The Collapsing Periphery

By: Doug Noland

Friday, December 12, 2014

The collapsing Periphery took aim at the Core.

This week saw things take a turn for the worse for the Faltering Periphery Bubble. On the back of crude oil's $8.03 collapse (to five-year lows), Venezuela CDS surged another 1,402 bps to 4,151 bps. Ukrainian bond yields surged 517 bps this week to 28.63%. Russian ruble yields jumped another 95 bps to 12.82%. On the currency front, the Russian ruble was slammed for another 9.25% (down 43.6% y-t-d). The Colombian peso fell 3.7%, the South African rand 2.1%, Indonesia rupiah 1.4%, Chilean peso 1.1% and Indian rupee declined 0.8%. The Chinese renminbi declined a not insignificant 0.6% against the dollar this week.

Importantly, the Periphery's core has fallen under major duress. The Mexican peso was hit for 2.7% (down 11.7%) this week, with the Brazilian real down 2.5% (down 11%) and the Turkish lira 1.7% (down 6.5%). Brazilian CDS surged 48 bps to a one-year high 212 bps. Mexican CDS jumped 22 bps to a one-year high 112 bps. Brazilian stocks sank 7.7%. Turkey CDS rose 36 bps to 185 (high since October). Indonesian rupiah yields jumped 34 bps to 8.11%.

With EM currencies faltering, local currency denominated debt has been under pressure. Yet, for the most part, dollar-denominated EM debt has performed well - that is, until this week.

Importantly, the EM dollar-denominated bond dam gave way. Russia dollar bond yields surged 59 bps to 6.62%. Brazil yields jumped 47 bps to 4.56%. Turkey yields rose 45 bps to 4.45%; Mexico 18 bps to 3.53%; Peru 22 bps to 3.80%; and Colombia 28 bps to 3.94%. Venezuela dollar-denominated yields jumped 381 bps this week to 24.28%.

Interesting dynamics at the Core. German stocks were hit for 4.9%, Spanish stocks fell 6.9% and Italian stocks dropped 7.4%. Greek stocks collapsed 20%. Greece five-year bond yields surged 332 bps to 9.15% - "worst week since the euro crisis." Italian to German bond spreads widened 25 bps, and Portugal to German spreads widened 38 bps. Here at home, the S&P500 fell 3.5%. Yet the Morgan Stanley Retail index gained 0.8%. Healthcare, pharmaceuticals and the airlines advanced. Treasury bond yields sank to below closing levels from tumultuous October 15th. Corporate bond spreads blew out to the widest level since the October market tumult.

U.S. equities bulls are clinging to a sanguine view of collapsing oil and commodities prices. A well-known strategist was on CNBC late Friday afternoon espousing the bullish thesis, comparing the current backdrop to back in 1997 when the U.S. expansion soldiered on, impervious to EM debacles and sinking commodities. Yet EM debt was miniscule then compared to now. Global debt was a fraction of today's level. U.S. debt was about a third the current level. And, importantly, the amount of global leveraged speculation was a small fraction of that which surely inflates speculative markets these days. That said, the Russian collapse and LTCM debacle almost brought the global financial system down in October 1998.

Especially these days, "Core vs Periphery" analysis is as fascinating as it is challenging. As always, it's as much an "art" as it is a "science."

Importantly, initial stress at the Periphery only tends to spur financial flows to the Core. 

Serious unfolding issues can go so far as to rejuvenate Core Bubble Dynamics. At some point, however, a profoundly consequential transformation begins to unfold: De-risking/de-leveraging (liquidity "vaporization") actually begins to suck liquidity from even Core markets.

Increasingly powerful contagion momentum at the Periphery is apt to jump what had seemed an impermeable fire wall (between Periphery and Core). This will manifest first, often subtly, at the Core's periphery. Still, with bullishness having become so engrained throughout the Core marketplace, critical warning signals will be readily dismissed.

I believe Collapsing Bubbles at the Periphery have at this point attained irreversible momentum. And the further that crude, commodities and EM currencies fall, the less likely EM countries, corporations and financial institutions will have the wherewithal to service huge amounts of dollar-denominated debt. A critical issue to ponder today is to what extent higher-yielding dollar-denominated debt has been used as fodder for leveraged speculation - for so-called "carry trades" as well as in the proliferation of high-return derivative structures and products. This debt has also found a home in scores of funds that ballooned in size courtesy of central bank measures and an unmatched global yield chase. The amount of dollar-denominated EM debt and its widespread distribution are unprecedented. The associated risks (especially Credit and liquidity) seemed this week to begin resonating.

Back in the late-nineties, the emerging markets were referred to as "roach motels." It's always the case that funds flow so smoothly into EM markets and economies. And as long as flows spur domestic lending, booming securities markets, generally loose financial conditions and economic expansion, the dream can persist that EM policymakers and economic players have learned from previous fiascos. At the same time, I do sympathize with EM. Developed world policy ineptness helped to really, really bury them this time around.

It's a harsh fact of life that "loose money" and attendant Credit and speculative Bubbles provide fertile breeding grounds for fraud and corruption (not even mentioning resource misallocation).

Throw Trillions of cheap finance at "developing" financial and economic systems and you'll at some point be dealing with major problems. And this is fundamental to the "global government finance Bubble" thesis: it's been six years of history's biggest and, by far, most dangerous Bubble. Now that Bubbles are Collapsing and the days of endless "hot money" inflows have turned to a rush for rapidly closing exits, some of the chicanery is coming into clearer view (i.e. Russia, Venezuela, Turkey, Brazil, Mexico, etc.). Just you wait for China.

It is also fundamental to my current analysis that central bank reflationary measures have rapidly lost their capacity to hold the global Bubble together. The wheels almost came off in October. Yet the efforts of Bullard, Draghi and Kuroda turned things around and incited yet another destabilizing speculative run. The market viewed that a Trillion from Draghi and another Trillion from Kuroda would more than offset the end of Federal Reserve liquidity creation. The game would continue.

The game, however, has changed. Flagrant euro and yen devaluation propelled king dollar, in the process giving a powerful bear hug to already deflating Periphery Bubbles. King dollar placed further downside pressure on crude and commodities markets. Collapsing crude and commodities impaired financial and economic stability for scores of countries and companies - too many that had ballooned debt (much dollar-denominated) throughout the previous boom.

Huge amounts of global debt have rather suddenly turned suspect, inciting a self-reinforcing flight out of currencies, debt markets and commodities. And the more flows reverse out of the Periphery and head to the bubbling Core, the more destabilizing the unfolding king dollar dynamic for the global financial "system" and economy.

I'm sticking with my view of the existence of a massive "yen carry trade" (short a devaluing yen to leverage in higher-yielding instruments elsewhere). As was experienced during October's bout of market instability - and as we saw at times again this week - any yen rally almost immediately fosters problematic de-risking/de-leveraging. And the assumption has been that as long as Kuroda remained at the helm, ongoing yen devaluation could be taken to the bank. This is reasonable and it may still play out this way. Indeed, the assumption of ongoing yen devaluation has been key to the resilient Bubble at the Core.

Yet, from the game aspect of it all, trading dynamics have undergone some subtle yet important changes. Nowadays, yen weakness powers king dollar - at the expense of Collapsing Periphery Bubbles. In a world where the Periphery and Core Bubble Dynamics have so profoundly diverged, no longer does yen devaluation keep the global Bubble afloat.

And I think it's reached the point where yen weakness has actually become destabilizing for the overall global Bubble. Yen devaluation works to sustain huge amounts of speculative leverage, but at the same time resulting dollar strength has pushed the unfolding EM collapse to the breaking point. This new dynamic provides a real policy quandary. Throwing more liquidity at the problem isn't going to help.

The Fed released its Q3 2014 Z.1 "flow of funds" report this week. I won't take as deep a dive as usual. From my perspective, what appears on the surface as a relatively benign Credit backdrop is in reality one with extraordinary vulnerability. I look out to 2015 and it is not clear how the system achieves ample Credit growth to sustain elevated securities markets, profit expectations and bullish optimism for the markets and real economy more generally - especially with ominous global storm clouds now gathering on the horizon.

Total Non-Financial Debt (TNFD) expanded at a 4.4% rate during Q3, up from Q2's 3.4% and compared to Q3 2013's 3.5%. Total Household debt expanded at a 2.7% rate, down from Q2's 3.4%. And while Household Mortgage debt posted its first expansion in four quarters (0.7%), non-mortgage Consumer Credit slowed to a 6.4% pace, down from Q2's 8.2% and Q1's 6.6%.

Total Business borrowings expanded at a 5.2% pace, up slightly from Q2's 5.0% - but weaker than Q1's 6.0%. State & Local government borrowing contracted at a 2.8% pace during Q3, more than reversing Q2's 1.2% increase (which was the first positive number in five quarters).

The star for the quarter, federal borrowings, expanded at a 7.2% annual pace, up significantly from Q2's 2.5% rate.

In seasonally-adjusted and annualized rates (SAAR), TNFD expanded $1.801 TN, up from Q3's $1.370 and Q1's $1.688 TN. It was actually the strongest SAAR Credit growth since Q4 2012 ($1.962 TN). It is certainly worth noting that at SAAR $913bn, federal borrowings accounted for about half of TNFD. Household Debt expanded SAAR $366bn (mortgage $67bn and Consumer $206bn). Total Business borrowings expanded SAAR $605bn. State & Local contracted SAAR $84bn.

With equities under a little pressure during the period, Total Household Assets declined slightly in Q3 to $95.410 TN. And with Household Liabilities increasing $121bn (3.5% rate), Household Net Worth declined $141bn during the quarter to $81.349 TN. Over the past year, Household Assets increased $5.467 TN, with Net Worth inflating $5.140 TN. Net Worth was up a staggering $11.823 TN in two years and $26.664 TN in four years. As a percentage of GDP, Household Net Worth has increased from 331% to 463% in four years - to return almost to the record level from the end of 2007 (476%). There would be significant economic impact if Household Net Worth were to give back a few years of inflated gains.

I am fond of analysis combining Treasury Securities, Municipal debt, GSE Securities, Corporate Bonds and Equities as a proxy for Total Marketable Securities (TMS). After beginning 1990 at about $10 TN, TMS ended the nineties at about $33 TN. By the end of 2007, TMS had inflated to $52 TN. As a percentage of GDP, 2007's 371% compared to 1990's 178% and 1999's bubbly 355%.

TMS ended Q3 at $70.79 TN, or 403% of GDP (both down slightly from Q2). TMS is now up $27 TN, or 62%, from the end of 2008. It is also worth noting that Equities at 200% of GDP surpasses 2007 (182%) and is almost back to 1999's record 209%. And despite talk of system "deleveraging," Total Debt Securities to GDP ended Q3 at 203%, up from 2007's 182%, 1999's 147% and 1989's 114%.

One doesn't have to go too crazy in search for cause and effect. The Federal Reserve's Balance Sheet expanded SAAR $291bn during the quarter to a record $4.508 TN. Fed holdings jumped $720bn over the past year, for 19% growth. This puts the two-year open-ended QE operation (announced in the summer of 2012) at a staggering $1.700 TN, for 58.8% growth. It's also worth noting that Security Credit jumped $189bn, or 16%, over the past year, to a record $1.373 TN. Throughout the financial sector, no expansion is even remotely comparable to Federal Reserve and Security Credit.

Home mortgage borrowings expanded SAAR $77bn during Q3. This compares to 2005's $1.128 TN, 2006's $1.080 TN and 2007's $771bn. Amazingly, six-years of ultra-loose monetary policy have done little to spur mortgage Credit expansion. And with Fed Credit growth supposedly ending and corporate Credit increasingly vulnerable to the forces of risk-aversion, mortgage Credit becomes only more critical to overall system Credit expansion. A strong case can be made that lowering market yields (and declining mortgage rates) no longer has much impact on mortgage borrowing (Household mortgage borrowings up 1.3% over the past two years!).

It is worth noting that GSE Securities expanded SAAR $225bn during Q3 (to $7.834 TN), up from Q2's SAAR $185bn expansion. GSE Securities increased $240bn in 2013, the first growth since 2008. And with Fannie and Freddie now moving to lower lending standards, Washington appears ready for another push of GSE-induced Credit growth. As difficult as it is to believe, we'll have to again keep close tabs on the GSE over coming quarters.

But the winner of the Q3 Z.1 Credit Sweepstakes goes to, once again, the U.S. Treasury.

Treasury Securities expanded SAAR $914bn during the quarter to a record $12.756 TN. Over the past year, Treasury Securities increased $799bn, or 6.7%, with a two-year gain of $1.500 TN, or 13.3%. Since the end of 2007, outstanding Treasury Securities has increased $7.656 TN, or 150%. Over this same period, total Household Debt declined about $420bn (to $13.414 TN).

Tough to call this "deleveraging."

Expanding upon comments made earlier, I think "ominous" when I analyze this Z.1. There is very little to indicate that an unprecedented expansion of Federal Reserve and Treasury Credit has resuscitated a private-sector Credit cycle. Corporate debt has expanded briskly over recent years, but even this important source of system Credit is now susceptible to both global and domestic forces.

My analytical hunch is that "hot money" flowing freely into our booming securities markets helps explain the robust asset price inflation backdrop in the face of lackluster underlying Credit dynamics.

Thus far, troubles at the Global Bubble's Periphery have ensured that king dollar flows inundate Core U.S. markets. But, again, there will be a point where Global de-risking/de-leveraging leads to waning risk-taking and liquidity - even at the Core.

I've argued for awhile now that the maladjusted U.S. economic structure requires in the neighborhood of $2.0 TN of annual non-financial Credit growth. The number for Q3 was $1.801 TN. System Credit has remained meaningfully below the $2.0 TN bogey since 2012. Yet I would argue strongly that the Fed's massive QE program short-circuited typical dynamics.

Miraculously, QE provided "money" for inflating securities prices, for ensuring ultra-loose corporate Credit conditions, for federal and state receipts, for corporate cash-flows and earnings, for record stock buybacks, for record M&A and for lots of spending (especially by the wealthy!). QE incited leveraged speculation and booming "hot money" flows. But QE has ended (for now).

I expect the post-QE landscape to be one of disappointing market performance, weakening corporate profits, less financial engineering and waning growth in government revenues (resurgent deficits!). I look out to 2015 and it's not clear how we get anywhere near the $2.0 TN system Credit growth bogey.

"Hot money" is the big wildcard. King dollar flows could help to sustain inflated securities markets, in the process inflating Household Net Worth (perceived wealth) and spending. But with my view that the global Bubble has burst, probabilities for a problematic Risk-Off dynamic impacting the world has increased significantly. 

 In that scenario, I don't see the sources of sufficient liquidity and system Credit expansion to keep the U.S. Bubble markets and Bubble Economy levitated.

To summarize, six-years of unprecedented fiscal and monetary stimulus has ensured that everyone is today fully dressed up, liquored up, and silly eager for The Big Party. "Where's the punchbowl?" "Where is it, and I mean now!" "Oh crap, where on earth did it go!!" "Who took it away!!" "I'm telling you to bring it back right now or there's going to be some serious trouble!!!" What a fiasco.

International trade

A troubling trajectory

Fears are growing that trade’s share of the world’s GDP has peaked. But that is far from certain

Dec 13th 2014

WHEN Apple launched the iPhone in 2007, it deployed a state-of-the-art global supply chain.

Although the pioneering smartphone was designed in America, and sold first to consumers there, it arrived in stores from Shenzhen, China. It had been assembled there by Foxconn International from parts made by two firms in Singapore, six in Taiwan and two in America.

Since then, competition in smartphones has intensified thanks to lower-cost rivals such as China’s Xiaomi. It uses a similar supply chain, but slightly fewer parts are imported: the growing sophistication of Chinese manufacturers means that more components are being made at home.

The rapid spread and subsequent slight retreat of such far-flung supply chains provides one possible explanation to a puzzle that is troubling policymakers: why international trade has been growing no faster than global GDP in the past few years. In the two decades up to the financial crisis, cross-border trade in goods and services grew at a sizzling 7% a year on average, much faster than global GDP.

But although trade bounced back fast from its post-crisis plunge, rising by 6.9% in 2011, it has been decidedly sluggish since, growing by only 2.8% in 2012 and 3.2% in 2013 in dollar terms, even as global GDP grew by 3.1% and 3.2%. When measured in terms of volume, trade is still growing faster than the world economy, but by a decreasing margin (see chart). Having soared from 40% of the world’s GDP in 1990 to a peak of 61% in 2011, trade has fallen back slightly to 60%, the same level as in 2008.

As a result, the notion of “peak trade” is being taken increasingly seriously. Cristina Constantinescu and Michele Ruta of the International Monetary Fund and Aaditya Mattoo of the World Bank argue that the slowdown in trade relative to GDP reflects the end of a rapid evolution of supply chains that yielded big gains in productivity. This innovation was made possible by the removal of trade barriers that followed the completion of the Uruguay Round in 1994 and the creation of the World Trade Organisation (WTO), plus the integration into the world economy of China and the former Soviet bloc. In the absence of further trade deals or more big countries opening up, the evolution has slowed, causing a lasting slowdown in trade.

If this loss of dynamism is a lasting change in the structure of the global economy, then it may help explain the sluggishness of the recovery after the crash. The initial rise of global supply chains, thanks to which imported components (“intermediate goods”) came to account for 30-60% of the exports of G20 countries, brought about a sharp increase in the share of the workforce that is ultimately dependent on foreign demand. In 2008, for example, foreign demand supported 25% of jobs in Germany, up from around 16% in 1995, according to the OECD. France, South Korea and Turkey each saw similarly large increases. Just under half the value of global exports is attributable to parts and materials imported by the exporting country—but that share is no longer rising.

Some economists reckon trade is peaking due less to the limits of current trade arrangements being reached than to a post-crash rise in protectionism. A recent report by economists at Citigroup cites this as one of several factors causing globalisation more broadly to stall. There has been a significant increase in new measures impeding trade worldwide since the crash, to a net 2,500 a year since 2008, compared with barely half that number in 2000. Many of these are non-tariff barriers, including onerous environmental and safety standards. “Even if tariffs are low, for example, it may still be difficult to import a car whose tail-lights are not recognised as conforming to national standards,” notes Douglas Lippoldt, an economist at HSBC. Even so, he points out in “Trading Up”, an upbeat new paper on prospects for trade, new protectionist measures introduced in the year to May affected only 0.2% of world imports of physical goods.

Another factor, say the economists at Citigroup, may be a shift in the composition of global demand away from traded goods and services. In 1995-2007 59% of global economic growth came from advanced economies, which during that period had an average ratio of import growth to GDP growth of 2.5, compared with 1.6 for emerging economies. In 2010-13, emerging markets, with their lower trade intensity, had become the world’s economic engine, accounting for 70% of global GDP growth.

(Nonetheless, the share of total global trade that takes place between emerging-market economies has grown to 25% from 12% in 2000.)

The composition of global demand could yet move back towards greater trade intensity, for several reasons. There may one day be stronger growth in the European Union, which has a far bigger share of world imports (33%) than it does of the global economy (19%). As they get richer, it is likelier than not that developing countries will trade more relative to their income.

Recent signs of life in trade negotiations may help. Last month America and China struck a deal which should allow a proposed treaty on trade in information technology among willing members of the World Trade Organisation to proceed. A long-stalled deal among all members to make it easier for goods to pass quickly through ports and customs also seems to be moving forward at last.

The Republican takeover of the Senate may also help spur trade deals involving America, several of which are under negotiation. There are huge differences in the share of intermediate imports in exports in different industries, which is a rough proxy for the extent to which trade rules have allowed global supply chains to flourish. In machinery and transport equipment it exceeds 35%, whereas in finance, insurance and food it is below 20%.

Not everyone agrees that, if trade has indeed peaked, it is worth worrying about. Paul Krugman, who won a Nobel prize in part for his work on trade theory, maintains that “ever-growing trade relative to GDP is not a natural law” and “we should neither be amazed nor disturbed if it stops happening.”

Others question whether trade has peaked at all: they put the apparent decline down to mismeasurement. For instance, James Manyika of the McKinsey Global Institute argues that there has been a sharp rise in trade in software and other digital goods that statisticians struggle to track, not least because it is often unclear where transactions are taking place.

This is why efforts have begun to construct new trade data based on where economic value is added. The initial findings do not seem to show that trade is slowing down. They also challenge simplistic analyses of where economic clout lies. A study last year by the Asian Development Bank of China’s $2 billion of iPhone exports found that only $73m of their value was added in China, compared with $108m in America and $670m in Japan.

Whether trade is declining relative to GDP and why may not be clear for years. Yet one thing is: were more barriers to be lifted, especially in areas like services and farming where many still remain, it would probably lead to a new spurt in the evolution of supply chains that would lift trade far above today’s “peak”.

Op-Ed Columnist

Mad as Hellas

DEC. 11, 2014

Paul Krugman 

The Greek fiscal crisis erupted five years ago, and its side effects continue to inflict immense damage on Europe and the world. But I’m not talking about the side effects you may have in mind — spillovers from Greece’s Great Depression-level slump, or financial contagion to other debtors. No, the truly disastrous effect of the Greek crisis was the way it distorted economic policy, as supposedly serious people around the world rushed to learn the wrong lessons.
Now Greece appears to be in crisis again. Will we learn the right lessons this time? 

What happened last time, you may recall, was the exploitation of Greece’s woes to change the economic subject. Suddenly, we were supposed to obsess over budget deficits, even if borrowing costs were at historic lows, and slash government spending, even in the face of mass unemployment. Because if we didn’t, you see, we could turn into Greece any day now. “Greece stands as a warning of what happens to countries that lose their credibility,” intoned David Cameron, Britain’s prime minister, as he announced austerity policies in 2010. “We are on the same path as Greece,” declared Representative Paul Ryan, who was soon to become the chairman of the House Budget Committee, that same year.
In reality, Britain and the United States, which borrow in their own currencies, were and are nothing like Greece. If you thought otherwise in 2010, by now year after year of incredibly low interest rates and low inflation should have convinced you. And the experience of Greece and other European countries that were forced into harsh austerity measures should also have convinced you that slashing spending in a depressed economy is a really bad idea if you can avoid it. This is true even in the supposed success stories — Ireland, for example, is finally growing again, but it still has almost 11 percent unemployment, and twice that rate among young people.

And the devastation in Greece is awesome to behold. Some press reports I’ve seen seem to suggest that the country has been a malingerer, balking at the harsh measures its situation demands. In reality, it has made huge adjustments — slashing public employment and compensation, cutting back social programs, raising taxes. If you want a sense of the scale of austerity, it would be as if the United States had introduced spending cuts and tax increases amounting to more than $1 trillion a year.
Meanwhile, wages in the private sector have plunged. Yet a quarter of the Greek labor force, and half its young, remain unemployed.

Meanwhile, the debt situation has if anything gotten worse, with the ratio of public debt to G.D.P. at a record high — mainly because of falling G.D.P., not rising debt — and with the emergence of a big private debt problem, thanks to deflation and depression. There are some positives; the economy is growing a bit, finally, largely thanks to a revival of tourism. But, over all, it has been many years of suffering for very little reward.
The remarkable thing, given all that, has been the willingness of the Greek public to take it, to accept the claims of the political establishment that the pain is necessary and will eventually lead to recovery. And the news that has roiled Europe these past few days is that the Greeks may have reached their limit. The details are complex, but basically the current government is trying a fairly desperate political maneuver to put off a general election. And, if it fails, the likely winner in that election is Syriza, a party of the left that has demanded a renegotiation of the austerity program, which could lead to a confrontation with Germany and exit from the euro.
The important point here is that it’s not just the Greeks who are mad as Hellas (their own name for their country) and aren’t going to take it anymore. Look at France, where Marine Le Pen, the leader of the anti-immigrant National Front, outpolls mainstream candidates of both right and left. Look at Italy, where about half of voters support radical parties like the Northern League and the Five-Star Movement. Look at Britain, where both anti-immigrant politicians and Scottish separatists are threatening the political order.
It would be a terrible thing if any of these groups — with the exception, surprisingly, of Syriza, which seems relatively benign — were to come to power. But there’s a reason they’re on the rise.
This is what happens when an elite claims the right to rule based on its supposed expertise, its understanding of what must be done — then demonstrates both that it does not, in fact, know what it is doing, and that it is too ideologically rigid to learn from its mistakes.
I have no idea how events in Greece are about to turn out. But there’s a real lesson in its political turmoil that’s much more important than the false lesson too many took from its special fiscal woes.

Getting Technical

The Charts Don’t Believe In the Santa Claus Rally

After a record-breaking string of gains, stocks finally ran out of juice. Now comes a real test for the bulls.

By Michael Kahn           

December 10, 2014

No market goes straight up forever. This week’s pullback should be a welcome event for investors as a technical correction sets in.
The problem is that the market has already worked off its stretched technicals. And the exclusive group of strong global markets lost a big player Tuesday when China scored a massive bearish reversal.
I am not ready to say that a major decline is pending, but with the latest round of bad news from inside and outside the market, it does look as if the Santa Claus rally will have to wait.
To be sure, major moving averages as well as the long-term trendline on the Standard & Poor’s 500 are still intact (see Chart 1). After the October decline, the trendline was revised, and with the index only three days removed from all-time highs, that line is far from jeopardy.

Chart 1

Standard & Poor’s 500
Short-term patterns, however, are negative. The first is a three-week double top breakdown (see Chart 2).

Chart 2

Standard & Poor’s 500

A double top is simply a rally, small decline and rally back to the previous high and is sometimes called an “M” pattern. The spirit of the pattern is a failure of the trend to reach a new high, although that by itself is not a signal. If and when the index dips again, below the center low of the “M,” the pattern completes and short-term traders get a sell signal.
Tuesday, it seemed that would be the case as the market sold off hard at the open, thanks to the 5.4% thrashing in the Chinese stock market. Fortunately for the bulls, the market staged one of its typical intraday comebacks to trim losses and save the breakdown. Wednesday, as oil prices continued to plunge, the market fell again, and this time it did break the double top pattern to the downside.
What is more interesting is that the high-flying Dow Jones Transportation Average, which previously enjoyed falling oil prices, also shows signs of breaking down. Truckers seem to be tipping the scales – perhaps the market sees the battle between the good news (low energy costs) and the bad news (lack of demand) as changing for the worse.
Another negative signal is a bit more persistent. Junk bonds continue to fall while Treasury bonds continue to climb, and as I wrote here last week that suggests a real change in the market’s mood (see Getting Technical, “Bond Charts Show a Rising Aversion to Risk,” Dec. 3).
Wednesday, the iShares 20+ Year Treasury Bond exchange-traded fund scored its highest close of the year, only exceeded by the intraday, panicky high set in October as stocks seemed to be falling apart. In contrast, the SPDR Barclays High Yield Bond ETF is trading well below even the worst intraday levels of its own October low.
On the esoteric side, the financial news now reports the appearance of the dreaded Hindenburg Omen, a signal that often appears before major market dislocations. It is a warning, not a guarantee, however: It also appears without ensuing selloffs and, therefore, gets a bad rap from investors, mostly thanks to how it is portrayed in the media.
Essentially the Hindenburg Omen warns of a bifurcated, or split market. It is not unlike falling breadth indicators in that both tell us that fewer stocks are pulling their weight as the market makes new highs. It is worse, however, in that large numbers of stocks are not only absent from the rally, but they are actually setting new 52-week lows. Such a condition warns of an unstable market, and when the omen fires in a cluster we know the condition can turn into a real problem. We already have that cluster.
Around the world, we are seeing plenty of bad stock market movements, with serious bearish action in Russia, Saudi Arabia, Canada, Greece, and emerging markets in general. Falling oil prices have a lot to do with it. Weak economies, especially in Europe, also play a big role. For the domestic market to continue to plow higher without any real pause, if not correction, seems to be a high-risk bet.
Michael Kahn, a longtime columnist for, comments on technical analysis at A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.

Heard on the Street

Commodities Go From Hoard to Floored

Oil and Iron Woes May Be Far From Over

By Justin Lahart

Dec. 14, 2014 2:06 p.m. ET

 Sacks of rice at a grain market in India. When the nation banned rice exports in 2007, it kicked off a price bubble which offered academics clues about how other commodities bubbles work. Reuters        

In understanding the latest commodities selloff centered on oil, consider a raw material lurking in your kitchen: rice.

Economists think stockpiling plays a big role in commodity bubbles, but are only now getting the evidence needed to understand exactly how it works. One implication of what they are learning: Prices haven’t bottomed yet.

A standard theory of how commodity bubbles form begins with an imbalance between supply and demand. This raises prices and prompts some stockpiling, due either to worries about having enough or hopes of selling for more in the future. This curbs supply further, pushing prices higher still. Cautionary stockpiling morphs into hoarding, and the bubble inflates.

Yet it is hard to see exactly how these bubbles play out, says Princeton University economist Harrison Hong, as commodity markets are complex networks of suppliers, middlemen and consumers.

When cotton hit 140-year highs in 2011, it was clear hoarding was happening, but nobody knew how much. Big producers including India and Brazil didn’t provide stockpile data. When The Wall Street Journal visited China’s Shandong province that January, farmers were storing thousands of pounds of cotton in their homes. Cotton has fallen about 70% from its peak.

Recently, though, researchers have accessed a huge data set on consumer behavior. For the Nielsen Homescan Panel, a partnership between Nielsen and the University of Chicago Booth School of Business, 100,000 U.S. households record the bar codes on every packaged item they buy.

Working with University College London economist Áureo de Paula and New York University economist Vishal Singh, Mr. Hong used the Homescan data to examine another bubble, in rice.

This started in late 2007 when India, worried about food security, banned rice exports. Fears of shortages emerged and panic buying ensued. The U.S. didn’t face a rice shortage, but prices still shot higher, and people started to hoard. Costco Wholesale and Sam’s Club even started rationing bulk purchases.

The economists found some surprises. For example, while one might think lower-income households are more prone to panic over rising prices, those with higher incomes hoarded the most. Maybe they watched the news more closely or just had more money to buy rice.

The really odd thing was that a bunch of households who hadn’t bought rice before did so during the crisis, then never did again. They may have been reselling it, but more likely is that they just got swept up by the situation. Rice prices have fallen by roughly half since early 2008.

The takeaway: Commodity bubbles feed on irrational behavior and don’t last forever. Eventually, high prices encourage lower consumption and more supply. Prices ease, and stockpiles are run down.

Middlemen who were looking to profit on perceived shortages start selling to limit losses.

Maybe they weren’t in a bubble, but the two largest commodity producing industries, oil and steel, are seeing something like that now as prices for crude and iron ore, used to make steel, tumble.

Now, imagine there was a bit more than just ordinary stockpiling going on. Driven by expectations that rising global consumption would keep outstripping supply, people got swept up into the same sort of scarcity mind-set as those peculiar rice hoarders.

Certainly, iron ore and other metals played a significant part as speculative collateral in the rapid boom in “shadow lending” in China that Beijing is now squeezing. In the U.S., there was an expensive land grab by exploration and production companies, financed by everyone from regional banks to private-equity firms, convinced that triple-digit oil was a given. That is now teeing up a potential crisis in the high-yield bond market.

As reality sinks back in, it is possible prices have a lot further to fall.

December 12, 2014 6:15 pm

US budget battle shows Wall St still toxic

Megan Murphy in Washington

An American flag waves outside the United States Capitol building

©Getty Images

Wall Street’s still-toxic political reputation nearly derailed a $1tn spending bill that both the Democratic and Republican parties had worked on for months.
As lawmakers sifted through the rubble from Thursday’s chaotic scenes on Capitol Hill, with revolts on both sides of the aisle threatening to scuttle a bill that had to be passed to keep the government’s lights on, two things were clear: Washington remains as dysfunctional as ever, and big banks need to buckle up for another bumpy ride.

The so-called “cromnibus” spending package was initially pitched as a sign of progress — a bipartisan, comprehensive piece of legislation that would fund nearly all of the government through September, instead of the short-term budgets Congress has become accustomed to in recent years.
Only the Department for Homeland Security, which is responsible for immigration, will face a renewed battle for funding early next year, as Republicans look to force changes to President Barack Obama’s plan to shield millions of unauthorised immigrants from deportation.
But a provision that would ease restrictions on some kinds of derivatives trading triggered a revolt on the left, led by a growing faction of populist Democrats who believe that what is good for Wall Street has been shown to be bad for the American people.

With the party still licking its wounds after November’s disastrous midterm elections, Democrats believe they can claw back ground with voters by painting Republicans as the party of corporate and financial industry excess.
As Republicans gear up to try and roll back a wide range of business regulations when they take control of both chambers of Congress next year, the battle over one corner of the Dodd-Frank financial reforms is a preview of much bigger skirmishes to come, both on the Hill and on the 2016 campaign trail for president.

“Keep in mind, this was a provision that was written by Citigroup lobbyists. I mean, they literally wrote it,” said Elizabeth Warren, the first-term senator from Massachusetts who led the revolt. “The biggest financial institutions in this country can make more money if this little provision gets stripped out of Dodd/Frank, and that`s why we`re here to fight.”

Much of what happens in Washington during budget battles can be dismissed as political grandstanding in a town that appears to have become inured to the theatrics of brinkmanship.

But even long-time Capitol Hill watchers appeared surprised by the twists and turns of the cromnibus.

What began as a bipartisan bill backed by the White House and which included compromises on both sides was soon being characterised as Republican “blackmail” by House minority leader Nancy Pelosi, in a rare public split with the president.

As Thursday’s midnight deadline to avert a shutdown approached, Mr Obama and Joe Biden, the vice-president, were forced into a round of frenzied calls to rally support for the legislation over the objections of their own party’s ranking House member.

“Congress has turned into crazy town right now,” Dana Bash, CNN’s respected political anchor, said late on Thursday.

The prospect that things will be different when the GOP controls both the House and the Senate appears increasingly remote. Senior members of the party insist they intend to govern constructively, pursuing bipartisan support for overhauling the corporate tax system, revamping energy regulation and boosting international trade.

But with the bitter fight over the president’s sweeping changes to the immigration system as one of the first items on their agenda, any hopes that Congress will be more productive next term were severely tempered by the sheer mayhem of this week.

While a majority of Republicans voted in favour of the bill, 67 members rebelled, mostly out of outrage that it did not go further to stop Mr Obama’s immigration plans.

Republicans have long made Mr Obama the focus of their ire, swaying voters by linking Democrats with his unpopular policies. Democrats are hoping that Wall Street can prove an equally appealing target, again, in the run-up to 2016.

Opinion: These ETFs are as good as gold

By Dave Fry

Published: Dec 4, 2014 5:29 p.m. ET

 Gold bullion and related ETFs have taken a steep dive. A much stronger U.S. dollar, along with more confidence in the U.S. economy, are two big reasons.

The table below outlines the rise in gold prices since former President Richard Nixon's Bretton Woods Agreement in 1971 that decoupled the U.S. dollar from gold. This allowed gold and the dollar to float freely. Since that time the price of gold has risen dramatically while the dollar index has generally declined from its high in 1985 at 164.70 to an all-time low in 2008 at 77.58.

With dollar-index levels near 88.60, gold has generally been inversely correlated to gold prices. Below are two unannotated monthly charts showing this relationship.

Gold demand is broken down further, from ETFs even to dental work. In India, gold is a sign of wealth.

Three ETFs primarily constitute global gold securities investments: SPDR Gold Trust GLD, -0.23%  , Market Vectors Gold Miners ETF GDX, +0.39%  and Market Vectors Junior Gold Miners ETF GDXJ, +0.65%  . Some miners, particularly small operators, will be hard-pressed to continue mining if gold prices remain depressed.

Marcus Grubb, a managing director at the World Gold Council, focuses on three themes for investors.

1. Return to fundamentals. Asian demand, including trading cartels and central banks, is steadily growing.

2. Central banks will continue to buy gold to satisfy portfolio diversification allocations.

3. Focus on the bigger picture. By the World Gold Council's estimates, 2,000 more tons of gold will need to be produced over the next five years. This demand will come most certainly from India, China and central banks. Where will supply come from? It's estimated in 2015-16 many mining projects, due to current price declines, will be delayed. Recycling of gold through jewelry sales won't make up the difference.

In many ways this is not much different than the issues oil drillers face, where lower prices makes new exploration less attractive. In addition, the Indian government's abandoning of 80/20 import restrictions may generate greater demand from gold's largest customer.

France drifts into deflation as ECB 'pea-shooter' falls short

The Bank of Italy warns that any further falls in prices at this stage could have 'extremely grave consequences for economies with very high public debt levels'

By Ambrose Evans-Pritchard, International Business Editor

8:14PM GMT 11 Dec 2014

France's fans react after watching the rugby union World Cup 2007 semi final match England vs. France in Toulouse, southern France

France's price slide is comes at a delicate juncture, as many firms have been going bankrupt over recent months, as occurred during the Lehman crisis Photo: AFP
France is sliding into a deflationary vortex as manufacturers slash prices to keep market share, intensifying pressure on the European Central Bank to take drastic action before it is too late.
The French statistics agency INSEE said core inflation fell to -0.2pc in November from a year earlier, the first time it has turned negative since modern data began.
The measure strips out energy costs and is designed to “observe deeper trends” in the economy. The price goes far beyond falling oil costs and is the clearest evidence to date that the eurozone’s second biggest economy is succumbing to powerful deflationary forces.
Headline inflation is still 0.3pc but is expected to plummet over the next three months. French broker Natixis said all key measures were likely to be negative by early next year.
Eurostat data show prices have fallen since April in Germany, France, Italy, Spain, Holland, Belgium, Portugal, Greece and the Baltic states, as well as in Poland, Romania and Bulgaria outside the EMU bloc. Marchel Alexandrovich, from Jefferies, said the number of goods in the eurozone’s price basket now falling has reached a record 34pc.

“Eurozone deflation is now inevitable. There is no way around it,” said Andrew Roberts, at RBS. “We think yields on German 10-year Bunds will fall to 0.42pc next year.”

“The ECB is presiding over a deflationary disaster. They need to act fast and aggressively or else markets will start to attack Italian debt. Italy’s nominal GDP is falling faster than their borrowing costs and that is pushing them towards a debt spiral,” he added.
The Bank of Italy’s governor, Ignazio Visco, said any further falls in prices at this stage could have “extremely grave consequences for economies with very high public debt levels, such as Italy”.

The trade-weighted exchange rate of the euro has risen by 2pc over the past two months as the rouble plummets and currencies buckle across the emerging market nexus, despite the ECB's efforts to talk it down. This is a form of monetary tightening.
The German-led hawks at the ECB are running out of excuses for opposing quantitative easing after demand for the ECB’s second auction of cheap four-year loans (TLTROs) fell short of expectations. “The TLTRO is a peashooter rather than a bazooka,” said Nick Kounis, at ABN Amro.
Lenders took up just €129.8bn of fresh credit, far less than €270bn of old loans due to be repaid. This means that the ECB’s balance will continue to contract – rather than expanding by €1 trillion as intended - unless it embraces full-blown QE. Alasdair Cavalla, at the Centre for Economics and Business Research, said QE was “all but inevitable” at this stage.
Mario Draghi, the ECB’s president, vowed to pull out all the stops to head off deflation. “Let me be absolutely clear. We won’t tolerate prolonged deviation from price stability,” he said last week.
Yet the ECB council continues to insist that it will expand its asset purchases only “if needed”, without explaining what the threshold is. Critics say it should already be obvious that full QE is needed immediately.
Mr Draghi faces stiff opposition from Germany’s members, Jens Weidmann and Sabine Lautenschlager. He has to navigate a legal minefield involving one case at the European Court, and another likely case at Germany’s top court against any QE.
Yet the hawks are becoming isolated. Their suggestions that QE will not work because rates are already low are hard to square with orthodox monetary theory. “The interest rate is totally irrelevant. What matters is the quantity of money,” said Tim Congdon, at International Monetary Research.

 “Large scale money creation is a very powerful weapon and can always create inflation.”

The tide is clearly moving in favour of sovereign bond purchases. Several ECB governors have given hints of strong action over recent days. Peter Praet, the ECB’s chief economist, suggested this week that the latest oil price shock is a further reason for stimulus.
“Normally, any central bank would prefer to look through a positive supply shock. After all, lower oil prices boost real incomes. But we may not have that luxury at present. Shocks can change: in certain circumstances supply shocks can morph into demand shocks via second-round effects,” he said 
France’s price slide is comes at a delicate juncture, as many firms have been going bankrupt over recent months, as occurred during the Lehman crisis. The jobless rate has remained stuck at 10.4pc with a record 3.4m workers in “category A” unemployment. This spells political disaster for President Francois Holland, who asked voters to judge him on creating jobs.

The biggest price falls in France were in photographic, audio and information equipment (-7.3pc), medical goods (-3pc), household appliances (-2.5pc) and toys (-2.2pc). Even services fell slightly. “The struggle against deflation must be our absolute priority; at a national and a European level,” said Karine Berger, a French economist and Socialist MP.
Mathieu Plane, at the French Observatoire, said a “dangerous dynamic” is setting in where high unemployment is sapping demand, causing companies to cut prices to hold on to market share. This in turn leads to further pay cuts in a vicious cycle. It is exactly what happened in Japan.

Criminal justice

America’s police on trial

The United States needs to overhaul its law-enforcement system

Dec 13th 2014

THE store camera tells a harrowing tale. John Crawford was standing in a Walmart in Ohio holding an air rifle—a toy he had picked off a shelf and was presumably planning to buy. He was pointing it at the floor while talking on his phone and browsing other goods. The children playing near him did not consider him a threat; nor did their mother, who was standing a few feet away. The police, responding to a 911 caller who said that a black man with a gun was threatening people, burst in and shot him dead. The children’s mother died of a heart attack in the ensuing panic. In September a grand jury declined to indict the officers who shot Mr Crawford.

Most people have probably never heard this story, for such tragedies are disturbingly common:

America’s police shoot dead more than one person a day (nobody knows the exact number as not all deaths are reported). But two recent cases have sparked nationwide protests. First Michael Brown, a black teenager, was shot dead in murky circumstances in Ferguson, Missouri, just after he robbed a shop, and then Eric Garner, a harmless middle-aged black man guilty only of selling single cigarettes on the streets of New York, was choked to death by a policeman while five cops watched—and this time the event was filmed by a bystander.

So far much of the debate within America has focused on race. That is not unreasonable: the victims were all black, and most of the policemen involved were white. American blacks feel that the criminal-justice system works against them, rather than for them. Some 59% of white Americans have confidence in the police, but only 37% of blacks do. This is poisonous: if any racial group distrusts the enforcers of the law, it erodes the social contract. It also hurts America’s moral standing in the world (not aided by revelations about the CIA’s use of torture.

But racial division, rooted as it is in America’s past, is not easily mitigated.

There is, however, another prism through which to examine these grim stories: the use of excessive violence by the state. It, too, has complex origins, but quite a lot of them may be susceptible to reform. In many cases Americans simply do not realise how capricious and violent their law-enforcement system is compared with those of other rich countries. It could be changed in ways that would make America safer, and fairer to both blacks and whites.

Don’t shoot
Bits of America’s criminal-justice system are exemplary—New York’s cops pioneered data-driven policing, for instance—but overall the country is an outlier for all the wrong reasons. It jails nearly 1% of its adult population, more than five times the rich-country average. A black American man has, by one estimate, a one in three chance of spending time behind bars.

Sentences are harsh. Some American states impose life without parole for persistent but non-violent offenders; no other rich nation does. America’s police are motivated to be rapacious: laws allow them to seize assets they merely suspect are linked to a crime and then spend the proceeds on equipment. And, while other nations have focused on community policing, some American police have become paramilitary, equipping themselves with grenade launchers and armoured cars. The number of raids by heavily armed SWAT teams has risen from 3,000 a year in 1980 to 50,000 today, by one estimate.

Above all, American law enforcement is unusually lethal: even the partial numbers show that the police shot and killed at least 458 people last year. By comparison, those in England and Wales shot and killed no one.

Fewer armoured cars, more body cameras
One reason why so many American police shoot first is that so many American civilians are armed. This year 46 policemen were shot dead; last year 52,000 were assaulted. When a policeman is called out to interrupt a robbery, he knows that one mistake could mean he never makes it to retirement. As this newspaper has often pointed out, guns largely explain why America’s murder rate is several times that of other rich countries. And the vastly disparate rate at which policemen shoot young black men is not simply a matter of prejudice. Roughly 29% of Americans shot by the police are black, but so are about 42% of cop killers whose race is known.

If America did not have 300m guns in circulation, much of this would change. That, sadly, is not going to happen soon. But there are other ways to make the police less violent.

The first is transparency. Every police force should report how many people it kills to the federal government. And if communities want to buy gadgets, they should give their police body cameras. These devices deter bad behaviour on both sides and make investigations easier.

Had the officer who shot Mr Brown worn one, everyone would know how it happened.

The second is accountability: it must be easier to sack bad cops. Many of America’s 12,500 local police departments are tiny and internal disciplinary panels may consist of three fellow officers, one of whom is named by the officer under investigation. If an officer is accused of a crime, the decision as to whether to indict him may rest with a local prosecutor who works closely with the local police, attends barbecues with them and depends on the support of the police union if he or she wants to be re-elected. Or it may rest with a local “grand jury” of civilians, who hear only what the prosecutor wants them to hear. To improve accountability, complaints should be heard by independent arbiters, brought in from outside.

The third, and hardest, is reversing the militarisation of the police. Too many see their job as to wage war on criminals; too many poor neighbourhoods see the police as an occupying army. The police need more training and less weaponry: for a start, the Pentagon should stop handing out military kit to neighbourhood cops.

In many ways America remains a model for other countries. Its economic engine has roared back to life. Its values are ones which decent people should want to spread. Yet its criminal-justice system, the backbone of any society, is deeply flawed. Changing it will be hard; but change is overdue.

December 12, 2014 6:18 pm
Stephen Hawking: Superhero of science

The life and works of the astrophysicist enthral the public in his books and on the big screen
Stephen Hawking
Cosmic superhero Stephen Hawking never ceases to amaze his admirers. At the age of 72 he is the world’s most celebrated scientist and the ultimate symbol of triumph over adversity, as he celebrates five decades of intellectual achievement while living with motor neurone disease, which kills most patients within two or three years.

This week Professor Hawking enjoyed the limelight at the London premiere of the latest film about his life, The Theory of Everything, starring Eddie Redmayne. Last week he showed off a new communications system designed by Intel, which enables him to write and speak more efficiently — in his famous American android voice — by registering tiny movements of his cheek muscles.
At the same time Prof Hawking stirred up controversy with his views on artificial intelligence, which “could be a real danger in the not too distant future”, he told the Financial Times by email. “The risk is that computers develop intelligence and take over. Humans, who are limited by slow biological evolution, couldn’t compete and would be superseded.”
Lord Rees, astronomer royal and fellow cosmologist, first met Prof Hawking in 1964 when both were graduate students at Cambridge university. “He was already unsteady on his feet and spoke with great difficulty,” recalls Lord Rees. “I learnt that he might not live long enough even to finish his PhD.

“Astronomers are used to large numbers,” he adds. “But few numbers could be as large as the odds I’d have given, back in 1964 when Stephen received his ‘death sentence’, against ever celebrating this uniquely inspiring crescendo of achievement sustained now for more than 50 years.”

Prof Hawking’s scientific reputation rests on his work on the relationship between gravity, space and time. “He has done as much to advance our understanding of gravity as anyone since Einstein,” says Lord Rees.

His most celebrated research concerns black holes, concentrations of matter so dense even light cannot escape their gravitational pull. Prof Hawking showed black holes are not just a bizarre theoretical construct but also play an important role in the development of the universe. His eureka moment came in the early 1970s, when he realised that black holes would not be completely black but would emit what became known as “Hawking radiation”, a key concept in mathematical physics.

Although his subsequent work has not had such a strong scientific impact, he has as continued to publish research papers on quantum cosmology, tackling questions such as what happened before the birth of our universe. His later output is doubly remarkable in a mathematical subject where most researchers peak at an early age.

He became a celebrity in 1988 with the publication of his first popular book, the bestselling A Brief History of Time. Ten further books have appeared, including four written for children with his daughter, Lucy. “The concept of an imprisoned mind roaming the cosmos plainly gripped people’s imagination,” Lord Rees says.
Prof Hawking enjoys his fame, happily filling lecture rooms from London’s Royal Albert Hall to the White House. He has featured in Star Trek, The Simpsons and many other television shows. Several films have been made about him, including a notable portrayal by Benedict Cumberbatch in 2004.

The best account of Prof Hawking’s early life is his memoir, My Brief History, published last year. He grew up just north of London, the son of Oxford graduates. After three laid-back undergraduate years, also at Oxford, serious work began as a Cambridge postgrad. His illness started at that point, too.
The Theory of Everything focuses on Prof Hawking’s marriage to Jane Wilde, who looked after him and their three children with extraordinary devotion for more than 25 years. They broke up under the strain of 24-hour medical care — and in 1995 he married Elaine Mason, one of his nurses. That, too, ended in divorce and since 2006 he has depended on a team of helpers — and the best medical technology available.

Prof Hawking retains a strong sense of fun and adventure, though respiratory problems are curtailing his ability to travel and in particular to fly.

“He is a fantastic symbol for people living with motor neurone disease,” says Belinda Cupid, research director of the UK Motor Neurone Disease Association, with his role in the 2012 London Paralympics opening ceremony particularly inspiring. “As patron of our charity, he is very generous with his time.” Why Prof Hawking has lived so much longer than other MND patients remains a medical mystery, however.
In the past 15 years Intel engineers have looked after his communications needs. “They have redesigned my software and incorporated new word prediction algorithms that allow me to write faster,” he says. “Through my computer I can write, talk, read scientific papers, make Skype phone calls and search on the internet . Recently I decided to join Facebook .
Important as Prof Hawking’s own research has been, his role as a beacon inspiring young people to study maths and physics may be even more influential in the long run, says Professor David Wands, director of Portsmouth university’s cosmology institute: “The iconic figure of Hawking the celebrity is impossible to disentangle from his profound contribution as a scientist.”

The writer is the FT’s science editor. Additional reporting by Sally Davies

Putin’s Rules of Attraction
Joseph S. Nye
DEC 12, 2014

Stop Russia rally

CAMBRIDGE – Russian President Vladimir Putin’s covert aggression in Ukraine continues – and so do Western sanctions against his country. But the economy is not all that is under threat; Russia’s soft power is dwindling, with potentially devastating results.
A country can compel others to advance its interests in three main ways: through coercion, payment, or attraction. Putin has tried coercion – and been met with increasingly tough sanctions. German Chancellor Angela Merkel, Putin’s main European interlocutor, has been expressing her frustration with Russian policy toward Ukraine in increasingly harsh terms. Whatever short-term gains Putin’s actions in Ukraine provide will be more than offset in the long term, as Russia loses access to the Western technology it needs to modernize its industry and extend energy exploration into frontier Arctic regions.
With Russia’s economy faltering, Putin is finding it increasingly difficult to employ the second tool of power: payment. Not even oil and gas, Russia’s most valuable resources, can save the economy, as Putin’s recent agreement to supply gas to China for 30 years at knockdown prices demonstrates.
This leaves attraction – a more potent source of power than one might expect. China, for example, has been attempting to use soft power to cultivate a less threatening image – one that it hopes will undermine, and even discourage, the coalitions that have been emerging to counterbalance its rising economic and military might.
A country’s soft power rests on three main resources: an appealing culture, political values that it reliably upholds, and foreign policy that is imbued with moral authority. The challenge lies in combining these resources with hard-power assets like economic and military power so that they reinforce one another.
The United States failed to strike this balance with respect to its 2003 invasion of Iraq. While America’s military power was sufficient to defeat Saddam Hussein’s forces quickly, it did so at the expense of its attractiveness in many countries. Likewise, though establishing a Confucius Institute in Manila to teach Filipino people about Chinese culture may help to cultivate China’s soft power, its impact will be severely constrained if China is simultaneously using its hard power to bully the Philippines in the territorial dispute over the Scarborough Shoal.
The problem for Russia is that it already has very little soft power with which to work. Indeed, as the political analyst Sergei Karaganov noted in 2009, Russia’s lack of soft power is precisely what is driving it to behave aggressively – such as in its war with Georgia the previous year.
To be sure, Russia has historically enjoyed considerable soft power, with its culture having made major contributions to art, music, and literature. Moreover, in the immediate aftermath of World War II, the Soviet Union was attractive to many Western Europeans, owing largely to its leadership in the fight against fascism.
But the Soviets squandered these soft-power gains by invading Hungary in 1956 and Czechoslovakia in 1968. By 1989, they had little soft power left. The Berlin Wall did not collapse under a barrage of NATO artillery, but under the impact of hammers and bulldozers wielded by people who had changed their minds about Soviet ideology.
Putin is now making the same mistake as his Soviet forebears. Despite his 2013 declaration that Russia should be focusing on the “literate use” of soft power, he failed to capitalize on the soft-power boost afforded to Russia by hosting the 2014 Winter Olympic Games in Sochi.
Instead, even as the Games were proceeding, Putin launched a semi-covert military intervention in Ukraine, which, together with his talk of Russian nationalism, has induced severe anxiety, particularly among ex-Soviet countries. This has undermined Putin’s own stated objective of establishing a Russia-led Eurasian Union to compete with the European Union.
With few foreigners watching Russian films, and only one Russian university ranked in the global top 100, Russia has few options for regaining its appeal. So Putin has turned to propaganda.
Last year, Putin reorganized the RIA Novosti news agency, firing 40% of its staff, including its relatively independent management. The agency’s new leader, Dmitry Kiselyov, announced in November the creation of “Sputnik,” a government-funded network of news hubs in 34 countries, with 1,000 staff members producing radio, social media, and news-wire content in local languages.
But one of the paradoxes of soft power is that propaganda is often counterproductive, owing to its lack of credibility. During the Cold War, open cultural exchanges – such as the Salzburg Seminar, which enabled young people to engage with one another – demonstrated that contact among populations is far more meaningful.
Today, much of America’s soft power is produced not by the government, but by civil society – including universities, foundations, and pop culture. Indeed, America’s uncensored civil society, and its willingness to criticize its political leaders, enables the country to preserve soft power even when other countries disagree with its government’s actions.
Similarly, in the United Kingdom, the BBC retains its credibility because it can bite the government hand that feeds it. Yet Putin remains bent on curtailing the role of non-governmental organizations and civil society.
Putin may understand that hard and soft power reinforce each other, but he remains seemingly incapable of applying that understanding to policy. As a result, Russia’s capacity to attract others, if not to coerce and pay them, will continue to decline.