Q2 ’13:   On the Bank of the Rubicon

The revelation that the U.S. government is vacuuming up, storing and data mining virtually all communications of U.S. citizens is probably not a huge surprise to anyone who has been paying attention to policy trends since 9/11. Just the same, Edward Snowden has done the country a great service by sparking a public discussion of these practices. The American people are in the process of choosing their fate. They will no longer be able to say “I didn’t know” or to blame anyone but themselves for what will come if they allow these practices to continue.

A remarkable element of the debate on this matter is how little of it dwells on the implications of pervasive government invasion of privacy.

To put these operations in perspective, McClatchy interviewed Wolfgang Schmidt, former head of the Stasi, East Germany’s secret police. “You know, for us, this would have been a dream come true,” said Schmidt. And for those who think that because they don’t have anything to hide, they have nothing to fear, Schmidt had this to say:

“It is the height of naivete to think that once collected this information won’t be used…This is the nature of secret government organizations. The only way to protect the people’s privacy is not to allow the government to collect their information in the first place.”

On August 4th the Sunday New York Times reported that other agencies are in fact “clamoring” for NSA data, and the next day Reuters reported that they are already getting it, courtesy of a “secret” DEA division that is funneling data from the NSA dragnet to other agencies, who are then systematically covering up the source of their information.

The wisdom of Benjamin Franklin comes to mind:

“Those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety.”

Thus the title of this quarter’s letter. Like Caesar in 49BC, we are collectively camped on the bank of the Rubicon, debating the fate of the republic. If we do not turn away from this path and reject the paranoid principles of the surveillance state, we will soon be a republic no more. A recent Pew poll (7/26) indicates that sentiment continues to swing against the government position as information about the NSA programs proliferates. New revelations are surfacing daily in what is shaping up to be a Watergate level scandal. Glenn Greenwald at The Guardian is the go-to source for the latest information on this escalating scandal.


Since the intervention to save Long Term Capital Management in 1998, the Fed has enabled a series of asset bubbles…the dotcom bubble, the housing bubble, the gold bubble, most recently the bond bubble, presently deflating, and it appears that the bubble du jour is stocks.

The recent selloff in bonds cut through major support, signaling the formal end of the 30 year bull market in bonds and a general trend of rising rates for the foreseeable future. There has been a lot of talk on the street about the Great Rotation, out of bonds and into stocks. Who knows how far stocks will run, but they are running on the back of Fed policy. When QE is finished, the bull market will be finished. That could still be a long way away. The notion that the Fed will be able to back away from QE and then unwind it when the economy gets strong enough is a fantasy. They are all-in now and they will continue until the dollar is toast.

On June 20th, the markets demonstrated their addiction to ongoing Fed support, throwing a collective hissy fit when Fed Chairman Ben Bernanke suggested that the Fed might begin withdrawing the monthly fix stimulus at the end of the year if the economy appears strong enough. The panic was short lived, however, as one Fed governor after another stepped up to declare that the Fed is not going to abandon the market. Complacency quickly returned and stocks have rallied straight up to new all time highs. With few exceptions, market prognosticators are predicting an open field ahead.

The Bernanke mini-panic also demonstrated the futility of trying to manage risk by diversification in this age of universal correlation. Everything across the board was down sharply on June 20th. From a macro risk management perspective, we have only one market to trade these days. Our only choice is which flavor we want to work with.

Gold and commodities have been selling off. Gold has been especially hard hit, as long liquidation has taken hold of this market. After an 11 year bull market, gold is finally correcting its 700% advance in earnest. 50% of the entire move up from 2001 is $1061. My point and figure downside target is $1050. Most professional traders remain long term bullish on gold. Jim Rogers, a buyer at $1200, gives his thoughts on gold in this interview at Hard Asset Investor.


The June 15th Sunday New York Times featured this front page article…”Even Pessimists Feel Optimistic About the American Economy,” citing the near unanimity of economists over the improving prospects for the economy. As a natural contrarian, I find this article a prompt for caution. Economists have a dismal track record at prediction, highlighted by John Mauldin in his recent newsletter “Economists Are (still) Clueless,” coincidentally also published on June 15th.

If you want a hint of where the problems are going to come from to upset the prevailing rosy view, read this July 21st New York Magazine article by Jonathan Chait, entitled “Anarchists of the House” on the nihilistic agenda of House Republicans. Also, see this insightful July 27th Guardian article by John Naughton on the consequences of the NSA revelations for the free and open flow of information on the Internet and for American technology corporations.

Employment numbers have been gradually sloping upwards, but at the slowest pace since the ‘30’s. The following chart tells the story…posted as “The Scariest Jobs Chart Ever” at Business Insider.

Of course that chart only tells you the story on the number of jobs being created. The following chart gives you some color on the quality of the jobs being created.

On the plus side, housing appears to have made an important bottom. Housing starts this year have been steadily creeping back toward the 1 million annual rate, before dropping sharply in June primarily in response to the uptick in mortgage rates, demonstrating the headwinds that housing will face as, and if, the economy continues to grow and rates climb.

A bigger problem in the housing sector is the large presence of private equity groups such as Blackrock who have been buying up huge swaths of depressed housing for rentals. Private equity sometimes performs a great service, especially when a languishing business or sector is ripe for revamping and renewal. But private equity can also be predatory, and this venture into housing is purely about maximizing rent extraction while the banks are not lending. Predictably, rents are soaring to record highs even as home ownership is hitting 18 year lows. These rental units will also remain as overhanging stock, limiting future gains.

China has become a very big part of the interconnected global economy, and has in fact been the big driver of economic growth for some time. But no market goes up in a straight line forever, and China has accumulated an enormous amount of dead wood. Could we be entering the long awaited consolidation of the massive growth China has seen over recent decades?

Martin Wolf puts China’s situation in perspective:

“The new Chinese government is, in effect, now engaged in the task of redesigning the jumbo jet, as it comes into land, with half of the engines working poorly. The market is most unlikely to deliver such a huge change smoothly…”


“An enlightened citizenry is indispensable for the proper functioning of a republic. Self-government is not possible unless the citizens are educated sufficiently to enable them to exercise oversight. It is therefore imperative that the nation see to it that a suitable education be provided for all its citizens.”
Thomas Jefferson

Self-governance is a noble ideal, difficult enough to realize under the best of conditions; impossible to when half of the political establishment is committed to undermining government and dividing and confusing the citizens with a strategy of deliberate distortions and misinformation, and the other half is too corrupt and cowardly to oppose them on principle.

Der Speigel reports that on July 16th President Jimmy Carter told an audience in Atlanta that “America does not at the moment have a functioning democracy.” That’s a pretty shocking statement coming from a former President, and it’s a rather telling statement on the condition of the U.S. media that the American people have to learn what a former U.S. President thinks about the current state of affairs in America from a German publication.

Our representatives spend most of their time fundraising and tending to the needs and wishes of their financiers, and the balance posturing for their constituents. Remarkably, despite the lowest approval ratings on record, the Congressional Management Foundation reports that members of Congress think they are doing a great job! How checked out can you possibly be?

We are like the addict who refuses to come clean. We elect…and re-elect…and re-elect these people, and we are getting the government that we deserve.

A group called No Labels has been doing heroic work in Washington on a virtual No Budget, sponsoring a variety of initiatives to try to bridge the partisan divide and promote good process. They call their primary initiative the Problem Solvers. This is a very positive effort from a group of very capable people, but unless and until the system is released from the death grip of its financiers, I doubt that much of real substance that will come of No Labels’ laudable efforts.

Most of us are distracted by the propaganda and misinformation that is rained down on us daily by our news media. However, if you take the time to dig, you can find thoughtful commentators, such as Max Frankel who published a good editorial in the June 26th New York Times entitled “Where Did Our Inalienable Rights Go?” Frankel illustrates well enough where they went, and where they are headed, and makes sensible suggestions as to how to fend off the threat we face.


The U.S. role globally is on the wane, and will soon become a full scale retreat. The next financial crisis will usher in many changes. There will be a few outposts of influence, such as the Middle East, where the flow of oil and our deeply rooted relationship with Israel will likely keep us in place for decades.

China’s dominance in the Far East will soon be undeniable, and once North Korea has rejoined the family of nations via Chinese influence, South Korea will ask us to leave. Okinawa and the Philippines have been chaffing at our presence for a long time and will be happy to see us leave. Japan will re-militarize, which is a scary proposition, but inevitable, given the rise of China. In fact it has already begun.

It’s amazing how quickly it is happening. The invasion of Iraq, followed by Abu Ghraib and Guantanamo, destroyed America’s moral standing in the world and set in motion a downward spiral in U.S. influence. And now the NSA spying debacle. Witness the public humiliation of the President of the United States over the Snowden Affair, and the pathetic spectacle of the U.S. abandoning its embassies in response to a threat from al-Queda, a rag-tag foe that we have spent 12 years and trillions of dollars pursuing.

In the other major development in the Middle East, the Egyptian military has lowered the boom on Mohamed Morsi and the Muslim Brotherhood, and their efforts to hijack the fledgling Egyptian democracy and turn Egypt into an infinitely more dangerous version of Gaza. Egypt is the intellectual birthplace of the global Islamic jihadi movement. Events there should be closely monitored. This could be the beginning of the end for the jihadi movement, or it could be the beginning of a total conflagration in the Islamic world. One thing both sides agree on is that they hate America.


Technology is coming of age on Main Street. There is something of a feeding frenzy going on in the retail sector that is reminiscent of the dot-com craze. Investors are hot for new “disruptive” technology in retail, and merchants are adopting new technology at a blistering pace. Technology is enabling retailers to connect with their customers and promote their products in very targeted ways. Omni-channel marketing is the latest buzzword in retail.

In general, real opportunity is hard to come by these days. Since the election of Ronald Reagan, we have been in an Ayn Rand economy. The combined influences of policy and technology have promoted the flow of the fruit of economy increasingly to the top and away from the general population…a reverse redistribution of wealth. The disparity in wealth and income is reaching crisis levels, as the American dream is fading into history. This chart from the Cleveland Fed puts the situation in perspective.


We are in the midst of a phase transition in our global economy. Persistent central bank intervention has disrupted the natural cycles, so it’s hard to get a solid feel for where we are in the transition, or how it is going to unfold going forward…only that we are in the middle of it somewhere. There will eventually be a reset, a new order, and eventually…new organic growth. But there is still a lot of dead wood to be cleared.

The world has become such a complex and interconnected place. We need an elevation of our political process and public ethics to equal the elevation in our technological capabilities. Otherwise, the story just is not going to end well.

Most importantly we need to accept the inadequacy of the existing paradigm going forward and the damage that has been done, and start addressing that reality. Unfortunately, Republican insurgency and the appalling corruption of our political process is making it difficult to see any substantive measures being taken without another crisis to force action. It’s difficult to find a solution if you can’t even have an honest discussion about the problem. Even given another crisis, how bad will it have to get to force meaningful action? In 2008 we had a truly world class crisis, but nothing has been done to address the underlying causes of that crisis or to hold those responsible accountable. In fact, those underlying problems are even worse. The “too big to fail” banks are even bigger, the derivative bonfire is piled even higher, the rating agencies are still being hired by issuers, swarms of lobbyists are unleashed to defeat any effort at meaningful reform, and regulators are still revolving from government to industry.

Perhaps the ensuing consequences of these combined dislocations will eventually give way to a higher order and a more equitable society. We can only pray for a good outcome. Reason and honor seem to have lost out for the time being.