Riots, Protests and Revolutions

The video above has some interesting comments made by futurist Gerald Celente in the past few years, along with future predictions of what he thinks is to come. I want to expand on some of what he says in this post as there are various topics worthy of discussion.

Inflation Index

The video includes a scathing attack on Americas CPI index and with justification. Statistics are always open to manipulation and to exclude food and energy in peoples living costs is simply not representative of the average persons consumption patterns. The current monetary system we have then uses this index to target what level to set interest rates at, and how expansive monetary policy should be. A centralised monetary planning board, known as central banks, periodically modify this index in an attempt to represent peoples buying habits.

Why do they set targets of 1-2% for these indexes? Why not 5% or 10%? Why not set monetary policy based on population growth? Or on how fast GDP growth is? Why not any random figure. My point is that the current system is no different to Communisms version of centralised quotas, which had no relationship with fundamental market forces, specifically supply and demand.

As I have mentioned in a past post the market should take control of producing money. Karl Marx was right, money was the key, he was just wrong on everything else. Governments monopoly of this product means that people have no choice but to use their national currency. This in turn creates artificial demand, as I can't buy food in Euros or US Dollars here in the UK. Therefore there is no check in the short term on what the government can do, especially if all governments are following the same policies. In a free market of competing currencies they would all compete with one another, based on supply and demand of consumers desires. If people preferred a certain type of money, then the market would increase supply of that currency based on demand. If people chose not to use a currency, then a contraction in the supply would occur in order to match up with consumers needs. If money was oversupplied, as has been the case with the current government monopoly that exists today, then it would cease to exist as there would be no demand.

The above is not experimental either. Before Kings monopolised money (in recent times the government) money was always a spontaneous creation by the free market in order to overcome barter. Money originated from the market, the authorities just mearly copied it's conception. In fact fiat money like the system we use today has only ever existed when it has been enforced on the people by governments.

There are many currencies in danger due to the above supply and demand dynamics. If we take for example the US Dollar the worlds reserve currency, there are currently many overseas holders. The problem over the last couple of decades has been the increasingly amount that has been printed and the existence of deficits. Many major holders have expressed their concern, Brazil, Russia, Japan, China etc. In fact these nations are already moving away from the Dollar for example Brazil and China have discussed conducting trade in RMB, along with Malaysia and various African nations. Indeed China has been shifting its wealth into commodity's, Gold, Oil or companies and nations associated with these assets.

The problem occurs when everyone heads for the exit. This is a situation where all foreigners sell their dollars. Then we come into the supply demand dynamic above, with no buyers but lots of sellers the price of the dollar will obviously decline. With the government in fiscal overstretch it becomes near impossible for them to do anything about it. Over the long term China, Russia or whoever deals with dollars have no interest in the US. They are currently slowly planning their exit strategies exiting first on the trading currencies they use and keeping their reserves for the time being so as not to put too much downward pressure on the dollar.

Latvia is another worthy example of this currency supply and demand dynamic at work. With the recent IMF loan the country has received (fiscal strings attached) the government needs to rapidly cut current spending due to IMF fiscal constraints. With the economy already in a deep depression, this will further hit growth in the short term. This should create strong devaluation conditions as the market has less demand for the currency of an economy that is in a perilous condition compared with other nations (as its prior perceived productivity decreases). The IMF loan is nominated in another currency, and due to the authorities not wishing for the value of the loan to increase if their currency was to devalue along with the further credit rating downgrades which would result from such a devaluation, they have begun trying to defend their currency with their currency reserves by buying up the domestic currency to create artificial demand. Of course the market is placing positions that the authorities attempts will be useless so are putting it under further pressure as the market believes a devaluation has to occur. This is a prime example of how market forces can't be beaten. Latvia will eventually have to devalue and abandon it's peg (they only have so much reserves), it's just the politicians don't want to face the pain. This is what George Soros did when he broke the BoE and made a billion. He was simply getting the government to face reality sooner than they wanted (in the process the UK government wasted billions of taxpayers money for nothing, however it would have been more costly in the long term if the market hadn't forced their hand earlier).

Price Stabilisation

If we come back to the concept of the price index representing a price stabiliser, some economists believe that markets forces can operate better if prices are 'stable', and have chosen a rate between 1-2% as an optimal range to target. We can take two simple items priced in Sterling to illustrate the fallacy behind this 'price stability' concept, houses and DVD players. Ten years ago a DVD would have cost you around £400, now they sell for £20. A house during the boom went up around 200-300% priced in pounds. If you look around there are many other items that either went drastically up in price, or drastically down in the price.

People don't think that if house prices or stock prices rise in price that this is inflation, but it is. It's priced in pounds or whatever the domestic currency is and these new pounds have to be created either from private banks or by the government. Due to the fact that they are usually an asset for many voters this is deemed as good inflation, despite the fact that it is the same as any other type of inflation. You just don't buy these on a daily basis like food and energy, that's the real reason its accepted.

If you look into the data used you have to wonder the reasoning behind what items appear in the CPI/RPI algorithms. If we take the UK index for example, last year they removed Parmesan cheese and put in its place Cheddar cheese (presuming you buy cheese). Why the change? Could it be to do with that we import Parmesan and with the pounds recent devaluation this good has gone up in price? Could it be some Bureaucrat somewhere wishing to look busy so swapped the specific cheese that is used? To take another example they have also substituted DVDs for Blueray discs, "to represent consumers move away to newer technologies". Would this be due to the fact that new technology has greater potential to fall in value, thus creating a lower inflation value for the headline press releases to give the illusion that we have no inflation?

Neither 'price stability' or 'inflation targeting' makes any sense when you start to analyse it and think critically (they have to create inflation in order to combat market forces that increase purchasing power by making goods and services more plentiful). In the years to come I'm sure these statistics will be heavily fudged in order to try and fool members of the public, trying to maintain the illusion of prosperity.

There were a plethora of amusing quotas that Communist Russia used to try and replace the free markets pricing mechanisms, by using measurements of produced materials rather than prices (prices which are determined by supply and demand). An example would be steel production based on measuring tonnage produced per year. The managers aim was to try and produce enough to meet his target (so he didn't get shot or sent to Siberia by under producing) but to not overproduce in case they increased next years quota too much. Due to the fact that it was based on tonnage there was no incentive to produce good quality steel that was of any use to industry.

So then we come onto say the state controlled oil sector, where they would require drilling equipment made from such steel. Due to it's poor quality it would make drilling laborious as the drilling equipment would keep breaking requiring more effort and time to drill into the well (a classic hallmark of state planned economies is where labor intensive techniques are used over productivity improvements). When they eventually got to the oil, there is usually a natural gas cap on the top, as is the case in many oil wells. As they only had a quota for oil production the gas would be burned off, creating huge environmental damage along with the waste of a precious and non-renewable resource.

Can you imagine the above in a capitalist economy? A company burning off millions of pounds worth of natural gas? A company wasting time buying poor quality steel and then continually having to re-drill? Despite the myth that capitalism overuses the planets resources, capitalism actually makes the most effective use of them compared to all other economic systems. Its only that it supplies us with such a luxurious lifestyle that we use more resources. Compare this with a regime such as North Korea where half the population suffer from basic malnutrition, despite the fact that South Korea supplies aid. There we contrast how well free market forces treat us.

Sub Prime

Celentes comments on sub prime are very true, as many people still think this is the cause of the current crisis when it just a symptom of easy monetary policies. There is far more downward pressure than just sub prime to come in housing. The next stage is prime mortgages as people loose their jobs and can't find new incomes. For those in the UK don't feel too smug, we have sub prime too, we are just behind the US curve. In fact UK home delinquencies are now worse than US sub prime. It just takes time for the banks to write these loses off.

In the US there is Alt-A, Option ARM mortgages which will be the next wave of defaults. Mortgages where the person could pay less than the rate of interest on the loan. As more of these deals are worth more than the value of the asset there will be little incentive for these individuals to continue with such arrangements.

What happens when the central banks have to raise interest rates to defend their currencies? Central Banks will be very reluctant to do this which comes to the next issue, the inflation that they will create. When prices of staple goods such as food and energy are rising how will people pay their mortgage. Would you choose to eat or default on your home loan?

Population demographics are another factor, with many looking to retire in the coming decades won't these people be looking to downsize, to supplement their pensions (presuming they have one or that it hasn't closed/collapsed etc).

Still people talk about the next housing boom in the news. The TV and papers are still full of articles. Denial is still all around with many talking about houses as a great long term investment. We will see what these opinions are at the end of this bear market, but we are a long way off.

Tax revolts, Food riots, Crime and Revolution?

California has already experienced a tax revolt as the people chose for state spending to be cut rather than face higher taxes. With inflation down the road, food will always rise in price as money ripples through the economy. It's one of those goods that you can't avoid not to buy. As unemployment rises along with the general disillusionment of people trying to re-enter the workforce, many will resort to crime. Then with the deficits many nations are running up, will there be cuts in crime enforcement? With protests and riots distracting the police will there be enough resources to cope? Ever wonder why the military is returning from Iraq?

We are living in extraordinary times, indeed a revolutionary era. All the conditions are present, government overstretch, money printing, plutocracy as the rich are bailed out, economic instability and so on. Will the traditionally strong liberal democracies such as the US and UK survive? I suspect so, but it will feel like a revolution in the years to come. When the currency and bond bubbles burst, then we will have a real crisis, not the banking crisis last autumn that was just a warm up, as Celente has remarked "The Bailout Bubble". The real crisis is yet to come.

“Every generation needs a new revolution.”
Thomas Jefferson, American 3rd US President

The Global Race to the Bottom

Since the financial carnage during late 2008, the real effects of the credit crunch have now started to be fully felt with members of the public now under no illusion of the severity of the situation the world finds itself in. No country has been isolated. The question is, how much worse can it get? Is the world heading towards a path of destruction?

Consumption based economies, resource rich nations, export driven countries - all have been hit hard by the turbulent events we find ourselves in. Since the collapse in commodity prices, after the huge de-leveraging that began in September last year, resource rich nations have come under intense pressure. The Rubble is in dire shape as Russia's Oil and Gas revenues have dried up. Run under a corrupt political system that is trying to keep together its fragmented collection of states by use of oppressive force which now seems unsustainable in the long run. Mexico, whose low cost manufacturing operations have been hollowed out in recent years by the lower Chinese labor costs, has been heavily reliant on it's Oil revenues, however production has been in decline for a good number of years. Along with the collapse in Oil's price, the nations stability has become questionable. The Peso has slid to record lows recently, with the Central Bank trying to stop the slide. Markets always have more money then Central Banks, however authorities always like to waste money to try and prop up their currency as though that changes fundamentals. It's remains to be seen if Venezuela can remain solvent with Oils new low price. Iran faces increasing fiscal pressures, along with other Middle Eastern states in an already unstable region of the world.

The Euro continues to mask the various problematic states that hide behind it. The Mediterranean nations and the Iberian Peninsula, Portugal, Spain, Greece and Italy all with a traditional weak work ethics and a short association with democracy, seem like they could once again fall under a Totalitarian dictatorship once more. Salazar, Franco, Mussolini or the "Junta" - we could well see a new generation of radical political movements. Germany's output has collapsed, as its export market has dried up. Eastern Europe's economic miracle after the break up of the Soviet empire is beginning to unravel. Latvia posted a 10.5% fall in GDP in the last quarter in 2008. After the IMF bailed out Hungary, the government are looking to cut government spending and balance the books further. Meanwhile in Ireland they have begun looking at cutting public pay, in order to keep the illusion of solvency for the time being.

After the surge in the Yen last year, as the unwinding of the Yen carry trade took its course, the BOJ will no doubt try and stem the rise by looking at measures to devalue, as its exports have fallen off a cliff. Many of the other Asian nations have not fared any better. China's exports have also collapsed, but so has their imports by a larger amount putting pressure on resource rich nations in the region such as Australia. China's creditor position, now as cash is king, is finally beginning to buy into the markets it will so desperately need when its rise as world superpower resumes. Layoffs in the urban cities continue to displace people back to the countryside, and its not just China where layoffs are occurring in Asia. Taiwan, South Korea, Vietnam all of these export based nations are suffering.

Back in the UK, Ed Balls, Gordon Browns trusted advisor and friend who recommended granting the BOE independence back when Labour came to power, stated recently that this was the worst financial crisis in 100 years. He also mentioned we could see a rise in extreme right wing politics as unemployment increases. Just like the 1930's another crisis in "Capitalism" has arrived, with worldwide contraction occurring once more. Once more the same mistakes are being committed. The Krona collapsed last year, however this won't be the last currency collapse of the crisis, or for years to come. There will be more that come under pressure. The Forint, Rubble, Dollar, Pound or Euro - no paper currency will be immune to what is happening. Continual debasement will occur and further currency crisis seem inevitable as a race to the bottom takes place.

The US are leading the world with further bailout packages. Obama's recent stimulus plan will soon be in the system. Who will pay for it? Who will pay for the $1Trillion and growing budget deficit? Domestic citizens? Foreigners? In the climate we find ourselves in? Recent losses have been announced at the recently formed giant UK banking group Lloyd's. More pain is yet to come, along with further nationalisation of the UK banking sector. In a post I wrote just before the globe came close to financial collapse, I said there will be a limit to how much Governments will prop up institutions and infuse money into the system. Well it looks like I was wrong on that point as most governments are more incompetent than I gave them credit for.

The 'Fear' Index

Since the Credit Crunch began around 18 months ago, we have seen great volatility in the stock markets and the currency markets. One measure that is used to measure volatility in the S&P 500 stock index is the VIX index, the volatility index, which the below chart illustrates.


The parabolic move, that can be seen in September/October of last year shows how distressed the financial markets became during this period. If we look at the blue line in the middle graph (the 50 day moving average of the index) we can see it has steadily been rising from a low of 0 in October 2007 (Just after the Credit Crunch began), to around 35 currently. Its been on a downtrend for the past couple of months, so does that mean the worst is behind us? Far from it. We are just starting the Bull market in market volatility as the graph illustrates, with further, and in my opinion greater shocks to come. A recent downtrend has emerged but for how long? The Western stock market will not be a place to be for at least the next decade in my opinion. The bailouts, money printing, increased government intervention, currency instability and record low interest rates will ruin the free markets price mechanism and further flatten the production structure. These destructive effects are yet to be felt.

So who will suffer the Worst and who will lead the upturn when it comes?

We are not going to see an upturn in 2009. That's for sure. The exporting giants, such as China, Germany and Japan will suffer a great deal, indeed China should fall into a serve depression if it allows markets to work their magic (I mentioned back in May that this should be expected). Germany and Japan should follow similar fates. In fact nations similar to this will experience as bad downturns if not worse than consumption based nations such as the UK and the US. But some of these nations should lead the world economy out of the downturn when the markets have cleared, along with resource rich nations such as Canada as people will always need materials. They already have the productive capacity or resources when the recovery arrives. The key thing is that they let their domestic markets clear. As Japan illustrated this is not always the case. China will no doubt experience shocks and inevitable set backs (just as the US did back at the turn of the Twentieth Century with the panic of 1907, or the UK did at the turn of the Nineteenth Century with the wars with France), but their leaders are about as Communist as Adam Smith, and have a long term outlook to supplant America as the economic superpower. They are not concerned with short termism, polls, or quarterly GDP figures. They are concerned about building a productive capacity, and becoming the economic engine of the globe. 600 years ago China was the largest economy in the world under the Ming Dynasty. There's no reason why it can't be again. The other Asian giant, India, may well suffer from their larger public sector debt than other countries in the region. For all India's progress, there are still great issues there, whether it is their poor infrastructure (bad roads, frequent power cuts) or the caste system, I still see great potential but it will be limited by these factors.

Nations similar to the UK and US, who have used up most of their natural resources, are running huge deficits, have lost all thrift and have lived on a mirage of debt and cheap goods will be the slowest to recover. Many Western Countries belong in this category. Countries like Italy and Greece, with greater life expectancy, will suffer even worse fates as their vast public sector debt will no doubt drown out any possible recovery. Nations such as Germany may well be hampered by nations such as these as they try to hold the Euro together.

After the fall of the Roman empire, European culture went backwards not forwards. It slipped into what is now known as the dark ages, as the Islamic nations along with the Orient, became the cultural centers of the world, producing goods that fascinated the outmoded Europeans. It wasn't until the fourteenth century that the Renaissance began in Europe, with cities such as Florence and Venice importing goods and ideas from the Orient and the Middle East. The conquests of the Islamic Moors on the Southern Iberian Peninsula further dispensed wisdom and knowledge that spread slowly throughout Europe. The Occident, or what we now refer to as the West, began a long transformation, increasing their material wealth and ideas. Once again, Eurasia finds itself in what seems like a similar junction. Ideas, knowledge and culture are flowing in the reverse, from West to East. In the past it took centuries. This process may well take decades, as technology has increased the ease and speed at which ideas can be spread. The race to the bottom has begun, but who will be the first to resume the race to the top when the recovery arrives?

To fight and conquer in all your battles is not supreme excellence; supreme excellence consists in breaking the enemy's resistance without fighting.
Sun Tzu, The Art of War

By nature, men are nearly alike; by practice, they get to be wide apart.
Confucius, The Confucian Analects