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jk
07-29-06, 10:22 AM
Ithink we are living in a transition period. The last transition was from about 1914 to 1945 and involved 2 world wars as bookends to a global depression. The current transition will be backdated to about 1991 and the fall of the Soviet Union, or perhaps 1989 and the Soviet withdrawal from Afghanistan.

If, like last time, the transition takes about 30 years it won't resolve til 2020, so we're only about halfway done. We haven't had a huge war so far - just the 2 Iraq wars and the toppling of the taliban in Afghanistan, along with the intra-former-Yugoslavia conflicts, and some local conflicts without U.S. involvement such as the Chechnya war in Russia and various civil conflicts in Africa. The current Israel-Hezbollah war and the Sunni-Shiite violence in Iraq may be a taste of still more violence to come in the middle east.

A transition is the interregnum between one global order and another. The last transition in global power and order took the UK from being THE premier world power to being a second rank power compared to the U.S. and the U.S.S.R.

On 9/18/1949 [I just looked it up] the British pound was devalued from $4.03 to $2.80, a 30% drop in one day. Of course this was in the era of fixed exchange rates, and the pound had gone from being THE global currency to having its price pegged to the dollar, which became the new global currency. In recent decades the dollar peaked in 1985. [Perhaps 1985 will be marked as the beginning of this transition.] The dollar's devaluation will continue in a market driven way, with countertrend rallies, etc, but the dollar will become a second tier currency, or perhaps will be one of several globally utilized currencies for a while. And the U.S. will go from being THE world power to one of many powers, or perhaps even becoming a second rank power.

Transitions don't come easy. A new order can't emerge fully formed directly from the prior order. First there there must be a period of disorganization so that the forces, the flows, the capital and the resources can re-arrange themselves.

The last transition required 2 world wars and a depression. If we are lucky it won't be quite that bad this time around. It will be bad, but hopefully not THAT bad.

The Israel-Hezbollah war reminds me of the Spanish civil war - the overture to World War II. In the Spanish civil war, the Nazis supplied fascist Franco with the latest in military gear, while the USSR sent supplies and the democracies held bake sales [metaphorically speaking] to help the Spanish Republicans. The 2 sides played out in miniature the tactics and conflicts of the greater war that followed.

Now we have a US client, Israel, fighting Iran's client, Hezbollah, while Iran is itself the client of Russia and China. The Hezbollah-launched missile that hit an Israeli warship not long ago was an Iranian model of a Chinese silkworm shore to ship missile.

Meanwhile the US has supplied not-so-covert aid to the "color" revolutions in the former Soviet Union: the "velvet revolution" in the former Czechoslovakia, the "rose revolution" in Georgia, the "tulip revolution" in Kyrgystan, and most recently the "orange revolution" in the Ukraine. US troops are based in central asia, while China and Russia beef up the Shanghia Cooperation Organization to try and dislodge them.

The old order, stabilized by the cold-war, is dissolving. And in its place we have growing... chaos. There's a Chinese curse: "may you live in interesting times." Interesting times, historically, means turmoil, war and pestilence. We live in interesting times.

During the cold war we worried about a global cataclysm of nuclear war, which was avoided at least in part because of its global scale. Now we worry about nuclear weapons in a growing number of hands, the hands of rogue states like North Korea and possibly Iran, and the possibility that such weapons will get into non-state hands. Israel is fighting a war against Hezbollah, an organization, not a state. The non-global scale of a terrorist nuke is precisely what will allow it to be used.

I think the world held more danger during the cuban missile crisis, but I can't think of many other times that there was as much danger and instability.

So if we're lucky there will be small civil and local wars, and revolutions with low levels of violence. If we're lucky there won't be any nuclear bombs set off, and if we're only mildly unlucky we'll have only one or two nuclear bombings. And if we're lucky we won't have a full-scale global depression, but only recessions and stagflation, underemployment, bankruptcies and only hunger instead of starvation.

So this is our disorganized present morphing into our chaotic not-so-distant future. It makes our concerns about how to invest during this period look a little petty. But ok, let's be petty and worry about our miserable selves. What else can we do but try to survive as best we can while the hurricane rages?

Yesterday i came across an article by Gary Shilling, http://www.forbes.com/columnists/business/forbes/2006/0814/114.html
which says it's time to get out of oil and energy, and that a global recession will drop the price of oil $30-40/bbl. Given the hypothesized recession, this seems plausible. On the other hand, a crisis involving Iran could pop the price over 100. Shilling says sell now, but buy back at lower prices.

Also yesterday, ej posted a link to Bill Gross' latest piece, titled "the end of history and the last bond bull market."
http://www.pimco.com/LeftNav/Late+Breaking+Commentary/IO/2006/IO+August+2006.htm
In it, Gross argues that the sell off in bonds is over, and that we are now entering "the last bond bull market." This is a "primarily because of [the tightening cycle's] effect on housing and related repercussions on consumer spending and economic activity." [emphasis his] Gross doesn't worry about whether the inevitable slowing will turn into a recession. "Recession/no recession is really a faux decision to be entertaining at bond market turning points."

So the economy is slowing, further evidenced yesterday in the announcement of second quarter gdp growth of 2.5% compared to the first quarter's 5.6% So long rates will drop for a while [and maybe we'll see a rising equity market-jk]. Gross goes on to say, however, that "The important idea [in calling for the LAST bond bull] is that such a forecast speaks to eventual reflation, inflation, and declining bond prices sometime out there in 2009 and far beyond as the U.S. seeks to address its enormous future liabilities concentrated in social security, healthcare, and foreign holdings of U.S. bonds." These liabilities are what will make the coming bond rally the LAST bond rally.

In the interim, increased consumption by the developing world is pushing up commodity prices. But given the high levels of oil and gas in storage, even a mild recession could have significant but transitory effects on oil prices until stores are worked down. The longer term trend remains inflationary.

EJ, in a recent post, wrote "I continue to believe we are headed into a completely unique and chaotic economic and market environment." I agree.

Alfredo Dominguez
07-29-06, 03:03 PM
Good post. I don't buy the oil drop scenario, however. Oil and gasoline demand aren't that elastic. I don't see a decline in US summer travel taking it down that much, not to mention that such a view places more emphasis on the demand/supply frontier than the USD, which has more to do with the current oil price. What happened to the price of oil during the recession earlier this decade? In a stagflation, prices rise in the face of declining GDP. Don't get thrown off track.

jk
07-29-06, 03:40 PM
Good post. I don't buy the oil drop scenario, however. Oil and gasoline demand aren't that elastic. I don't see a decline in US summer travel taking it down that much, not to mention that such a view places more emphasis on the demand/supply frontier than the USD, which has more to do with the current oil price. What happened to the price of oil during the recession earlier this decade? In a stagflation, prices rise in the face of declining GDP. Don't get thrown off track.

it's worth reading the shilling piece. he's a smart guy, and the only guy i'm aware of who right on bonds from the early 80's on. he points to very high inventories in storage. add a recession, a recession deeper than the one in 2000 and more global in its impact, and consumption will drop. with prices set on the margin, taking high inventories with even slightly soft demand and down you go.

blazespinnaker
07-29-06, 06:32 PM
yeah, i didn't see "oil" once used in that post by Bill.

Not sure you can talk about bonds, inflation, and the fed without talking about oil.

jk
07-29-06, 08:02 PM
yeah, i didn't see "oil" once used in that post by Bill.

Not sure you can talk about bonds, inflation, and the fed without talking about oil.

i think the assumption is that if the economy slows globally, demand for oil will be reduced. anyway, gross doesn't care about oil in itself, he's interested in where long rates are going, which is understandable given the many billions in bonds that he runs.

blazespinnaker
07-30-06, 06:14 AM
i think the assumption is that if the economy slows globally, demand for oil will be reduced. anyway, gross doesn't care about oil in itself, he's interested in where long rates are going, which is understandable given the many billions in bonds that he runs.

well, i've been following gross particularly carefully over the last few weeks and he's been spending a lot of his credibility on predicting a pause in the fed rates (lots of appearances on bloomberg).

The wild card here that greenspan missed with his interest rate movements was the price of oil. you can even tell, when he left office, how he spoke in a rather alarming manner regarding it.

he had the housing situation all worked into his calculations, however, I don't think he realised that oil would become the inflationary issue that it has. and it is oil which might force the feds hand much to the suprise of everyone if it continues to heat up core inflation.

that being said, I (like gross) expect a pause in the rates. I just think you can't talk about the fed without talking about energy.