The unwatched geopolitical pot is coming to a slow boil. Many behind-the-scenes developments, by and large ignored these past few months, are now turning up the heat.
What follows is a general recap – just a few of the hotspots and danger zones worth watching.
Swine Flu Goes Global
As Adam Lass noted in May 5th's Taipan Daily Swine Flu Is No Joke, the World Health Organization (WHO) has raised its swine flu alert level from Phase 5 to Phase 6 (the highest level there is). The H1N1 outbreak is the first full-blown global pandemic in more than 40 years. The threat measure focuses on how widespread the flu is, rather than the severity of the strain, but the dangers are linked.
Whether or not H1N1 mutates into a more deadly strain this winter, the world’s governments are now on high alert. We are not yet in the mortal danger stage, but heading towards that possibility. Tough precautions may be taken.
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Iran’s Powder Keg Election
Iran has been thrown into chaos by a hotly contested presidential election. Mahmoud Ahmadinejad, the hardline incumbent, won re-election this weekend by an improbable landslide, leading to widespread outrage and cries that the vote was rigged. (Observers agree that fraud was highly likely, if not 100% certain, due to the staggeringly lopsided nature of the results.)
Mir-Hussein Mousavi, the main challenger to Mr. Ahmadinejad, favored economic reform, equality for women, and more friendly relations with the West. Mousavi’s followers were devastated by the (likely rigged) loss, taking to the streets and shouting from the rooftops. A further protest in Tehran was called off by Mr. Mousavi for fear of bloodshed, after he learned that riot squads would be equipped with live ammunition and probable authority to fire on demonstrators.
Iran is now being divided between a hardline camp, still in power, and a change-seeking pro-West camp, not in power but bolstered by the energy and vitality of Iran’s youth. With strong evidence of election fraud and the open threat of bloodshed, Iran’s hardline faction is showing fear, not strength, in its vicious actions. Some believe reformist leaders like Mr. Mousavi are in danger of being killed. This, too, is a sign of fear on the part of Iran’s ruling regime. If the hardliners lose control of an outraged populace, lashing out on the world stage could be a last-ditch diversionary tactic.
North Korea Threatens War
Relations with North Korea are quickly deteriorating from bad to worse. Tongil Sinbo, a weekly broadsheet that functions as a mouthpiece for the North Korean state, said over the weekend that “the Korean peninsula is becoming an area where the chances of a nuclear war are the highest in the world.”
On the same day, North Korea openly declared plans to “weaponize” its plutonium, vowing to start a war if North Korean ships are stopped or searched as part of a planned U.N. sanctions program.
Kim Jong-Il, North Korea’s “dear leader,” reportedly suffered a stroke last August. The sharp uptick in belligerence may have to do with the dear leader’s failing health, and uncertainty as to who will next lead the regime or how the transition will take place.
Latvia… the New Thailand?
In Eastern Europe, Latvia’s attempt to maintain its currency peg to the euro looks doomed. “The Latvian currency is hugely overvalued,” opines the U.K. Telegraph. “Big loans can keep Latvia going. But a devaluation of the lat is as essential as pulling a rotten tooth that is poisoning the whole system.”
The only trouble is, if Latvia gives up its euro peg and devalues, the knock-on result could resemble what happened to Thailand in 1997. The Asian Currency Crisis of the late ‘90s – nicknamed the “Asian Contagion” because of the way it spread around the world – kicked off when the government of Thailand decided to abandon its dollar peg and let the Thai baht “float” on the open market.
The dynamics are very much the same. Latvia, like Thailand, is a once-roaring tiger now crushed by economic woes, forced to throw good money after bad in defending a currency peg that may well prove indefensible. The fear is that the aftermath could also prove the same. If Latvia throws in the towel, Eastern Europe could implode, spreading further contagion to Europe’s still-rotten banks and sucking the whole continent into a panic vortex.
Protectionism Fears on the Rise
Canada, America’s largest trading partner in both directions, expressed deep worry on Saturday over a “rising tide of protectionism” from the United States. (Canada sends 75% of its exports to the U.S.) Canada’s fears have been particularly stoked by the “Buy American” provisions coming out of Washington.
Secretary of State Hillary Clinton promised Canada that “nothing in [America’s] legislation will interfere with our international trade obligations.” But America’s largest trading partner is rightly skeptical. As economic challenges increase, it will become more and more tempting for the United States to turn inward... and for politicians to give in to angry voices demanding that steps be taken to preserve U.S. jobs.
While this logic makes sense on a local level (“What’s wrong with protecting American jobs?” some will fume) the trouble is what such thinking threatens to unleash on a more global level. The “beggar thy neighbor” policies of the early 1930s, in which countries all over the world threw up barriers with an eye for protecting their own, led to a widespread collapse in trade at perhaps the worst possible time.
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California Falling Into the (Fiscal) Ocean
T-minus 50 and counting? John Chiang, the California state controller, said last Wednesday that "Without immediate solutions... we are less than 50 days away from a meltdown of state government.”
“A truly balanced budget,” Chiang added, “is the only way out of the worst cash crisis since the Great Depression.”
Unfortunately for Chiang (and all Californians), the golden state is paralyzed by political gridlock. There is little money and even less willingness among rival factions to cooperate. Over the past year, California’s personal income taxes have fallen by almost 40%. Corporate tax revenues have fallen by more than 52%. It is not at all clear how California will dig its way out. And just as California was ground zero for the housing bubble, the state’s dramatic fiscal problems are a bleeding-edge indicator of what’s in store for the rest of the country. Chiang will not be the last state controller counting the days until meltdown.
Fiscal Time Bombs Still Ticking
Last but not least, there is still massive risk embedded in the heart of the rotten U.S. financial system. Mounting evidence points to the fact that the banks’ problems have not been solved, only papered over, entirely in keeping with the Fed and Treasury’s strategy of playing for time and outrunning the problem.
The current White House is working from the same playbook as the past White House. The current Fed Chairman is working from the same playbook as the last Fed Chairman. In result, the game has been to pump the system full of easy money and shovel obscene amounts of cash into the banks, in the hope that a quick piling up of profits would cover over any toxic residues while the economy limped towards recovery.
But this always counted as a highly risky strategy because of the hidden cost of failure. In order to make the play work, the public had to gag down some very unpalatable measures in the name of saving the system. The implicit promise was that all that fat-cat largesse would be worth it.
But now, like a set of bowling pins waiting for a strike, the U.S. banking system is set to be hit with a another wave of mass defaults and forced write-downs... embedded losses relating to commercial real estate loans, consumer credit deterioration, prime mortgage resets, toxic assets not yet disgorged, and the general fallout of one out of eight homeowners struggling to make payments.
When this second pain wave hits – making it clear that the first round of bailouts was an expensive sham – the public outrage that results could be enough to make the AIG fiasco look like a tempest in a teacup. The real threat here, besides the economic fallout of a newly shattered banking system, is a total loss of confidence in Washington’s ability to manage the country’s problems. Some would say that loss of confidence is already deserved. But when it is felt anew with a fresh sense of fury, watch out.
A Golden Thread
There is a single idea, a golden thread if you will, that unites most if not all of these developments. The idea is captured in something called “the J Curve.” I’ll explain what that is tomorrow, and why it is such an important concept to understand right now.
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