sign multiple peace agreements, giving away [Golan Heights] and providing for Palestinians better territorial conditions.

Important part: Given the relations with Azerbaijan and Central Asia - all Muslim and turkish-like nations. Most unexpected outcome - Much wider spread of moderate, Sunni Islam all over Russia with support from Orthodox church and government structures. Some politics see this as only choice to stop dying off Russian population in Northern Russia."

This message provides a picture of a very complex Russian plan to counter U.S. influence in Russia's backyard, and to punish East European "élites" for siding with Europe and the U.S.

According to this message, based on postings by knowledgeable Russians, Turkey, Russia and Iran form an anti-West alliance and use their control of gas and oil supplies to gain hegemony over Western allies.

There are a couple of very interesting things that particularly are worthy of more research. First, we've frequently discussed radical "Islamist" Sunni Islam -- al-Qaeda, the Taliban, Muslim Brotherhood, Jemaah Islamiah in Indonesia, GSPC (Salafist Group for Preaching and Combat in Northern Africa), and so forth.

However, Turkey and some central Asian countries are also Sunni Muslim, but not allied with the al-Qaeda groups. According to the message, these groups will ally with Russian Orthodox community.

The message closes by referring to what many see as a huge Russian problem today: The negative growth of the Russian population.

What's missing from this analysis is the same thing that's missing from Western analyses: The recognition of a coming world war. Everyone is assuming that things will continue to evolve in the same manner as before. Regular readers of this web site know that that isn't going to happen.

The three nations forming this new alliance -- Turkey, Russia and Iran -- are all countries that I would expect would be allied with the West against China, Pakistan, Bangladesh, and others in the coming Clash of Civilizations world war. The exact nature and timing of these alliances of course cannot be predicted, since they depend on chaotic events that can't be predicted. But if this message is correct, then it illuminates an important scenario that the world will be following in the coming months. (18-Aug-2008) Permanent Link
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"The deal is done" for Pakistan's President Musharraf to resign

Pakistan looks into the abyss.

A week after being threatened with impeachment, Pakistan's President Pervez Musharraf appears to be close to resignation.

According a front-page article in Pakistan's prestigious Daily Times, "The deal is done." Musharraf will be permitted to flee to a foreign country.

Who will replace Musharraf? It will certainly be someone younger, someone without anything close to the same negotiating skills required to achieve peace with India. A younger President will have to prove that he can stand up other foreign leaders, and he'll be far more confrontational.

I heard one Pakistani official on the BBC get asked how any new president would handle the violence going on in Pakistan's tribal regions. His answer: "The fighting will stop by itself, since it's Musharraf's presence that's causing the fighting."

Thus we see the crazy level of fantasy that many Pakistanis are exhibiting as they go forward to get rid of the one person who had held the country together for 8 years, and maintained peace with India. That remark about the fighting stopping by itself is a very familiar sounding kind of statement to me. In America, it would be a nihilistic Gen-Xer with contempt for any accomplishment by anyone older, and a willingness to destroy all such things. As I've said many times, this nihilism and destruction backfires and turns into self-destruction.


Pakistan's  Federally Administered Tribal Areas (FATA) form a safe haven for Taliban and al-Qaeda terrorists. <font face=Arial size=-2>(Source: cfr.org)</font>
Pakistan's Federally Administered Tribal Areas (FATA) form a safe haven for Taliban and al-Qaeda terrorists. (Source: cfr.org)

Pakistan seems well on the way to similar self-destruction. I've heard nothing from the politicians who might replace Musharraf that gives me anything remotely close to the feeling that these people have a clue what's going on. Pakistan has enormous problems -- huge economic problems, conflict in the tribal areas, and conflict in Kashmir -- and the new President will be clueless about how to handle them.

Fighting in the Bajaur between the Pakistan army facing Taliban and al-Qaeda forces has gotten so bad that 135,000 residents have fled to other regions.

Fighting has also been escalating in Kashmir and Jammu provinces, mainly in the Indian-administered region, as there are massive protests by both Muslim and Hindu residents.

A new Pakistan president will have to deal with all of these problems, and the chances are that a younger, clueless President will be extremely confrontational and will over-react.

We now have two regions that are becoming increasingly dangerous and unstable -- Pakistan and the Caucasus. From the point of view of Generational Dynamics, a new world war will affect both of these regions. It only remains to be seen where it will start. (15-Aug-2008) Permanent Link
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Questions from readers on the conflict in Georgia

Some technical issues about generational theory and the Caucasus.

"Strange but you start the recital with no mention of the Georgians striking first. Read the LA Times for the true historical record. They refer to it as a military blunder. One's dislike of Putins Russia (which I share) does not give us license to rewrite the historical record."

I make no attempt to give every detail of every battle. Also, at the time I wrote that article, there was no confirmation of any of Russia's claims. Even today, the Russian claims of Georgian "ethnic cleansing" have not been confirmed. However, for that particular article, the most relevant fact is that the Russians are ACCUSING the Georgians of "ethnic cleansing," and I did mention that, because that perception is highly relevant to the article.

"The truth will prevail as events unfold. The genocide, war crimes and violations of international law by Georgian troops during their surprise attack will resolved in a court of law. There are hundreds of civilian victims who are ready to testify."

Well, we'll have to see how the investigations proceed. But I'm not so sure that "the truth will prevail." As I'm always pointing out on this web site, certain perceptions will prevail, but they may or may not have anything to do with the truth.

"Had Georgia actually been part of the EU, I doubt the conflict with Russia would have got even close to breaking out."

This is an interesting point, but things are a lot more complicated than that.

Georgia has been lobbying to become a member of the European Union and/or NATO. It's widely believed that if Georgia had become a member, then Russia would never have invaded Georgia, since that would have forced a military response from Europe.

Therefore, goes the reasoning, let's admit Georgia to the EU or Nato, to prevent a future conflict.

The problem with that reasoning is that it would probably backfire. Depending on which side you favor, Georgian President Mikhael Saakashvili either "stands up to the Russians" or "purposely provokes the Russians." However, Saakashvili's actions are restrained because he's a small, lone country. But if he could count on the backing of EU or Nato, then he would be free to take far more provocative actions. Sooner or later, he would do something so provocative that the Russians would respond militarily anyway, and then there would be a much larger war.

Remember that World War I began because of interlocking treaties. Germany had no intention of going to war with France, but they were forced to do so because of a treaty with Austria. If Georgia were part of Nato, then a small war would spread to a big war very quickly.

"[With regard to a bigger war between Georgia and Russia] 5M vs. 116M: The Georgian-Russian war you refer to will be very brief. Probably on par with the war against the Chechens. But if it were expanded to include Ukrainian-Russian and Baltc-Russian, then it gets more interesting."

The relative populations and power of the combatants does not determine how long a war will last, or how savage and bloody it will be. What matters most is whether or not it turns into a generational Crisis war.

The 1960-70s American war with Vietnam was won by the North Vietnamese, who had a smaller population than America, because it was a Crisis war for the Vietnamese, but an Awakening era war for the Americans. The Americans crippled themselves politically, as often happens during an Awakening era war, while the Crisis era Vietnamese fought savagely and ruthlessly.

Russia's 1990s war with the Chechens (people of Chechnya) was not a Crisis war, because Chechnya was in a generational Unraveling era. Chechnya's last crisis war was Stalin's massive relocation of Chechens to Kazakhstan and Siberia, starting in 1944.

I don't want to go too deeply in the weeds here, because this is a highly technical subject within generational theory, but in simplest terms: Russia is a huge country, with many ethnic populations, and it's possible for such a large country to have separate generational timelines for the different populations. For the Russians and the Georgians, the last Crisis war was the 1917 Bolshevik Revolution and the subsequent series of civil wars in the 1920s. But for the Chechens, the last Crisis war was Stalin's savage relocation of the Chechens after WW II. So, in the 1990s, Chechnya was in a generational Unraveling era, and so the Chechen war didn't spiral into a crisis war. But a war today between Georgians and Russians is much more likely to do so, because both countries are deep into generational Crisis eras.

(For information about generational Awakening and Crisis eras, see "Basics of Generational Dynamics.")

"It looks like the world war will have a different line up than you have been proposing...."

I assume that you're referring to my previous statements that in the coming Clash of Civilizations world war, Russia will be allied with America and the West. That is still true, irrespective of any Georgian-Russian conflict, should it occur.

Russia's crisis wars have ALWAYS been with the Asians -- the Mongols, the Turks, the Muslims. One of the most interesting findings of generational theory is that Russia has had three major wars with Europeans, but they were all non-crisis wars. They were the Great Northern War, 1700-1720, when Sweden invaded Russia; the Napoleonic wars, when France invaded Russia in 1812; and World War II, when Germany invaded Russia. All three of those wars were non-crisis wars for the Russians, but occurred during major crisis wars for the Europeans (the War of the Spanish Succession, the Napoleonic Wars, and World War II, respectively). And Russia won all three of those wars in pretty much the same way: Let the invading enemy go deep into Russia, where the frigid Russian defeated the invaders.

Bringing this back to today, it's possible that Europe and America will support Georgia in a civil war against Russia, but when difficult choices have to be made in the Clash of Civilizations world war, Russia and the West will side with India and Japan against China and Pakistan. (15-Aug-2008) Permanent Link
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Russia continues to tighten its grip on a humiliated Georgia

It's still not known what Russia's final objectives are, though there's no doubt in my mind.

Theoretically, Russia and Georgia have agreed to a cease-fire in the Russian invasion of Georgia, but Russia apparently isn't honoring it.

Russian soldiers are effectively splitting the country in two, by blocking critical points in major highways. Russian bombers continue to attack Georgian cities, and Russian troops are looting and setting homes ablaze.

There's a lot of public debate about what are the intentions of Russia and of Russian Prime Minister Vladimir Putin in Georgia.

But there's little doubt about it in my mind: Putin's intention is to lay the groundwork for a complete takeover of Georgia in the near future. All other stated intentions are pure subterfuge.

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Why am I so certain? Because I've been watching Putin for several years now, particular during the 2004 takeover of oil giant Yukos.

In 2003, Yukos a privately owned Russian energy provider that supplied 11.4% of all the oil in the whole world. But then Yukos CEO Mikhail Khodorkovsky indicated that he was going to challenge Putin politically -- the biggest mistake of his life. Khodorkovsky was jailed on trumped-up political charges, and he's in jail to this day.

By the end of the year, Yukos had been dismantled and nationalized by means of the vilest series of steps imaginable.

It was in July, 2004, when I wrote "I wish we knew more about Putin's plans for Yukos," where I expressed my confusion about what Putin was doing.

By the end of the year, it was obvious that Putin had lied about his intentions, and that he was willing to use any means available to him to get what he wants, while still retaining personal deniability.

My conclusion was, and is, that Putin considers himself to be the new Nicolai Lenin (Vladimir Ilyich Ulyanov), the father of the 1917 Bolshevik Revolution. I've previously quoted this 1922 memo to the Politburo on the destruction of the Russian Orthodox Church in order to harvest the Church's wealth:

"We must pursue the removal of church property by any means necessary in order to secure for ourselves a fund of several hundred million gold rubles (do not forget the immense wealth of some monasteries and lauras). Without this fund any government work in general, any economic build-up in particular, and any upholding of soviet principles in Genoa especially is completely unthinkable. In order to get our hands on this fund of several hundred million gold rubles (and perhaps even several hundred billion), we must do whatever is necessary. But to do this successfully is possible only now. All considerations indicate that later on we will fail to do this, for no other time, besides that of desperate famine, will give us such a mood among the general mass of peasants that would ensure us the sympathy of this group, or, at least, would ensure us the neutralization of this group in the sense that victory in the struggle for the removal of church property unquestionably and completely will be on our side."

By the end of 2004, it was obvious that Putin was much more politically subtle than Lenin, but just as ruthless.

Like Lenin, Putin has a secret police available to kill or jail political enemies. Like Lenin, Putin is willing to use extortion and fraud and violent force to take anything he wants.

It's also clear that the new President, Dmitry Medvedev, is simply Putin's puppet. Putin is the one in charge.

There's something else. The Bolshevik Revolution was followed by an extremely savage civil war, with mass executions and many atrocities. And a major component of that civil war pitted Georgians against Russians.

Thus, one thing that has become apparent in the last few days is that we're seeing the beginning of the re-fighting of the Russian-Georgian crisis war of the 1920s.

It's always been 100% certain that a new crisis war would begin in the Caucasus. In the past, when I've talked about a major new genocidal war in the Caucasus, I assumed that it would be along the Orthodox / Muslim fault line, and would grow out of the existing conflict in Chechnya and Dagestan. That conflict may revive, but the epiphany I've had in the last week is that the major battle will be between Georgians and Russians.

In the 1920s, Lenin died of a stroke in 1924, and in the subsequent wars, Joseph Stalin -- a Georgian -- became the supreme dictator of the Soviet Union, and remained so until his death in 1953. He committed savage purges directed at Russians and Ukrainians, causing tens of millions of deaths by execution and starvation.

When Putin accuses modern Georgians of "genocide" and "ethnic cleansing," he may in fact be thinking of Joseph Stalin's genocide of his political enemies in the 1920s and 1930s.

There is nothing that can stop this re-fighting of the war between Georgians and Russians. There are only two important questions.

The first question is: How far will the West and the United States get pulled into this war? America's involvement has already begun, as indicated by a Wednesday afternoon statement by President Bush, that included the following:

"I've also directed Secretary of Defense Bob Gates to begin a humanitarian mission to the people of Georgia, headed by the United States military. This mission will be vigorous and ongoing. A U.S. C-17 aircraft with humanitarian supplies is on its way. And in the days ahead we will use U.S. aircraft, as well as naval forces, to deliver humanitarian and medical supplies."

The second major question is whether the war between the Georgians and the Russians will be the war that launches World War III -- the Clash of Civilizations world war. (14-Aug-2008) Permanent Link
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Russian invasion of Georgia continues, objective is not known

I'm raising the "Conflict Risk Index" for the Caucasus from 2 (medium risk) to 3 (high risk).

This kind of thing was standard operating procedure for the Soviets after World War II.

World War II was particularly brutal for Soviets. Although it was a generational non-crisis war for Russia (the previous crisis war was the Bolshevik Revolution and the massive civil war of the 1920s), it was a particularly brutal war, as Hitler's Germans attempted to eradicate everyone in European Russia.

The "lessons learned" for the Soviets were to repress, quickly and brutally, any neighboring country that might pose a threat. As Ukraine and Georgia move towards joining the EU and Nato, some of Russia's worst nightmares are being realized.

Now Russia is evidently applying these "lessons learned" to Georgia.


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

The following has happened:

Late on Monday afternoon, President Bush made the following televised statement:

"I just met with my national security team to discuss the situation in Georgia.

I am deeply concerned by reports that Russian troops have moved beyond the zone of conflict, attacked the Georgian town of Gori, and are threatening the Georgia's -- Georgia's capital of Tbilisi. There's evidence that Russian forces may soon begin bombing the civilian airport in the capital city.

If these reports are accurate, these Russian actions would represent a dramatic and brutal escalation of the conflict in Georgia. And these actions would be inconsistent with assurances we have received from Russia that its objectives were limited to restoring the status quo in South Ossetia that existed before fighting began on August the 6th.

It now appears that an effort may be underway to depose Russia's* duly elected government. Russia has invaded a sovereign neighboring state and threatens a democratic government elected by its people. Such an action is unacceptable in the 21st century.

The Georgian government has accepted the elements of a peace agreement that the Russian government previously said it would be willing to accept: an immediate cease-fire, the withdrawal of forces from the zone of conflict, a return to the military status quo as of August 6th, and a commitment to refrain from using force. There are representatives of the European Union and the Organization for Security and Cooperation in Europe currently in Moscow seeking Russia's agreement to this peace plan.

Russia's government must respect Georgia's territorial integrity and sovereignty. The Russian government must reverse the course it appears to be on, and accept this peace agreement as a first step toward resolving this conflict.

Russia's actions this week have raised serious questions about its intentions in Georgia and the region. These actions have substantially damaged Russia's standing in the world. And these actions jeopardize Russians' relations -- Russia's relations with the United States and Europe. It is time for Russia to be true to its word and to act to end this crisis."

This is definitely a return to "Cold War rhetoric," strongly condemning the Russians. But no military threats are made.

However, he does threaten to damage Russia's standing in the world which, I'm sure, will leave Vladimir Putin quivering in his boots.

The Russian view

A Generational Dynamics analysis of a war cannot be complete without examining the war from both sides. Even when two sides fight in a war, it's often a completely different war to them. This is similar to a married couple arguing about sex, when he's really arguing about money and she's really arguing about his mother.

The Russian view of the conflicting is breathtaking, as you'll see from this video that presents the Russian view of the conflict, accusing the Georgians of committing ethnic cleansing:

I will only quote one portion of the 6:55 minute video.

At the 5 minute point in the video, they play a sound byte from Georgian President Mikhael Saakashvili:

"This has happened before. Russians have brought their tanks into Hungary in 1956 and Czechoslovakia in 1968, into Afghanistan in 1979. I have to remind you of this in Stalin's Russia."

And now, here's the incredible and amazing response from Russian military analyst Evgeny Khruschchev:

"Well, it's very interesting, if he thinks that Western citizens are totally oblivious or ignorant that Stalin himself was Georgian for God's sake. Why the hell he would have brought up the subject altogether. He was Georgian.

And it was Stalin and his KGB chief [Lavrenti] Beria, these two Georgians, who mutilated all nations of the USSR, including Russians, Georgians, and everybody else.

So I think that those who helped him [Saakashvili] to prepare this speech, his speechwriters, were really just trip over.

The second important point, about Afghanistan. Please, give me a BREAK! Myself as a Soviet Afghan war veteran, it was Brzezinski junior, it was his brilliant information campaign to draw Soviet Union into Afghanistan in Soviet times. And now, in effect, the current Georgian president, he reminds me, [it was that person] who managed to draw the Soviet Union into that conflict, which was totally an internal affair, and he converted the Afghan civil war into the biggest cold war battle, or proxy war between the Soviet Union and the USSR [he probably meant "the US"]. And I hope that those who run Saakashvili that they also remember that he got his law degree in the United States, and I hope he will not wind up as a ?? himself."

In other words, the Russians played no part in the Budapest and Prague invasions, because Stalin was a Georgian!

In fact, Khruschchev actually sees the current invasion of Georgia as getting even for Stalin's atrocities committed against the Russians!

And the Afghan war? Well, that's the fault of "Brzezinski junior," who conducted a disinformation campaign to suck the Soviets into the Afghan war. Who's Brzezinski junior? I'm honestly not sure, but I believe it has to be Zbigniew Brzezinski, who was President Jimmy Carter's national security adviser at the time of the Soviet invasion of Afghanistan. However, Brzezinski has children, and perhaps Khruschchev was referring to one of them.

So the Soviet invasion of Afghanistan wasn't the Russian's fault either! It was the Americans' fault!! Amazing!!

The danger in a crisis era

At the time of the Budapest and Prague invasions, America and Western Europe were in generational Recovery and Awakening eras. The countries of Eastern Europe and the Caucasus, including Russia, had all had crisis wars in the 1920-1945 period, so they were in Awakening or Unraveling eras. In any case, from the point of view of Generational Dynamics, it was very unlikely that any of those invasions could have led to a wider war.

But that's not true today. All of these countries are now in a generational Crisis era. Russian President Dmitry Medvedev and Georgian President Mikhael Saakashvili are both young men, with little fear of the consequences of their actions. Thus, the danger of the current situation spiraling out of control into a larger war is much higher today than it was at the time of the previous invasions we discussed.

Conflict risk level for next 6-12 months as of: 6-Nov-2007
W. Europe 1 Arab Israeli 3
Russia Caucasus 2 Kashmir 3
China 2 North Korea 2
Financial 3 Bird flu 3
Key: 1=green 1=Low risk 2=yellow 2=Med 3=red 3=High 4=black 4=Active

The last time that I changed the Conflict Risk Graphic was last year in November. I raised the Kashmir risk level from 2 (medium risk) to 3 (high risk). I did this because the Pervez Musharraf government in Pakistan was becoming increasingly unstable, and the risk of all out war between Pakistan and India within six months had gotten considerably greater. The epicenter of such a war would be the disputed regions of Kashmir and Jammu.

(Incidentally, I don't have time to write a complete article about it, but the violence is Kashmir between Hindus and Sunni Muslims is still getting much, much worse, following the article that I wrote last week on the subject.)

It's now time to recognize that the Caucasus region is becoming similarly unstable, thanks to the events of the last week.

Quite honestly, when the 2004 Beslan school massacre occurred, I was surprised that it didn't lead to wider violence. Since it didn't, I kept the conflict risk level at 2 (medium risk).

Conflict risk level for next 6-12 months as of: 11-Aug-2008
W. Europe 1 Arab Israeli 3
Russia Caucasus 3 Kashmir 3
China 2 North Korea 2
Financial 3 Swine/Bird flu 3
Key: 1=green 1=Low risk 2=yellow 2=Med 3=red 3=High 4=black 4=Active

But that's now in the past. As long as Russia is crushing a small neighbor during a generational Crisis era, and another small neighbor, Ukraine, is similarly threatened, anything can happen.

I am therefore going to raise the "Conflict Risk Level" for the Caucasus from 2 (medium risk of war within 6 months) to 3 (high risk of war within six months). The new graphic is as shown on the right.

From the point of view of Generational Dynamics, the Caucasus mountain region, which controls many valuable land routes connecting the Caspian Sea to the Black Sea, has been the battlefield for many crisis wars between the Orthodox Christian and Muslim civilizations, and between different ethnic groups of the same or different religions for many centuries. A new genocidal crisis war in the Caucasus is coming with absolute certainty. (12-Aug-2008) Permanent Link
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Georgia capitulates in South Ossetia as Russia expands war

Russia's overreaction may lead to wider war.

Georgia evidently capitulated in South Ossetia, withdrawing its troops after four days of fighting.


The Black Sea, Caucasus, Caspian Sea region
The Black Sea, Caucasus, Caspian Sea region

However, Russian soldiers and tanks continue to pour into South Ossetia. Russian bombers continued to attack military targets throughout Georgia, including an airport south of the capital, Tblisi.

The city of Tskhinvali, the capital of South Ossetia, is being described as a humanitarian disaster, with a shortage of food and water, and thousands of bodies littering the streets. Each side blames the other, and accuses the other of genocide and ethnic cleansing.

Russia appears to be taking total control of South Ossetia. It is not known whether Russia will claim that South Ossetia is now Russian territory.

Russia also is moving tanks and soldiers into another secessionist Georgia province, Abkhazia. It is not known whether Russia will also claim that Abkhazia is now Russian territory.

Russia has blockaded Georgia's Black Sea ports by moving its Black Sea fleet into Georgia's ports. The Russian fleet is normally stationed in Sevastopol, which is in the Crimea, which is part of Ukraine.

As Georgia seems to be pretty much militarily defeated, and western nations are refusing Georgia's request for military support, it seems unlikely right now that the war will spread into a major regional war.

However, Ukraine is taking Georgia's side in the fight, which is not unexpected since leaders of both countries have said they wish to join the European Union and NATO.

On Sunday, Ukraine warned Russia that it might bar Russian navy ships from returning to their base in Sevastopol, because of their deployment to Georgia's coast. Right now, this seems to be the only significant possibility of a lead to a wider conflict.

However, it's really probably up to Russia right now, as Russia is continuing to expand the war.

From the point of view of Generational Dynamics, the Caucasus mountain region, which controls many valuable land routes connecting the Caspian Sea to the Black Sea, has been the battlefield for many crisis wars between the Orthodox Christian and Muslim civilizations, and between different ethnic groups of the same or different religions for many centuries. A new genocidal crisis war in the Caucasus is coming with absolute certainty. (11-Aug-2008) Permanent Link
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As commodities plummet worldwide, the meaning is unclear.

We speculate on some possibilities.


Price of oil plummets
Price of oil plummets

Commodities -- oil, soybeans, gold, corn, etc. -- are suddenly falling sharply in price. The dollar is significantly strengthened in one day. And stocks surge on Wall Street.

The conventional view is that commodities were in a speculator-induced bubble, and that now the bubble is ending. Prices will return to "normal" in an orderly fashion, and many of the problems caused by the commodities bubble will sort themselves out fairly quickly.

That may well be what's happening, but let's speculate on something far different.

From the point of view of Generational Dynamics, what I watch for are major shifts in public opinion, since these usually indicate an important new generational viewpoint.

That's exactly what's going on, according to The Telegraph's Ambrose Evans-Pritchard:

"US dollar rallies as extent of worldwide recession becomes clearer

The psychology of global markets has shifted hugely over recent days as it becomes clear that Europe, Australasia and parts of Asia are sliding into recession.

The US dollar has launched its best rally in half a decade, reflecting a recognition that half the world is in even worse shape than the US. In fact, America is the only G7 country to eke out modest growth this summer.

The US dollar index - currencies watched closely by traders - smashed through resistance yesterday in the biggest one-day move since the long dollar slide began seven years ago.

"This was highly significant. Perceptions have changed," said Ian Stannard, currency strategist at BNP Paribas. ...

Commodities tumbled as hedge funds and financial investors struggled to untangle themselves from crowded positions on the futures markets. Brent crude fell $4 to under $114 a barrel, down over 20pc since peaking in early July. The Baltic Dry Index has now fallen every day for over three weeks, dropping 30pc on fears that ship demand is fizzling out.

Copper fell to a six-month low on reports of rising inventories in China and Europe. Lead, nickel and tin all dived in frantic trading on the London Metal Exchange.

"We see a deep global recession," said Albert Edwards, chief strategist at Société Générale.

"Growth prospects in the Eurozone, Japan and the UK have deteriorated. Most now accept that recession has already begun in all three," he said. Mr Edwards predicted a "collapse" in emerging markets next. "You ain't seen nothing yet," he said."

This article goes to the heart of the global financial system today.

I've written many times on the subject of deflation -- how the country is in a deflationary spiral, and there's no danger whatsoever of "hyperinflation," as many people fear.

Those who have worried about hyperinflation in the US often overlook the important fact that, as bad off as the American economy is, it's actually much better off than many foreign economies.

The huge international credit bubble has been almost entirely an American dollar bubble. That's because the $750 trillion in credit derivatives that have been created in the past few years have all been denominated in dollars. As the bubble leaks, it reduces the amount of money (in dollars) in the world, which actually makes the dollar more valuable. Thus, the American dollar is in a deflationary spiral around the world.

But that's not true, for example, of the euro. The volume of credit derivatives denominated in euros is tiny compared to those in dollars. Any inflationary tendency in US dollars is overwhelmed by the deflationary spiral in US dollars, but an inflationary tendency in euros would not be similarly deflated.

The sudden spike in the international value of the dollar currency is, according to the article quoted above, not something based on the American economy, but on something based on the other economies -- that they're deteriorating quickly, more quickly than the American economy.

Thus, investors are pulling money out of non-dollar-denominated assets. Thus, we've seen substantial plunges in stock market indexes, particularly in Asia. Even China's Shanghai Stock Market, which had finally seemed stable in the last month after falling 50%, has now resumed its plunge in the last week.

Commodities prices are also denominated in dollars, and so the rapid strengthening of the dollar last week means that commodity prices are going to fall in price relative to the strengthened dollar.

This would seem to be good news -- and it is for any business that purchases copper or oil as raw material. It's also good news if it means that food prices will moderate. It also seems to be good news for Wall Street -- money invested in foreign markets is now being redirected into American stocks.

But it may be very bad news for numerous Asian economies. With stock markets crashing, the fall in commodities prices may be caused by financial crises in these countries -- not just recessions, as Evans-Pritchard suggests, but full-fledged stock market crashes.

The speculation, then, is that the sudden strengthening of the dollar, combined with a fall in commodities prices, is the sign of an imminent global financial crisis. Presumably, we'll know within a week or two which of the two views (mainstream or speculative) is in play.

Corporate earnings

As regular readers know, 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 growth estimate as of that date
  ------- -------------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%   Start of quarter
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%   End of quarter
  Jul  3:             -12.4%
  Jul  8:             -13.0%
  Jul 11:             -14.7%
  Jul 18:             -17.1%
  Jul 25:             -17.9%
  Aug  1:             -20.4%
  Aug  8:             -22.1%

As you can see, second quarter earnings estimates have fallen by another 8%, which means that price/earnings ratios will rise by 8%.

I don't know where the P/E ratio index will end up this week, but stock prices surging and earnings plunging, it should be quite dramatic.

Banks cave re auction rate securities

I wrote on August 3 that New York's attorney general Andrew Cuomo was bringing fraud charges against several banks over auction rate securities.

(For a discussion of the hare-brained auction rate securities scheme, see "Investment bank UBS is now 'writing down' clients' auction rate securities.")

It didn't take long to get a response. Swiss bank UBS AG, Citigroup and Merrill Lynch have all agreed to repurchase the near-worthless auction rate securities from retail customers, charities and small and mid-size businesses, and to pay substantial fines.

What's interesting about this is how quickly these financial institutions caved in to the accusations, agreeing to settle very quickly. Why were they willing to settle very quickly?

Obviously it's because they knew they would be found guilty, but there's more to it, according to some pundit conversations I heard on CNBC last week. It seems that the brokers in each of these financial institutions were pressuring their bosses to settle, because the brokers themselves were afraid of being individual prosecuted, for having lied to their customers.

Two months ago we had "'Operation Malicious Mortgage' indicts 406 people including Bear Stearns execs." Now we have more a few more banks.

Last year in September, I made a list of people who are currently being blamed, or soon will be blamed, and who will be the subject of investigations, civil lawsuits and possible prosecution. Let's take another look at that list, and update it a little:

We can now see that the deception and fraud were ubiquitous, occurred in every financial, real estate and government organization, from top-level management to bottom-level salesmen. Furthermore, it occurred throughout the world.

What I really think is hilarious is that everyone I hear on tv is now blaming the current situation on Alan Greenspan, because the Fed lowered interest rates to near-zero in 2002-2003.

This is totally absurd. For one thing, it doesn't explain the dot-com bubble and crash that occurred earlier. More important, to say that brokers, salespeople, home buyers, etc., at every level, in countries ALL AROUND THE WORLD, all committed fraud because of something that Greenspan did is so ridiculous that it could never possibly be believed by anyone except the macroeconomics and finance experts we see on tv, and who, almost without exception, have their heads up their asses.

The only explanation of this mess that makes any sense is generational. The survivors of the 1930s Great Depression would never have tolerated any of this fraud, but they're dead and gone now. In their place are entire generations of Boomers and Gen-Xers who willingly pursued fraudulent policies that screwed everyone else for their own gain.

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. (11-Aug-2008) Permanent Link
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Iraq's Shiite cleric Moqtada al-Sadr turns from arms to "culture"

This follows several Sunni "Tribal Awakenings" to expel al-Qaeda.

Shiite cleric Moqtada al-Sadr ordered most of his militiamen to disarm on Friday, but said he will maintain "small and limited" élite fighting units to resist Americans.

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According to an al-Sadr spokesman, al-Sadr is creating a cultural wing that will be part of a complete reorganization of the Mehdi Army to "transform it into a social organization" from a militia.

On the Sunni side in Iraq, the "Anbar Awakening" that drove most of al-Qaeda out of Iraq is more and more being seen as one of series of "Awakenings" that are uniting the Sunni tribes against the radical Islamists. For example, the assassinated original founder of the Anwar Awakening is being "praised ... as a martyr and as a true non-sectarian Iraqi patriot."

"Iraqi and Arab progressives have long tended to view the persistence of tribes and tribalism as a negative phenomenon that is keeping the Middle East from developing modern societal relations based on voluntarism and a modern political system. ...

Recently, [Iraqi] liberals have begun to rethink this view of the Iraqi tribes, and, in light of the successes of the tribal Awakenings Councils, have begun to argue that the tribes can be a force for progress and a positive alternative to Islamists.

Iraqi author Hussein Karkush wrote ... that the tribes are relatively secular and that the Awakenings are essentially Iraqi civil society's revolt against political Islam."

The Iraq situation has been a remarkable test case for the validity of Generational Dynamics that's turned out to be incredibly successful.

Many people describe this web site as "too negative," because it focuses on the increasing danger of world war. That focus is quite appropriate, inasmuch as most countries of the world, those that fought in WW II as a crisis war, are in a generational Crisis era.

But from the point of view of validating generational theory, the contrast between countries in Crisis and Awakenings eras has been startling.

At the end of the 2006 war between Israel and Hizbollah, I wrote a lengthy analysis in "Aftermath of Lebanese war: The winners and losers." What was really striking is how closely the Hizbollah warriors of Lebanon, a country in a generational Awakening era, followed their precise generational archetype.

In fact, if you want to say that many discussions on this web site are "too negative," then you'd have to call the discussions of Lebanon and Iraq as "extremely positive." In both cases, there were widespread claims by pundits, analysts, politicians and journalists that the countries were near or in civil war. In both cases, this web site said that a civil war was impossible, because the country was in a generational Awakening era, or that if anything like civil strife broke out, it would fizzle quickly.

Today, we can look back at the last few years, and see that generational theory has been remarkably successful in predicting certain types of outcomes. In particular, the predictions that Lebanon and Iraq would follow typical Awakening-era behaviors were completely counter-intuitive, were completely opposed to the analyses and predictions of pundits, analysts, politicians and journalists -- and were completely correct.

(See "List of major Generational Dynamics predictions" for more information about these predictions.)

On this web site, there are three kinds of discussions, and I phrases like "according to generational theory" or "my expectation is" to distinguish among them:

The point is that this web site gives you the information you need to know, and tells you how to evaluate it. In particular, you may disagree with my opinion on something, but you can't disagree with the Generational Dynamics analyses because of their success record. Moqtada al-Sadr's recent announcement that he's disbanding his militia, is a striking confirmation of that.

This is a good time to remind you that you can write to me with comments and questions. You can write to me at mailto:comments@GenerationalDynamics.com, or else use the "Comment" link at the top of every page. It may take a few days or a couple of weeks to get back to you, but so far I've been doing OK keeping up with the e-mail messages. (10-Aug-2008) Permanent Link
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Russia and Georgia are in a "state of war"

Russia pours tanks and soldiers into South Ossetia, as planes bomb Georgia military targets.

There are fears of all-out war between Russia and the Republic of Georgia as both sides are escalating the battle over South Ossetia. Furthermore, Russia appears to be expanding the war, by bombing military targets in Poti, on the Black Sea coast.

I've often referred to the Caucasus in the last few years. For web site readers who weren't sure what I was talking about, here's a great map from Der Spiegel that makes things clear:


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


Top: Russia's President Dmitri Medvedev; Middle: Georgia's President Mikheil Saakashvili; Bottom: Russian Prime Minister Vladimir Putin scolds American President George Bush at Beijing Olympics. <font face=Arial size=-2>(Source: BBC)</font>
Top: Russia's President Dmitri Medvedev; Middle: Georgia's President Mikheil Saakashvili; Bottom: Russian Prime Minister Vladimir Putin scolds American President George Bush at Beijing Olympics. (Source: BBC)

Historically, the Caucasus mountain region, which controls many valuable land routes connecting the Caspian Sea to the Black Sea, has been the battlefield for many crisis wars between the Orthodox and Muslim civilizations, and between different ethnic groups of the same or different religions for many centuries. A war between Russian and Islamist forces has been going on in Chechnya since 1994.

Georgia itself has been the object of rivalry between Russia, Turkey and Iran (Persia) for many centuries. Russia took control in 1921, but Georgia gained independence in 1992 following the collapse of the Soviet Union. Former Soviet Foreign Minister Eduard Shevardnadze became Georgia's leader, but was overthrown by the "Rose Revolution" in 2003, resulting in the Presidency of Mikheil Saakashvili, someone who has not been to Russia's liking. Many Georgians accuse Russia of imperialism, while Russia criticises Georgia of nationalism and pursuing an anti-Russian foreign policy.

The current crisis comes during a long period of increasing tensions between Georgia and Russia over the two of Georgia's breakaway regions: Abkhazia and South Ossetia. Both regions have ethnic Russian populations that are claiming to be part of Russia rather than Georgia.

Russia has been conducting a diplomatic war with Georgia for several years, imposing harsh sanctions in 2006. By these sanctions, Russia stopped all railway, marine, air and car communication with Georgia for a period, and even ended all postal communication between the two countries, claiming a security risk.

The populations of both Abkhazia and South Ossetia have become increasingly restless over the years. This week, Georgia initiated a police action in Tskhinvali, South Ossetia's capital. Russia responded by pouring troops into South Ossetia, and by bombing Georgian targets both in and out of South Ossetia.

Georgia is a close political ally of the United States, and Georgian officials had expressed the desire to get closer to Europe and to join Nato. This possibility is extremely threatening to Russia, and explains the harsh response.

Neither side appears willing to back down, at the present time, despite widespread international calls for peace talks.

I'd like to quote a portion of a Spiegel article on the conflict:

"Caucasus Violence Took Europe By Surprise

European diplomats have been trying to maintain peace in Georgia with financial incentives and promises of partnership. But now that bombs have started to fall, no one in Brussels, Berlin or Paris quite knows what to do.

At 6 p.m. on Thursday, the mood in Brussels was still positive: The crisis in the Caucasus appeared to be under control.

For days Georgian troops and fighters in South Ossetia had been exchanging fire. And on Thursday morning, Russia -- which backs the Ossetians and is present in the region with a 1,000-man "peacekeeping" force -- openly warned that Georgia was preparing to wage war.

But when chief European Union diplomat Javier Solana telephoned with Mikhail Saakashvili on Thursday afternoon, the Georgian president sought to calm him down, saying he had just called a unilateral cease-fire. And, Saakashvili reportedly said, of course he shared Solana's opinion that every possible step to stop the violence should be taken, and that the problem could only be solved at the negotiating table.

Of course.

A few hours later, though, heavy fighting broke out. Bombs fell on civilians. A Georgian general spoke of "retaking" South Ossetia. The developments caught Europe by surprise.

Helplessly, Solana said the European Commission and the French government -- which is currently the rotating president of the 27-member club -- were "deeply concerned." German Foreign Minister Frank-Walter Steinmeier didn't miss the chance to call the Georgian president from his vacation spot in the Alps around noon on Friday to express his "concern." Just days earlier, Steinmeier had visited Saakashvili, who had given him assurances of his desire for peace. Of course, NATO General Secretary Jaap de Hoop Scheffer didn't want to be missing from the list of senior European officials expressing their "serious concern," either.

But the truth is that in Brussels -- both at the European Union and NATO headquarters -- leading personalities are concerned because no one actually knows what's going on. How did the shooting start? Who escalated it? With what intention? There's been a clueless shrugging of shoulders.

For some time now, relations between the EU, NATO and Georgia have been steadily deepening. As the gateway to the Central Asian oil and gas fields, the former Soviet nation has huge strategic importance to Europe. Planned pipelines will pass through Georgia to help reduce Europe's energy dependence on Russia. ...

The last time the Brussels emissary visited with Georgian Prime Minister Vladimir Gurgenidze, the politician defined his country's political course by saying: "We want free trade with you, simplified visa procedures and EU membership."

But overnight, it appears, the country has fundamentally shifted course.

Georgia may want to improve its strategic position ahead of the coming peace negotiations, and take back a bridge or a hill here or there. Or else the South Ossetians saw their chances of independence slipping away after Russia signalled that it might wash its hands of the whole problem. According to this theory, the South Ossetians have decided to reach for their weapons and heat up the war. But there may be some truth to a story by a journalist who knows the region well that the new conflict is nothing but a flare-up of "seasonal" violence.

NATO was also surprised by the fighting. Until very recently (from July 5 to 30), around 1,000 American soldiers were on maneuver in the region with the Fourth Infantry Brigade of the Georgian army in a training mission called "Immediate Response 08." The goal was to train Georgians for a stint in Afghanistan, where Tbilisi is soon set to send 400 soldiers."

There's one particular sentence I want to mention again: A Georgian politician defines his country's political course by saying: "We want free trade with [Russia]," but overnight the country fundamentally shifted course. People who think that China and Taiwan will not go to war because it's bad for business should understand that business concerns dissolve instantly during a generational crisis era.

People who criticize me or Generational Dynamics should read the above description, because it illuminates some important principles. People tell me, "There's no war with China on the horizon." Or, "There's no stock market crash on the horizon."

But that's the way these things always work. For reasons I've stated many times, a war with China is absolutely certain, and a stock market crash is absolutely certain.

When I started saying in 2002 that a stock market crash had to happen because of generational reasons and because stocks were overpriced by over 200%, I didn't know about CDOs or CDSs or that there would be a crippling worldwide credit freeze starting in August, 2007. All I knew was the final result.

I don't know how many times I've heard things like, "Where did this credit crisis come from?" It was perfectly obvious since 2004 that there's been a real estate bubble, but everyone was caught by surprise when it leaked.

Now we're in the same kind of situation with the Caucasus.

I wrote an an analysis of the South Ossetia situation in 2004, and several additional articles since then.

And so, when you read the above article excerpt that talks about how "surprised" everyone is that this happened, you have to remember that it's exactly the same kind of "surprise" that occurred over the global financial crisis. The survivors of the Great Depression and World War II would not have been "surprised" by any of this, and they would have been prepared for it.

The Caucasus is a major crossroad of the world, bringing many different ethnic and religious groups into close proximity, as they try to pursue trade or expand their populations. It's not surprising at all that there have been many genocidal wars in this region, nor should it be any surprise to anyone that a new genocidal war in this region is coming, with absolute certainty. It's only today's leaders, born after World War II, who are "surprised" by everything, and who don't have a clue what's going on in the world. Unfortunately, there will be many more surprises to come. (9-Aug-2008) Permanent Link
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Pakistan government combines chaos with paralysis as Musharraf is threatened with impeachment.

The army may have to step in.

One of the major themes of this web site over the years has been the increasing paralysis of one government after another, among those countries that fought World War II as a crisis war.

The main example has been the United States itself. After WW II ended, the survivors were united in the determination that nothing so horrible should even happen again, and particularly should never happen to their children.

To this end, the survivors did some great things -- they created the United Nations, World Bank, Green Revolution, World Health Organization, International Monetary Fund, and so forth. They created these organizations and managed them for decades with one purpose in mind: That their children and grandchildren would never have to go through anything so horrible as World War II. Now all those people are gone, and the people left behind have no idea what's going on or what to do. They're unable to lead or govern. All they know how to do is whine and complain, and wait until the next disaster, the next world war, forces them to do great things as well.

The same thing has happened in country after country. Europe is totally dysfunctional in its attempt to get a constitution adopted. Israel's government has an approval rating of close to zero. The Palestinians have split into two factions that are close to civil war. Japan's government has gone from scandal to scandal.

In Pakistan, the last couple of years have seen the government go down the same path.

Last July (2007), there was a spectacular Red Mosque attack in Islamabad, Pakistan's capital, leading to a substantial weakening of President Pervez Musharraf.


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

Then in December, the assassination of Benazir Bhutto threw the planned parliamentary elections into chaos, and Musharraf's party was crushed by opposition leaders who were more interested in vengeance and infighting than in governing. As a result, Pakistan's government is completely paralyzed and rudderless, unable to cope with the country's substantial problems.

What happened on Thursday is a further disaster for this country already facing disaster.

The opposition leaders announced on Thursday that they would seek the immediate impeachment of Musharraf.

This means that the already dysfunctional government will be spending weeks or months on this process. This is clearly a move of political revenge, and the entire country will suffer for it.

It leaves an opening for the army to take over. The Pakistan army has a history of government coups when things look really chaotic. Musharraf himself came to power in 1999 through an army coup.

Meanwhile, India is deploying 10,000 more troops to the ongoing conflict in Kashmir. The new troops will particularly target violent Hindu demonstrations.

And, in Pakistan's Swat Valley and in the FATA (tribal areas), the Pakistan security forces are in a continuing major conflict with the Taliban.

From the point of view of Generational Dynamics, a re-fighting of the massively genocidal war following the 1947 Partition is coming with absolute certainty. This war will involve numerous ethnic groups, but underlying it will be Sunni Muslims versus Hindus + Shia Muslims. (8-Aug-2008) Permanent Link
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Wall Street stock prices soar amid terrible earnings news

A year after the global credit crisis began, investors are convinced that it has to be over.

Wall Street stock indexes spiked 3% in the last two days, despite the shocking $821 million earnings loss during the second quarter. This was THREE TIMES worse than analysts expected. There is no way to interpret this situation as anything but incredibly disastrous, but investors weren't fazed, as the bought lots of stocks.

On top of this, the foreclosure rate keeps rising, and regional bank failures are expected to increase substantially. Furthermore, second quarter earnings estimates have notched a little bit lower, as indicated by the following update, based on cumulative figures from CNBC earnings central:

  Date    2Q Earnings growth estimate as of that date
  ------- -------------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%   Start of quarter
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%   End of quarter
  Jul  3:             -12.4%
  Jul  8:             -13.0%
  Jul 11:             -14.7%
  Jul 18:             -17.1%
  Jul 25:             -17.9%
  Aug  1:             -20.4%
  Aug  4:             -20.4%  Mon
  Aug  5:             -20.4%  Tue
  Aug  6:             -20.5%  Wed

What's going on? Why are investors ignoring what's going on?

As far as I can tell, investors simply can't believe that these problems can possibly continue much long. The global credit crisis began a year ago, and none of these people can believe that it will go on. I've heard even normally cautious financial pundits say, "We may have a bumpy ride for the next months, but the S&P and Dow indexes will be up by the end of the year." This conclusion is not based on a shred of evidence, except "nothing like this has happened in my lifetime." And if there's going to be a major stock market rally, these dim bulbs don't want to risk missing out.

I've quoted the following paragraph from John Kenneth Galbraith's 1954 book The Great Crash - 1929, a dozen times before, but you can't read it too many times, where he contrasted the 1929 with previous panics:

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

The fortunate speculator who had funds to answer the first margin call presently got another and equally urgent one, and if he met that there would still be another. In the end all the money he had was extracted from him and lost. The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. ... The bargains then suffered a ruinous fall. Even the man who waited out all of October and all of November, who saw the volume of trading return to normal and saw Wall Street become as placid as a produce market, and who then bought common stocks would see their value drop to a third or fourth of the purchase price in the next twenty-four months. ... The ruthlessness of [the stock market was] remarkable." (p. 108)

This is what's going on today. Today's financial managers, none of whom have any personal memory of the Great Depression, simply cannot bring themselves to believe that this can continue.

This leads to what I've been calling the Principle of Maximum Ruin. Investors continue to lose money in the market, since they can't believe that bad news will continue. The maximum number of investors are ruined to the maximum extent possible - the Principle of Maximum Ruin.

When I was watching cartoons on TV in the 1950s, there was always an inviolable rule: What goes up, must come down. This rule needed no proof; nothing else was conceivably possible.

Today's investors have an equally inviolable belief: What goes down must come back up. This rule needs no proof; nothing else is conceivably possible. The above quote from Galbraith's book shows how the same inviolable belief was held by investors in 1929. The rule needed no proof then either. Nonetheless, it turned out to be disastrously wrong.

A fall in earnings estimates means an increase of price/earnings ratios estimates. Here's the Friday's version of the graphic that appears on the bottom of the home page of this web site:


S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 1-Aug-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 1-Aug-2008. (Source: MarketGauge ® by DataView, LLC)

It now looks as if a new trend has been established. For two years, investors had been tuning their buy/sell algorithms to maintain price/earnings ratios (also called "valuations") of almost exactly 18. But now they've re-tuned their computer software to target valuations around 21.

I've written this recently, and a web site reader sent me the following comment:

"Regarding your observation that the trading programs appear to have reset their P/E multiple targets for 21 - I've been watching the DJIA over the past few weeks wondering when it was going to sink below 10,000 and it suddenly struck me today as I looked at the index that the P/E multiple targets have probably been reset to prevent that. A below 10,000 dip would be a powerful psychological blow to the market and could lead to full-blown panic selling. It seems like the Principal of Maximum Ruin has been kicked into operation."

This comment goes much farther than I ever went -- the writer implies that that "they" are actually conspiring to keep the market indexes up.

Now, I almost always reject conspiracy theories as a matter of course, but there's actually a precedent in this case to support the conspirational theory.

In 1929, a banker consortium got together to support the market. They believed that the market collapse was simply a matter of "confidence," and they felt that the market bubble would start growing again, if only they could restore confidence. That worked for a day or two, but no longer. It was only years later that the 1920s stock market was recognized by everyone as a bubble.

Today it's widely believed that the only problem with the stock market is a lack of confidence. 99 and 44/100% of the analysts, journalists and politicians have ABSOLUTELY NO IDEA what's going on, and think that just by jawboning, the market bubble can start growing again.

Furthermore, there's an actual government-sponsored group that's been set up to play the part that the informal banker consortium played in 1929.

The Plunge Protection Team (PPT) is the whimsical name used in a 1997 Washington Post story.

The real name of the group is the "Working Group on Financial Markets," and it's in the Treasury Dept. The working group languished for several years, but was reactivated 1½ years ago by Treasury Secretary Hank Paulson.

So I have to admit that the comment above might quite possibly be correct. In my opinion, it's not possible for the P/E index to have remained constant at 18 for two years, and now to have adjusted to 21 in the last month, without some coordination. I had assumed that the coordination was unconscious, but now when I read the above comment, and I think about what happened in 1929, I have to agree that there may be some conscious coordination. It may have been informal, or may have been done formally through the "PPT", but either way there must be some conscious coordination.

Incidentally, if there is formal coordination, then it's against the law -- it violates securities laws and antitrust laws. It was just last month that the SEC blamed the stock market problems on "false rumors." Conspiring to lower stock prices is, of course, completely illegal and worthy of the harshest punishment. But conspiring to keep stock prices up? Well, that's such a good thing, that it must be ok.

It's thought that one of the reasons for the stock market surge is that commodity prices have been falling, especially oil prices. Now, I don't believe that there's been any conspiracy by speculators to keep commodity prices up, and I don't believe that the current fall is related to any action (or inaction) by speculators.

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The Baltic Dry Index, which measures the demand for ocean transportation of dry goods, has been plunging for 18 weeks in a row.

The only reasonable explanation for all this is that demand for many commodities has been falling, and that seems obviously to be caused by a slowing of China's economy. This view is supported by the fact that the Shanghai stock market has falled by over 50% since October, 2007.

In January, 2005, I wrote "China approaches Civil War," and the reasons given at that time haven't changed. China has held off peasant unrest by the massive economic bubble that the country has sustained for many years. If commodity prices continue to fall, it will probably mean that China's economy is entering a recession, and this will certain generate many more peasant demonstrations and result. At some point, one of those demonstrations will trigger a nationwide rebellion, and a civil war.

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. (6-Aug-2008) Permanent Link
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Hindu vs Sunni Muslim violence increases sharply in Kashmir and Jammu

The army in Indian Kashmir opened fire at hundreds of stone-throwing Hindu protestors on Wednesday, killing one person. Thousands of other Hindu protesters also clashed with police in other parts of Kashmir and Jammu.


Indian subcontinent, showing the disputed regions of Kashmir and Jammu.
Indian subcontinent, showing the disputed regions of Kashmir and Jammu.

This comes as a reaction to a general increase in violence by Sunni Islamists (Taliban and al-Qaeda) in the entire region, including Afghanistan and northern Pakistan.

In a previous analysis, we described the almost total analysis of the Pakistan government. The paralysis surged in January when a new and totally ineffective parliament was elected.

The trigger for the violence in Kashmir and Jammu (K+J) was an incident involving a Hindu shrine last month. Thousands of Muslims protested against a plan to transfer some land to a Hindu shrine, leading to violence and clashes with police. India reversed the plan to transfer the land, and that led to the Hindu demonstrations and violence.

Indian Prime Minister Manmohan Singh met with opposition political leaders to find a way to end the violence. However, the main opposition party Hindu nationalist Bharatiya Janata Party (BJP), and it has been suggested that BJP activists have been aiding the Hindu demonstrators in K+J.

Although we haven't discussed it much, India's government is becoming similarly paralyzed. India's Prime Minister Manmohan Singh is still in power, but he recently came very close to losing a vote of confidence in the Parliament, after losing some supporters. A political split over the the violence in K+J would really expose the paralysis of the Indian government.

From the point of view of Generational Dynamics, a re-fighting of the massively genocidal war following the 1947 Partition is coming with absolute certainty. This war will involve numerous ethnic groups, but underlying it will be Sunni Muslims versus Hindus + Shia Muslims. (6-Aug-2008) Permanent Link
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CIA accuses Pakistan's ISI of aiding in Indian embassy bombing in Kabul

The level of Afghanistan - Pakistan - India tension has substantially increased in just the last few days since I wrote my lengthy analysis of these three countries.


India's Prime Minister Manmohan Singh (R) and Pakistan's Prime Minister Yousaf Raza Gilani shake hands at SAARC meeting. <font face=Arial size=-2>(Source: VOA)</font>
India's Prime Minister Manmohan Singh (R) and Pakistan's Prime Minister Yousaf Raza Gilani shake hands at SAARC meeting. (Source: VOA)

The principal new development is that the US is now publicly accusing Pakistan and its intelligence services of assisting in the bombing of the Indian embassy in Kabul last month, based on evidence uncovered by the CIA.

US officials say that they've intercepted communications linking Taliban militants with agents from Pakistan's Inter-Services Intelligence (ISI) directorate and with the bombing.

On Saturday, there was a previously scheduled summit meeting of the South Asian Association for Regional Cooperation (SAARC). The meeting was closely watched because the heads of government from India, Pakistan and Afghanistan would all be present.

Afghan President Hamid Karzai attacked Pakistan harshly for providing safe sanctuary to terrorists. "It is because of the safe havens and sanctuary which terrorists are getting in Pakistan, the country lost their great leader Benazir Bhutto. Terrorism is a result of narrow minded politics and institutional support."

India made similar accusations through its foreign minister, but India's Prime Minister Manmohan Singh and Pakistan's Prime Minister Yousaf Raza Gilani shook hands at the SAARC meeting. The two Prime Ministers agreed to push ahead with the peace process.

Nonetheless, relations with Pakistan have taken a sharp downturn in recent days, even just since my recent analysis, for several reasons:


Pakistan's  Federally Administered Tribal Areas (FATA) form a safe haven for Taliban and al-Qaeda terrorists. <font face=Arial size=-2>(Source: cfr.org)</font>
Pakistan's Federally Administered Tribal Areas (FATA) form a safe haven for Taliban and al-Qaeda terrorists. (Source: cfr.org)

All this occurs in the context of economies in the region close to crisis. Thanks to global doubling of food prices in the last year, as well as sharp increases in energy prices. These have pushed millions of people into poverty, and created double-digit inflation rates in Pakistan, India, and most other countries in Asia. Those who worry about hyperinflation in America should understand that hyperinflation is much more likely in other countries.

The Pakistan region is certainly the most dangerous and unstable in the world right now. An ethnic or sectarian civil war within Pakistan is very much a possibility, and this would quickly spread to India. This would draw in the US, India and Russia fighting against Pakistan, Bangladesh and China. The war could then spread to the Mideast and the Caucasus. (3-Aug-2008) Permanent Link
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Alan Greenspan calls this a "once in a century" liquidity crisis.

Says that the "big surprise" is the "impressive" American economy holding up rather well.

Here's the first part of Alan Greenspan's interview, when he appeared on CNBC on Thursday:

"Well, I think the big surprise at the moment is, given the extraordinary pressures coming from the financial sector, that the American economy is holding up rather well, actually. And indeed if you look in a global context, it's even more impressive.


Former Fed chairman Alan Greenspan <font face=Arial size=-2>(Source: CNBC)</font>
Former Fed chairman Alan Greenspan (Source: CNBC)

One of the reasons, of course, is that fact that when the crisis began, just about a year ago, the non-financial corporate sector was in exceptionally good shape.

The balance sheets were such that borrowing requirements were minimal, and indeed they've weathered, very significantly, much of what has created huge problems in the financial system, and only recently are they beginning to feel the pressures.

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The problem, unfortunately, is that the financial system has gone a whole year now -- we've had huge amounts of liquidity engendered by central banks, and it's getting increasingly evident that this is a once in a century type of phenomenon.

It is not the standard liquidity crises that we have seen in the past. It's verging on the issue of solvency, and the reason we know this is basically we have seen that only when -- For example in Britain, when Northern Rock was bailed out with sovereign credit that the system stabilized. And we had a very major problem prior to the Bear Stearns bailout, but once sovereign credit was substituted for their credit, that too stabilized.

But, it's very clear from the spreads that we see in Libor, OIS and credit default swaps for the financials, that we have not gotten closure yet. And it's going to take a while.

It's essentially, fundamentally the price of homes in the United States which are of course determining what the equity is in homes here, and therefore, what the ultimate collateral of the mortgage-backed securities is, pretty much around the world.

And we're still no where near the bottom of the home price thing, and we're looking for that as the critical statistic that will create a balance fundamentally in the economy.

And until then, I hope we can get a sufficiently stable stock market because there is the fundamental source of capital from which we get the ability to recapitalize a goodly part of the financial system, which surely needs it."

At this point, CNBC anchor Maria Bartiromo made a typically CNBC-like airhead remark: "And that's built on confidence." Like so many other people, including supposedly brilliant Nobel prize winning economists and central bankers, Bartiromo believes that fundamentals are irrelevant to the stock market, and all that matters is that investors have to just BELIEVE that everything's ok, and thing's will be ok.

Greenspan understands that the problem is much more serious. We're in a massive deflationary spiral that leaves less money in the world each day than there was the day before.

And by saying that "this is a once in a century type of phenomenon," he's acknowledging that it's comparable to the 1930s Great Depression, though it's unclear to me whether or not he yet understands that it's WORSE than the Great Depression.

However, he provides an explanation for one thing that's been puzzling me: Why has the deflationary spiral affected only financial services firms? It's true that investment banks and hedge funds were most heavily invested in near-worthless CDOs and other mortgage backed securities, but there should have at least a few casualties in other industries.

He says that non-financial firms have solid balance sheets, and didn't need to borrow. That's still puzzling, because financial firms also had solid balance sheets prior to the credit crisis that began a year ago.

At any rate, he expects other firms to be hit hard now, and we only have to look at General Motors, whose stock is at 1950s levels and which is close to bankruptcy, to see what he means.

Second quarter corporate earnings

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

Here's the latest table for second quarter earnings:

  Date    2Q Earnings growth estimate as of that date
  ------- -------------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%   Start of quarter
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%   End of quarter
  Jul  3:             -12.4%
  Jul  8:             -13.0%
  Jul 11:             -14.7%
  Jul 18:             -17.1%
  Jul 25:             -17.9%
  Aug  1:             -20.4%

As you can see, earnings estimates have taken another big hit in the last week,

A fall in earnings estimates means an increase of price/earnings ratios estimates. Here's the Friday's version of the graphic that appears on the bottom of the home page of this web site:


S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 1-Aug-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 1-Aug-2008. (Source: MarketGauge ® by DataView, LLC)

It now looks as if a new trend has been established. For two years, investors had been tuning their buy/sell algorithms to maintain price/earnings ratios (also called "valuations") of almost exactly 18. But now they've re-tuned their computer software to target valuations around 21.

This is a startling development, since it means investors are really brain-dead about what's going on.

But it also means that the stock market is (21/18)-1 = 17% higher than it would have been if investors hadn't made that algorithmic adjustment. That is, the Dow Industrials would have been around 9700 if it hadn't been for this adjustment.

I'd have to guess that investors are VERY nervous about this situation. After living with P/E = 18 for two years, being at P/E = 21 in the current environment would have to be considered very high risk even by the most oblivious investors.

Fraud accusations for UBS and Citibank

New York Attorney General Andrew Cuomo is about to charge Citibank (actually, Citigroup Inc.) with fraud related to auction rate securities.

Cuomo has already brought the same charges against UBS AG, and as I wrote last month, there's a "smoking gun" memo that provides solid evidence.

The banks are charged with having "repeatedly and persistently committed fraud" by falsely representing to customers that auction-rate debt was safe, liquid and the equivalent of cash.

(For a discussion of the hare-brained auction rate securities scheme, see "Investment bank UBS is now 'writing down' clients' auction rate securities.")

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.

The accusations of fraud directed at Citi and UBS are related to auction rate securities, but we should expect to see many more such accusations, related to ARSs and also to mortgage-backed CDOs and other securities.

Accounting rule postponed a year

Banks accused of fraud may have the perfect defense: "The regulators told me to commit fraud."

That's the gist of a a rule change by the Financial Accounting Standards Board that would postpone for one year a rule that would require banks to declare worthless assets more quickly.

As we discussed recently with regard to the latest of Merrill Lynch's repeated asset writedowns, financial institutions have been postponing as long as possible having to admit that they have near-worthless assets in their portfolios. Not admitting it is fraud, because investors in the bank are fooled into thinking that the bank is worth more than it actually is worth.

But fraud should be perfectly ok if everyone is doing it, and if government officials tell you to do it, shouldn't it?

The FASB rule change says that it's perfectly ok to continue perpetrating fraud for another year.

That should give Citi and UBS a perfect defense - the regulators are urging banks to continue committing fraud. Quite honestly, I don't see what possible justification Cuomo has for charging Citi and UBS with fraud, when fraud is the current standard. Why should they be singled out for selective prosecution when everybody's doing the same thing and regulators are encouraging everyone to do the same thing.

It's especially ironic that Cuomo is the attorney general of New York.

It was New York Insurance Superintendent Eric Dinallo who spent several months earlier this year helping the banks and "monoline" bond insurance to collude to commit fraud. One of the major banks involved was Citi.

Now how on earth could Citi possibly be guilty in New York of any similar fraud, if the New York Insurance Superintendent was openly and publicly helping Citi to conspire to commit fraud. Shouldn't Dinallo himself be charged with conspiring to commit fraud? There's hardly any doubt that he did it -- just read any business newspaper in February or March and see for yourself.

And, not surprisingly, Citi was the major proponent of postponing the FASB rule, so that they could continue to mislead investors about the value of their portfolio.

And the people on CNBC wonder why bankers no longer have any credibility!

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. (3-Aug-2008) Permanent Link
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CNBC's Jim Cramer announces that the market has hit bottom.

Pushing toy stuffed bears through a meat slicer, the screaming, peripatetic CNBC anchor Jim Cramer declared that he "had unbelievable guts to call a bottom," and said:

"I am indeed sticking my neck out right here, right now, declaring emphatically that I believe the market will not revisit the panicked lows it hit on July 15. and I think anyone out there who’s waiting for that low to be breached is in for a big disappointment and [they’re] missing a great deal of upside.

Stop waiting, [and] buy the next dip because I think it might be the last big one."

If you have a few minutes, listen to it yourself:

The first thing to note is that the reasons he gives are all based on data for the last few days. That data could all change in the next few days. People like Cramer believe that "history always begins this morning," and that's why they always get things wrong.

The analysis by Oppenheimer's Meredith Whitney predicting imminent meltdown of over 25 financial institutions at least uses 6-12 months of data.

And the analyses that I've been posting on this web site since 2003 all use decades of data. That's why they always turn out right.

(See "List of major Generational Dynamics predictions" for more information about these predictions.)

But for Cramer, a couple of days is all you need.

Let's take a look at some of the reasons he gives for a bottom:


Market summary, July 29-31, 2008
Market summary, July 29-31, 2008

Well, the last prediction is already wrong, as the market indexes were sharply lower on Thursday.

So we can assume that Cramer's whole "call bottom" thing is a colorful publicity stunt, with no rational justification whatsoever. If you've been depending on Cramer to provide investment advice, you might be better off flipping a coin.

Why there won't be a rally

Every few weeks, I post the reasons why a stock market rally is almost impossible, and today is a good day to do so again. This is the same argument that I've been using since 2003; only the data has been updated, and the details have changed. Regular readers may wish to switch to another blog.

First, and most important, corporate earnings keep falling. During the bubble they were way above the historic average, and now the Law of Mean Reversion is kicking in, and they'll be way below average for a long time.

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

Here's the latest table for second quarter earnings:

  Date    2Q Earnings growth estimate as of that date
  ------- -------------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%   Start of quarter
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%   End of quarter
  Jul  3:             -12.4%
  Jul  8:             -13.0%
  Jul 11:             -14.7%
  Jul 18:             -17.1%
  Jul 25:             -17.9%
  Jul 28:             -17.8%  Mon
  Jul 29:             -17.9%  Tue
  Jul 30:             -17.9%  Wed
  Jul 31:             -18.0%  Thu

If earnings fall, then either stock prices have to fall, or price/earnings ratios have to rise.

As usual, a fall in earnings estimates means an increase of price/earnings ratios estimates. Here's the last Friday's version of the graphic that appears on the bottom of the home page of this web site:


S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 25-July-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 25-July-2008. (Source: MarketGauge ® by DataView, LLC)

Price/earnings ratios have been astronomically high since 1995, and by the Law of Mean Reversion, they'll have to be far below average (well below 10) for an equivalent amount of time.

As you can see from the steadiness of P/E ratios (also called "valuations") since 2005, investors followed a formulaic strategy that kept the ratio at 18 for over two years. In March, P/E ratios jumped to a stratospheric level of around 22-23, and in the last month, the index has fallen to 21.

Putting these earnings and P/E figures together, in order for a rally to occur, investors would have to be willing to push valuations back up to 23 or 24.

Now, I'll admit that I was surprised when they went up to 23 after the March crisis, but it's hard for me to believe that investors are going to do that again. But this is the crux of the argument, and if you believe that institutional investors will do that, then you should expect a rally, and you should follow Jim Cramer's advice and buy, buy, buy. But I don't think that will happen.

In fact, I think it's more likely that P/E ratios will fall again to 18, which means that stock prices will fall at least another 10-15% for where they are today.

And if Oppenheimer analyst Meredith Whitney's prediction that 25 financial institutions will melt down in the next two months, the plunge could go a lot deeper.

As I've been saying hundreds of times since 2002, the stock market is overpriced by a factor of more than 200%, as I described in "How to compute the 'real value' of the stock market," indicating that we're entering a new 1930s style Great Depression. In 2002 I had no idea what scenario we would follow to reach that point, but the end result has always been certain with 100% probability.

Here's the first graph that I used in that article:


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

The historic average of the P/E1 (price divided by one-year trailing earnings) is about 14. From 1995 to the present, it's averaged around 25, creating a huge bubble. By the Law of Mean Reversion, the price/earnings ratio will fall well below 10 for a dozen years or so. You can see that it's poised to fall quickly in the near future, leading to a stock market crash.

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. (1-Aug-2008) Permanent Link
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Depression-era chic: in fashions, what's old is new again.

Even in a depression, women still want interesting clothing.

A thoughtful web site reader referred me to this New York Post article:

"Taking a cue from the grim economy, this fall's fashions at Banana Republic, Gap and H&M are featuring a distinctly Depression-era trend of cloche hats, pencil skirts, conductor caps and baggy, vintage-style dresses.

One of the most popular styles appears to hark back to the impish, newsboy getup of the 1930s: baggy trousers, caps, pinstriped vests, oxford lace-up shoes and utilitarian handbags.

"We associate the newsboy look with urban poverty - street kids of the 1930s," said Daniel James Cole, a professor at the Fashion Institute of Technology.

"Given that we're in an unstable economy and an uncertain political landscape, it's possible that a retro style has come back as a way to connect with our heritage."


Lower east sider Renee Finn (left) eyes up a '30s-style hat at a Midtown Gap, while model Megan (right) looks ready to peddle some newspapers in the Financial District. <font face=Arial size=-2>(Source: NY Post)</font>
Lower east sider Renee Finn (left) eyes up a '30s-style hat at a Midtown Gap, while model Megan (right) looks ready to peddle some newspapers in the Financial District. (Source: NY Post)

(1-Aug-2008) Permanent Link
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