"The World Remains a Dangerous Place"

Sydney M. Williams

Thought of the Day

“The World Remains a Dangerous Place”

September 28, 2011

Dissociative identity disorder is a psychiatric diagnosis that describes a condition in which a person displays multiple distinct identities. That sounds like a definition of the stock market over the past few weeks – or perhaps it defines portfolio managers. Every time the S&P 500 moves up or down about 70 points (about 6.5%), as it has eight times in the past eight weeks, the value of that index gains or loses approximately a trillion dollars. Either unwilling to confront the future, which seems true of Europeans, or unsure as to what it holds, which is always true of investors, the market is far more schizophrenic than actual events. Recognizing this blossoming potential for disruption, the SEC has begun an overhaul of rules adopted following the 1987 stock market crash. Under their proposal, curbs would be initiated when the S&P 500 fell 7 percent. Previously the index used to trigger a closure was the DJIA and the curb was a 10 percent decline.

The market’s three-day rally (+4.1%, with futures higher this morning) has been based on positive rumblings emanating from Europe – Greece’s apparent willingness to live a more Spartan life, and the possibility that the €440 billion available to the European Financial Stability Facility (EFSF) might be levered to €4 trillion – a rumor more than a probability. Any increase needs approval from the seventeen countries. Importantly, the German Bundestag votes Thursday and it is not a given that they will approve. Their citizens do not seem to be in a particularly charitable frame of mind, at least when it comes to profligate Greeks. The Greek parliament did approve a property tax; it remains to be seen as to what success they will have collecting. As far as the U.S. intervention into Europe’s financial problems, Ambrose Evans-Pritchard, in yesterday’s The Telegraph, wrote: “Berlin savaged (US) plans to boost the EU Rescue Fund as a ‘stupid’ idea.” Take that as a “no interest.”  “Extend and Pretend,” is the way a Danish economist on Bloomberg characterized the situation in Europe.

Later this week representatives from the EU, the IMF and the ECB will fly to Athens to assess the situation. This week’s meeting in Basel of the Basel Committee on Banking Supervision will be of interest given the deteriorating conditions in Europe. There has been some talk of providing relief to the systemically important financial institutions (SIFI,) or simply, “banks too big to fail.” Under Basel III, a Tier I capital surcharge was imposed of 2.5% on top of the existing requirements of 7% on Tier I capital. But it is liabilities that should be of greatest concern to investors. In the U.S., the issue continues to be one of mortgages and at what value are they carried, especially as they continue to be put back. In Europe, the same concern holds for sovereign debt. In both places, there is the concern as to the value of their notional derivatives outstanding – most of which is offset – and the unknown risk of counterparty failure. According to the newsletter, Hedgeye, credit default swaps on the bonds of ten European banks are trading over 700 basis points, an indication that there is a 40% default probability. That sounds , to borrow a phrase from Wilbur Ross, like an actual risk, as opposed to a perceived risk.

But Europe is not alone in appearing riskier than normal. Despite the Arab “springs” that emerged six months ago, peace in the region seems no closer. Washington has long practiced a form of diplomacy that it is better to support the dictator you know than to take a chance on the freedom fighter you don’t. Leaders in Libya, Tunisia and Egypt have been deposed, but thus far no replacement governments have yet been formed. Palestine and Israel are no closer to accord than they have been in the past sixty-five years. Syria has shown no remorse in its treatment of dissidents and women. Iran continues to work toward nuclear weapons, with little being offered in terms of deterrents. Pakistan, a nuclear power, is becoming a basket case, having gone from an ally to a risk. Admiral Mullen, Pakistan’s best friend in the Department of Defense, gave testimony on Monday before the Senate Armed Services Committee. He spoke regarding the September 13 attack on NATO headquarters in Kabul that killed twenty-five, stated: “With ISI (Pakistan’s spy agency) support, Haqqani operatives planned and conducted that truck bomb attack, as well as the assault on our embassy.”

“The southern-hemisphere summer has given way to autumn, but the sun is still shining on Chile,” is the way The Economist recently started a piece on Latin America. Democracies appear to be under pressure in the continent. Hugo Chavez’ influence is increasing. Left of center governments now operate in Argentina, Bolivia, Brazil, Ecuador, Paraguay and Uruguay, besides Venezuela. President Juan Manuel Santos of Colombia does not have the close relations with the U.S. as did his predecessor, Álvaro Uribe. Peru’s newly elected president, Ollanta Humala, is a left-leaning politician who has vowed to distribute wealth to the poor, taxing the mining industry to do so. Chile, with Ricardo Lagos as president, is the one country in South America now firmly in our camp.

Increasingly the world is looking east, to China. When the subject of economic growth arises, no matter one’s country, we consider China. They are a major player in the global economy on all continents, despite an economy slightly more than one third. Militarily, China is becoming a power to be reckoned with. As relations with the U.S. have become increasingly tenuous, Pakistani President Zardari recently invited delegates from the Peoples Republic in a demonstration that should the United States no longer provide Islamabad with its $5 billion annual allowance, the shortfall would be made up by Beijing. However, we must always remember that China’s capitalism is of a mercantilist form – the state makes the crucial decisions and that political repression remains a way of life.

Rancorous continues to be the operative adjective when describing America’s political circus. Unemployment remains above 9 percent. GDP growth in the first half of this year was less than one percent, and it does not appear that the third quarter will show any improvement. Yet, with the election over thirteen months in the future, the President has chosen this moment – purportedly to drum up votes for the job bill he knows has no chance of passing, at least as written – to chase across the country drumming up the $1 billion in cash he claims he needs to win re-election. We have a problem of discord in Washington and he is doing his utmost to further divide the people along class lines. The top one percent of all tax payers now pay 38% of all federal income taxes, while 46.5% pay none. The President’s gaffe on Monday when he said “Jews” instead of “janitors” might have been excusable, except the man never speaks without a teleprompter. Yesterday I noted that in repeating the same line he substituted “plumbers” for “janitors” – safer, I guess, unless you happen to be Polish.

The world does remain dangerous, but it always is; though this time it seems to have a harder edge. Nevertheless, while Treasuries have been rocketing skyward, stocks are in the midst of a ten-plus-year digestion phase. And the future, as always, remains a mystery wrapped in an enigma. Yesterday, Richard Fisher, President of the Dallas Fed spoke before the Dallas Assembly. He relayed a story of a sign his brother had seen on the desolate island of Jan Mayan, 600 miles west of Norway’s North Cape:

“Theory is when you understand everything and nothing works.

Practice is when everything works, but nobody understands why.

At this station, theory and practice are united, so nothing works and nobody understands why.”

Words that resonate back here at home, as we ponder our tomorrows.