• With little thought of long term consequences, the US bullies international companies with monetary threats if they do business with countries the US doesn't like.
  • The US international arrogance continues to give more fuel to countries to move to a post-dollar system.
  • When the world rejects the dollar, the US standard of living will decline rapidly.
On June 30, U.S. authorities announced a stunning $9 billion fine on French bank BNP Paribas for violations of financial sanctions laws that the United States had imposed on Iran, Sudan and Cuba. In essence, BNP had surreptitiously conducted business with countries that the United States had sought to isolate diplomatically (sometimes unilaterally in the case of Cuba). Although BNP is not technically under the jurisdiction of American regulators, and the bank had apparently not broken any laws of its home country, the fine was one of the largest ever issued by the United States and the largest ever levied on a non-U.S. firm. The Treasury Department and the Federal Reserve made clear that unless BNP forks over the $9 billion (equivalent to one year's of the company's total earnings), the U.S. will prevent the bank from engaging in dollar-based international transactions. For an institution that makes its living through such transactions, that penalty is the financial equivalent of a death sentence. The fine will be paid.
It is widely rumored that Germany's Commerzbank will be the next European institution to face Washington's wrath. It is rumored that it will face a penalty of at least $500 million, an amount that is roughly equivalent to one year of the bank's income.
As if choreographed by a financial god with a wicked sense of humor, the very next day marked the official implementation of the Foreign Account Tax Compliance Act (FATCA), a new set of laws that will require all foreign financial institutions to routinely and regularly report to the U.S. Internal Revenue Service all the financial activities of their American customers. The law also requires that institutions report on all their non-American customers who have ever worked in the U.S. or those persons who have a "substantial" connection to the U.S. (Inconveniently the law fails to fully define what "substantial" means.) Failure to report will trigger 30% IRS withholding taxes on any dollar-based transactions made by clients who the U.S. has determined to be American...either by birth, marriage, or simply association.
Given that the United States is one of only two nations in the world (the other being Eritrea) that taxes its citizens on any income received, regardless of where that income was earned and where the tax payer lived when they earned it, the FATCA laws are an attempt to extend American tax authority and jurisdiction (by unilateral dictate) to the four corners of the Earth. The Economist magazine, which is not known for alarmist reporting, described FATCA as "a piece of extraterritoriality stunning even by Washington standards." (For those of you who did not pay attention during world history class, "extraterritoriality" is an attempt by one country to enforce its own laws outside of its own borders.)

What's worse is that many accountants and analysts have estimated that the compliance costs that the United States has imposed on these non-constituent banks (which have limited ability to lobby or influence U.S. lawmakers) will far outweigh the $800 million in annual revenue that the law's backers optimistically estimated. In a June 28th article, The Economist quotes an international tax lawyer saying that FATCA is about "putting private-sector assets on a bonfire so that government can collect the ashes." The laws are particularly irksome to many because the United States typically refuses to subject itself to the same standards it requires of others. When foreign governments ask Washington for financial information from its citizens, the U.S. government hypocritically trots out privacy laws and poses on the altar of civil liberties. In fact, despite its war on foreign tax havens, for non-Americans the United States is by far the world's largest tax haven.

But as is the case with BNP, the foreign banks will have little choice but to comply. Given the importance that U.S. dollar-based transactions play in daily banking operations, U.S. authorities call the tune to which everyone must dance. However, the complexity and opacity of the laws have at least generated some mercy from the U.S. which has allowed foreign banks more time to implement compliance procedures. In many ways this is similar to how the Obama administration has extended Obamacare mandates to a persistently confused and overwhelmed public. This is cold comfort.

The FATCA and the BNP developments have occurred just a few months after the U.S. has finished tightening the screws on a variety of Swiss banks that had attempted to follow the bank privacy laws that exist in their home country. Through heavy-handed tactics, U.S. authorities made it impossible for the Swiss banks to transact business internationally unless they played ball with Washington and turned over all information the banks possessed on U.S. customers. Not surprisingly, the U.S. prevailed. Additionally, June marked the end of Germany's farcical campaign to repatriate the hundreds of tons of gold that are supposedly on deposit at the Federal Reserve Bank of New York. After asking for its gold back two years ago, and after having only received the smallest fraction of that amount over the ensuing years, the Germans have decided to make a virtue of necessity and drop its demands to receive its gold. (See interview with Peter Boehringer.)

But the fate of BNP appeared to kick up a storm that went beyond the usual grumblings that American financial muscle-flexing usually inspires. A few days after the fine was announced, French Finance Minister Michel Sapin questioned its legality by pointing out that the offending transactions were not illegal under French law. (The Obama Administration reportedly ignored requests by French President François Hollande to reduce the fine.) Going further, Sapin appeared to bring into question the entire monetary regime that has granted the U.S. its unique unilateral power: "We have to consider...the consequences of pricing things in dollars when it means that American law applies outside the U.S.....Shouldn't the euro be more important in the global economy?" (Bloomberg, 7/5/14) Politicians, French or otherwise, rarely deliver such explicit statements.

As if on cue, a few days later Christophe de Margerie, the CEO of French national energy company Total SA, raised eyebrows when he made repeated comments at a conference in France that the euro should be used more often in international oil transactions, saying, "Nothing prevents anyone from paying for oil in euros." Perhaps these are the opening salvos in what may be a long war.

The anger is particularly acute in Germany where the United States has already come under criticism for a series of surveillance and espionage revelations, including illegally tapping Chancellor Merkel's cell phone, and planting spies in the upper echelons of Germany's military. Bloomberg recently compiled a selection of frustration with the United States' actions from Germany's leading newspapers. Among the highlights:

"The EU should think about introducing similar senseless rules and then punishing U.S. companies for violating them" (Frankfurter Allgemeine Zeituing).

"The United States is not really our friend. Friends treat each other with respect, the way Russia and Germany treat each other, and they do not try to order each other about" (Handelsblatt).

When Germans hold up Russia as a better ally than America, you realize how fundamentally the world is changing. And as we know, Vladimir Putin is doing all that he can to construct a post-dollar financial system.

These types of frictions should be expected now that America finds its economic and diplomatic influence to be waning. The failures of the American military to create stability in Afghanistan and Iraq, of American diplomacy in heading off crises in Syria, the Ukraine and Palestine, and most importantly the culpability of the American financial system in bringing the world to the brink of financial ruin in 2008, have left the United States with few good options with which to exert her influence. The predominance of the dollar and its reserve status around the world provides the leverage that America's other failed institutions no longer can.

This power is magnified by the ridiculous Keynesian notion that a strong currency is a liability and a weak currency is necessary for a healthy economy. This means that every bad move by the Federal Reserve needs to be matched by its counterpart bank in Frankfort and London. As such, America can debase its currency and serially acquire debt while avoiding the consequences that lesser countries would inevitably encounter.

For the moment the backlash against these laws has been limited to those Americans living abroad who are increasingly finding themselves to be financial lepers. Many local banks and mortgage companies are seeking to avoid the heavy hand of the IRS and FATCA by simply closing their doors to Americans. Even non-financial firms abroad have shown increasing reluctance to hire Americans as a result of the tax complications. As a result, it is well documented that the number of Americans renouncing their citizenship has skyrocketed in recent years.

The real danger of course is that the United States overplays its hand and arrogantly goes too far. While many would believe that milestone has come and gone, the truth is that the U.S. has yet to pay a price broadly for its actions. The dollar's reserve status is as yet intact, and U.S. Treasury debt is being sold at generationally low yields. But the longer this goes on, the greater the danger becomes.

Arrogance breeds contempt. The more reckless the United States becomes in throwing its weight around, the greater the temptation will become for the rest of the world to jettison the dollar like an unwanted house guest. If that happens, the value of U.S. dollar-based investments, and the living standards of all Americans, will pay a very heavy price.

As Caliphates Compete, Radical Islam Will Eventually Weaken


A still from a video released by Nigerian militant group Boko Haram in February shows leader Abubakar Shekau surrounded by numerous armed militants. Boko Haram

The rise of the Islamic State will inspire other jihadist groups to claim their own caliphates and emirates. In the long run, the extremism of these contrived dominions and the competition among them will undermine the jihadist movement. However, before that happens, the world will witness much upheaval.


In a 52-minute video that surfaced in late August, Abubakar Shekau, the head of Nigerian jihadist group Boko Haram, spoke of an Islamic State in northeastern Nigeria. The statement came two months after Abu Bakr al-Baghdadi, the chief of the transnational jihadist movement in Syria and Iraq, declared the re-establishment of the caliphate, renaming the group the Islamic State. Though likely inspired by the Islamic State, Boko Haram is not simply mimicking its more powerful Syrian-Iraqi counterpart; it is taking its cue from the Nigeria-based Sokoto Caliphate, which was established in the early 1800s and existed for almost a century until Britain gained control of the region.

The Caliphate's Role in History

According to classical Muslim political theorists, there can be only one caliphate for the entire Muslim global community, or ummah. In practice, though, there have been rival claimants to authority and even competing caliphates throughout the history of Islam. In our July 1 analysis on the subject, Stratfor explained not only how multiple emirates and sultanates emerged independently of the caliphate but also that there were rival caliphates -- for example, the Abbasid in Baghdad (749-1258), Umayyad in the Iberian Peninsula (929-1031) and Fatimid in Cairo (909-1171).

Competing Caliphates Circa 1000 A.D.

These medieval-era caliphates were not just the byproduct of geographical constraints facing the original caliphate but also heavily shaped by political and religious rivalries and political evolution. These dynastic empires were the building blocks of the Muslim world, not unlike the wider international system of the time. For this reason, they endured for centuries until Europe's geopolitical push into the Muslim world in the 18th century.

In the past two centuries, the medieval caliphates, emirates and sultanates have been replaced by nation-states. Though artificially created and weak, these modern Muslim polities are unlikely to be swept away by radical Islamists seeking to re-establish caliphates and emirates. Although nationalism was initially a European import into the Arab/Muslim world and continues to face competition from religious and tribal identities, it is well established in the public psyche.

This can be seen in the organization of most Islamists along national lines. Most Islamists, who are aligned with the Muslim Brotherhood or some variant of it, embrace the nation-state and should not be conflated with the minority of radical Islamists and jihadists who seek to eliminate national boundaries and return to a romanticized notion of the past. Still, caliphates and emirates have emerged because of the failures of the modern Muslim nation-states to create democratic systems and, more broadly, to provide a viable political economy for their citizens -- a failure that radical Islamist forces have deftly exploited.

Deficiencies in Modern Caliphates

Radical Islamists are able to capture the imagination of the economically disadvantaged youth who understand neither politics nor Islam. The most successful jihadist entity in terms of capturing territory, the Islamic State, rose in part because of rare circumstances related to the regional geopolitical struggle between the Shiite and Sunni camps in the Middle East. However, as is evident from the international alignment of forces against the Islamic State, the transnational jihadist movement faces severe challenges moving forward.

In addition, its ultra-extremist policies and behavior are further alienating the Islamic State from the Muslim world. Al Qaeda's denunciation of the Islamic State as a deviant force underscores the competition it faces from within the jihadist movement. Furthermore, there is an entire constellation of radical Islamists beyond al Qaeda that does not accept the Islamic State's claim to a caliphate. These Islamists will seek to form their own caliphates or emirates in the same battle spaces. Meanwhile, other groups operating in different parts of the Muslim world seek to form their own caliphates.

An important concept in this context is that of the leader of the faithful, or emir al-momineen, which was the title given to the second caliph of Islam, Omar bin al-Khattab (579-644). Since then, this title has become synonymous with that of the caliph. In the contemporary age, Afghan Taliban founder Mullah Mohammad Omar assumed the title in the 1990s, when the movement ruled most of Afghanistan. Decades earlier, Morocco's constitution conferred this title upon the country's monarch.

Morocco's king only claims leadership of the country's Muslim majority. Likewise, the Afghan Taliban's status as a nationalist jihadist force meant that Mullah Omar only claimed leadership of the Muslims of Afghanistan. Al-Baghdadi's move to declare himself caliph of all the Muslims of the world therefore challenges the authority of the emirates and dynastical or republican regimes in the Islamic world.

The Fate of Jihadists and Caliphates

In the distant future, radical Islamism will likely lose its appeal because of two broad factors. First, the attempt to create caliphates and the associated difficulties of governance will force many radical Islamists to opt for pragmatism and become relatively moderate. Second, opposition from fellow Muslims also learning about politics and governance will give them less room to operate.

Yet, while this modern phenomenon of competing caliphates, emirates or Islamic states will only further weaken jihadist groups, the idea of the caliphate remains an unresolved matter. Muslims have long accepted that the notion does not connote a single state for the ummah; instead it symbolizes pan-Muslim cooperation in the form of a supra-national regime such as the European Union. This remains a desirable goal, as is evident from the Organization of Islamic Conference which, though anemic, remains intact.

Still, these developments will be the outcome of a multigenerational struggle. Until then, the social, political and economic problems of the Arab/Muslim world, along with sectarian strife, geopolitical rivalries and the interests of outside powers (especially the United States and the West), will sustain the conditions in which violent extremists thrive. Thus, radical Islamism will remain a threat globally -- and especially for Muslims themselves -- for decades.

“Finest Worksong”

John Mauldin

Sep 17, 2014

“In theory there is no difference between theory and practice. In practice there is” – Yogi Berra, as cited by Ben Hunt in today’s Outside the Box. Or, to put it in macroeconomic terms, “Why is global growth so disappointing?” In the
aftermath of the Great Recession, fearing a deflationary equilibrium (which, as Ben notes, is macroeconomic-speak for falling into a well, breaking your leg, at night, alone), the Fed bought trillions of dollars in assets … and saved the world. Sort of. If you don’t count the reckoning yet to come. The theory was that with all that monetary-policy injections, global growth would spring back to “normal.”

But what did practice show? The global economic engine never fired back up. The central banks’ answer? Do more. So the Fed gave us QE 2 and QE 3, and then we got Abenomics, and now it’s Draghinomics.
Still no real growth. What’s missing? asks Ben. He has a surprising answer. Read on.

I had dinner last night with my good friend Richard Howard, who, besides being a charming young Australian lad, is also the wickedly brilliant chief economist of Hayman Advisors, the hedge fund outfit run by my friend Kyle Bass. We try to get together every few months at one of the local eateries and hash out the world. And yes, for those interested, the recent action in Japan has both of us smiling a “we told you so” sort of smile. But also thinking that the magic will last for Abe-sama a little while longer. Actually, we talked about why this trade could take a lot longer than most yen bears expect.

(Side note: As longtime readers know, I had just hedged a good portion of my newly acquired mortgage this year by shorting the yen using 10-year put options. Just for grins, I called my broker [a.k.a. The Plumber – Eric Keubler of JPMorgan] and asked how much my position was up. I know, I bought 10-year options and shouldn’t check more than once a year at most, but I was just curious – so sue me. Anyway, with a 5-yen move in my favor I expected to see a rather nice profit. It turned out the profit was about 3% of what I was expecting [not a typo]. That seems odd, I said. No, he told me, all the volatility in the option price has collapsed. The complacency in the currency market and especially in the yen-dollar market is simply massive. This made me glad that I bought 10-year options, as I fully expect that the volatility will have to reappear in the future – unless human nature has somehow changed without sending me a memo. But it goes to show you, gentle reader, that you can be right on the trade and lose money, perhaps a lot of it, if your timing sucks. Ironically, I can get roughly the same trade today for only a few dollars more than I paid five or six months ago, with the 5-yen advantage to the home team. Go figure. I plan to add to this trade, so if you are watching and know when I’m going to do it, you will know that volatility is exceedingly high when my personal situation allows me to execute.)

Richard and I then went on to talk about the interesting decision by CalPERS to completely exit hedge funds. I think the consensus as we left the table was that it is both an odd decision and a perfectly reasonable one, depending on your perspective. Please note that in their press release CalPERS used 5 years and 20 years as their retrospective time horizons. The intervals between 1994 and 2009 and the present just happen to be very convenient time periods to compare overall portfolio returns for CalPERS and for equity markets in general versus hedge funds. If you used 2000 or 2006, your internal rate of return would suck, and your portfolio performance would be less than flattering. Still, hedge funds in general have not performed as well for the last five years as they did in the past, and in general they didn’t offer the downside protection in 2008 that they did in the prior correction of 2000-2001.

In my opinion, CalPERS was not very good at choosing hedge funds, and their timing in entering and exiting a number of their funds wasn’t any better. You can go to any number of pension funds and find far better results than CalPERS achieved. To be fair, I would suggest that the majority of hedge funds are not worth the fees they charge, as they simply provide leveraged beta. Choosing hedge funds is as much an art form as it is a science. Kind of like choosing stocks.

I mean, every asset class has its own particular rhythm. As we all know, over the very long run stocks generally do well. But there are some periods of time when the performance numbers don’t live up to the promise. Those are called secular bear markets, and we had one beginning in 2000. I don’t think we have come to the end of it, and so we still live in a world where we have to look for absolute returns. That’s just the way I see the data.
All that said, I can totally understand CalPERS’ decision to exit the hedge fund world. First, their entire hedge fund investment portfolio was less than 2% of their total portfolio. Even if their hedge fund portfolio was crushing it, that wouldn’t move their overall needle. They were paying $135 million in fees for the privilege of being continually second-guessed by their critics. Frankly, if they had asked me, I would have said, either go large or go home.

And there’s the problem. They really can’t go large. Let’s say they put 10% of their fund into hedge funds. That means at least $30 billion. I don’t think you can allocate $30 billion appropriately from the standpoint of public pension fund responsibility. I wouldn’t even begin to know how to do it. Two or three billion? Absolutely. It would be difficult, but it could be done.

The problem is, you don’t want to become too big a portion of any one fund. Seriously, there are not that many good large funds. Most hedge funds are way too small to be considered as potential investments by CalPERS. So if you are CalPERS you are size-constrained and limited to a small universe of very large hedge funds. Which is not typically where you find hedge fund alpha. And you don’t want to have 100 different funds, as the complexity of tracking all that is enormous.

So you either end up with a portfolio that is ridiculously spread out and is going to regress to the mean, that is, to general market performance; or you going to be over-allocated to some fund that will prove to be a time bomb just when your public relations team is being overwhelmed with something else. I’m not sure who in the universe is in charge of the rules on timing, but it does seem that things are structured so as to cause the greatest possible embarrassment.

So I can certainly understand extremely large public funds leaving hedge funds. I do think that they should consider what other forms of alternative investing might make sense. Pension funds have one commodity that very few other investors have: they have time and lots of it. Most of them sell their time for ridiculously cheap premiums in the fixed-income market. Perhaps figuring out how to increase the return on your patient cash would be the way to go. And that’s not a bad strategy for individual investors as well. Just saying…

That’s the news from beautiful, sunny Dallas. It is time to go ahead and hit the send button as The Beast is lurking in the gym, waiting for me. Have a great week, and enjoy Ben Hunt’s essay.

Your ready to get on a plane again analyst,

“Finest Worksong”

Take your instinct by the reins
You'd better best to rearrange
What we want and what we need
Has been confused, been confused
– REM, “Finest Worksong” (1987)

The politics of dancing

The politics of oooh feeling good
– Re-flex, “The Politics of Dancing” (1983)

The fault, dear Brutus, is not in our stars, but in ourselves.
– William Shakespeare, “Julius Caesar” (1599

In theory there is no difference between theory and practice. In practice there is.
– Yogi Berra, (b. 1925)

Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back. ...

Indeed, the IMF's expectation for long-run global growth is now a full percentage point below what it was immediately before the Global Financial Crisis. ...

But it is also possible that the underperformance reflects a more structural, longer-term, shift in the global economy, with less growth in underlying supply factors.
– Fed Vice Chairman Stanley Fischer, “The Great Recession: Moving Ahead,” August 11, 2014

There is one great mystery in the high falutin’ circles of the Fed, ECB, and IMF today. Why is global growth so disappointing? There are different variations on this theme – why aren’t businesses investing more? why aren’t banks lending more? – but it’s all one basic question. First the Fed, then the BOJ, and now the ECB have taken superheroic efforts to inflate financial asset prices in order to bridge the gap between the output shock of 2008 and a resumption of normal economic growth. They’ve done their part. Why hasn’t the rest of the world joined the party?

The thinking was that leaving capital markets to their own devices in the aftermath of the Great Recession could result in a deflationary equilibrium, which is macroeconomic-speak for falling into a well, breaking your leg, at night, alone. It’s the worst possible outcome. So the decision was made to buy trillions of dollars in assets, forcing all of us to take on more risk with our money than we would otherwise prefer, and to jawbone the markets (excuse me ... “employ communication policy”) to leverage those trillions still further. All this in order to buy time for the global economic engine to rev back up and allow private investment activity to take over for temporary government investment activity.

It was a brilliant plan, and as emergency intervention it worked like a charm. QE1 (and even more importantly TLGP) saved the world. The intended behavioral effect on markets and market participants succeeded beyond Bernanke et al’s wildest dreams, such that now the Fed finds itself in the odd position of trying to talk down the dominant Narrative of Central Bank Omnipotence. But for some reason the global economic engine never kicked back in. The answer? We must do more. We must try harder. And so we got QE2. And QE3. And Abenomics. And now Draghinomics. We got what we always get in the aftermath of a global economic crisis – a temporary government policy intervention transformed into a permanent government social insurance program.

But the engine still hasn’t kicked in.

So now villains must be found. Now we must root out the counter-revolutionaries and Trotskyites and Lin Biao-ists and assorted enemies of progress. Because if the plan is brilliant but it’s not working, then obviously someone is blocking the plan. The structural villains per Stanley Fischer (who is rapidly becoming a more powerful Narrative voice and Missionary than Janet Yellen): housing, fiscal policy, and the European economic slow-down. Or if you’ll allow me to translate the Fed-speak: consumers, Republicans, and Germany. These are the counter-revolutionaries per the central bank apparatchiks. If only everyone would just spend more, why then our theories would succeed grandly.

Hmm. Maybe. Or maybe what we want and what we need has been confused. Maybe the thin veneer of ebullient hollow markets has been confused for the real activity of real companies. Maybe the theatre of a Wise Man with an Answer has been confused for intellectually honest leadership. Maybe theoretical certainty has been confused for practical humility. Maybe the fault, dear Brutus, is not in external forces like Republicans or Germans (or Democrats or Central Bankers), but in ourselves.

Let me suggest a different answer to the mystery of missing global growth, a political answer, an answer that puts hyper-accommodative monetary policy in its proper place: a nice-to-have for vibrant global growth rather than a must-have. The problem with sparking renewed economic growth in the West is that domestic politics in the West do not depend on economic growth. What we have in the US today, and even more so in Europe (ex-Germany), are not the politics of growth but rather the politics of identity. At the turn of the 20th century the meaning of being a Democrat or a Republican was all about specific economic policies ... monetary policies, believe it or not. You could vote for Republican McKinley and ride on a golden coin to Prosperity for all, or you could vote for Democrat Bryan and support silver coinage to avoid being “crucified on a cross of gold.”

Today’s elections almost never hinge on any specific policy, much less anything to do with something as arcane as monetary policy. No, today’s elections are all about social identification with like- minded citizens around amorphous concepts like “justice” or “freedom” ... words that communicate aspirational values and speak in code about a wide range of social issues. Don’t get me wrong. There’s nothing inherently bad or underhanded about all this. I think Shepard Fairey’s “HOPE” poster is absolute genius, rivaled only by the Obama campaign’s genius in recognizing its power. Nor am I saying that economic issues are unimportant in elections. On the contrary, James Carville is mostly right when he says, “It’s the economy, stupid.” What I am saying is that modern political communications use neither the language nor the substance of economic policy in any meaningful way. Words lik e “taxes” and “jobs” are bandied about, but only as totems, as signifiers useful in assuming or accusing an identity. Candidates seek to be identified as a “job creator” or a “tax cutter” (or accuse their opponent of being a “job destroyer” or a “tax raiser”) because these are powerful linguistic themes that connect on an emotional level with well-defined subsets of voters on a range of dimensions, not because they want to actually campaign on issues of economic growth. Candidates have learned that while voters certainly care about the economy and their economic situation, the only time they make a voting decision based primarily on specific economic policy rather than shared identity is when the decision is explicitly framed as a binary policy outcome – a referendum. Even there, if you look at the ballot referendums over the past several decades (Howard Jarvis and Proposition 13 happened almost 40 ye ars ago! how’s that for making you feel old?), the shift from economic to social issues is obvious.

Both the Republican and the Democratic Party have entirely embraced identity politics, because it works. It works to maintain two status quo political parties that have gerrymandered their respective identity bases into a wonderfully stable equilibrium. The last thing either party wants is a defining economic policy question that would cut across identity lines. But until the terms of debate change such that an electoral mandate emerges around macroeconomic policy ... until voters care enough about Growth Policy A vs. Growth Policy B to vote the pertinent rascals in or out, despite the inertia of value affinity ... we’re going to be stuck in a low-growth economy despite all the Fed’s yeoman work. I know, I know ... what blasphemy to suggest that monetary policy is not the end-all and be-all for creating economic growth! But there you go. At the very moment that elections hinge on the question of economic growth, we will get it. B ut until that moment, we won’t, no matter what the Fed does or doesn’t do.

What reshapes the electoral landscape such that an over-riding policy issue takes over? Historically speaking, it’s a huge external shock, like a war or a natural disaster, accompanied by a huge political shock, like the emergence of a new political party or charismatic leader that triggers an electoral realignment. In the US I think that the emerging appeal of national Libertarian candidates (all of whom, so far anyway, have the last name Paul) is pretty interesting. The 2016 election has the potential to be a watershed event and set up a realignment, if not in 2016 then in 2020, which hasn’t happened in the US since Ronald Reagan transformed the US electoral map in 1980. And yes, I know that the conventional wisdom is that a viable Libertarian candidate is wonderful news for the Democratic party, and maybe that will be the case, but both status quo parties today are so dynastic, so ossified, that I think everyone could be in for a rude awakening. It&rsq uo;s a long shot, to be sure, mainly because the US economy isn’t doing so poorly as to plant the seeds for a reshuffling of the electoral deck, but definitely interesting to watch.

What’s not a long shot – and why I think Draghi’s recently announced ABS purchase is a bridge too far – is a realigning election in Italy.

I like to look at aggregate GDP when I’m thinking about the strategic interactions of international politics, but for questions of domestic politics I think per capita GDP gives more insight into what’s going on. Per capita GDP gives a sense of what the economy “feels like” to the average citizen. It addresses Reagan’s famous question in the 1980 campaign with Jimmy Carter: are you better off today than you were four years ago? It’s a very blunt indicator to be sure, as it completely ignores the distribution of economic goodies (something I’m going to write a lot about in future notes), but it’s a good first cut at the data all the same. Here’s a chart of per capita GDP levels for the three big Western economies: the US, Europe, and Japan.

The Great Recession hit everyone like a ton of bricks, creating an output shock roughly equal to the impact of losing a medium-sized war, but the US and Japan have rebounded to set new highs. Europe ... not so much.

Let’s look at Europe more closely. Here’s a chart of the big three continental European economies: Germany, France, and Italy.

Germany off to the races, France moribund, and Italy looking like it just lost World War III. I mean ... wow. More than any other chart, this one shows why I think the Euro is structurally challenged.

First, why in the world would Germany change anything about the current Euro system? The system works for Germany, and how. Alone among major Western powers, the politics of growth are alive and well in Germany. “But Germany, unless you lighten up and embrace your common European identity, maybe this sweet deal for you evaporates.” Ummm ... yeah, right. The history books are just chock-full of self-interested creditors with sweet deals that unilaterally made large concessions before the very last second (and often not even then).

Second, why in the world would Italy accept anything about the current Euro system? The system fails Italy, and how. The system fails other countries, too, like Spain, Portugal, and Greece, but these countries are in the Euro by necessity. Their economies are far too small to go it alone. Italy, on the other hand, is in the Euro by choice. Its economy is plenty big enough to stand on its own, and with a vibrant export potential, an independent and devalued lira is just what the doctor ordered to get the economic growth engine revved up. Short term pain, long term gain.

Why doesn’t Italy bolt? Lots of reasons, most of them identity related. Also, let’s not underestimate the power of cheap money to keep the puppet-masters of the Italian State in a Germany-centric system. The system may fail Italy as a whole, but if you’re pulling the strings of the State and can borrow 10-year money at 2.5% to keep your vita nice and dolce ... well, let’s keep dancing.

Still, nothing focuses the electoral mind like the economic equivalent of losing a major war. At some point in the not so distant future there will be an anti-Euro realigning election in Italy. And that will wake the Red King.

In the meantime, Draghi will go forward with his ABS purchase scheme, a brilliant theory that will deliver frustratingly slim results quarter after quarter after quarter. Until the politics of growth are embraced outside of Germany, European banks will remain reticent to lend growth capital to small and medium enterprises. Until the politics of growth are embraced outside of Germany, large enterprises with plenty of cash and access to cheap loans will remain reticent to invest growth capital. Maybe a little M&A, sure, but no new factories, no organic expansion, no grand hiring plans. The thing is, Draghi knows that he’s pushing on a string with the ABS program and that growth won’t return until the fundamental political dynamic changes in France in Italy, which is why he is calling both countries out by name to institute “structural reforms”. But in typical European fashion this entire debate is Mandarin vs. Mandarin, with almost all of the proposals focused on regulatory reform rather than something that must be hashed out through popular legislation. So long as economic policy reform is imposed from above ... so long as we are engaged in modern-day analogs of Soviet Five-Year Plans ... I believe we will remain stuck in what I call the Entropic Ending – a long gray slog of disappointing but not catastrophic aggregate economic growth. That’s not a terrible environment for stocks, certainly not for bonds, and the alternative – economic reform based on the hurly-burly of popular politics, is almost certain to be a wild ride that markets hate. But to get back to what we need (real growth) rather than what we want (higher stock prices) this is what it’s going to take.

Elections always matter, but in the Golden Age of the Central Banker they matter even more.