“Where are they going to go?” asks one McCain adviser

Complacency triumphant:

The pollsters for John McCain’s campaign sent out a memo challenging the findings of a poll conducted by the Los Angeles Times and Bloomberg. Hundreds of polls are released during a typical campaign without such a public objection. One finding in particular caught their attention. According to the L.A. Times, 22 percent of those surveyed identified themselves as Republicans, 39 percent as Democrats, and 27 percent as independents. The party identification in this poll, argued McCain’s pollsters, “is greatly out of line with what most other surveys are reporting.”

They’re right. And that fact probably helps explain why the L.A. Times/Bloomberg poll has Barack Obama beating John McCain by 15 points (in a field including Nader and Barr)–a much larger margin than most other respected polls. (The Gallup daily tracking poll, the McCain campaign eagerly points out, has McCain down just 3 points.)

McCain’s pollsters point to the findings of other surveys on party identification. That they would do this suggests just how damaged the Republican party brand is heading into the 2008 general election. Although the L.A. Times/Bloomberg poll shows a larger gap between Democrats and Republicans than all others–+17 for Democrats–the news for Republicans is uniformly bad.

Among the numbers the McCain campaign highlighted: AP/Ipsos’s +14 for Democrats; CBS News/New York Times’s +14 for Democrats; and Democracy Corps’s +12 for Democrats. The average advantage for Democrats in the ten surveys the McCain campaign cited was 9.3 points. So Republicans are clearly at a significant disadvantage.

The conventional wisdom, adopted and internalized by many on the McCain campaign, is that McCain must move to the center to appeal to independents. So that’s largely what he’s done. Immediately after McCain became the de facto nominee, he toured the country touting his biography. Shortly after that he spent a week on a trip informally dubbed the “Places Republicans Don’t Go” tour. Not long afterwards, he traveled to Washington and Oregon talking about global warming. He has launched radio ads explicitly targeting Hispanics and last month held secret meetings with Hispanic and gay leaders. Twice in recent weeks, McCain has participated in virtual town halls targeting disaffected Democrats and moderates.

[...]

“Where are they going to go?” asks one McCain adviser, expressing a sentiment I’ve heard from several others.

One possibility: nowhere. Unmotivated by a candidate who would rather talk about global warming than gay marriage, conservatives might simply stay home. This lack of enthusiasm for McCain among conservatives was evident in the Washington Post/ABC News poll taken in mid-June. Ninety-one percent of those who identified themselves as Obama supporters say they are “enthusiastic” about their candidate; 54 percent say they are “very enthusiastic.” Seventy-three percent of self-identified McCain supporters say they are “enthusiastic” about his candidacy; but only 17 percent say they are “very enthusiastic.” More ominous, while almost half of the liberals surveyed are enthusiastic about Obama, only 13 percent of conservatives are enthusiastic about McCain.

Republican pollster David Winston believes that McCain can close this enthusiasm gap by campaigning on issues where there are sharp differences between the candidates. “We are still a center-right country,” says Winston. “And voters will still prefer a center-right candidate to a liberal one.” …

All surveys are showing declining Republican affiliation over their time series. Whether it’s Dems +8 or Dems +15, Republican party ID has collapsed over the past 12 months.

At this point in the horse race, the guy arguing against the data trends is the guy who’s losing.

Oil prices aren’t going anywhere until Asian economies stop subsidizing oil consumption, which incidentally would cripple the Asian export advantage by forcing businesses to pay the full cost of energy. Therefore, inflation-driven discontent against the incumbent administration won’t subside in the near term.

US regulators drive more speculation offshore

Limits Put on Some Oil Contracts On ICE Amid Outcry Over Prices
By IAN TALLEY
June 17, 2008

WASHINGTON — The U.S. commodity futures regulator Tuesday said ICE
Futures Europe has agreed to make permanent position and
accountability limits for some of its U.S.-traded crude contracts,
subjecting itself to the same regulatory oversight as its New York
based counterpart.

Following intense scrutiny and censure by Congress over skyrocketing
oil prices, the U.S. Commodity Futures Trading Commission also said it
would require daily large trader reports, and similar position and
accountability limits from other foreign exchanges.

Many in Congress have criticized the agency for not doing enough to
rein in what they believe is rampant speculation contributing to
record energy prices and have pointed the finger in particular at
trading on IntercontinentalExchange’s ICE Futures Europe.

ICE and other foreign exchanges have been exempt from the many of the
rules that govern the New York Mercantile Exchange, which critics
charge has attracted a host of financial investors intent on pushing
prices higher. The new agreement, made in consultation with the U.K.’s
Financial Services Authority, will subject ICE to the same oversight
as Nymex.

“This combination of enhanced information data and additional market
controls will help the CFTC in its surveillance of its regulated
domestic exchanges,” while preserving the integrity of its
cross-border cooperation with other regulators, acting CFTC Chairman
Walter Lukken said in prepared testimony.

“We have not found a smoking gun… [but] we’re definitely taking
constructive steps to make sure the markets are working correctly, to
make sure there is not excessive speculation driving the markets,” Mr.
Lukken said.

Specifically, the agreement will require trader reports on positions
in the benchmark U.S. crude contract — the West Texas Intermediate
contract — traded on the ICE Futures exchange. The contract is linked
to the WTI contract on the regulated New York Mercantile Exchange.

ICE has 120 days to implement the new reporting requirements.

On the Nymex, where the majority of oil futures are traded, most
traders face accountability levels and position limits on their
positions in crude oil and other commodities. Accountability levels
are guidelines for trading in all futures contracts, while position
limits are hard-and-fast caps on the number of front-month contracts a
trader may hold in the last three days before the contract expires.

Traditionally, the U.K.’s FSA has had informal accountability levels
of 10,000 contracts in West Texas Intermediate crude, but no position
limits, an ICE spokeswoman said. The new CFTC rules will make ICE oil
trading consistent with practices on Nymex: a 3,000 contract position
limit in the last three days of trading, and a 20,000-contract
accountability level.

Lukken said the same oversight requirements would apply to the Dubai
Mercantile Exchange if it were to also offer the WTI contract.

The Nymex and DME have been mulling offering such a contract and will
decide in the next few months, said Nymex chief executive James
Newsome.

ICE Warns Oversight Won’t Lower Prices

The CFTC will incorporate the ICE data into its commitment of traders
report, a weekly report categorizing positions held by speculators and
companies that use futures contract to hedge against operations in the
physical energy market.

ICE said it would comply with the new regulations but warned tighter
oversight won’t lower oil prices.

“With a mere 15% market share of global WTI, on a futures equivalent
basis, we feel it is highly unlikely that the ICE Futures Europe’s WTI
market is the primary driver of WTI prices,” Charles Vice, ICE
president, told a special Senate committee exploring exploring
oversight and resources for the CFTC.

“Therefore, any expectation that WTI crude oil prices will fall as a
result of increased restrictions on this relatively small portion of
that market are likely to go unmet,” he said.

Jennifer Gordon, an analyst at Deutsche Bank in New York said the
greater regulatory oversight was driving volatility and leading to
less liquidity in the oil markets. “So whatever the CFTC is doing, it
is certainly scaring away the marginal player,” she said. Ms. Gordon
noted that the CFTC move was “adding to the bearish tone on crude,” in
Tuesday trading.

Oil prices climbed within shouting distance of $140 a barrel on Monday
before slipping towards $134.03 on Tuesday, down 58 cents. Prices are
still up about 40% so far this year.

The CFTC action follows rebuke by Congress, which has ratcheted up its
efforts to regulate oil-markets trading. Several of the most powerful
U.S. senators and representatives have introduced proposals that would
give more money and power to the agency.

In the past several weeks, the CFTC has announced a raft of
investigations and new initiatives targeting speculation, the role of
financial participants in current prices and the potential for market
manipulation. Mr. Lukken said the agency couldn’t rule out that market
manipulation was going on in the commodity markets.

The agency disclosed in late May that it is conducting a broad
investigation into practices surrounding the purchase, transportation,
storage and trading of crude oil and related derivative contracts.

Mr. Lukken said the agency was studying the impact of swaps deals and
index trading in the commodity markets and would report back to
Congress by Sept. 15.

The agency said the massive increase in commodity trading, the growing
complexity of the market and an aging CFTC workforce meant that it was
just about able to maintain a business status quo.

“This agency’s lack of funding over the course of many years has had a
negative impact on our staffing situation, rendering it unsustainable
for the long run,” Mr. Lukken said.

“Given our staffing numbers, the agency is working beyond its steady
state capacity and is unable to sustain the current situation for much
longer without being forced to make…choices about which critical
projects should be completed and which ones will be delayed,” the
acting chairman said in his testimony.

The agency is now requesting a 20% rise in its funding for the next
fiscal year to $157 million, from $130 million previously requested.

Same script, different day: the Asian Financial Crisis of 2008?

From Times Online

June 13, 2008

Vietnam on brink of Thai baht-style currency crisis of 1997

Rhys Blakely, Bombay

Vietnam, until recently a poster child among emerging economies, is on the brink of a currency collapse, which would mirror the rout of the Thai baht that sparked the Asian crisis in 1997.

This week the State Bank of Vietnam effectively devalued the dong 2 per cent against the dollar, a move that analysts said was designed to head off a speculative attack on the embattled currency.

The move highlighted concerns that Vietnam, where consumer price inflation is running at more than 25 per cent, is poised to suffer an exodus of foreign-controlled capital.

The nation’s benchmark equities index has lost 60 per cent of its value since January, making it the world’s worst performing stock market. Vietnam’s trade deficit for the year to May, at $14.4 billion (£7.4 billion), exceeds the $12.4 billion shortfall for 2007.

Claire Innes, at Global Insight, said: “The weakening of the currency is principally aimed at preventing speculative attacks.”

Matthew Hildebrandt, an economist at JP Morgan, said the move “will embolden the view that Vietnam is on the verge of a [balance of payments] crisis and larger devaluation.”

On the streets of Vietnam’s cities, there has been growing disquiet over the fate of the dong. Vietnam’s black-market currency exchange rate has reportedly jumped to a record high of more than 18,000 dong to the dollar - above last week’s official rate of 16,268.

Sherman Chan, at Moody’s economy.com, said: “A sense of déja vu and fears of sky-rocketing inflation are causing individuals and merchants to hoard rice, cement and steel, a return to old habits formed back when annual inflation exceeded 60 per cent.”

She added that inflationary pressures has prompted a stampede into gold: “The price of gold has tended to be a reliable proxy for the public’s assessment of the Government’s ability to stabilize the economy. Gold’s price in recent months underscores their stunning lack of confidence.”

The situation underscores the sharp reversal of sentiment over the Vietnamese economy, which, until last year, was among the fastest growing in Asia. In March 2007, the combined value of stocks on the Ho Chi Minh City and Hanoi stock exchanges stood at about $29 billion – up from less than $1 billion in 2005.

Economists say that a recent suggestion by the Vietnamese Government that it does not have sufficient foreign reserves to fend off an attack from speculators, who may bet on the dong suffering a sudden and sharp drop, was ill-timed.

Ms Chan said: “The bitter lessons of the Thais and Indonesians in 1997 are clear: even $22 billion can be used up very quickly when the currency is under heavy pressure from determined and well-financed speculators.

“The only way to regain credibility is by employing serious tools to attack the roots of the problem, which are an overheating economy and excessive inflation.”

She added: “To prevent a currency and balance of payments crisis, it is necessary that the Government take a tough tightening stance. This could dampen growth in the near term but the benefits outweigh the downside, as it would take an extended period for an economy to recover from a major crisis.”

Counting inflation

======================================================================
country; nominal interest rate; date; official CPI; last update; real interest rate
======================================================================
China 7.47% 06/13/08 7.70% 05/31/08 -0.23%
Hong Kong 3.50% 06/13/08 5.40% 04/30/08 -1.90%
India 8.00% 06/11/08 8.75% 05/31/08 -0.75%
Indonesia 8.50% 06/13/08 10.38% 05/31/08 -1.88%
Japan 0.50% 06/13/08 0.80% 04/30/08 -0.30%
Malaysia 3.50% 06/12/08 3.00% 04/30/08 0.50%
Pakistan 12.00% 05/23/08 19.27% 05/31/08 -7.27%
Philippines 5.25% 06/05/08 9.60% 05/31/08 -4.35%
South Korea 5.00% 06/30/08 4.88% 05/31/08 0.12%

Sri Lanka 10.50% 06/06/08 26.20% 05/31/08 -15.70%
Taiwan 3.50% 03/28/08 3.71% 05/31/08 -0.21%
Thailand 3.25% 05/21/08 7.60% 05/31/08 -4.35%
Vietnam 14.00% 06/11/08 25.20% 05/31/08 -11.20%
==============================

========================================

Quote of the day

on today’s seismic Treasury selloff:

“The point is that the world was long Treasury, and we can see how they’ve been suckered.”

In other news, more insanity from the federales, who think they can permanently reduce commodities prices by shoving out leveraged players.

Huh?

Didn’t get this memo. No sir.

Fetch your tin helmets once again. The European Central Bank is opting for a monetary purge. So too is the US Federal Reserve, now ruled from Dallas.

Über-hawks and Cromwellians have gained the upper hand at the great fortress banks. Whether or not they admit it, both are embarked on policies that must lead to retrenchment across the Atlantic world.

The City mood turned wicked as the full import of this policy switch sank in last week. On Wall Street, the Dow’s 396-point dive on high volume late Friday had an ugly feel.

“There is now the distinct possibility of a simultaneous sell-off in global bonds, equities and commodities,” said Jonathan Wilmot from Credit Suisse.

I dunno. I saw Lehman almost die again, and we all knew that the Fed was ready to fire a paper fusillade in the hole.

Trichet’s hawkishness is not in doubt. Bernanke’s is. Spain and Ireland do not a dovish majority make.

Bernanke’s hawkishness is in doubt.

Establishment-liberal bankruptcy

Thomas Palley, Open Society Institute pontificator emeritus cum DC-cocktail laude, mocks himself best when he’s most honest. As do most political people.

Defending the Bernanke Fed

Filed under: U.S. Policy, Uncategorized — Administrator @ 6:37 am

Federal Reserve Chairman Ben Bernanke has recently been on the receiving end of significant criticism for recent monetary policy. One critique can be labeled the American conservative critique, and is associated with the Wall Street Journal. The other can be termed the European critique, and is associated with prominent European Economist and Financial Times contributor, Willem Buiter.

Brought up on the intellectual ideas of Milton Friedman, American conservatives view inflation as the greatest economic threat and believe control of inflation should be the Fed’s primary job. In their eyes the Bernanke Fed has dangerously ignored emerging inflation dangers, and that policy failure risks a return to the disruptive stagflation of the 1970s.

Both argue the Fed has engaged in excessive monetary easing, cutting interest rates too much and ignoring the perils of inflation. Their criticisms raise core questions about the conduct of policy that warrant a response.

At least he didn’t call us “liquidationists.” Generous.

Rather than cutting interest rates as steeply as the Fed has, American conservatives maintain the proper way to address the financial crisis triggered by the deflating house price bubble is to re-capitalize the financial system.

Correct.

This explains the efforts of Treasury Secretary Paulson to reach out to foreign investors in places like Abu Dhabi. The logic is that foreign investors are sitting on mountains of liquidity, and they can therefore re-capitalize the system without recourse to lower interest rates that supposedly risk a return of ‘70’s style inflation.

“Supposedly.“

The European critique of the Fed is slightly different, and is that the Fed has gone about responding to the financial crisis in the wrong way. The European view is that the crisis constitutes a massive liquidity crisis, and as such the Fed should have responded by making liquidity available without lowering rates. That is the course European Central Bank has taken, holding the line on its policy interest rate but making massive quantities of liquidity available to Euro zone banks.

In other words, the Buiter critique advocates one set of interest rates for banks, and a very different one for individuals, without regard to respective credit risk. Presumably, there would be no arbitrage between these two bifurcated markets. Presumably, liquidity provisions to other banks–”inflation by other means”–would both 1) save the banks, and 2) not institutionalize higher prices on the tabs of the people who didn’t take the stupid risks.

Never made much sense to me either. [I used to like Buiter because he was the only person who trashed Bernanke way back in the day. Unfortunately his "lender of last resort" bailout loophole was an unforgivable leap of illogic, and while formally very different from the Bank of Japan's disastrous early-1990's bailout, was functionally indistinguishable.]

According to the European critique the Fed should have done the same. Thus, the Fed’s new Term Securities Lending Facility that makes liquidity available to investment banks was the right move. However, there was no need for the accompanying sharp interest rate reductions given the inflation outlook. By lowering rates, the European view asserts the Fed has raised the risks of a return of significantly higher persistent inflation. Additionally, lowering rates in the current setting has damaged the Fed’s anti-inflation credibility and aggravated moral hazard in investing practices.

The problem with the American conservative critique is that inflation today is not what it used to be.

It’s different this time.

1970s inflation was rooted in a price - wage spiral in which price increases were matched by nominal wage increases. However, that spiral mechanism no longer exists because workers lack the power to protect themselves. The combination of globalization, the erosion of job security, and the evisceration of unions means that workers are unable to force matching wage increases.

DC establishment liberal: “Inflation is okay now, because workers have to eat all costs themselves.” As if workers will just sit back and take this? As if they can’t read these internet posts, which presume weakness, ignorance and stupidity on the part of American workers?

The problem with the European critique is it over-looks the scale of the demand shock the U.S. economy has received. Moreover, that demand shock is on-going. Falling house prices and the souring of hundreds of billions of dollars of mortgages has caused the financial crisis. However, in addition, falling house prices have wiped out hundreds of billions of household wealth. That in turn is weakening demand as consumer spending slows in response to lower household wealth.

Different. This. Time.

Countering this negative demand shock is the principal rationale for the Fed’s decision to lower interest rates. Whereas Europe has been impacted by the financial crisis, it has not experienced an equivalent demand shock. That explains the difference in policy responses between the Fed and the European Central Bank, and it explains why the European critique is off mark.

The bottom line is that current criticism of the Bernanke Fed is unjustified. Whereas the Fed was slow to respond to the crisis as it began unfolding in the summer of 2007, it has now caught up and the stance of policy seems right. Liquidity has been made available to the financial system. Low interest rates are countering the demand shock. And the Fed has signaled its awareness of inflationary dangers by speaking to the problem of exchange rates and indicating it may hold off from further rate cuts. The only failing is that is that the Fed has not been imaginative or daring enough in its engagement with financial regulatory reform.

Copyright Thomas I. Palley

The bottom line is, DC policy emerati are profoundly ignorant, sycophantic, and irresponsible people.

The Mofaz meme

There were about five pieces of news on Friday that delivered such a massive upside kick to oil.

1) Chinese oil consumption numbers came in much higher than expected.

Wall Street is still being blindsided by the impact of the Sichuan earthquake, and apparently most of it is ignorant that ~30 percent of Chinese oil/ natgas/ heating oil comes from Sichuan and Gansu (which was also thrown into chaos by the quake).

2) Shaul Mofaz rattled Kadima’s flimsy sabre at Iran, again. Anyone who took that seriously is ill-informed.

3) The dollar continued hemorrhaging. Brokers are cutting back trading with Lehman Brothers, and Bernanke will probably be called out on his fateful March 17 nationalization of banks’ default risk. He will have to throw hundreds of billions of dollars in Treasuries at Lehman’s crippled balance sheet, further debasing Treasuries specifically and US financial credibility generally.

4) Morgan Stanley said oil would go to $150.

5) The USD and EUR are both heavily overvalued. As long as China keeps its currency peg alive, the dollar and euro will both be overvalued. The only other large currency alternative is commodities, so that’s where money is going.

As I have said many times, government witch hunts against “speculators” never signal the top of a bull market.

Israel’s saber-rattling might have been good for 1 percent of oil’s gain. Obama’s triumph in the US presidential primaries multiplied that, for a total of maybe 3 percent.

In the meantime, Asia’s cracking currency regimes are effectively increasing their subsidies of fuel.

HONG KONG: Buckling under the weight of record oil prices, several Asian countries have cut or are thinking of cutting their fuel subsidies, which raises a pressing question for Beijing: Can China afford its own oil subsidies at a time when it is spending billions on post-earthquake reconstruction?

The short answer is yes, because China is blessed with both large trade account and fiscal surpluses. The reconstruction cost is projected to amount to about 1 percent of China’s gross domestic product, while the fuel subsidies account for another 1 percent, JPMorgan estimates.

Remember that China had a fiscal surplus of 0.7 percent of gross domestic product last year, or $174 billion. So even if spending on post-earthquake rebuilding and fuel subsidies were to cause a 1 percent fiscal deficit, that would still be very manageable.

But here is a more important question: Why should China keep domestic fuel prices at about half of the global average?

The usual answers are to keep inflation in check and stave off social instability that could result if prices were to rise too quickly.

But by distorting fuel prices, China is encouraging fuel consumption and discouraging the use of new energy. Since the Chinese still live in an $80-a-barrel oil environment, demand for anything from cars to chemical products will spiral higher and raise the risks of economic overheating.

Increasing subsidies on fuel will crowd out more investment in other areas, such as education or health care, to name two possibilities.

What’s more, a worsening fiscal situation might put downward pressure on the yuan. Fuel subsidies have exaggerated inflation in the developed world, while understating inflation in the developing world. China’s inflation could well hit 15 percent if Beijing were to free up caps on energy prices, Morgan Stanley estimates.

“If China is not able to take away the subsidy and cut down its demand, it will have huge implications for the world,” said Shikha Jha, a senior economist at Asian Development Bank.

Countries like China and India, along with Gulf nations whose retail oil prices are kept below global prices, contributed 61 percent of the increase in global consumption of crude oil from 2000 to 2006, according to JPMorgan.

Other than Japan, Hong Kong, Singapore and South Korea, most Asian nations subsidize domestic fuel prices. The more countries subsidize them, the less likely high oil prices will have any affect in reducing overall demand, forcing governments in weaker financial situations to surrender first and stop their subsidies.

That is what happened over the past two weeks. Indonesia, Taiwan, Sri Lanka, Bangladesh, India and Malaysia have either raised regulated fuel prices or pledged that they will.

Actions taken by those countries will not be able to tame a rally in prices though unless China, the second-largest oil user in the world, changes its policy. While the West is critical of China’s energy policy, there is little outcry for change within the country, except for complaints from two loss-making refineries.

By contrast, Indonesia has convinced its people that fuel subsidies benefit the rich more than the poor, because rich people drive more and consume more electricity. Jakarta rolled out a $1.5 billion cash subsidy program to help low-income Indonesians cope with higher prices. Although no country wants to build a system on subsidies, the cash subsidy at least makes fuel subsidy cuts politically feasible.

“The people need to wonder, who pays for the subsidies?” said Louis Vincent Gave, chief executive of GaveKal, a research and asset management company. “Most Asian countries are printing money to pay for them.”

Fuel subsidies compromise countries’ ability to control their own budget spending. If China and India can cut their subsidies, they would be able to spend more on infrastructure and education.

While Asian governments dole out cheap food and cheap energy, Asian currencies settle the bill. Morgan Stanley expects some emerging market currencies to face downward pressure, probably for the first time in a decade, as those countries unwind their fuel subsidies and domestic inflation shoots up.

China’s domestic fuel prices are among the lowest in the world, equal to about 61 percent of prices in the United States, 41 percent of Japan and 28 percent of England. The longer it waits, the more painful it will be when it tries to remove the subsidy.

China actually doesn’t have much freedom to splash dollars for fuel. Its entire macroeconomic policy can be summarized as “long USD, short RMB.” Not a good trade.

Apologies

for the lack of posting recently.

I have been extremely busy, but things should lighten up by Saturday or Sunday.

Iceland, under siege

via

May 30 (Bloomberg) — Iceland’s lawmakers passed a bill allowing the central bank to sell as much as 500 billion kronur ($6.76 billion) of foreign-currency bonds, equivalent to more than a third of the country’s gross domestic product.

The bill was passed late yesterday, Thorsteinn Thorgeirsson, chief economist at the Finance Ministry in Reykjavik, said in a telephone interview. The move would allow the central bank to more than triple foreign reserves.

The bank needs to restore confidence in an economy whose currency slumped 20 percent against the euro this year on concern commercial banks may have expanded abroad too fast. The assets of Iceland’s three biggest banks were nine times the size of the economy last year. Kaupthing Bank hf, the biggest of the three, had 87 percent of its assets denominated in foreign currencies.

“This definitely helps to boost confidence in the economy,” said Bjarke Roed-Frederiksen, an economist at Nordea Bank AB in Copenhagen, the biggest Nordic lender. “But it’ll be an expensive loan, if they decide to act on it.”

The krona gained for the first day in four, rising 0.3 percent to trade at 115.4969 against the euro as of 12:16 p.m. in Reykjavik.

“The central bank will probably take advantage of the bill,” said Ingolfur Bender, head of economic research at Glitnir Bank hf in Reykjavik. “That’s what the government wants them to do and that’s what they will do.”

An official at the central bank, or Sedlabanki, declined to comment.

Currency Slump

The krona has tumbled this year on concern the global credit crunch may force some of the island’s banks, who rely on money- market funding to run their operations, to turn to the central bank for aid. Interest rates at a record high have failed to reverse the slump in the currency, which pushed the inflation rate to an 18-year high of 12.3 percent this month.

The central bank on May 22 kept the benchmark rate unchanged at a record 15.5 percent, indicating policy makers may prefer to boost foreign reserves to support the currency rather than raise rates further.

“I know the central bank is working quite hard on it right now; they’re on a roadshow talking to possible investors in London today and yesterday,” Bender said. “I definitely expect them to announce something within the next couple of weeks.”

The bank on May 16 entered an agreement with its Norwegian, Swedish and Danish counterparts to swap kronur for as much as 1.5 billion euros, allowing it to almost double its foreign reserves.

Reserves

“It’s clear that this move, and the swap agreement, are more significant at the moment than changes in the interest rate in supporting the krona,” Roed-Frederiksen said.

Currency reserves stood at 206.8 billion kronur at the end of April, the bank said on May 8. That compares with combined assets of 11.4 trillion kronur at Kaupthing, Landsbanki Islands hf and Glitnir Bank hf at the end of last year. Including the value of the swap agreement entered earlier this month and the debt sale approved today, reserves could rise as high as 880 billion kronur at today’s exchange rates.

Moody’s Investors Service cut Iceland’s credit rating on May 20 to Aa1 from Aaa citing concern that the government may have to cover liabilities at the nation’s banks.

Iran: “US voters want policy change”

As noted here time and again, Iran has nothing to lose by waiting out the end of George Bush’s term.

May 29, 2008 | 1944 GMT

Iranian Foreign Minister Manouchehr Mottaki said May 29 that Iran thinks U.S. voters want to change the foreign policies of President George W. Bush, and he said that the present U.S. presidential campaigns make that clear, The Associated Press reported. Mottaki, who would not endorse a candidate, said that foreign policy would play an important part in the election of the next U.S. president.

Iran could not have had a better March-May. A rumored Israeli Gaza offensive, against Iran’s proxy Hamas, failed to materialize. Hezbollah, staked by Iran, was forced to go all-in in Lebanon, won, and has returned to a defensive crouch.

Mottaki’s announcement is a signal to Ahmadinejad’s domestic foes that Iraq is worth waiting for for a little while longer. He happens to be right.

US econo-political analysis is divided into two camps. The “mainstream” camp sees US growth figures as credible, and takes at face value the idea that the US, by sheer economic vitality, has avoided a recession. This school views US inflation as temporary. It views 10/90 “right track/wrong track” numbers as merely a dubious poll, a product of stampeding pessimism, spawned by the media’s sensationalizing of US malaise. This group has faith in government and banking institutions, and little faith in consumers’ ability to assess or predict their own behavior. Curiously, this group is also disproportionately Republican and “free-market.” It does not see much potential for an economic- or inflation-driven political upheaval in November 2008.

The “cynics,” e.g., Bill Gross, Mish Shedlock, and John Williams, trust consumers’ perceptions over the government’s. Cynics argue that consumers are telling the truth when they say how pessimistic they are, and trace the dissonance between official and consumer perceptions to vagaries of BLS unemployment and inflation accounting–a story flogged to death here, and much more persuasively on other sites.

The cynics see much higher potential for political upheaval in November 2008.

Apparently, so does Iran.

Bush Administration policy vis-a-vis Iran/Iraq usually means dialing up tensions over Iranian nukes and weapons supplies into Iraq, bringing up aircraft carriers, launching large operations against Iran’s Mehdi Army Iraqi proxy, slapping sanctions on Iranian banks, using its own militias to incinerate strategic people inside Iran, etc.

After Hezbollah routed the US alliance in Lebanon (followed by an abrupt end to the US/Iraqi crackdown on Sadr in Baghdad) one would assume that the Bush Administration policy of “we’d like to talk, but we’re happy to pull the trigger too” attitude has lost credibility. Iran is quietly leveraging its gains by edging the US out of Iraq:

May 29, 2008 1419 GMT
Senior Iraqi official Sa’ad Javad Qandil told Alalam television May 29 that a draft of an agreement to extend U.S. troops in Iraq beyond 2008 was problematic, especially any condition that would allow the U.S. to establish a military base there.

Predictably, Qandil is a member of the Islamic Supreme Council of Iraq, Teheran’s “mainstream” Iraq proxy (the Mehdi Army is, most of the time, its militant proxy). Hezbollah’s unanswered victory in Lebanon has ramifications across the entire region, not so much in the eyes of Americans as in the eyes of Arabs who were reminded, once again, that the personal bonds between Ahmadinejad and militia leaders can result in very quick and decisive action when Teheran’s interest are threatened.

Anyway, Iran hasn’t been deterred by US tough talk in the past, and there’s less reason than ever to think that louder tough talk will change Iran’s behavior at all. Lebanon has changed the game.

I would repeat my “sh*t or get off the pot” mantra about the US and Iran, but the US has backed down one too many times. I’m beginning to believe we should throw the Saudis the keys as soon as possible, to hedge against a probably adverse US election outcome while it’s still possible.

Chinese reserves

Setser on the PBOC:

What cann’t go on still hasn’t slowed, let alone stopped (Chinese reserve growth)

… Back in 2004, it was considered rather stunning when China added close to $100 billion to its reserves ($95 billion) in a single quarter, bring its total reserves up to around $600 billion.. The dollar’s fall against the euro (and associated rise in the dollar value of China’s euros) explains around $15 billion of the rise. But at the time, $80 billion was considered a very large sum for China to have added to its reserves.

Now China has $1756 billion in reserves, after a $74.5 billion April increase. The dollar rose against the euro in April, so the underlying pace of increase – after adjusting for valuation changes – was more like $82 billion.

In a month.

And not just any month – in a month when oil topped $100 a barrel.

$82 billion a month, sustained over a year, is close to a trillion dollars. A trillion here, a trillion there and pretty soon you are talking about real money. If a large share of China’s reserves is going into dollars, as seems likely, this year’s increase in China’s dollar holdings could be almost as large as the US current account deficit.

The fact that one country’s government – and in effect two institutions (SAFE and the CIC) – are providing such a large share of the financing the US needs to sustain large deficits (particularly in a world where Americans want to invest abroad as well as import far more than they export) is unprecedented.

The real surprise in some sense is that the increase in China’s April preserves isn’t that much of a surprise. At least not to those who have been watching China closely.

Wang Tao – now of UBS – estimated that China added $600 billion to its foreign assets in 2007, far more than the reported increase in China’s reserves. Logan Wright (as reported by Michael Pettis) and I concluded that Chinese foreign asset growth – counting funds shifted to the CIC – could have topped $200 billion in the first quarter.

China hasn’t disclosed how much it shifted to the CIC, let alone when it shifted funds over to the CIC. But it seems likely that the surprisingly low increase in China’s reserves in March stems from a large purchase of foreign exchange by the CIC. Indeed, the CIC’s March purchase may have used up all of the RMB 1.55 trillion the CIC initially raised.

As a result, all of the increase in the foreign assets of China’s government seems to have showed up at the PBoC in April. Or almost all. China raised its reserves requirement in April, and the banks may have been encouraged to meet that reserve requirement by holding foreign exchange.

China’s current account surplus – adding estimated interest income to its trade surplus – was no more than $25 billion in April. FDI inflows were around $7.5 billion. Sum it up and it is a lot closer to $30 billion than $40 billion. Non-FDI capital inflows – hot money – explain the majority of the increase.

No wonder Chinese policy makers were so focused on hot money this spring. Hot money flows seem to have contributed to their decision to stop the RMB’s appreciation in April. But interest rate differentials still favor China – so it isn’t clear that a slower pace of appreciation will stem the inflows.

It certainly though helps to sustain the underlying imbalance that has given rise to massive bets on China’s currency.

The scale of China’s reserve growth suggests that China’s government is no longer just lending the US what it needs to buy Chinese goods. And it is now lending the US – and indeed the world – far more than the world needs to buy Chinese goods. Vendor financing is a fair description for China’s reserve growth in 2003 or 2004, but not now.

China’s government is increasingly acting as an international as well as a domestic financial intermediary. It has long borrowed — whether through the sale of PBoC bills of Finance Ministry bonds to fund the CIC – rmb to buy dollars, effectively taking the foreign currency domestic Chinese savers do not want to take. Now though it is borrowing from the rest of the world to lend to the rest of the world.

Most intermediaries though make money. Or at least try to. By contrast, China’s government is almost sure to lose money on its external financial intermediation. Selling RMB cheap to buy expensive dollars and euros is not a good business model.

China cannot be entirely comfortable with all the money that is pouring into China. But it isn’t at all clear that Chinese policy makers are willing to take the steps needed to shift decisively toward a new set of policies. It is clear that the costs of China’s current policies are rising.

Remember, China looses [sic] money on its reserves. More isn’t better.

NYT front page slobbers all over BS Bernanke

“With Bold Steps, Fed Chief Quiets Some Criticism”:

[...]

“It has been a really head-spinning range of unprecedented and bold actions,” said Charles W. Calomiris, professor of finance and economics at Columbia Business School, referring to the Fed’s lending activities. “That is exactly as it should be. But I’m not saying that it’s without some cost and without some risk.”

[As yours truly noted back in November, Charles Calomiris wrote a verbose and obtuse article for VoxEU which proclaimed that there was no credit crisis -- a restatement of his August claim that there was no credit crisis. I guess that makes him almost as good a forecaster as Bernanke is. ]

Timothy F. Geithner, president of the Federal Reserve Bank of New York, and a close Bernanke ally, defines the Fed chief’s “doctrine” as the overpowering use of monetary policies and lending to avert an economic collapse. “Ben has, in very consequential ways, altered the framework for how central banks operate in crises,” he said. “Some will criticize it and some will praise it, and it will certainly be examined for decades.”

Mr. Bernanke’s actions have transformed his image as a self-effacing former economics professor.

“I am tempted to think of him as somewhat Buddha-like,” said Richard W. Fisher, president of the Dallas Federal Reserve Bank. “He’s developed a serenity based on a growing understanding of the hardball ways the system actually works. You can see that it’s no longer an academic or theoretical exercise for him.”

Did he just say “Buddha-like”?

Within the Bush administration, Mr. Bernanke’s willingness to work with Democrats in Congress on measures to prevent mortgage foreclosures has stirred unease. “The fact that he, an appointee of George Bush, has come very close to advocating — though he hasn’t quite advocated it — a piece of legislation that George Bush threatened to veto is an illustration of his willingness to put his head on the chopping block,” said Alan S. Blinder, a professor of economics at Princeton and friend of the Fed chief.

One reason Mr. Bernanke is sticking his neck out is that he believes the broader economy’s recovery depends on the housing sector, which remains in a serious slump. Plenty of new evidence surfaced on Tuesday that this year’s spring home-buying season will be dismal, with one report showing that prices fell 14.1 percent in March from a year earlier and another that new-home sales are down 42 percent over the last year.

Among Democrats, Mr. Bernanke, a Republican, had previously been criticized by such party luminaries as the two former Clinton administration Treasury secretaries, Robert E. Rubin and Lawrence E. Summers, who worried that he was downplaying the dangers of a recession. But that view has changed.

“I think in the last few months they’ve handled themselves very sure-footedly,” Mr. Rubin said of the Fed. Many Democrats in Congress agree.

“They say that crisis makes the man,” said Senator Charles E. Schumer, Democrat of New York and the chairman of the Joint Economic Committee. “He’s made believers out of people who were just not sure about him before.”

To lessen the chances of a financial collapse, Mr. Bernanke engineered the takeover of one investment bank, Bear Stearns, and tossed credit lifelines to others with exotic new lending facilities — the Fed now has seven such lending windows, some of them for investment banks as well as commercial banks.

He also allowed the Fed to accept assets of debatable value — mortgage-backed securities, car loans and credit card debt — as collateral for some Fed loans. For the first time ever, he installed Fed regulators inside investment banks to inspect their books.

Much to the dismay of conservative economists, Mr. Bernanke has also presided over an extraordinarily aggressive series of interest rate cuts, lowering the fed funds rate seven times, to 2 percent from 5.75 percent, since last September, though it has signaled a pause in further rate-cutting barring a further crisis. …

Bernanke and Paulson are the worst thing that’s happened to capitalism since Arthur Burns and Richard Nixon. Carter would have been awful, but conditions were so bad by 1979 that he had to authorize significant deregulation and capital gains tax cuts (from 35% to 28%, from memory) kicking and screaming.

Good news for dollar bears …

Vietnam world’s highest consumer of gold in Q1

via

Using figures compile [sic] by independent research house GFMS Ltd., the council says the consumption of 31.5 tons in the first quarter shows a steep increase of 110% year-on-year and accounting for 43% of the world’s net retail investment demand of 72.2 tons in the period.

Vietnam’s arrival into pole position in the retail investment sector ousts India from the top slot with 31 tons, a decline by half from the first quarter in 2007 as Indian purchasers withdrew from the market and waited for lower and more stable prices.

The report says the surge in Vietnam’s demand was partly a response to soaring inflation, which hit 11.6% in 2007 and prompted a rush to buy gold, reflecting its perceived qualities as a hedge against inflation.

Demand was also spurred by the performance of gold relative to other investments such as equities and real estate, which have declined in value over recent months while gold has strengthened.

Furthermore, gold investments have been increasingly marketed by Vietnamese banks. High interest rates enable local banks to offer an interest rate on gold deposits since they can profitably sell the gold for dong, lend the dong out at high interest rates and hedge their gold position by entering into a forward buying agreement with an international bank.

Many Vietnamese prefer to hold gold rather than dong and the fact that this gold can earn interest from commercial banks makes it still more appealing as for investment option, says the report.

Vietnam’s gold demand for jewellery in the first quarter was 5.3 tons, that is stable from the previous quarter but down by 18.9% on a year-on-year comparison and the high price of gold was the primary reason for the decline.

Gold demand is divided into three purposes, jewellery demand, industrial and dental demand, and identifiable investment, comprising net retail investment (primarily bars and coins) and investment in Exchange Traded Funds and similar products (ETFs), the latter not yet available in Vietnam.

The world’s total gold demand in the first quarter fell 16% from a year earlier to 701.3 tons. Of which, jewellery demand was 445.4 tons, down 21%, industrial and dental demand fell 5% to 110.3 tons, while investment in ETFs was double to 72.9 tons and net retail investment dropped 35% to 72.2 tons.

(Source: SGT)

In some parts of the world, gold consumption and CPI are apparently correlated. Who knew?!

Let’s hope the rest of Asia picks up on the trend.

Cokeflation

“Sometimes anecdotal evidence is the best evidence” …

For decades, the Drug Enforcement Administration has measured the price and purity of illicit drugs. Its methodology is cryptic, but the dea says it’s a reliable way to spot trends.

And it says it has spied one: The cost of pure coke rose 44 percent in the United States between January and September 2007. The dea credits its own efforts, of course, along with increased Mexican and Colombian cooperation, for the downturn in supply it says caused the price hike.

But the agency omits an important factor: the plummeting value of the dollar, especially as compared to the soaring euro. Even as the dea has made it more bothersome to bring coke into the United States, the sliding dollar has made importing it less profitable. Both the UN and dea note that a kilo of coke brings in two times as much in Europe as it does in America.

As with any commodity, producers look to maximize earnings by selling in markets with the strongest currencies. But unlike oil, for instance, the value of which is measured in dollars, the cocaine market is more fluid. “The euro has become the preferred currency for drug traffickers,” declared then-dea administrator Karen Tandy at an anti-drug conference last May. “We’re seeing a glut of euro notes throughout South America,” she said, adding that “9 of 10 travelers who carried the $1.7 billion euros that came into the United States during 2005 did not come from Europe…They came from Latin America.”

Europe has become attractive to traffickers not just because of its healthy economy, but also for its open borders, less stringent drug policies, and increasing demand. American officials estimate that just a few years ago U.S. consumers snorted several times more blow than their Old World counterparts. That gap has dramatically narrowed as Europe feeds a cocaine binge that has been compared to America’s in the ’80s.

This new European focus is changing global drug-supply routes. West African nations have become important staging areas for packages on the way from South America to Spain and Portugal, the region’s main points of entry. The UN estimates that cocaine seizures in Africa increased nearly sixfold between 2005 and 2007 and that more than 90 tons of coke were intercepted in Portugal and Spain in 2006, more than was seized in all of Europe in 2004.

So how does all this affect the end market here at home? “The guy from the suburbs may be paying a little more, but there are no crackheads going without crack,” says Dale Sutherland, a narcotics investigator with the Washington, D.C., police department. That’s likely because increased costs are passed on down to low-level slingers who are more inclined to cut their product with talcum powder than risk being undercut by competitors. Indeed, the dea reported that during the same period when prices rose, there was a 15 percent decline in the purity of coke that officers seized or bought on the street. As they say on The Wire, “All in the game, yo. All in the game.”

The Wire was great, although too many main characters were dead or put away by the end of the third season, and anyway I won’t have the time to watch 4 & 5 for some while. Plus, the gratuitous seediness-to-plot ratio had deteriorated significantly.

It seems like when the cable shows start the ratings slide, they really go all-out on the skin…

Flogging Israel, again

During a somewhat heated argument with some Jewish friends over Israel’s recent backstabbing of the US, a national security hobbyist recommended the following article as a defense of recent Israeli policy. Phrases which jumped out at me are highlighted in bold.

Hizbollah’s Increased Strength: Risks and Opportunities for Israel, INSS Insight No. 57, May 26, 2008
Shalom, Zaki

One tangible aftermath of the Second Lebanon War and the agreement that concluded it is an increase in Hizbollah’s strength. [... ...]

Since the end of the Second Lebanon War, Hizbollah has succeeded in rehabilitating its forces to a great extent. According to various reports, Hizbollah today has tens of thousands of missiles, some of them long range, and is capable of inflicting very serious damaged deep into Israel. Thus, the risks involved in Hizbollah taking control of Lebanon are quite apparent. Less apparent are the pluses that may emerge from this process.

[Hezbollah didn't "rehabilitate" anything. Its victory in 2006 did not even require a full Hezbollah mobilization. 10,000 IDF soldiers were defeated by 3,000 Hezbollah fighters. At most 184 Hezbollah fighters were killed in the war -- much less than the "at least 450" bandied about by Israeli propaganda.]

[...]

… For many years Lebanon has been ruled by moderate, pro-West leaders. This leadership views Hizbollah as a bitter and hostile rival, and it too is interested in clipping the organization’s wings. At the same time, Lebanese leaders are afraid of a confrontation, and in practice allow Hizbollah to operate against Israel in a “bloodletting” effort, while stressing their inability to restrain the organization. When Israel responds against Lebanon, the Lebanese leadership uses its good relations with Western countries, in particular the United States and the moderate Arab countries, to exert pressure on Israel not to harm it.

This phenomenon was evidenced in prominent fashion on July 12, 2006. In a Cabinet discussion held after the serious consequences of that day’s Hizbollah operation became clear, then-Chief of Staff Dan Halutz proposed attacking infrastructure installations in Lebanon, including electric plants, oil refineries, and water sources. His suggestion was supported by a number of ministers. However, the senior political echelon, and in particular the prime minister, defense minister, and minister of foreign affairs, vetoed the idea. The reason: unequivocal clarifications received by Israel that very same day from senior levels in the American administration and the British government to the effect that Israel must refrain from damaging Lebanese targets [1] because this might undermine the stability of the pro-Western government headed by Fouad Siniora. Consequently, the proposal was shelved.

We lack adequate tools to assess whether that proposal, if implemented, would have generated an essentially different outcome from the events of July-August 2006. Nonetheless, it is clear that an American-British veto of this option stemmed from the fact that the official government in Lebanon was pro-Western and enjoyed the support of the United States. The fact that Israel was not able to exercise the option to attack Lebanon represents a significant constraint on Israel’s freedom to maneuver.

Should Hizbollah in fact take control of Lebanon, Israel’s options of maneuvering vis-à-vis Hizbollah are significantly increased. It will become clear to all sides that no international element will get involved to protect Hizbollah from Israeli attacks. Obviously, this does not mean that Israel would necessarily attack Lebanon’s infrastructure should Hizbollah cast down the gauntlet. Beyond international constraints, the Israeli leadership also has to contend with a set of legal and normative, value-based constraints and restrictions that would make it very difficult indeed for Israel to take steps against civilian infrastructure.[2] This has become clear in Israel’s refraining from damaging the electrical and fuel infrastructures of the Gaza Strip under Hamas control. At the same time, there is no doubt that Hizbollah’s taking control of Lebanon would expand Israel’s ability to maneuver vis-à-vis Lebanon in case of another armed conflict, at least from the international perspective.

From Israel’s own perspective, Hizbollah is first and foremost a body representing a military threat against Israel. However, Hizbollah is also a powerful body with economic and financial assets, and an organization with far-reaching political ambitions. Therefore, in any military confrontation with Israel, if Hizbollah holds the reins of leadership it would conclude that there is nothing stopping Israel from severely damaging its assets. The very awareness of this fact, i.e., that there would not be anyone trying to delimit Israel’s scope of action in terms of damaging Lebanon, may cause it to refrain from a confrontation with Israel.

Beyond this, one may speculate that Hizbollah’s taking control of Lebanon will bring about a new awareness on the part of various international elements of the “Iranian threat.” To date, the concerns of the international community regarding Iran have focused on its intention to develop nuclear capabilities. Hizbollah’s taking control of Lebanon would bring the danger inherent in Iran into sharper relief, not only regarding the nuclear question but also vis-à-vis the stability of other pro-Western regimes in the region, chief among them Saudi Arabia, Egypt, and the Gulf states. Such a development might very well match the interests of the State of Israel.

[1] Not only is this immaterial (for reasons which I will soon explain), but it’s also an audacious exaggeration.

Very few people know the exact phrasing of the back-channel US request/ demand/ recommendation/ “directive” on the scope of Israel’s operations. [Since when was Israel a shackled vassal to US/UK politics?] One would think that collateral damage to Lebanon was of secondary importance to winning the war.

More importantly, however, Lebanon 2006 was an Israeli tactical, strategic, intellectual and logistical catastrophe, from top to bottom. Had Hezbollah’s military bandwidth been stretched by the conflict, a Western “veto” of strikes on Hezbollah assets such as power generators, etc., could have borne culpability.

However, Hezbollah’s capabilities were not remotely stretched. Hezbollah didn’t even call up its own reserves!

The US Army has at least one detailed dissection of Israel’s Second Lebanon War, by Matt Matthews of the US Army Combined Arms Center. It could be that politics could have obscured the mention of retrospectively adverse US “directives” in an Army study. That isn’t consistent with Army practice, but I will concede it for the sake of argument.

[2] is long-hand for, “We base our policy on what others think of us, not on what we believe best for our country; and anyway, our culture just doesn’t let us win wars anymore.” “One may speculate” that Israel has completely lost its martial vigor as well as touch with reality. But Nasrallah’s and Ahmadinejad’s vindication is no matter of speculation.

Without further ado, here’s a representative US Army assessment of Lebanon 2006:

[p. 25-26]

… Brigadier General Shimon Naveh’s Systemic Operational Design (SOD) was a tool intended to help IDF commanders plan their campaigns. Naveh founded the IDF’s Operational Theory Research Institute (OTRI) in 1995. After years of work by Naveh and other intellectuals within the OTRI, SOD attempted to provide commanders with the aptitude necessary “to think critically, systemically and methodologically about 25 war fighting.” The design focused “on the concept of the ‘enemy’ and provides operational commanders with tools to conceptualize both their enemies and themselves for the purpose of designing suitable campaigns,” wrote a former OTRI member.38

Canadian Army officer L. Craig Dalton, who interviewed Naveh in 2006, described SOD as an “intellectual exercise that draws on the creative vision, experience, intuition, and judgment of commanders to provide a framework for the development of detailed operational plans.”39 For this new design, Naveh drew heavily on terminology from “post modern French philosophy, literary theory, architecture and psychology.” An IDF general explained SOD in the following way:

This space that you look at, this room that you look at, is nothing but your interpretation of it. Now, you can stretch the boundaries of your interpretation, but not in an unlimited fashion, after all, it must be bound by physics, as it contains buildings and alleys. The question is, how do you interpret the alley? Do you interpret the alley as a place, like every architect and every town planner does, to walk through, or do you interpret the alley as a place forbidden to walk through? This depends only on interpretation. We interpreted the alley as a place forbidden to walk through, and the window as a place forbidden to look through, because a weapon awaits us in the alley, and a booby trap awaits us behind the doors. This is because the enemy interprets space in a traditional, classical manner, and I do not want to obey this interpretation and fall into his trap. Not only do I not want to fall into his traps, I want to surprise him! This is the essence of war. I need to win. I need to emerge from an unexpected place. . . . This is why we opted for the methodology of moving through walls. . . . Like a worm that eats its way forward, emerging at points and then disappearing.40

For the IDF, the major problem with SOD was the new terminology and methodology. Not every officer in the IDF had the time or the inclination to study postmodern French philosophy. It was questionable whether the majority of IDF officers would grasp a design that Naveh proclaimed was “not intended for ordinary mortals.”41 Many IDF officers thought the entire program elitist, while others could not understand why the old system of simple orders and terminology was being replaced by a design that few could understand.42

After several alterations and revisions, the new IDF doctrine was endorsed and signed by the new Chief of the IDF General Staff, Lieutenant-General Dan Halutz, in April 2006. Halutz was the fi rst IAF officer ever appointed Chief of the IDF General Staff. On the first page of the document, Halutz wrote, “Familiarity with and use of the concept of operation are the key to our success in warfare, in which the only option available is victory. Therefore, the commanding offi cers of the IDF must understand, assimilate and implement what is written there when they call their forces into action and prepare them for their goal.”43 It is possible that not even Halutz understood the new doctrine he endorsed and signed. Naveh explained that the “core of this document is the theory of SOD.”

[p. 37]

Halutz convinced Olmert and Peretz that Israel should strike back against Hezbollah and the Lebanese central government with a substantial air campaign. The plan was not designed to directly or fully crush Hezbollah’s capabilities but to produce “effects” that would force Hezbollah out of southern Lebanon and cause them to disarm.14 Halutz proposed an immense air strike against “symbolic” Lebanese targets and Hezbollah’s military resources. The plan also called for targeted strikes against Hezbollah’s military and political leadership. “His idea,” Naveh stated, “was that . . . we hit all these targets [and] Hezbollah will collapse as a military organization. No one really believed that the Lebanese government was in position to really pressure Hezbollah. The idea was that Hezbollah would give up and then everybody would go home happy. Again, the idea was to change something in the equation; to change the conditions by forcing them to become political and abandon the military option.”15 Hezbollah, however, had prepared for an effects-based campaign, and the Lebanese government was too weak and incapable of challenging Hezbollah. There was simply no lever to pull that would cause Hezbollah to crumple.16

While some Israeli politicians and IDF officers were skeptical of Halutz’s campaign plan, he failed to effectively address or present their doubts to Olmert and Peretz. The Winograd Report maintains Halutz did not reveal substantial deficiencies in the ground forces that may well thwart the success of their mission. Furthermore, he did not adequately address the fact that the military’s own assessment indicated ground operations would most likely be warranted.17

The stage was now set to reveal to the world what one Israeli writer described as “a witches brew of high tech fantasies and basic unpreparedness.”18 …

[p. 45]

… A general on Hulutz’s staff told a reporter on 22 July that “The goal is not necessarily to eliminate every Hezbollah rocket. What we must do is disrupt the military logic of Hezbollah. I would say that this is still not a matter of days away.” Many ground commanders were stunned by the remark and questioned the true aims of the war.10

On the same day the IDF reserve forces were called to duty, Israel was forced to request an emergency resupply of precision-guided missiles from the United States. In 10 days, the IAF had used up most of its high-tech munitions, and yet, this huge expenditure of weaponry did little to change Hezbollah’s “military logic” or its fighting capability. Mossad was already gathering information to leak to the press on 28 July, indicating “Hezbollah had not suffered a significant degradation in its military capabilities, and that the organization might be able to carry on the conflict for several months.”11

… Hezbollah Secretary- Undeterred by the failure of the air campaign and stiff Hezbollah resistance, Halutz and his staff continued efforts to secure a “consciousness of victory” and to deliver to Hezbollah a “cognitive perception of defeat.” …General Nasrallah had delivered his well-known victory speech in Bint Jbeil after the 2000 Israeli withdrawal from Lebanon. Halutz asserted that capturing the town would prove symbolic and “create a spectacle of victory.” This “spectacle of victory” was undoubtedly designed to effect the cognitive perception of Hezbollah. In the end, however, the battle for Bint Jbeil would have a great deal more effect on the Israeli public’s perception of the IDF’s professionalism and judgment.13 …

… Halutz ordered Adams to “conquer Bint Jbeil” with just one battalion. Adam was infuriated and quickly reminded his commander that “the casbah [old quarter] of Bint Jbail alone contained more than 5,000 houses. And you want me to send in one battalion?” …

[p. 50]

By 5 August, the IDF had approximately 10,000 soldiers in southern Lebanon. In three weeks of war, the ground forces managed to penetrate no farther than four miles. Remarkably, the border zone remained unsecured, as were the towns of Maroun al Ras and Bint Jbeil.34 Yet, the entire Hezbollah force south of the Litani consisted of only 3,000 fighters. Unlike the IDF, Hezbollah did not call on its sizable reserve forces and chose to fight the entire war south of the Litani with its original force of 3,000 men.35 For Israel and the IDF, there was still no “spectacle of victory” or any sign of Hezbollah’s impending defeat. …

… Knowing full well that the war would be over in days and the old border reestablished, Olmert and Peretz made the decision to expand the 52 war effort by ordering their divisions north to the Litani. It was perhaps one of the most bizarre episodes of the war. While the reasoning for the offensive maneuver remains clouded, the move was clearly not designed to annihilate Hezbollah. Ron Tira was certain that “at no point was an order given to systemically and comprehensively deal with the rockets or Hezbollah.”40 It would appear that the IDF was still following Halutz’s “raid” strategy, albeit this time with divisions instead of battalions and brigades.41 Senior IDF officers would later state that the operation was designed as a “Battle of Awareness against Hizbollah.” Others thought the operation was designed as “a kind of show designed to demonstrate to Hizbollah who is the Boss.”42

I’m guessing that my long-term readers have been driven to nausea from my endless ruminations on Lebanon. However, this will go a long way to explaining future US policy shifts away from Israel.

The INSS is presumably a respected and connected part of the Israeli nonprofit think-tank apparatus. While Dan “Derrida” Halutz may have been thrown on his sword, the intellectual arrogance exemplified by Halutz continues to rule Israeli strategy in Halutz’s stead. Not only that, but Israeli commentators (beyond this one) have the chutzpah to blame the United States for such dereliction!

In other news, Sayyid Hassan Nasrallah today gave his blessing to “all the resistance fighters in Iraq.” Including, presumably, al Qaeda.

Here’s to Israel.

The Palindrome missed a move

Soros must be fuming that he dumped commodities and called a bottom in equities when he did.

Soros’s public pronouncements are consistently somewhat at odds with how he actually invests. (He couldn’t have made money any other way; the track record of his public pronouncements is awful.) This instance, presumably, is no exception.

Not that he has any other viable choice.

George Soros: rocketing oil price is a bubble

By Edmund Conway, Economics Editor

Last Updated: 12:53am BST 27/05/2008

Speculators are largely responsible for driving crude prices to their peaks in recent weeks and the record oil price now looks like a bubble, George Soros has warned.

The billionaire investor’s comments came only days after the oil price soared to a record high of $135 a barrel amid speculation that crude could soon be catapulted towards the $200 mark.

In an interview with The Daily Telegraph, Mr Soros said that although the weak dollar, ebbing Middle Eastern supply and record Chinese demand could explain some of the increase in energy prices, the crude oil market had been significantly affected by speculation.

“Speculation… is increasingly affecting the price,” he said. “The price has this parabolic shape which is characteristic of bubbles,” he said.

‘We face the most serious recession of our lifetime’

The comments are significant, not only because Mr Soros is the world’s most prominent hedge fund investor but also because many experts have claimed speculation is only a minor factor affecting crude prices.

Oil prices stalled on Friday after their biggest one-day jump since the first Gulf War earlier in the week.

At just over $130 a barrel, the price has doubled in around a year, causing misery for motorists and businesses.

However, Mr Soros warned that the oil bubble would not burst until both the US and Britain were in recession, after which prices could fall dramatically.

“You can also anticipate that [the bubble] will eventually correct but that is unlikely to happen before the recession actually reduces the demand.

“The rise in the price of oil and food is going to weigh and aggravate the recession.”

The Bank of England recently warned that soaring energy and food costs would push inflation above its target range for most of the next 18 months, making it more unlikely that it will cut borrowing costs soon.

Mr Soros warns Britain is facing its worst economic storm in living memory, dwarfing those of the 1970s and early 1990s, with a housing slump and serious recession.

He said: “The dislocations will be greater [than in the 1970s] because you also have the implications of the house price decline, which you didn’t have in the 1970s.”

The warning undermines predictions that Britain will suffer only a brief and relatively painless recession, unlike the precipitous dives of previous years.

Mr Soros also warned that the Bank’s inflation report represents a “Faustian pact”, obliging it to keep interest rates high to control inflation, even as the economy is starting to slump.

“You had the nice decade,” he said. “Now that is over and you are in a straitjacket.”

Consummation of Israeli surrender

Hezbollah’s coup was formalized with Gen. Michel Suleiman’s election today as president of Lebanon. Suleiman directly disobeyed Fouad Siniora’s orders to put down the Hezbollah coup. Siniora and Hariri are finished politically. Druzes and Maronites associated with the pro-Western majority leaders of their factions face dhimmitude and gradual tribal exile.

Western media may, for a time, parrot Jerusalem’s jaw-dropping chutzpah and insist that Hezbollah was weakened by this confrontation. Liberals, unfortunately, often invent ludicrous ex post facto justifications for refusing to stand up to hostile force.

Didn’t kill enough looters in Iraq immediately after the occupation? “Well, the occupation would have been so much more dysfunctional otherwise!”

Positive results of the surge? “That was because the mixed neighborhoods were already totally cleansed anyway, there was no more cleansing to be done!” [Uh. OK.]

Bill Richardson’s hilarious Darfur negotiations broke down immediately after he left? “You don’t know that! He got them to promise a cease-fire–even you would admit that’s better than nothing, right?” [No, because it makes us look naively stupid, as well as impotent.]

No progress on North Korean nukes? “Bush’s “appeasenik” North Korea policy was so much more successful than the Iraq quagmire!” [Actually, it was a combination of NK bluffing the whole way, combined with the threat of fatal Chinese sanctions for significant misbehavior, that are bringing in North Korea from the cold.]

Iran runs the Middle East since we consistently backed down from confronting them? ["splutter... peace process ... Palestinians ... splutter splutter"]

No doubt, liberals will issue similar pacifism-queered ex post propaganda convincing themselves that, really, Hezbollah lost the world by winning Lebanon. The 101st Appeaseniks must bridge the gap between their relentless egomania and the reality that their cult of peace has, once again, proven an embarrassing failure.

However, a lot of us understand what happened. Israel shirked its near-term obligations for much more extinction a few years down the road. American warships were directly off the Lebanese coast, ready to provide electronic support to Israeli columns.

Mainstream Israeli political coverage is no more predictive than American political coverage. It’s a long-running soap opera in which the best bet — at all times — is against the mainstream media consensus.

The drama of Olmert’s latest trial apparently involves piddling amounts of money transferred between a US Jewish financier, Morris Talansky, and Olmert himself. Presumably this represents an attempted power grab by pro-Likud elements within the Israeli prosecutorial apparatus. More importantly, though, the trial doesn’t seem to be going anywhere.

It’s one thing for Americans, who are so far away from these tribal feuds, to be ignorant of foreign affairs. Israelis, however, seem no less, if not far more naive about prospects for peace than their American counterparts, judging by the popularity of Tzipi Livni’s born-again pacifism. It says a lot about how insulated many Israelis are from Israeli “crises” which inundate Western media.

In any case, in the United States, money talks — more than ever. Israel has less of it than ever, the Arabs more. The neoconservatives lost public credibility years ago, but at this point, they’ve lost credibility with everyone. The Arabists will be running the show from here on out.

The “shadow stats thesis” goes mainstream, …

… underwritten by PIMCO’s Bill Gross.

Just in time for the huge TIPS burp a couple of nights ago, when massive buying pushed the 5-year TIPS yield down to -.77.

I’ve been a huge fan of the SS hypothesis for a long time, so it’s good to see the world’s biggest fixed income guru practically copy-paste from the Shadow Stats website for his latest letter.

Without further ado:

What this country needs is either a good 5¢ cigar or the reincarnation of an Illinois “rail-splitter” willing to tell the American people “what up” – “what really up.” We have for so long now been willing to be entertained rather than informed, that we more or less accept majority opinion, perpetually shaped by ratings obsessed media, at face value. After 12 months of an endless primary campaign barrage, for instance, most of us believe that a candidate’s preacher – Democrat or Republican – should be a significant factor in how we vote. We care more about who’s going to be eliminated from this week’s American Idol than the deteriorating quality of our healthcare system. Alternative energy discussion takes a bleacher’s seat to the latest foibles of Lindsay Lohan or Britney Spears and then we wonder why gas is four bucks a gallon. We care as much as we always have – we just care about the wrong things: entertainment, as opposed to informed choices; trivia vs. hardcore ideological debate.

It’s Sunday afternoon at the Coliseum folks, and all good fun, but the hordes are crossing the Alps and headed for modern day Rome – better educated, harder working, and willing to sacrifice today for a better tomorrow. Can it be any wonder that an estimated 1% of America’s wealth migrates into foreign hands every year? We, as a people, are overweight, poorly educated, overindulged, and imbued with such a sense of self importance on a geopolitical scale, that our allies are dropping like flies. “Yes we can?” Well, if so, then the “we” is the critical element, not the leader that will be chosen in November. Let’s get off the couch and shape up – physically, intellectually, and institutionally – and begin to make some informed choices about our future. Lincoln didn’t say it, but might have agreed, that the worst part about being fooled is fooling yourself, and as a nation, we’ve been doing a pretty good job of that for a long time now.

I’ll tell you another area where we’ve been foolin’ ourselves and that’s the belief that inflation is under control. I laid out the case three years ago in an Investment Outlook titled, “Haute Con Job.” I wasn’t an inflationary Paul Revere or anything, but I joined others in arguing that our CPI numbers were not reflecting reality at the checkout counter. In the ensuing four years, the debate has been joined by the press and astute authors such as Kevin Phillips whose recent Bad Money is as good a summer read detailing the state of the economy and how we got here as an “informed” American could make.

Let me reacquaint you with the debate about the authenticity of U.S. inflation calculations by presenting two ten-year graphs – one showing the ups and downs of year-over-year price changes for 24 representative foreign countries, and the other, the same time period for the U.S. An observer’s immediate take is that there are glaring differences, first in terms of trend and second in the actual mean or average of the 2 calculations. These representative countries, chosen and graphed by Ed Hyman and ISI, have averaged nearly 7% inflation for the past decade, while the U.S. has measured 2.6%. The most recent 12 months produces that same 7% number for the world but a closer 4% in the U.S.

This, dear reader, looks a mite suspicious. Sure, inflation was legitimately much higher in selected hot spots such as Brazil and Vietnam in the late 90s and the U.S. productivity “miracle” may have helped reduce ours a touch compared to some of the rest, but the U.S. dollar over the same period has declined by 30% against a currency basket of its major competitors which should have had an opposite effect, everything else being equal. I ask you: does it make sense that we have a 3% – 4% lower rate of inflation than the rest of the world? Can economists really explain this with their contorted Phillips curve, output gap, multifactor productivity theorizing in an increasingly globalized “one price fits all” commodity driven global economy? I suspect not. Somebody’s been foolin’, perhaps foolin’ themselves – I don’t know. This isn’t a conspiracy blog and there are too many statisticians and analysts at the Bureau of Labor Statistics (BLS) and Treasury with rapid turnover to even think of it. I’m just concerned that some of the people are being fooled all of the time and that as an investor, an accurate measure of inflation makes a huge difference.

The U.S. seems to differ from the rest of the world in how it computes its inflation rate in three primary ways: 1) hedonic quality adjustments, 2) calculations of housing costs via owners’ equivalent rent, and 3) geometric weighting/product substitution. The changes in all three areas have favored lower U.S. inflation and have taken place over the past 25 years, the first occurring in 1983 with the BLS decision to modify the cost of housing. It was claimed that a measure based on what an owner might get for renting his house would more accurately reflect the real world – a dubious assumption belied by the experience of the past 10 years during which the average cost of homes has appreciated at 3x the annual pace of the substituted owners’ equivalent rent (OER), and which would have raised the total CPI by approximately 1% annually if the switch had not been made.

In the 1990s the U.S. CPI was subjected to three additional changes that have not been adopted to the same degree (or at all) by other countries, each of which resulted in downward adjustments to our annual inflation rate. Product substitution and geometric weighting both presumed that more expensive goods and services would be used less and substituted with their less costly alternatives: more hamburger/less filet mignon when beef prices were rising, for example. In turn, hedonic quality adjustments accelerated in the late 1990s paving the way for huge price declines in the cost of computers and other durables. As your new model MAC or PC was going up in price by a hundred bucks or so, it was actually going down according to CPI calculations because it was twice as powerful. Hmmmmm? Bet your wallet didn’t really feel as good as the BLS did.

In 2004, I claimed that these revised methodologies were understating CPI by perhaps 1% annually and therefore overstating real GDP growth by close to the same amount. Others have actually tracked the CPI that “would have been” based on the good old fashioned way of calculation. The results are not pretty, but are undisclosed here because I cannot verify them. Still, the differences in my 10-year history of global CPI charts are startling, aren’t they? This in spite of a decade of financed-based, securitized, reflationary policies in the U.S. led by the public and private sector and a declining dollar. Hmmmmm?

In addition, Fed policy has for years focused on “core” as opposed to “headline” inflation, a concept actually initiated during the Nixon Administration to offset the sudden impact of OPEC and $12 a barrel oil prices! For a few decades the logic of inflation’s mean reversion drew a fairly tight fit between the two measures, but now in a chart shared frequently with PIMCO’s Investment Committee by Mohamed El-Erian, the divergence is beginning to raise questions as to whether “headline” will ever drop below “core” for a sufficiently long period of time to rebalance the two. Global commodity depletion and a tightening of excess labor as argued in El-Erian’s recent Secular Outlook summary suggest otherwise.

The correct measure of inflation matters in a number of areas, not the least of which are social security payments and wage bargaining adjustments. There is no doubt that an artificially low number favors government and corporations as opposed to ordinary citizens. But the number is also critical in any estimation of bond yields, stock prices, and commercial real estate cap rates. If core inflation were really 3% instead of 2%, then nominal bond yields might logically be 1% higher than they are today, because bond investors would require more compensation. And although the Gordon model for the valuation of stocks and real estate would stress “real” as opposed to nominal inflation additive yields, today’s acceptance of an artificially low CPI in the calculation of nominal bond yields in effect means that real yields – including TIPS – are 1% lower than believed. If real yields move higher to compensate, with a constant equity risk premium, then U.S. P/E ratios would move lower. A readjustment of investor mentality in the valuation of all three of these investment categories – bonds, stocks, and real estate – would mean a downward adjustment of price of maybe 5% in bonds and perhaps 10% or more in U.S. stocks and commercial real estate.

A skeptic would wonder whether the U.S. asset-based economy can afford an appropriate repricing or the BLS was ever willing to entertain serious argument on the validity of CPI changes that differed from the rest of the world during the heyday of market-based capitalism beginning in the early 1980s. It perhaps was better to be “entertained” with the notion of artificially low inflation than to be seriously “informed.” But just as many in the global economy are refusing to mimic the American-style fixation with superficialities in favor of hard work and legitimate disclosure, investors might suddenly awake to the notion that U.S. inflation should be and in fact is closer to worldwide levels than previously thought. Foreign holders of trillions of dollars of U.S. assets are increasingly becoming price makers not price takers and in this case the price may not be right. Hmmmmm?

What are the investment ramifications? With global headline inflation now at 7% there is a need for new global investment solutions, a role that PIMCO is more than willing (and able) to provide. In this role we would suggest: 1) Treasury bonds are obviously not to be favored because of their negative (unreal) real yields. 2) U.S. TIPS, while affording headline CPI protection, risk the delusion of an artificially low inflation number as well. 3) On the other hand, commodity-based assets as well as foreign equities whose P/Es are better grounded with local CPI and nominal bond yield comparisons should be excellent candidates. 4) These assets should in turn be denominated in currencies that demonstrate authentic real growth and inflation rates, that while high, at least are credible. 5) Developing, BRIC-like economies are obvious choices for investment dollars.

Investment success depends on an ability to anticipate the herd, ride with it for a substantial period of time, and then begin to reorient portfolios for a changing world. Today’s world, includi