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December 3, 2009

In his West Point speech President Obama said, among others, that “Afghanistan & Pakistan are the epicentre of the violent extremism as practiced by al-Qaeda”. He was right, but only up to a point; for, while it may the ‘sharp end’ thereof, if one ‘follows the money’, one ends up in Saudi Arabia. A more fatal flaw in what was, within its limitations, a well-written, well-balanced &, of course, well-delivered speech was the fact he concentrated unduly on being a conciliator & not enough on being a political leader presenting a vision, as he did in his campaign (& selling a vision is far less hard than trying to please everyone). On the other hand, conciliation had to be perhaps his prime short-term domestic priority, given the split in his country, his party & his Cabinet.


In this ‘war’ the US has relied unduly on its military might. That  worked in Iraq; for it is flat ‘tank country’ as were the West- & North European plains in WW II. But it doesn’t in mountainous terrain; it blunts the edge of traditional military might & hands one to guerillas (thus over the centuries no one ever attacked Switzerland & in WW II a few ‘maquis’ could tie up entire divisions of German soldiers in France’s Massif Central). The US, like Moscow before it, took the wrong page out of Mao Tse Tung’s play book (i.e “Political power grows out of the barrel of a gun”) & ignored his admonition that “The guerilla must move among the people as a fish swims in the sea.” 

The battle for the “hearts & minds” is not an option, it is the only option,  especially in a country with a long history of suspicion of & hostility to, and a track record of successfully warding off, foreigners. And it isn’t won by flashing more foreign (camo) uniforms and depending on air superiority & local allies that don’t provide a modicum of good governance. General McCrystal recognized this when he recently told an audience about an American patrol that, after being alarmed by a couple of Afghans digging alongside the road they were on, relaxed when they found out it was just routine farm-related activity, to the point where they ended up helping them with it.  

Development is critical to the winning the hearts’ & minds’ battle. But it is a non-started when the other guts can destroy the schools as fast as they are built, kill the teachers staffing them & disfigure the girls attending them by throwing acid in their faces. And it requires public confidence that the changes are permant - which is why the President’s emphasis on a schedule for withdrawal was not helpful). All now depends on General McCrystal’s use of the new troops placed at his disposal, & of those already in place, and on the training that both the new troops & those ‘rotating in’ receive before leaving for Afghanistan. Ideally he should seek to turn the mountainous terrain to his advantage by concentrating his military capability on the security of the relatively limited number of prime ‘developable’ parts of the country, i.e. the cities & the key agricultural areas, & let the guerillas stew in their juice in the mountains. For if he can be successful in such a limited way, this in time will limit their ability ‘to swim like fish in the sea’ among the local population in a country where young men currently are said to be ‘volunteering to be suicide bombers in order to support their families’ (in contrast to Pakistan where a deep-seated dislike & distrust of government & the Americans, and a widespread resentment of the perceived US perversion of the country’s national identity & souvereignty, enable the insurgents to hide in the general population).


The Globe & Mail published data on Canada’s provincial- & federal government targets for emission reduction targets by 2020 & those put forward by Obama & the EU (from 1990 levels) :

        ∙ Newfoundland  - 10%  Saskatchewan  - 3%

        ∙ Prince Edward Island - 10%  British Columbia  - 14%

        ∙ Nova Scotia   -10%  Alberta   - 58% above 1990

        ∙ New Brunswick  - 10%  Canada   - 3%

        ∙ Québec   - 20%  US    - 4% (Obama’s 17%)

        ∙ Ontario   - 15%  EU    - 20%  

        ∙ Manitoba   - 6% (by 2012) 

The Washington-based Pew Center calculates the average industrialized countries’ emission target to be in the 13-19% range while the UN Intergovernmental Climate Change Panel has called for a 25-40% reduction off 1990 levels by 2020.  Small wonder that the developing countries aren’t convinced the developed countries are serious & that some Albertans are embarrassed . 

A propos Prime Minister Harper’s visit to Beijing, one commentator noted that the Chinese leaders have a unique way of simultaneously giving others the back of their hand as well as ‘face”. Thus they made him first endure what amounted to a public tongue-lashing for his past China policies & then handed him a prize, Approved Tourist Destination status (Canada was among the first to apply for it a decade ago but its tourist industry has been gnashing its teeth ever since while  dozens of johny-come-latelies, incl. the US, were given such status & Canada wasn’t). 

Yesterday’s Globe and Mail carried a headline in its Business Section “When fear strikes, we turn to the U.S. dollar - Investors don’t like the greenback’s weakness, and they’d love an alternative, but they haven’t found it yet.” This is the common wisdom; unfortunately it tends to be guided by what it sees in the rearview mirror rather than through the windshield. It’s true that investors, from governments through central banks & corporations to individuals, can’t find a single alternative to the US dollar. But they certainly are piling with great abandon & diversifying into a lot of different ones, incl.  gold & other commodities, other currencies, the ownership of US ‘real assets’, and farm land & real estate generally (I write this as gold is having a weak spell this morning, slumping 3% from US$1205 at the opening in the first two hours of trading, on sudden (& unwarranted?) expectations the Fed will start raising interest rates sooner than hitherto expected (& without regard for the implications for the global economy if the Fed were to do so).   



No. 340 - December 3rd, 2009 


    ∙ The common wisdom has been that the 1,300 year-long ice age in the Northern Hemisphere that got underway 12,800 years ago took a decade or more to get going. But mud core samples from Ireland’s Lake Monreach, which are unusually neatly layered, now cause some scientists to wonder if it may have happened almost overnight, or over at most two years. For when Lake Agassiz in Northern Canada broke its banks, it spilled more water than is now in the five Great Lakes into the Atlantic Ocean, cooling off the Gulf Stream in short order. They now worry about the rapid melt of Greenland’s ice cap. 

While most people believe ‘The soup is never eaten as hot as it is served’, risk management must assume ‘that whatever can go wrong, will go wrong - & will do so at the most inopportune time’).  


    ∙ A significant part of this debt is ‘sharia law-compliant’ (i.e. it pays no interest but joins lenders & borrowers into a sort of partnership). But there are no established rules for such debt as to who gets repaid first in a bankruptcy. Bondholders believe they have a secured position with respect to the underlying assets & should be repaid before the banks (rather than the other way around, the traditional order of things in bankruptcies). But the 237-page prospectus for a bond issue by Nakheel, Dubai World’s real estate subsidiary, specifies bondholders have no guarantee of “repayment of their claims in full or at all”, and under Dubai law no debt of the ruler or the government can be recovered by seizing their assets. 

Investors buying Dubai bonds assumed (rather foolishly?) that the emirate’s government would stand by them, no matter how riskythey might be, even there was no explicit guarantee. Big Mistake! The time is long overdue that investors are re-educated on the reality of risk; for it has  historically been shown over & over again that this is a key aspect of a period of deleveraging such as the global financial system is now egoing through.  So once risk-insensitive investors are likely in for some rude shocks; for ‘debt destruction’ is a key aspect of deleveraging. Elsewhere JPMorganChase said the Royal Bank of Scotland was the biggest underwriter of Dubai loans & HSBC has the “largest absolute exposure” in the UAE.  A sign of things to come may lie in the comment by Saudi Arabia’s richest individual, Prince Alwaleed bin Talal, to Bloomberg that “These banks are very mature banks and they have to differentiate between a corporate loan and a sovereign loan ... When things go sour, you can’t have some banks in the West going to Dubai and saying ‘oops’ and crying wolf and saying : ‘You should have guaranteed those loans.’ “  


    ∙ On December 2nd it made public the results of its most upbeat survey in two years, which reported that in eight of its twelve Federal Reserve Districts there had been improved conditions and/or some pickup in activity and/or even some new hiring. With inflation still believed tame, the rate-setting FOMC is expected at its mid-December meeting to keep interest rates at their record lows in the hope this will entice consumers & business people to step up their spending. But the overall employment picture remains dismal & the commercial real estate market is continuing to deteriorate even though the housing market may be starting to improve somewhat (albeit from rock bottom levels) across the country. 

Averages often obscure realities, in this case that there’s still a lot of pain out there, as well as problems not owned up to in the banking system. Economies are like car engines; both need to operate on all cylinders to perform satisfactorily. And while interest rate policy enables the central banks to choke off economic growth when public sentiment is euphoric, it is much less effective in reinvigorating economic growth when public confidence is in the dumpster when people are reluctant to take on new debt, even if it is free. This is basic economics : borrowing money makes sense only when the returns thereon, be they financial or emotional, exceed the cost thereof; so when people’s outlook is negative, even free money has little appeal. 


    ∙ In the Third Quarter the default rate for commercial real estate loans held by banks was 3.40%, up 0.52% QoQ, the highest since 1993's 4.1%, & the outlook is said to be “. And for CMBS (commercial mortgage-backed securities) the situation is far worse : in October US$32.55BN worth was in default, a 2.6% MoM, & 504% YOY, increase & 14x their low point of US$2.1BN in March 2007.  This is expected to go to US$40-50BN by March 2010 & the default rate to rise from its current 4.01% to up to 8% as some loans made in 2006 & 2007 are showing “signs of stress” & maturing loans are difficult to roll over. 

Everybody & his brother who knows anything about the state of the financial system, other than the ‘talking heads’, has been warning commercial real estate would be the next domino to fall (& possibly thereafter credit cards, car loans & ultimately the entire derivatives’ structure). 


    ∙ Many Albertans are asking questions about the political state & direction of their province & about Premier Stelmach’s ability to reinvigorate a long-serving government that seems to have lost its way & its vision.  The historical pattern of Alberta politics has seen decades of one-party rule during which the ruling party remakes itself several times, followed by its downfall when it fails to continue doing so, & its replacement, not by the traditional opposition but by something & someone new. The question now is if the far right-wing Wildrose Alliance Party will be that something & its leader, Danielle Smith, that someone. A Conference on Alberta’s Future is now being organized to address three key questions (that may well have relevance for every Western democracy) : What is your vision of Alberta’s future, How well is Alberta performing in key areas, and What policies & actions should be pursued if performance in any of the areas is deemed inadequate? And those key areas identified are the handling of public money, balanced economic growth (incl. the responsible development of the energy sector), environmental conservation, health & education, democratic participation & leadership on the national (& international?) level. 

Manning was the moving force behind the evolution, & the spiritual father, of Harper’s Conservative Party. He had firsthand experience with the Alberta phenomenon he describes : his father was a long-serving Premier of Alberta whose party succumbed to it under his successor when in 1971 Peter Lougheed became the first of what now have been have been four provincial conservative premiers in the past 38 years.     


    ∙ While Moscow claims it is “concerned” about Iran’s nuclear ambitions, it can nevertheless block any UN sanctions to bring it to heel by exercising its veto in the Security Council (as can China). Seeking to ensure it will continue to do so, during the November 30th visit of Russian Energy Minister Sergei Shmatko to Iran’s Bushehr nuclear power plant that Russia is building, Ali Akbar Salehi, the head of Iran’s Atomic Energy Organization, told reporters “Iran will need 20,000 megawatts of new (power) capacity  within the next 15 to 20 years and, for these projects, Russia will have a priority.” 

This came in response to a November 27th 25-3 vote on a motion by the 35-member Board of Governors of the UN’s International Atomic Energy Agency (with both Russia & China voting Aye) that censured Iran for covertly constructing a second (underground) uranium enrichment plant near the holy city of Qom. But on December 1st a ‘senior Russian diplomatic source’ in Moscow said that, while Moscow wouldn’t move as fast on harsher sanctions as the US & the EU, it would join any consensus on more sanctions against Iran (leaving it an out if China failed to join such a ‘consensus’). And this in turn, later that same day, prompted President Ahmadinejad to bluster on state television, criticizing Russia’s position and declaring sanctions would have no effect & no more talks with the West on the nuclear dispute were needed. 


(G&M, Patrick Martin) 

    ∙ Driving through West Bank towns one can see & feel the difference from a few months ago. Jenin has become a shopping destination for Israeli Arabs, Nablus’ historic market is packed with Palestinians from all over the West Bank, and Ramallah & Hebron are bustling cities where people enjoy normal lives. All this is due to the withdrawal of Israeli soldiers, & the removal in recent months of many checkpoints between Palestinian communities.  

Even the IMF agrees; for its has been forecasting a rate of economic growth for the West Bank that would make developed country politicians turn green with envy. But while the Chairman of the Canada-Israel Committee declared this was Netanyahu “signalling to his camp, and to the enemy, that he’s serious about the negotiations” (an interesting choice of words - ”enemy” rather than “Palestinians”  - about as helpful as Bush 43's use of the word “crusade” in his initial post-9/11 public comment). But it may be too little too late; for both Israeli hardliners & Palestinians now have ‘the bit in their teeth’, and to the latter these improvement may matter less than his intransigence on Jerusalem & continuing construction in the West Bank settlements (rather interestingly the article was accompanied by a photo of labourers on a construction site in the Gilo settlement near the town of Bethlehem, with the town itself in the distant background), and his insistence that any Palestinian state should not be given all the trappings of a souvereign state. And the observation that people in Hebron “enjoy normal lives’ is hard to reconcile with a situation in which 600 harline Jewish settlers protected by a strong IDF force lord it over 160,000 Palestinians.  


    ∙ Four months ago the Somali pirate community launched an around-the-clock sort of stock exchange in Haradheere, 400 kms. Northeast of Mogadishu, to enable the population as a whole to share in the pirates’ success by investing in cash or in kind in their endeavours & to make “piracy a community activity” (the local government already gets a cut to spend on infrastructure items like schools. Starting with 15 ‘companies’, it is now said to have 72, ten of whom “have so far been successful at piracy.” While every week gang members & equipment are lost at sea, business has been good : recently ransoms collected have ramped up from US$2-3MM to US4MM/month & one woman claimed to have  collected US$75,000 in 38 days on her ‘investment’ in kind, a rocket-propelled grenade.

This sounds like the early stages of a Ponzi scheme. Still, truth is often stranger than fiction. And this is how Lloyd’s of London got its start & what English merchants did in the 17th century when they invested in ships’ captains setting out for foreign lands or on piracy voyages : while they often were lost at sea, if they did make it back, the payoffs often were sweet. 



    ∙ The first day of the Dubai Air Show saw most interest in military hardware. The UAE is talking to France’s Dassault about buying Rafale combat jets, Kuwait & Oman are looking to update their fighter fleets & Saudi Arabia is thinking about boosting its order for Eurofighter Typhoons & has been talking to Boeing about buying F-15s. The only order for civilian aircraft came from Ethiopian Airliners that confirmed the purchase of 12 Airbus 350s for US$2.9BN, helping  to move the order book for the mid-sized jet above the 500 mark.  

This demand for military hardware is indicative of, & will do little to ease, the rising tensions in the region (caused by Iran’s quest for regional hegemony & nuclear superiority, and Israel’s hard line vis a vis the Palestinains &, rather ironically, its musings of perhaps having to take out Iran’s nuclear facilities).   


    ∙ After meeting with his French counterpart, François Fillon (President Sarkozy was on a trip to Trinidad & Brazil to prepare for Copenhagen), Putin proclaimed a breakthrough in the economic ties between Russia & France after he offered Électricité de France a 10% share in the hitherto 50-50 Gazprom/ENI-owned South Stream natural gas pipeline project that, when completed,  will move as much as 4.5BCFD of Russian natural gas to Central & Western Europe & received help for the heavily indebted Soviet-era car giant OAO Avto-Vaz. France is already one of Russia’s top energy investors, due to Gazprom’s partnership with Total in the ‘elephant’ US$15BN Shtokman gas field.  Also discussed was Russia’s interest in Mistral-type warships with amphibious assault- & tank-carrying capabilities. 

The South Stream gas pipeline will run from Beregovaya in Southern Russia 900 kms on the bottom of the Black Sea (through Turkish territorial waters so as to bypass the Ukraine) to Bulgaria, then across Bulgaria before splitting into two branches, one North across Serbia & Hungary to Austria, and the other West across Greece & underneath the Ionian Sea to the boot of Italy. First conceived in 2007, construction is to start next year & be completed in 2015. It appears designed to pre-empt the European market for the US-backed Nabucco pipeline, the idea for which was conceived in 2002 by five gas companies fro Austria, Bulgaria, Hungary, Romania & Turkeyas a way to move 2.3BCFD of Central Asian gas from the Caucasus across the territories of their countries to the same endpoint in Austria, bypassing Russia. So much for Europe becoming less dependent on Russian gas; but then, money talks & France always marches to its own drummer.   


    ∙ China’s economic clout is growing. It is the world’s third-largest economy, on the way to becoming the second & owns more US debt than anyone else. This is shifting the dynamic between the two countries toward one of greater equality. In evidence thereof Chinese officials have started hitting back at pressures to ease its currency controls; thus Liu Mingkang, Chairman of the China Banking Regulatory Commission, on November 15th told a finance forum : “The continuous depreciation in the dollar, and the U.S. government’s indication, that in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitration speculation ... (which has) seriously affected global asset prices, fuelled speculation in stock markets and property markets, and created new, real and unsurmountable risks to the recovery of the global economy, especially emerging-market economies.” 

Liu’s comment sounds as if the Beijing doesn’t have a high level of confidence that China’s current rate of economic growth is sustainable. This seemed also implicit in an announcement emanating from the Communist Party’s Politburo on November 27th that it had decided to “maintain the continuity and stability of economic policies, and continue to implement the pro-active fiscal policy and loose monetary policy” (a matter of the pot calling the kettle black?). Having China on an equal footing with the US will be only one of several bitter pills Americans are going to have to swallow during the foreseeable future, the only question being if they will react negatively by retrenching inside a ‘Festung America’ or positively by shaking off their indolence.  


(Dow Jones, Neelabh Chaturvedi)  

    ∙ Third Quarter GDP was up 7.9% YoY (vs. 6.1% in the Second) & an estimated 13.9% QoQ. India’s factories & mines have been busy as interest rate cuts & fiscal stimulus measures, and pay increases & bonuses for civil servants, have lifted the demand for automobiles, steel & cement. Even the agricultural sector, that employs 60% of the country’s work force but accounts for just 17% of its GDP, surprised analysts by chalking up a small gain despite adverse weather conditions in many of the country’s primary farm regions. 

Another straw in the wind that Asia is leading the global economic recovery. But it may also prompt the Reserve Bank of India to start raising interest rates to head off a possible burst of inflation. 


    ∙ There is evidence that China is surpassing India in the ability to speak English. In the wake of Prime Minister Harper’s visits to India & China, Canadians may be underestimating the potential of business opportunities in China due to an assumption of India’s quasi-membership in the Anglosphere (& a shared history as part of the British Empire?) For David Graddol, a British linguist, recently made public some of the results of a study done for the British Council that will be released in January which concludes that there may already be more people in China than in India who are conversant in English because it is being taught in China across a far larger socio-economic range than in India. 

India has at least two competitive advantages & one possible disadvantage for Canadian business : it has a modicum of a functioning democratic & legal system but on the other hand, its economy is far more domestically-, & less foreign trade-, oriented than China’s. 


    ∙ In the first ten months of 2009 remittances from Mexicans working abroad to their families back home were down 16% YoY to US$18.1BN & in October 36%, to US$1BN, from US$1.7BN a year earlier. 

Even in a US$1.1TR economy this annualized US$8½  reduction in remittances is going to hurt; for much of this money goes to grass roots consumers & has a big ‘multiplier’ effect.

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