When things get hot, events can move faster than the 24-hour news cycle can keep up.

On Monday afternoon, not long after part one of this two-part series was submitted, news came in that unauthorized mass protests took place in Tehran in spite of crackdown warnings. The latest, as of this writing, is that Iran’s Guardian Council is open to a limited vote recount. The concession comes in response to the country’s largest demonstrations since 1979. Seven have died thus far. By the time you read this, the situation on the ground may have changed yet again.

Like breaks in a fault line or cracks in a dam, pressure points around the world are starting to build. Taken in isolation, any single pressure point might be deemed of little concern. But simple probability tells us that, as the number of pressure points increases, so too do the odds that one of them will explode…

One might look around and wonder, “why this growing trend of instability?” In other words, why does it feel so true that, geopolitically speaking at least, “when it rains it pours”?

In part it has to do with long-term cycles, in which conditions oscillate between stability and instability. There is peace and quiet for a time, and then there is chaos. Then things settle down and the cycle starts again...

During the heyday period of “Bretton Woods 2,” for example – in which U.S. consumers gorged on “stuff” paid for with Chinese credit – we had a multi-year period of artificially induced stability.

Many saw the deal as unsustainable, and that view turned out to be quite correct... but while it lasted, the trend of rising leverage, rising valuations and rising debt was a stable one. The directional rate of change was more or less constant. Investors got what they expected for a lengthy period of time.

But, as cycles throughout history have shown, stability begets instability. There was a great buildup of hidden excess in the stable period… until finally, when fresh instability burst forth onto the scene, all turned to chaos.

We are in a period of extreme instability now (as if you hadn’t noticed). Many of the old conventions have been turned upside down. Stemming from that, one benefit of unstable times is a new focus on ideas. When the old clichés no longer apply, closed minds tend to open… the search for answers gains a new sense of urgency.

Introducing the J Curve

And so, with the search for answers in mind, let’s talk about the “J Curve” – a concept that helps explain much of what the world is going through now.

The concept was first presented in a book called The J Curve: A New Way to Understand Why Nations Rise and Fall, by Ian Bremmer. The book was first published in 2006. Bremmer is head of the Eurasia Group, a global consulting firm focused on political risk.

The thrust of the J Curve idea has to do with “closed” countries versus “open” countries.

Imagine a graph in which the X axis (horizontal) represents how free and open a country is, while the Y axis (vertical) represents how stable and prosperous a country is. The upper right quadrant of the graph represents maximum openness and stability. The lower left quadrant represents a closed and unstable regime.

The key takeaway can be summed up like this.

• “Closed” countries (like North Korea) can be stable, at least for a time.
• “Open” countries with functioning democracies (like the United States) can be even more stable for great lengths of time.
• To make the transition from closed to open, a country must pass through a period of great instability.

This is where the letter “J” comes in. There is a sort of less-than-desirable stability at the tail end of the J.

In order to make it to the other side – to the top of the J, where greater openness and stability coincide – the country must first travel downward through the dangerous part of the curve.

As Bremmer writes, “movement from left to right along the J curve demonstrates that a country that is stable because it is closed must go through a period of dangerous instability as it opens to the outside world.”

Iran and North Korea

Bremmer introduced the J Curve as a way to understand the geopolitical dynamics of closed versus open countries. In that respect, it’s a helpful tool for understanding countries like Iran and North Korea.

For decades, Iran has been more or less a closed-but-stable country. Now that there is a powerful surge of interest in making Iran a more open and tolerant society, a dangerous instability has been introduced. The hardliners, comfortable with the old way, are running headlong into the forces of change... and blood has already been shed.

North Korea is another clear example of how the J Curve works. In order to preserve a harsh stability born of being closed to the outside world, the DPRK (Democratic People’s Republic of Korea) has shunned openness at all costs. As Bremmer writes,

To protect the DPRK’s isolation – and therefore its stability – the North Korean leadership has used tactics familiar in other closed authoritarian societies, but it has taken them to extremes rarely seen anywhere else. Few foreigners are allowed into the country. Those who are admitted are allowed virtually no meaningful contact with locals. They are shown “Potemkin villages,” hastily built movie-set style communities meant to persuade outsiders that the standard of living is substantially higher than it is. In general, aid workers are no more welcome in the DPRK than are international weapons inspectors. The leadership doesn’t want foreigners to see North Koreans – or North Koreans to see foreigners. The country’s J curve is already too low to allow such a threat.

North Korea’s recent escalation of threats – including open talk of nuclear war – is likely born out of fear that the fragile stability holding the country together, and thus keeping the Kim Jong Il regime in power, is under dire threat. That threat could bear down in the form of outside pressures, internal power struggles, an exhaustion of resources, or a combo of all three.

It is the potential for a sudden plunge into the lowest part of the J curve that the world rightly fears. As Bremmer reminds us, “North Korea is geopolitically important because it is a heavily militarized police state with a million soldiers, several million malnourished citizens, and an arsenal of the world’s most dangerous weapons.”

Golf Swings and Bankruptcies

But the J curve’s usefulness is not strictly limited to country analysis or the plight of unsavory regimes. Taken a little more broadly, it applies in many other walks of life as well.

This is because the transition from one form of stability to another, higher form of stability is almost always a challenge.

Take the golf swing, for example – something many Taipan Daily readers will be familiar with. When Tiger Woods decided to completely take apart and rebuild his golf swing early on in his career, it was seen as an incredibly brave act.

Why? Because, in abandoning his old swing, Tiger Woods had to descend into the depths of the J curve. He had to risk the possibility of ruining his old swing forever (which seemed to work well enough), without knowing for certain his new swing would work out.

Descending into the J curve, and enduring the period of instability required before emerging victorious on the other side, takes bravery and conviction. It requires a willingness to take calculated risks in the present, in confidence that the future will be worth it.

This explains why big stakeholders in any existing system are loath to endure the trials of the J curve. They would rather preserve the status quo because, in casting a wary eye on that looming period of instability at the bottom of the J, they see too much at risk... and too much to lose.

This attitude often displays itself as stubborn resistance to change. Such resistance can lead to disaster.

Take the $691 billion Lehman Brothers bankruptcy, for example – the largest bankruptcy in all of corporate history. (The second biggest, that of Washington Mutual, was less than half as big.)

Was Lehman doomed no matter what? We’ll never know. But we do know that, well before the ship went down, Lehman’s executives were given plenty of chances to take workable losses and pare back their risks. Bear Stearns went under a full six months before Lehman. There were countless warning signs, and opportunities, for Lehman to do the hard thing and cut back the portfolio.

Why didn’t they do it? In part because Lehman’s execs feared the J curve. They didn’t want to sell hundreds of billions worth of assets at what they perceived as fire-sale prices. (Those same prices would appear golden in hindsight).

But even more than eating a heaping helping of balance sheet losses, Lehman’s stakeholders didn’t want to let go of the status quo. They feared and loathed change because they had too much to lose, in terms of pride and stature as well as financial worth.

And so Lehman stayed crowded and bunched up on the tail of the “J”, passing up all their chances to go through a voluntary period of wrenching change... until finally the buildup of pressure forced them violently down the curve against their will, at which point extinction was assured.

What Washington Doesn’t Understand

Let’s talk about the U.S. financial system for a minute.

In order to make it to the “other side” – to return to a beneficial environment of stability – we have to pass through the bottom of the J curve. We have to endure the unstable nature of change in order to reap the long-run benefits of that change.

Because the big stakeholders in the current system (politicians, oligarchs, Wall Street fat cats and so on) have the most to lose, they are also the most resistant to change.

Unfortunately, these same stakeholders also tend to be the ones with their hands on the levers of power. And so again we see that sort of “crowding up” on the tail of the J, with great hesitance to make the journey through reform and real change.

This refusal to move forward is likely to make things get worse before they get better. As with the Lehman bankruptcy, it’s all about the difference between spotting a problem early and taking tough measures to fix it, versus trying to preserve the old order of things until the bitter end, when the moment of forced awareness arrives.

What Washington fails to understand, in your editor’s humble opinion, is that the tail of the J is not a place America can stay. There is no way to avoid moving forward. It’s a matter of whether we do so willingly and intelligently, making the wisest decisions we can... or whether we stick our fingers in our ears and pretend the moment of forced awareness will never come. It will.

Broader Applications

To sum up, the broader lesson is that we are not going to find a true period of stability again until we descend into the depths of the J curve and really come to grips with what got us here.

In result, my trading plan will have a heavy emphasis on volatility and instability until that sense of awareness has been demonstrated. It is not the same world... we can’t go back to the way it was. For instance:

• We are going to have to deal with the reality of a deleveraging U.S. consumer (and stop fantasizing that this process is anywhere near done.)


• We are going to have to start thinking about what a U.S. economy might look like that is no longer 70% oriented towards consumer spending.


• We are going to have deal with the rotten bank balance sheets once and for all, rather than papering over the looming losses.


• Tomorrow’s emerging market leaders will have to truly wean themselves from Western export dependency, and build robust economies based on internal domestic demand instead.


• The open question regarding trillions of dollars in debt weighing on the developed world, and the trillions of dollars of stimulus cash pumped in to counter it, will have to be resolved.


• We will have to get our heads around the dollar problem, and get a clearer sense of what the next world’s currency will be (or what exactly will replace it).

A tall order, no? Every one of those elements requires a descent into the J curve... a willingness to embrace instability for the sake of positive change before we get to the other side. So far, the powers that be have barely opened their eyes.

Expect serious volatility, and serious trading opportunities, as the J curve makes its presence felt in the years ahead.

Other Related Topics: Justice Litle , Macro Trader , North Korea

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