Reality Bites Again

The feeble American response to Russia’s assertion of power in the Caucasus of Central Asia was appropriate, since, according to James Howard Kunstler, the United States’ claims of influence in that part of the world are laughable.

The U.S. had taken advantage of temporary confusion in Russia, during the ten-year-long post-Soviet-collapse interval, and set up a client government in Georgia, complete with military advisors, sales of weapons, and even the promise of club membership in the Western alliance known as NATO. These blandishments were all in the service of the Baku-to-Ceyhan oil pipeline, which was designed specifically to drain the oil region around the Caspian Basin with an outlet on the Mediterranean, avoiding unfriendly nations all along the way.

At the time this gambit was first set up, in the early 1990s, there was some notion (or wish, really) among the so-called western powers that the Caspian would provide an end-run around OPEC and the Arabs, as well as the Persians, and deliver all the oil that the US and Europe would ever need – a foolish wish and a dumb gambit, as things have turned out.

For one thing, the latterly explorations of this very old oil region – first opened to drilling in the 19th century – proved somewhat disappointing. U.S. officials had been touting it as like unto "another Saudi Arabia" but the oil actually produced from the new drilling areas of Kazakhstan, Turkmenistan, and the other Stans turned out to be preponderantly heavy-and-sour crudes, in smaller quantities than previously dreamed-of, and harder to transport across the extremely challenging terrain to even get to the pipeline head in Baku.

Meanwhile, Russia got its house in order under the non-senile, non-alcoholic Vladimir Putin, and woke up along about 2007 to find itself the leading oil and natural gas producer in the world. Among the various consequences of this was Russia’s reemergence as a new kind of world power – an energy resource power, with the energy destiny of Europe pretty much in its hands. Also, meanwhile, the USA had set up other client states in the ring of former Soviet republics along Russia’s southern underbelly, complete with U.S. military bases, while fighting active engagements in Iraq and Afghanistan. Now, if this wasn’t the dumbest, vainest move in modern geopolitical history!

It’s one thing that U.S. foreign policy wonks imagined that Russia would remain in a coma forever, but the idea that we could encircle Russia strategically with defensible bases in landlocked mountainous countries halfway around the world…? You have to ask what were they smoking over at the Pentagon and the CIA and the NSC?

So, this asinine policy has now come to grief. Not only does Russia stand to gain control over the Baku-to-Ceyhan pipeline, but we now have every indication that they will bring the states on its southern flank back into an active sphere of influence, and there is really not a damn thing that the U.S. can pretend to do about it.

We could have spent the past ten years getting our own house in order – waking up to the obsolescence of our suburban life-style, scaling back on the Happy Motoring, reconnecting our cities with world-class passenger rail, creating wealth by producing things of value (instead of resorting to financial racketeering), protecting our borders, and taking the necessary measures to defend and update our own industries. Instead, we pissed our time and resources away. Nations do make tragic errors of the collective will. The cluelessness of George Bush is nothing less than a perfect metaphor for the failure of a whole generation. The Boomers will be identified as the generation that wrecked America.

So, as the vacation season winds down, this country greets a new reality. We miscalculated in Western and Central Asia. Russia still "owns" that part of the world. Are we going to extend our current land wars there into the even more distant and landlocked Stan-nations? At some point, as we face financial and military exhaustion, we have to ask ourselves if we can even successfully evacuate our personnel from the far-flung bases in Uzbekistan and Kyrgyzstan.

This must be an equally sobering moment for Europe, and an additional reason for the recent plunge in the relative value of the Euro, for Europe is now at the mercy of Russia in terms of staying warm in the winter, running their kitchen stoves, and keeping the lights on. Russia also exerts substantial financial leverage over the U.S. in all the dollars and securitized U.S. debt paper it holds. In effect, Russia can shake the U.S. banking system at will now by threatening to dump its dollar holdings.

The American banking system may not need a shove from Russia to fall on its face. It’s effectively dead now, just lurching around zombie-like from one loan "window" to the next pretending to "borrow" capital – while handing over shreds of its moldy clothing as "collateral" to the Federal Reserve. The entire US, beyond the banks, is becoming a land of the walking dead. Business is dying, home-ownership has become a death dance, whole regions are turning into wastelands of "for sale" signs, empty parking lots, vacant buildings, and dashed hopes. And all this beats a path directly to a failure of collective national imagination. We really don’t know what’s going on.

The fantasy that we can sustain our influence nine thousand miles away, when we can’t even get our act together in Ohio is just a dark joke. One might state categorically that it would be a salubrious thing for America to knock off all its vaunted "dreaming" and just wake up.

Until next time,

James Howard Kunstler
for The Daily Reckoning
August 19, 2008

James Kunstler has worked as a reporter and feature writer for a number of newspapers, and finally as a staff writer for Rolling Stone Magazine. In 1975, he dropped out to write books on a full-time basis.

His latest nonfiction book, The Long Emergency describes the changes that American society faces in the 21st century. Discerning an imminent future of protracted socioeconomic crisis, Kunstler foresees the progressive dilapidation of subdivisions and strip malls, the depopulation of the American Southwest, and, amid a world at war over oil, military invasions of the West Coast; when the convulsion subsides, Americans will live in smaller places and eat locally grown food.

Today, we take a break. Yes, dear, dear reader…there will be little reckoning today. Short Fuse will write tomorrow’s issue – and then The Daily Reckoning is taking the rest of the week off, as Fuse and Addison are traveling to Omaha for the premier of I.O.U.S.A. Elizabeth needs help preparing for her big hullabaloo. We’re expecting about 150 people for a soiree on Thursday night, about which, more below…

Before we leave you, though…we have just a couple thoughts…

We’re sticking with our views and our investments – either until we’re proven wrong or we go broke, or both.

Our view is that the great dollar-based credit expansion of the last half-century is coming to an end. And our guess is that it will end with BOTH a bang and a whimper – that is, both a deflationary contraction…and an inflationary blow-off. A deflationary contraction is the market’s normal response to an inflationary boom. And an inflationary blow-off is the market manipulators’ normal response to a deflationary contraction; but, we hasten to add, there is no guarantee that they can pull it off.

So, as usual, we live in a world of great unknowns…and lesser unknowns…and things we don’t even know we don’t know. What we do know is that stocks have not yet bottomed out (they are nowhere near their low points)…and bonds are still expensive (people still lend to the U.S. government for 10 years at less than 4% – that’s substantially less than the current consumer inflation rate)…and the dollar is still treated with respect, even though its long-term value is zero. There is a lot that can go wrong that hasn’t gone wrong yet, in other words. Until it does, we’ll stick with gold.

*** "The worst is to come." Sometimes it’s nice to hear things laid out bluntly – and long time sufferers know that we aim to do that at The Daily Reckoning, as well. Former chief economist of the IMF, Professor Kenneth Rogoff is not one to sugarcoat or mince words. He told attendees of a conference in Singapore that in the worldwide credit crunch, "The U.S. is not out of the woods. I think the financial crisis is at a halfway point, perhaps. I would even go further to say the worst is to come."

Professor Glass-is-Half-Full went on to say: "We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a big one – one of the big investment banks or big banks."

And the dark twins of mortgage finance didn’t escape unscathed, not by a long shot. Yesterday, on the heels of a report that suggested that the Treasury may have no choice but to nationalize Fannie and Freddie, investors began dumping shares.

The chance of nationalization of the mortgage giants scares the beejeezus of out foreign investors, especially our friends in Asia. And with good reason…while Japan wasn’t too exposed to subprime, they do hold around ¥9.6 trillion in bonds and mortgage-backed paper issued by finance groups. We all know that these securities aren’t guaranteed by the U.S. government. Whoops…

*** As if there wasn’t enough bad press for Fannie, David Hilzenrath at the Washington Post printed a pretty damning article, titled "Fannies’s Perilous Pursuit of Subprime Loans."

The article is definitely worth a read through, and here are some highlights to tide you over:

In a confidential memo to his board, chief executive Daniel Mudd (has anyone ever had a more unfortunate last name?) "said one of Fannie Mae’s achievements in 2006 was expanding its involvement in the market for subprime and other nontraditional mortgages. He called it a step ‘toward optimizing our business.’"

We know…yikes. But wait, it gets worse. The Post continues:

"Internal documents show that even late in the housing bubble, Fannie Mae was drawn to risky loans by a variety of temptations, including the desire to increase its market share and fulfill government quotas for the support of low-income borrowers.

"Fannie Mae documents from the period, obtained by The Washington Post, paint a picture of a company with the dual incentives of fostering affordable housing and making money, and of one caught between the imperatives of increasing its market share while avoiding excessive risk. In a bid to juggle these demands, the company’s executives took on risks they either misunderstood or unduly minimized.

"Fannie Mae aimed to benefit from subprime loans and expand the market for them – and hoped to pass much of the risk on to others, documents show. Along with subprime loans, which were typically issued to borrowers with blemished credit, the company targeted so-called Alt-A loans, which were often made with no verification of the borrower’s income."

And so on. While it’s not a pretty picture, the article doesn’t say anything that everyone didn’t already assume.

*** Meanwhile, back at home, people are already coming and going so fast – we can barely keep up with them. Jules came home last night. Henry is leaving today – as a first year student at the University of Virginia; he has to show up early. And as a "foreign student," he has to go earlier still.

"Are you sure you’re a ‘foreign student’?" we wanted to know.

"Yeah…I haven’t lived in the U.S. since I was 6 years old. And I’ve only studied in French. So I’m considered as a foreigner."

Tomorrow, cousins…daughters…and friends arrive for the big party.

The original reason for the party was a big birthday milestone. Your editor turns 60 in a couple of weeks. Then, we realized that most of our friends and family couldn’t make it to France…so we planned a another party for Annapolis, Maryland a week or two later. But since the party in France was already underway, we turned it into a "summer celebration." Celebration of what? Well, we’ll have some explaining to do…

The Daily Reckoning