Making Sense of Chaos in the Bread Basket: Analysis

History was made in Ukraine this weekend as an overwhelming majority of Crimean slaves (96%; turnout of 83%) self-determined that they wanted to pay tribute to the Russian oligarchs instead of the Ukraine oligarchs.

The Crimean parliament passed a bill to adopt the inflation prone Ruble as their currency practically right away, and Russia subsequently incorporated the peninsula, amid jeers and howls from the west.

On March 1^st, another eastern Ukraine city, Donetsk, voted to have a referendum too, while a 1000-strong march in Kharkov, another city, a few days later demanded a referendum on “federalism” for the whole country (and obviously a new constitution), but making Russian the state language.

Notwithstanding, skeptics refuse to accept the ballot outcome in Crimea’s referendum.

The numbers are too good to be true!

They are ”specious…impossible to believe…[and] patently made up,” was one reaction I read from a friend of mine who lives in Ontario, among some Ukrainians.

He held this view even after I showered him with some of the history of the peninsula, plus media reports such as these:

“135 international observers have arrived from 23 countries, including Austria, Belgium, Bulgaria, France, Germany, Hungary, Italy, Latvia and Poland, Crimean authorities said. Among those monitoring the referendum are members of the EU and national European parliaments, international law experts and human rights activists.” RT.com

Further, writes the Russian owned media group, RT.com, typically a good source,

“No violations at the Crimea referendum have been reported by the international observers currently present in the republic. “It’s all quiet so far,” Mateus Psikorkski, the leader of the European observers’ mission and Polish MP told Itar-Tass. “Our observers have not registered any violations of voting rules.” Another observer, Ewald Stadler, member of the European Parliament, dispelled the “referendum at gunpoint” myth, by saying he felt people were free to make their choice. “I haven’t seen anything even resembling pressure,” he said. “People themselves want to have their say...The lines are very long, the turnout is big indeed,” a member of international observer mission, Bulgarian parliament member Pavel Chernev, said. "Organization and procedures are 100% in line with the European standards," he added”

RT.com has come under fire because of the resignation of a reporter claiming the media group was misleading the public about what was really happening in the Ukraine. But after following that up I found her charges a bit light on facts, plus RT found she was involved with neocon pro war schemers in the US.

I watched her resignation and didn’t think it was very sincere.  Besides, only a week or two earlier, I read about the resignation from CBS of an award winning reporter claiming the network censored her work as well.

One would have to be naïve to think any of their sources of news or analysis is pure.

A very skeptical west (US-EU) immediately imposed sanctions (i.e. asset freezes) against over 30 officials in Russia and the Ukraine to “build on sanctions already in place,” arguing that the “individuals targeted are responsible for undermining the sovereignty and territorial integrity of Ukraine & for facilitating Russian military action against Ukraine” said the white house (which has ratcheted them up since).

The Nobel peace prizewinning US president Obama and his pet hawk, John Kerry, already announced their intentions previously, stating,

“If there is no sign of any capacity to be able to move forward and resolve this issue, there will be a very serious series of steps on Monday in Europe and here with respect to the options that are available to us.”

I would have thought that a referendum meets a “resolution” requirement.  I was wrong.

“The international community “will not recognize the results of a poll administered under threats of violence and intimidation from a Russian military intervention,” the White House said in a statement. “Russia’s actions are dangerous and destabilizing. Military intervention and violation of international law will bring increasing costs for Russia.”” Bloomberg

The white house, heh.  Was anyone from the whitehouse there to observe the referendum?

Adds Bloomberg, citing another politician as its source of factual content.

“The U.S. and the European Union warned Russia not to annex Crimea after a referendum in Ukraine’s southern region, setting the stage for sanctions on Russia in the worst diplomatic standoff since Cold War.”

The hawks want war.  This week the western media interpreted demands by local Russian defense units in Crimea for Ukrainian officials to leave their bases (since they are in the Russian Federation now) as an invasion.

I mean, whom to believe??  Says one shrewd colleague, “they’re all lying.”  Indeed, whether due to the players or the media biases, two conflicting stories seem to have evolved.

He Said, She Said…

The west fears Russia’s motives for moving troops to the Ukraine border are unscrupulous…that they are trying to intimidate the new government, and that Russia is getting ready to invade the Ukraine.

Western sources have interpreted the events in Crimea as if the place was already “taken over three weeks ago by Russian forces” (CBC), ignoring the history of the region, and mocking reports of local self-defense units, which had reportedly sprung up for protection in the absence of a functioning Ukrainian authority, while the media implied they were Russian troops –only without their “insignias.”  Another politician denounced the referendum as “a lame excuse by Putin to invade Crimea and take it over.”  Can’t they make up their minds –I thought he already took it over!  The general western (US-EU) view is the Russians are just being bullies like in the old days.  As one analyst described the western view of the new Ukraine government,

“With a few brave exceptions, Western media coverage has put out a single, unitary message – a fable of brave, freedom-loving Ukrainians striving to break the Russian yoke…”

The west sees it not as a coup, as the Russian population does, but as a genuine public revolution against a corrupt group of oligarchs loyal to the Russian political establishment.  They want to see a Ukraine that is ready to reject its old USSR bondage and adopt western liberal democratic ideas.

The Russian position is that the previous government had already conceded power, as well as early elections, when he was chased out by an angry mob funded by neo-fascist nationalist elements bent on taking over the government forcefully.

The eastern part of the Ukraine is predominantly Russian speaking (58% in Crimea), and most of them generally believe that the new government acquired power illegitimately.

Reportedly, the new government has mistreated many Ukrainian officials, and left them unpaid, causing some to join the pro-Russian self-defense units, and forcing the government to recruit new soldiers from the untrained civilian population (using funds from western governments, sources say).

The Russian speaking parts of the country see a violent coup, not a legitimate deal.

In the Russian view, the self-defense units arose out of fear of retribution by Russian hating Ukrainians and nationalists – they think of them as dangerous – and their existence testifies to the fact that they are on their own…i.e. without Russia’s help.

If Russian troops were on the peninsula already there would probably be no need to have private security forces.  But the west believes that they are not real forces – that the Russians are merely hiding the fact that they have invaded.  The Russians believe the CIA funded the chaos in the west as a ploy to break Russia’s gas monopoly and help Berlin integrate the Ukraine into the EU for its gas resources –since they aren’t building nuclear plants in Germany anymore. And no doubt, the US has an agenda for NATO there too.

My View

I am not really skeptical of the referendum or of the explanation for self-defense militias.

Nor do I buy the idea that Russia set out to reacquire the Ukraine with force –and if they did they would not do it by cloaked armies.

Ukraine is not strategic enough to risk a world war.  Besides, the Crimean peninsula happens to be the location of Russia’s second largest naval base.  Many foreign nations have controlled Crimea in the past but it has been under Russia’s control for over a century.  It was gifted to the Ukraine in the 1950’s while the Ukraine was basically a USSR satellite – like putting an account in your brother’s name – so it remained in the USSR’s control until it broke down in the 1990’s.  Many of the ethnic Russian majority (58%) who live on the Peninsula either work or used to work for the Russian military.

One could say that historically, over the past century, it has always been full of Russians, dominated by Russians, and controlled by Russians.  Crimean Tatars make up a small part of the population (about 12%) and seem to get a lot of sympathy for their mistreatment at Stalin’s hands.  Of course, the Tatars were slave traders for centuries – raiding the villages of Slavs and Russians, and selling them into slavery –i.e. to the Ottoman Turks.

But it seems to me that western zealots have jumped the gun, assuming the Russians were the bad guys in this as, perhaps, they often are. It seems also as though the new Ukraine government is stirring up the pot in order to lure the west in further –in order to legitimize it!  It is seeking legitimacy from the outside.

The hasty intolerance of the west has pushed Russia and China closer together as a result.

I can’t tell you what the truth is, but so far we have not seen the referendum contested by anyone credible –outside of the off the cuff remarks by politicians like those reported earlier.  Assuming that it was conducted fairly and openly, as reports from RT.com indicate, then let us deal with the fundamental issue.

The US position is that the referendum is illegal because (1) it was done without the consent of the rest of the Ukraine, because (2) it violates the latest Ukrainian constitution, and (3) jeopardizes its “territorial integrity.”

I’m no legal theorist, but I don’t think you have to be in this case to see that the US position is not only hypocritical, since it historically seceded from the British empire itself, without consent; and inconsistent, given its role in the Yugoslav conflicts of the past, and other similar quarrels; but also, it is inflammatory, interested, and maybe even irrelevant if all sides have decided to throw out the former constitution or redo it again.

Right of Secession, Prerequisite of Peace

“The right of self-determination in regard to the question of membership in a state thus means: whenever the inhabitants of a particular territory, whether it be a single village, a whole district, or a series of adjacent districts, make it known, by a freely conducted plebiscite, that they no longer wish to remain united to the state to which they belong at the time, but wish either to form an independent state or to attach themselves to some other state, their wishes are to be respected and complied with. This is the only feasible and effective way of preventing revolutions and civil and international wars”, Ludwig von Mises

If you accept Mises’s insight, that there is no other peaceful way to resolve a situation like this, the U.S. position implies that it does not want peace.  Unlike us anarcho capitalists, Ludwig von Mises believed in Democracy as a political system.  But he believed in secession as a check against its abusers.

He felt that “No people and no part of a people shall be held against its will in a political association that it does not want”, and that, “If anybody has a right to be heard in this case it is these inhabitants. Boundary disputes should be settled by plebiscite.”

Seems cut and dried.

In Libertarian theory, or Classic Liberalism, the right of self-determination discussed above and by the Russian leadership is an extension of the self-ownership principle.

So, then, why are the freedom loving governments so unanimously predisposed to rejecting this doctrine right at the outset?

Why are their reactions so predictable?

In a true libertarian world, western leaders (hopefully not politicians) would encourage the referendum, and even offer advice.

They would give speeches and encourage peace, not threaten war and interventionism.

But in Obama’s view, the time for debate has passed.  The time for redrawing lines and borders has long passed into history.

That policy perspective implies only two choices: either further consolidation or no change, regardless of how anyone feels about it! –even if it means holding people against their will in political associations they do not want to be a part, despite a plebiscite, despite self-ownership, despite their free will!

All hail Obama, bring us more change!

As one compromise of outright fascism, at least he believes any “discussion” of the future of Ukraine should include the “legitimate” government of the Ukraine.

So he is not ruling out “discussion.”

But the first problem with that approach is that the question of legitimacy is precisely what divides he country.  The Russian half of the population of Ukraine doesn’t accept the new government in Kyiv as legitimate.

The second problem is that, even if it were legitimate, and even if they weren’t in the midst of deciding on another new constitution, isn’t requiring permission from a majority the same as requiring it from any other ruler?

Doesn’t that fail the test of self-determination and the purpose of the democratic “check.”

The topic of secession is controversial in the United States.  The establishment teaches the idea as a movement belonging to a racist confederate south and that it contradicts the underlying philosophy of the union – that the states are subordinate parts of one nation that preceded the states as parts of it – and which it also believes was settled by the civil war.

This view teaches that the constitution aimed at consolidation, according to at least one historian I’ve heard on the topic.

The politically incorrect but more accurate fact is that the US was created out of an association of independent nation-states without a central power.  And it was meant to stay that way.  The “fathers” distinguished between federalism and nationalism.

I’ve read that one of the factors motivating Lincoln in his war on the southern states – after alienating them from the west – was because he knew that if he waited until after the south seceded he would have to get congress to approve a declaration of war, which would ratify the south’s legitimacy.

Again, this is a very key word.

For, I suspect that the new government in Kiev is motivated to escalate the crisis in order to drag the US into a fight, thus underwriting its legitimacy in a situation where it is questioned within the country.

At any rate, fundamentally speaking, it is interesting that Mises saw the right of secession as “the only feasible and effective way of preventing revolutions and civil and international wars.”  You will see that, whatever the truth, time and again, Mises was right.  But the war loving world goes on giving O’bomber the nobel peace prize!

In their eyes, we have neither self-ownership nor the right to self-determination.

Who Cares About Philosophy

Obviously there is more to the US position in the Ukraine than philosophy.

Unfortunately, the western (US-EU) alliance believes that Russian troops have long taken control of Crimea, and have intimidated the local population into having the referendum and voting it this way.

The Russians for their part believe the US has interests related to NATO, and is funding the unrest through neo-fascist right wing nationalist groups, and also, that the EU wants the Ukraine for its gas.

The complex interests and post cold war tit for tat between the US and Russia go beyond Ukraine.  The Ukraine is just another stop on the way to bigger and better things!

There are several factors escalating the confrontation.  One is the bigger picture –the motif driving the secessionist “movement” around the world.  Another is the hypocritical, immoral, and war provoking position of the US on the fundamental issue of secession.

Another is the division within the country (and without) over the legitimacy of the new government.  Other factors include the need for the usual distractions from the mismanagement of the economy, other interests, racism, nationalism, and so on.

It is hard to imagine these things going away any time soon…not with other parts of the Ukraine still largely in a mess, and with the apparent dichotomy of reporting on this issue I get from reading the accounts of both sides.

The Bigger Picture

The winds of secession have blown through many regions of the world lately; Scotland, Catalonia, and Veneto (Italy) are all voting this year.  The Falklands won independence vote in December.  Even Quebec is back on the table (in Canada), we hear.  The general impetus is usually the knock on effects of the recent financial crisis even if there are other more historic divisions in any given situation.

The planners keep failing to deliver, and the situation just worsens on the road to serfdom.

They call it a market failure when the market doesn’t agree with their plans.  But it is their plans that bring chaos.  The secession movement suggests people see a solution in the way of smaller (local) governments.

If anything is failing it is the one-size-fits-all solution(s) for multi-cultural societies where huge swaths of the population have diametrically different or opposing values.

That’s sort of what’s happening in the Ukraine.  It has happened in Europe often.

It happened in Iraq, in Africa, Asia, South America –almost wherever you see strife and other types of chaos or disorder.  It happened in Mali, as our readers may recall, although that secessionist movement was violent.

But as far as the Ukraine is concerned, not only should the US stay out of it, it should encourage the peaceful path: secession.

Market Spooked by FOMC Suggestion of Early Tightening Amid Further Taper

During Yellen’s press conference Wednesday, the markets seed and sawed over the exact timing of the end of the “considerable period” clause in the FOMC’s communiqué, after which the Fed will have to start to actually raise rates –i.e. the time between the end of the current asset purchase program (in the third quarter of 2014 tentatively) and the expected tightening of monetary policy, which is also tentative.

She put a number on it: “six months”, causing markets to factor in the first 25 bp rate hike starting in the second quarter of 2015 – a few moths earlier than thought previously.

CNBC’s maverick reporter, Rick Santelli, shed light on the action in interest rate markets even before Yellen began speaking.

I only caught a snippet of what he said but presumably someone was privy!

For me it suggests that her “number” was planned ahead of time, indicating that fed policy is shifting to immunize expectations against future tightenings.  The Fed overtly tries to condition market expectations.  It’s no conspiracy.  That is just what it does.  Again, however, all tentatively.  If it scares markets too much it conditions in the other direction.

All I kept hearing though was that they removed the 6.5% unemployment rate target, while continuing to worry about the structure of the labor market (thus justifying continued accommodation in monetary policy even as the unemployment rate approaches its target), and wished for higher price inflation.

The Thing About “Economic Growth”

The question is not whether there is some growth in the economy.  There may be.  There may not be.  We can’t say.

All we can tell you that the Fed is doing its utmost to undermine its engines.

Recall our criticisms of GDP: it over weights consumption expenditures, should not include government expenditures, and is influenced by the effects of changes in the money supply despite attempts to filter them out (via price deflators).  We know that the net effect of the Fed’s policy is that it subsidizes consumption at the expense of saving, and directs money creation to fill the gap and fuel the investment instead.  So we find that even the indications of production, industrial activity, investment, and so on –factors that might otherwise give us some idea of whether the economy is growing or not – tell us next to nothing.

Since investment is funded by money creation rather than by real savings we know that some extent of it is untenable, and we may also suspect the investment is not necessarily in line with market preferences.

In other words, rising GDP might indicate nothing but an increase in malinvestment even while the capital foundation is weakened through a policy that is increasing feel-good consumption as a distraction.

At heart of course is the simple problem that the academics at the Fed don’t understand: consumption does not drive growth; saving and investment drives growth.  But those latter activities have to be guided rationally.

We can’t merely aim at their expansion in money terms.  They need to be guided by a rational framework of economic calculation.

Through Hayek, however, we know why this is not possible to do this top-down.

The Dispersion of Knowledge

Interest rates have a role in determining the right balance between investment and consumption – and they provide signals to entrepreneurs about the future in the same way that prices offer signals about the present.  A lot of knowledge, Hayek wrote, is dispersed throughout society and can never actually be possessed centrally because it is circumstantial.  An opportunity reveals itself somewhere due to a very unique combination of events.  Maybe only someone present perceives it, or who has had a unique life experience, and not anyone else.  The price system is a medium.  Every exchange that humans make on this planet transmits information to this feedback medium that enables people from all over the world to gauge it and see if there is cause for them to act in turn – in their unique circumstances.

The point is that when central planners interfere and aim at simple expansion in consumption and investment they create artificial incentives and send out the wrong signals for action.  Through an indicator like GDP they can fool people into thinking that is growth when it is actually destroying growth.

It destroys the incentive to actually save and hence undermines the capital structure – the foundation that sustains wages and wage growth.  If there is a problem with the labor market look no further than what the Fed has done – not just to our money – but also to our capital structure and foundation.

That does not mean there is no growth.

Someone is always saving & investing smart.

The Causes of Stagnant Growth

Personally, I think it is harder and harder for the economy to grow, in part because of the fact that the Fed’s interventions are bigger than ever, but also because of the fact that the malinvestments built up in the tech bubble of 1999 as well as the housing bubble of 2005 were not allowed to entirely clear.

Frank Shostak believes that the pool of real savings that sustains production and the capital structure has begun to shrink, which he suggests is the reason they can’t expand private sector credit very far.  Other theories include “regime uncertainty”, a Robert Higgs concept, which basically says investment is frozen on account that investors are not sure what the regulatory and policy future will be.

However, those explanations are only for those of us who see saving and investment as driving growth.  The lambs are focused on aggregate consumption expenditures and the direction of various activities (or housing and construction, or stock/bond prices –sectors that are essentially subsidized by the Fed).

Even If There is Growth

But let’s give them some rope.  Let’s assume that there is some growth out there.

That fact is still moot.  With the stock market trading at the upper end of its historic multiples (DJIA: 16x, Transports: 18x, Utilities: 21x, S&P: 18x, and NASDAQ 100: 21x), hasn’t it priced this growth in?

So the real question is rarely whether there is growth today, but whether there will be growth tomorrow – beyond the time frame already discounted by the market.  If you are investing at today’s share values you are not betting on whether there is growth today, but whether there will be growth in 2015, or later.

What else is in the market?

The recovery is a foregone conclusion, for one.  Low inflation as far as the eye can see is in the market too.  And heck, let’s throw in the first 25 bps.  There are many more things “in the market” of course.  I’m just pointing to the relevant factors.  Now, let’s turn to what is not in the market yet.  The official reason the Fed is maintaining its accommodative policy is the declining participation rate of labor.

The unacknowledgeable reason is to prevent an accident in the Treasury market after years of damage to the capital structure and the dollar by a reckless monetary policy intent on supporting an artificial interest rate and state of economic affairs.

That is NOT in the market, but we expect it will creep in over the course of the next few years.  First the market needs to learn that any talk of an exit is tentative whether it was to start now or later. That’s not ‘in-the-market’ either.  If it were, the Fed wouldn’t have to worry about inflation or inflation expectations running below target, PE’s would probably be lower, and gold prices probably much higher.

Market Analysis & Forecasts

Obama ruled out military involvement in the Ukraine, thus adding to the pressure on gold prices that started after the referendum, deflating a small war premium that developed in the weeks prior.  However, the new government in the Ukraine seems paranoid - based on what I’ve read.  And the rhetoric seems so irrational to me that we cannot rule war out altogether.  Although I am not predicting it either.  I have heard arguments that Obama will start something to drive up his popularity at home.  But if he really wanted to do that he’d take marijuana off the schedule 1 drug list.  The dichotomy of reporting on this issue notwithstanding, the Internet seems to be playing the same role in restraining the hawks here as it did in Syria.

Moreover, I am skeptical the west will go too crazy on the sanctions, for fear of giving the markets a dose of LTCM nostalgia.

Massive withdrawals and sales of US Treasuries by foreign interests were reported to have recently occurred, and perhaps part of Yellen’s intent was to create a smoke screen obfuscating this.  The FOMC news was largely immaterial.  At most, the market shortened its time line a bit on the timing of a tightening.  But the monetary policy remains overtly inflationary.  Total US money supply grew $109 billion in February – that’s a 13% annualized rate – driven largely by an uptick in the growth rate of demand deposits in the commercial banking system.  According to the last H.8 release, bank credit grew an annualized 9% rate in Feb, and looks set to average a post-2008 quarterly record.

Gold prices fell over $20 Wednesday following the FOMC, along with equities initially before they bounced together.

Support for the three month gold price trend lies at about the current level (1325). There is downside to 1250-1275 if it doesn’t hold.

Most of the gold price rally this year has been the result of a weakening USD rather than the Ukraine crisis, or any real safe-haven flows, though there was some of that last week.

That’s as it should be.

However, the USD index bounced after the FOMC, as it approached the 79 level -where bulls have discovered support in the past.

What happens in the short term is a tough call, but I see stock prices possibly continuing higher for now with gold prices consolidating between 1300 and 1400 until summer, when all hell breaks loose.  The timing of that call is based on seasonal factors.  I think gold bears are lucky that the USD has survived the Fed’s attack on it so far –they are lucky that other central banks have been so much more brutal with their own currencies.  Dollar bulls like to say that they are the best of a bad bunch.

But the USD is also a reserve currency while the others are not.  It has more worldwide circulation and can be rejected from more corners of the world than any other.

And the Fed has adopted a monetary policy as inflationary as any emerging country!

So the USD has more to lose than a fiat currency that hardly anyone owns (relatively speaking) even if it isn’t running a Weimar like policy.  But the seasonals still favor equities over gold for the next 2 months.

The China Crisis

Another economic story that has made the news is China’s slow down and looming credit crunch.  It isn’t a crisis yet.  I’m just mocking the cycle.  We have covered China in a previous piece.  The bears are right.

A liquidity crunch there is probably unavoidable – note that New Zealand confidently raised rates and that the BOJ continues to inflate less than most think.

The Chinese monetary authorities have since responded to the concern by reinflating the money supply, but there is a lot of noise about the reform of their shadow banking system that is likely to make it worse in the short term.  However, I don’t know how big the hit might be, and given the relatively light exposure of investors to Chinese assets (and their risk assessment), I’m skeptical that it will disintegrate into a 2008 type crisis.  I haven’t pushed China because we don’t really have much exposure.  If a crisis emerges we’ll make out okay.  The gold stocks will follow gold up, if it goes up, which it probably would.

However, paradoxically, if it merely prompted more QE from the Fed, it might work against the price of gold in the short term – if it fuels higher stock prices first.  Fundamentally, however, it is all-bullish –the FOMC, the Ukraine crisis, the China crisis, you name it.

We need a breakdown in the US$ against the ‘major’ currencies to thwart goldilocks.

(Source:  Ed Burgos:  [email protected]  -- Precious Metals Equity Research)