Everybody was umbrella fighting…

In my last two posts, I highlighted the rising tail-risk from the protests in Hong Kong (see The Big Kahuna Korrection, or buy Yom Kippur? and HK tail-risk is rising). While the markets focuses on the actions of the ECB and the US Employment report this week, the risk of the derailment of one of the three key engines of global growth, namely China, is heightened.

Xi shows the world that he can handle an umbrella too

Lots of analysis and opinions
Since I penned those two posts, much analysis has been written about the so-called umbrella protests in Hong Kong, where pro-democracy residents are in the streets over a decision by Beijing to limit the candidates for the election of Hong Kong`s next chief executive. Here is the summary from Bloomberg:
The most violent protests in Hong Kong in almost 50 years pose a dilemma for President Xi Jinping: clear the streets and risk embedding anti-China sentiment in a city that has prized its relative freedom, or make concessions and appear weak at home.

Thousands of protesters have remained on the streets, refusing to back down after Hong Kong police on Sept. 28 fired tear gas and pepper spray in the worst clashes since unrest swept the city in 1967, led by pro-Communist groups inspired by Mao Zedong’s Cultural Revolution. The protests prompted banks to close branches in the central area and pushed the main Hong Kong stock market index down a further 1.4 percent today.

As China prepares to celebrate the 65th anniversary of the establishment of the People’s Republic of China, Xi may want to demonstrate his grip on power on the mainland as he presses an anti-corruption drive that has snared senior officials and seeks to curb separatist sentiment in the Xinjiang region. Even so, acting forcefully to quell the protests may threaten Hong Kong’s standing as a city where businesses prize the rule of law and citizens cherish their freedom of expression.
Here is the key dilemma facing Chinese President Xi Jinping:
“When push comes to shove, Xi Jinping has to calculate what this means for his own authority,” said David Zweig, professor of political science at the Hong Kong University of Science and Technology. “It is a delicate balance between not having a terrible outcome in the streets and looking weak. I am not sure if the students quite understand that.”
As well, Xi has to consider the risks that protests could spread to nearby Macau, or even China itself. If he does intervene forcefully, then he can kiss the dream of Taiwan reunification under the Hong Kong formula of ”One Country, Two Systems” for a generation.

Sara Hsu, writing in The Diplomat, outlined three possible outcomes. First, the protesters could back down, either willingly or grudgingly. The government could come to some form of compromise with the demonstrators (as they did before in Wuhan in 2011). The first two outcomes would calm markets and likely see relief tallies in risky assets. The third is the most unpleasant and involves a clampdown with dire consequences:
Third, Beijing may use violence, perhaps real bullets, to crack down, in a Tiananmen-like confrontation. This is the least desirable outcome for both Hong Kong and Beijing, as it would stifle relations between the two regions for some time to come. It would dampen trade and investment with Hong Kong, harm the stock market, which contains a large percentage of Mainland-based companies, and put the Shanghai-Hong Kong Stock Connect program on ice. Currently, trade from the Mainland into Hong Kong measured at $384.8 billion in 2013, direct investment from Hong Kong into the Mainland weighed in at $73.4 billion in 2013, and the market capitalization of Mainland firms listed in Hong Kong amounts to $1.8 trillion. Disruption of these financial flows would cause a serious economic shock to both regions.

Further, the wider economic implications of a crackdown should also be considered. A shock to the China/Hong Kong trade nexus, combined with an arrest in direct investment into the Mainland, would sharply impact the rest of the world, cutting off access to imported goods from China, and rerouting export channels to Shanghai, creating congestion and reducing exported goods to China. A crackdown would also call for an international response, possibly in the form of a trade embargo, as has been implemented against Russia. This would certainly disrupt trade, and would weaken economic ties between China and the West.

Why a crackdown is likely
Here is my two cents worth on the decision making process. I believe that there are many reasons for the authorities to lean towards using force to resolve the situation.

First, the fact that the world is watching is unlikely to much to affect the actions of the authorities. Beijing was full of western reporters in 1989, but their presence did not deter the Politburo`s decision to send in the troops into Tiananmen Square in the face of an existential threat to their authority, which the Hong Kong protests are today.

As well, China has evolved since 1989 and they appear to be better prepared for incidents like these. Zero Hedge posted a provocative piece about PLA (People`s Liberation Army) Police Riot units. Note that they refer to a Shezhen based riot police unit, who are typically trained to handle protesters with non-lethal force, rather than the regular PLA employed in 1989, who were not. The presence of these PLA riot police units that could use non-lethal force to put down the demonstrators would serve to mitigate the kinds of outcomes seen in 1989 where PLA units were ordered in and start shooting.

In addition, a recent poll by the University of Hong Kong (via the WSJ) shows that the protesters do not enjoy majority support. Only 27% of Hong Kongers agreed with the Occupy Central movement while 54% disagreed. This will serve to give Bejing the moral authority to put down what might be perceived as an unpopular insurrection.

Xi loses face
Lastly, there is the matter of the Chinese culture and character that I have not seen talked about in much of the analysis that I have read. These protests are occurring at the start of the Chinese national holiday commemorating the Mao Zedong Communist Liberation of China. Moreover, the protesters have given an October 1st deadline, the day of the national holiday, for the current HK executive CY Leung to resign. As well, this week marks the start of Golden Week holiday, when many Mainlanders go to Hong Kong to shop. Moreover, the protesters have boxed themselves in a corner so that HK chief executive Leung has nothing to offer them.

In effect, these protests are a direct affront to Xi Jinping and will cause him to lose face.  You don`t provoke a major Chinese leader and make him lose face without suffering consequences. Such actions are likely to cause emotional reactions that go beyond the normal political and economic calculus that accompany such decisions.

I hope that I am wrong, but I fear that events are likely to turn out in a less than benign fashion. Neither side seems to backing down and we will either see a settlement or a violent confrontation in the next few days. The outcome will be critical for the fate of Hong Kong, Macau, China, Taiwan and the growth outlook for the Asia-Pacific region.

Stay tuned.

Talking Points: Robots, Wages, Technology, Peter Thiel

I was supposed to go on Bloomberg News this afternoon to talk about robots, wages, and is very smart but differently-thinking Peter Thiel. But 10 minutes before I was supposed to go on the air the CDC announced that a case of Ebola had been diagnosed in Dallas. So I had to play public health economist for five minutes...

  • Very smart but differently-thinking Peter Thiel is a techno-optimist--he sees the extraordinary increases in human productivity that robots and computers make possible, and seems that is driving an enormous increase in typical wages in the future.

  • I think he has fallen into the diamonds and water paradox--the average human will be highly productive in the robot world of the future but that does not mean that the typical human will be well-paid; just as the average gallon of water we consume is valuable, but the price of water is (usually) low.

  • we should not talk about whether computerization and robotization raises or lowers wages. We should distinguish among the wages for doing six different things

    1. Using our backs to move heavy things--the coming of the steam engine greatly reduced relative demand for this, and computerization and robotization will eliminate it.
    2. Using our fingers that manipulate things via skilled craftwork--Mass production greatly reduced relative demand for this, and computerization and robotization will eliminate it save for that fringe market where hand-made is of the essence.
    3. Using our brains as underemployed routine cybernetic control loops to make sure that material and accounting processes stay on track--the steam engine and mass production greatly increased relative demand for this, but computerization and robotization will greatly reduce it: human brains will remain the only supercomputers that fit in a shoebox and run on 50W, but most blue-collar machine-control and white-collar transactions-processing Jobs do not require a supercomputer.
    4. Using our mouths (and touch-typing fingers) that inform--and steam engines and mass productions supplied the size of the economy we also multiplied demand for such services, but computerization and robotization will transform this set of activities from one-to-one to one-to-many and so into an amplifier of global inequality.
    5. Using our smiles to make each other feel happy and valued, and keep us all pulling roughly in the same direction--personal services and human interaction and motivation will remain human unless the Singularity comes.
    6. Using our minds to have have genuinely original and useful thoughts--this might remain human unless the Singularity comes.
  • When I look at this, I see three ways that humans can make money in the computerized and robotized world of the future:

    1. Owning the computers and the robots.
    2. Having genuinely original and useful thoughts.
    3. Figuring out personal service-like things we can do that the people who do own the robots and thus have money to spend will be I willing to pay for--things that make them directly happy.

„Come Hell or High Water“ Promise Morphs Into „Infinity and Beyond“

In 2010, vice-president Joe Biden publicly vowed the US would be “totally out” of Afghanistan “come hell or high water, by 2014.”

In a few short months, 2014 will be gone. Are US troops out of Afghanistan? Nope. Iraq? Nope. Instead, we have troops in Syria.

Political Promises

Political promises should never be believed.

Today the US signed an extension allowing US forces to remain in Afghanistan until "at least" 2024.

At Least Until 2024

The Guardian reports a new Afghanistan pact means America's Longest War Will Last Until at Least 2024.
The longest war in American history will last at least another decade, according to the terms of a garrisoning deal for US forces signed by the new Afghanistan government on Tuesday.

Long awaited and much desired by an anxious US military, the deal guarantees that US and Nato troops will not have to withdraw by year’s end, and permits their stay “until the end of 2024 and beyond.”

The entry into force of the deal ensures that Barack Obama, elected president in 2008 on a wave of anti-war sentiment, will pass off both the Afghanistan war and his new war in Iraq and Syria to his successor. In 2010, his vice-president, Joe Biden, publicly vowed the US would be “totally out” of Afghanistan “come hell or high water, by 2014.”

Under the Bilateral Security Agreement’s annexes, the US military will have access to nine major land and airbases, to include the massive airfields at Bagram, Jalalabad and Kandahar, staging areas not only for air operations in Afghanistan but the US drone strikes that continue across the border in tribal Pakistan.

The additional bases – in Kabul, Mazar-i-Sharif, Herat, Helmand, Gardez and Shindand – ensure the reach of the US military throughout Afghanistan.

US defense leaders greeted the signing of the accord with enthusiasm.
Enthusiasm of Defense Leaders Soars

Opium Connection

To help highlight the absurdity of US policy in Afghanistan, please consider U.S. Turns a Blind Eye to Opium in Afghan Town
KABUL, Afghanistan — The effort to win over Afghans on former Taliban turf in Marja has put American and NATO commanders in the unusual position of arguing against opium eradication, pitting them against some Afghan officials who are pushing to destroy the harvest.

From Gen. Stanley A. McChrystal on down, the military’s position is clear: “U.S. forces no longer eradicate,” as one NATO official put it. Opium is the main livelihood of 60 to 70 percent of the farmers in Marja, which was seized from Taliban rebels in a major offensive last month. American Marines occupying the area are under orders to leave the farmers’ fields alone.
Opium Production at Record High

That story was from 2010. An article from January of 2014 highlights the "success" of US opium strategy: Afghan opium production on the rise despite U.S. troops, inspector says
Citing the United Nations Office of Drugs and Crime, Sopkp said the cultivation of poppy plants — used to make opium and its derivative drugs such as heroin — is greater today than in 2001 when the United States invaded Afghanistan.

Indeed, he said it’s the highest in modern history.
Afghanistan Absurdities

  1. US troops protect the Afghanistan poppy harvest to aid local farmers in the battle against the Taliban.
  2. That battle has been so "successful" that the Taliban Storms Afghanistan and is on the march towards the capital.
  3. Meanwhile, drug agents attempt to intercept heroin before it hits the US.
  4. The effort to stop smuggling pushes up the price of heroin to the explicit benefit of drug lords who do get some of it through.
  5. Those drug lords are apt to be the Taliban.
  6. Drug money goes to buy weapons for the Taliban.
  7. To counteract the rise of the Taliban, we train "moderates" to fight the Taliban.
  8. We also give weapons to "moderates" to fight the Taliban.
  9. Unfortunately, we cannot successfully identify moderates. Many US weapons fall into the hands of the Taliban.
  10. Ultimately US weapons as well as weapons purchased with drug money are used to kill US soldiers and fight the puppet regime the US seeks to protect.

The above process necessitates keeping US troops in Afghanistan to 2024, if not infinity and beyond.
Thus, the Battle for Perpetual War is Won.

Is it any wonder the process has garnered rabid enthusiasm of the defense industry?

The only missing ingredient of the warmonger's ultimate fantasy is multiple wars on multiple fronts with a large power like Russia.

Mike "Mish" Shedlock

Wow, Met Our First Goal, On to Our Second!

Thanks to our loyal readers! We've already gotten nearly 200 donations in the first 24 hours (out of our fundraiser target of 1000 donors), and blew past our first goal, which was $12,700 to provide for more technology investments in the site, which will provide for a better reader experience on mobiles and tablets, and faster resolution of other site issues.

A Poor End to a Bad Month

With the month of September and the third quarter now in the books, below is a look at the performance of various asset classes using key ETFs traded on US exchanges.  It was a rough month for stocks, especially for smallcaps.  The Russell 2,000 (IWM) finished the month down 6.19% and the quarter down 7.96%.  

Six sectors finished the quarter lower, while four traded higher.  Health Care and Technology were the winners of Q3, while Energy was the big loser.

Foreign markets didn't fare well in September either.  The Brazil ETF (EWZ) was by far the worst with a decline of 19.09% for the month.  Australia (EWA) fell the second most at -11.86%.

Commodities and fixed income fell as well in September.  For the quarter, commodities took it on the chin, with declines of more than 10%.  

About the only thing that did well in September was the US dollar index.

10 Tuesday PM Reads

My afternoon train reads:

• Bill Gross: Not the King of Bond Markets, After All? (CIO) but see Pimco Is in a Race to Keep Investors After Bill Gross Exits (WSJ)
• Emotions make awful investment managers (Certifiable Planner)
• ERP: The single, best way to tell whether stocks are worth it (Fortune)
• Why investors are ignoring war, terror and turmoil: Global political change has done more to create opportunities than to destroy them (Financial Times)
• A Dozen Things I’ve Learned from Henry Ellenbogen (25iq)
• Revisiting the Lehman Brothers Bailout That Never Was (NY Times)
• Why Rumors Outrace the Truth Online (NY Times)
• Eric Holder’s Mixed Legacy on White-Collar Crime (DealBook)
• Investing to Make a Difference Is Gaining Ground (NY Times) see also Yale Fund Takes Aim at Climate Change (NY Times)
• Robert Plant and Jimmy Fallon are your new favorite doo-wop supergroup (Daily Dot)

What are you reading?



America is getting richer, but most voters can’t feel it

Source: The Economist



Fannie Mae: Mortgage Serious Delinquency rate below 2% in August, Lowest since October 2008

Fannie Mae reported today that the Single-Family Serious Delinquency rate declined slightly in August to 1.99% from 2.00% in July. The serious delinquency rate is down from 2.61% in August 2013, and this is the lowest level since October 2008.

The Fannie Mae serious delinquency rate peaked in February 2010 at 5.59%.

Freddie Mac has not reported for August yet.

Note: These are mortgage loans that are "three monthly payments or more past due or in foreclosure".

Fannie Freddie Seriously Delinquent RateClick on graph for larger image

The Fannie Mae serious delinquency rate has fallen 0.62 percentage points over the last year, and at that pace the serious delinquency rate will be under 1% in 2016 - although the rate of decline has slowed recently.

Note: The "normal" serious delinquency rate is under 1%.

Maybe serious delinquencies will be close to normal in 2016.

Afternoon Must-Read: Paul Krugman: The Pimco Perplex

Paul Krugman: The Pimco Perplex: "Why was Gross betting so heavily against Treasuries?...

...Brad DeLong tries to rationalize Gross’s behavior in terms of a coherent story about an impending U.S. recovery.... But Gross wasn’t saying anything like that. Instead, he... warned that the impending spike in rates when QE2 ended would derail recovery. So why did he believe all that?... Since 2008 the basic logic of the economic situation has been that the private sector is trying to run a huge surplus, and the public sector isn’t willing to run a corresponding deficit.... A lot of people... have just refused to accept this account.... You might think the failure of higher rates to materialize... would cause them to reassess.... The big excuse was that rates would have gone higher if only the Fed weren’t buying up the stuff.... You can see why I found Gillian Tett’s apologia for Gross--that he was blindsided by central bank intervention--frustrating. For one thing, that’s accepting a model that has failed with flying colors; but beyond that, Gross’s really bad call was almost exactly the opposite, his claim that rates would soar when the Fed’s intervention ended.... Finance people seem weirdly determined to believe in a macro canon whose hold on their perceptions appears to be completely unbreakable, no matter how much money it causes them to lose.

Checking on the "Pulse" of the Consumer

Late last week we published our September Consumer Pulse Report over at our sister website --bespokeintel.com.  Our monthly Pulse report makes up the backbone of our new Pulse subscription offering.  The report is an analysis of a 75-question survey we conduct on a statistically significant sampling of more than 1,500 US consumers.  From this unique, detailed survey, we're able to get an early read on trends in the economy ahead of the big economic data dump that comes out at the start of each month, including the widely-followed Nonfarm Payrolls report set for release this Friday.  Our Pulse report comes out a week before the monthly Nonfarm Payrolls report, giving subscribers ample time to position themselves properly based on the results from our survey.

Since the new Pulse subscription is in its early stages, we're currently offering a 30% discount on membership rates to attract a group of "charter" members.  If you have yet to sign up, there's still time to do so with the 30% discount.  All you have to do is enter "pulsecharter" in the coupon code section of the Pulse subscribe page to get 30% off the price of the service for the life of your membership.  This means you can get in for less than $1 per day!  With the 30% discount, the annual Pulse membership cost is just $350 per year.

So what did we learn from our September Pulse survey?  While we obviously can't provide you with the bulk of our key findings (you'll have to subscribe for that!), we are willing to highlight a few statistics so you can see just what this new service is all about.  

Jobs data will be dominating the financial headlines over the next three days, so below are a few labor-market related results from our September survey.  

Our first chart shows the results from our question that asks how current income levels compare to levels from one year ago.  As shown, consumers have clearly made big gains in income levels over the last year, with 42% responding "more" or "much more" compared to just 16.2% responding "less" or "much less".  

Another employment-related question in our survey asks participants if they have filed for unemployment assistance over the past month.  As shown below, the September reading came in at 4.7%, which is the lowest level we have seen in the last three months.

In terms of forward expecations for employment, survey participants are moderately positive, with 32% expecting the unemployment rate to be "better" or "much better" compared to 27.7% expecting the unemployment rate to be "worse" or "much worse".

One of the unique questions we ask Pulse survey participants is whether they consider themselves "living paycheck-to-paycheck".  Over time this question will provide Pulse members with a great sentiment gauge on the consumer.  While we're witholding the month-to-month trend of this "paycheck-to-paycheck" indicator, below is a look at the results from this question in our September report.  Unfortunately, a higher percentage of consumers currently consider themselves living paycheck-to-paycheck than not.  43.5% either "agree" or "strongly agree" while 34.4% either "disagree" or "strongly disagree".  A fifth of survey participants (20.1%) "strongly agree" compared to just 12.9% who "strongly disagree".

The labor-market results featured above are mostly positive, but one of the negative trends we found in this month's survey was expected spending on discretionary items over the next few months.  As shown below, while a majority (53.7%) expect to spend the same on discretionary items, the percentage that expect to spend "less" or "much less" was double (30.9% vs. 15.4%) the percentage that expect to spend "more" or "much more".  This is not a great sign for consumer spending heading into the holiday season.

It has been widely documented over the last few years that even though the economy has been growing at a decent pace, consumers just aren't that happy with it.  As shown below, the percentage of respondents that have a negative view on the economy is more than double the percentage that are positive.  While we saw a slight tick-up in the percentage of "positive" views in September, these numbers clearly skew negative.  

While we'd like to see a more confident consumer, contrarians treat this kind of reading as a positive.  Just as you don't want to see bullish sentiment towards the stock market get too high, you don't want to see consumers get overly excited or complacent about the economy either.  That's when the cycle is likely topping out.  Given current economic sentiment levels, there's a ton of room for improvement!

All of the data points featured above are included in this month's Bespoke Consumer Pulse Report.  But this is just a very small portion of the treasure-trove of findings in the entire publication.  To view the full report, you can sign up now for a 5-day free Pulse trial and access it immediately.  Yes, you can view this report for free by taking advantage of our 5-day free trial offering.  If you're not satisfied, simply cancel within the 5-day period and you won't be charged.

Head on over to the Pulse subscribe page to view the full September Pulse report now.  And remember -- use "pulsecharter" in the coupon code section to receive a 30% discount for the life of your membership!

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