Thursday, August 21, 2008



There has been a big swing in the presidential race. McCain has quickly seen Indiana go from leaning democratic to a significant republican lead. He also has picked up small leads in Colorado and Nevada. The most recent Zogby national poll gives McCain a 5 point lead. The average poll gives Obama a slight lead which is likely to tighten or disappear as other polls are updated.

Over the next few weeks, the election pendulum is likely to swing from one side to the other. Obama is likely to pick up points during the democratic convention and McCain is likely to take them back during the Republican convention.

McCain is in the lead because of two issues. 1) He is the obvious choice for Commander in Chief. 2) He is for reducing energy costs by increasing the energy supply. Obama has appeared "in over his head" in international affairs and he is for spending huge sums on poor ways "to save the environment". He is among those who do not understand that the lowest cost way to produce clean energy is the most environmentally friendly way. Drilling for oil does effect the environment but making all the concrete and steel that goes into the thousands of wind wills needed as substitutes would do even more damage.

Obama and McCain have pretty much battled to a political draw as far as taxes go. McCain is for lower taxes and Obama is for higher taxes but Obama does a good job of selling tax fairness. Obama is willing to take money from "the rich" in order to pay for extra babies because he wins votes with such a program. The fact that births per thousand are three times as high among those who receive welfare payments is nothing but a fact. The political backlash for bringing up the fact is too great but facts are stubborn things (John Adams). The result of Obamanomics would be more children and substantially lower wealth per person. As Hillary has so well noted, it takes a village to raise a child. All Americans will eventually suffer economic duress under the Obama plan. The common retort is that Bill Clinton presided over rapid growth, but the fact is that Bill Clinton presided over reduced spending on welfare, increased trade and lower capital gains tax rates; the opposite of the Obama plan.


Numerous cartoons and editorials equate the invasion of Georgia with the invasion of Iraq. How silly! The US went before the UN and presented reams of evidence against Iraq. Much of the evidence, including the use of chemical weapons on Iranians, Kurds and Iraqi citizens, was proven to be true. Some of the evidence has never been proven but the US went before the international court and received the approval of the main body and the unanimous approval of the Security Council. The US acted in accordance with international law. Russia's invasion of Georgia was a multiple violation of international laws.

McCain warned of the danger about 18 months before it happened and again about a month before it happened. When it did happen, he quickly gave a strong well reasoned response. Obama waffled, which has has hurt him in the polls. The primary purpose of the federal government is to protect our sovereignty.

The invasion has temporarily taken the pressure off Iran. America and Europe have turned their focus on what to do about Russia. Since the invasion, a US missile defense system has been deployed in Poland and a defense treaty has been signed. Poland joined NATO in 1999. It became a member of the EU in 2004. Russia is not pleased to have a NATO country bordering Russia. Georgia has applied for membership in NATO. Russia cannot stand the thought of having another NATO country with Russian borders. According to international law, Russia has no say in the matter.

China makes the bulk of the news about economic development but the former Eastern Bloc countries and the former Soviet States have enjoyed substantial economic growth since the fall of the Soviet Union. Strong neighbors are not what Russia wants.

Poland is more than double the size of Georgia, which is smaller than the state of South Carolina. Poland's population is 8 times as large. Georgia is a mountainous country with no large cities. Poland's GDP a couple of years back was 620 Billion Dollars while Georgia's was 20 Billion Dollars; Poland's economy is 31 times the size of Georgia. The size does not diminish the illegality of the evasion by Russia. The real point is that the West has already strengthened its relations with former Soviet and Eastern Bloc States as a result of the unlawful invasion. When a Bear comes growling out of the woods, the homesteaders seek safety and comfort among their friends.

Russia overran Poland in the late 1700's and again around 1921. Germans overran Poland several times. Yet, Poland has maintained its identity, which includes its religious history. Poland is more than 90% Christian, mostly Roman Catholic.

The Big Swing has swung. The presence of US troops in Poland helps the country go about the business of democracy with reduced fear from being bullied by Russia. Russia has never tried to manhandle a NATO country, it certainly does not want to try to manhandle a NATO country with US troops. It will take time to sort out but Russia has lost more than it has gained by invading Georgia. (Unless, some compromise negotiations are necessary to get Russia into the WTO and to get the 123 Nuclear Agreement with the USA passed).

Russia has responded to the deployment of defense missiles in Poland by holding meetings with Syria. The indication is that Russia might sell advanced military equipment to Syria. Russian hardware is a poor match for the benefits of transit fees for oil and gas out of the Middle East. The bottom line is that it is economic strength that gives a nation power. The EU is the largest economy in the world, the USA is second and Japan is third. The economic trade pouring in and out of Poland is powerful stuff relative to a few missiles in Syria.

Russia agreed to sell Iran an advanced missile defense system long ago, but it has procrastinated. Russia, like the rest of the world, does not wish to permit Iran to posses nuclear weapons. It wants to complete the sale of defense missiles after Iran has agreed to surrender its nuclear bomb ambitions. Iran will be much better off if it agrees to sell oil and gas and quits trying to become a super power. Ironically, it stands a better chance of becoming a super power by developing its energy resources than by adding nuclear bombs that can never be used to advantage.

So, the big swing away from Iran is temporary. After a "cooling off", Iran is going to once again become the focus of the international community. It is in every nations interest to reach a peaceful settlement with Iran. Besides, the confrontation between the USA and Russia over Georgia does not change the mutual benefits contained in the 123 Nuclear Agreement. Passing the agreement though the congress may be much more difficult but, one should not cut off ones nose to spite ones face. Some way or another, I believe the 123 Agreement will be completed. Perhaps as part of a "global settlement" that includes the withdrawal of troops from Georgia.

The progress in regard to the Indian 123 Agreement has been remarkable. This has been and continues to be a very complicated negotiation. The original agreement was negotiated back in 2005. To make last minute adjustments work, an International Council of 45 nations must pass the deal without objection. Japan was recently won over. A presentation was made yesterday. A meeting of international atomic energy exporters is underway today. The prospects have come from nearly impossible to better than even odds. Should the international community pass the deal, the US Congress will have the option to pass it or to let it go forward without the participation of US vendors. GE, Westinghouse and many other US companies will push for passage.


Back in 2000, US short interest rates were at 6.5% and inflation was low. The US Dollar soared. At the time, UK short rates were at 6% and Eurodollar rates were at 4.25%. The Internet bubble popped, the economy was hammered and short rates fell. The worst of the economic slowdown was about over when the events of 9-11-2001 hit the economy hard. By mid 2003, US short rates were down to 1%, UK rates were down to 3.75% and Eurodollar rates were down to 2%. By taking a ride on the BIG SWING, pushing rates from the highest to the lowest levels, the US economy made it through some tough times. The UK and Eurodollar Land tagged along, experiencing more moderate swings.

Similarly, to prevent a fast moving train from jumping the tracks, by the middle of 2006, the FOMC slammed on the brakes. The FOMC rate had climbed from 1% to 5.25% and the US held firm on the brakes for 19 months (the US yield curve was inverted 19 months). During the time that US rates went from 1% to 5.25%, UK rates went from 3.75% to 4.5% and Eurodollar rates only went from 2% to 3%. It took until June 2007 for UK rates to go above US rates. By March of 2008, the US economy had slowed so much that rates were once again pushed down. The US 5.25% of 2007 was 2.25% by March of 2008. It is the opinion of many that the FOMC held rates low too long or high too long or both. The past does not matter except as a guide to the future.

The most recent decline in US rates has not been sufficient to provide another world wide swing because the UK and the ECB are still standing on the brakes. The 19 months of high rates in the US were insufficient to bring down world wide inflation. The UK and the ECB have continued to fight inflation; their rates have averaged about double the US rate for the past 6 months or so. The swing in Japan has not been as wild but Japan also still has its foot on the brakes. Real rates are deceptively high in Japan because inflation is lower than in other nations. As a result, the economies of Europe and Japan are slowing quickly. Both Europe and Japan are close to recession.

The combined GDP of Eurodollar Land makes it the largest economy in the world. The USA is second and Japan is third. In the USA, the FOMC has let off the brakes but tight credit at commercial banks is doing the braking for the FOMC. With the three top economies in the world braking, the demand for imported goods from the rest of the world is falling. China, India, Saudi Arabia and the rest of the world are being hit by the slowdown. The verification of this story can be found in the capacity utilization rate at US oil refineries last week, 85.7%! After Katrina, working US refineries ran flat out to achieve 90% utilization as repairs were being made. Today, the run rate is at 85.7% because demand is weak.


The current situation is very similar to that of 1990. As a result of the Gulf War, oil prices had soared, but the world was in the middle of a slowdown. Headline inflation peaked at 6.38% before oil prices rolled over. Within 4 months of the peak in oil prices, the average big stock had jumped 32%. The 32% is a deceptive number because massive numbers of oil shares fell. The big stock markets averages are weighted averages. There were many stocks that appreciated more than 100% in just 4 months in order to bring the total average gain to 32%. Just like the turn in 1990, in recent weeks, US small cap stocks have been outperforming big cap stocks, again, partly because the big caps include Exxon, etc.

In 1990, when oil prices fell, the real estate market turned up. Savings and loans and bank stocks soared. Some of them doubled and doubled and doubled again in three years or less. This time there has been a bounce in bank stocks that is still being tested while Fannie and Freddie continue to head toward zero.

However, there is much more going on than the pending bail out of Fannie and Freddie. For example, first time home buyers (anyone who has not owned a home in three years) are eligible for a $7,500 interest free loan from Uncle Sam. Accountants are now showing people how the credits can be used for down payments. A second example is the actions of the FDIC in regard to IndyMac customers. Hundreds of thousands of home owners are being offered better terms. Most of these homeowners want to keep their homes, they simply need to stretch out the payments a little.

Housing sales bottomed four months ago. Even some very weak markets, such as Orange County California are now experiencing higher sales. The world wide slowdown will bring lower interest rates and lower commodity rates. While it is true that the fall in oil prices will put pressure on the price of other goods because consumers will have more money to spend on other goods, the other items are not in short supply as has been oil. Inflation is too much money chasing too few goods which means that more goods are automatically available when spending losses its focus on energy.

Many pundits talk about the turn in home building taking another year or more. They could be right, but even new home construction bounced back quickly after prior recessions. Still, inventory of existing homes is the current sword hanging over the market place. As a result, bargains can be found. Yesterday, I learned that a condo at Myrtle Beach sold for less than 50% of the price that it sold for in 2005. Three hundred ninety thousand dollars worth of loss to the seller and a savings of $390,000 to the buyer.


After the "temporary embargo of Iranian oil" pushed oil prices to $147 per barrel, a sense of calm set-in. The "temporary embargo" proved two things; 1) the rest of the world can make it without Iranian oil, 2) the UN + 1 plans to use sanctions rather than military confrontation if at all possible.

There are unconfirmed reports that Russia is sending ships to "protect Syria" and Syria reports that it is considering accepting defense missiles from Russia. The increased tensions have pushed the price of oil back up.

These tensions only add to the economic problems. In the short run, the tensions have re-invigorated oil market bulls. In the long run, the tensions increase the logic of voting for drilling in America, voting for McCain over Obama, moving forward with nuclear power with haste, and continuing to pressure Iran to make a deal. The wisdom of having bases and troops in Iraq is highlighted by the understanding that Russia would run rough shod over the whole area if the EU and the US were to stand down. If you want to pay $10 a gallon for gasoline, let Russia get its choke hold on Middle Eastern oil.

The history of Georgia is interesting. While Poland has been repeatedly hammered by Russians and Germans, Georgia has been the stomping ground for Persians, Turks and Arabs. That is until Russia entered the territory some 90 years ago. Turks, Arabs and Persians have never been what you would call fond of Russians. Islamic tribes have fought Russians for decades.

Turkey does wholesale trade with Russia and encourages Russians to vacation at Turkey's resorts, but Turkey's oil pipelines carry oil out of the Middle East and into Europe. Russia covets pipelines, but (perhaps due to private communications between the US and Russia and Europe and Russia) stopped short of taking the pipeline that runs through Georgia. Iran is a close ally of Syria and Iran (Persia) would like to once again become the Persian Empire. It wants to own Georgia and beyond. Interesting also is that Georgia is 85% Christian and 10% Islamic. Clearly, Christian, democratic Poles and Christian, democratic Georgians want the Russians to go home. It is a thorn in Iran's side that Georgia accepts the military council of the Israelis.

The table has been set for some interesting political conventions and, alas, it is still 18 days before the congress comes back into session. Both parties are ready to drill. Democrats will not allow an up or down vote. Major issues are not going to be resolved during the first days of the return of congress. One of the firm deadlines is the fiscal year beginning on October 1.

Central bankers around the world are currently unified around the goal of "starving Iran out". The vote on drilling is being timed to occur around the deadline that has been given to Iran. Incumbent politicians will vote for a drilling bill at an opportune time, just as central bankers will release their strangle hold on the worlds economy at just the right time. The tough part for investors is the "hurry-up and wait". Even the Fannie Mae, Freddie Mac crisis will be solved at an appropriate time.

Hank Paulson has gotten what the investment banking community wanted. He has already announced that he will return to the private sector in January (Presumably back to Goldman Sachs). He is currently in control of the fate of Fannie and Freddie. The government can bail out or close these institutions at any moment. The bail out could be an infusion of capital that allows them to survive as crippled reminders of the folly of two headed Government-Private Corporations or the bail out could be the buyout by the government.