Flying home Sunday from Ireland, more than a bit tired from the previous days’ festivities, I was tempted to take my second week off in 9 ½ years of writing this column because it’s just not that easy staying in touch on the west coast of the place, specifically Lahinch. Internet service is spotty at best plus the days are taken up by golf and a little 19th hole action. Alas, please excuse this relatively brief review, understanding I know I missed some key stories and will catch up next time. Also know that I caught up with your e-mails but haven’t had a chance to respond to all of them.
For starters, my playing partner David P. and I were attempting to solve the world’s problems over a few pints and I commented how depressed I was about the Russia-Georgia situation because of what it foretold down the road, be it Ukraine or the Baltic republics, for starters. And I also couldn’t help but think of all my talk about loose nukes over the years as the other day George Will commented:
“There is no bigger issue in the world than loose nuclear material.”
Along these lines Michael Bronner, an independent journalist, had an op-ed in the New York Times.
“Even as Russia and Georgia continue their on-again, off-again struggle over South Ossetia and Abkhazia, a frenzied tea-leaf reading about the war’s global political ramifications has broken out across airwaves and think-tank forums. But as the situation on the ground recedes inevitably to some new form of the pernicious ‘frozen conflict’ that has plagued the region since Georgia’s civil wars of the early 1990, few are paying attention to a less portentous but equally critical international threat: an increase in the longstanding, rampant criminality in the conflict zones that is likely to further destabilize the entire Caucasus region and at worst provide terrorist groups with the nuclear material they have long craved.
“While the Russian ‘peacekeepers’ who entrenched themselves in the conflict zones in the 1990s (and who will now likely resume their posts anew) have proved ineffectual and uninterested in maintaining stability, they’ve been highly successful in protecting an array of sophisticated criminal networks stretching from Russia through Georgian territory. South Ossetia, in particular, is a nest of organized crime. It is a marketplace for a variety of contraband, from fuel to cigarettes, wheat flour, hard drugs, weapons, people, and, recently, counterfeit United States $100 bills ‘minted’ at a press inside the conflict zone….
“Far more dangerous contraband than fake bills is bartered in the conflict zones. On a bleak winter day last year, I hitched a ride from Tbilisi, the capital, to the ‘administrative border’ – the semi-porous line of control that swoops deep into Georgian territory from the Russian border demarking the contours of South Ossetia. I was investigating one of the most serious nuclear smuggling incidents in years – an offer of up to 3 kilograms of bomb-grade highly enriched uranium….
“Three years ago, Georgian intelligence officials began receiving reports from South Ossetian criminal contacts that a Russian smuggler – a North Ossetian calling himself Oleg – was circulating in Tskhinvali, the South Ossetian capital. He was reportedly looking for a buyer for what he claimed was high-quality enriched uranium pilfered from the Russian military….
“Huge international efforts sponsored by the United States State, Energy and Defense Departments have sought to counter such nuclear smuggling…but conflict zones like South Ossetia have been an Achilles’ heel.”
And so we have to care about what goes on in Georgia for yet another reason.
John McLaughlin [former deputy director of the CIA] / Washington Post
“It has been 17 years since the Soviet collapse. Measured against the post-World War I-era time frame, we are at about the equivalent of 1935. In 1935, no one would have confidently foreseen the major events to come – not just World War II but the Holocaust, the invention of nuclear weaponry, the more than doubling of the world’s nations, the long struggle with the Soviet Union.
“I am not suggesting that we are in for similarly dramatic or catastrophic events. But it’s clear that the dust has hardly begun to settle from the Soviet collapse, and we should not expect global stability for many years.”
Last Wednesday was the 40th anniversary of the Russian invasion of Czechoslovakia to put down Alexander Dubcek’s “Prague Spring.” If I were the Czechs today, I don’t know how easy I’d be resting.
Ralph Peters / New York Post
“The bitter truth is none of us can move Russia. Only force could do the trick – and, brutally put, we don’t deem Georgia worth any serious risks. For the record, I don’t think a military response at this point would do any good – only more harm. But the West has no alternative tools that impress the Russians.
“Putin believes in force. Just because we don’t share his values doesn’t mean he’s going to see the light. [Imagine a President Barack Obama pitted against Putin – the Left’s new messiah would be gobbled up in one bite.]
“ ‘Empty words.’ That’s how Moscow glibly dismissed NATO’s criticism yesterday of Russia’s continued occupation of Georgia. The Russians may be bullies, but like all bullies they know weakness when they see it.
“The most NATO ministers could muster at their meeting in Brussels was a statement that they ‘cannot continue with business as usual’ with Russia. There was no move to fast-track Georgia’s bid to join NATO, nor a pledge to help the battered democracy rebuild its defenses.
“Asked about NATO reconstruction aid, NATO Secretary-General Jaap de Hoop Scheffer pointedly said, twice, that it would go for ‘civilian infrastructure.’ So here we have a military alliance going out of its way to stress that it will not be providing any military aid. The alliance didn’t even cancel any cooperative programs with Russia, though Mr. de Hoop Scheffer said ‘one can presume’ that ‘this issue will have to be taken into view.’ That must have the Kremlin shaking.”
On Sunday, the Russians blew up a Georgian fuel train and continue to attempt to control the key port city, Poti. At least the U.S. moved a destroyer in to deliver humanitarian aid, the arms on board not lost on the Georgian citizenry as they pray for us to protect them. For his part, Russian President Medvedev, trying to play tough guy and gain the respect of his people, all of whom know that Czar Vladimir the Great is really calling the shots, said of Russia’s continuing invasion:
“If someone thinks they can kill our citizens, kill soldiers and officers fulfilling the role of peacekeepers, we will never allow this,” Mr. Medvedev told a group of Second World War veterans in Kursk. “Anyone who tries to do this will receive a shattering blow.” Russia has moved SS-21 missiles into South Ossetia, capable of hitting Tbilisi at the push of a button.
Meanwhile, you know all the stories I have passed on regarding growing racial violence in Russia and Moscow? The UN called on Moscow to take firm action against ultranationalist and neo-Nazi groups. Fat chance of this happening. These are Putin’s storm-troopers.
But all the while we’ve been talking about Russia and Georgia these past few weeks, what nation has fallen off the front page? Iran, which continues to play a brilliant stall game on the nuclear weapons program front. And what happened to the agreement the Bush administration had with North Korea to disclose everything, including details on their existing nuclear force? It suddenly seems dead in the water. What of Hizbullah, who because of U.S. inaction in 2005 after the Hariri assassination, has gained strength beyond the force that went to war with Israel in 2006? With just five months left in Bush’s presidency, no one in their right mind expects anything of a positive nature on any of these fronts, while I continue to say Israel will strike Iran before the year is out, whether the White House wants it to or not.
So, yes, the world changed with Russia’s move on Georgia, big time, and it’s more than a bit depressing. Next spring, Ukraine.
Stocks moved lower with the Dow Jones losing 31 points, 0.3% to 11628. The S&P 500 lost 0.5% and Nasdaq had its five-week winning streak snapped as it fell 1.5% to 2414. This coming week is heavy on the economic calendar front so I’ll have some extensive comments on just where we stand next time. For now, though, it’s pretty clear we can draw one conclusion…this coming holiday shopping season is going to be dreadful. Retailers such as Lowes, Staples, Saks, Home Depot and Target all reported last week and comments such as “the consumer is very cash-strapped” (Target) to we are seeing “slower growth at the highest end as well” (Saks) predominated.
Last week was also about Fannie Mae and Freddie Mac. Fannie, once $70, is now $5, while Freddie, once $65, saw its shares finish Friday at $2.80. Everyone is in agreement the two mortgage giants need more capital but with the stocks trading where they are, common shareholders could be wiped out in any capital infusion due to the ongoing dilution; let alone any government bailout could demand the common go away.
Everyone also knows that Fannie and Freddie can’t make any kind of case for survival in their current forms because it’s all about their real estate portfolios and there is no end in sight to the carnage on that front, i.e., foreclosure rates for the various pools of securities the two hold. The current values placed on the instruments simply don’t reflect reality.
Just this week Freddie went to market with a 5-year debt issue and it sold at 113 basis points (1.13%) over Treasuries when in the past both Freddie and Fannie generally paid 40 to 50 over. Equally worrisome is the fact Asian participation in these auctions is declining, this as Fannie and Freddie have some $220 billion in debt maturing at quarter end.
On the inflation front, the figures were awful as the producer price index for July came in at an annualized rate of 9.8%, the highest since 1981. Even the core rate is running at a hot 3.5%. Overseas, other important markets such as Germany’s are also reporting big upticks with their PPI now running at its own highest level since 1981, 8.9% in their case.
Finally, with the end of the Beijing Olympics (and we congratulate the Chinese for the efficiency of the Games, as well as Michael Phelps, Usain Bolt, and the Redeem Team for their performances), economist Robert J. Samuelson had some of the following thoughts in his Washington Post op-ed.
“China’s economy is now only a fourth the size of the $14 trillion U.S. economy, but given plausible growth rates in both countries, China’s output will exceed America’s in the 2020s, Goldman Sachs forecasts. But this is the wrong worry. By itself, a richer China does not make America poorer. Indeed, because there are so many more Chinese than Americans, average Chinese living standards may lag behind ours indefinitely. By Goldman’s projections, average American incomes will still be twice Chinese incomes in 2050.
“The real threat from China lies elsewhere. It is that China will destabilize the world economy. It will distort trade, foster huge financial imbalances and trigger a contentious competition for scarce raw materials. Symptoms of instability have already surfaced, and if they grow worse, everyone – including the Chinese – may suffer. China is now ‘challenging some of the fundamental tenets of the existing [global] economic system,’ says economist C. Fred Bergsten of the Peterson Institute.
“This is no small matter. Growing trade and the cross-border transfers of technology and management skills contributed to history’s greatest surge of prosperity. Living standards, as measured by per capita incomes, have skyrocketed since 1950: up 10 times in Japan, 16 times in South Korea, four times in France and three times in the United States. Significantly, these gains occurred without serious political conflict. With the exception of oil, world commerce expanded quietly. The chief sources of global strife have been ideology, nationalism, religion and ethnic conflict.
“Economics could now join this list, because the balance of power is shifting. The United States was the old order’s main architect, and China is a rising power of the new. Their approaches contrast dramatically….
“At first, China pursued its ambitions within the existing global framework. Indeed, the United States supported China’s membership in the World Trade Organization in 2001. But as it grows richer, China increasingly ignores old norms, Bergsten argues. It runs a predatory trade policy by keeping its currency, the renminbi, at artificially low levels. That stimulates export-led growth. From 2000 to 2007, China’s current account surplus – a broad measure of trade flows – ballooned from 1.7 percent of gross domestic product to 11.1 percent. The biggest losers are not U.S. manufacturers but developing countries whose labor-intensive exports are most disadvantaged.
“Next, China strives to lock up supplies of essential raw materials: oil, natural gas, copper. If other countries suffer, so what? Both the United States and China are self-interested. But the United States has seen a prosperous global economy as a means to expanding its power, while China sees the global economy – guaranteed markets for its exports and raw materials – as the means to promoting domestic stability.
“The policies are increasingly on a collision course. China’s undervalued currency and massive trade surpluses have produced $1.8 trillion in foreign exchange reserves (China in effect stockpiles the currencies it earns in trade). Along with its artificial export advantage, China has the cash to buy big stakes in American and other foreign firms. Predictably, that has stirred a political backlash in the United States and elsewhere…. China has undermined world trade negotiations, and its appetite for raw materials leads it to support renegade regimes (Iran, Sudan).
“The world economy faces other threats: catastrophic oil interruptions; disruptive money flows. But the Chinese-American schism poses a dilemma for the next president. If we do nothing, China’s economic nationalism may weaken the world economy – but if we retaliate by becoming more nationalistic ourselves, we may do the same. Globalization means interdependence; major nations ignore that at their peril.”
–U.S. Treasury Yields
Despite the dire inflation news, the bond market was unchanged as the feeling predominates that coming data will be far more sanguine given the sick economy. At least this is also the opinion of Fed Chairman Ben Bernanke and your editor.
–Crude rallied back to the $120 level on Thursday amidst ongoing concerns over Russia and its actions in Georgia that impact critical pipelines. But then it dropped to $114 on Friday. There is a bigger long-term issue when it comes to Russia, however. As Tom Lasseter reported for McClatchy-Tribune News Service, Russia has done zippo when it comes to developing new sources of oil and instead continues to bleed existing fields dry. One analyst cited by Lasseter, Valery Kryukov, says “If the situation which exists now stays the same, oil production will start to decline seriously in two years.”
This is yet further evidence for those of us in the Peak Oil camp. The bottom line is any new fields that you read about are only serving to replace the rapidly depleting ones, whether they are in Mexico, the North Sea, Saudi Arabia or Russia. And of course state control, such as in Russia, Saudi Arabia, Iran and Venezuela doesn’t allow for the needed private investment. This is Boone Pickens’ main point.
I just have to reiterate, though, that I think in this current cycle oil is headed lower, but that might be the worst thing that could happen longer-term because when the global economy begins to run on all cylinders again, demand will skyrocket anew. The current high price at least keeps the debate going about alternative energy sources, and the needed tax credits to allow the technologies to obtain scale. You and I know what will happen, though, if oil falls below, say, $80. Complacency could reign in Congress.
[Of course the flip side, as reader Scott P. and I were discussing this week, is that after what we saw in the nation of Georgia, many of us would like to crush the Russians where it hurts…their pocketbook.]
–Related to the above, Jad Mouawad of the New York Times had a good piece on the supply issue for oil. While government control of the resource can lead to less than required investment, Big Oil itself could have done more; failing to invest heavily in exploration after the price collapse of the mid-1980s. As Mouawad writes:
“In 1994, the top five oil companies spent 3 percent of their free cash on share buybacks and 15 percent on exploration. By 2007, they were spending 34 percent of their free cash on buybacks – in effect, propping up their share prices – and a mere 6 percent on exploration.”
Again, you can see where this is all headed as the world’s worst characters call the shots.
–Speaking of which, Venezuela’s Hugo Chavez is seizing cement plants owned by Mexico’s Cemex; this on top of Chavez’s taking control of oil and telecommunications companies from private hands.
–For the month of July, Southern California home sales were up 13.8%, spurred on by foreclosure auctions. Like the couple cited in a Los Angeles Times piece who successfully bid $385,000 for a property valued at $700,000 just a few years ago. Josh P. reports that in San Diego County, 41% of all sales are foreclosures. As for the median price in the six counties comprising the entire region, it fell 31% to $348,000 from $505,000 in July 2007. [J.P. told me three years ago the median price would hit $350,000, so I owe him some premium beer.]
–USA Today noted a Commerce Department report last week that says governments are on track to spend a record $300 billion this year on schools, roads, bridges and other projects; a 7% increase on top of a 12.4% jump in 2007. So government projects now generate more spending than construction of homes and apartments. In 2005, for example, spending on housing hit a record $481 billion – more than twice what governments spent. So there’s a little ray of sunshine for you, or as University of Oregon economist Mark Thoma said, “Tax rebates peter out. Building a new bridge helps the economy long after the work is done.”
–I’ve written a fair amount about Australia, seeing as they are a leading economic indicator in my book, especially because of their economy’s heavy dependence on the commodity trade, but the Aussies have the same housing issues everyone else does and in Sydney, it is really reaching crisis proportions. It’s a battle of the haves vs. the have nots writ large. The latter are now paying over 40% of their income on mortgage payments, while the ‘haves’ have seen their incomes rise fast enough to meet their obligations on this front relatively comfortably.
–Inflation alert: The Tennessee Valley Authority approved its largest electric rate increase in more than 30 years, 20 percent. Directors of the seven-state TVA blamed rising costs of coal and natural gas.
–When I was at PIMCO, I was in charge of our broker/dealer relationships as part of the ongoing battle for shelf space in a highly competitive industry. So I couldn’t help but notice that brokers at Merrill Lynch are in an uproar over PIMCO’s and BlackRock’s refusal to buy back auction-rate securities. As Bloomberg reported, "More than 300 brokers have e-mailed PIMCO saying its executives may ‘no longer be welcome in our offices’ unless they redeem the securities." PIMCO and BlackRock, among others, used the ARS market to finance their closed-end funds, which were sold furiously at the likes of Merrill. I can just hear some of the discussions taking place and the grief the wholesalers are taking.
–In 2006 and 2007 combined, U.S. investors pumped a net $404 billion into foreign mutual funds, according to Financial Research Corp. That was over three times the net $125 billion invested in U.S. stock funds in that period, as noted by Tom Petruno of the Los Angeles Times. Yup, some of us just hopped on another bubble, and by my investment in China, I guess you could say I was as guilty as anyone else.
Iraq: Once again it appears the U.S. and Iraq are close to a security agreement that would call for American troops leaving the cities by June 30, to be then repositioned on outside bases. As you know the big issue here is that the Iraqi parliamentarians, up for election soon, want to be seen as being tough on the U.S. while protecting Iraqi sovereignty. This debate is pitiful. You also have the ongoing flash point of Kirkuk, with the Kurds effectively having taken it over, which in turn is impacting when provincial elections are finally held.
Poland: Washington and Warsaw formalized the deal to station elements of a U.S. missile defense shield on Polish soil, which Russia then slammed, threatening a preemptive strike. The Kremlin is also now considering arming its Baltic fleet with nuclear warheads for the first time since the Cold War in response to the missile system.
Israel: The United States has refused to sell Israel Boeing 767 refueling planes because it doesn’t want to be seen as encouraging an Israeli attack on Iran. Meanwhile, Syria’s President Assad is making waves about buying new Russian weapons systems.
Afghanistan: To say the least it was a terrible week here. Ten French soldiers were killed in an ambush amidst stories the U.S. is set to take over all military operations and launch an Iraq-style surge. French President Sarkozy faces strong domestic opposition to continuing France’s key role and similar sentiment exists among the other Afghan partners.
So it didn’t help matters that a coalition airstrike on Saturday killed up to 95 Afghans, including 50 children, in another tragic mistake. President Karzai strongly condemned it and it obviously acts as yet another recruiting tool for the Taliban.
Pakistan: President Musharraf resigned under pressure and now there is a power struggle between Benazir Bhutto’s widower, the corrupt Ali Zardari, and the equally corrupt Nawaz Sharif, the man who Musharraf toppled in the 1999 coup. Sharif has known ties to Islamists and Pakistan’s efforts in the war on terror have been futile, witness another horrific attack, this one on a key arms facility that killed 59.
Back to Musharraf, he started strong, but then lost his way, particularly in his handling of the Supreme Court judges. He should be remembered, however, for improving relations with India and he did make initial inroads on the terror front, arresting some key al Qaeda figures. But now Pakistan could implode.
Mexico: Planning a trip here? Drug-related killings have already exceeded last year’s total, now at 2,700. Over 40 were killed in one week in Ciudad Juarez, across from El Paso.
–Finally, the presidential campaign heats up in earnest. I’ll keep my comments to a minimum this time but expect a few observations the next go ‘round after the Democrats have their food fight in Denver. Right now, the latest Washington Post/ABC News poll has Obama with a 49 to 45 lead, but other surveys have McCain ahead. Interestingly, the Post/ABC tally shows only 14 percent list Iraq as the preeminent concern, the lowest yet in this election cycle, while the economy and jobs are selected by 40 percent. As for Obama’s selection of Joe Biden, it’s not going to make a difference unless Biden issues one too many gaffes. He’s certainly capable of it, but at the same time I always liked the guy as a talk show guest for the simple reason that he has something interesting to say; as opposed to Condoleezza Rice who is dullsville, but I digress.
For now I do just have to add Peggy Noonan’s thoughts from her Wall Street Journal column on last weekend’s Saddleback Church Forum hosted by Rick Warren. I only saw snippets myself but by all accounts the big winner was Warren for his fair and balanced treatment of the candidates and for asking the right questions. As for Noonan’s position:
“The Rick Warren debate mattered. Why? It took place at exactly the moment America was starting to pay attention. This is what it looked like by the end of the night: Mr. McCain, normal. Mr. Obama, not normal. You’ve seen this discussed elsewhere. Mr. McCain was direct and clear, Mr. Obama both more careful and more scattered. But on abortion in particular, Mr. McCain seemed old-time conservative, which is something we all understand, whether we like such a stance or not, and Mr. Obama seemed either radical or dodgy. He is ‘in favor…of limits’ on late-term abortions, though some would consider those limits ‘inadequate.’….
–All plane crashes are tragic, but the Spanair disaster in Madrid on Wednesday seems particularly so because it appears to have been preventable, as in the plane never should have been allowed to fly. And you had one passenger who wanted off after hearing of mechanical issues and the airline wouldn’t let him. This is a big deal for this country.
–Australians lose at least $36 million a year to so-called Nigerian e-mail scammers. But in Britain, it’s estimated the cost is $300 million, though it goes far beyond just losing money. Marriages break up, bankruptcies, suicides. [I haven’t seen a figure for the U.S.]
–Just a few notes on Ireland and my 17th trip there since 1989. I’ve written often in the past of the Irish Miracle turned Bubble and it’s hitting hard these days. It’s clear there is overbuilding everywhere, including in hotels as the locals are quick to point out, and layoffs are beginning to cascade.
I was reading of an indicator in one of the papers before I went over, the record #s of bad debtors, especially in unpaid phone bills, as a sign of the building disaster. The property market is in “crisis” because of the credit crunch and lack of financing. Values are down 20% since 2006 (at least) and the official GDP forecast of 0.5% growth for all of 2008 seems a bit unrealistic when you consider retail sales have tumbled 5% already.
Ireland has deeper seated problems, however. College students simply aren’t interested in science, engineering or technology, to the detriment of its future. One story I read said there are 15,000 unfilled positions in these fields, jobs then being filled from outside if at all. On a related issue, the cost of doing business here is no longer the advantage it once was. It’s far cheaper to build facilities in Eastern Europe, for example.
Even when it comes to beer drinking, Ireland is in a slump with beer consumption down 15% since 2001 and many a rural pub being forced to close, in no small part because of the smoking ban, which was a good thing.
Otherwise, the golf is still great (Dave and I even won some crystal this time) and there’s no shortage of good craic. It helps to keep your mind off Russia, if but for a fleeting moment.
Oil, $114.59
S&P 500 -0.5% [1292]
Bears 38.4 [Source: Chartcraft / Investors Intelligence]
