The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

It is obvious that America has long supported dictators, instead of democracies, in developing countries.

Why?

Is it simply – as Noam Chomsky asserts – that America supports strong men who will ensure that their country acts as a “client state” to the U.S., and moves to crush countries which refuse to act as satellites to the U.S.?

Perhaps.

But – as usual – faulty economic models are part of the problem.

Specifically, Morton Halperin, Joe Siegel and Michael Weinstein co-wrote a book called The Democracy Advantage: How Democracies Promote Prosperity and Peace, published by the Council on Foreign Relations in 2005, which provides insight into the economic model used to justify America’s historic support for dictators.

Halperin is no outsider, being a high-level adviser in the Clinton, Nixon and Johnson administrations and to the Council on Foreign Relations. In the Johnson Administration, he worked in the Department of Defense where he served as Deputy Assistant Secretary of Defense (International Security Affairs), responsible for political-military planning and arms control. During the first nine months of the Nixon administration, Halperin was a Senior Staff member of the National Security Council staff with responsibility for National Security Planning. In the Clinton administration, he served Director of the Policy Planning Staff at the Department of State, the Special Assistant to the President and Senior Director for Democracy at the National Security Council, and consultant to the Secretary of Defense and the Under Secretary of Defense for Policy. He was nominated by the President for the position of Assistant Secretary of Defense for Democracy and Peacekeeping.

Halperin, Siegel and Weinstein gave a speech at the Carnegie Foundation in 2005 explaining their research findings.

Halperin noted:

Successive American presidents have said, particularly since the end of the Cold War, that a major goal of American foreign policy was to spread or enlarge or enhance democracy, and that our foreign policy was geared to supporting those who were struggling to establish and maintain democratic regimes.

Yet if you look at development assistance from the United States, from the international financial institutions, and even from the Europeans and the European Community, you find that there is no democracy advantage. That is, democratic countries, in fact, receive less development assistance than do non-democratic countries. You also find in the rhetoric, and even the charters, of development agencies a belief that democracy is not their business. They increasingly talk about good governance as one aspect of development, but not about democracy. The people who run USAID believe that their job is to promote development, and not democracy. That permits them to consider good-governance issues, but not to ask the fundamental question: Is this a democratic society that we want to support?

Indeed, the international financial institutions have, with one exception, charters which require them not to take account of whether a country is a democracy, or as it is referred to in the charters, its political criteria.

Underlying this policy of governments and international financial institutions is a belief about how democracy relates to development. There is a widely held view that poor countries need to delay democracy until they develop. Back when I was in college, this was the Scandinavian view of democracy, that only Scandinavian countries were capable of being democratic, and that you needed to have a solid middle class before you could contemplate democracy. The argument went—as presented in the writings of Samuel Huntington and Seymour Martin Lipset —that if a poor country became democratic, because of the pressures in a democracy to respond to the interests of the people, they would borrow too much, they would spend the money in ways that did not advance development—arguments that the current president of Mexico is making about his possible successor. These poor decisions would mean that development would not occur; and because people would then be disappointed, they would return to a dictatorship.

Therefore, the prescription was, get yourself a benign dictator—it was never quite explained how you would make sure you had a dictator that spent the money to develop the country rather than ship it off to a Swiss bank account—wait until that produces development, which produces a middle class, and then, inevitably, the middle class will demand freedom, and you will have a democratic government.

That proposition was wrong.

Siegel picked up from there. Siegel is a Senior Research Scholar at the University of Maryland’s School of Public Policy, and an expert on the political economy of democratic transitions , who has contributed articles to leading policy journals and newspapers including Foreign Affairs , Harvard International Review , Georgetown Journal for International Affairs, Los Angeles Times, Financial Times, Newsweek International, Wall Street Journal, and The International Herald Tribune. Siegel was also a high-level researcher for the CFR.

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Interesting quote of the from Bob Lefsetz:

EGYPT:

“We were there first, music fans already revolted.  They killed not only the album, but the major labels.  We’re living in an era of chaos.  To complain is to be Mubarak.  The audience was oppressed for too long, given an opportunity to go its own way, it did.  Remind me how it helped the audience to have to buy a fifteen dollar CD to hear the one track that was a hit?  Now they just buy the hit on iTunes.  And if they don’t do that, they don’t even bother to steal it, they just watch it on YouTube.  You don’t need to own it, next year it won’t mean anything.”

Fascinating stuff . . .

Smug Hipster puppies, auto-corrected texts of Dads who say “divorce” when they mean “Disney” (oops) , and Asian moms who steal napkins from Chipotle. The world of user-generated blogs is full of random time-wasters, but also lucrative book deals. In his latest Tech Diary, WSJ’s Andy Jordan examines the current market for blog-to-book deals and looks at the pesky question of profiting from user-generated content.

40 insane photos of the great blizzard

1.

A car landed vertically in a snowbank in an accident involving several vehicles on Interstate 93 north of Salem, N.H. No one was injured.

Time’s Man of the Year.  Now the new Moses?  The guy who’s invisible connectivity community helped bring down the Pharaoh of Egypt.  Mark Zuckerberg getting credit for Egypt’s revolution?   We were stunned last night as we watched Anderson Cooper and Wolf Blitzer interview the de facto leader of Egypt’s revolution, the “Google Ganhdi,” Wael Ghonim.

During the course of the interview Wolf Blitzer asked Ghonim where the next revolution would take place.  He answered, “Ask Facebook.”

Isn’t the leader of a revolution in a Muslim nation supposed to answer,  “Ask God?”  In Tahrir Square square you could hear chants,   “Muslim, Christian, doesn’t matter; We’re all in this boat together!” Didn’t Obama give a speech about this in Cairo in June 2009?   This isn’t your father’s Islamic revolution,  our friends.

You can watch the entire interview with the Google Ghandi  in the video below.  Here is the relevant excerpt from the transcript,

BLITZER: Wael, this is Wolf Blitzer in Washington. So first Tunisia, now Egypt. What’s next?
GHONIM: Ask Facebook.
BLITZER: Ask what?
GHONIM: Facebook.
COOPER: Facebook.
BLITZER: Facebook. You’re giving Facebook a lot of credit for this?
GHONIM: Yes, for sure. I want to meet Mark Zuckerberg one day and thank him, actually. This revolution started online. This revolution started on Facebook.
You know, I always said that if you want to liberate a society, just give them the Internet. If you want to have a free society, give them the Internet.

The one meme of the Global Macro Monitor is “transformative tech” and it is now transforming the map of the Mid-East just as it did in the 2008 U.S. Presidential election.

Lookout!

Next up, Algeria?

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Why politics and investing don’t mix
Washington Post
Sunday, February 6, 2011; G06
Barry Ritholtz
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Washington, I’m here to tell you, politics and investing don’t mix.

Yep, I thought I’d begin our conversation about investing by rocking your most cherished beliefs. Many of you are active in party politics, work for government or are involved in related fields. Well, I have some bad news: Your politics are killing you in the markets.

In my work, I use behavioral psychology, statistics, cognitive biases, history, data analysis, mathematics, brain physiology, even evolution to make better investing decisions. Indeed, these are all key to learning precisely what not to do. While making good decisions can help your portfolio, avoiding bad ones is even more important.

We humans make all the same mistakes, over and over again. It’s how we are wired, the net result of evolution. That flight-or-fight response might have helped your ancestors deal with hungry saber-toothed tigers and territorial Cro Magnons, but it drives investors to make costly emotional decisions.

And it’s no surprise.

It’s akin to brain damage.

To neurophysiologists, who research cognitive functions, the emotionally driven appear to suffer from cognitive deficits that mimic certain types of brain injuries. Not just partisan political junkies, but ardent sports fans, the devout, even hobbyists. Anyone with an intense emotional interest in a subject loses the ability to observe it objectively: You selectively perceive events. You ignore data and facts that disagree with your main philosophy. Even your memory works to fool you, as you selectively retain what you believe in, and subtly mask any memories that might conflict.

Studies have shown that we are actually biased in our visual perception – literally, how we see the world – because of our belief systems.

This cognitive bias is not an occasional problem – it is a systematic source of errors. It’s not you, it’s just how you are built. And it is the reason most people are terrible investors.

How does this play out in the world of investing? Let me share two examples. I don’t pick favorites: Both Democrats and Republicans are implicated.

Back in 2003, the dot-com crash had about run its course. From the peak of the market in March 2000 to the March 2003 trough, the Nasdaq had gotten crushed, losing 78 percent of its value.

As Federal Reserve chief Alan Greenspan took rates down to 1 percent, the Bush administration passed $1 trillion in tax cuts. As someone else once said about the stock market, “Give me a trillion dollars, and I’ll throw you one hell of a party.”

Yet many of my Democrat friends on Wall Street – fund managers, traders and analysts – were highly critical of the tax cuts. At the time, I heard all the reasons why they were so bad: They were deficit-busters, unlikely to create jobs, giveaways to the wealthy.

While those critiques may have been true, they were also irrelevant to equities. As armchair policy wonks obsessed over these issues, they missed the bigger picture: Liquidity is a major factor in how the economy and stock markets perform. Trillions of dollars in fresh cash was very likely to goose equities higher. (Sound familiar?) Indeed, the impact of the tax cuts did just that. Combined with Greenspan’s ultra-low rates, you had the makings of a cyclical bull market rally. From 2003 to 2007, the Standard & Poor’s 500-stock index – the usual benchmark for equities – gained 100 percent.

And my politically active friends on the left missed most of it.

Fast-forward six years to the recent credit crisis. The S&P 500 had fallen 57.69 percent. By March 2009, op-eds in the Wall Street Journal blamed the crash on President Obama.

But conditions were forming that would hasten the end of the sell-off. Markets were deeply oversold. Once again, the Fed chair was cutting rates – this time, it was Ben Bernanke, and he took rates down to zero. In a panic, Congress forced the accounting rule-making body to be more accommodative to the banking sector. FASB 157, as it is known, ended mark-to-market accounting – essentially allowing banks to hide their bad loans.

All these factors suggested that a substantial rally from the market lows was coming. Historically, average gains in post-crash bouncebacks were 70 percent. The easy money to the downside had been made, and it was time to stop betting that the markets were heading south. If history held true, we were looking at the mother of all bear market rallies.

By that March, I was explaining this to clients, the news media and co-workers. But the greatest pushback this time around came from across the political spectrum. My GOP pals were lamenting the occupant of the White House. I heard things like “Obama is a Kenyan, a Muslim, a Socialist. He is going to kill business.”

What followed was the single most intense two-year rally in Wall Street history. As of Friday, the S&P 500 has gained 93.8 percent.

And my politically active friends on the right missed most of it.

Remember, the cycle of booms and busts are surprisingly regular occurrences. What some people all a “100-year flood” actually happens far more frequently – since 1929, there have been 18 crashes.

It’s just as important that an investor participate in the cyclical bull markets, capturing the rally as well. All things considered, missing the downside and catching the upside makes for a pretty decent investment strategy.

You need not be a mathematical wizard to learn this lesson. When you are in the polling booth, vote however you like; But when you are reviewing your investing options, it is best to do so with a cold, dispassionate eye.

Understanding how your own biases impact your investing process is a key step. If you want to avoid making certain errors, you must at least be aware of them.

And now you are.

Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, The Big Picture.

Invictus here. I have been reviewing a variety of assorted miscellaneous items:

Likely flat-earther/creationist Peter Wallison continues to believe that if he blames Fannie, Freddie, and CRA enough times, eventually it will be true that they — and they alone — were the sole causes of the financial crisis.  His inability to back down in the face of overwhelming evidence is, frankly, quite remarkable (in a what-sort-of-psychological-disorder-is-that kind of way).

Jerry “Bush Boom” Bowyer has a new book out, thereby proving conclusively that some people have no shame.

Henry Blodget took a personal interest in the Vanity Fair article by Michael Lewis about a Merrill analyst — Philip Ingram — who was allegedly terminated for a spot-on report about trouble at the Irish banks.  Henry, who I’d swear once said or wrote that he’d never again discuss his banishment from the securities industry and/or the fines he paid, can’t help but once again proclaim his innocence:

(For example, in an email, I once referred to a stock that Merrill rated “Buy” as a “piece of junk.” Spitzer said this proved that I did not think investors should buy the stock. In my week of testimony at Spitzer’s office, I explained my side of this story–that when I wrote the email I was reacting to inaccurate negative information that I had just been given about the company, that the stock had already fallen 90% from its high and therefore was probably fairly described as a piece of junk regardless of what one thought the stock might do in the future, that stock ratings are an opinion about a stock’s “appreciation potential over the next 12 months,” not assessments of a company’s quality, a summary of past performance, or an action recommendation for all investors, and, perhaps most persuasively, at least to me, that I wasn’t actually covering the stock at the time. But these explanations had fallen on deaf ears.)

Here’s the SEC’s side of the story (Spitzer’s complaint apparently not available on the web).  They saw things a wee bit differently.

I listened to the first 45 minutes of two hours worth of a Stan O’Neal interview by the FCIC before I had to puke.  Although of course it was only audio, I got a very good sense of Stan’s looks:

(Source:  Merrill Lynch Photo Archives)

Finally, a word about the battering that David Rosenberg is taking of late for having “missed” an almost 100% move in the stock market.  If only.  While no one would ever confuse Dave with a bull, the fact is that stocks are not the only asset class and that even as it relates to equities, Dave has long advocated what he called Safety and Income at a Reasonable Price (SIRP) — you can find it in many of his daily missives.  For the sake of discussion (and based on his writings), let’s call SIRP a focus on larger cap, stronger-balance-sheet, dividend paying companies.  That said, let’s look at some investments that Dave has recommended over the past couple of years:

Gold and Silver — Dave has been bullish gold — and even more so silver — for quite some time.  Anyone who committed some capital to this space has done well; I was buying SLV — on Dave’s call — since it was a pre-teen.  (At one point DR wrote that he felt silver had — relative to gold — more upside.  Enough said.)

Bonds — If you bought most any bonds, you’ve done okay (though you’ve clearly given some gains back of late).  Not many were calling for rates — especially 10-years and out — to fall as low as they did and, if you were lucky enough to sell at or near the top, you had a very nice trade.

Stocks (SIRP) — As a proxy for Dave’s SIRP strategy, let’s take a look at an index many might not even know exists — the S&P500 Dividend Aristocrats which, according to S&P:

The S&P 500® Dividend Aristocrats index measures the performance of large cap, blue chip companies within the S&P 500 that have followed a policy of increasing dividends every year for at least 25 consecutive years.

Mind you, only about 40 stocks make the grade — it’s a very elite little club, but exactly the types of companies Rosie’s been recommending for quite some time.

Here’s what that index — including dividends — looks like over the past five years (which is what the file S&P sent me contained; looks very much like a fresh five-year high):

(Source:  Standard & Poors)

So if you’d allocated assets based on Dave’s recommendations over the past couple of years, the fact of the matter is you’ve done okay, which is why I don’t understand all the hyperbole over his “missed” call:  Stocks are not the only asset class and he’s never suggested being out of the market entirely.  And please, no need to weigh in if you don’t read his reports on a daily basis — be mindful of BR’s comment caveat.  (Awaiting commentary from those who bought at the 666 intraday low on March 6, 2009; kudos to you.)

For those who want the Dividend Aristocrats constituent list (and are too lazy to click through to the link I provided), here it is:

Q: Why do Burger King Franchisees care about derivatives reform?
A: huh ?

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NPR discusses what a Bloomberg reporter found:

Last summer, one still unnamed company hired a PR firm to launch a “grassroots letter writing campaign” on derivatives reform. The PR firm hired a contractor, who hired a subcontractor in Arkansas. And instead of finding real people who care about derivatives — financial contracts tied to some other asset — the subcontractor went ahead and forged letters from grassrootsy sounding people.

The scam is a firm (likely a bank) hires a PR firm, who then hires a sub-contractor, who hires a sub sub-contractor. They send letters to congress, signing them to individual business people as well as Judges and Sheriffs — despite the fact that impersonating law enforcement personnel is a a felony.

This is absolutely unnecessary and serves only to fabricate a false plausible deniability for the original bank. But its a giant scam, and the bank and its employees are still liable for their actions. Anyone fooled by this purposeful chain of contractors simply does not have a clue.

I keep saying this over and over: Its time to prosecute these criminals and put them into general prison population.

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NPR broadcast:

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Sources:
Forged Comment Letters Sent to U.S. Regulators Writing Derivative Rules
Silla Brush and Clea Benson
Bloomberg, Nov 30, 2010
http://www.bloomberg.com/news/2010-11-30/forged-comment-letters-sent-to-u-s-regulators-writing-derivatives-rules.html

Forged Letters, And Other Stories From The Trenches Of Financial Regulation
CHANA JOFFE-WALT
NPR, February 12, 2011
http://www.npr.org/blogs/money/2011/02/10/133660842/forged-letters-and-other-stories-from-the-trenches-of-financial-regulation

Here is the email offer I got today: Get a day of free high performance driving lessons from Skip Barber with every Lotus Exige S 260 you purchase!

Skip Barber its terrific, and the Lotus looks like a fun car. But you can show up without a car at Skip, they provide RX8s and BMW 3 series to learn on (all manual 6 speed tansmissions)

Lotus cars

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The Future of Public Debt
By John Mauldin
February 11, 2011

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The Future of Public Debt
A Bit of Background
Drastic Measures
The Future Public Debt Trajectory
Debt Projections
Phoenix, Tokyo, and London

This week I find myself in Bangkok, and I must admit to enjoying the experience a great deal, so much so that I am going to preview a portion of my coming book, Endgame, so that I can go back out and play tourist. Next week I get back to my more or less regular schedule, but I think you will enjoy this first portion of chapter six, where we look at an important paper from the Bank of International Settlements on “The Future of Public Debt.” It is not a pretty one. We are watching one of the last great bubbles begin to deflate – the bubble of government and government debt – all over the developed world. This is a serious weight that will be a drag on our growth, and it is interesting to contemplate as I sit in Bangkok, a city that is vibrant and teeming with opportunity.

Endgame will be in the bookstores in a few weeks, but let me once again ask you to not pre-order the book from Amazon or online. Pre-order books do not get into the book sales numbers (long story and more information than you want to know). I encourage you to pre-order from your local book store if you have one. Let me note that in the portion below, the pronoun we is used a lot. It is not the royal we – I do have a co-author, Jonathan Tepper, and this book has very much been a collaboration. More on some Thai thoughts at the end, but let’s jump into today’s Thoughts from the Frontline.

The Future of Public Debt

Our argument in Endgame is that while the debt supercycle is still growing on the back of increasing government debt, there is an end to that process, and we are fast approaching it. It is a world where not only will expanding government spending have to be brought under control but also it will actually have to be reduced. In this chapter, we will look at a crucial report, “The Future of Public Debt: Prospects and Implications,” by Stephen G. Cecchetti, M. S. Mohanty, and Fabrizio Zampolli, published by the Bank of International Settlements (BIS).

The BIS is often thought of as the central banker to central banks. It does not have much formal power, but it is highly influential and has an esteemed track record; after all, it was one of the few international bodies that consistently warned about the dangers of excessive leverage and extremes in credit growth.

Although the BIS is quite conservative by its nature, the material covered in this paper is startling to those who read what are normally very academic and dense journals. Specifically, it looks at fiscal policy in a number of countries and, when combined with the implications of age-related spending (public pensions and health care), determines where levels of debt in terms of GDP are going.

Throughout this chapter, we are going to quote extensively from the paper, as we let the authors’ words speak for themselves. We’ll also add some of our own color and explanation as needed. (Please note that all emphasis in bold is our editorial license and that we have chosen to retain the original paper’s British spelling of certain words.)

After we look at the BIS paper, we will also look at the issues it raises and the implications for public debt. If public debt is unsustainable and the burden on government budgets is too great, what does this mean for government bonds? The inescapable conclusion is that government bonds currently are a Ponzi scheme. Governments lack the ability to reduce debt levels meaningfully, given current commitments. Because of this, we are likely to see “financial oppression,” whereby governments will use a variety of means to force investors to buy government bonds even as governments actively work to erode their real value. It doesn’t make for pretty reading, but let’s jump right in.

A Bit of Background

But before we start, let’s explain a few of the terms the BIS will use. They can sound complicated, but they’re not that hard to understand. There is a big difference between the cyclical versus structural deficit. The total deficit is the structural plus cyclical.

Governments tax and spend every year, but in the good years, they collect more in taxes than in the bad years. In the good years, they typically spend less than in the bad years. That is because spending on unemployment insurance, for example, is something the government does to soften the effects of a downturn. At the lowest point in the business cycle, there is a high level of unemployment. This means that tax revenues are low and spending is high.

On the other hand, at the peak of the cycle, unemployment is low, and businesses are making money, so everyone pays more in taxes. The additional borrowing required at the low point of the cycle is the cyclical deficit.

The structural deficit is the deficit that remains across the business cycle, because the general level of government spending exceeds the level of taxes that are collected. This shortfall is present regardless of whether there is a recession.

Now let’s throw out another term. The primary balance of government spending is related to the structural and cyclical deficits. The primary balance is when total government expenditures, except for interest payments on the debt, equal total government revenues. The crucial wrinkle here is interest payments. If your interest rate is going up faster than the economy is growing, your total debt level will increase.

The best way to think about governments is to compare them to a household with a mortgage. A big mortgage is easier to pay down with lower monthly mortgage payments. If your mortgage payments are going up faster than your income, your debt level will only grow. For countries, it is the same. The point of no return for countries is when interest rates are rising faster than their growth rates. At that stage, there is no hope of stabilizing the deficit. This is the situation many countries in the developed world now find themselves in.

Drastic Measures

“Our projections of public debt ratios lead us to conclude that the path pursued by fiscal authorities in a number of industrial countries is unsustainable. Drastic measures are necessary to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability.”

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