Up and Down Wall Street

Markets: What Everyone Knows That Isn’t So

U.S. shares recovered, bond yields stayed low, gold rose, the dollar fell, and EMs surprisingly did better.

By Randall W. Forsyth               

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The Cyclone roller coaster in Coney Island, Brooklyn. Photo: Daniel Acker/Bloomberg News

           
The thing about a roller coaster is that you get off at the same place as you got on, but you might feel queasy after the ride.
 
It’s unlikely that investors thought they were buying tickets to the markets’ version of the Coney Island Cyclone when they started out the year. As usual, most strategists were assuring them of a mild, instead of wild, ride, with high single-digit returns.
 
Instead, global equities returned all of 0.4% for the first quarter, according to Bank of America Merrill Lynch’s tally, with U.S. stocks providing just 1%. But that was after a double-digit plunge in the first few weeks of 2016, followed by a sudden climb in the final weeks.
 
Still, the U.S. fared a good deal better than other developed markets, with Europe down 2.4%, the United Kingdom off 2.3%, and Japan worse by 6.4%—a surprise because overseas markets were touted as the places to be. That is, except for emerging markets; but their results also confounded the seers, as they returned a robust 5.8% for the quarter.
 
Once again, magazine covers gave clues to the contrarians. As Paul Macrae Montgomery pointed out many times in this space, when magazine editors catch on to something or somebody, it has long been digested and discounted by the markets. The magazine cover is a sign that some tide is about to crest or to rise.
 
That notion was caught perfectly by Walter Zimmermann, the market maven at United-ICAP. Back in January, he took note of a negative Brazil cover story in the Economist (the first of several) featuring the travails of the country’s president, Dilma Rousseff, and contrasted it with Time magazine naming Germany’s Angela Merkel its Person of the Year and indeed, “Chancellor of the Free World.”
 
The magazine covers tipped off investors to the fact that those perceptions were discounted in the markets. “The broadest implication is the contrarian value of ‘long-Brazil-short-Germany’ perspective. The most narrow interpretation is that Dilma is oversold and Angela is overbought,” Zimmermann wrote on Jan. 21.
 
And so the iShares MSCI Brazil Capped exchange-traded fund (ticker: EWZ) returned 27.18% in the first quarter, while the iShares MSCI Germany ETF (EWG) had a negative 1.76% return.
 
The reversals of fortune affected the entire investment universe, with a tidal change coming on Feb. 11.
 
From the turn of the year until that date, volatility rose as the collapse in crude oil and other commodities continued. Against that deflationary backdrop, Federal Reserve officials were sticking to their December script that four interest-rate increases in 2016 were “in the ballpark,” as the central bank’s vice chairman, Stanley Fischer, put it.
 
Crude found a bottom, for now at least, around $26 a barrel, and the major central banks, led by Mario Draghi’s European Central Bank, turned full-tilt expansionary (although the Bank of Japan’s introduction of negative interest rates in late January failed to have the desired effect).
 
Whatever the impetus, the change in the roller coaster’s course was dramatic. From an 11.3% negative return through Feb. 11, global equities rallied 13.2% to end the quarter barely positive. U.S. stocks went from being thrown for a 10.8% loss to a 13.2% gain, winding up ahead by 1%. And emerging markets went from being behind by 10.1% to a 17.7% rebound, and ended up nearly 6% for the first three months.
 
At the beginning of 2016, “everybody knew” that bond yields had nowhere to go but up (and their prices had to fall), while the dollar was certain to continue its ascent and gold could only drop. Wrong on all counts. Global government bonds were the place to be, with a 6.9% return, according to BofA Merrill, except for the Pet Rock of gold, which scored a 16.1% gain. That came as the greenback lost 4.1%, especially owing to the Fed’s relenting on rate hikes.
 
Fed Chair Janet Yellen has given notice that the central bank won’t be fighting the proverbial tape.

In a speech last week, she took note that falling bond yields were helping to offset the tightening in financial conditions wrought by the slide in the equity markets and the widening of credit-risk spreads (a product of the debt-deflation vise squeezing the high-yield bond market), which came after the central bank’s implemented its initial rate hike after keeping its policy target near zero for seven years. Global developments, notably the weakness in China and other emerging economies, also served as counterweights to the steady but modest pace of the U.S. economy.
 
While the so-called dot plot of expectations of central-bank solons at last month’s meeting of the Federal Open Market Committee predicted two increases in the federal-funds target rate by year end—from the current 0.25%-to-0.5% range—the fed-funds futures market is pricing in only a single hike by December, and with just a 61.7% probability. “Low for longer” remains the most likely course for rates after the first batch of major March data was released on Friday.
 
The monthly jobs report showed a 215,000 increase in nonfarm payrolls, insignificantly higher than economists’ consensus guess of 205,000. The jobless rate inched up slightly, to 5% from 4.9%, but for the positive reason that more folks were actually looking for jobs. Average hourly earnings ticked up by 0.3%, reversing February’s dip and leaving the year-on-year increase at 2.3%.
 
That could be as good as it gets, however. Josh Shapiro, chief U.S. economist at MFR, thinks “declining corporate profit margins will prompt aggressive cost-cutting and thus a slower trend for nonfarm-payroll growth late this year and into 2017, which in turn will lead to a slower trend for consumer-spending growth.”
 
It’s too early to expect these trends to show up in the numbers, he avers. But first-quarter gross domestic product is tracking just a 0.7% annual rate, according to the Atlanta Fed’s GDPNow model.

JPMorgan’s GDP tracking model shows a somewhat better, if still tepid, 1.2% growth pace.
 
Decent employment gains, combined with sluggish GDP growth, is consistent with persistently slow productivity trends. The push to raise the minimum wage to $15, which gained further impetus in New York and California last week, will probably add to the squeeze on profit margins to which MFR’s Shapiro alluded. Perhaps it will also spur productivity gains, as machines become more-economical replacements for workers who may be too expensive at $15 an hour, plus payroll taxes.

That would be another unanticipated outcome for this surprising year.

GIVEN THE STOMACH-CHURNING SWINGS in stocks in the first quarter, and the continued firmness in bonds, it’s perhaps not surprising that the equities most in favor were the most bondlike.

Utilities, telecoms, and consumer staples all were winners, even to the extent that these stolid stocks have been bid up to price/earnings ratios that are half again the 17 times expected 2016 earnings that the broad market commands.
 
Indeed, the Utilities Select Sector SPDR ETF (XLU) hit a record high on Friday after coming off a 15.52% first-quarter total return, according to Morningstar. The Vanguard Telecommunication Services  ETF (VOX) racked up an 11.11% return, while the Consumers Staples Select Sector SPDR ETF (XLP) returned 5.63%.
 
Investors’ eagerness to pay up for safety may be understandable, not only because of the rocky road they’ve traveled, but also due to the risks they see ahead. The earnings-reporting season about to begin looks especially dicey. According to FactSet Research Systems, 94 companies in the S&P 500 have issued negative preannouncements—just one shy of the record set in the fourth quarter of 2013.
 
Energy isn’t the culprit this time, however. Twenty-five information-technology companies top the negative-guidance list, followed by 18 consumer-discretionary and 17 health-care outfits, according to FactSet. Indeed, earnings warnings were running 50% above the five-year average in the last group, which may have had something to do (along with politics) with the negative 5.57% return of the Health Care Select Sector SPDR ETF (XLV.)
 
But bulls needn’t totally despair. April is not the cruelest month for the stock market; exactly the opposite, in fact. Bespoke Investment Group’s numbers show that the Dow industrials bloom in April, with an average return for the month of 2.09% and positive returns 66% of the time. Over the past 20 years, the record is even better, with the Dow returning, on average, 2.6% and ending in the plus column 75% of the time.
 
A strong April typically starts the “sell in May and go away” chorus, and B.I.G. says that history tends to confirm the old saw. That said, a 5%-plus month (such as March, in which the Dow was up 7.08%) has been followed by a median gain of 1.3% the following month (and a positive showing 71% of the time) in the past 20 years. The following three months notched a median return of 4.54% and a positive return 74% of the time.
 
And the markets have the monetary winds at their backs. The dollar’s uptrend has been broken, which is positive for commodities and multinational U.S. stocks.
 
Of course, confidence is rising, as the decline in the VIX fear gauge to a somnolent reading just over 13 suggests. The first three months of 2016 should provide ample warning against complacency, especially as the U.K. votes in June whether to opt out of the European Union. And there’s also that small matter of the U.S. presidential campaign. Another roller-coaster ride, anyone?


The global liquidity trap turns more treacherous


The adoption of negative interest rates will do little to stimulate growth
 
 
 
For the first time since the Great Depression, the world is in a global liquidity trap.
 
The unintended consequence of many central banks pushing negative interest rate policy is conjuring deflationary headwinds, stronger currencies, and slower growth — the exact opposite of what struggling economies need. But when monetary policy is the only game in town, negative rates are likely to beget even more negative rates, creating a perverse cycle with important implications for investors.

When central banks reduce policy rates, their objective is to stimulate growth. Lower rates are designed to spur savers to spend, redirect capital into higher-return (ie riskier) investments, and drive down borrowing costs for businesses and consumers.

Additionally, lower real interest rates are associated with a weaker currency, which stimulates growth by making exports more competitive. In short, central banks reduce borrowing costs to kindle reflationary behaviour that helps growth. But does this work when monetary policy is driven through the proverbial looking glass of negative rates?

There is a strong argument that when rates go negative it squeezes the speed at which money circulates through the economy, commonly referred to by economists as the velocity of money.

We are already seeing this happen in Japan where citizens are clamouring for 10,000-yen bills (and home safes to store them in). People are taking their money out of the banking system to stuff it under their metaphorical mattresses. This may sound extreme, but whether paper money is stashed in home safes or moved into transaction substitutes or other stores of value like gold, the point is it’s not circulating in the economy.
 
The empirical data support this view — the velocity of money has declined precipitously as policymakers have moved aggressively to reduce rates.

A decline in the velocity of money increases deflationary pressure. Each dollar (or yen or euro) generates less and less economic activity, so policymakers must pump more money into the system to generate growth.

As consumers watch prices decline, they defer purchases, reducing consumption and slowing growth.

Deflation also lifts real interest rates, which drives currency values higher. In today’s mercantilist, beggar-thy-neighbour world of global trade, a strong currency is a headwind to exports.

Obviously, this is not the desired outcome of policymakers. But as central banks grasp for new, stimulative tools, they end up pushing on an ever-lengthening piece of string. The Bank of Japan and the European Central Bank are already executing massive quantitative easing programmes, but as their balance sheets expand, assets available to purchase shrink.
 
The BoJ now buys virtually all of the Japanese government bonds that are issued every year, and has resorted to buying exchange traded funds to expand its balance sheet.

The ECB continues to grow the definition of assets that qualify for purchase as sovereign debt alone cannot satisfy its appetite for QE. As options for further QE diminish, negative rates have become the shiny new tool kit of monetary policy orthodoxy.

If Doctor Draghi and Doctor Kuroda do not get the outcome they want from their QE prescriptions — which is highly likely — then more negative rates will be on the way.

It would not be a surprise to see the overnight rates in Europe and Japan go to negative 1 per cent or lower, which will in turn pull down other rates along their respective yield curves.

Negative rates at these levels would make US Treasuries much more attractive on a relative basis, driving yields even lower than they are today.

If the European overnight rate were cut to minus 1 per cent from its current level of negative 40 basis points, German 10-year Bunds would be dragged into negative territory and we could see 10-year Treasuries yielding 1 per cent or less.

This experiment with negative interest rates on a global scale is unprecedented. While there may not yet be enough data to draw the final conclusion about the efficacy of negative interest rate regimes, I have little confidence this will work.

Monetary policy primarily addresses cyclical economic problems, not structural ones. Fiscal and regulatory policies are doing little to support growth and in most cases are restraining it. Combined with negative interest rates, the current policy prescriptions are a perilous mix that is deepening the global liquidity trap.


Scott Minerd is global chief investment officer at Guggenheim


Artificial intelligence

Million-dollar babies

As Silicon Valley fights for talent, universities struggle to hold on to their stars
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THAT a computer program can repeatedly beat the world champion at Go, a complex board game, is a coup for the fast-moving field of artificial intelligence (AI). Another high-stakes game, however, is taking place behind the scenes, as firms compete to hire the smartest AI experts. Technology giants, including Google, Facebook, Microsoft and Baidu, are racing to expand their AI activities. Last year they spent some $8.5 billion on research, deals and hiring, says Quid, a data firm. That was four times more than in 2010.

 In the past universities employed the world’s best AI experts. Now tech firms are plundering departments of robotics and machine learning (where computers learn from data themselves) for the highest-flying faculty and students, luring them with big salaries similar to those fetched by professional athletes.

Last year Uber, a taxi-hailing firm, recruited 40 of the 140 staff of the National Robotics Engineering Centre at Carnegie Mellon University, and set up a unit to work on self-driving cars. That drew headlines because Uber had earlier promised to fund research at the centre before deciding instead to peel off its staff. Other firms seek talent more quietly but just as doggedly. The migration to the private sector startles many academics. “I cannot even hold onto my grad students,” says Pedro Domingos, a professor at the University of Washington who specialises in machine learning and has himself had job offers from tech firms. “Companies are trying to hire them away before they graduate.”

Experts in machine learning are most in demand. Big tech firms use it in many activities, from basic tasks such as spam-filtering and better targeting of online advertisements, to futuristic endeavours such as self-driving cars or scanning images to identify disease. As tech giants work on features such as virtual personal-assistant technology, to help users organise their lives, or tools to make it easier to search through photographs, they rely on advances in machine learning.

Tech firms’ investment in this area helps to explain how a once-arcane academic gathering, the Conference on Neural Information Processing Systems, held each December in Canada, has become the Davos of AI. Participants go to learn, be seen and get courted by bosses looking for talent. Attendance has tripled since 2010, reaching 3,800 last year.

No reliable statistics exist to show how many academics are joining tech companies. But indications exist. In the field of “deep learning”, where computers draw insights from large data sets using methods similar to a human brain’s neural networks, the share of papers written by authors with some corporate affiliation is up sharply (see chart).
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Tech firms have not always lavished such attention and resources on AI experts. The field was largely ignored and underfunded during the “AI winter” of the 1980s and 1990s, when fashionable approaches to AI failed to match their early promise. The present machine-learning boom began in earnest when Google started doing deals focused on AI. In 2014, for example, it bought DeepMind, the startup behind the computer’s victory in Go, from researchers in London. The price was rumoured to be around $600m. Around then Facebook, which also reportedly hoped to buy DeepMind, started a lab focused on artificial intelligence and hired an academic from New York University, Yann LeCun, to run it.

The firms offer academics the chance to see their ideas reach markets quickly, which many like.

Private-sector jobs can also free academics from the uncertainty of securing research grants.

Andrew Ng, who leads AI research for the Chinese internet giant Baidu and used to teach full-time at Stanford, says tech firms offer two especially appealing things: lots of computing power and large data sets. Both are essential for modern machine learning.

All that is to the good, but the hiring spree could also impose costs. One is that universities, unable to offer competitive salaries, will be damaged if too many bright minds are either lured away permanently or distracted from the lecture hall by commitments to tech firms. Whole countries could suffer, too. Most big tech firms have their headquarters in America; places like Canada, whose universities have been at the forefront of AI development, could see little benefit if their brightest staff disappear to firms over the border, says Ajay Agrawal, a professor at the University of Toronto.

Another risk is if expertise in AI is concentrated disproportionately in a few firms. Tech companies make public some of their research through open sourcing. They also promise employees that they can write papers. In practice, however, many profitable findings are not shared. Some worry that Google, the leading firm in the field, could establish something close to an intellectual monopoly.

Anthony Goldbloom of Kaggle, which runs data-science competitions that have resulted in promising academics being hired by firms, compares Google’s pre-eminence in AI to the concentration of talented scientists who laboured on the Manhattan Project, which produced America’s atom bomb.

Ready for the harvest?
 
The threat of any single firm having too much influence over the future of AI prompted several technology bosses, including Elon Musk of Tesla, to pledge in December to spend over $1 billion on a not-for-profit initiative, OpenAI, which will make its research public. It is supposed to combine the research focus of a university with a company’s real-world aspirations. It hopes to attract researchers to produce original findings and papers.

Whether tech firms, rather than universities, are best placed to deliver general progress in AI is up for debate. Andrew Moore, the dean of Carnegie Mellon University’s computer-science department, worries about the potential for a “seed corn” problem: that universities could one day lack sufficient staff to produce future crops of researchers. As bad, with fewer people doing pure academic research, sharing ideas openly or working on projects with decades-long time horizons, future breakthroughs could also be stunted.

But such risks will not necessarily materialise. The extra money on offer in AI has excited new students to enter the field. And tech firms could help to do even more to develop and replace talent, for example by endowing more professorships and offering more grants to researchers.

Tech firms have the cash to do so, and the motivation. In Silicon Valley it is talent, not money, that is the scarcest resource.


Debunking America’s Populist Narrative

J. Bradford DeLong
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BERKELEY – One does not need to be particularly good at hearing to decipher the dog whistles being used during this year’s election campaign in the United States. Listen even briefly, and you will understand that Mexicans and Chinese are working with Wall Street to forge lousy trade deals that rob American workers of their rightful jobs, and that Muslims want to blow everyone up.
 
All of this fear mongering is scarier than the usual election-year fare. It is frightening to people in foreign countries, who can conclude only that voters in the world’s only superpower have become dangerously unbalanced. And it is frightening to Americans, who until recently believed – or perhaps hoped – that they were living in a republic based on the traditions established by George Washington, Abraham Lincoln, and Teddy and Franklin Roosevelt.
 
But what is even more unsettling is the political reality this rhetoric reflects. There can be no comparing Democratic presidential candidate Bernie Sanders’s policy-oriented critique of neoliberalism to the incoherent bluster of Donald Trump or Ted Cruz on the Republican side.
 
And yet, on both the right and the left, a common narrative is emerging – one that seeks to explain why the incomes of working- and middle-class Americans have stagnated over the past generation.
 
Unfortunately, this narrative, if used as a basis for policymaking, will benefit neither the US nor the rest of the world; worse, it has yet to be seriously challenged. For decades, senior Republican politicians and intellectuals have been uninterested in educating the American people about the realities of economic policy. And Democratic frontrunner Hillary Clinton has been too busy trying to fend off Sanders’s challenge.
 
Broadly, the narrative goes something like this. American middle- and working-class wages have stagnated because Wall Street pressed companies to outsource the valuable jobs that made up America’s manufacturing base, first to low-wage Mexicans and then to the Chinese.
 
Moreover, this was a bipartisan effort, with both parties unified behind financial deregulation and trade deals that undermined the US economy. First, the North American Free Trade Agreement (NAFTA) led to the export of high-quality manufacturing jobs to Mexico. Then the US established permanent normal trade relations with China and refused to brand its government a currency manipulator.
 
The reason this narrative is wrong is simple. There are good reasons why the US adopted policies that encouraged poorer countries to grow rapidly through export-led industrialization.
 
In helping Mexico, China, and other developing countries grow, the US is gaining richer trading partners. Furthermore, there is a strong case that US national security will be improved if, 50 years from now, schoolchildren around the world learn how America helped their countries prosper, rather than trying to keep them as poor as possible for as long as possible.
 
It was not globalization that caused incomes to stagnate. Trade with countries like China and Mexico is just one factor affecting income distribution in the US, and it is by no means the most important one. The reason that incomes have stagnated is that American politicians have failed to implement policies to manage globalization’s effects.
 
As Steve Cohen and I argue in our book Concrete Economics, macroeconomic management requires the government to do what it always did before 1980: pragmatically adopt policies that promote equitable growth.
 
There were good reasons for the US to offload industries that required low wages to be globally competitive. But there was little reason for the US to offload industries that had become important “technology drivers.” Nor were there good reasons for a lot of other bad decisions, such as allowing the financial industry to profit by convincing investors to bear risks they should not and allowing health-care providers to profit from administration at the expense of the care and treatment of the sick. Other bad decisions include incarcerating 2% of the country’s young men and concluding that America’s economic problems would be solved if only the rich could keep more of their money.
 
It is not difficult to see where the blame lies. As Mark Kleiman of NYU’s Marron Institute points out, the Republican Party’s rigid and die-hard ideological opposition to “taxing the rich [has] destroyed, on a practical level, the theoretical basis for believing that free trade benefits everyone.” It is difficult to argue for redistributing the benefits of globalization when you believe that the market channels gains to those who deserve them. Nor can you ameliorate the painful effects of globalization if you believe that social-insurance programs turn their beneficiaries into lethargic “takers.”
 
It is not globalization, poor negotiation tactics, low-wage Mexicans workers, or the overly
clever Chinese that bear responsibility for what is ailing America. The responsibility lies instead with politicians peddling ideology over practicality – and thus with the citizens who elect them, as well as those who don’t bother to vote at all.
 
 


How Fickle Markets Are Challenging ECB’s Mario Draghi

The bank faces challenges from market moves

By Richard Barley

European Central Bank President Mario Draghi is finding the market reluctant to dance to the ECB’s tune.

European Central Bank President Mario Draghi is finding the market reluctant to dance to the ECB’s tune. Photo: Yves Herman/Reuters
 

It is just a month since the European Central Bank announced a package of rate cuts, bank loans and expanded bond purchases that exceeded the market’s expectations. But the market isn’t dancing to the ECB’s tune.

One area that has shown durable improvement has been corporate bond markets. That makes sense, since the ECB’s plan to buy company debt was a large surprise.

But otherwise, the scorecard isn’t inspiring. The Stoxx Europe 600 is down 2.6% since ECB President Mario Draghi unveiled the new measures; European banks are down 10.2%.

Southern European government bonds have underperformed: the gap between 10-year Spanish and German yields has risen to 1.47 percentage points from 1.33.


And the euro has continued to rise. It is up 3.6% against the dollar and 4.5% against the pound since the ECB’s March meeting; on a trade-weighted basis the move is smaller, but still the euro is 1.8% stronger on that measure too.

These developments won’t be welcome. The ECB’s account of its March meeting talks of the problem of tightening financial conditions generated by euro appreciation and falling equities.

And while the ECB is clearly now focusing on the credit channel as a way to boost the economy, the euro remains a vital influence. The strengthening of the euro has come about in part because real interest rates elsewhere have fallen, in particular in the U.S., given the Federal Reserve’s dovish tone. In the eurozone, inflation expectations are still in the doldrums.

Perhaps the biggest sign of challenge to the ECB is that the talk among economists is already about whether “helicopter money”—effectively, direct cash injections into the economy—will be deployed in the eurozone. It may just be the latest fashionable topic of discussion, and looks highly unlikely for now. But it also shows the scale of the challenge the ECB has in getting ahead of the market.


How Covenants Make Us

David Brooks


When you think about it, there are four big forces coursing through modern societies. Global migration is leading to demographic diversity. Economic globalization is creating wider opportunity but also inequality. The Internet is giving people more choices over what to buy and pay attention to. A culture of autonomy valorizes individual choice and self-determination.
 
All of these forces have liberated the individual, or at least well-educated individuals, but they have been bad for national cohesion and the social fabric. Income inequality challenges economic cohesion as the classes divide. Demographic diversity challenges cultural cohesion as different ethnic groups rub against one another. The emphasis on individual choice challenges community cohesion and settled social bonds.
 
The weakening of the social fabric has created a range of problems. Alienated young men join ISIS so they can have a sense of belonging. Isolated teenagers shoot up schools. Many people grow up in fragmented, disorganized neighborhoods. Political polarization grows because people often don’t interact with those on the other side. Racial animosity stubbornly persists.
 
Odder still, people are often plagued by a sense of powerlessness, a loss of efficacy. The liberation of the individual was supposed to lead to mass empowerment. But it turns out that people can effectively pursue their goals only when they know who they are — when they have firm identities.
 
Strong identities can come only when people are embedded in a rich social fabric. They can come only when we have defined social roles — father, plumber, Little League coach. They can come only when we are seen and admired by our neighbors and loved ones in a certain way. As Ralph Waldo Emerson put it, “Other men are lenses through which we read our own minds.”
 
We’re not going to roll back the four big forces coursing through modern societies, so the question is how to reweave the social fabric in the face of them. In a globalizing, diversifying world, how do we preserve individual freedom while strengthening social solidarity?
 
In her new book “Commonwealth and Covenant,” Marcia Pally of N.Y.U. and Fordham offers a clarifying concept. What we want, she suggests, is “separability amid situatedness.” We want to go off and create and explore and experiment with new ways of thinking and living. But we also want to be situated — embedded in loving families and enveloping communities, thriving within a healthy cultural infrastructure that provides us with values and goals.
 
Creating situatedness requires a different way of thinking. When we go out and do a deal, we make a contract. When we are situated within something it is because we have made a covenant. A contract protects interests, Pally notes, but a covenant protects relationships. A covenant exists between people who understand they are part of one another. It involves a vow to serve the relationship that is sealed by love: Where you go, I will go. Where you stay, I will stay. Your people shall be my people.
 
People in a contract provide one another services, but people in a covenant delight in offering gifts. Out of love of country, soldiers offer the gift of their service. Out of love of their craft, teachers offer students the gift of their attention.
 
The social fabric is thus rewoven in a romantic frame of mind. During another period of national fragmentation, Abraham Lincoln aroused a refreshed love of country. He played upon the mystic chords of memory and used the Declaration of Independence as a unifying scripture and guide.
 
These days the social fabric will be repaired by hundreds of millions of people making local covenants — widening their circles of attachment across income, social and racial divides. But it will probably also require leaders drawing upon American history to revive patriotism. They’ll tell a story that includes the old themes. That we’re a universal nation, the guarantor of stability and world order.
 
But it will transcend the old narrative and offer an updated love of America.
 
In an interview with Bill Maher last month, Senator Cory Booker nicely defined patriotism by contrasting it with mere tolerance. Tolerance, he said, means, “I’m going to stomach your right to be different, but if you disappear off the face of the earth I’m no worse off.” Patriotism, on the other hand, means “love of country, which necessitates love of each other, that we have to be a nation that aspires for love, which recognizes that you have worth and dignity and I need you. You are part of my whole, part of the promise of this country.”
 
That emotion is what it means to be situated in a shared national life.


The War Whose Name No One Dares to Utter

George Friedman
Editor, This Week in Geopolitics


French President François Hollande and US President Barack Obama held a joint press conference last week. At the conference, Hollande referred to Islamist terrorism, but his remark was inaudible on the video that was released. After the omission was noticed, the White House said that it was due to a technical error, and a later release contained the restored wording. The muting of Hollande’s remark may have been a technical snafu, but it reminded me of Obama’s unwillingness to refer to “Islamist terrorists.” And that thought, in turn, drove home a rather extraordinary fact.

Fifteen years after 9/11, there is no consensus in the United States as to what the enemy should be called. This semantic murkiness reflects a deeper conundrum: there is no consensus as to who the enemy is. Obama is not the first president to struggle with the problem. President George W. Bush named the conflict the Global War on Terror, effectively dodging the question of who the enemy actually might be. In his famous definition of the Axis of Evil, he named Iraq, Iran, and North Korea. Bush’s inclusion of North Korea in the Axis of Evil may have been valid on some level, but it did nothing to focus the country on the war it was waging. Nor did the concept of a “war on terror.” Even less useful was Bush’s conflating the criminal code with the rules of war. And Obama has only compounded the situation.

There are good reasons for the lack of consensus. After 9/11, as the war effort in Afghanistan and then Iraq ramped up, the United States depended on Muslim countries, including Saudi Arabia, Pakistan, and Central Asian states, as allies. Whatever the quality of their support, it was needed. Talking about “Islamist terrorists” would have only complicated matters, potentially offending allies. Neither Bush nor Obama wanted to go that route.

The problem with proclaiming a “war on terror,” lies in defining a war against a strategy rather than an opponent. Imagine some of our ships sunk by submarines and the United States declaring a global war on underwater warfare. Terror is an inherent part of any war. It is utilized to undermine the enemy’s will to fight and to split the enemy public from its government. The Germans used terror bombing against the British; the British and Americans used it against the Germans; and the Americans used it against the Japanese. The Japanese terrorized China. Terror can’t be the enemy. The enemy must be a nation or some other actual entity. It has to have a name.

This line of reasoning brings us to names and some legal questions. It has never quite been clear whether the United States is waging a war or investigating a crime. Immediately after 9/11, Bush pledged to bring the perpetrators of the attack to justice. Similarly, Obama sought to have Guantanamo prisoners tried in a US criminal court. Yet, US divisions were deploying in Iraq and Afghanistan, fighting what seemed by all appearances to be a war, and both presidents frequently referred to it as a war.

There is a tremendous difference between fighting crime and fighting a war. In the US, the goals of fighting crime are to apprehend criminals, judge their acts, and mete out punishment, usually after crimes have been committed. War is the reverse. The goal is not punishment but rather the destruction of the enemy army. A soldier is not killed for what he has done, but to prevent him from posing a threat. The soldier is a target by association.

Imagine if, after Pearl Harbor, Franklin D. Roosevelt had promised to bring all the pilots who bombed Pearl Harbor to justice. He didn’t, because it was understood that the Japanese pilots were not guilty of any crime. They were, however, part and parcel of the Japanese military and therefore subject to destruction.

In the conduct of war, warriors must be identified as such. All soldiers’ identities, rights, and immunities flow from the uniforms they wear. The Geneva Convention of 1949 recognizes the right of forces that are not formally military to conduct organized resistance to occupation, such as the resistance in Europe during World War II. However, the Convention requires two things. First, the partisans, as they are referred to, must be marked as soldiers. They must at least wear armbands if they lack uniforms. Second, they must carry their weapons openly.

It has long been a rule of war that a soldier not in uniform has no right to the protections of the laws or the customs of war. Nathan Hale, an officer in the Continental Army during the American Revolutionary War, was executed after he was captured spying out of uniform. In World War II, Americans executed German soldiers who were captured wearing American uniforms at the Battle of the Bulge.

It must be understood that the Geneva Convention offers no protection to the attackers in Brussels—like other terrorists, they were not identifiable as soldiers. Then the question is, who and what are they? If mere criminals, their acts and rights fall under the normal legal system, not the Geneva Convention.

The same action may be a crime or an act of war—or a war crime. A US citizen who attacks a US military facility alone and for his own reasons is a criminal. An enemy of the United States—military or partisan—who attacks the same facility and is apprehended alive must be held as a prisoner of war. But an attacker acting out of uniform on behalf of an organization that uses terror as a strategy is a war criminal. If caught, he or she is not a prisoner of war and is not guaranteed any rights other than those criminal law requires.

With the exception of the Islamic State’s seizure of territory, which resembles conventional warfare, all that can be said of Islamist terrorism today is that there is a jihadist uprising within the broader Muslim community, and it is engaged in a low-intensity conflict against non-Muslims. Its targets include Christians, Hindus, and Jews as well as Euro-American secularists. The jihadists also attack Muslim targets they regard as hostile. In many countries, far more Muslims than non-Muslims have died at their hands. At this stage, the jihadists wage war by attacking randomly and unpredictably with explosives and firearms, and their targets are primarily civilian. Their movement has various names and factions, and the lines between them blur. Sowing such confusion is an intentional security measure, but it also reflects splits within the decentralized movement.

The jihadist movement does not require membership cards or dues, or even formal contact among factions or individuals. It is a movement of shared values and beliefs. Its tactics are simple and can be carried out by anyone with a will and a modicum of tradecraft. These people are encouraged by various means to undertake their actions without instruction, which actually increases the effectiveness of the organization. Searching for multiple operatives and combing communications for evidence of intent will not help capture people like the husband and wife team who attacked in San Bernardino.

The movement’s strategy is to destabilize society sufficiently so that the Muslim communities in Western nations come under extreme pressure. That pressure will, in turn, radicalize these communities and create a near-war situation, which however it ends, will benefit radical Islamism. It’s a low-cost, low-probability strategy that plays to the terrorists’ strengths. They have time, and they have patience. The failure of any one terrorist act does not mean defeat of the movement.

The unwillingness of Obama and others to single out Muslims makes sense. But the counter-strategy must constantly grind against itself. Firmly drawing the distinction between radical Islamists and ordinary Muslims is a vital strategy—one that reflects reality and must be used against the radicals. At the same time, it is impossible not to face the fact that there is no marker for radicalism. Not all Muslims are radical Islamists, but all radical Islamists are Muslims. This remains the core dilemma.

The failure to name the enemy with functional precision reflects the monumental challenge of fighting a decentralized movement. But our unwillingness to name the enemy does not help to distinguish our Muslim friends from our jihadist enemies. The price of resulting public confusion is evident in the YouGov/Huffington Post survey released last week that found that 51 percent of Americans now support banning all non-citizen Muslims from the United States.

The Muslim community understands itself at least as well as the United States does. It is aware of the factions within Islam, and it understands the United States’ dilemma. The only people offended by the term “radical Islamist” are those who wish to be offended.

We are waging war, not against a nation-state, but against a movement. We must be clear that non-state actors in that movement do not have the protection of the Geneva Convention. It may well be that IS fighters in Syria and Iraq are soldiers in the conventional sense, but those who struck in New York, Paris, and Brussels were not.

Ambiguity on the part of our senior political and military leadership engenders confusion among our citizens and troops. Obama’s intent may be to calm the Muslim community and to discourage hostility toward Muslims; but while that intention is praiseworthy, it is also failing in every way. The President’s failure to clearly name the enemy and state the legal basis for combatting it combine to create a crisis of confidence that does not eliminate anti-Muslim sentiment.

The constraints on Obama to act as he does can be understood. But the enemy must be named because the unintended consequences of ongoing ambiguity are too costly. The movement is blurred, and its membership is fungible, but it can be named according to its purpose and function. It is radical Islamism, an international movement of Islam that is fragmented in organizational terms yet unified in waging war against Christians, Hindus, and Jews, as well as many Muslims.


Wisdom wanes for ‘don’t fight the Fed’


Janet Yellen Fed rates rise©Getty


For generations, “Don’t fight the Fed” was a mantra beaten into market neophytes by Wall Street’s grizzled veterans. Now the tables seem to have turned.

The Federal Reserve’s unexpectedly dovish stance, reiterated by chair Janet Yellen last week, contrasts sharply with relatively firm economic data, and is stirring a longstanding debate over what really influences central bank officials.

The US bond market, through low yields, has long reflected the wider market view that the Fed’s outlook for the economy, inflation and interest rate policy was optimistic.

Now it appears the Fed is coming around to the market’s view, as the central bank worries more about the negatives than the positives in the economy.

No matter the robust headline job-creation numbers from March. Or how despite market turmoil, US growth continues to trundle on at an underwhelming but respectable rate, the labour market is performing strongly and inflation is cautiously picking up.
 
Friday’s mixed employment data only underlines Ms Yellen’s apprehension and keeps investors fretting about a renewed market volatility.

After a dramatic V-shaped performance in asset prices during the first quarter, investors are on the defensive, led by sinking equities and sharply lower oil prices.
 
That defensive posture has much to do with the market’s draining confidence in the Fed.
Gnawing at investor sentiment is what central banks can do to offset fundamental forces, led by weaker emerging market growth and supply gluts for many commodities, while highly levered companies face falling revenues and lower profitability.
 
‘’Unfortunately for Yellen, risk is trading increasingly like they are losing faith with the big central banks, because central banks can’t create value where there is ‘none’, in growth dependent commodities, or relatively rich, earnings depleted equities,’’ says Alan Ruskin, Deutsche Bank strategist.

“We feel too close to the market fearing central bank ineffectiveness for comfort. The market rejoices in Yellen’s dovishness, but with a fear about how long the impact will last.”

Ostensibly, the data still matters. Speaking to the Economic Club of New York, Ms Yellen reiterated the Fed mantra that “our actions are data-dependent”.

Many analysts and investors, however, have seized on the dichotomy between the reasonable economic fundamentals and Fed dovishness as proof the US central bank is more influenced by markets than it dares admit.

Fed officials bridle at suggestions they can be pushed around by markets. Ms Yellen is the official who matters, so when she speaks of the need to “take into account the potential fallout from recent global economic and financial developments, which have been marked by bouts of turbulence since the turn of the year”, it is fair to assume the Fed no longer treats market mood with blithe disregard.

Some feared the market turmoil was severe enough to raise the risk of a US recession. But the US economy has proved resilient and markets have snapped back. That is largely thanks to the market anticipating Fed caution and its retreat from the prospect of four interest rate rises in 2016, as Ms Yellen herself noted.

According to Steven Englander at Citigroup, this suggests she regards this hair trigger reaction as “not only correct but desirable and likely to be confirmed by subsequent Fed action”.

This offsetting theme is one Ms Yellen likes. The market is helping to act as an “automatic stabiliser” for the economy because incoming data surprises “typically induce changes in market expectations about the likely future path of policy, resulting in movements in bond yields that act to buffer the economy from shocks”, she said.

But is Ms Yellen in danger of letting markets dictate Fed policy? After all, she recognised that the headwinds of weak global growth, low oil and China uncertainty were likely to ease, and yet despite efforts by hawkish Fed members to talk up rate-rise prospects, the dovish tone of Ms Yellen prevails.

The Fed is mistaken if it shifts to a market-dependent strategy, says Steven Barrow, foreign exchange G10 strategist at Standard Bank. “Financial markets are very fickle things and sometimes when you want things to happen they don’t always work the way you want. That’s how any central bank can get tripped up,” he says.
 
The argument that the Fed is overly influenced by markets goes back decades. Many have long argued there has been a tacit “Fed put” lasting two decades whereby officials will quickly seek to quell turmoil through dovish coos or policy action.

The Fed’s caution in the face of arguments supporting rate normalisation suggests that “the put still seems to be in place”, says BNY Mellon strategist Simon Derrick. The difference this time around is the context of pressure from policymakers globally for the Fed to go beyond its domestic remit and be sensitive to the impact of policy on other markets.
 
“If the Fed is becoming, by default, the global central bank and the ‘Yellen put’ is effectively there to support global markets (even if not intentionally) then that introduces a whole new dynamic to this 20-year-old story,” says Mr Derrick.

Acute sensitivity to market ructions follows the financial crisis, when the Fed was slow to track parts of the bond market. Nonetheless, some investors are wary that the central bank’s ability and inclination to support the market — in the face of the economic data — could in the long run prove unhealthy as it introduces a more fickle dynamic into policymaking.

For example, if markets continue to heal from the early-year fright, it could force the Fed to restore its initial rate outlook for 2016. If that sends markets back into a tailspin it may spur the Fed to once again reverse course.

“It’s a delicate balancing act they [the Fed officials] have to figure out,” says Gregory Peters, a bond fund manager at Prudential.