Monthly Archives: August 2012

Mexico’s Strategy

Mexico’s Strategy

August 21, 2012 | 0900 GMT


By George Friedman

A few years ago, I wrote about Mexico possibly becoming a failed state because of the effect of the cartels on the country. Mexico may have come close to that, but it stabilized itself and took a different course instead — one of impressive economic growth in the face of instability.

Flash Point: Europe is fixed! Not!

We received this note from our friend JR that echoes what appears to be a common sentiment.

This is simple. If the ECB sets rate caps on long-term rates then the solvency crisis is essentially over. This would essentially be a pseudo guarantee of bond markets with the ECB’s backing. This would almost certainly bring private investors back to these markets and help fund the governments. So we eliminate the solvency crisis. That’s a HUGE first step.

We will argue that the solvency issue is not resolved but simply kicked down the road. That in turn opens up a rarefied space we haven’t seen commentary or speculation on yet.

Flash Point: QE Coming

We’ve decided to initiate an ongoing series of short notes that address a single point. We have long been of the view that QE has no longer any significant impact on the economy and therefore no central bank (CB) will embark on more. We note that QE has major (economic) impacts on markets but this translates into little impact on the economy. We have written extensively on this before. We will summarize why QE will have no impact on the economy and present our view why in fact QE will come.

The only real tool CBs have to stimulate the economy is their control of interest rates. Lower rates encourage borrowing and spending leading to economic growth. Control at the front end of the yield curve was broken when the zero bound was reached (ZIRP – do a search on this site). QEs (note that the FED definition of QE includes the requirements that interest rates be at zero) in various forms were then used to lower rates across the curve. Later ones addressed the long (30-year) bond to lower mortgage rates with an insignificant effect on the housing market.

In short, QE has reached its limit in being able to affect the real economy which is why we have argued that the Fed in particular will not engage in more of it. The reason for this we have detailed in other posts: the consumer who is responsible for 70% of GDP in the US has reached a debt ceiling. He has no capacity left for borrowing more. Moreover as we have described, this condition (high debt among all players in the economy) will lead to reduced growth and lower GDP for decades.

For support of these points see Bloomberg yesterday – Banks Use $1.77 Trillion to Double Treasury Purchases:

  • There’s all sorts of good long-term developments that are occurring on household balance sheets, but you sense the Fed would like them to be not quite as thrifty and instead put a little more money to work
  • It’s a function of inherently weak demand for loans and that relates to inherently weak demand in the economy, … Consumers, households, businesses: they’re paying down debt, they’re saving money, they’re not borrowing. They don’t have an appetite.
  • Household purchases, which account for about 70 percent of GDP, grew at the slowest pace in a year, according to the commerce department’s report on GDP.

The Europeans, however, are using monetization, of which QE is one form, to purchase the sovereign debt of peripheral countries whose yields are out of control. The latest plan by the ECB to cap interest rates is described by Ambrose Evans-Pritchard in Germany backs Draghi bond plan against Bundesbank. If Mario Draghi gets his way, this will result in massive open-ended purchases of Italian and Spanish debt initially and several more countries ultimately. This of course will require a massive printing of euros, dropping its value, possibly precipitously.

The Fed will likely have to respond in kind to maintain a currency alignment that is not destructive to US export industries. This falls into the area of currency wars that Jim Rickards has lately been pounding the table about to promote his new book on the subject (Reserve Bank of Australia Under Pressure, ABC NewsHow China Is Driving Federal Reserve Policy). His argument is the Fed will have to entertain some form of QE such as GDP targeting in some kind of an open-ended policy, in an effort to combat the Chinese yuan.

The market has largely priced in (we recently saw an 80% figure: BofA: QE3 is 80% priced into the markets) QE3. A clear signal from the Fed that there will be no QE will cause a sharp equity correction. This would not sit well with a weak economy in front of presidential elections. On the other hand, to announce QE3 would have the appearance that the Fed had abandoned its neutrality to support Obama. Look for more equivocating similar to what has come out of the last few FOMC meetings, to come out of the Jackson Hole conference this weekend.

Ultimately the fed will probably have to intervene from the currency market rather perspective rather than the job market perspective (we have shown how QE has had little or no effect on the unemployment numbers). However the latest FOMC minutes show a growing view that more may be necessary and relatively soon (Zero Hedge: FOMC Minutes Indicate No Shift In Fed’s Views, Even As Many Members See More Easing Likely Warranted):

Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.

This sentiment has been slowly but steadily growing over a number of FOMC meetings.


Momentum is moving in the direction of massive ECB bond purchases and monetization. Germany may yet block the initiative but the signals are becoming if anything, more mixed. The Finns may prove to be the source of any effective block to the strategy. They are a small player but have taken very hard positions all along and recently stated effectively ‘no more money’. We think the ECB at this point may prevail and the result will be called QE in some eurozone parlance.

Pundits keep saying Bernanke needs an economic event such as a really bad non-farm payroll number, to justify a new QE program. We think the Fed should know that they really have no leverage left over unemployment despite this being one of their mandates. However, the increasing sentiment towards some form of stimulus intervention suggests they think they still have a card or two left to play. They may try to drag it out hoping for signs of a real recovery. Eventually they will have to decide which side of the fence appears to have the greener grass (less risk or pain). The easiest route is more QE. The currency angle is a wildcard. In either case, we think they will probably announce something by year end.


Since posting this we have found support for argument on the limitations of Fed policy from Jeffrey Lacker, president of the Federal Reserve Bank of Richmond. Reported in USNews, in an interview with The Associated Press, he said that the Fed can only do so much to lower the 8.3 percent unemployment rate. There are a lot of people overestimating the extent to which monetary policy is capable of having any sustained effect on growth or labor markets.

Targeting Tribal Leaders: A New Militant Tactic in Sinai

Targeting Tribal Leaders: A New Militant Tactic in Sinai


By Ashley Lindsey

Militants killed Egyptian tribal leader Khalaf al-Menahy and his son Aug. 13 as the two were returning from a conference in east Sinai organized and attended by tribal leaders to denounce militancy, according to Sinai security forces. The senior al-Menahy was a prominent proponent of bolstering the Sinai Peninsula’s representation in Egypt’s parliament and of improving security in the region. He also was a prominent sheikh in the Sawarka tribe, said to be the largest in Sinai. Following his burial Aug. 13, the tribe vowed to seek vengeance.

This is the first reported case of militants attacking tribal leaders in Sinai. It comes soon after an attack on Egyptian security forces Aug. 5 and an attack on military checkpoints in northern Sinai on Aug. 8.

Although the militant tactic of targeting tribal leaders is new to Sinai, the tactic has been common in conflict zones in the Middle East and South Asia, such as in Yemen, Iraq and the Afghanistan-Pakistan border region. Though it can offer many benefits to these militants — including weakening the targeted tribe and possibly leading to its co-option — these kinds of attacks tend to only succeed in zones with little government control and against tribes that cannot effectively retaliate. Examining similar instances of this tactic thus provides a helpful tool for assessing the consequences of attacks against tribal elements in the Sinai Peninsula.

Feeling a Little Punchy?

We Canadians have been told by our government how we are “Punching Above Our Weight” (Department of Foreign Affairs); also by our Finance Minister, Jim Flaherty.

So what does it mean? The Phrase Finder gives the meaning of the expression as competing against someone who you are no match for. Before we consider whether this is an indication of bravery or stupidity or something else we should check to see if we have any comrades in arms, so to speak. It turns out that we have.

According to the big kid on the block, Denmark punches above its weight also. And wait, so does Norway, … and the Netherlands, and Ireland, and the Philippines. The BBC news doesn’t want the UK to be left out:  UK’s world role: Punching above our weight. Let’s not leave out South Africa: Punching above our weight, and Australia: Australia, Punching Above Our Weight.

Even regions within countries such as the Government of South Australia are feeling scrappy: Punching above our weight.

To see others who punch above their weight and some who punch below their weight, read Over-achievers and under-achievers.

We suspect that the need to be seen to punch above one’s weight stems from a feeling of inadequacy and insecurity – the need to have to prove something to someone. The problem is that a good part of the world is feeling the same way so the effort is somewhat denigrated. If everyone is punching above their weight, what’s accomplished other than a waste of lives and resources?

And if we hear the phrase used one more time we may throw up – or start punching above our weight.

A Floor on CO2 Reduction

From What Is Your Carbon Foolprint?, looking at the CO2 maximal concentrations at the peak of the previous three inter-glacial periods in Figure 1, the number is estimated at an average of about 280 ppm. This is the CO2 generated by the natural temperature increase.

Looking at the current inter-glacial warm period since the last ice age, we would estimate the average CO2 maximum at about 260 ppm. With the current (as per the graph) CO2 concentration at 383 ppm, if we assume the different is anthropogenic, then the best reduction we could hope to get would be of about 180 ppm. This of course would necessitate the cessation of all human activity.

We throw out this thought as we haven’t encountered it elsewhere.

Stratfor Geopolitical Weekly: 20120814

The Israeli Crisis

August 14, 2012 | 0859 GMT

The Israeli Crisisis republished with permission of Stratfor.”


By George Friedman

Crises are normally short, sharp and intense affairs. Israel’s predicament has developed on a different time frame, is more diffuse than most crises and has not reached a decisive and intense moment. But it is still a crisis. It is not a crisis solely about Iran, although the Israeli government focuses on that issue. Rather, it is over Israel’s strategic reality since 1978, when it signed the Camp David accords with Egypt.

Perhaps the deepest aspect of the crisis is that Israel has no internal consensus on whether it is in fact a crisis, or if so, what the crisis is about. The Israeli government speaks of an existential threat from Iranian nuclear weapons. I would argue that the existential threat is broader and deeper, part of it very new, and part of it embedded in the founding of Israel.


In an effort to try and post some good news, we reference Ambrose Evans-Pritchards’s article of Aug. 7, Global slump risk falls as world money rebounds. In it he suggests that a measure of the global M1 money supply has turned up and that because the M1 data leads industrial output by a few months, we may expect an economic upturn in the fall. Here’s the graph (click to open in a new window to enlarge):

Guns & Bullets

While Toronto city councilors debate variously banning guns and bullets for their own constituents (and others) within a larger national debate (Adam Vaughan calls for Toronto bullet ban), the inquiring reader may wish to put the debate in context. This info-graphic gives a global picture of each country’s import and export trade in small arms and ammunition. It’s quite a beautiful work of art covering such a deadly subject. The national interest in protecting the export revenues from this trade guarantees that any attempt to interfere with it is  futile. This of course means the efforts by certain segments of the population to prevent citizens from owning guns and particularly children from possessing anything that resembles a weapon, is an equally futile and misguided exercise.

Stratfor Geopolitical Weekly: 20120807

Financial Markets, Politics and the New Reality


By George Friedman

Louis M. Bacon is the head of Moore Capital Management, one of the largest and most influential hedge funds in the world. Last week, he announced that he was returning one quarter of his largest fund, about $2 billion, to his investors. The reason he gave to The New York Times was that he had found it difficult to invest given the impossibility of predicting the European situation. He was quoted as saying, “The political involvement is so extreme — we have not seen this since the postwar era. What they are doing is trying to thwart natural market outcomes. It is amazing how important the decision-making of one person, Angela Merkel, has become to world markets.”

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