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11-23-14: Ukraine, Russia and War
by Mark Lawrence

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Markets stalled last week trying to break through the channel top at S&P 2040, then stalled again as they broke through and then back tested the level. Then they took off as several major central banks announced stupid initiatives to print money and thereby affect their economies somehow. We continue to be in a world-wide liquidity trap, where commercial banks have no one to whom they are willing to lend, but the central banks have only one hammer so they're going to continue to pound nails until the economy is fixed. Or, more likely imho, the hammer shatters something valuable.


S&P 500 May 31 2014 to November 21 2014

This week I'm driving to Texas for thanksgiving with two of my sons and my new daughter-in-law. It seems I'm the only one in the family who knows how to cook a turkey, so I was invited - no dummy, that new DIL. If I have a blog for Nov.30 it will be abbreviated. Good news: although I delayed my piece on Russia for a week, Russia is still here.

Robert Schiller, who coined the phrase "irrational exuberance" and won the Nobel prize for his work on house prices, also likes to look at stocks with a very long-range viewpoint. This week he tells us that stocks are overbought by the 2nd highest amount in history - the only comparable time was 1999-2000 at the top of the internet bubble. Are stocks in a bubble? This is a topic of great debate; I say yes. Will stocks crash? Without question - basic laws of physics, it goes up, eventually it must go down. Will they crash soon? I don't think so. Too many central banks are printing too much money, too many politicians have a stake in this big lie. The last time we got to 90% above trend line, it was 20 more months before the market crashed. I think we're good for 2015, absent wars or major terrorist attacks. Will there be set backs and corrections? Very likely, imho. I consider another 10% correction very likely in the next 12 months. I think a 15-20% correction is possible if something really stupid happens, like Obama's immigration orders lead to a showdown with republicans, who then go all in with a government shutdown or impeachment hearings. But a 50% to 80% drop? Not happening anytime soon, as I see it. In fact, given my opinion that stocks are in a bubble manufactured by the Fed, I see no problem with stocks going up another 30% to S&P 2600 from here. Japan's central bank is now buying some stocks directly; if our Fed panics in a couple years and starts doing that, then I see no problem with stocks going up to S&P 3200. And then crashing historically.

Are we in a bubble now? To my knowledge no one has a measure of "bubbleness." Currently we recognize a bubble when it pops. This leaves a couple rather interesting questions: (1) Can you identify when you're in a bubble, indicating you should take extreme caution? And (2) can you predict when a bubble will pop, allowing you to make extreme profits by short selling? I'm personally of the opinion shared by many economists that the date of a bubble popping cannot be predicted: to quote two people famous for their predictions, "Markets can remain irrational longer than you can remain solvent." -- John Maynard Keynes; and "But about that day or hour no one knows, not even the angels in heaven, nor the Son, but only the Father." -- Matthew 24:36. As to identifying bubbles, there is a number used to typify time series called the Hurst coefficient. If the Hurst coefficient is near 1 the time series is trending, nearly a straight line with minimal interruptions, and can be predicted to some extent. If the Hurst coefficient is near zero, the time series is bouncing back and forth in a range and again can be predicted to some extent. If the Hurst coefficient is near 1/2 the time series is what mathematicians call a "random walk" or a "drunk walk" and cannot be predicted by any known techniques. It seems clear that bubbles would be typified by a Hurst coefficient which was near 1 on many time scales simultaneously - minutes, days, months, years - for a very extended time. The S&P is showing such behavior, it's been almost three years since we had a proper 10% or more correction. One of my readers is an expert on Hurst coefficients and I write this with hope he will choose to investigate this further.

Super Mario said it's imperative to get inflation on target as fast as possible, and he will "step up pressure and broaden even more the channels through which we intervene." It's not clear he has authority to do this - the Bundesbank will try to stop this as Germans hate inflation above all else. And it's not clear that even if he intervenes he can influence inflation: the Japanese and US central banks have both failed at this. In any case, the Euro immediately dropped below $1.25 on expectations of more printing. China announced a cut in interest rates. The Chinese growth rate continues to drop and their central bank wishes to get it above 7.5%. It seems unlikely to me that cheap money will do this, but it will further enrichen Chinese insiders. US markets immediately jumped up almost 1% on news of new central banks bringing monetary alcohol to the Wall Street party punch bowl. Since 2000, China has increased the holdings of their central bank by 9x and lowered interest rates to near nothing, resulting in bridges to nowhere, cities where no one lives, airports where no one lands, malls where no one shops, a real estate bubble that's breath-taking even by Japanese standards. Europe has Super Mario promising that there are no limits to what he will do to re-kindle inflation; meanwhile Europe's GDP is still stuck where it was in 2006 and Europe's CPI has risen 20% over the same period, very close to an average of 2% per year, while savers are now paying the banks to hold their money. Japan has had essentially no real growth since 1990 while their central bank has tried everything you can imagine and a few things perhaps you can't. And our beloved Fed has increased their holdings by 5x since 2008 and reduced interest rates to near zero. Here's a question for you: How is the latest round of money printing different and how is it going to change anything for any economy?

The Philly Fed manufacturing report came out and crushed expectations, rising to a level not seen since 1993. By all statistical measures, the US economy is doing great - the one bright spot among the world's large economies. Japan is falling faster than expected, Germany is flatlined, France is falling deeper into recession, China is flatlined.

Japan is in recession with a 1.6% annualized contraction in the 3rd quarter. This is in the face of their unprecedented money printing; it's not working for them. Their over-65 population rose to 25% of everyone this year and continues to go up - more and more people are retired and depend on fewer and fewer young workers.

China and "one or two" other countries are capable of mounting cyber attacks that would shut down the electric grid and other critical systems in parts of the United States. Admiral Michael Rogers, director of the NSA, said U.S. adversaries are performing electronic "reconnaissance" on a regular basis so that they can be in a position to disrupt the industrial control systems that run everything from chemical facilities to water treatment plants. "All of that leads me to believe it is only a matter of when, not if, we are going to see something dramatic. China's economic cyber espionage ... has grown exponentially in terms of volume and damage done to our nation's economic future. The Chinese intelligence services that conduct these attacks have little to fear because we have no practical deterrents to that theft. This problem is not going away until that changes."

King Abdullah of Saudi Arabia said recently, "If [the Iranians] get nuclear weapons, we will get nuclear weapons." Similarly, the UAE notes that their nuclear treaty with Washington which allows them Korean reactors with US technology includes a clause: "The terms and conditions accorded... shall be no less favorable in scope and effect than those which may be accorded from time to time to any other non-nuclear weapons state in the Middle East in a peaceful nuclear cooperation agreement." Obama's lack of will and leadership to end Iran's nuclear plans is going to lead to a new nuclear arms race - among people who marry their 1st cousins, believe in warrior priests who live in caves for 600 years, and want Israel gone at any cost. Israel, it's been nice knowing you. Those Jewish holidays - "They attacked, we survived, let's eat!" - we might need to change those a little bit.

Putin is evil and starting a war in Ukraine, right? Well, as I see it, not exactly. Russia's history in Europe does not give them a lot of confidence that they will be left alone to live peacefully. Although the Russians have never particularly been aggressive conquerors, they have been invaded by Sweden, Poland, Turkey, France and Germany enough times that they're sick of it. Russia has no natural boundaries to the west. In the east they have frozen Siberia that hasn't been crossed for a long time and the Ural mountains. To the south are the muslim countries - the Stans - which are a mixed bag of barely friendly buffer states for Russia. They end in the uncrossable Taklamakan desert to the east and the Himalayas to the south. The Caucasus mountains protect Russia between the Caspian and Black seas. West of the Black sea they're protected by the Carpathian and Balkan mountains to the south, but to the north their borders are wide open to the North European plain.

To defend this plain Russia believes, accurately I think, that they need a lot of room to fight and retreat. For most of the last century that room has been provided by Romania, Moldova, Poland, Ukraine, Belarus, Lithuania, Latvia and Estonia. If they lose those buffer states, Moscow is an easy 200 mile tank ride from anywhere on an indefensible 800+ mile front. Remember, in WWII they held the Germans at Kiev in central Ukraine with the help of the Dnieper river - pretty much the only major river between Russia and the west. In 1990 Germany reunified, producing a threat to the Russians just as the USSR was crumbling. We made good use of that chaos and signed the Czech republic, Hungary and Poland to NATO in 1999, then Estonia, Latvia, Lithuania, Slovakia, Romania and Bulgaria in 2004. From the Russian perspective we had opened up invasion routes to Russia over the Carpathians, through the Baltic Sea, and encroached deeply into the North European plain.

Early this year we promised military and economic aid culminating in EU and NATO membership to Ukraine if they broke away from Russia and formed a new government; they promptly started a grass roots revolution. This was the final straw for Russia, threatening to put NATO troupes, tanks and missiles within 200 indefensible miles of Moscow. On Wednesday Russian Foreign Minister Sergei Lavrov said, "We believe, and we've been talking about it since the very beginning of the current historical period, that the reckless, endless expansion of NATO is a mistake that undermines Europe's stability." Lavrov added that Ukraine's neutral status was key for security and Russia's national interests. Also taking Crimea away from Russia would steal their only navy ports that gave them warm water access to the Mediterranean and the Atlantic. Unsurprisingly, Russia decided enough was enough and reacted quickly, militarily and decisively. Imagine how we would react if Russia stationed tanks, missiles, aircraft, men in Cuba.

Today we have a weak president in the US who is reneging on his promises to Ukraine - even Obama is not stupid enough to think he can prosecute a ground war against Russia in Ukraine - and a nationalistic president in Russia who is committed to his country's security and has the backing of a super majority of his countrymen. Putin is massing Russian jets, tanks and men on the Ukraine border making it painfully clear that there are no limits to his determination to keep Ukraine out of NATO. We have backed the Russians into a corner with an existential threat, and now with the help of the Saudis and the European banks we're doing everything we can to bankrupt them as punishment for defending their vital interests.

Frankly I'm sympathetic to Putin. I wish we had a president who expressed and supported our own interests as unequivocally as Putin does for Russia. In the long run Russia will lose and likely disintegrate. In 2000 Russia had about 150 million people; by 2050 that number will be more like 115 million with about a third of those over 55 years old. Russian men have a life expectancy which is 20 years shorter than European or US men, likely due to vodka, poor diet and their 3rd world hospitals. Russia's economy is now completely dependent on oil and gas exports which are declining resources; Russia has no other significant exports, and imports an alarming percentage of their food and manufactured goods. It's likely that in 15 to 30 years Russia will find they no longer have the resources to dominate their own territory, and their hold on Siberia and the muslim countries including Kazhakstan, Kyrgyzstan, Uzbekistan, Turkmenistan, Azerbaijan and Georgia will crumble. From the Russian strategic viewpoint this will open up invasion routes from Turkey and Iran and leave Siberia to be picked over by China and Japan - two countries that have been jealous of Siberia's resources for centuries. In Russia they are preoccupied with holding off the inevitable decline of their nation. Russians are not stupid, they see this even more graphically than I do and they are not going to allow this process to be accelerated by a weak and indecisive US president. They have overflown NATO countries and installations roughly 50 times in the last two weeks with armed fighters and bombers. They have stated that their bombers can reach the gulf of Mexico. They have practiced launching cruise missiles at the US, Sweden, Denmark, the Baltics, Poland, Turkey and Guam. I don't know how Washington interprets this, but to my eyes the message is clear: "We will go to war over Ukraine."

If I were elected president tomorrow, I would find a way to quietly withdraw from Ukraine and allow Russia their buffer state; the alternative results in a war we cannot win. Reagan bankrupted the USSR with Star Wars; now we can just be a bit patient and Russia will do the rest of the work for us with their declining birth rate, poor health, obsolete manufacturing, inefficient farming and gross overspending on the military. And this presumes that we want Russia weakened and then broken up. When I look at muslim population growth, ISIL and the emergence of a caliphate, the strong potential for a nuclear Iran, muslim designs on dominating Europe and the destruction of Israel and the US, I see Russia as a natural ally, not an enemy. We won WWII in large part by supplying Russia with food and war materials - it was the Russians who did the heavy lifting in WWII. Perhaps in the not too distant future we will again find ourselves in a position where Russia is willing and able to supply ground troupes for a war that has even more meaning for them than for us.

The Skinny Mirror is a new company in the People's Republic of California that sells mirrors that make you look skinny. They take an apparent 10 pounds or so off a typical shopper. Retailers are putting these in their dressing rooms where they increase sales by a bit over 20% and contribute to a bit over 50% of all sales.

Paranoia strikes deep department: If you think the government is spying on you, here's a program which will check your computer for you. It's written by Amnesty International. Detekt. I scanned my computer, apparently the government doesn't care enough about me to spy.

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