MacroProfit January 2014 Issue
Happy New Year!!
Welcome to the January 2014 issue of MacroProfit, and a happy, healthy, and prosperous New Year to all.
While all eyes are on the gyrations of the cash-rich manufacturer of must-have gadgets, namely Apple, Inc., and what their next move will be to reinvigorate their lack of innovations, “something else is happening.” While mainstream media reports on the day-to-day machinations of Twitter and the rest of the social media shooting stars, “something else is happening.” While the American Association of Individual Investors and the National Association of Active Investment Managers (NAAIM) push their bullishness to levels never seen before in history, “something else is happening.”
Whether it’s the most glamorous and skillful stage magician or the guy on the street corner with three shells and a pea, the idea is to keep our eyes focused in one direction while “something else is happening.” All throughout history, the man on the street never took a step back to look at what was happening around him. The expression most often used was “to see the forest for the trees.” In 1861, while all eyes were on Fort Sumter and the secessionist states, “something else was happening.” In 1997, while all eyes were firmly on the dot-com mania, thousands of miles away “something else was happening.”
And just what is this “something else?” It’s known as…
In this month’s issue, we’ll look at the current financial mayhem that has engulfed Thailand and Turkey, the so-called lynchpins of U.S. stability. Is this simply a rerun of the Asian crisis of 1997-1998?
We’ll examine the elections to be held for the European parliament, normally a boring event, which nevertheless might have dramatic consequences for the entire world in 2014.
We’ll take a peek at the emerging markets and the almost inevitable crisis they face in the coming year.
We’ll also take a walk back in time in order to see how Abraham Lincoln’s problems were much more than just a reconciliation of a nation.
Our “odds and ends” this month will be a classroom reminder of the “17-year cycle” and all that it brings with it.
As most people’s eyes continue to be focused on an ever-higher Dow Jones, we’ll remove the blinkers and introduce you to…
The Asian Contagion
The Asian crisis of the late 1990’s was caused by a rising dollar and a misguided pegging mechanism utilized by governments of dollar-pegged countries worldwide. The main culprit was the U.S. dollar, which was being mismanaged by the Federal Reserve. Fears of a worldwide economic meltdown due to financial contagion focused most eyes away from the dot-com explosion to a more prolific reality. All hell was breaking loose, and it had its origins in Thailand. Fast-forward to today and once again the so-called unintended consequence of the most epic experiment of central bank liquidity provision on record seems to be playing itself out in Southeast Asia.
Investor’s abandonment and currency collapse have led us to believe that the implosion of Thailand has begun, and the worldwide contagion, much like 1997-1998, is imminent. During the 1980’s and 1990’s, currency stability made it possible for capital from the developed countries to flow more easily to the less developed regions, while also allowing for more stable trade relations and the expansion of export related industries. Thus, a brand new cycle of wealth creation began. Thailand and others acquired an ever-rising burden of foreign debt that made it almost unsustainable at the first sign of trouble. This potential chink in the armor was not relevant to either borrowers and lenders or buyers and sellers. The developing countries were a playground for the financial entrepreneurs and hot money of the world. The natural results of these capital flows included the expansion of current account deficits in the developing countries as their balance sheets boomed. The current account deficit was not in and of itself a problem, however, corporations in developing countries were borrowing directly or indirectly from lenders in developed countries. And therein lies the problem. Large amounts of cross-border borrowing means that a greater part of the developing countries’ economies were exposed to exchange-rate risks. Since most loans were denominated in dollars, and usually short maturity, the risk was borne by the corporation or bank of the developing country. In addition, foreign lenders did not escape since they bore a default risk. At this time, there seems to be no end to the asset bubble fueled by the hot money. After all, the baht was pegged to the dollar, so what possibly could go wrong? As money flowed in, there was no attempt to use it for the development of the economy and the betterment of the people. It simply went to that top 1% who could best benefit from the leverage and lack of control; usually it was those who were closest to the center of power. Sound familiar? There is always, of course, the unexpected: the Chinese renminbi and the Japanese yen were devalued.
U.S. interest rates rose, leading to a strong dollar and a sharp decline in semiconductor prices, which was very significant to the region, all of which combined to deal a death blow. Consequently, the Thai currency, the baht, was de-pegged from the dollar due to a lack of foreign currency to support its fixed exchange rate. Effectively, given the debt load that the government and the corporation embraced, they were bankrupt even before the collapse of the currency.
A shock was heard around the world as markets and economies reacted from Tokyo to Madrid and from London to New York. The historic collapse and demise of Long-Term Capital Management L.P. (LTCM) was directly related to the Asian crisis, a catastrophe which had its beginning in Thailand.
What were central banker’s reactions? Of course, it was more of the same. And of course, instead of disavowing the Keynesian approach, the response was “faster, bigger, and more, at even greater leverage.” So, what happens when just the word “trim” is introduced? It will be the same result as last time. According to Bloomberg, “The baht has plunged 5.1% as of the end of October, to a 3-year low as international investors pulled a net $2.75 billion out of equities, the worst outflow in at least 14 years.” Indeed, political turmoil mounts as political opposition becomes more violent. As economists review the Asian crisis, most come to the conclusion that the problems were not created by market psychology or technology, but by misguided incentives regarding the use of unsustainable leverage, the disparity between rich and poor, and the distortions between lender and borrower.
They will come to the same conclusion, but when presented with almost the exact same scenario today, they all look at Thailand not with fear or alarm, but with the questionable mantra of “this time it’s different” and therefore the economists will suggest that it’s another great buying opportunity.
It really does sound familiar, doesn’t it?
As money has been fleeing from the most recent Asian financial crisis, the same can be said for the star of the emerging markets of the Middle East, namely Turkey. For the past 11 years, the former Ottoman Empire has been the poster boy for political and economic stability. It has even been able to restore a certain degree of religious stability, unheard of in an area that almost prides itself on daily instability. The excellent demographics, the low debts, and the expanding industrial base — despite the ongoing civil war occurring next door in Syria — made Turkey a haven for foreign capital.
Most emerging markets have a continuing battle with inflation and so too did Turkey. However, the Prime Minister of Turkey, Recep Tayyip Erdoğan, subdued that number from 70% annually to 7.5% this past year. The debt-to-GDP dropped from 74% to 40%, unemployment declined from 16% to under 10%, and annual GDP growth since 2002 has averaged nearly 4%.
As the leader of the emerging market world, there could not be a better representative. Once again, a good thing can often go awry as the profitability of borrowing in New York and buying in Istanbul to reap outlandish profits came to an end.
The assessment was that the U.S. “taper” was real and U.S. interest rates, following record lows since 2008, would finally start to rise. Hot money flew, leaving a plunging stock market, down 32% since May, and the bond market, which lost $18 billion worth of notes over the past half-year, witnessed the 2-year note yield climbing to 10.17%. Turkey’s stability was not based on an export economy in part due to its lack of natural resources, which is why they spend $60 billion per year on the purchase of oil and gas. Rather, Turkey’s stability was based upon giving its people the benefits of foreign currency inflow that went into retail consumption. In other words, as long as the hot money was still hot, everyone was happy and was guaranteed all the social services and gadgets they ever needed or wanted. In the past year, the Turkish lira has lost one-fifth of its value. Economic reality always has a way of coming to the fore, no matter how much central bankers try to control the situation. Unfortunately, as the emerging markets, including Turkey, were the beneficiaries of a liquidity experiment, so too will they be the victims of the withdrawal of the same liquidity. As developing economies start to crumble, so too will be the support for authoritarian regimes, which will create such political turmoil that all reasons for hot money to stay will be abandoned.
Turkey’s longstanding policy of being a neutral neighbor has gone by the boards, and the quest for “zero problems with neighbors” has likewise gone up in smoke as tensions increase with Egypt, Iran, and Syria.
All this foreign financial disorder has occurred as the policy of cheap money is continuing to be unwound (or least discussed.) Although they’re on opposite sides of the world, Thailand and Turkey (and all emerging markets) share the same problem, specifically a Keynesian philosophy that was always destined to reach an unfortunate conclusion.
Yes, a real…
Civil War Conspiracy
All throughout history, foreign intrigue has been a culprit lying in wait to undo that which seemed to be inevitable. When we think about Abraham Lincoln and the Civil War, it seems pretty clear; it was North, South, Border States, pro-slavery, and anti-slavery. Yet, very rarely discussed was the overriding impact of England, France, and even Russia. Contrary to the North’s multi-manufacturing prowess, the South depended upon a crop – cotton, for its income. That income was used to buy for the South that for which the North could easily produce. Logic dictated that if you shut off the South’s cotton export, you would shut off their ability to survive and make war. Thus, almost immediately, Lincoln instituted a blockade along the entire east coast.
The unintended consequence was that an entire country, England, and an entire continent, Europe, were deprived of their cotton to keep millions of people not only clothed but also employed. English cotton ships understood the danger but many continued to evade capture by operating under the guise of being a mail ship. Frustrations continued to mount on both sides of the pond until one overzealous U.S. Captain boarded an alleged British mail ship and removed two passengers, ostensibly Confederate representatives who were traveling under the protection of the British flag.
Increasing unemployed workers and an insult to the dignity of the world’s maritime superpower required some type of response by England. Countries around the world all weighed in on whether the Confederates should be released or should still be maintained. While Americans everywhere were hearing about Bull Run, Manassas, and Vicksburg, the “foreign intrigue” continued to play out in palaces, salons, and dining halls around the world.
The United States of America was not so united and appeared to be very ripe for the taking. The unemployment and hardship created by the blockade was very real and most certainly had a significant impact on the well-being of the British people. However, leaders not only in England but also in France saw an opportunity to exploit the conditions being offered by the Civil War. British troops were dispatched to Canada as well as French troops to Mexico. Abraham Lincoln not only had to deal with a “house divided” but also had to be conscience that any misstep could ultimately result in not just one more war being contested, but perhaps a second war against not just one but two world powers. The president exercised great caution and extreme diplomacy in settling the matters of the detained Confederates. He was able to successfully bring under control Napoleons III’s North American ambition and also utilized the Russian Atlantic Fleet to his advantage from a public relations point of view.
The Civil War concluded to Lincoln’s great success, however, for a period of time, it looked like the demise of the United States would occur not because of the obvious which was happening on its shores, but because of…
Europe is Burning
As quiet as the sideshow was that played out during the Civil War between the U.S., England, and France, just the opposite was occurring during the 1920’s and 1930’s in Germany and Italy. The passage from monarchy/elected leader to fascism was loud, apparent, and in-your-face. Mussolini was elected on the premise of making the trains run on time, whereas Hitler was elected to create change for a country that was firmly oppressed by the First World War victors. The transitions by both men have been predicted in their writings and speeches. The ultimate outcome, however, was not predictable until it was too late.
Normally, the election to fill the slots for the European Union is a very boring affair. Since historically it has seen the same candidates with the same Keynesian philosophies, almost like a U.S. election where the titles may be different but in the end the philosophies are pretty much the same, in other words a “repub-ocrat.” There are moments in history like the European involvement in the U.S. Civil War and the resurgence of Germany in the 1930’s that certainly stand out as defining moments. In my opinion, right now is also one of those moments. The Golden Dawn and the Pitchforks were names that attracted few voters at the polling booths in the past. However, given the wave of hostility against the European Union that is sweeping across the continent, it would not be surprising to see these Neo-Nazi parties of Greece and Italy, respectively, gain dramatically.
Parties such as the UK Independence Party, the National Front in France, Alternatives for Deutschland, and the Freedom Party in Holland will form a majority. A newly elected anti-EU majority will more than likely throw out the budget, block legislation, and veto appointments of commissioners. What could very well prevail is a full-blown constitutional crisis. Of course, more than likely, the first victim will be the euro currency itself. We might finally be witnessing the 99% saying to the 1%, “Enough is enough.” While America sleeps, Europe will be burning, another example of…
INTERNATIONAL INTRIGUE gone wild.
The 17-Year Cycle
Why is it so important to watch what is happening around the world? Because given the speed in which information travels, the days in which the news was brought by sailing ships are long gone.
Instantaneous, immediate, in the blink of an eye, thus what happens in Thailand, or Turkey, or Dallas, is known to the world immediately and becomes part of the day-to-day decision making process. Therefore, it comes as no surprise that this speed of awareness is an integral part of the 17-year cycle.
A brief recap of the cycle goes something like this: Every 17 years, the pendulum swings from bullishness to bearishness, not just with the stock market but also in the general overall economy at-large. Take a look at 1982 to 1999, one of the best overall stock markets in history punctuated by the emergence of Silicon Valley and the dot-com craze. Of course, 1987 was a bump in the road — but only that — a mere bump in the road which led to much greater prosperity. From 1965 to 1982, just the opposite was the case as Richard Nixon took us off the gold standard for good, interest rates were double-digit, and Jimmy Carter said, “Put on a sweater.” The time period of 1948 to 1965 saw the return of the GIs to marry, have children, and go back to school, providing the economy and the markets their best surge in decades. 1931 to 1948 was highlighted by economic depression, famine, and war, enough said. The years of 1914 to 1931 were punctuated by the Roaring Twenties. Continuing every 17 years, you will find much of the same as far back as the eye can see. But what about 1999 to 2016?
According to the cycle, we’ve been in a bear phase and should shortly be approaching the end. However, even though we’ve experienced two crashes, in 1999 and 2008, we rallied each time to now be at an all-time high for certain markets. Why is it that in every 17-year cycle, it works its way from top to bottom and vice versa? For the cycle to continue to be correct, it means the markets have a long way to go on the downside in a short period of time. Therefore, if for the first time in history the cycle is wrong, well, no problem, it’s off to the races. If, however, the cycle continues to be right, then the next 24 months could be one of the worst time periods in our country’s history. What is it that could create such a precipitous drop in the markets in such a short period of time? Of course, worry and concern will be part of the equation, and fear and panic goes without saying. But perhaps the most significant thing to watch out for is…
The Middle East — obvious. Asia — unquestionable. These are the areas that most people focus on when they hear the words “INTERNATIONAL INTRIGUE.” However, just like a champion chess player who thinks several moves ahead, the reality is that contemporary dangerous actions, unbeknownst to most, are occurring in Africa.
China has proposed or committed about $100 billion in commercial projects in Africa since 2010. African governments, underdeveloped and undercapitalized, are welcoming Chinese investments with open arms.
Is it because China wants to see Africa become a more accomplished citizen of the world, or is it because the estimation is that on and off the African shores there are 25 billion barrels of oil? Imagine all the strife and turmoil in the Middle East due to the global scramble for energy. Now translate that to an embryotic stage of a new continent’s abundance of fossil fuel.
The country that gets there first (so far it’s China) will need to realize that just like the Middle East those, “Who have lost out will be tempted to support armed rebellions that weakens their rivals influence, encouraging conflicts that are inherently destabilizing, not just to the oil-rich nations but to the region.” — Charles Hugh-Smith
Instead of hearing about our boots on the ground in Iraq, Libya, or Afghanistan, we could be discussing oil-rich Ghana, Gabon, and Angola. The jockeying for position behind the headlines has already begun and no energy-importing power can afford to be sidelined in the scramble for African wealth and fossil fuels. Oil is also known as black gold; in the future we may refer to it as liquid ivory.
A bubbling caldron just beginning to percolate, but very much worthy of being called…
Asset Class Impact (New This Month!)
So how does understanding INTERNATIONAL INTRIGUE help you in the world of MacroProfit? Commencing with this issue, we will dispense with the traditional daily portfolio which has had some dramatic success and equally dramatic failure. Since the goal of this publication is to give you a better understanding of what is happening, has happened, and will happen, and thereby allowing you to apply it to your own individual situation, we will endeavor to look at what asset class or classes will be impacted significantly, both positively and negatively by our central theme.
In 2013, U.S. Treasuries declined 3.4% and the overwhelming negative attitude toward owning a treasury bill, note, or bond, has reached levels never seen before. As pundits continue to stress that interest rates cannot possibly go lower, there becomes a disconnect to actually how low the 10-year Treasury went. In July of 2012, the benchmark 10-year bond reached a low of 1.38%. Having flirted with, and exceeding 3%, it now finds itself on a downward path at 2.84%. Subscribing to various wave patterns (Elliott, etc.), a case could be made that a worldwide disruption would create a scenario where money flows, at least briefly, to safe havens. And thus, initially, this yield pullback could retest the 2012 low. A move from 3% to 1.38% could produce a double-bottom, and a decline of 54% in yield. Remember, when the yield declines, prices appreciate, and a double-bottom would have great appreciation potential.
Now you see why it was important to understand…INTERNATIONAL INTRIGUE.
Til next time,