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


Web Log - July, 2009


China's bubble economy becomes increasingly unstable.

The Shanghai stock market fell sharply on Wednesday, over investor worries that the stock market is in a bubble, and that a crash is inevitable.

In March, 2007, over two years ago, I quoted Chinese premier Wen Jiabao as saying that China's economy was "unsteady, unbalanced, uncoordinated and unsustainable." It's worthwhile looking again at what he said:

"China's economy has maintained fast yet steady growth in recent years. However, this gives no cause for complacency, neither in the past, nor now, or in the future. My mind is focused on the pressing challenges. "A country that appears peaceful and stable may encounter unexpected crises." There are structural problems in China's economy which cause unsteady, unbalanced, uncoordinated and unsustainable development.

  • Unsteady development means overheated investment as well as excessive credit supply and liquidity and surplus in foreign trade and international payments.
  • Unbalanced development means uneven development between urban and rural areas, between different regions and between economic and social development.
  • Uncoordinated development means that there is lack of proper balance between the primary, secondary and tertiary sectors and between investment and consumption. Economic growth is mainly driven by investment and export.
  • Unsustainable development means that we have not done well in saving energy and resources and protecting the environment.
All these are pressing problems facing us, which require long-term efforts to resolve."

What's becoming increasingly apparent is that China's economy has become even more unstable and unbalanced since then.

For many years, China has had an export-led economy. This means that China's economy depended on manufacturing products and shipping them to other countries, particularly the US. China would loan us money by purchasing Treasury bonds, now totalling well over $1 trillion, and we would use that money to purchase Chinese goods. This relationship has sometimes been described as a deadly embrace.

Chinese trade balance, in millions of US dollars per month <font size=-2>(Source:</font>
Chinese trade balance, in millions of US dollars per month (Source:

With the US in recession, and American people's savings rate increasing rapidly, China is purchasing far fewer Chinese products, and this is throwing China's economy into chaos. The adjacent graph shows this quite dramatically.

At the time that Wen gave his news conference, quoted above, China was entering a period of wild thrashing in its balance of trade. There was a huge trade bubble that lasted into 2008, largely propelled by an economic frenzy preparing for the Beijing Olympics in August. The bubble collapsed as August approached.

Last fall I began writing about a major new development: A worldwide collapse in transportation and trade. (See, for example, "World wide transportation and trade sink farther into deep freeze.") I made a comparison to the old science fiction movie, "The Day the Earth Stood Still," except that it wasn't science fiction. You can see from the above graph that China's export trade crashed, going into 2009. And when China's export trade crashed, so did China's entire economy.

That was when the stimulus packages in countries around the world began to kick in, including a $500 billion stimulus package in China. The stimulus package was supposed to restore China's economy. And you can see from the graph that the trade balance has begun to shoot up again in the last few months.

This is a perfect illustration of the Law of Diminishing Returns, which says that when you supply a lot of one resource without supplying the related resources, then the first resource is essentially wasted. There are more and more signs of that in China's economy.

The most obvious problem is that people are simply taking the stimulus money and pouring it into new real estate and stock market bubbles. Chinese officials are expressing concern about exactly that.

More serious is that in the rush to use the stimulus money, a lot of it is being wasted and unneeded or shoddy products.

Shanghai building that toppled over, remaining relatively intact <font size=-2>(Source:</font>
Shanghai building that toppled over, remaining relatively intact (Source:

One spectacular failure is a building in Shanghai that seems to have toppled over on its side but remained intact:

"According to Shanghai Daily, initial investigations attribute the accident to the excavations for the construction of a garage under the collapsed building. Large quantities of earth were removed and dumped in a landfill next to a nearby creek; the weight of the earth caused the river bank to collapse, which, in turn, allowed water to seep into the ground, creating a muddy foundation for the building that toppled."

This is just one example of a widespread problem in Shanghai and throughout China: "While the real estate market appears to be is in the midst of a boom, defaults among developers are also beginning to rise. Small and medium developers are resorting to faking sales to get bank loans to relieve their funding pressure."

This kind of corruption should not be a surprise, since it's generational, and we're seen it in the US as well, and continue to see it. (For more insight into corruption in China, see "A generational view of China's growing melamine food disaster.")

This has led to a Chinese economy that's completely unbalanced, according to one one well-known analyst, Jeremy Grantham, who says, "My colleague, Edward Chancellor, strongly suspects that the Chinese economy is dangerously unbalanced and very likely to come unhinged in the next few quarters, surprising the pants off investors."

What China's officials are trying to do is to convince the Chinese people to start spending more money on consumer goods, so that they can have a consumer-driven economy, rather than an export-led economy. But there's little chance of that happening in the middle of a major generational financial crisis. To the contrary, Generational Dynamics predicts that the Chinese people will change from being savers to being super-savers, just as Americans did in the 1930s.

People often ask me what's going to happen to China, especially since China has been a creditor nation, while the US has been a debtor nation. The implication was that China would do well, while the US would do poorly. But all you have to do is look at America in the 1930s, to see that a creditor nation suffers just as much in a Great Depression.

We can expect to see stories of China's manufacturers using the stimulus money to produce more and more products that will remain in warehouses, since Chinese people don't want to spend money. One important indicator we're already seeing is copper prices, which have been spiking during the last few months, and which now appear to be peaking. China has been using stimulus money to stockpile copper and other commodities, but by now has stockpiled more than it can use.

Morgan Stanley's China expert, Stephen Roach, expresses even greater concerns:

"On the surface, China appears to be leading the world from recession to recovery. After coming to a virtual standstill in late 2008, at least as measured quarter-to-quarter, economic growth accelerated sharply in spring 2009. ...

The bad news is that China’s recent growth spurt comes at a steep price. Fearful that its recent economic shortfall would deepen, Chinese policymakers have opted for quantity over quality in setting macro-strategy, the centrepiece of which is an enormous surge in infrastructure spending funded by a burst of bank lending.

Sure, developing nations always need more infrastructure. But China has taken this to extremes. Infrastructure expenditure (including Sichuan earthquake reconstruction) accounts for fully 72 per cent of China’s recently enacted Rmb4,000bn ($585bn) stimulus. The government urged the banks to step up and fund the package. And they did. In the first six months of 2009 bank loans totalled Rmb7,400bn – three times the pace in the first half of 2008 and the strongest six-month lending surge on record.

This outsize bank-directed investment stimulus leaves little doubt as to how bad it was in China in late 2008 and early 2009. An unprecedented external demand shock, stemming from rare synchronous recessions in the developed world, devastated the export-led Chinese growth machine. That triggered sackings of more than 20m migrant workers in export-intensive Guangdong province. Long fixated on social stability, Beijing moved quickly with massive firepower to arrest this deterioration. The government was determined to do whatever it took to restore rapid growth.

Yet there can be no avoiding the destabilising consequences of these actions. Surging investment accounted for an unprecedented 88 per cent of Chinese GDP growth in the first half of 2009 – double the average contribution of 43 per cent over the past decade. At the same time, the quality of Chinese bank lending most assuredly suffered from the rash of credit disbursements in the first half of this year – a trend that could sow the seeds for a new wave of non-performing bank loans. Just this week Chinese regulators sounded the alarm – telling banks new loans must be used to bolster the real economy and not for speculation in equities and real estate. ...

Unlike most, I have been a steadfast optimist on China. Yet I am starting to worry. A macro strategy that exacerbates already worrying imbalances is ultimately a recipe for failure."

However, there's another side to this story.

In April, I posted my notes on a lengthy presentation by Richard C. Koo, Chief Economist at Nomura Research Institute, on "Fiscal stimulus programs in 1930s and today." I'd like to quote a few paragraphs from my notes on Koo's presentation:

"Audience question: Where would the stimulus money best be spent? Answer: Historically, the best way is military spending, because it creates demand, without creating supply. That's why economies recover quickly. But if you increase both demand and supply, then they start chasing each other. If you want the smallest budget deficit, and largest bang for money, that's the best way. Koo said he's not here to advocate military spending. "There are lots of roads and bridges here needing repair." ...

Koo's most dramatic remarks came at the very end. FDR's spending programs didn't end the 1930s Depression. World War II did. Spending on the military, according to Koo, gives the highest "bang for the buck."

Koo said Hitler did everything right -- spending massively on the military. (He would be forgiven for not mentioning that probably the Japanese did everything right as well.) He expressed the hope that this worldwide financial crisis would not allow dictatorships to get ahead of democracies.

What dictatorships is he talking about? Well, maybe Russia, but you can be sure that he's thinking of China.

A few days ago, in "New Pentagon report shows China continues to prepare for war with US," I discussed the rapid military buildup that China is pursuing.

China is now embarking on a very aggressive fiscal stimulus plan. China doesn't say how much of the stimulus is going into the military. But China has already been increasing the military budget by 10-20% a year for years, as they prepare for war with the United States. I think it's quite certain that China will take advantage of this fiscal stimulus program to further increase military spending.

In the US, by contrast, President Obama is planning to cut weapons systems. As the world becomes increasingly dangerous, the US is becoming weaker.

I don't know whether Koo intended this when he made those final remarks about Hitler, but he illuminated a fast-approaching world in which the US and the world's democracies will be stumbling forward with social programs and bridges to nowhere, while China is turning into a high-powered military machine, preparing for war.

China does not tell us how much money they're spending on the military, but they're as aware of Koo's theories as anyone else is, and there's little doubt in my mind that a lot of China's stimulus money is going into the military, preparing for war with the US.

(Comments: For reader comments, questions and discussion, see the China thread and the Financial Topics thread of the Generational Dynamics forum.) (30-Jul-2009) Permanent Link
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Obama's health plan, a proposal of economic insanity, appears to be losing support

The tv drama, "The education of Barack Obama," continues.

Last week, President Obama was forced to delay by six months the creation of a plan on closing Guantánamo prison.

And now a rift among Democrats in Congress has forced President Obama to accept a delay in his health plan legislation until much later in the year than he had hoped. Even worse, public opposition to the plan is growing, and Obama's poll ratings have been falling.

It seemed so easy when Obama was campaigning last year. He would be guided by facts, not like President Bush, who was guided by ideology and ignored facts. The world would change on January 21. He would cure global warming, close Guantanamo, become friendly with Iran and North Korea, bring a two-state solution to Palestinians and Israelis, beat the Taliban in Afghanistan, reflate the stock market bubble and, of course, provide universal health care.

The youthful President Obama is learning that there are more and more facts to be guided by, facts that he apparently wasn't aware of. The education of President Obama continues, with exciting new episodes every day.

In the case of his health plan, we can only be thankful that it appears to be going nowhere, since it's an economic disaster. If Obama ever manages to use his overwhelming party majorities in both branches of Congress to push something through, it will be a mess.

Price controls

Politicians say that our health system is "broken," and perhaps it is. Politicians say that health-related costs have been rising faster than inflation, and they say that some people (the poor, the unemployed, the minorities, the sick, etc.) don't have health insurance.

In other words, the worst of what the politicians say is wrong with our health care system may well be true, but the insanity is believing that you can just pass a law and the problems will be solved. As bad as things are now, passing a 1,000 page law will make things much, much worse.

If prices are going up faster than inflation, it means that the law of supply and demand is pushing prices up. And if some people don't have health insurance, it means that rationing is going on. This isn't too difficult to understand -- unless, of course, you're a politician, to whom simple economics is as difficult as rocket science.

President Obama's health care plan amounts to price controls and rationing. This is a recipe for total disaster.

Inflation rate following the imposition of wage-price controls on August 15, 1971 <font size=-2>(Source:</font>
Inflation rate following the imposition of wage-price controls on August 15, 1971 (Source:

I've lived through price controls before. On August 15, 1971, President Richard Nixon imposed national wage-price controls by executive order. It was an unmitigated catastrophe.

There were many little mini-catastrophes, but the one that's always stuck in my mind was that farmers in New Jersey were drowning chickens. The problem was that chicken feed was a commodity whose price was determined by the international commodities markets, and so its price could not be controlled, while the prices of chickens WERE controlled. So the prices of chicken feed went up, and the prices of chickens stayed the same, meaning that farmers could no longer afford to raise chickens. So they drowned the chickens, leading to a big shortage of chickens.

Another thing that I remember was that wage-price controls applied to private industry, but not to government agencies. Thus, books and pamphlets sold by private publishers were price-controlled, but books and pamphets sold by the Government Printing Office were not. Thus, you had to pay huge prices for federal government publications, while many publications from private publishers simply became unavailable.

President Nixon's wage-price controls were the worst kind of Rube Goldberg contraption. You had different government agencies involved, keeping track of prices, making sure no one was cheating, and reviewing requests to raise prices if someone could defend it as an "emergency." As you can see from the inflation graph above, it didn't control prices at all. All it did was distort the markets so much that ordinary market efficiencies broke down. Without the market efficiencies, inflation got astronomically worse, before the entire disastrous program was finally abandoned in 1974.

A Rube Goldberg contraption

You cannot defeat the Law of Supply and Demand by passing a law. Only a politician or economist is stupid enough to believe you can.

Apparently few people have even read the 1000+ page proposed law that's supposed to solve all our health care problems, and apparently no one, even its sponsors, has any real idea how it's supposed to work. This isn't surprising, since the problem that it's intended to solve cannot be solved without making the problem worse than it is already.

Health care plan diagram from Republican opposition <font size=-2>(Source:</font>
Health care plan diagram from Republican opposition (Source:

The Republican opposition have put together this "organizational chart" of the health care plan. (Click here for a full-sized chart on the House web site.)

I don't know whether this diagram is correct in detail, but in concept it's very close to what's going on, because there's no way to administer a price control and rationing scheme this complex without numerous government agencies.

Apparently the Democrats agree, because they've been using procedural methods to block Republicans from sending the chart to their constituents.

If President Obama manages to push anything like this contraption through Congress, you can expect things like the following to happen, analogous to President Nixon's disastrous wage-price controls:

This is yet one more example, as if more are needed, of the results of the lethal combination of greedy, nihilistic Gen-Xers, combined with greedy, stupid Boomers. No one capable of thought can possibly believe that this health care plan will work. This leaves us with the obvious conclusion that nihilistic Democratic Gen-Xers are pushing this plan because they expect to get votes or make money from it, and don't care how destructive it is, and stupid Democratic Boomers are going along with it for the same reason.

As I keep emphasizing, the same people who perpetrated the massive fraud leading to the current financial crisis are still in charge, in the Obama administration, in Congress, in financial institutions, in health care organizations, and in other organizations. Nothing has changed, except the nature of scams, and this has the potential to be an even worse scam than selling fraudulent mortgage-backed securities.

There is one big advantage that we have today that we didn't have in 1971. President Nixon's wage-price controls were wildly popular when they were imposed, and so there was little political opposition to them until the disaster became apparent. Today, the health care plan is becoming increasingly unpopular BEFORE its imposition, so if we're all lucky, the effort will collapse completely.

Incidentally, rationing problems are not unique to the United States. The Law of Supply and Demand has forced rationing on Canada, the UK, China, and other countries that have public health plans. That's why we always have news stories about people from these countries coming to the US to get immediate health care that they'd otherwise have to wait months for. Any price control and rationing scheme will always permit exceptions for the élite -- wealthy people, politicians and their cronies. The rest of us will always have to suffer.

The future of health care

So what's going to happen to health care? It's a fair question, given the very real problems of existing rationing and increases in health care costs.

The answer is that the market will take care of it in ways that can barely be foreseen today.

I believe that within ten years or so we'll have computerized health care that will reduce costs dramatically. The reason that health care is so expensive is because it's so people-intensive, and nurses and doctors are very expensive. These costs will come down dramatically.

First, in the short run, as we go deeper into a new Great Depression, the salaries of nurses and doctors will be pushed down substantially, making health care and health insurance more affordable. There will be a new mood of parsimony, and this should reduce many auxiliary costs, including the huge awards to malpractice lawyers.

Second, in the longer run, many duties that today are performed only by doctors and nurses will increasingly be performed by computers. This doesn't mean that there won't be a human doctors and nurses; but it does mean that many of the repetitious functions of doctors and nurses will be performed by intelligent robots.

As I wrote in "I, Robot is science fiction, but intelligent computers will soon be science fact," we're in a world where computers are rapidly becoming as intelligent as human beings are, and are able to make decisions that are as intelligent as (or even more intelligent than) a human being can.

We already have some primitive forms of this. In a hospital room today, there are computerized devices that continuously monitor heartbeat and blood pressure and notify nurses if there's a problem. And there are people walking around with implanted devices that keep the heart beating and wirelessly notify doctors of sudden emergencies.

I'm imagining the following: A robot that can take care of a sick person in the home or hospital. It can monitor the patient 24 hours per day, take your temperature, dispense pills, give shots and provide meals. More sophisticated versions will even be able to clip toenails. It will have computer vision and hearing, and will be able to respond to simple patient requests like, "Please bring me a glass of water." If something happens that it can't handle, it will wirelessly call for a real live human nurse or doctor.

This will be technologically possible within ten years or so, and will be the key to reducing health care costs, and will happen whether or not any health care bill passes. All a health care bill can do now is make things disastrously worse in the meantime.

(Comments: For reader comments, questions and discussion, see the President Barack Obama thread of the Generational Dynamics forum.) (25-Jul-2009) Permanent Link
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Investors pop the champagne corks as stock markets return to 1998 levels

The current rally has been continuing for four months.

As I've written several times, a rally of this size in the midst of a calamitous stock market plunge is not unusual. I described in "Enquiring minds want to know: How long will the rally last?" that the stock market fell a full 90% from its peak in the years 1929-1932. During those three years, there were six rallies, including one 49% rally that lasted five months. So the current rally means nothing in terms of the overall direction of the market and the economy.

The Dow index crossed 9000 on Thursday, still 36% below its highs. The Dow is now at the level it was at in 1998, so we're not seeing an explosive new rally.

One reason that the rally is continuing is that 2nd quarter earnings are better than analysts had predicted. Earnings fell 31% from 2nd quarter of last year, when they had previously been expected to fall 35%. (See "Stock market rally raises cautious, anxious hope among investors.")

Today's mood must be something like it was in June, 1930, when President Herbert Hoover responded to a request with, "Gentlemen, you have come sixty days too late. The depression is over."

We've been discussing this in the Financial Topics thread of the Generational Dynamics forum. Please read through some of the recent postings there if you'd like further information, and feel free to contribute your own thoughts.

(Comments: For reader comments, questions and discussion, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (24-Jul-2009) Permanent Link
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Boomers celebrate themselves on the death of Walter Cronkite

Boomers never really celebrate other people - just themselves.

I was never really impressed with Walter Cronkite, largely because he didn't understand 4th grade percentages. I'll come back to that.

Walter Cronkite made his mark as a journalist in World War II. He was part of the GI Generation (generational Hero archetype) that fought the war. His bravery in reporting on the ground during the European battle following the landing at Normandy established him as one of the greatest journalists of the 20th century.

But that was only rarely mentioned in the flood of news reports that have accompanied his death in the last few days. His coverage of the 1969 moon landing was frequently mentioned, but that's because we're celebrating the 40th anniversary of the moon landing.

The main thing that Boomers are proud of was his opposition to the Vietnam War and the Nixon administration, beginning with his February 27, 1968, commentary on saying that "we are mired in stalemate" in the war:

"To say that we are closer to victory today is to believe, in the face of the evidence, the optimists who have been wrong in the past. To suggest we are on the edge of defeat is to yield to unreasonable pessimism. To say that we are mired in stalemate seems the only realistic, yet unsatisfactory, conclusion. On the off chance that military and political analysts are right, in the next few months we must test the enemy's intentions, in case this is indeed his last big gasp before negotiations. But it is increasingly clear to this reporter that the only rational way out then will be to negotiate, not as victors, but as an honorable people who lived up to their pledge to defend democracy, and did the best they could."

This statement, coming from one of the most powerful newsmen of the time (Chet Huntley and David Brinkley were more powerful at the time), shortly after the Summer of Love, energized the "antiwar movement," and led to President Lyndon Johnson's decision not to run for a second term as President.

Cronkite had been a balanced journalist up to that time, but after that he moved farther to the left, conducting a virtual media war against President Nixon's administration, much to the delight of the Boomers.

The first "4th grade percentages" moment that I recall happened around 1975. At that time, there was an ideological battle going on over the "socialist" takeover of the economy, with conservatives claiming that the government's share of the economy had increased by 25% in the preceding few years. Cronkite commented on this, saying (I'm paraphrasing from memory), "That's not true. The government used to control 19% of the economy, and now it's only 24%. That's only a 5% increase."

Now, for those of you who also have trouble with percentages, that's a 26% increase. (24 is 26% higher than 19.) Perhaps others may think that that's a trivial matter, but to me it means that he should stick to stories about the war and women's lib, and not report any stories that contain a number, since he can't do simple arithmetic.

The second "4th grade percentage" moment came late in the 70s. OPEC had been raising the price of oil, and so gasoline (petrol) prices had been going up. The ideological battle was over how much profit the oil companies were making, especially when a gallon of gas (petrol) reached the astronomically high price of $1.00 per gallon.

As I recall, Mobil was making about 1.5 cents per gallon in 1977, and 1 cent per gallon in 1978. Then in 1979 it went up to 1.60 cents per gallon. This meant that Mobil's profits had increased by 60%, but it also meant that if Mobil made no profit whatsoever, the price of a gallon of gas would only go down by 1.6 cents.

Cronkite reported this with a huge graphic on the screen next to his head saying "60%" in big numerals. He made it appear that Mobil's profit was 60%, not 1.6%. So which was it? Was he too stupid to understand percentages, or was he purposely lying for ideological reasons? I report, you decide.

I actually still respected Cronkite, and kept watching his newscast, as it was the best one on at the time. But then, in 1981, he was replaced by Dan Rather, who was really the pits. I still remember the day I vowed that I would never watch Rather again. It was around 1982, and it was a news reports on AIDS, which just beginning to make itself widely known. Rather reported that some Soviet-controlled medical academy had "found" that AIDS was a plot perpetrated by the American CIA. Rather didn't report this story as a joke. He reported it as a serious news story, just as if the American Medical Association had made the claim.

I decided I would never watch the jerk again, which wasn't too much of a sacrifice since CNN had begun broadcasting by then. In the years since then, I've probably violated that rule less than five times. It serves Rather right that he ended his career in disgrace with that ridiculous forged document scandal that occurred in 2004. To this very day, Rather still sticks to the flawed story that ended his career.

This is your brain on ideology
This is your brain on ideology

But that brings me to the point of this tale. How dumb does Rather have to be to allow a ridiculous story like that destroy his whole career? At any point, he could have said, "OK, the evidence is piling up that the document is forged. I apologize to my viewers, blah, blah, blah." Instead, he took the story to his (professional) grave. How can anybody be so stupid? That's the problem with these journalists. They're so ideological that their brains are fried.

The fact is that few people younger than Boomers ever watched Rather or his peers. As of ten years ago, the average age of a viewer of one of the network newscasts was 55 years old. That's when the Fox News Channel started taking off.

As I described a couple of months ago in "Vile 'teabagging' jokes signal the deterioration of CNN and NBC news," the network newscasts continue to disgrace themselves. They are no longer barely recognizable as news casts; they're mostly ideological recitations.

That's the real accomplishment of Walter Cronkite. He opened the door to replacing journalism with ideology, and by not being able to deal with 4th grade percentages, he opened the door to journalistic stupidity. May he rest in peace.

(Comments: For reader comments, questions and discussion, see the Fox News Channel vs CNN and MSNBC thread of the Generational Dynamics forum.) (21-Jul-2009) Permanent Link
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Tens of thousands protest in Tehran after Rafsanjani says Iran is "in crisis "

It was just yesterday that I heard that the protests were all finished.

In fact, the BBC was reporting this all day on Thursday. But they should have waited a day.

The thought that the protests and demonstrations had been completely crushed was widely believed among journalists, commentators, analysts and pundits. Many of them used as a historical comparison the Tiananmen Square massacre of 1989, where the Chinese army slaughtered hundreds or thousands of unarmed students, crushing the demonstrations and protests.

But as I've been writing all along, Tiananmen Square is the wrong historical analogy, because it occurred at the wrong time in the generational timeline.

The best and most familiar historical analogy is America's 1967 Summer of Love and the following events, including the violence at the 1968 Democratic National Convention in Chicago.

(For information about generational eras, see "Basics of Generational Dynamics." For information about America's Awakening era in the 1960s, see "Boomers commemorate the 40th anniversary of the Summer of Love.")

Friday's demonstrations were timed to coincide with a major speech by Hashemi Rafsanjani, a powerful cleric and former president, who supported the opposition candidate Mir Hussein Moussavi in the recent election won by Mahmoud Ahmadinejad.

In his speech, Rafsanjani urged the release of prisoners who had been detained for protesting, and warned that the government was in crisis:

"Today is a bitter day. People have lost their faith in the regime and their trust is damaged. It's necessary to regain people's consent and restore their trust in the regime. Everyone has lost. ...

Doubt has been created [about the election results]. There is a large portion of wise people who say they have doubts. We need to take action to remove this doubt. Where people are not present or their vote is not considered, that government is not Islamic."

This was a thinly veiled attack on Supreme Leader Ayatollah Ali Khamenei and Ahmadinejad.

Those inside and outside of Iran who have been expecting or hoping for an end to the demonstrations are going to end soon will be disappointed. Even if Khamenei and Ahmadinejad step down, and were replaced by Rafsanjani and Moussavi, the protests wouldn't stop.

On the other hand, those who expect a violent revolution to overthrow the regime will also be disappointed. These confrontation will be political, with only minor violence.

In fact, I would expect the demonstrations to become even more chaotic in the fall, when the students return to college.

Generational Dynamics predicts that these protests and demonstrations become even more chaotic, and will continue for years, through Iran's generational Awakening era.

(Comments: For reader comments, questions and discussion, see the Iran thread of the Generational Dynamics forum.) (18-Jul-2009) Permanent Link
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CIT Group bank nears bankruptcy, as Nouriel Roubini declares the worst is over

CIT Group provides credit to almost a million small and medium sized businesses.

Delinquency rates for CIT loans <font face=Arial size=-2>(Source: WSJ)</font>
Delinquency rates for CIT loans (Source: WSJ)

The service is known as "factoring." A small business issues an invoice to a customer. The business turns the invoice receivable over to CIT, and CIT pays the business immediately, taking the risk of collecting from the customer for a small fee. But delinquency rates have been soaring since the beginning of the credit crisis, and CIT itself is no longer financially stable.

A CIT bankruptcy, which may occur as early as Friday, would freeze this source of credit to these small and medium sized businesses, creating cash crises for many of them.

CIT was bailed out in December with $2.35 billion, and there's been a week-long debate in Washington whether to bail CIT out again. Part of the debate was the question of whether the bankruptcy of CIT would pose a "systemic threat" to the world financial system, and the Treasury Dept. decided that there was no such sufficiently great threat.

Furthermore, Nouriel Roubini, the famous NYU professor who has gained worldwide acclaim for having predicted, in 2006, that the collapse of the real estate bubble would cause a recession, apparently doesn't think that there's a major problem either.

This is an interesting story because Roubini's words on Thursday are being credited as the cause of the big stock market rally on Thursday afternoon. He said that the worst of the financial crisis is over and the recession will end this year. Specifically, he said, "The freefall of the economy has stopped, There is light at the end of the tunnel. And the light at the end of the tunnel for once is not the one of an incoming train."

With the CIT Group facing bankruptcy, Roubini's statement was grabbed onto by the media as a bright spot in the news, triggering the late afternoon rally. The reaction from the media and investors was so great that Roubini felt it necessary to put out a statement claiming that he was only saying the things he's said before.

In fact, that's true. I posted a report last December entitled "Nouriel Roubini predicts recession will end in 2009."

So why did Roubini's statement on Thursday cause such a sensation? I believe it was for this reason: Last December it was relatively easy to believe that the recession would end by the end of 2009; now, in July, the end of 2009 is only five months away, and a lot fewer people believe that the recession will end by December. So Roubini's statement pushed the little Wall Street junkies into a further stock buying binge.

If Roubini isn't changing his mind, there's one person who apparently is. I wrote recently that stock market wise man Art Cashin expected the direction of the market to be clarified by Friday of this week. However, on Thursday morning, he backed off, saying that "This market is now overbought. There is a chance for a reversal. We may have to extend that checkpoint into next week." So I guess we'll just have to wait another week.

A much more sensible analysis was posted in the Generational Dynamics forum by the trader Gordo:

"If you are still long the market, I think the recent rally is a good opportunity to unload.

The positive media spin on everything this morning is pretty entertaining. The jobs report is supposedly bullish despite the fact that the actual (unadjusted) number of initial claims was 667,000 which is an increase of 86,389 from the previous week and yet this is being portrayed as an improvement. Then you have the biggest headline story about JP Morgan’s profits SOARING 36% or whatever, this report is even funnier when you dig into it, so they made a few bucks TRADING during the biggest short term market rally since the depression, and yet at the same time, they admit their core business is looking ill with a loan portfolio that continues to deteriorate despite all the so called green shoots. They set aside 5 TIMES the amount of so called profits from the quarter for bad loan loss reserves! Hahah….

Sorry I didn't give more detail yesterday, but the key reversal in the VIX along with treasury action may be signaling a stock-market peak. I’m starting to believe the market is very close to a multi-year peak right NOW. VIX managed to get back down to levels last seen in Sept. 2008, signaling complacency. The remarkable reversal in VIX yesterday could be indicating an important trend change, I expect it to move considerably higher, probably to the 40 range, as the market sells off over the next several weeks. After that I'm not sure...

It is possible that the market will not get back to current levels for a decade or more when all is said and done. Real bear markets end with single digit P/E ratios (based on peak or 10 year trailing earnings) and 6+% dividend yields, that’s the bottom line. Being long before that point is just asking for trouble, not that I don’t play bounces. LOL"

The VIX is the "volatility index," and it's dropped sharply lately, indicating a great deal of complacency among investors and the media. According to Gordo, this complacency is so great that it actually serves as a sell signal to day traders. This is an obvious contrarian strategy: Whatever the herd is doing, do the opposite.

Another analyst who definitely hasn't changed his mind is ... me. Since 2002 I've been saying that we're entering a new 1930s style Great Depression, and certainly nothing has happened to make me change my mind. That forecast was based on a long-term analysis of stock market trends. (See: "How to compute the 'real value' of the stock market.") Those conclusions are just as valid today as they were in 2002.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (17-Jul-2009) Permanent Link
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Israeli soldiers accuse Israel's army of genocide in Gaza war

Soldiers gave about 50 anonymous testimonies to Breaking the Silence, an Israeli soldiers’ organization.

They describe the Israeli army’s use of human shields and deliberate targeting of civilian structures. The descriptions support the claim that soldiers were given orders to shoot first and ask questions later.

As I've written in the past, Israel has been following a typical path that any country follows during a generational Crisis era. Any country will become increasingly genocidal as the Crisis era progresses, until the crisis war reaches a climax.

(For more information, see "Sri Lanka, Pakistan and Gaza are all following the same path," "Gaza war heads toward cease-fire, while violence surges in Sri Lanka," and "In Gaza and Sri Lanka, war slides into genocide.")

You can find translations of all the soldiers' testimonies here. I read through a couple of dozen of the testimonies, and I can't say I really found anything particularly shocking.

The coverage that I heard on the BBC had led me to believe that the soldiers were monsters, killing every civilian in sight. The actual testimonies showed some of that, but very little.

Here's one of the testimonies under the category "Bombardment". This is probably one of the most graphic of all the testimonies:

"Nearly no one ran into the enemy. I know of two encounters during the whole operation. The soldiers, too, were disappointed for not having had any encounters with terrorists. The defined situation was that sparing our forces was of primary importance. This means that if we detect anyone, we disconnect, summon a helicopter and take down the house. That was the clear definition and that is how it was done. As soon as we detect anyone, our forces improve their position and get into defense layout, and a helicopter takes down the house. No direct contact unless it happens at the first moment of the encounter. At least in the paratroopers' designated area, there were hardly any encounters at all.

Question: Were there definitions for identifying things?

Not as far as we were concerned. I don't know whether things were clearly defined, but as for the language, it was "suspects, lookouts, people standing on roofs and looking towards our forces, making suspect movements on the roof, bending down, looking out beyond the rim" – such were definitions of suspects that were enough to call a UAV or helicopter.

Question: You said there were orders to take down people seen on a roof.

As far as I know, I'm not certain what is considered suspect and what proper rules of engagement are. We responded to anything that seemed suspect to us. A helicopter or a firing *** was activated passed on detailed reports of what we see. A *** would arrive, connected to the command post at and then the people at the central command post could see what was going on and if it looked suspect to them, they would activate it."

Other testimonies describe looting of houses and the use of white phosphorous. Some of these things may technically be war crimes, but they're nothing compared to what happened in Sri Lanka. And by the way, they're nothing compared to the tactics that Israel will be using in the next war, whenever and wherever it may occur.

(Comments: For reader comments, questions and discussion, see the Mideast thread and the Sri Lanka crisis civil war thread of the Generational Dynamics forum.) (16-Jul-2009) Permanent Link
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Will the market's direction be clarified by Friday of this week?

Long-time market veteran Art Cashin says that it will.

Art Cashin has worked on the floor of the New York Stock Exchange for decades, and is thought to be among the "wisest" of the wise old men working there.

And so what Cashin said on CNBC last week really made me sit up and take notice:

"I think we will know the course of the stock market by July 17, 2009. Whether we retest the lows or not, we will have an answer by the end of next week. As far as earnings go, I an discounting the earnings and focusing on the outlook.

The first stimulus package was part illusion and hope, we misused it, we may not be able to help ourselves now the we actually need it."

What was interesting about Cashin's remarks were their specificity. Long time readers of this web site know that I make many predictions (See "List of major Generational Dynamics predictions"), but I avoid being specific about time, using phrases like, "such and such is coming with absolutely certainty sooner or later, and probably much sooner than later."

So I'm absolutely fascinated by the boldness of Cashin's prediction. He is saying, definitively, that questions about the stock market will be answered between Wednesday and Friday of this week. Appearing again on CNBC on Tuesday morning of this week, Cashin was quite vehement in repeating his forecast of last week that there will be a lot of market clarity -- one way or the other -- by Friday of this week, as earnings reports come pouring in. And although he said it could go in either direction, his facial expression made it pretty clear that the expected direction was down.

The reason why we'll know the market direction by Friday, according to Cashin, is that a flood of Q2 corporate earnings reports will come out between Wednesday and Friday. These reports will indicate whether the economy is recovering or continuing to crater.

According to the official Standard & Poor's earnings spreadsheet, analysts' estimates of earnings per share (EPS) for Q2 2009 have been falling steadily:

   Date         Q2 2009 S&P 500 EPS estimates as of that date
----------      ---------------------------------------------
 6/30/2008      $ 26.73
 9/30/2008      $ 25.44
12/31/2008      $ 19.92
 3/30/2009      $ 14.84
 6/30/2009      $ 14.15

Any one of these numbers would be astonishing, when you realize that the reported Q4 earnings per share value was -$23.25, and reported Q1 EPS was $7.54, 25.5% below analyst estimates.

And yet, the analyst estimates for Q2 are at $14.15. Not only that, but here's what I heard from a Deutsche Bank analyst: He said that "street" expectations for earnings this week are considerably higher than analysts' estimates. He added that a further rally based on good earnings reports is unlikely, since good earnings are already priced in.

Cashin works for UBS AG as a floor manager, one of the old-timers on the New York Stock Exchange floor. He probably talks to hundreds of people a day, and reaches conclusions based on those conversations. What he's sensing is that something very big is coming. I've quoted him several times in the past, and last October, I quoted him as saying that he's expecting "something major, something that will be remembered for generations."

I don't know if he still expects something major that will be remembered for generations or, if he does, whether that something will be occurring this week.

From the point of view of Generational Dynamics, something major that will be remembered for generations - a generational panic and stock market crash - is coming with certainty. The market has been overpriced since 1995, and is still overpriced by a factor of 150% or so. (See: "How to compute the 'real value' of the stock market.") However, I would never be so bold as to name a specific week and day of the week, as Cashin has done.

So I'll be joining everyone else to watch breathlessly what happens this week. Will this week's earnings reports clarify the direction of the market? I guess we'll know by Friday afternoon.


By the way, I'd like to encourage all web site readers to read and contribute to the Financial Topics thread of the Generational Dynamics forum each day or so. It's a bit of a pain, because you have to click on the little box that moves you to the last page of the thread to get the most recent postings. But it's some of the most intelligent discussion of financial topics on the internet.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (15-Jul-2009) Permanent Link
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Turkey's Prime Minister Erdogan accuses China of genocide in Xinjiang

Emphasizing Turkic ethnic identity over Muslim religious identity.

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Muslims are supposed to share common interests, yet among Arabs and Persians, reaction to China's crackdown on the Muslim Uighurs in Xinjiang province has been muted and perfunctory.

Not so among the citizens of Turkey. In a dramatic development, thousands of them have been demonstrating and protesting in Ankara and across Turkey in support of the Uighurs, burning Chinese flags and products.

Turkish Prime Minister Recep Tayyip Erdogan said Friday that genocide was being committed:

"The incidents in China are, simply put, a genocide. There's no point in interpreting this otherwise. ... We're having trouble understanding how the Chinese government would remain a bystander to this. We want the Chinese administration, with which our bilateral ties are continuously improving, to show sensitivity."

On Saturday, Erdogan escalated escalated the rhetoric by urging China to stop the "assimilation" of its Uighur minority:

"We ask the government of China to abandon assimilation, because such assimilation can do you no good. No state, no society which attacks the lives and rights of innocent civilians can guarantee its security and prosperity. Whether they are Turkic Uighurs or Chinese, we cannot tolerate such atrocities. The suffering of the Uighurs is ours."

Turkey's foreign ministry added, "The Turkish people feel very close to the Uighur people and share their suffering."

From the point of view of Generational Dynamics, what's interesting about this situation is that the Uighurs have two identities -- an ethnic Turkic identity and a religious Muslim identity -- and it's the ethnic Turkic identity that's turning out to be more important in the current crisis.

(At this point, it's worthwhile pointing out that the Turkish people are not so named because they're from the country Turkey. Instead, it's the opposite: The original name of the region was "Anatolia." The Turkish or Turkic people came from central Asia, and they named the country "Turkey" when they settled there and created the Ottoman Empire. For more information about the generational history of Turkey, see "Consequences of Russia/Georgia conflict spread to southern Caucasus.")

There's undoubtedly a feeling among the Turkish people for wanting a tiny bit of political revenge. They're furious that the west is blaming them for the Armenian genocide that occurred during WW I, and accompanied the destruction of the Ottoman Empire. So now they have an opportunity to accuse someone else of genocide. And Erdogan's remarks about "assimilation" refer to their own failure to assimilate the Armenians in the 1910s and, more recently, the PKK Kurds.

What's most interesting about this situation is the that way it illuminates developing international alignments. Turkey has been trying to boost economic ties with China, and President Abdullah Gul last month became the first Turkish president to visit China in 15 years.

But instead of developing closer ties with China, there are calls for a Turkish boycott of Chinese goods. This is not surprising since the Turkic people have had many wars with the Chinese people over the centuries, and the hatred exhibited by the Uighurs in the last couple of weeks toward the Han Chinese has been truly enormous. We will be watching this in the months to come.

(Comments: For reader comments, questions and discussion, see the China thread and the Turkey thread of the Generational Dynamics forum.) (13-Jul-2009) Permanent Link
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New Iran demonstrations commemorate the student protests of July 9, 1999

Hardline Iranian mullahs had thought that they had crushed the demonstrations once and for all, since the streets had been relatively quiet for 11 days.

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But on Thursday, thousands of protestors ran down the streets of Tehran shouting "Allahu Akbar" (God is great) and "Death to the dictator," the latter referring to Supreme Leader Ayatollah Ali Khamenei.

This is a surprise to many analysts, who had thought that the demonstrations would quickly fizzle. Many analysts are comparing this situation to the Beijing's 1989 Tiananmen Square massacre, which fizzled quickly after China's People's Liberation Army sprayed bullets into demonstrators, killing hundreds or thousands of unarmed students.

But that occurred at the beginning of a generational Unraveling era, 40 years after the end of the previous crisis war, Mao Zedong's Communist Revolution civil war.

Today's crisis in Iran is occurring 21 years after the end of Iran's last crisis war, the war that began with the 1979 Islamic Revolution, and continued with the Iran/Iraq war that climaxed in 1988. Thus, the correct historical event to compare it to is not the Tiananmen Square massacre, but America's 1967 Summer of Love and the following events, including the violence at the 1968 Democratic National Convention in Chicago.

(For information about generational eras, see "Basics of Generational Dynamics." For information about America's Awakening era in the 1960s, see "Boomers commemorate the 40th anniversary of the Summer of Love.")

The period 20-25 years after the end of the preceding crisis war is the time of greatest political protest, usually with little violence. Thus, we should expect the current demonstrations in Iran to continue for several years.

Today was chosen for the demonstrations because it's the tenth anniversary of a violent student uprising that began on July 9, 1999. That uprising was met with government violence and fizzled after only four days, which is to be expected only 11 years after the end of the previous crisis war.

The following is a fascinating al-Jazeera video describing the July 9, 1999, uprising:

(Comments: For reader comments, questions and discussion, see the Iran thread of the Generational Dynamics forum.) (10-Jul-2009) Permanent Link
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China's Xinjiang province is scene of violent anti-government protests

Xinhua reports that 156 people have been killed in Urumqi, Xinjiang's capital city. Over 1,000 people were injured in the riot, according to the official Chinese government statement.

China's Xinjian province is scene of violent riots and demonstrations <font face=Arial size=-2>(Source: CS Monitor)</font>
China's Xinjian province is scene of violent riots and demonstrations (Source: CS Monitor)

The rioting occurs across an ethnic fault line. The Muslim Uighurs, of Uzbek origin, have historically occupied the Xinjiang region. However, the Chinese Communist Party (CCP) government has been relocating Han Chinese into the Xinjiang region in order to dilute the Uighur population. The CCP has used the same policy to dilute the Tibetans in Tibet (the province just south of Xinjiang), with equal success.

From the point of view of Generational Dynamics, this can never work. You cannot resolve an ethnic fault line in a region by flooding the the region with the favored ethnic group. Has this ever worked throughout history? I'm not aware of any example. All that this does is inflame the fault line so that it's worse than ever, leading to a crisis civil war.

The event that triggered the violence occurred on the other side of China last month. Two Uighur migrant workers, working in a toy factory Guangdong province in southeast China, were accused of raping a Han woman, a charge which appears to have been fabricated. The two Uighurs were killed in a Han Chinese mob attack on their dormitory, and nobody has yet been charged with the two murders.

This Sunday, thousands of Uighurs rioted and demonstrated against CCP rule in Urumqi. Xinhua reports that the Uighurs killed the Han in their homes, and that the Han are astonished by the ferocity of the attack by people who have been their neighbors. Apparently the CCP security forces struck back against the Uighurs violently.

Interestingly, the CCP has said that 156 people have been killed, but the casualties haven't been characterized, as to being Uighur or Han or security forces. The CCP is characterizing the riots as an uprising against Chinese rule, while the Uighur Congress in Exile is claiming that the police had opened fire on the demonstrators.

The Uighurs say that the CCP discriminates against them. They resent the flood of Han Chinese "colonizing" the region, taking all the good jobs, leaving the menial jobs for the Uighurs. They also point out that there's language discrimination, since few Han speak the Uighur language.

There are a lot of cross accusations, but they're probably all true on both sides. This is a generational crisis era for China, and a violent ethnic attack leading to a major civil war would not be a surprise to anyone familiar with Generational Dynamics.

Whether that happens this time cannot be predicted, and remains to be seen.

China has tens of thousands of "mass incidents" every year, but everyone is describing this one as "unprecedented," because of its severity and because it appears to be organized. There are late reports that it's spreading to Kashgar, in the southern part of Xinjiang. There were violent Uighur terrorist incidents in Kashgar just prior to last year's Beijing Olympics.

There's no doubt that the CCP is frightened. This was already obvious last month when China commemorated the 1989 Tiananmen Square massacre. Now they've shut down mobile phones and internet access in Xinjiang, and they've arrested 1400 people. China has a history of violent rebellions and civil wars, and the senior citizens running the CCP in Beijing are very well aware that the government could collapse quite easily.

As I wrote in 2005 in "China approaches Civil War," and many times since, Generational Dynamics predicts that China is headed for a new civil war with absolute certainty.

(Comments: For reader comments, questions and discussion, see the China thread of the Generational Dynamics forum.) (7-Jul-2009) Permanent Link
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The Bubble Algorithm - How computers and herd behavior are inflating the stock market bubble

But Thursday's jobs report is changing attitudes quickly.

My report last week on "The influence of computerized trading programs" has raised some interesting discussions.

In that article, I discussed the fact that the S&P 500 price/earnings index had remained in the range 18-20 for many years (2004-2008), and I inferred that the only possible explanation was that programmed trading algorithms used by the major financial firms all used similar algorithms, and that a P/E valuation of 18-20 has been a part of those common algorithms.

A couple of people wondered if this claim of similar algorithms was too extravagant. Speaking now as a computer software consultant who's worked for a number of financial firms, there's little doubt. There are only so many trading algorithms, and they're all well known -- in fact, they're taught in colleges. Different firms might vary some of the parameters, and attempt to gain a trading advantage that way. But when you have almost five years of a constant P/E valuation of 18-20, there's really no other credible possibility.

This really isn't surprising. Different companies use similar algorithms for accounting, for architecting buildings, for diagnosing illnesses. Only the top-notch research centers are developing new algorithms for things, but once a new algorithm is developed and proven to be successful, it becomes widely used.

For example, here's a paragraph from a recent Naked Capitalism blog entry on a different subject -- "value at risk" (VaR) models for risk evaluation:

"The other perversity of that approach to VaR is that it encourages herd behaviour in volatile markets, before the banks have even made it to the sidelines. In other words, since all the models in all the banks are essentially the same model of the same data, they all start screaming ‘fire’ at the same time, with predictable consequences at the exits. All this and more is well covered by Triana: particularly the way that a long period of low volatility before 2007 meant that VaR endorsed massive positions in assets that were suddenly big loss makers, when things went sour."

It's this concept of "herd behavior" that I want to focus on. This phrase could be used to describe many of the things that I've been describing on this web site for years. These things include the offering of predatory mortgage loans, the securitization of faulty mortgage loans into "toxic assets" (as we now call them), and the Pollyannaish reporting by CNBC, Bloomberg TV, the Wall Street Journal, and other financial media.

A point being made by the above quoted paragraph is that herd behavior increases systemic risk. Most theories about the market assume that each investor is acting completely independently, making independent decisions, so that one person's bad decision is canceled out by another person's good decision. But if all investors are acting in unison, then a mistake or bad decision by one becomes a mistake by all.

Herd behavior and the Bubble Algorithm

It's pretty clear that the herd behavior that pegged buy/sell decisions to a S&P 500 P/E valuation of 18-20 for almost five years was completely abandoned at the beginning of 2009. Starting in January, the computerized buy/sell algorithms were modified to something else. As I discussed in last week's article, I'm suggesting that these algorithms are producing a new stock market bubble.

I would suggest that we call this the Bubble Algorithm.

A web site reader questioned this concept as follows:

"If there are computer programs all buying millions of shares in microseconds, who is selling all these shares. There has to be a buyer for every seller. The total amount of stock is constant at any moment. If we had insight into both sides of the transaction, we would understand better what is happening here. I thought all transactions had to go through exchanges and specialists."

The behavior we're talking about is ordinary human behavior, encapsulated in computer software. We implement all sorts of human actions in computer software, so implementing the Bubble Algorithm really isn't that remarkable.

Even in an ordinary bubble, like the Tulipomania bubble, there has to be a buyer for every seller. This relates to the "greater fool" concept. You have to be a fool to purchase assets during a bubble, but you can buy the assets expecting to sell them to someone else, a greater fool, at an even higher price.

When the stock market is operating a low volume, then lots of tricks are available to insiders.

Consider the following mind-blowing example:

Let's suppose I have a million shares of stock A, selling at $1.00 per share, and you have a million shares of stock B, also at $1.00 per share. Then we each have $1 million in stock.

I sell you one share of A for $2.00, and you sell me one share of B for $2.00. Then all of a sudden, we now each of $2 million in stock. Isn't that incredible?

Once you understand that example, then you can see how all kinds of variations can be played. I can buy a large position in one stock, knowing that there are plenty of insiders who will buy some of it at a slightly higher price, thus boosting the value of my entire position, and increasing the size of the stock market bubble. If a lot of people are doing that, then you have the Bubble Algorithm.

It's "herd behavior" that makes a bubble possible. As we quoted from Garet Garrett's 1932 book, "The bubble that broke the world:"

"Mass delusions are not rare. They salt the human story. The hallucinatory types are well known; so also is the sudden variation called mania, generally localized, like the tulip mania in Holland many years ago or the common-stock mania of a recent time in Wall Street. But a delusion affecting the mentality of the entire world at one time was hitherto unknown. All our experience with it is original."

In a "normal" situation, individual investors make individual decisions about individual stocks, evaluating each stock purchase based on fundamentals, an appraisal of the underlying corporation.

Program trading is a negation of the "normal" situation. No fundamentals are used. The trading algorithms detect small changes in the prices of stocks and attempt to take advantage of them by buying or selling within a few milliseconds.

This whole concept is a rejection of anything fundamental, and rejection of all common sense, and is perhaps the best illustration of the mass delusion of investors today. The only difference today is that these delusions are implemented in computer software.

Bubble Algorithm - the crash

There are two parts to a bubble -- growing the bubble, and the crash.

So the Bubble Algorithm has the same two sides. We've discussed the side that grows the bubble. What happens when the crash comes?

Let's return to the example I gave before. When the bubble is growing, you can buy a large position in a stock at, say, $100 per share, and then sell a small portion of that stock at $101 per share. When you do that, the value of your entire holding goes up to $101 per share. This makes you a lot of money, and it also increases the size of the bubble.

But what happens when the market starts to go down? Suppose you have a large position at $101 per share. If the price falls to $100 per share, then you can't just sell of a small portion; you have to sell the entire position. That's the sell side of the Bubble Algorithm, and you can see that the crash is going to be much more rapid than the growth was.

Putting on my hat as a software development consultant, there's little doubt in my mind that something like the Bubble Algorithm has been implemented the major financial institutions today, and that the buy side and sell side of the algorithm have both been implemented.

Switching from the buy side to the sell side, whether by human investors or by a computer running the Bubble Algorithm, is what's commonly known as a "panic."

If the growth of a bubble, whether by humans or computers, is a manifestation of mass delusion, then a panic is a sudden end to the delusion, and a huge dose of reality. The only difference is that the delusion can go on for weeks, months or years, while the panic may require only a few hours or days.

The jobs report changes the mood

We may or may not ever know what triggers a switch from bubble to crash. The cause of the 1929 panic is still debated. All we can say for sure is that it will be some chaotic event (in the sense of Chaos Theory), and that it can't be predicted.

Thursday's jobs report may or may not be such a trigger, but it has certainly changed the mood. It was a huge disappointment to economists and politicians alike.

To see why, take a look at the following graph from the Calculated Risk blog:

Percent Job Losses in Post WW II Recessions <font face=Arial size=-2>(Source: Calculated Risk)</font>
Percent Job Losses in Post WW II Recessions (Source: Calculated Risk)

This graph very well represents the kind of data that economists and politicians look at it. It compares the job losses, month by month, in all the post-WW II recessions. If you look at it long enough to get a feeling for what's going on, you can see that in the previous post-war recessions, job growth began to spike up right about now, if not earlier. Politicians and economists were CERTAIN that the same would happen now. The fact that it hasn't happened is a signal to economists that their assumptions have been disastrously wrong.

From the point of view of Generational Dynamics, what's wrong with that analysis is that this isn't an ordinary post-war recession. We're in the middle of a generational stock market crash, the first since the one that began in 1929, and job losses are following the post-1929 pattern.

That this is an "ordinary" recession is part of the mass delusion that politicians and investors have been suffering from.

It's hard to list all the factors that went into this mass delusion, but certainly the inauguration of President Obama was a major one. Throughout the campaign last year, and even after the election, Obama promised that the world would change after January 21. He would be "guided by facts, not ignore them." He would cure global warming, provide universal health care, and restore the stock market bubble.

As I've written many times, he doesn't have a snowflake's chance in hell of succeeding at ANY of these programs. The fact that it was widely believed that he would is part of the mass delusion that's infected Americans since January.

Thus, on Thursday, President Obama said that the jobs report was "sobering news." Returning to campaign mode, he added, "It took years for us to get into this mess, and it’s going to take us more than a few months to turn it around." And on the Sunday morning news talk shows, Vice President Joe Biden said that the Obama administration had "misread the economy" when it made its earlier forecasts after taking office.

Thus, our new tv drama, "The education of Barack Obama," continues apace, with intriguing new episodes almost every day, as the mass delusion continues to dissolve.

From the point of view of Generational Dynamics, the question is whether this is enough to trigger a panic. That's impossible to predict, of course. But if the public mood continues to deteriorate, and my expectation is that it will, then the current stock market bubble should not continue much longer. Whether that means a gradual fall or a full-fledged crash in the near future can't be predicted.

Will money market funds 'break the buck'?

Many money market funds are in increasing danger because the stocks backing the funds are less than the nominal value of the funds themselves. Last year, some market funds were already forced to "break the buck," meaning that a share in the money market fund is worth less than $1.00. The deteriorating financial crisis means that breaking the buck will occur much more frequently, and may trigger a panic on money market funds.

In a posting in the Generational Dynamics forum, Higgenbotham describes what could happen:

"In the event that there is a run on the money market funds, it would work in a similar way to the bank runs in the 1930's, but at the same time it will be different. The reason it will be different is that a money market fund has a value of 1.000 dollars. That 1.000 value is called "the buck". If the value drops below 1.000 it is called "breaking the buck". The Federal Reserve has said that they will guarantee this value. With credit card charge-offs hovering at 10% and increasing, unemployment at nearly 10% (officially and we know this is a lie), auto sales getting smashed, and all these other problems, the true value of the money in these money market funds is dwindling. Now investors are coming to the point where they need to make a decision. They will need to decide whether they want to be in a money market fund that pays, say, 1.5% interest and has a value of, say, 0.950 but is still trading at 1.000 because the Fed has said they will guarantee the 5% loss (these are the "junk dollars" I have been talking about) OR whether they want to be in safe and secure dollars like treasury bills that pay, say, 0.3% interest and where a dollars worth of treasury bills is really worth a dollar."

Higgenbotham's comments serve as a warning to those who still have money in money market funds. The only safe investments today are cash, FDIC insured bank accounts, and short-term Treasury bills.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (6-Jul-2009) Permanent Link
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Feminist alert: Millionaires' mistresses and wives are biggest victims of financial crisis

Abusive, controlling husbands are forcing wives to do their own cooking and cleaning.

The first signs of this new form of abuse came last November, when a study of millionaires showed that these men were taking the financial crisis out on their mistresses:

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"According to a new survey by Prince & Assoc., more than 80% of multimillionaires who had extra-marital lovers planned to cut back on their gifts and allowances. ...

“Rich people are getting hit, and they’re all expressing the need to curtail unnecessary spending,” said Russ Alan Prince, president of Prince & Assoc., a wealth-research firm based in Connecticut. “Lovers are part of the same calculation.” ...

Fully 82% of men in the study said they planned to lower the allowances to their mistresses, while more than three quarters planned to provide fewer gifts, less expensive gifts and fewer perks, like jet rides, resort vacations and top restaurant meals."

It's a symptom of how misogynistic our society is that these women have to suffer just because of the financial crisis.

But now a study shows that even more women are being abused -- specifically, the wives of hedge fund managers.

According to a new study by Tatiana Boncompagni Hoover:

"On a recent sunny afternoon in New York City I was talking with a girlfriend who happens to be a hedge fund wife. She was complaining about her husband, once a highly compensated trader whose fund had closed down and who now, in her opinion, wasn’t doing enough to find a job. The couple had been bickering non-stop about their cashflow problems. From behind a pair of oversized black lenses, she confided in me that she was at her wit’s end and was considering pulling the plug on the relationship. “I didn’t get married for this,” she whimpered, adding ruefully, “Do you know I have to take the subway now?” ...

Life for New York’s hedge fund wives has changed dramatically. Almost half the city’s 1,000 hedge funds have disappeared. Globally, 10,000 hedge fund workers lost their jobs last year, and a further 20,000 are expected to be out of work this year. An industry that was once worth about $1.9 trillion is now worth half that. ...

As a New Yorker living among financial kings and wizards, it is hard to avoid getting caught in somebody else’s awkward moment. Not too long ago my husband and I were invited to the apartment of an extremely successful hedgie for dinner. Five of us were sitting around the giant coffee table, enjoying our cocktails, when one woman remarked that the hedgie’s wife, who also works in the industry, was likely to out-earn her husband that year. The silence was deafening. I expected someone — the husband, the wife or the silly cow who had made the gaffe — to attempt to make light of the situation, but it turns out that when it comes to money matters, these people don’t have much sense of humour. ...

Here in New York there is a quiet revolution taking place. The once-almighty hedge funders are finally getting their comeuppance and almost everyone is happy to have a bird’s-eye view of their long (and, thus, quite entertaining) fall from grace."

Maybe it's the male hedge funders getting their comeuppance, but it's clear that their wives are the ones being victimized. Abusive and controlling husbands are forcing their wives to do their own cooking and cleaning.

As feminists like to point out, all men are abusers and all women are victims in this misogynistic society of ours, and this is just one more example. It's time for all of us to join together with feminists to stamp out this cruelty and victimization of millionaires' mistresses and wives.

(Comments: For reader comments, questions and discussion, see the Gender Issues thread of the Generational Dynamics forum.) (5-Jul-2009) Permanent Link
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The influence of computerized trading programs

It may be that computer software is already in charge of our futures.

In 2005, I posted an article called "A new mystery: Why is the P/E ratio remaining constant?" I noticed that the S&P 500 price/earnings ratio had remained almost constant for over a year, something that had not occurred in the previous century or more.

In that article I described something called the "Fed Model," a simple trading algorithm which, I understood, was widely followed by many traders and financial institutions. The Fed Model was based on a 1997 Federal Reserve report that related price/earnings ratios to changes in long-term Treasury yields. I inferred from the evidence that most traders and financial institutions were all following the same buy/sell strategies based on P/E ratios, as a result of which the P/E ratio was remaining constant.

If you look at the bottom of the home page of this web site, you'll see the price/earnings ratio chart that gets updated every week. Here's last Friday's version of the chart:

S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 26-June-2009. <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 26-June-2009. (Source: MarketGauge ® by DataView, LLC)

As you can see from this chart, the mystery of the constant P/E ratio continued long after 2005. The P/E ratio was in the 18-20 range for years, starting in 2004. This happened despite the fact that the S&P index was going up and down (mostly up). This behavior was interrupted for a few months in 2008, and was abandoned completely in 2009.

I've written about this a number of times since 2005. My conclusion was that the only way that this could be happening was if programmed trading algorithms at different financial institutions were very similar to one another.

Speaking as a software development consultant, I've worked at a number of financial institutions, and I know that programmers tend to move from one company to another over time. Thus, it's not surprising at all that the trading algorithms at different financial institutions were similar to one another. So I'm not saying that there was any conspiracy. I'm simply saying that the trading algorithms were and are common knowledge across the industry, so different institutions are likely to implement roughly the same algorithm. And it seems clear that a P/E valuation of 18-20 has been a part of those common algorithms.

But it's clear from the above chart that something changed early this year, as I wrote two months ago in "Stock market rally raises cautious, anxious hope among investors."

The change was triggered by fourth quarter earnings last year -- which were negative. This caused the P/E ratio index to shoot up to 60. This led to a lot of lying and prevarication in the financial media.

(See "Wall Street Journal and Birinyi Associates are lying about P/E ratios" and "Laszlo Birinyi provides insight on his fantasy price/earnings computations." The Wall Street Journal recently completely reversed its policy, as I described in "Wall Street Journal sharply revises its fantasy price/earnings computations.")

This lying about P/E ratios should be major industry news, but I've never seen anything about it in the mainstream media, nor in any of the financial blogs, including Nouriel Roubini's blog, Michael ("Mish") Shedlock's blog, the Calculated Risk blog, the Sudden Debt blog, the MinyanVille blog, Yves Smith's Naked Capitalism blog, and the Financial Times alphaville blog. I don't check all of these blogs every day, but as far as I know, this P/E ratio issue is never mentioned by any of them.

If you look at the "official" S&P 500 P/E index spreadsheet, you can see that the Q2 P/E is 133.62.

If you look at the latest WSJ chart, with its newly revised more "honest" reporting, then you see that the S&P 500 P/E index is 35.38.

But if you listened to Bloomberg TV today, then you heard "the P/E index is around 15, and there are many stocks with very low valuations." I have no idea where this figure of 15 comes from.

Mainstream financial reporting has gone completely off the rails. It's almost completely total nonsense, catering to brokers and investment bankers who make fat commissions and fees off of traders, and who don't want anyone rocking the boat by reporting a P/E ratio of even 20, let alone 133.

A new mystery

But we're still left with a mystery. What algorithms are the computerized buy/sell trading programs using today? They're obviously not pegging the algorithm to a P/E ratio of 18-20 any more; that's been thrown out. But what algorithms are they using?

The answer to the question was provided by an interview of Joe Saluzzi of Themis Trading on Bloomberg TV on Tuesday. The following is my transcript:

"I'm a realist. I like to cut through the garbage that we hear constantly from hopeful politicians and hopeful corporate executives, trying to tell you they see things are good.

Joe Saluzzi of Themis Trading <font face=Arial size=-2>(Source: Bloomberg TV)</font>
Joe Saluzzi of Themis Trading (Source: Bloomberg TV)

Let me see some numbers. Show me the quarterly earnings. Are you going to prove to me that second quarter was good, in the retailing sector when the savings rate is sky high, and consumers aren't spending?

No, I don't believe it. I'm a cynical person at heart, I guess, but I'm also a realist, and it keeps me out of trouble a lot. ...

The problem is that most people are pessimistic on this market right now, but they're afraid because they see the market running.

What my job is during the day is I'm an institutional trader for large mutual funds and hedges. So my job is to trade for them, and to not get caught upin the noise.

The volume that you see during the day, sometimes as high as 12 billion across all three exchanges, is fictitious. It's not real. I'm going to say that 60-70% of this volume that you see coming across -- it's volume, but it's done by what they call 'high frequency traders.'

These are machines. The biggest machine out there wins the game nowadays. And these people deal in sub-seconds. 50 milliseconds is a huge amount of time. Anything over that and you're a dinosaur in the business.

So what they do all day long is they buy and sell and they try to collect liquidity rebates from the exchanges, who basically in partnership with them, and they trade for no apparent fundamental reason, and this is my problem.

And being that we're all in a bullish tape right now, they're all just buying. ...

I trade for my clients. I'm an agency-only trader. My job -- they make the decisions, I execute around the noise. Some of the clients buy, some of them sell, we deal with all different types. Some short, and so on. Some are sector based.

But my job is to make sure -- that during the day when a program gets shot through, -- by the way, a billion shares a week going through certain broker on the exchange principally with programmed trades -- it's a way to get the market to go in your direction. And what happens is -- since we're all electronically linked, the algorithms that all these programs use, according to the guys that I talk to, chase the stocks and artificially inflate the prices.

It cuts both ways. Since we're in a bull tape, everyone is jumping on board, but here's the trick: They could run for the trap door tomorrow, and if everybody becomes a seller, they'll all just go the other way. They don't care about the prices any more."

According to Saluzzi, these computerized buy/sell programs are dominating the market these days.

But there's more -- a remarkable concept. What he's saying is that the computerized trading algorithms are essentially doing panic buying (though he doesn't use that phrase). He's saying that these trading programs are programmed to push stock prices up.

Once again, I'm not implying any conspiracy or collusion. Let me put on my computer programmer hat again. I've never had to implement an algorithm of this sort before, but I can imagine what kind of algorithm I'd implement if a client told me, "Assume that the market is going up, and program the computer to stay ahead of the market and make money." If I assume that the market is going up, then I'd program the computer to pursue a strategy that pays a little more as time goes on.

And now, once again, we know that computer programmers move from company to company, and we can conclude that all the financial institutions are implementing roughly similar algorithms.

There's a remarkable concept. We normally think of panic buying as based on human emotion, but Saluzzi is essentially saying that the computers are panic buying, pushing up the stock market prices.

This is a weird concept since, as we all know with absolutely certainty, computers are mechanical devices totally lacking in emotion.

Presumably then, the reason that computer programs "artificially inflate the prices" is because the programmers tweak the program parameters to do so.

However, Saluzzi points out that this won't go on forever. He says that there's a "trap door," and this could reverse very quickly.

If I were a computer programmer for such a client, I'd parametrize my software algorithms so that if my client suddenly said, "Assume that the market has stopped rising, and it's going to fall for a while," then my software would instantly change its strategy. Instead of panic buying, my software would be panic selling.

And so would everyone else's software algorithms.

So what I'm suggesting is this: The the computerized trading algorithms have changed drastically in the last year.

Since 2004, these algorithms have been pegged at maintaining a P/E ratio of 18-20. Obviously that's out the window now, as the P/E ratio is well above 100.

Is any other peg being used? I'm certainly not aware of anything.

This gives meaning to Saluzzi's statements: "And what happens is -- since we're all electronically linked, the algorithms that all these programs use, according to the guys that I talk to, chase the stocks and artificially inflate the prices."

In other words, the computerized trading algorithms are specifically designed to create a bubble. Once again, I'm not saying that this is a conspiracy, any more than the Tulipomania bubble was a conspiracy. I'm simply saying that the "human emotions" or "animal spirits" that normally cause a bubble have been encapsulated in computer algorithms and programs, resulting in computers that create bubbles.

As I've said for decades, "To err is human. To really screw things up takes a computer." And that seems to be where we are.

These computer programs make decisions in microseconds, far faster than human beings can react. In the 1929 stock market crash, it was human beings using the telephone to flood their stock brokers with sell orders that clogged the ticker tapes for hours.

What Saluzzi is telling us is that we're headed for a different kind of crash, where blindingly fast computers will be competing with each other to sell as quickly as possible.

As I've been saying for years, Generational Dynamics predicts that we're headed for a generational panic and crash, the first since 1929. Some people believe that the stock market has already crashed, but it hasn't been even close. Here's how I've described this several times in the past:

"A generational crash is an elemental force of nature, like a tsunami.

You'll have millions or even tens of millions of Boomers and Generation-Xers in countries around the world, never having seen anything like this before, not even believing it was possible, and in a state of total mass panic, trying to sell all at once. Computer systems will crash or will be clogged for hours, or perhaps even for a day or two. People who had hoped to get out just as the collapse is occurring will be totally screwed, and will lose everything. Brokers and other institutions will go bankrupt."

This might happen tomorrow, next week, next month or thereafter. We can't predict when it will happen, but it's coming soon with absolute certainty.

What Saluzzi's comments tell us is that the crash will be led more by computers than by humans.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (2-Jul-2009) Permanent Link
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Brookings Institution does a full reversal on Iraq war

As Americans withdraw from cities, Brookings admits there's no civil war.

In December 2006, I quoted Brookings Institution analyst Ken Pollack as saying, "Iraq is in a dangerous state, and it's headed for a Bosnia or Lebanon state of all-out civil war."

I commented on this quote as follows:

"Now this is exactly what Generational Dynamics tells is impossible. Iraq is in a generational Awakening era, just one generation past the genocidal Iran/Iraq war of the 1980s. Now, you can call anything a civil war if you want, and if you want to call terrorist acts by non-Iraqis a civil war, then you can do it. But it is ABSOLUTELY IMPOSSIBLE for Iraq to spiral into a state of all-out civil war like Bosnia in the 1990s or Lebanon in the 1980s. It has never happened in history, during a generational Awakening era, and cannot happen now.

This is why journalists, pundits and politicians keep getting their predictions wrong. You'd think that Ken Pollack was some sort of expert, but he has NO IDEA what's going on. He simply made that "fact" up, because he and all these other journalists and pundits make ideological predictions, and they have as much chance of getting them right as if they flipped a coin. As I wrote a few days ago, Thomas Friedman and other pundits have gotten one prediction wrong after another. Generational Dynamics is the only methodology which has produced correct predictions, and this is the only web site in the world that tells you what's going on in the world, and what's going to happen."

Now, 2½ years later, US soldiers are withdrawing from Iraqi cities, and security duties are being taken over by Iraqi forces. It's still my expectation that US forces will be in Iraq for years to come, but there will not be a civil war in Iraq's generational Awakening era.

Now, Brookings appears finally to agree. Michael E. O'Hanlon of Brookings writes the following:

"Violence is not increasing in a strategically significant way. There have been several spikes this year but, in retrospect, all wound up being isolated incidents. Violence levels remain 90 percent reduced relative to pre-surge levels. The country is still quite troubled, but it is no longer in the grips of civil war and is unlikely to return to that sad state. There probably have been extra efforts by extremists to use violence in these recent, momentous days, with the goal of creating a snowball effect by making Iraqi citizens worry that the change in the U.S. role is leading to a security vacuum. But this will probably wind up being seen as nothing but a tragic yet containable set of ruthless bombings, and, in fact, there is no security vacuum. There does not appear to be any ripple effect of attack followed by revenge attack followed by counterrevenge attack, so I believe the extremists are failing."

This is a grudging admission by O'Hanlon, who attempts to hedge by saying that there is "no longer" a civil war, as if there ever was.

Number of civilian casualties in Iraq, May 2003 to present <font size=-2>(Source:</font>
Number of civilian casualties in Iraq, May 2003 to present (Source:

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But the above graph from a new report (PDF) on Iraq from Brookings gives the lie to this hedging. The graph shows the number of civilian casualties each month since 2003.

Ken Pollack made his original prediction, that Iraq was headed for a major civil war like the ones in Lebanon and Bosnia, in December 2006, at the height of the casualties. As you can see from the graph, Pollack's prediction was almost a cue to Iraq, as the number of casualties collapsed immediately after his prediction, at the time when President Bush's "surge" took hold. And now, finally, US forces are withdrawing from Iraqi cities.

It must be a bitter pill for Brookings' O'Hanlon now to have to admit that there's no civil war, as politicians, journalists and analysts on the left were predicting.

It was at this time that NBC "news" put on a huge dog-and-pony show, declaring that the Iraq war was a civil war, and that the US would lose.

Organizations like NBC News and the New York Times were swimming in the sewer, allying themselves with the terrorists in Iraq, with the purpose of defeating and humiliating the US in Iraq. Their actions were shameful beyond belief, and were close to treason.

At least the Brookings Institution has been able to bite the bullet and make at least a half-hearted admission that they were wrong. But not NBC News or the New York Times, who are still suffering from what one pundit has called "Bush Derangement Syndrome," where their hatred of President Bush is so great and so vitriolic that they almost can't think of anything else.

The people at the New York Times are certainly still suffering from Bush Derangement Syndrome, if we're to judge from an article on the US withdrawal, containing the following bizarre paragraph:

"Seizing on the desperation of Sunni insurgents, foreign fighters were able to entrench themselves in the neighborhood. Those fighters, who Ahmed said were aligned with Al Qaeda in Mesopotamia, a mostly homegrown Sunni insurgent group that American intelligence says is foreign-led, were not only brutal in battling Shiites but also in enforcing control over Sunni residents."

The first bizarre thing is the reference to "Al Qaeda in Mesopotamia." This phrase was uniquely adopted by the NYT to avoid admitting that al-Qaeda was in Iraq. The organization was actually called "Al-Qaeda in Iraq," and it was not homegrown at all. It was led by Jordanian terrorist Abu Musab al-Zarqawi, who imported suicide bombers from Saudi Arabia and other Arab countries. I wrote about all this in my April 2007 analysis, "Iraqi Sunnis are turning against al-Qaeda in Iraq," which was a much better analysis that anything that came out of NBC News, the New York Times, or the Brookings Insitution.

It was in August, 2003, that I nervously wrote my first major prediction about Iraq in, "Terrorist suicide bombings in Iraq may backfire against terrorists." The predictions that I posted in that article, and repeated many times since then about Iraq and many other countries, have all turned out to be true, or are trending true. Not a single Generational Dynamics prediction has turned out to be wrong.

Once again, as has happened many times since I set up this web site almost seven years ago, Generational Dynamics has been proven to be correct, while the analysts have been proven wrong. (See "List of major Generational Dynamics predictions," and "Generational Dynamics forecasting methodology.") This is not because I have any psychic capability or political skills (I have none of either), but because the Generational Dynamics methodology works consistently.

One thing that hasn't changed is that, Generational Dynamics is still the only methodology which has produced correct predictions and, after almost seven years, this is still the only web site in the world that tells you what's going on in the world, and what's going to happen. In fact, there is no other web site in the world like this one. (1-Jul-2009) Permanent Link
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