Financial Doombattery And Kennan's "Quotation"  

I came across the latest installment of extreme financial doomerism from the Leap 2020 guys this week (whom you will hopefully remember got the starting slot in my "Day Of The Doombats" post back in the day).

According to LEAP/E2020, the end of the third quarter of 2008 will be marked by a new tipping point in the unfolding of the global systemic crisis. At that time indeed, the cumulated impact of the various sequences of the crisis (see table below) will reach its maximum strength and affect decisively the very heart of the systems concerned, on the frontline of which the United States, epicentre of the current crisis. In the United States, this new tipping point will translate into a collapse of the real economy, final socio-economic stage of the serial bursting of the housing and financial bubbles (1) and of the pursuance of the US dollar fall. The collapse of US real economy means the virtual freeze of the American economic machinery: private and public bankruptcies in large numbers, companies and public services closing down massively (2),

A revealing harbinger: from March 2008 onward, the US government will stop a service publishing its economic indicators due to budget restrictions (3). Those who read the GEAB N°2 (02/2006) and included Alert certainly keep in mind our anticipation which connected the upcoming fall of the US dollar with the US Fed's decision to cease publishing the M3 indicator. This new decision is another clear sign that US leaders are now anticipating a very bleak economic outlook for their country.

In this 22nd issue of the GEAB, LEAP/E2020's experts try in particular to anticipate very specifically what will come out of the collapse of the US real economy for the United States themselves and for the other regions of the world. Meanwhile our team presents five sets of strategic and operational recommendations helping to protect oneself from the upcoming deterioration of the global systemic crisis.

While the LEAP 2020 guys are Europeans, I occasionally wonder if some of the "Long Emergency" style doomerism emanating from the US is a reaction to the ongoing demise of George Kennan's post war "pattern of relationships" for maintaining the enormous position of economic "disparity" the US found itself in after the second World War.

I sometimes think of the outcome of this as a form of the "Dutch Disease" - instead of being dependent on income from a single depleting resource, the US became dependent on (and wasteful in its use of) a number of depleting resources. Now that period of dominance is waning with the rise / resurrection of Europe, China, India and Russia, and the financial costs of maintaining oil dominance via the Iraq war and the associated "war on terror" help to cripple the US economy, this dependence has become a huge liability. Resource depletion, particularly in the case of oil, makes the situation even worse.

The end result of this is that US based doomers may see through their looking glasses much more darkly than those elsewhere - because the adjustment the US faces will most likely be more severe.

In its favour however, the US still has a large, well educated and creative population (there are some exceptions to this of course), and a reasonable endowment of native resources which should still make for a prosperous economy once a number of adjustments have been made.

The neo-marxist article I linked to yesterday, theorising about dominant capital groups within economies and noting the strange cycles that the oil industry goes through in terms of its dominance relative to other sectors (I'd love to see an overlay of the same data for the military-industrial complex on that chart), made me wonder what will happen if the Democrats - largely beholden to a different set of capital groups - manage to seize control in the US elections later this year. It may well spark a clean tech boom, which would help initiate a lot of the adjustments required, and greatly weaken the capital groups that have been wreaking so much havoc at the same time.

Anyway - enough rambling - when I went to look up the famous Kennan quote about his institutionalised system of disparity, my Google query popped up another one of those fascinating essays from Gilles at Swans - this one noting that Kennan has usually been taken out of context.

"We have about 50% of the world's wealth, but only 6.3% of its population. ... In this situation, we cannot fail to be the object of envy and resentment. Our real task in the coming period is to devise a pattern of relationships which will permit us to maintain this position of disparity. ... To do so, we will have to dispense with all sentimentality and day-dreaming; and our attention will have to be concentrated everywhere on our immediate national objectives. ... We should cease to talk about vague and ... unreal objectives such as human rights, the raising of the living standards, and democratization. The day is not far off when we are going to have to deal in straight power concepts. The less we are then hampered by idealistic slogans, the better."
—George F. Kennan, Policy Planning Study 23 (PPS23), Foreign Relations of the United States (FRUS), 1948

You've all seen this quotation cited countless times on Web sites, listservs and other mailing lists, from the left to the right, and everything in between. Simply google George Kennan, PPS23, and you'll get an idea... Problem is, it's a truncated quotation, patched together from various parts of the original text with ellipses, and taken out of context. It is more than time to debunk this little assemblage. One should not have to resort to this kind of fabrication, either out of sloppiness or willfulness, to elaborate on conjectural analysis. To use and reuse this misquotation does a disservice to all. Please, people, can you check your sources?

George F. Kennan recently died (March 17, 2005). He was 101 years old. Kennan, whether one endorsed his view of the world or not, had a sharp and honed mind; he was a prolific writer with literary skills rarely encountered at foggy bottom (see "George F. Kennan on the Web"); and he was credited for having fathered the containment strategy of the former Soviet Union, which may be giving the man too much credit -- the entire US power apparatus was in the containing mode -- but it appears that Kennan did coin the word "containment" (though I can't certify this contention) and he wrote, aside from PPS23, two important secret (at the time) documents: the February 22, 1946 Telegram from Moscow and "The Sources of Soviet Conduct," published in the July 1947 issue of Foreign Affairs under the name X -- documents that greatly contributed to shaping the US strategy after WWII. These documents have long been analyzed, discussed, parsed, deconstructed and interpreted by legions of historians and political pundits.

Mr. Kennan was a realist (and some suggest a pessimist) as opposed to faith-based neocon Wilsonianism. He eventually left the State Department to pursue a scholarly career at Princeton; was generally opposed to the Vietnam War; and even managed to express his dissatisfaction with Bush's Iraq crusade (again, he was a realist). Upon his death, obits ran large in the mainstream media as well as in the "alternative press" (honestly, I'm having a harder and harder time figuring out the alternatives offered by the majority "alternative press," but this is a story for another time...). Anyhow, the alternative press made ample use of this "quotation" (these are not scare quotes; simply the proposition that one can make up a "quotation" by assembling bits and pieces of what someone actually said, or wrote, in order to further one's line of thinking, a.k.a. ideological preferences according to one's frame of references).

Alexander Cockburn posits ("The Passing Show," AVA, March 23, 2005) that Kennan "will be best remembered for his self-consciously 'realistic' assessment in those postwar years, in State Department PPS23 that, [enter quotation]." In his latest Anti-Empire Report (#19, March 21, 2005) the ever-sharp Bill Blum has an entry on Kennan that includes the PPS23 quotation (see my Blips #15). Even Louis Proyect posted the NYT obit on Marxmail, beginning with the quotation... (See Marxmail archives.) The source is properly indicated, but then, how many people go the source...? And so like some kind of a meme, the "citation" propagates all over Cyberspace...and not just in Cyberspace...but in books, and special reports like that of John Pilger's "Breaking the Silence: Truth and Lies in the War on Terror." ...

What did Kennan actually write? (Note, I've bolded the passages used in the quotation) ...

Once the full quotation is read, one can engage in interpretating, parsing the text according to the historical context and one's own intellectual inclinations. (It is worth noting, especially in light of the current US strategy in the region -- e.g. pushing Japan to re-arm...besides encircling China, and supposedly wanting to elevate India to medium superpower status -- that Kennan's recommendation in regard to Japan has been followed almost to the letter for half a century, while his recommendation regarding Taiwan has been ignored.)

The issue here is not to defend George Kennan, or what he actually meant, but the accuracy of one's sources. While Kennan eventually regretted some of the positions he had taken and the strategies he had advised, one cannot forget that he initiated, or was an ardent proponent of, the covert operations launched by the CIA during the Cold War and thus carried a moral responsibility for the deaths or overthrow of many courageous leaders, from Iran's Mohammad Mossadegh to Chile's Salvador Allende... A brilliant thinker, blessed with the ability to doubt and acknowledge his mistakes, he was nevertheless a cold warrior, deeply conservative, and a supporter of the status quo. But there is no reason, besides sloppy research or willingness to assemble a "quotation" for ideological purposes (here, I'm convinced that it has more to do with the former than the latter), to misquote an author, any authors...

Moving on, Martin Wolf at the Financial Times is also spreading financial fear and loathing in "Twelve steps to meltdown" - although he has a somewhat soothing conclusion.

“I would tell audiences that we were facing not a bubble but a froth – lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy.” So wrote Alan Greenspan in The Age of Turbulence.

That used to be Mr Greenspan’s view of the US housing bubble. He was wrong, alas. So how bad might this downturn get? To answer this question we should ask a true bear. My favourite one is Nouriel Roubini of New York University’s Stern School of Business, founder of RGE Monitor.

Recently, Professor Roubini’s scenarios have been dire enough to make the flesh creep. But his thinking deserves to be taken seriously. He first predicted a US recession in July 2006. At that time, his view was extremely controversial. It is so no longer. Now he states that there is “a rising probability of a ‘catastrophic’ financial and economic outcome”. The characteristics of this scenario are, he argues: “A vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe.”

Prof Roubini is even fonder of lists than I am. Here are his 12 – yes, 12 – steps to financial disaster.

Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000 billion and $6,000 billion in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.

Step two would be further losses, beyond the $250 billion-$300 billion now estimated, for sub-prime mortgages. About 60 per cent of all mortgage origination between 2005 and 2007 had “reckless or toxic features”, argues Roubini. Goldman Sachs estimates mortgage losses at $400 billion. But if home prices fell by more than 20 per cent, losses would be bigger. That would further impair the banks’ ability to offer credit.

Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The “credit crunch” would then spread from mortgages to a wide range of consumer credit.

Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150 billion writedown of asset-backed securities would then ensue.

Step five would be the meltdown of the commercial property market, while step six would be bankruptcy of a large regional or national bank.

Step seven would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.

Step eight would be a wave of corporate defaults. On average, US companies are in decent shape, but a “fat tail” of companies has low profitability and heavy debt. Such defaults would spread losses in “credit default swaps”, which insure such debt. The losses could be $250 billion. Some insurers might go bankrupt.

Step nine would be a meltdown in the “shadow financial system”. Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.

Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.

Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.

Step 12 would be “a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices”.

These, then, are 12 steps to meltdown. In all, argues Roubini: “Total losses in the financial system will add up to more than $1,000 billion and the economic recession will become deeper more protracted and severe.” This, he suggests, is the “nightmare scenario” keeping Ben Bernanke and colleagues at the US Federal Reserve awake. It explains why, having failed to appreciate the dangers for so long, the Fed has lowered rates by 200 basis points this year. This is insurance against a financial meltdown.

Is this kind of scenario at least plausible? It is. Furthermore, we can be confident that it would, if it came to pass, end all stories about “decoupling”. If it lasts six quarters, as Roubini warns, offsetting policy action in the rest of the world would be too little, too late.

Can the Fed head this danger off? In a subsequent piece, Roubini gives eight reasons why it cannot. (He really loves lists!) These are, in brief: US monetary easing is constrained by risks to the dollar and inflation; aggressive easing deals only with illiquidity, not insolvency; the monoline insurers will lose their credit ratings, with dire consequences; overall losses will be too large for sovereign wealth funds to deal with; public intervention is too small to stabilise housing losses; the Fed cannot address the problems of the shadow financial system; regulators cannot find a good middle way between transparency over losses and regulatory forbearance, both of which are needed; and, finally, the transactions-oriented financial system is itself in deep crisis.

The risks are indeed high and the ability of the authorities to deal with them more limited than most people hope. This is not to suggest that there are no ways out. Unfortunately, they are poisonous ones. In the last resort, governments resolve financial crises. This is an iron law. Rescues can occur via overt government assumption of bad debt, inflation, or both. Japan chose the first, much to the distaste of its ministry of finance. But Japan is a creditor country whose savers have complete confidence in the solvency of their government. The US, however, is a debtor. It must keep the trust of foreigners. Should it fail to do so, the inflationary solution becomes probable. This is quite enough to explain why gold costs $920 an ounce.

The connection between the bursting of the housing bubble and the fragility of the financial system has created huge dangers, for the US and the rest of the world. The US public sector is now coming to the rescue, led by the Fed. In the end, they will succeed. But the journey is likely to be wretchedly uncomfortable.

Continuing the credit crunch doomer march, Gary Shilling at Forbes is also spreading a relatively mild form of financial doomerism, predicting that likely the US recession will be a global one (no friend of the decoupling theory either, he), and that commodity prices are due to plummet.

His peak oil analysis is devoid of reasoning - prices will fall because of new output from tar sands, coal liquefaction and "maybe shale". Plus substituting nuclear for liquid fuels. And Petrobras' "enormous" find offshore Brazil (presumably he means Tupi). This sort of amateur analysis in supposedly reputable journals (ignoring Steve Forbes' faux pas a couple of years ago when he got caught publically saying oil prices will fall while at the same time telling clients in his private newsletter to buy) drives me nuts.

The flow from tar sands is subject to a lot of constraints, coal prices are soaring, shale oil has yet to be proven economically practical (and will also be subject to flow limits), the Tupi field is apparently complex and a long way off producing anything, let alone large quantities of oil (I'd bet the jump in production from Iraq over the next 5 years is far larger than that from Brazil), and all of these will be appalling carbon emitters, likely to run into strong interference as the world economy attempts to decarbonise. The only saving grace here is that he isn't a fan of corn ethanol.

What to do? Sell or short commodities, perhaps via exchange-traded funds, stocks in companies that produce them or futures. Commodity prices, still high, are poised to fall hard as the worldwide recession takes hold.

Chinese demand, terrorism and talk of peak oil drove crude prices. Agricultural prices were hyped by biofuel's popularity, droughts and the prospect of a shift in demand in poorer countries from grain to meat. So institutional investors rushed into commodities, believing they are a relatively stable asset class like stocks and bonds. Individuals bought commodity-backed ETFs. That enthusiasm will soon be history.

With global recession, demand for industrial commodities and oil will fade. It will become clear that much of China's demand for commodities was not primarily to supply its citizens but to supply its export market.

No one will be talking anymore about how oil production is peaking. Look at Petrobras' huge oilfield discovery off Brazil and consider the gigantic energy supplies that will come from tar sands, nuclear, coal liquefaction and maybe shale. More supply equals lower prices.

Good weather and weak ethanol prices may knock down ag prices. A recent report in Science magazine has discredited many biofuel schemes as environmental salvations. We're going to stop fueling our cars with taco ingredients.

The WSJ's Environmental Capital blog points to a Richard Branson video up at Grist, with Dick expressing regret for having jumped on the first generation biofuel bandwagon.

They also point to reports about the new carbon tax being introduced in British columbia. I wonder when Alberta will follow suit ?

British Columbia broke ranks with the rest of Canada and announced its own carbon tax of $10 per ton, reports the Toronto Star. The plan, which won’t be levied on petroleum producers but on businesses and consumers, could hit the poor the hardest, notes the Globe and Mail. That’s exactly what some groups in California are afraid will happen with an emissions cap-and-trade scheme favored by Gov. Schwarzenegger, reports the L.A. Times. None of that has deterred Japan, notes Reuters: The country will consider replacing its voluntary emissions caps with a mandatory cap-and-trade scheme like Europe’s.

Finally, Richard Branson says he regrets supporting first-generation biofuels, in a video at Grist.

ABC (the US version) has an article on the peak oil / resource wars war game "Frontlines: Fuel Of War" (long time readers should remember tinfoil from both RI and Cryptogon at various stages regarding the use of video games as a desensitisation / propaganda / recruiting tool for these scenarios).

Sometime in the near future, gas will cost about $20 a gallon. It gets worse: China and Russia will form a military alliance that threatens the security of the United States and Europe.

Amid hunger, water scarcity and power outages, the two sides will go to war. Soldiers will descend upon bombed-out cities and abandoned villages, where rusting appliances and old car engines litter the streets. But don't let that get you down. "What you're trying to deliver in the game is fun," said Luis Cataldi. "We don't want someone to come in and become depressed."

Cataldi, an art director at New York-based KAOS Studios, is one of dozens of minds behind the dystopian vision presented in Frontlines: Fuel of War, a new video game inspired in part by contemporary fears about oil, war and, yes, war over oil.

The game, which cost about $15 million to produce, is set in the year 2024. It is a time when, according to Frontlines' "speculative fiction," the Western Coalition (the U.S. and Europe) are at war with the Red Star Alliance (Russia and China) over the world's last oil reserves on the Caspian Basin in Turkmenistan. Taking on roles as American troops, gamers use futuristic weapons and vehicles to battle their way across Central Asian oil fields, ghost towns and crumbling cities. In the game's multi-player version, gamers can also assume the identities of Red Star troops.

While Cataldi and KAOS emphasize the game's graphics, fast pace and technical prowess — in the game's "open world" setting, just about any object, structure or person you see can be shot at, blown up or otherwise annihilated — they're also passionate about Frontlines' fraught premise.

Conflict over oil "is a very resonant story in the world. It's a global issue that everyone's very much aware of, but it's also fascinating," Cataldi said. He spoke breathlessly of oil's role in World Wars I and II, of the Peak Oil theory – the idea that the world's oil production is on the brink of falling — and of reported military exercises between China and Russia aimed at protecting their oil interests. "You don't have to dig very deep to realize that it isn't a new problem," he said. "There are some great pieces of research that suggest that the world is in a very sensitive place."

Envisioning War

To devise the game's geopolitical context, he said, developers "read everything we could get our hands on." That included the books "The Party's Over: Oil, War and the Fate of Industrial Societies," by Richard Heinberg, and "Resource Wars: The New Landscape of Global Conflict," by Michael Klare.

Heinberg, a senior fellow at the California-based Post Carbon Institute, was surprised but pleased to learn that his book helped to inspire a video game. "I think anything that helps people understand the situation that we're facing is, in general, good," he said. "My hope would be that people who play the game then take the time and trouble to actually research some of these issues and look both into the science of oil depletion and the implications for our economy and our future."

Klare, a professor at Hampshire College in Massachusetts, called the prospect of a world war over oil "very plausible" and said he saw potential for the game to raise awareness of the issue among young people. "If you want to have an impact on young people on important issues, it's important to reach them outside the classroom as well as inside the classroom," he said, "Therefore entertainment has to be part of the mix."

Klare is hoping another form of entertainment will turn more people on to his research: movies. His book "Blood & Oil" is being made into a documentary. "I know the power of visual imagery," he said.