Where Did This Financial Turbulence Come From?

Date:  Sun, 2008-07-13

SpringSide Chats: No. 1Where did this financial turbulence come from?  How the subprime debacle got started and where it might end up.A Discussion at The Arlington Institute in Berkeley Springs, WVAnalysis by Dr. David Martin Edited by Ken Dabkowski and Dr. David MartinEditors Note:  Welcome to Spring Side Chats.  One of the new resources we hope to facilitate in reaction to our current economic situation is a program at The Arlington Institute known as SpringSide Chats.  These chats, reminiscent of FDR’s Fireside Chats, hope to be a beacon of hope shining through the shoals of collapse.  Discussion topics will serve as welcoming open tables, psychological refreshers and invigoration instigators.   Our office is located in the town of Berkeley Springs, WV, USA, just up the hill from a local water spring.  We posit that water, not just fire, will be a cause for gathering and fostering of community spirit as we progress into the 21st century and beyond.  As the source of all life on this planet, we value it highly, and feel it is important metaphor for our mission.  In times of cyclical downturn, we are confronted with our dependency on the attachments to which we had been accustomed in the good times. Currently we face an economic downturn.  The ideals of free market thinking combined with Western consumerism have been supplying a sense of stability and growth.  Our attachments to this system have brought many progresses but are now are showing signs of weakness.  As our markets have declined over the past several months, all involved have been trying to do two things: diagnose the problems and propose system fixes or entirely new systems of operation.  We offer these chats as a scenario generation tool.  We believe scenarios are an important for preparedness and often use the logic, “If you haven’t thought about it, you haven’t thought about it.  What you haven’t thought about is, by definition, a surprise.  Negative surprises in combination with a lack of preparedness are hard to respond to.  Significant thought and active planning however can reduce the severity and negative effects and costs of negative surprises.”While scenarios are important to think through, we must also note: SCENARIOS ARE NOT PREDICTIONS!  Scenarios are possible future outcomes.  In considering a scenario, we may be led down possibility paths we had never imagined.  Some possibilities will be useful, others will not.  We do not ascribe probability to our scenarios, only possibility.  To the extent we can, we leave no stone unturned in order to give you the largest array of decision making information possible.  This information may be from sources credible in some circles and not so in others.  In the world of possibility, there is only possibility.  As we embark on the next leg of humanity’s journey, we wish you luck, success, and resilience.The discussion to follow is an annotated recording of our first SpringSide Chat which took place at our office in Berkeley Springs, WV, attended by a group of community members.  The ideas have been clarified from the original discussion and elaborated upon.    The most recent iteration of America’s economic system has its roots in a small meeting in Bretton Woods, NH, in 1944.  The hope – and assumption – that developed during that meeting was that out of the victory of World War II, a single global trade and economic supremacy (potentially a nation state) would emerge, ending fascism and all other “isms”.  In this meeting, there was an assent to certain financial dynamics, particularly an assent to the gold standard. Fast forward to August, 1971.  Facing many new economic hardships, the emergence of credible international technical and industrial competition, and unprecedented capital calls on the U.S. Treasury, the United Stated decided to supplant its previously established economic ground rules.  Today, we have forgotten what happened in 1971. Off the gold standard, on to fiat… On Friday, August 13, 1971, the Nixon administration called an emergency session of the Federal Reserve.  The French Government had indicated that they were planning to redeem a large amount of its U.S. paper dollars for gold.  The U.S. Treasury did not have enough gold to redeem France’s treasury call, rendering that money impaired.  Due to this rush of call options, it became clear to the administration that if, on August 15th, the United States did not go off the gold standard, the country would  be insolvent because there was not  enough gold in the U.S. Treasury to fulfill the request of the French government.   A plan had to be devised and sold in two short days if the U.S. economy was to stay afloat.  Chairman of the Federal Reserve, Arthur F. Burns encouraged Richard M. Nixon to give this speech on Sunday the 15th. (Text)(Video)  With this initiative the seeds of our current subprime mortgage bubble were planted.  The speech explained that the government was going to pump cash into the hands of the American consumer, place restricted tariffs on imports and reprice the minimum wage.  It authorized spending up to 25% of GDP on the finance of infrastructure on non-market rate conditions using debt.    A series of national infrastructure building projects were initiated and someone had to bear the financial risk.  The Fed created long term investment vehicles that allowed government to finance the debt.  A significant amount of the cost was financed in bonds with very long (most at 30 years) horizons.   At this time we also started allowing foreign investors to buy U.S. debt, although the amounts were capped.  In 1971, Europe was not interested in buying US debt; however the Chinese central government did show interest and started purchasing it.  Repeatedly, the Chinese government reached its capped limit.  Each administration since has consistently revised the upper limit of the debt the U.S. would issue the Chinese.  Over the years, the limit was raised so much that China eventually achieved a controlling minority interest in the U.S. Treasury.  At that point, reached in the third quarter of 2007, they effectively stopped buying.  When a company sells interest in its stock, and sells a veto proof minority interest, it has subordinated its majority control because the minority interest vote can block the majority vote.  China now owns enough of the treasury to vote “no” and have their no carry a compelling consequence.  Their ‘no’ vote now has power to influence the market dynamics and price of our Treasury reserves.  In the past year, each time Congress or the White House sought to alter the Chinese monetary policy, China’s ability to maintain intransigence is evidence of their Treasury power.  Regardless of U.S. pressure, China can operate with an autonomy that they purchased since 1971. Immediately after gaining voting power, the Chinese discounted the treasuries’ value by 30% by stating, in October 2007, that they would modify their imputed value of their currency and treasury reserves.  They did this, knowing full well that by doing so they were putting their own asset in jeopardy since the only way they could realize value for it was to sell it.  Nonetheless, in essence they told the market that their asset was worth less than they bought it for.  Why?  By shorting the US treasuries they held, they invited the U.S. Congress to buy them back and the U.S. demonstrated that it couldn’t afford to.  In October of last year, the U.S. threatened trade sanctions against China for coupling the RMB to the dollar.  Why did our legislature stop?  Why did none of these threats ever get to a committee vote or floor vote? The simple explanation is that the Chinese elegantly reminded the U.S. government that they have both the economic lever (in their Treasury holdings) and the fulcrum (in their export imbalance) to handle their currency as they deem in their best interests.  If the Congress or White House elects to impose their will, China has two compelling economic weapons that it can unilaterally use – both of which will profoundly add to the economic instability that the U.S. economy already faces.  Add to this that the  Chinese government has supported a  policy of both invited and mandatory technology  transfer for most  of their largest contracts with U.S. corporations (thereby holding critical and sensitive competitive technology) and  one quickly  realizes that the U.S. has sold its control and influence a long time ago without considering the  consequences. The Chinese have put $1.3 trillion worth of U.S. Treasuries into an effective “junk bond” rated status.  When you change the rating of capital in a central bank position to that of “junk rated”, you increase cost of reserve capital by 625%. For example, if you are a local bank and want to issue a $100 loan, somewhere in the books, you must have $8 backing the $100 loan because you need to hold a loss reserve.  There must be enough residual liquidity so that, in the aggregate, you have the liquidity to backstop the loan.  Assuming that you maintain the 8% loss reserve you are on very thin ice as default rates are becoming considerably higher and their volatility is altering from historical levels with considerable amplitude.  The U.S. Treasury is no different than the commercial banks.  If the Treasury fails to retain adequate loss reserve controls, its underlying influence and value suffer. While Chinese were shorting the U.S. currency, the FDIC stopped reporting its loss reserves.  The FDIC was supposed to be, in essence, an insurance policy which allegedly insured deposits in federally chartered banks.  An insurance company has lower loss reserve than a bank.  Unfortunately, a large amount of the FDIC’s balance sheet is sitting in reinsurance products, collateralized loan obligations, and default swaps.  Many of those financial vehicles have lost a significant portion of the value in the last six months.  The American citizen who thinks that their individual deposits are guaranteed secure would find, on close examination, that neither the Federal Reserve (supporting inter-bank lending), nor the FDIC (insuring institutional liquidity guarantees) are sound. If you read the FDIC charter, you will notice that it does not insure any depositors, but only the deposits made by the approved financial institutions.  The role of the FDIC is to protect a lending institution, NOT its depositors.  Most people think that they are insured up to $100,000 when depositing in an accredited bank.  When it becomes apparent that an insurance policy doesn’t insure what the public believes it’s insuring, confidence falls. Why did the FDIC fail to report their loss reserves?  In its 2nd quarter report of 2007, the FDIC showed that it had, as its secondary loss reserve investment holdings, a considerable holding of Collateralized Debt Obligations.  At no point has the public had a transparent accounting of the effect of the CDO and CMO market devaluation on the loss reserves of the FDIC or the Treasury. Remember the emergency meeting of the Fed a few months ago?  What we think we know is that the Fed saved Bear Stearns from going bankrupt.  What really happened was that the American taxpayer got saddled with a huge burden of debt.  Bear Stearns couldn’t be saved and they couldn’t go bankrupt because the federal government owned the debt.  In a bankruptcy situation, a U.S. trustee is appointed to review the assets.  When you review the assets of a bankrupt corporation, you find out who the counterparties are.  Since, under bankruptcy law, the disclosure would have been public and the effects of it devastating to the economic system, it was essentially impossible for them to go bankrupt without bankrupting the entire system.  JP Morgan is the principal shareholder in the Federal Reserve Bank.   JP Morgan, acting on its own behalf, turned the Federal Reserve Bank into an off balance sheet holding company.  The U.S. Central Bank ended up with $40B of junk assets by the primary asset holder of the primary bank.  No one could afford the disclosure of the illiquidity of Bear Stearns because the real challenge would have undermined the Federally chartered institutions which are essential to maintain the illusion of economic soundness.Where are we now? Collateralized Mortgage Obligations (CMO’s) appear to be failing not because they are CMO’s, but because they are second mortgages on consumer credit.  We have only just seen the tip of the iceberg here.  The fallout will continue because consumer credit does not default, foreclose or liquidate at the same rate as traditional CMO’s.  With 30 year real estate loans, on average, the 17th year is the trouble spot.    However, in consumer credit, the trouble spot is at 18 months.  If you were like most Americans, sometime after 9/11/2001, you might have taken out a second mortgage and bought durable goods, e.g. high priced products such as cars and refrigerators.  That second mortgage didn’t get spent in the real estate market; it got spent in the consumer credit market for home remodeling or expansion.    All of that purchasing made the economy look good.  The problem is, we rolled consumer credit into mortgage credit.  Historical consumer credit default rates have been getting worse.  Consumer credit is now highly unstable. While US consumers default and shuffle their way to figuring out how to repay their bills, the global banking system is moving or has moved to the Basel II standard and the US decided to forgo a seat at the international banking table.  International banks may choose to value US partners much less highly in the future.ICAP – Who are they and why they are an important monitor?  Why might they might be the canary in the coal mine In October, 2007, all of the major indicators pointed toward an economic downturn.  The most significant question behind that trend was:  Where does the real counterparty risk sit?  The bank is the originating broker of things. Most banks make the majority of their income from services rather than from the extension of credit. When a mortgage is sold, credit is instantly rolled into a packaged form and sold.  The bank has simply become an origination house that moves the risk somewhere else.  That “somewhere else” turns the loans into 3rd party investment vehicles and eventually they roll into a variety of securities that require both credit enhancements and are supported by complex risk transfer products.  At the extreme of counterparty risk management, you find the trading of default swaps and other financial products and you find entities like ICAP. ICAP trades more value in one week than the entire GDP of most countries – trading the equivalent value of the U.S. GDP every 10 days.  They trade $1.3-$1.5 trillion per day in counterparty risk.  They are an indicator or the “governor” on top of the system, trading contracts which cover the exposure of counterparty risk.  The profitability of ICAP depends on dynamic management.  They provide a place to buy on the direction of the market.    The net effect of the offsets is a constant.  There is a finite amount of liquidity in the market.  Bundled loans are sitting in 3rd party investment vehicles here.  They have giant consolidations of portfolio holds. In the tertiary markets such as ICAP’s brokerage space, large banks and sovereign funds are generally the investors.  An early indicator of systemic unraveling is visible here as the first movers will set market direction.    Large revenue movements up or down means unraveling is starting to occur.  Look for a change in the reported revenue and profitability of ICAP.  If the market appetite is saying the system is OK, ICAP’s net income should be flat but profitable.   The worst piece of news you can get is news of ICAP’s revenue having significantly changed.   If the contract values are down, then there are lots of sellers, but no buyers.  If contract values are up, there are lots of buyers and people don’t want to sell or are unable to alter their positions.  Look at how much ICAP’s income changed in the first quarter of this year.  It might be calm in the eye of the storm at the moment, but keep an eye on the fundamentals of what moves ICAP’s revenue.    The Problem While US Treasuries have not been a particularly desirable buy because of excessive US debt loads, default swaps and derivate products – the counterparty risk management surrogates on the market – have been purchased by foreign interests.  Why would someone buy the excess of the overconsumption of our economy?  For the same reason the Chinese were buying US Treasuries: to gain a controlling minority position.  By August 13th of 2008, we will have lost the ability to control our excessive exposure to our risk management credit exposure at the non-governmental level; in short, we will have sold our economy. By selling off our Treasuries, by imbalancing our production/consumption behavior and now by selling our ability to manage non-sovereign financial risk management, we have invited outside interests to enjoy the benefit of being significant minority shareholders.  We no longer maintain the autonomy of our destiny because we’ve invited others to acquire both fulcrum and lever control. What actions have sovereign wealth funds (China in this example) already taken?  They’ve shorted the value of U.S. currency 30%.  We are having our currency shorted to the extent that in the very near future it could trigger the risk of runaway inflation.  In the past the U.S. would have solved the problem by saying “We’ll get domestic production back up.”  However, domestic production takes years to get back online, many experts say upwards of 8 years or more. Pieces of a Wild Card Scenario At the end of the Olympics, China could dump a significant amount of its holdings of US Treasury bonds. China could choose to be free to totally decouple the RMB from the Dollar.  Chinese purchasing has already shifted to India, Central Asia, Persia, Africa and Europe. Because there are no buyers able to absorb anything approaching the quantities of U.S. Treasuries held by China, it is using its holdings to collateralize purchasing contracts which it then pays for in other currencies.  While the European Central Bank could not directly absorb a dollar to euro conversion for the Chinese, the Chinese have effectively begun such a conversion by effectively using dollar denominated collateral for euro priced purchasing.  The Chinese have recently collateralized the Iranian oil pipeline deal in US dollars.  So US Treasuries are collateralizing the development of critical infrastructure in Iran – via China. Immediate impact this summer: Foreign Direct Investment has been coming in to finance our infrastructure in bonds and increasing involvement to support our banking loss reserves.  The U.S. Economy isn’t financing its own infrastructure.  For example, most of the bonds for oil desulfurization refining capabilities of the US expire this year (starting in 1971 or later).  It is the end of the fixed income market for building out infrastructure, in order to retrofit refining capacity.  The new infrastructure investments and bonds will not be originated in the US because we can’t afford it.  We needed those bonds to fund our infrastructure going forward.  ·         As price at the pump goes up, the value of the dollar is going to decrease.  As the dollar decreases in purchasing power due to oil’s price increase, it is getting a second hit in value from sovereign wealth funds shorting it.  These two trends in combination are not usually being considered together when calculating inflation trends.  ·         There could be a spike of inflation in the summer in August, post Olympics.  ·         The Chinese may not perturbate the system until after the Olympics because of national pride.  ·         China will likely be the wild card that has the most compelling consequence to domestic U.S. economic and international commercial policy.  ·         China may begin to activate and leverage its decade long mandatory technology transfer which involved the importation of vast intellectual property from U.S. and European firms.  Every sovereign contract issued inside of China must operate under the mandatory Technology Transfer policy of China.   That policy states that China has the right of full access to all of the technology, secrets and know-how of the research and development integrated into products sold by U.S. and European companies in China integral in critical infrastructure to the Chinese government.  It will be a big wakeup call to the companies who have represented to their shareholders that they hold exclusive control of their intellectual property.    People invested in companies like Siemens, ABB, Alstom, GE, Fujitsu, DuPont, or any other major global corporation, need to be aware of the underlying technology options that have been sold to China in support of the large contracts that have been announced over the past 8 years.  The nature of commoditization that will ensue from the Chinese use of the technology that they’ve purchased is a major economic wild card that the U.S. and European markets have not priced into current volatility. ·         Many competitors may emerge to each of the Western Industries represented in China as their intellectual property may be increasingly exposed to more commoditization pressures.  ·         These companies (from the U.S. and E.U.) may file grievances in international court and trade arbitration bodies.  However, China will be able to show compelling evidence of ownership of interest based on contract terms that have been somewhat opaque to most corporate reporting interests.  ·         The U.S. and E.U. companies sold much of their future IP control to be able to work in China.  Even if they won their legal arguments and attempted to repatriate portions of their intellectual property, they would likely be forced to pay China rebates for the booked value of the assets they (China) thought they were getting. ·         If the Chinese dumped U.S. Treasuries it could cause at least 1/3 of the current Dow component to be expressly negative.  This is due to the combined effect of the degree to which Dow components report profit from their Asian business together with the impact on the cash holdings on the balance sheets of the same interests.  Significant downward guidance will come in at end of year and early fiscal ’09.  ·         Currently the electorate base is still heavily influenced by organized labor; however this may be the last election season where organized labor will play a role in the U.S. elections.  This is a consequence of the fact that the industrial base that supports the largest organized labor units will likely suffer the further downsizing pressures of an activation of a Chinese initiative to use and expand the technical capabilities that they have purchased over the past decade. ·         After August, 2008 there could be civil unrest because of unemployment and because of the erosion of the dollar’s purchasing power.  ·         In this scenario, poor Americans may not be the ones acting out.   Poor people will experience a more difficult situation to be sure, however the middle class will feel their entitlements slipping away and this erosion of perceived status quo could cause the middle class to lead the civil disobedience.  This has been seen already in Europe.  The middle class are connected with internet and mobile phones.  They can coordinate differently.  ·         The emotional response of the middle class will be one of the loss of entitlement.  We will have had something and someone would have taken it away.  This is going to be perceived as injustice. ·         We cannot sustain the current diversity of consumer products.  Companies that are manufacturing them won’t be able to access the market anymore.    ·         No U.S. financial institution warrants an AA rating under the Basel II guidelines.  Instead, U.S. banks said that Basel II doesn’t apply to us.  We will be excluded or will pay a premium to bank with the world community. ·         Internationally it is suggested that there will be a drift to the Euro, Pound, and Norwegian monetary products.  What happens or is happening elsewhere? If the US market collapses or goes into depression, what happens to the rest of the world? China: China’s only way forward would be to slow down growth, avoid internal uprising in the process and become an internal consumption engine.  If you are a Chinese policy maker, a major problem is a largely male-heavy population (estimated 40% more males than females), i.e. unmarried men entering 30’s and 40’s (135 million people – equal to almost half the population of the U.S.).  If you are going to be single for your whole life – a direct consequence of the one-child policy – you are likely to spend your disposable income on consumables.  The global economy has never seen the dynamic that is emerging in China where the notion of building value for posterity will be nothing more than a theoretical value as a huge segment of the population will have no progeny.  The Chinese government will need to respond to this by focusing considerable attention on domestic production for domestic consumption turning inward rather than rushing for greater export dynamics.  If China can control their growth, they might be ok.  They have huge capacity problems in terms of energy, telecommunications, bandwidth, shipping, etc.  By cooling off their economy, actually they would do themselves a favor in the long haul.  Whether or not the “5th generation” leadership will be able to deal with the complexities of the next 20 years is unknown.  The National Development Reform Commission as of two years ago started a planned migration plan.  This plan envisioned and initiated the urbanization and net migration of 200 million people.  The reasoning was that this centralization would allow central service access to be available to a larger population, i.e. better schools, water, etc.  However, the gender problem was not accounted for and there is a cultural problem in two ways.  One: in China, family is not just important; it is the point of life.  If 135 million men can’t continue their family line, it will start to spark outrage.  Next, all the migrants will have left their home property which was where they had their identity.  Once these men realize they no longer have family, home, or identity, they will realize they don’t have a future.  People without a future tend to act in undesirable ways.  This challenge will need to be managed without any historical precedent to inform the dynamic.India: India has built a primary service economy, not a production market.  India’s service economy depends on the US and Western consumption market and the services attendant thereto.  As our consumption drops off, they may experience a shortfall in demand for all the services they currently provide.  As one Indian entrepreneur put it, “We are already in the late phase in terms of the maturation of the call center industry.”  India is now going after higher value service options.  Areas like the Maintenance, Repair and Overhaul (MRO) sector in aircraft, or low cost automobile production (Tata).  They are rapidly moving into the manufacturing sectors. Middle East: The Middle East may have strong pockets of stability.  There are many NGO’s and Multi-nationals who are establishing a business presence on the road from Cairo to Alexandria.  Tech parks in the desert might be the new trend. Brazil: Stability may emerge in Brazil and they have an outside chance of solving their poverty problem.  Brazil could be the good news story here.  They are now energy independent, net energy exporters, their automobile fleet runs almost exclusively free of fossil fuels, and they have recently discovered what might be the third largest oil reserve in the world off their coast.  Their financial institutions, long shunned by many developed economy financial institutions, are showing the prospect of emerging as one of the Western Hemisphere’s strongest national infrastructures. Russia: Russia is very similar to Japan in the 1980’s.  Their spending pattern reflects more of the trophy property and trophy ownership desires that value the perceived value of identity rather than the actual value of long-term economic vision.  Russia needs to focus its investments on areas of strategic, long-term technological value rather than supporting the inflation of real estate and legacy public equities with diminishing market relevance. Future scenarios in the US:U.S. in two years: ·         The collective emotional sense suggests that “things are miserable”.  ·         Employees want jobs that probably won’t be there.  ·         States may have liquidity problems as the tax bases based on real estate will be pushed into insolvency.  What do you do with a bankrupt state?  What do you do with a work force that needs comprehensive retraining for jobs that don’t exist? ·         Gross receipts suggest fall off within 2 years.  ·         More US imports may come from Vietnam and Honduras.  ·         Wild card risk of an Indonesian rice crisis.  Indonesia went from having 3,000 cultivars of rice to 5 cultivars now.  A single viral outbreak could kill it all.  Take Indonesian rice production out of global market, food prices destabilize quickly.  If you don’t have protein, you don’t live.Within 4 years: We see an emergence of a non-nation state solution.  The emerging solution will show that social networks will not be defined by nationality.  If you ask someone in most parts of the world, “Who are you?,” they define themselves by culture, employer, nationality, etc.  In the Muslim world, people define themselves by their religion first, geographic/tribal identity second and national identity third. We must account for these identity differences.  We should learn that we need to rely on old social network logic.  In short, we need to remember that long-term economic and social sustainability is predicated on mutual beneficial engagement, not hegemony.  If we want a seat at the table going forward we need a lot less proprietary thinking and more emphasis on cooperation and networked collaboration.  In the United States, we need to decide what to do with returning troops from Iraq.  We have trained and socialized a large segment of society to live in a constant state of stress and conflict readiness, to kick down doors and shoot things.  We’ve trained them to function in hostile environments with little clarity of the rationale for this violence.  They have risked their lives for the cause of the United States and many will return with post traumatic stress syndromes and other injuries that may alter their ability to seamlessly integrate into the work-force.  They expect that their sacrifice will mean something and that their country will take care of them.  We need an economically stable country to which these people may return home.  If they cannot get meaningful work or if their country shows signs of recession or depression and they cannot be integrated and socialized, we will have a problem on our hands.  We must give the returning troops jobs, even if this means sacrificing our personal incomes to ensure this need is met. Investment considerations The Arlington Institute and its members, affiliates, and friends are not licensed financial advisors.  Therefore, while we will offer our considerations with respect to various market segments, we do not make any investment suggestions based on the possible scenarios we foresee.Water: We start by looking at the basic necessities of life, the first being water.  Research utilities that allow you to deal with the production of clean water for drinking and irrigation.  Who controls water will control the flow of value.  Water is a long bet.  Look for private equity opportunities in low energy membranes and reverse osmosis. Oil: In the immediate future, demand for oil and its components will only reduce slightly.  Overall demand is still increasing with minimal increases in supply.  Until alternatives come along, oil (barring excessive speculation or reduced consumption) doesn’t suggest huge decreases in price.  Any carbon that we use, whether coal or oil, etc., has increasingly higher sulfur content.   Desulfurization enterprises and technology will become necessary to produce the end product.    The technologies to tap alternative energy sources are still not cost effective enough to compete with oil at this time.  Producing a kilowatt with less environmental impact for less money than oil has been claimed, however these claims have not been market tested and none of them takes into account the infrastructure needed to support the new technology.  Most analysts quote commodity prices rather than the holistic, “all-in” price.  Consider buying at the utility side of the all in cost.  Food: There are multiple logistical steps for getting food from point A to point B.  When transporting it, find out who can move the product without biologics or chemicals in it.  Observe the quality of the food supply rather than just food.  Also, look at underlying food security. Logistics: The way we move things will change.  We may have bigger quantities in fewer containers.  We might be talking about people in this scenario as mass migrations might need to occur, moving people to areas with water and food.  In an economic downturn scenario, people will probably not drive 20 miles to buy $15 worth of merchandise from a big box retailer.  They will make fewer trips with a higher expenditure per trip.   In this scenario, we could see the re-emergence of the corner store which will be good for local employment.     Currencies: Long:  Euro, Pound and Swiss Franc. Short: Dollar and RMBGold: Gold is a nostalgic thing which at present is hard to argue with because of its rapid increase in value.  However, we suggest considering commodities that have critical industrial uses such as titanium, tungsten, and copper.  Metals and commodities have experienced huge price increases in the last year and particularly in the past few months.  However, commodities markets are highly volatile; as always consider buying low and selling high.Dow Jones Industrials: We are not optimistic about the current Dow Jones Industrial companies.  On April 14th, 2008 a major event occurred in the stock market.  For the first time, it was clearly evident that automated trading and heuristic driven trading moved the market based on statistical volatility requirements that were uncorrelated to any alteration in actual corporate value or fundamentals.  The interplay between human emotions, technical fundamentals and, quant funds drove market volatility up until that day when there was an interesting transition.  On all the financial news networks, there was a question about how the Fed decisions would come out.  All the major financials prior to the market opening said, “the market is set to open higher” but it should have gone negative based on all the indicators.  What happened on the 14th was that someone, some agency, or something bought into a flat market.  There was a market drag along effect as we were responding to volatility which is not emotionally programmed.  We know what the program is and we know that the notion of fundamentals-based investing on the merits of book or balance sheet value have been abandoned in favor of moving liquidity based on statistical variance parameterization.  By automated purchasing into markets that are lacking volatility spreads, traders are not investing in value, but feeding liquidity into volatility.  We believe that the market left the human factors on the 14th because model based heuristics can make more money on volatility than value. Scenario concluding thoughts: We hope you find these explorations of possible scenarios of use.  We hope to evaluate other elements of proposed downturns over the coming weeks.  If you see major flaws or would like to posit alternative solutions, please send them to ken@arlingtoninstitute.org.  As evidenced in our newsletter, we publish well thought through solutions when sent.  We look forward to our next discussion at SpringSide Chats.