Pop goes the weasel On the twelfth day NATO bombed Belgrade. It is not without irony that this Administration which went to great pains to inform us that the Iraq bombings would cease prior to Ramadan chose to ignore the pleas of the Pope to cease for the most holy of Christian holidays. A coherent foreign policy has never been a strong point of the current Administration. Indeed one could well characterize it as an improvisation laced with confusion and tempered with self-righteousness.
But to choose the Balkans as its military proving ground with its history of internal strife dating back at least six hundred years shows a singular disregard for the lessons of history.
The U.S. military expressed deep reservations regarding involvement. In the April 5th edition of the Washington Post, they complained about what they saw as "a lack of long-term vision for the Balkans and questioned whether US national interests there were strong enough to merit a military confrontation." These misgivings were obviously disregarded.
In the wake of the bombings the Russians were vociferous in their attack. Prime Minister Primakov stated "I want to repeat that the barbaric attacks by NATO are a tragic mistake. They not only fail to stabilize the situation in he Balkans, but lead to directly the opposite results." The Russian news agency TASS claimed that the US was "using Yugoslavia as a test range for secret means of destruction." The military said that the bomb generates an electric impulse similar to electromagnetic fluctuations caused by a nuclear explosion. "It was created in Los Alamos and is aimed to destroy radio electronic equipment."
The Pentagon refused immediate comment but subsequently allowed that this was the case.
Perhaps more insidiously Yugoslavia and Iraq have signed a cooperation agreement. The British Foreign Office confirmed the report first published in the Telegraph. In return for rebuilding Iraq's air defenses and making its jets airworthy, Saddam has promised to provide oil and cash to Serbia.
What this means is the U.S. is conducting protracted air campaigns on two fronts. The prolonged effort in Iraq while not ineffective is essentially a stalemate. A similar process in Yugoslavia can only sap U.S. resources and eventually strain domestic support and the NATO alliance. This was confirmed in today's Wall St. Journal: "The Pentagon has diverted air power that had been used to patrol Iraq skies, forcing it to shift some ships from Japan and leaving a carrier gap in the Pacific."
There is every indication of an escalation in hostilities with helicopter and artillery to be moved to Albania. Meanwhile in an effort to placate the Russians the IMF has effectively approved news loans for Russia. Russia media reports say that the IMF will give Russia $4.8 Bln in four installments over the next year (WSJ March 30th) It noted that Kosovo was a catalyst as it has accelerated the process because of Russian opposition to NATO air strikes. If this seems an odd quid pro quo consider that simultaneously the Russians further diluted the settlement of frozen Treasury bonds worth $1.5 billion. As one foreign banker put it "they've already stolen 95 cents on the dollar. They're just stealing another penny."
The bottom line is that Russia's economic failure has been redeemed by political means and it has a bargaining chip with which to extract concessions from the West.
A mix of signals is also coming from the Agriculture Department. US Agricultural Secretary Glickman said last week that there was "some indication" that Russia might need additional soybeans and soy oil as part of an additional food aid package. Speaking at a conference he allowed that no specifics on a second package had been discussed but "they are interested in another large package" and, "we're going to move aggressively as we can on this." However the next day his special advisor on trade Dr. Isi Siddiqui said before discussing further aid, "we want to see how the first shipments go and that they reach their target." We might also mention that Indian PM Vagpayee has called for a new "axis" to oppose NATO action which would include India, Russia and China.
We doubt that you have to hold your breath waiting for this to happen but it does give China leverage in dealing with the U.S.
China's Army Daily stated that "Every indication is that it will be hard to avoid sending in ground troops; otherwise it will be impossible to conclude this war." China's media has kept up a strong anti NATO campaign since the start of the air strikes. At the same time that this was being published over the Easter weekend China's Vice Minister of Trade flew to the U.S. to try to conclude a deal on the WTO entry prior to Chinese Premier Zhu Rongji's arrival on Thursday.
Some of the concessions won so far include allowing foreign banks full local currency operations within eight years (italics mine). Other obstacles remain in the areas of insurance, agriculture and tariffs on chemical imports. This begs the question, will China get its membership in the WTO after thirteen years of negotiations in the same manner that Russia has procured funds from the IMF?
The dollar is moving to new highs for the year. The dollar index is currently at 100.74. It is in a position to move higher and test the highs made last summer.
Dr. Neville Bennett of Christchurch New Zealand notes that last week Dr. Don Brash, the Governor of the Reserve Bank (New Zealand) urged favorable consideration of a currency union with Australia, reversing his views in January. At the same time Japan's Vice Finance Minister, Eisuke Sukakibara warned that turmoil in financial markets was not over and called for a peg to a basket of currencies. Japan's finance minister has estimated that annual currency trading represents $375 trillion vs. annual world trade of $11 trillion. It is against this backdrop that the world is attempting to develop alternates to the dominance of the dollar. So far these have met with little success. The euro has traded to a new low under 1.07 down 10% from its debut. But the fact that Sakakibara continues to attack the IMF's "shortcomings" is a thinly veiled attack on the dollar and the idea of an "Anzac dollar" indicates the concern that Central Banks worldwide have over dollar hegemony.
The financial and commodity markets so far have reacted to the global strife with remarkable equanimity. Or in the words of Alfred E. Newman, "What me worry?" Specifically the equity markets have moved higher albeit on thin breadth and leadership. As the WSJ put it, "the average stock mutual fund wasn't invited to the Dow 10000 party, but those that focused on technology and growth still found reasons to celebrate." More specifically Morningstar noted that large growth funds gained 28% for the last twelve months while "small value" declined by 22.7%. They noted that this range "has never been close" for the twenty years that they have data.
The Internet stocks have been the stars in this firmament. In a WSJ article headed "Amazon's CFO Sells Investors on the Merits of Losses" [the company recorded a loss of $124.5 million on revenue of $610 million in 1998.], one analyst gushed "since their business model doesn't work you have to suspend belief…you basically have to trust them." (WSJ March 25, 1999)
The U.S. equity markets as measured by the S & P has so far held its March 19th high. It is expected that this level will be tested this month but we expect a decline from the levels no later than the end of this month. Meanwhile commodities have remained mired in the depths of depression era price levels. There are indications that this is about to change. The CRB spent the month of March in a broad uptrend. This was reversed last week and it is currently holding above the 190 level. Not part of the rally were gold and silver which have continued to test lows.
Much has been written regarding the outstanding short position in the gold market. It is this writer's view that the gold carry trade has long ceased to have any productive function other than to allow the hedge funds and bullion banks a cheap source of capital. The counterparty risk management group which includes Chase Manhattan, Deutsche Bank, Goldman Sachs, Morgan Stanley Dean Witter and Credit Suisse First Boston plan a report this Spring. According to Derivatives Week this "will deal with credit and market risk reporting, close-out procedures and dispute resolution as well as the possibility of a master netting agreement."
One problem which arises is when your counterparty goes bust, or as the newsletter so delicately puts it "the difficulties of early termination when a counterpart has filed for bankruptcy." Participants grappled with the problem of what these positions were worth. Or again in the derivative vernacular "participants discussed the difficulties of getting market valuations for outstanding positions when a major player defaults." Someone suggested the obvious. That the writer of the derivative state the value of the contracts. Some parties reacted to this with alarm as it "could reveal the contents of their trading book." One approach was suggested by Goldman Sachs, specifically "breaking up the book and including dummy trades as a red herring." A novelistic approach to valuation if ever there was one.
What the reader might ask what do derivatives have in common with the plight of refugees in the Balkans? We would argue that the two are inextricably linked by a mindset that believes all risk can be hedged. In effect there is no conception of fear. Risk has been abolished courtesy of the Federal Reserve, the real counterparty to all these derivatives. This "too big to fail" policy allows uneconomic enterprises to continue in business, it matters little if they are companies or countries. But this underwriting by the Fed is what created the exponential increase in foreign exchange trading to the point where, as noted above, $375 trillion is traded on a base of $11 trillion. Now that's leverage that even LTCM could be proud of.
The Federal Reserve can only get away with this because the U.S. is the world's lone superpower. This supports the reserve currency status and despite, or rather because of, the yawning trade deficit domestic US prices remain stable. The implication is that the Kosovo situation is a political example of the same "too big to fail" doctrine. The fate of the dollar rests on the outcome. Too many dollars worldwide and the constant Fed pumping has succeeded in destroying any rational means of economic calculation. Excess goes unchecked.
The military risk can be hedged with aid from the IMF or trade with the WTO. The financial risk can be hedged with derivatives. And until the dominance of over the counter derivatives is questioned the universal hegemony of the dollar is assured. What will change this situation? It is this writer's opinion that the hubris that allows policy makers to countenance no possibility of failure in and of itself sows the seed of failure. It was the French writer Michel Leiris who stated most succinctly that human grandeur is intimately linked with futility.
Greg Pickup
Gpickup@ix.netcom.com8 April 1999
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