Q2 ’10:   Sliding Gradually Down the Slippery Slope

There has been a lot of water under the dam since my last letter. Not much change of real substance; just gradual erosion across the board. The economy is still in a funk, markets have been gyrating in broad trading ranges, our political devolution proceeds unabated, and the global scene, especially the Middle East, is just as fragile as ever.

The grip of corporate money over our political establishment has been demonstrated repeatedly as scores of lobbyists descend on Washington to spread their millions and our Senators dance to their tunes as each new “reform” is considered. As if the corruption were not bad enough, the Supremes, in Citizens United v. Federal Election Commission, decided that corporations should be freed of all constraints regarding their political “donations.” We have now made government of the corporation, by the corporation, for the corporation the law of the land.


The bear took another bite out of stocks in May and again in late June, erasing the gains for the year. The mood was so black at the June lows that, in retrospect, the lows should have been obvious. Of course stocks began to rally the next day, climbing back to even for the year and gyrating around the even mark since. At this writing stocks have been selling off again but sentiment is again so negative that I think we must be nearer to a bottom than a top. The 8/21 Sunday NY Times featured a front page article about small investors fleeing the stock market. Anything can happen, but this is not what one would expect to see at the beginning of a big move down.

Bonds have been rallying strongly. Rates on long bonds are approaching their all-time lows. The Fed recently announced that it is “reinvesting” its mortgage income in long bonds, and bond traders are convinced that the deflation trade is the place to be. For the time being it would be expensive to bet against them. Longer term, however, I disagree. Yes, the economic numbers have been horrible, and we are in a deflationary cycle, but the policy response to deflation is going to be even more aggressive quantitative easing, which is economic-ese for printing dollars. The Fed bond purchases are only the first step. It’s only a matter of time before bonds begin to discount the inevitable dollar devaluation and the ever growing risk of default. As Warren Buffet recently put it in a NY Times Op-ed piece entitled “The Greenback Effect,”

“The United States is spewing a potentially damaging substance into our economy — greenback emissions. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt.”

The Euro zone is under tremendous stress. John Taylor, Chief Investment Officer at FX Concepts, one of the largest currency hedge funds, places the value of a German euro at six times the value of a Greek euro. Of course there is only one euro, and therein lies the problem. The Euro zone does not have any internal mechanism for adjusting the relative values of the various countries’ euro-denominated debt. This obviously cannot last. Ultimately the resolution is going to be up to Germany, which will have to pick up the majority of the tab for Greece, Spain, Portugal, Ireland and several other euro-laggards. Politically this will be very unpopular, but in the end it may be in Germany’s best interest to do so as German banks own large chunks of bonds issued by Greece, Spain, etc. Big bets are being placed for and against the survival of the euro, and the relative position of the dollar will swing widely as perception of ongoing euro viability waxes and wanes.


The Bank for International Settlements (BIS) put out a paper recently entitled “The Future of Public Debt” that has received a lot of attention. The short of it is that the current trajectory of public debt in Western nations is “unsustainable.” This is not really news, but an official report like this gives politicians an opportunity to pretend that something new has happened. Not that they needed an excuse, but Republicans have focused their impressive propaganda machine lately on deficits. The deficits are indeed troublesome. Since 2002 I have been writing about the inevitable consequences of irresponsible fiscal policy, and we are witnessing those consequences every day. But the truth of the matter is that the damage has already been done, and most of it was done when Republicans were in power. If Republicans were serious about deficits they would have done something about them when they were in power. Instead, when they had the chance to put our fiscal house in order they went on the biggest deficit spending spree in history.

Several Republican leaders have recently gone on record that any spending for social benefits, for example unemployment benefits, must be balanced by spending cuts elsewhere. However, they say, tax cuts for the wealthiest Americans do not need to be balanced by cuts elsewhere, even though the latter will add to the deficit just as surely as the former. So clearly the issue for them is not the deficits.

What is really happening, for those who are not aware, is that Republicans are deploying the second half of their “starve the beast” strategy, which is designed to defund and weaken government functions across the board, and especially to undermine entitlement programs such as Social Security and Medicare.

The deficit reduction theme has Democrats (as usual) cowering before the latest Republican onslaught. Regarding the sincerity of Republican concern over deficits, I refer the reader to Martin Wolf’s recent post, “The Political Genius of Supply Side Economics.” Martin Wolf is the chief economics commentator for the Financial Times. His opinions are highly regarded and sought after by senior policy makers, economists and money managers around the world.


Republicans continue to wage their war of attrition on all things Obama and all things Democrat. No consideration is given, nor is there any thought at all apparently, to the damage this doing to the country. What’s most troubling about all of this is that we really could use some loyal opposition; some Republicans who actually believe in something and have something constructive to add to the national debate.

Unfortunately, they have been quite successful with their strategy of obstruction and distraction, if the polls are to be believed. Americans generally seem to have forgotten completely who implemented the policies that led to the awful deficits, the failed wars in Iraq and Afghanistan, and the financial meltdown and recession through which we are still suffering. All is forgotten. A majority of Americans, apparently, are more concerned that Obama might be a closet Muslim, a Socialist, or maybe a Fascist, than with understanding the array of bad choices he has before him.

The reality is that Obama is a somewhat right of center moderate. His profile is much closer to that of Richard Nixon than Lyndon Johnson. As such he continues to disappoint his supporters, who are generally much more progressive than he is. He is certainly not the bold, visionary leader that was promised in his campaign. Gail Collins has an interesting take on Obama’s uninspiring style, entitled “The Boring Speech Policy.” So there may be hidden benefits to Obama’s process oriented leadership. Let’s hope so. Also, Eric Alterman has an in-depth piece at The Nation entitled “Kabuki Democracy; Why a Progressive Presidency is Impossible, For Now.”

One area where there is great concern among Obama’s supporters has been in his embrace of pretty much the entire Bush agenda for the war on terror. Also, after all the talk during the campaign about bringing transparency to government, the Obama Justice Dept has been especially aggressive in pursuing whistle blowers, even reviving cases dropped by Bush. And in the “can you believe it” category, White House aides have taken to meeting lobbyists at a coffee house across the street so the meetings don’t have to be disclosed in White House visitor logs.

Obama apologists are willing to overlook these matters, insisting that because Obama is a good guy, honorable and well-intentioned; we can trust that he is doing the right thing. Well, that may or may not be true. But here is the problem, especially regarding the war on terror issues. By “looking forward, not back”; by refusing to make amends for the abuses of the Bush era, and refusing to hold accountable the blatant lawbreaking of the Bush crowd, and then embracing the full range of positions and actions of the Bush arsenal for the war on terror (with the exception of waterboarding), Obama is sanctioning these violations and making the unambiguous declaration that the powerful who violate the law will not be held accountable.

As Jeb Koogler at Foreign Policy Watch recently put it in a piece entitle “On Executive Power, Obama as Frodo”:

“One has to wonder: what happened to the Obama that we saw on the campaign trail and in the Senate — the Obama who so vigorously advocated for the closing of Guantanamo, an end to rendition, and the restoration of habeas corpus? That man is no longer to be found.”

Glen Greenwald has also posted some in-depth commentary on this issue, here and here.

This has also been the case in the financial arena. The case against AIG executive Joseph Cassano, who took advantage of AIG’s AAA rating to issue hundreds of billions of dollars of “insurance” in the form of credit default swaps without the collateral to back them, has been dropped. Not one of the dozens of top Wall Street executives who knowingly participated in the biggest Ponzi scheme in history while counting on the “Greenspan put” to bail them out when things went south will be prosecuted. Nor will anyone in the CIA, Defense Department, or Executive who enabled and engaged in torture and even murder of “enemy combatants” while in custody be prosecuted, other than perhaps a few low level grunts who foolishly followed orders or encouragement to do such things.

All of this means that when the folks who so egregiously abused their power when they were last in power, when it was unclear whether they would be prosecuted for doing so and thus had some constraints on their actions, the next time they come into power they will know with certainty that there will be no accountability for their actions. If they violated the law with impunity when they were unsure of accountability, what will they do when they know there won’t be any? I don’t want to find out.

Also, if you want to read an excellent in-depth piece on the sorry state of the Senate, then “The Empty Chamber” by George Packer in the recent New Yorker is for you.


On the global scene there is good news and bad news. The good news is that China recently inked a major trade deal with Taiwan. Apparently the Chinese Communists have been satisfied with the progress of integrating Hong Kong through engagement, so they have decided to try the same tack with Taiwan. This moves the possibility of armed conflict to the back burner. Perhaps as China grows more confident in its regional dominance it will start to lean on North Korea to open up and join the family of nations. If that happens there will be little justification for continued U.S. military presence in the area. Realignment continues at a solid pace.

In the Mideast things are not going so well. The Obama administration has been trying to convince Iran to let go of its nuclear ambition, relying first on engagement and then on sanctions. Neither strategy has had much effect. Russia has been ramping up their trade with Iran to minimize the impact of the sanctions, and China is not co-operating either. Iran is in turn providing Hezbollah, Hamas and Syria with advanced weaponry and upgraded rockets, and ratcheting up the bellicose rhetoric against Israel. The entire Middle East is on a war footing. The next war is almost certain to be regional and we will be in the midst of it.

Jonah Goldberg presents the “war is imminent” argument in a recent Atlantic article entitled “The Point of No Return.” Robin Wright, also in Atlantic, rebuts Goldberg in a piece entitled “A Long Way From the Point of No Return With Iran.” And here is piece from an Israeli blog, The Promised Land, which takes issue with Goldberg’s conclusions.


There is not a lot to look to regarding opportunity right now. However, readers should take note that it is during such difficult times that new ventures get started that often grow into great companies. John Mauldin reminds us that Microsoft, Apple, Intel, cell phones and the Internet came to us courtesy of the recessionary ‘70’s. So this may be the time for experiments and startups. Also, I believe we are in an interest rate bubble, so to the extent that you need to borrow money (prudently), this is as good as you are going to get, ever. You might want to take advantage of these super low rates for as long a term as you can get.


There is a general sense of deterioration across the board, hence the title of this letter. Deflation is the dominant theme in the marketplace and Republicans are pushing hard to exacerbate the deflation. This could easily get out of hand, and I expect it to create a scare which will in turn cause an inflationary policy response. This is the long term scenario I have been expecting for some years and I believe we are getting fairly close to the end game. The damage has been done and there are no good solutions at this point. The hyper-polarized political insanity that has consumed the nation is making it virtually impossible to deal with a very difficult situation.

We seem to be unable to come together to deal with our problems and in fact are drifting farther apart. Those agitating for chaos are in the ascendant. There is no power on earth that can defeat the United States, but we are doing it for them. This is how empires cease being empires. As Pogo said, “I have met the enemy and he is us.”