Global Thoughts — 29 October 2008 including review of The World is Curved

Some photos in Charleston, South Carolina, this month.

Yesterday we walked through the park and saw a doggie Halloween costume contest going on. New York City really does offer everything to everyone.

This is the time where one sits around trying to make the right investment decisions hoping that cash invested wisely will create a fortune. Historical trends show that the bottom of a market is hard to distinguish. Warren Buffett is telling people to buy now and I am close to agreeing with him on this one; but note that he has often been right and he has also often been wrong. This may be a good time to take 20% of one’s cash investment portfolio and put something away in equities for a long time, say 5 years. I would like to see some sense that the market is not going up 10% one day and down 10% the next; the volatility is a sign that the market is looking for direction. I think we might soon get a sense of that and this is discussed below.

The most important thing to keep in mind is that both on the upside and downside, things that are supposed to be true are still true in the long run.

US Presidential Race — It’s the economy stupid. That was supposed to be the truth and it is yet again because in almost all cases people vote their pocketbooks. I have the feeling we will see a reverse Bradley effect — meaning that a good number of people voting for Obama are afraid to tell their white friends that they are doing so, and that he will get more votes than we expect. Obama has the highest favorable ratings of anyone running for first-term presidency in 28 years; McCain and Palin have unfavorable ratings of over 40% which according to the rules of politics makes them unelectable. After he is elected, Obama will work hard to get the 20% of the country that doesn’t like him to change its mind and people will get excited about his inauguration hoping to be inspired.

Here’s a sobering thought. During the final debate, I watched it on CNN and there was a debat-o-meter on the screen showing people’s positive or negative reactions to whatever the candidates were saying. I noticed that whenever a candidate starting talking substantively about an issue, the needle started going negative or neutral. When the candidate talked aspirationally about the result he wanted to achieve, the needle would go up, even if ultimately there was no substance as to how to achieve the goal. In my previous posting, I wrote that Obama basically tells you the result he wants and makes it sound like a program. The problem is that the world needs to know how these things might happen. The real problem is that people don’t really want to hear people talking about the how. So even though people say they want substantive discussions of the issues, the debat-o-meter says they really don’t. Which helps explain why these campaigns are a problem for those seeking solutions to real problems.

Assuming there’s a recession, you’d think it would be easy to go out and buy things. I went to a Circuit City and asked about getting a TV delivered to my apartment a mile away. The TV was being sold in the store for about $150 less than it was selling for over the internet so it was a good deal. It was a 37 inch LG brand LCD TV for about $700. It took 2 managers to come back with an answer because they didn’t really know, and they then told me they wanted $450 to deliver and install it even though I already have a wall mount and all they have to do is switch the TV’s. Which I thought was nuts whereupon I walked out. Expect Circuit City to go out of business. 

Assuming that the Democrats are going to run the Congress and the White House, a happy thought is that according to the New York Times if you had invested a sum of money over the past 70 years solely under Democratic administrations as opposed to the Republicans (excluding the Depression-era administration of Herbert Hoover), you’d have made tons more money in the stock market. This tends to back up my inclination stated earlier this month that Democrats offer a better overall climate for people investing money. Republicans seem to be better at helping people with money keep more of it. All in all, I’m in favor of higher taxes if it helps people make more money. As my father would say, “if you are paying taxes, it means you are making money.”

Here is what I think will happen in the marketplace: The US is not in as bad a position as the rest of the world and it will take a recovery in the US for Asia, Latin America and even Europe to have their own recovery. So everyone right now wants the US to recover as quickly as possible because the world’s exporters need the American consumers to start buying again. The Central bankers around the world have done as best as they can to quickly deal with the crises relevant to their region and this is going to matter a lot in terms of quickening the recovery. The US recession may well be shorter than expected. I think that as soon as the market digests the fact that Obama is going to win big and run the Congress and as soon as hedge funds finish deleveraging, a wave of optimism will hit because people and the media will want to feel that change is coming. Whether or not the Democratic congressional leadership is capable of delivering that change is a difficult question because it would call for more talent than has thus far appeared. The fact that oil is quickly becoming reasonable to cheap will help fuel the recovery because I have always felt that the overall health of the economy is linked to the price of oil and that it was $150 per barrel oil that was the last straw that broke the camel’s back this year. Lowered commodities will help reduce the threat of inflation.

I think that investment will disproportionately favor tried and tested companies that have leading brands. The last thing people dispose of is their favorite toothpaste. The market has probably already priced into McDonalds the fact that more people will eat fast food during a recession. Exxon has probably not hit its low since the price of oil keeps declining. Companies that I like are Proctor and Gamble, Colgate, Phillip Morris or Altria, Johnson & Johnson, Kraft and maybe Hewlett Packard. If I had to choose a bank it would be Chase. If I wanted to buy into whatever Warren Buffett has bought into, I’d go for Berkshire Hathaway Class B stock.  Eventually, I might buy back into Brazil but not immediately. Brazil is the one country that is energy self-reliant and has a good economic backbone; it is being hit by the wave of selling and the pullback of capital but it still has a lot going for it. Two other stocks that have been mentioned to me by the head of a successful hedge fund as more speculative upside plays are US Enrichment Corp and Northern Dynasty Mining. These are companies that deal with mining who are not expected to go online for at least several years and who for various reasons have good prospects. The enrichment company deals with uranium and is one of the few companies in the world that does it. The other company is in Alaska with several of the world’s top mining companies invested in it. You are free to look into these. Another interesting choice might be Newell Rubbermaid and, if you believe in the enduring power of the military industrial complex, Lockheed Martin has always been a good play.

I think in the short term, Congressional action should include deficit spending on infrastructure and actions that help America produce and deliver goods and services. It is less important right now to be sending $1,000 checks to middle class earners to pay their bills and more important to use money to put into place longer term fixes. Even today, debt as a portion of US GDP is still low by historical or other country standards.  Money from other countries is still flowing to America and Japan out of safety and the events of the past year only reinforce the fact that America is where everyone else puts their money. China and Japan have no reason to pull back unless they want to ruin themselves in the process. 

Regulation of markets has to be done surgically to make them more transparent and to aid traders in knowing what is being sold so that it can be properly valued. Regulation must not be so onerous as to drive business overseas or so that government essentially makes the business decisions — government usually does poorly at this and favors the bigger most stable and politically connected players which tends to stultify economies. The best way to deal with market regulation is to get all the players together to fashion the rules of the road. If government bureaucrats do this on their own, it will not work as the Sarbane Oakley rules of a decade ago drove financial business from New York to London. If we keep talking about the greed and corruption on Wall Street and the evils of globalization but don’t see that it also helps create the wealth that created much of the middle class around the world that’s been created in the past 25 years, we’re missing something. People can talk about Wall Street and the evil bankers but they will have to use their credit cards less (and cashiers I talk to at the Macy’s food court say they are throwing them away). Boring people like Gordon Brown of the UK will have to be taken seriously. 

If the US does the right things, and there is a good chance of this, the US will come out of this recession stronger than it was before. Obama and the Democrats have taken a lot of money from people who favor globalization as opposed to nationalistic populism, and this indicates that they will be receptive to a more Clintonian economic model except perhaps being more willing to run up deficits in the short term which Clinton did not do but which we can probably afford at this moment in time on a temporary basis.

Today’s problems were created not only by the US, but by all kinds of countries that did wrong. Also problems of today are unintended consequences of fixes for earlier failures. We know that central bankers acted too cautiously as conditions deteriorated; biofuel prices for items such as corn-based ethanol pushed up commodity prices and drove up inflation; food export bans and fuel subsidies by developing countries pushed up prices further; many excesses in hedge fund trading and bank loans were built around tools created to get around government regulations in the first place. There is little evidence that small groups of speculators drove up the price of commodities or drove them down later. A whole government agency was created to regulate mortgages after the Great Depression (Fannie Mae and Freddie Mac) and it failed miserably as well as became politicized. 

So in looking for solutions, we need carefully calibrated programs of governmental oversight since the market won’t regulate itself, but not too much regulation or else the market will create end-runs around the regulations or simply go offshore. Wage controls over Wall Street won’t work; crazy taxes will backfire and be evaded. We need to preserve the incentive to compete and to initiate new ventures. 

We do need to deal with the aspect of the housing bubble that is leaving people in a position to not be able to afford their mortgages. The best ideas I’ve seen so far involve the FDIC’s (the person running it seems to be very good) proposal to go nationwide with a program put into place in Indiana that was recently described in the New York Times this past weekend.  Another idea is to allow people to give the deed to the mortgage holder for 5 years, pay rent and then have the option to buy back the house at fair market value after 5 years. Letting bankruptcy judges rewrite the terms of mortgages is interesting but I understand it will only affect a small amount of the market.

The speed with which the ethanol bubble blew was fascinating and a lot of very wealthy people lost big. I wrote back a few years ago that I wasn’t happy with corn-based ethanol and that the Brazilian model was the way to go. We don’t grow that much sugar-cane here but at least you don’t solve one problem by creating another. The corn product only drove up corn prices and was not really any greener in terms of its output.

Arab Sovereign Wealth Funds are, like many people with money today, hoarding their cash and not rushing to invest it. Similarly, in the US, banks who got all this money from the central bankers are also hoarding money. They don’t know if things will get worse and if anything they want to use it to buy out competitors. I think that US Treasury Secretary Paulson knew this and used the idea of money to give out loans as a fig leaf to get the bill to pass. I had said last month that perhaps fewer banks would be better from the government’s point of view; it would make it easier to regulate the industry. It may also be that the later deal he made with the banks — following the Europeans’ lead — was what he had in mind in the beginning but that he wouldn’t have been able to get that past the Congress, which is why he had it buried into the recesses of the bill but didn’t make an issue of it in the first round.The British plan had measures to force the banks to lend; the US plan didn’t. The main problem so far is that instead of mortgage rates going down, they’ve gone up, again because the US Government has given them money but not the backing they need to make the marketplace feel safe. So far, Paulson’s moves are having an effect — banks are lending to other banks — but it is not yet helping consumers.

Dubai has a debt that is roughly equal to 100% of its GDP. I have long been suspicious of this emirate and wouldn’t be surprised if within a few years its comparatively stodgy neighbor Abu Dhabi winds up taking over a good portion of it. 

Pakistan is basically bankrupt and neither the Saudis or the Chinese are bailing them out, forcing them to go to the IMF. The army won’t like this organization forcing the treasury to stop diverting so much money to the military. The Saudis tried to get the Pakistanis to help broker a settlement with the Taliban in Afghanistan and use money as a lever, but the Taliban is really not interested in being constructive. 

Russia is said to have lots of foreign reserves but you’ll see how fast they have to draw down on them. The Saudis are going to let the price of oil fall to drive Venezuela, Russia and Iran out of the market for the short term and to keep them from having the means to make trouble for the US and its interests so that the region can become a bit more stable for now, and so that business can have a chance to gain traction.

Israel — My wife told me earlier this month that a senior political source in Israel said that the leader of Shas wants elections now because in a year and a half Aryeh Deri (former head of the party) becomes eligible to re-enter politics and would take over the Shas party if elections were held at that time. If elections are now, the new government could expect to last 4 years and this would keep him out. This seems to be increasingly true; Livni’s associates have been charging that the head of Shas negotiated in bad faith for the past month and hid the negotiations from the leaders of his own party. On the other hand, commentators note that Livni never went to meet with Rabbi Ovadiah Yosef, the spiritual leader of the party who is the patron of Aryeh Deri. Everyone who has tried to form a government for the past 2 decades has met with him and they saw it is arrogance and naivete that kept her from doing so. Several people mention that she has no friends and that without friends it is impossible to form coalitions in such a country. In 3 months from now, if and when a general election is held, nobody will remember this. Livni has received very poor marks for political strategy and for judging the political scene. I feel that Barak has been playing her for the past month; he got her to concede that which she should not have conceded to him and it didn’t even matter because she still failed to form a government. She never met with the Arab parties who control almost 10% of the parliament; there is no reason why she couldn’t form a government with them or at least use the threat of doing so to force other parties to deal with her instead of letting them feel indispensable. Israel should move beyond the accepted norm that Arab parties cannot make up a necessary part of a coalition but might only exist as pile-on partners. They are citizens and taxpayers and might very well be reliable partners in governance. 

If I were Livni and I knew I were going down the tubes anyway, I would have said “I am forming a government with Labor and the Arab parties and with Meretz. We are going to ignore Shas and the ultra-orthodox parties, abolish the religious ministries and the Chief Rabbinate, and stop giving taxpayer’s money to a class of people that don’t work, serve in the army or even support the idea of the state but still know how to take from it. We are not going to be leftist in terms of our geopolitics (ie: We will submit our peace plans with the Arabs to a referendum), and we therefore invite all people from Likud and any other parties who agree with our domestic agenda that we should stop having our governments blackmailed by small sectors of our society to back our battle to take this country back into our own hands and away from the rabbinate — civil marriage and divorce, conversion law that accommodates reasonable people instead of being hijacked by a small minority opinion, and an end to corrupt ministries that waste taxpayer money on job sinecures for party hacks.”   If she would have done this, at least she would show that she stands for real change and that she has the nerve to crack the nut that is Israeli politics today. I’m afraid that otherwise, politics will be taken over by experienced backroom operators and that means that Bibi Netanyahu is soon to be back in the driver’s seat unless Labor can come up with someone immediately that attracts much more excitement than Ehud Barak. I think Livni made a serious mistake of going to elections without first having tried to act as an incumbent prime minister. Olmert hates her and won’t give her anything over the next 3 months, and most people feel she is not qualified for the job. She really has the uphill fight against Bibi in the general election. Bibi’s coalition partner will have to deal with him promising the moon and sky and knowing in advance that his word is meaninglesss. Meanwhile, Stratfor’s intelligence service now estimates that Israel will hold off on Iran to give the American president a chance to figure things out and not saddle him with a crisis right off the bat.

This month I got to reading David Smicks’ The World is Curved: Hidden Dangers to the Global Economy. If you can only read a few books per year, this should be one of them. It is just under 300 pages and written earlier this year. Lots of oped columnists are quoting it. The book describes in plain English what is going on in the world economy and where things might go from here. It provides context and is a little scary. I agree with most of it and must say that it does affect my thinking; I have had to reconsider some of my ideas after reading it and you may have noticed some changes this month against what I wrote earlier this month in my Action Plan for America. The book says that China is a disaster waiting to happen and could bring the whole world down with it. The Chinese are opaque, behind the curve, overproducing and hoarding commodities that may be totally superfluous and have to be dumped. You can’t talk to them because faceless bureaucrats who don’t meet with foreign delegations actually run the country. For example, they have factories producing millions of cars that they can’t use. What will America do if they start dumping them on us, especially as the Big 3 automakers in Detroit face bankruptcy? Japan is in bad shape due to its failure to adapt to a changing world and the housewives of that country having usurped the central government as the primary investor of record. India is on a better long-range track to succeed; if only their infrastructure were better they would be further along. The US must not become protectionist, class warfare crazy or so regulatory in nature that it kills globalization and entrepreneurship. Globalization caused tremendous benefits around the world and in the US; the amount of debt held by foreigners is small and the cost of dumping our system would be serious ruination for many years and people should remember that what was done in the 50’s thru 70’s didn’t work so why would we want to return to such an economic system? Do surgical work to repair what is broken; clearly more transparency is needed. Other fixes such as mark to market, getting rid of short selling or banning hedge funds are not going to fix things. Central bankers are becoming less relevant; government agencies that are supposed to regulate can themselves be politicized and fuel excesses such as Fannie Mae. 

Anyway, that’s all for now. We will all watch the elections, analyze the new appointees (expect Obama to do this quickly), and see how the world reacts. I now expect that Bush will not go after Iran as a lame duck and that the Israelis are in no position to do so either, considering how weak its internal house is and that Iran has basically been boxed in with $50 a barrel oil in the offing. 

I am here in New York for the next month, with trips to Florida planned for the end of November and December and travel abroad in the Gulf and Levant planned for mid-December. Instead of seeing the hype of Dubai, it will be more sobering; the banks are finding more talk than walk for the bankers who have been running over there thinking this was the new Golden Medina of deals, and the rulers cannot count on huge oil windfalls to cover the rising inflation and discontent that has been building up in the bubble economies. 

We will all have to sit down and take into account the prospect of a fundamental change in public perceptions in the US and of a new administration headed by somebody who nobody really knows much about or what his plans are. In the Middle East, we will have to recalibrate the prospects with the greater possibility of Bibi being back in the chair. I was at a political satire this Saturday night and they made jokes about Palin, Bush, Biden and McCain. But about Obama, they said, they couldn’t figure out how to make jokes about him. While this will help him get elected, it remains to see if it can help him govern and communicate. For now he remains a big question mark. Consider France’s Sarkozy who said today that Obama’s Iran policy is all fluff and no substance and this worries him. Nevertheless, in just 3 more months, he will be calling the shots and I can only hope that expectations will be exceeded.

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