Demographics and markets: The effects of ageing

Will the rising number of retirees cause inflation and help lift the economy?

by: John Authers

The Federal Reserve has an awful hunch. It suspects that the world’s shifting demographics, as longer lifespans and reduced birth rates combine to increase the proportion of the aged within western societies, have rendered central banks powerless to raise long-term interest rates.

That was the conclusion of a paper published this month by economists from the Fed’s research division, capping a debate that has intensified over the past year. Citing an example based on the changing age structure of the US population, they said: “The model suggests that low investment, low interest rates and low output growth are here to stay, suggesting that the US economy has entered a new normal.”
This has already created ripples. Last week Stanley Fischer, the Fed’s deputy chairman, said US interest rates were low in part for reasons beyond the central bank’s control, and added: “An increase in the average age of the population is likely pushing up household saving in the US economy.”
There is widespread agreement that the steady ageing of western populations over the past few decades — as the postwar baby boom generation neared retirement and birth rates among their children declined — has contributed to historically low interest rates. But there is an intense debate among investors and economists over how the pattern will play out.
All agree that society’s choices over how they treat the old will go beyond the obvious moral and social implications, but could also determine whether deepening inequality can be reversed, and whether the world can escape from low yields and low growth.
“The ageing issue is very emotional: who’s going to look after grandma?,” asks George Magnus, chief economic adviser at UBS. “As an economic issue it looks dark and impenetrable.
But demographics is not destiny. We need political courage to do this, and we need more of it.”
Measures such as later retirement, incentives for carers and part-time workers and more immigration can all mitigate the effect of an ageing population.
Impact on growth
The mechanics of how we arrived at this point are straightforward. People save most during their working years. This prompts them to buy bonds either directly or mostly through pension contributions, pushing down yields. Then in retirement they consume more than they save — and in the final few months of life tend to consume more, in expensive healthcare, than at any other time. Greater longevity has accentuated this by ensuring more people live to see an incapacitated and expensive old age. This tends to push yields upwards.
The effects of demographical change on the labour market are also pronounced. When there is a bigger proportion of workers in the population, there is more competition for work. This pushes down labour’s negotiating power, and reduces both wages and inflation. Inflation is a critical driver of the bond market: when it is low, investors will accept a lower yield from their bonds. So again, a large population in work tends to push interest rates down, and a growing retired population should push them back up again.

The new Fed paper suggests that “demographic factors alone account for a 1.25 percentage point decline in the natural rate of real interest and real gross domestic product growth since 1980”. This is a huge claim, as it implies that demographics — rather than fiscal or monetary policy, technology or other changes in productivity — are responsible for virtually all of the decline in economic growth over the past 35 years.

As this period also saw increased savings activity as baby boomers scurried to get ready for retirement, slow economic growth was accompanied by long bull markets in both stocks and bonds in the US. Thus the phenomenon of ageing baby boomers helped to explain rising inequality. Increasing asset prices raises the wealth of those who already have savings, while a lack of bargaining power kept wages down for the rest.
But as the chart (top left) shows, the US, western Europe and Japan have all reached the “tipping point” when the numbers of people in work compared with old and young dependants has peaked and started to fall. In all three examples, that moment came just as the country suffered a major market crash. But the growing weight of the elderly in society has not, yet, started to push up interest rates, which remain at historically low and sometimes negative levels.

The Fed research paper suggests the effects could be permanent. It is common to blame either loose monetary policy or the overhang of debt from a crisis. But the Fed economists warned of a “risk that permanent effects of demographic factors could be misinterpreted as persistent but ultimately transitory downward pressure on the natural rate of interest and net savings stemming from the global financial crisis”.

In short, low yields may be unavoidable and much of the current policy debate may be misguided.

Their suggestion that the “scope to use conventional monetary policy to stimulate the economy during typical cyclical downturns is more limited than … in the past” makes deeply uncomfortable reading for central banks already throwing everything they have at obdurately low growth.

Investors and traders have taken note. Marc Chandler, who heads foreign exchange strategy for the investment bank Brown Brothers Harriman, says conventional theories suggest that monetary or fiscal policy can increase aggregate demand, while the demographic hypothesis is more sombre.

“America’s working population is unlikely to materially increase over the next 20 to 30 years,” he says. “That means that periods of low growth and interest rates will last for a long time and is the material basis for the new normal. Moreover, the demographic forces at work in the US are also present in many other countries in Europe and Asia.”

Attacking inequality

What happens next is a matter of some controversy. Last year, a team of economists at Morgan Stanley headed by Charles Goodhart, a former member of the Bank of England’s Monetary Policy Committee, argued that the rising number of retirees would “reverse three multi-decade trends” by reducing inequality, pushing up yields and raising equilibrium growth rates. “Both the young and the old are inflationary for the economy,” they said. “It is only the working age population that is deflationary.” With the working age population shrinking, inflation could return.

Longer lives, and greater expense at the end of life, would only increase consumption, they argued. Housing was also an issue. “As nations get richer, the old stay in their existing homes, rather than go to live with their children,” the team pointed out. “They are already on the housing ladder. So they stay put.” In this way, ageing will mean increasing investment in housing, and will not lead to any release of equity.

The report also highlighted international factors. China’s rising population helped keep global growth going for the past two decades. Now, as the “one child” policy which was imposed in 1979 works its way through the age cohorts, there is an imminent demographic tipping point in China where the number of people aged between 15 and 64 peaked in 2013. That could mean less of a savings glut, and therefore less appetite to buy bonds — which will push up yields.

Morgan Stanley faced withering criticism but the critical point at issue is the deal that society is prepared to offer the elderly. If they hold on to their current package, then rates could rise fast. But many believe that package is no longer viable and must be reduced.

“Our political-economy assumption is that the contract that administrations have implicitly made with the elderly will continue … to provide support through pensions and healthcare,” said Mr Goodhart.

Many economists question that assumption. If the elderly are forced to accept a poorer deal, with later retirement ages and less help with healthcare and other costs, then rates could stay low and the economy stay trapped in a “new normal”. With an uncertain future ahead, workers would feel obliged to save at a greater rate while they were still employed. By working for longer, saving would continue for longer.

Mr Goodhart and his colleagues argue that the threshold for doing this would be very high, because attacking the elderly is politically difficult and “very unlikely until demographic pressures are already well under way”, adding that “administrations have typically responded only at the eleventh hour”.

Others disagree. Joachim Fels, an economist at Pimco, responded with his own paper earlier this year entitled “70 is the new 65: demographics still support ‘lower interest rates for longer’”. Mr Fels said:
“If you look at the data in more detail, people retire later and later in life and it’s those people who do the bulk of the savings who retire the latest. It’s the Warren Buffetts of the world, to take an extreme example. But there are many more people like that.”

The wealthiest find it easier to stay in work, and have a much lower propensity to spend what they earn. So, Mr Fels argues, this mutes the effects that ageing would have on markets.
Dividing the US labour force by income, he showed that the participation in work by the top 20 per cent after the age of 65 had increased dramatically in the past two decades, and was likely to continue.

He now suggests his paper should have been called “Is 75 the new 65?”. If retirement continues to be delayed, and people put more money aside when they are in work, then the tipping point for demographics when savings start to fall can be delayed by a decade or more.

Dwindling pensions

Inadequate pension provision in many countries adds to the problem. In China, there is little or no social safety net. In the US where the “401(k)” pension plans offered to baby boomers have had disappointing returns, many reach 65 without sufficient savings and have no choice but to keep working. With countries steadily moving away from offering guaranteed pensions, and requiring employees to bear the risk of any shortfall, the incentive to save increases.

But Manoj Pradhan, part of the team that produced the Morgan Stanley report and now a principal at Talking Heads Macro in London, argues that the sheer political difficulty of giving pensioners a worse deal ensures that a big demographic shift towards lower savings can only be delayed, not averted.
“In Japan,” he says. “They are not able to back away because the elderly are a large part of the voting population.”

Participation in work by the elderly bottomed out and started to rise 20 years ago, he says, but has still not kept pace with rising life expectancy. In western European countries, in particular, it is still rare for people to work after 65. “The spread between retirement ages and average life expectancies is widening over time; the rise in retirement ages isn’t keeping up,” he says.

Several European countries, such as Spain and France, could widen their retirement ages greatly. But the furious Greek response to lifting retirement ages during the eurozone crisis shows it is still politically difficult to implement.

In the US, where it appears that many corporate and municipal pension plans will be unable to pay what they promised, courts have blocked pension funds from reducing payouts.

All concede that broader cuts in what the state promises to pensioners are very difficult. As Mr Fels puts it: “Raising pension ages pushes down yields. The same argument applies to cutting payouts. Some call this ‘pension reforms’. Others call it ‘default’.”

Mr Magnus suggests a middle ground in the debate. He says various “coping mechanisms” have helped to mitigate the issue, such as reforms in Japan, to encourage carers and provide incentives for women to work. But migration, another way to offset the problem, is now going in the opposite direction, threatening to create a skills shortage.

“Capitalism rewards scarcity, and labour will become comparatively scarce,” he warns, adding that low rates will not be a long-term phenomenon. “That will raise the return on labour relative to capital.

That will turn into a redistributive mechanism within society. That won’t happen in the next 12 months, but it is a logical consequence, and does mean higher rates eventually.”

Don’t Sweat The Election. The Next Crisis Is Already Baked Into The Cake  

It will be this way until the vote, especially if polls continue to tighten and the outcome remains uncertain. So there’s no point in obsessing over fundamentals for now. Nothing real will matter until we find out who gets to mess things up going forward. It’s reminiscent of the original Ghost Busters where the demon/god says “Choose the form of your destructor.”

In other words it’s a mess either way. Only the details of the mess are in question.

From here on out politics are only relevant at the extremes — major war, corruption scandal, martial law etc. Short of that, the fiat currency/fractional reserve banking world has such institutional momentum that it really won’t matter whether Trump is picking on bankers and building his wall or Clinton is protecting Wall Street and raising taxes. Debt will keep soaring as it has under every president since Reagan and jobs will disappear as machines replace people, thus bringing the end of the current system inexorably closer.

So it’s both dangerous to try to time this kind of uncertainty and, in the end, unnecessary. Crisis is coming and governments (whether left or right, populist or establishment) will respond as they always do, with easier money and more borrowing.

Here are three trends that matter vastly more than the name of the next US president:

“China’s Debt Has Grown $4.5 Trillion In Past 12 Months, More Than The US, Japan And Europe Combined”

(Talk Markets) – While concerns about China’s debt load, capital flows, and depreciating currency have been pushed to the back-burner in recent months, perhaps facilitated by a welcome rebound in global inflation – perceived by markets and global central bankers that monetary policy is finally working – it is worth a quick reminder of how we got here. 
First, a quick trip through memory lane to remind us how much has changed in just the past year. 
In a note by Morgan Stanley’s Chetan Ahya released on Sunday, the strategist reminds us that a little more than a year ago, the global economy was facing intense disinflationary pressures. Global commodity prices were declining significantly and the slowdown in China and other major commodity-producing EMs had led to some concerns that it could pull developed markets into recession and drag inflation down along with it. At the same time, in China, producer prices fell by almost 6%Y and the regime change in its currency management approach meant that China was no longer absorbing disinflationary pressures from abroad. 
And while this seems like a distant memory today, thanks to China which has played a pivotal role in driving the global inflation cycle – this time on the upside – as the cyclical recovery has both lifted China’s own inflation and transmitted it globally, here is how this happened: the recovery in China has been driven by yet another round of debt indulgence. Debt in China has grown by US$4.5 trillion over the past 12 months, by far the highest amount of debt creation globally as compared to US$2.2 trillion in the US, US$870 billion in Japan and US$550 billion in the euro area. Indeed, China on its own has added more debt than the US, Japan and the euro area combined. 
While we have shown the IIF’s forecast of Chinese debt countless times in recent months, here it is once again to put China’s unprecedented debt expansion in context: 

World to face stress test as dollar Libor spikes and bond rout deepens

(Telegraph UK) – Surging rates on dollar Libor contracts are rapidly tightening conditions across large parts of the global economy, incubating stress in the credit markets and ultimately threatening overvalued bourses. 
Three-month Libor rates – the benchmark cost of short-term borrowing for the international system – have tripled this year to 0.88pc as inflation worries mount. 
Fear that the US Federal Reserve may have to raise rates uncomfortably fast is leading to an increasingly acute dollar shortage, draining global liquidity. 
“The Libor rate is one of the few instruments left that still moves freely and is priced by market forces. It is effectively telling us that that the Fed is already two hikes behind the curve,” said Steen Jakobsen from Saxo Bank. 
“This is highly significant and is our number one concern. Our allocation model is now 100pc in cash. This is a warning signal for the market and it happens extremely rarely,” he said. 
Goldman Sachs estimates that up to 30pc of all business loans in the US are priced off libor contracts, as well as 20pc of mortgages and most student loans. It is the anchor for a host of exotic markets, used as a floor for 90pc of the $900bn pool of the leveraged loan market. It underpins the derivatives nexus. 
The chain-reaction from the Libor spike is global. The Bank for International Settlements warns that the rising cost of borrowing in dollar markets is transmitted almost instantly through the global credit system. “Changes in the short-term policy rate are promptly reflected in the cost of $5 trillion in US dollar bank loans,” it said. 
Roughly 60pc of the global economy is linked to the dollar through fixed currency pegs or ‘dirty floats’ but studies by the BIS suggest that borrowing costs in domestic currencies across Asia, Latin America, the Middle East, and Africa, move in sympathy with dollar costs, regardless of whether the exchange rate is fixed. 
Short-term ‘Shibor’ rates in China have been ratcheting up. The cost of one-year swaps jumped to 2.71pc last week, and the spread over one-year sovereign debt is back to levels seen during the Shanghai stock market crash last year. 
These strains are not a pure import from the US. The Chinese authorities themselves are taking action to rein in a credit bubble. It is happening in parallel with Fed tightening, each reinforcing the other, and that makes it more potent. 
Three-month interbank rates in Saudi Arabia have soared to 2.4pc. This is the highest since the global financial crisis in early 2009 and implies a credit crunch in the Saudi banking system. The M1 money supply has fallen 9pc over the last year. 

The One Trillion Dollar Consumer Auto Loan Bubble Is Beginning To Burst

(Economic Collapse Blog) – Do you remember the subprime mortgage meltdown from the last financial crisis? Well, this time around we are facing a subprime auto loan meltdown. In recent years, auto lenders have become more and more aggressive, and they have been increasingly willing to lend money to people that should not be borrowing money to buy a new vehicle under any circumstances. Just like with subprime mortgages, this strategy seemed to pay off at first, but now economic reality is beginning to be felt in a major way. 
The total balance of all outstanding auto loans reached $1.027 trillion between April 1 and June 30, the second consecutive quarter that it surpassed the $1-trillion mark, reports Experian Automotive. 
The average size of an auto loan is also at a record high. At $29,880, it is now just a shade under $30,000. 
In order to try to help people afford the payments, auto lenders are now stretching loans out for six or even seven years. At this point it is almost like getting a mortgage. 
But even with those stretched out loans, the average monthly auto loan payment is now up to a record 499 dollars. 
Already, auto loan delinquencies are rising to very frightening levels. In July, 60 day subprime loan delinquencies were up 13 percent on a month-over-month basis and were up 17 percent compared to the same month last year. 
Prime delinquencies were up 12 percent on a month-over-month basis and were up 21 percent compared to the same month last year. 
In a quarterly filing with the Securities and Exchange Commission, Ford reported in the first half of this year it allowed $449 millionfor credit losses, a 34% increase from the first half of 2015. 
General Motors reported in a similar filing that it set aside $864 million for credit losses in that same period of 2016, up 14% from a year earlier.

These three things – soaring Chinese debt, disruptions in the money market, and the end of the auto loan bubble – matter vastly more than which party runs what part of the government.

When one or all (or some other problem like Deutsche Bank) blow up in 2017, deficit spending will soar, interest rates will be forced down (to the extent that that’s possible) and new rules will be imposed on whatever freely-functioning markets remain.

And so it will go until the old tricks stop working. Then the details will start to matter again.

The Battle for Mosul: Current Tactics, Future Fallout

The Islamic State faces the possibility of losing its largest stronghold in Iraq.


This battlefield assessment of the impending fight for the Islamic State-controlled city of Mosul surveys the battlefield’s geography, examines the capabilities of the numerous states and groups that have committed resources to the battle, and explains the steps taken by both sides to date. This report concludes that while the Islamic State is outmanned and outgunned, it is in a highly advantageous defensive position that will enable it to inflict serious enough casualties on the attacking force that any coalition victory will be a hollow one.

  • Current reports tracking progress of the coalition’s attack on Mosul are exaggerated and overly optimistic; anti-IS forces haven’t reached the city yet and are beginning to face resistance as they approach.
  • The battle for Mosul will be a textbook case of urban warfare, resulting in high casualties for the attacking force along with high civilian casualties.
  • The coalition against the Islamic State is formidable, but it is plagued by internal dissension and mistrust among its actors.
  • The Islamic State does not have to win the battle to achieve strategic goals; the higher the cost it inflicts on the attacking forces, the more reluctant regional actors will be to repeat this type of attack on IS in other urban strongholds.

The battle for the areas around Mosul began on Oct. 18. Although the battle for Mosul itself has yet to begin, it is fast approaching. Coalition forces, led by the Iraqi Security Forces (ISF) and Kurdish peshmerga forces, are advancing on the city from the north, east and south. They first met resistance on Oct. 19, roughly 10-25 miles outside the city in all directions, and remain preoccupied with IS resistance as of this writing. The Islamic State’s opponents are leaving the the western axis conspicuously open, hoping that IS will cut its losses and run into the desert to make a clear target for U.S. airstrikes. However, the Islamic State is not likely to withdraw. IS has already retreated as far as it can, and now it means to make its opponents pay dearly for every square mile of the city they try to take.

Battlefield Mosul
Mosul is a large city divided by the Tigris River. Before it was taken by the Islamic State in June 2014, Mosul was the second most populous city in Iraq. It is hard to say how the IS takeover affected the city’s population, but estimates from before the takeover range from 1.2 million to 1.8 million, and estimates for the current population range from 700,000 to 1.5 million. Sunni Arabs made up the majority of the pre-takeover population, and the city is the northernmost outpost of Sunni Arab territory in Iraq. (The lands north of Mosul are predominantly Kurdish.) Even with a Sunni Arab majority, Mosul was a fairly diverse metropolis before the arrival of the Islamic State and contained significant pockets of Shiites and Christians as well as Assyrians, Turkmens and other ethnic groups. Many of these groups have since fled, though pockets of Turkmens and others remain trapped in the city.

Mosul and Surrounding Area
To the north and northeast, Mosul is surrounded by mountainous regions that are controlled by the Kurdistan Regional Government (KRG). To the east, the land is relatively flat until it reaches Erbil, where the mountains begin to rise. To the south, the land is flat. The Tigris flows directly south from Mosul to Baghdad, and the population centers hug the riverbanks before branching out around Baghdad. To the west of Mosul is open desert. Five highways lead into Mosul from all directions, and there are at least four additional roads of varying size and quality that also lead directly into the city. From Mosul, one can reach Syria, Turkey, Iran or Baghdad directly by car. In effect, Mosul is an intersection for the major highways and roads that link most of the region’s major powers.
This close-up map of Mosul shows where and how IS’ opponents will begin to face real resistance. At the point where the city begins and buildings (rather than open desert) dominate the landscape, the coalition forces’ task will become much more difficult. The Islamic State can set numerous traps for invaders to fall into as they advance block by block and attempt to clear IS from the city. There are also at least five major bridges that span the Tigris and connect various areas of the city. (These bridges are highlighted on the map.) As coalition forces advance, IS can retreat across these bridges and still control at least half of the city.

After advancing fairly easily over open ground in the early phase of the campaign, the coalition forces have now begun facing resistance in towns surrounding Mosul. Invading Mosul itself will be another matter. As illustrated on the map above, the potential for civilian casualties becomes obvious. Each house could contain a family of human shields or unintended casualties; furthermore, the city’s many buildings could be demolished by IS to slow the coalition attack.

The Fragile Coalition

The coalition participating in the invasion of Mosul is made up of fighters from Iraq, mostly the ISF, and the Kurdish peshmerga, with support from the United States. The ISF is nominally in charge, but how that plays out in practice remains to be seen.

The bulk of Iraqi Security Forces are approaching Mosul from the south. The ninth armored division and the first, 15th and 16th army divisions make up a main attack force of approximately 24,000-36,000 soldiers. The peshmerga forces, meanwhile, are approaching from the east and from the north. There are approximately four peshmerga divisions committed to the fight, an estimated 10,000-15,000 fighters (though KRG leader Masoud Barzani has bragged that the number is 30,000).

According to the Iraqi government, the peshmerga will not breach the city of Mosul itself. Rather, the peshmerga’s aim is to close off the north and east to Islamic State fighters. To that end, Iraq’s Counter Terrorism Service (CTS) and special forces are reportedly at the front lines of both the ISF and peshmerga advances. These fighters represent Iraq’s best and have been trained by the U.S. in counter-insurgency tactics. If all goes to plan, they (and not the peshmerga) will be the ones entering the city from the east and north.

The United States is playing an integral role in the coalition’s attack. Without the U.S., there would likely be less productive communication between Kurdish forces and the ISF. Moreover, the CTS is participating in the Kurdish thrusts towards Mosul because the U.S. brokered a deal between Iraq and the KRG that allowed the CTS to be there. There are also at least 100 U.S. joint terminal attack controllers embedded in local units to coordinate airstrikes and artillery strikes in support of coalition movements. According to the Pentagon, both U.S. artillery and Apache helicopters are at the disposal of coalition forces, though the Kurds have already complained that they have not received the level of support they expected. There are also U.S. special forces embedded with the ISF at the division level and with the peshmerga in smaller units, according to the Pentagon.

There are two other groups of forces on the ground that are not officially part of the coalition. These actors are cooperating with the coalition’s advances but they are also pursuing their own interests, which complicates the coalition’s overall mission. The first of these groups consists of an unknown number of Shiite militias, 
many backed by Iran. Long War Journal has estimated that the total number of both Shiite and Sunni militia fighters is somewhere around 60,000. However, the Shiite militias in particular represent a major challenge to the coalition’s success because there have been numerous allegations of aggressive actions taken by Shiite militias against the Sunni populations they have occupied in neighboring Anbar province and other Sunni-dominated areas. Furthermore, The Sunni Arabs living in Nineveh province (where Mosul is located) are not interested in trading IS dictatorship for sectarian dictatorship.

Iraqi Prime Minister Haider al-Abadi and various Iraqi representatives have insisted that the Shiite militias will not be involved in the main attack on Mosul. Still, according to the Institute for the Study of War, units from the most powerful Shiite militia— the Popular Mobilization Forces — have advanced alongside Iraqi Federal Police units and have filled in areas behind ISF advances. According to Long War Journal, some of these militias will also be involved in a separate attack on Hawija, a pocket of IS territory to the southeast of Mosul.

There is also 
a small contingent of Turkish ground forces located at a base near Bashiqa; these forces number approximately 450 soldiers and 25 tanks. Turkey has stationed these troops there for over a year, much to the continuing chagrin of the Iraqi government. Both the U.S. and Iraq say Turkey is not a part of the coalition assault on Mosul, but Turkey has defiantly insisted it will be involved if necessary. On Oct. 25, Iran joined this political squabble, insisting that Turkey’s continued violation of Iraqi sovereignty is unacceptable. There are conflicting reports, but it appears that Turkish tanks and artillery have supported the advance of Kurdish peshmerga forces along the Bashiqa axis.

The Islamic State

The Islamic State’s military forces are much harder to parse. The Pentagon says that as recently as July, there were an estimated 10,000 IS fighters in Mosul, but the Pentagon also reports that many top Islamic State officials and their families have left the city. This was contradicted by an Oct. 25 report saying that hundreds of Islamic State fighters were actually pouring into Mosul, arriving via the desert on the western side of the city, to join the fight against the fragile coalition. The most recent estimates of the number of IS fighters in Mosul range anywhere from 2,000-10,000, and in general we tend to err on the side of the upper limit when it comes to gauging IS strength.
Iraqi Battlespace
Thus far, the Islamic State has not used much heavy weaponry against the approaching forces. We know from previous reports, however, that IS possesses significant (if limited) firepower. Al-Abadi said last year that Iraq lost 2,300 Humvees to IS fighters in Mosul when the city fell to IS forces in 2014. When things were going well for IS during that same year, the group held a military parade in Mosul and displayed various improvised fighting vehicles, artillery and armored vehicles that it had captured. According to the Pentagon, IS seized 10 M1A1 Abrams tanks as well as ammunition from Ramadi last summer, both of which could have been moved to Mosul. A report from Turkish newspaper the Daily Sabah claimed that the Islamic State has 30 Russian T-55 tanks and five to 10 T-72 tanks, some of which were previously spotted in Mosul.

IS, which has shaky supply lines at best as a result of the coalition’s approach, is likely conserving its ammunition and has thus far opted to both engage in suicide bomb attacks against approaching armor and troops and booby-trap approaches to the city with IEDs. IS has already used crude chemical weapons against 
U.S. forces in Iraq, and though such weapons are of limited effectiveness, it is suspected IS will continue to attempt to employ them. Additionally, IS is building tunnels in the city and is reinforcing them with concrete walls and barricades. IS is also burning oil and tires to create thick plumes of black smoke that make it harder for artillery to target. Furthermore, they have surrounded the city with oil tankers to block potential coalition advances.

The Islamic State has also resorted to what has become one of its classic tactics: attacking in areas outside the main theater in order to distract enemy forces. On Oct. 21, the Islamic State carried out major small-arms and suicide attacks in Kirkuk, roughly 90 miles southeast of Mosul, killing at least 16. Then, on Oct. 23, IS attacked Rutba, roughly 300 miles southwest of Mosul, and on Oct. 24 attacked Sinjar, a strategically important town on the highway that links Iraq to Syria. While the peshmerga succeeded in fighting off the attack on Sinjar, IS has succeeded in capturing at least half of Rutba, where fighting is still ongoing. Similar attacks will continue, even as the coalition creeps towards the city, although they have not been large enough to divert resources from the attack on Mosul.
The Advance
Now that we understand the battlefield and the major players, we can examine the scope of the battle itself.
There are currently four main approach vectors for the assault on Mosul. The ISF, led by four brigades of the Iraqi ninth and first divisions, including the 34th armored, have advanced up Highway 80 and reached al-Hamdaniya, roughly 20 miles south of Mosul. Meanwhile, Iraqi CTS and special operations forces, along with peshmerga fighters, have advanced along three axes. The first axis is to the east of Mosul along Highway 2, where forces have reached Bartella, about 10 miles from Mosul. The second is northeast of Mosul, where forces have reached Bashiqa. The third is directly north of the city, where forces are advancing from both Tall Kayf and from Nuran, seizing villages previously controlled by IS along the way.

There are two additional approaches shown on the map above. At least three Iraqi brigades and an unknown number of Iraqi Federal Police forces have advanced to Shura. An unknown number of Popular Mobilization Forces units have also advanced along a parallel line up Highway 1, the only highway leading to Mosul’s west bank. It is unlikely, however, that the Shiite militias or the ISF will continue to approach the city from Highway 1; this approach is dangerous because the highway is met by mountainous terrain before reaching the city, making the approach more difficult than approaches from the east and north. The militias and Iraqi forces are more likely stationed there to protect the flank of the main attack; it is unlikely that they will march on the city.

To date, neither the Iraqi Security Forces nor the peshmerga have reached the city of Mosul proper. However, coalition forces have encountered IS resistance at a number of locations, including Bashiqa, Bartella, Tall Kayf, al-Hamdaniya and Shura, all of which are roughly 10 to 25 miles from the city and are located in relatively sparsely populated areas. Additionally, the coalition has left the west open to tempt IS to retreat from the city rather than fight.

The coalition forces’ strategy will not include a siege; rather, they will attempt to break IS’ will and, failing that, to win a battle of attrition. Either of these options would result in horrific levels of civilian casualties in addition to high casualty rates for the attacking force. Based on current deployments, it appears as if the coalition is opting for the latter strategy, a battle of attrition via attacks from the north and east. It seems as though the coalition aims to drive IS across Mosul’s bridges, to the west bank of the Tigris River. From there, the task of cleaning out IS resistance will become even more difficult because of the potential for a bottleneck at the bridges, and because of the potential for IS to destroy the bridges. Even so, the Iraqi-U.S. coalition does have a significant advantage in terms of numbers of fighters, materiel and air support, and IS cannot hope to win the battle on strength of arms.

The coalition has two major weaknesses. The first is that the coalition’s many disparate parts must continue to play well together. (This includes the various actors that are present but not part of the coalition.) However, there is no guarantee this is possible. Both the Kurds and the Shiite militias have previously shown that they will make opportunistic attacks to secure territory if such a possibility is presented, and they will have ample such opportunities in the battle on Mosul. Additionally, the Turks do not want an Iranian puppet to be in control of Mosul – a city Turkey ruled during the Ottoman Empire – and can claim that their Turkmen brethren require their assistance as well. The Turks thus far have not put enough resources in the field to make a consequential military move, but their presence and political aggressiveness exacerbates already simmering sectarian tensions.

The coalition’s second weakness is that it will be increasingly difficult to maintain the ISF’s morale and composure while leading the attack on Islamic State positions in the city. The Islamic State has had two years to prepare for this attack, and IS will not simply drop its weapons and run when the coalition arrives. Furthermore, the Islamic State must have sympathizers in order to govern such a large city, so many locals are likely to view the invading ISF with a great deal of suspicion. There will be pictures of locals celebrating in the streets at the coalition’s arrival, but there will also be pictures of civilians dying and reports of massive population displacement. Such images and reports will undoubtedly chip away at ISF morale. At the same time, there will be no morale-boosting images of those waiting for the first opportunity to rebel against the Iraqi invaders once they inevitably leave the city.

The Islamic State’s weaknesses are much simpler. IS is outgunned and outmanned. Moreover, opposing forces control all of the major highways and roads into and out of Mosul, so all resupplying has to be undertaken through the desert and is therefore susceptible to U.S. airstrikes. Despite these weaknesses, the IS territory in Mosul is extremely defensible, and IS has proved that its skilled fighting force should not be underestimated. IS fighters are willing to die for their cause, and most of the fighters in Mosul may very well become martyrs, but they wouldn’t engage in this fight if they didn’t think they had a chance of winning. For IS to win the battle, it will need to erode the advance of coalition forces to such an extent that the coalition abandons the approach or devolves into infighting. Considering the complexity of the situation and the coalition’s internal tensions, this is within the realm of possibility.

We do not think IS is going to shrink from this fight; we are also skeptical of reports that say IS has only a few thousand fighters in Mosul and is completely overmatched. Evaluations of IS fighting strength have continually underestimated the group’s abilities. Furthermore, if IS was going to retreat, it would have done so before the coalition forces were arrayed against it and while it could still expect to move through the desert outside Mosul without being the certain target of U.S. air strikes. IS has decided to make a stand here, which means one of two things. IS may think it can fend off the U.S.-backed coalition for long enough to undermine its will to fight. Alternately, IS might think it can inflict such a high cost in the coming battle that all regional actors will pause in attempting a similar feat in Raqqa, IS’ main headquarters, and its stronghold in Deir el-Zour. This reluctance will become all the more pointed as the humanitarian scope of an urban battle in Mosul becomes clear.


A hodgepodge coalition of rivals, former enemies and uneasy allies is marching on the IS stronghold of Mosul. These forces have not yet reached the city, and the battle will not begin in earnest until they do. What lies ahead is a long, difficult and bloody affair. The U.S.-backed ISF and its partners have an overwhelming advantage in terms of fighters and resources, but victory will come at a very high price, one the Islamic State may be able to profit from more than the technical victors. In the meantime, historical rivalries and sectarian divisions – which led to the vacuum that created IS’ rise in the first place – will continue to shape and undermine the fight against IS even once the battle for Mosul has ended.

Can Latin America Free Itself from Dependence on Commodities?

If there is a market that draws special attention in Latin America, it is the market for raw materials.

The economies of the region are widely exposed to price fluctuations in markets such as corn, soy beans and copper, not to mention the region’s number-one commodity: petroleum.

At the beginning of this year, the governments of Latin America were very happy to watch how prices in these markets were moving. But their cheers turned into frowns during the summer: The Bloomberg Commodity Index, which tracks prices for 22 raw materials, closed the third quarter of 2016 with a sharp decline, after registering significant increases over the first two quarters of this year. Coincidence or not, ever since this kind of data began to be recorded in 1991, such a pattern has happened in only four years — and when it has happened, in three of those four cases, there was a sharp drop in prices in the subsequent fourth quarter of that year.

These sorts of statistics are not the only factor that is making people pessimistic. So is the way investors are reacting to the situation. From corn to petroleum, the existing oversupply in commodities has been making investors nervous about the future. From mid-August to mid-September, investors pulled $791 million out of exchange-traded funds tracking commodities, a reversal from earlier this year that still left inflows up by $34.1 billion this year. Along the same lines, high-risk hedge funds reduced their exposure to raw materials. Said Rob Haworth, Seattle-based investment strategist for U.S. Bank Wealth Management, which manages an investment portfolio of $133 billion, “There’s just not enough to keep speculators interested. There’s not been enough momentum or follow-through in any commodity price.”  

Mauro Guillen, Wharton management professor and head of the School’s Lauder Institute, notes, “The issue is that many of these countries have become addicted to commodities. During the 1950s, 1960s and 1970s, they tried to separate themselves from the commodity cycle by investing in manufacturing. Many of those investments were not very good, so they went through a big crisis during the 1980s. And the funny thing is that since then, especially between 2000 and 2008, these economies became addicted again to commodities. When China’s economy slowed down, and prices for commodities came down, many of these countries – Brazil, Peru, Argentina, Bolivia, Venezuela – got into a lot of trouble. The only exception is Mexico. It does have natural resources, but over the last 30 years, thanks to NAFTA, it has become a manufacturing economy, essentially linked to the U.S. economy. Other than Mexico, all of the others continue to be dependent on the commodity cycle. As for Colombia, hopefully they will find a solution to the peace agreement, and then Colombia will also be able to perform very well.”

A Cyclical Change?

These developments have called into question those voices that had claimed that a cyclical change of raw material prices had begun, following the rising prices experienced during the first two quarters of 2016. “It is hard to know, but I doubt that we are confronting a change in the cycle of primary prices,” says Hernando Zuleta, a professor of economics at the University of the Andes in Colombia. “I believe that in order to have a sustained recovery, it would be necessary for the major economies to grow more rapidly. Moreover, supply factors are involved in these price increases. At the moment, I don’t see any signs that either of those two things is happening.”

Zuleta adds, “I believe that in around two or three years, we will see the impact of low prices on the supply of raw materials. Then there will be a lasting increase in their prices.” Since the end of June, the Bloomberg Commodity Index has declined by 6.7%. These losses include a 41% plunge in some of the most important components, including 23% for soy futures, and 11% in petroleum futures. In the last month alone, investors withdrew $991 million from energy sector ETFs and $39 million from raw materials ETFs. Nevertheless, prices of some raw materials, including gold, continue to move strongly upward.

Key Factors in the Market

During the first half of 2016, investors placed their money into raw materials, based on speculation that the United States Federal Reserve would slowly raise interest rates, which would consequently weaken the dollar and make prices of raw materials cheaper for those who hold other currencies. At the moment, after digesting recent comments made by some members of U.S. Federal Reserve, analysts say there is a 50% probability that the Fed will raise rates by the end of the year.

However, the price declines haven’t resulted merely from expectations about interest rates. The oversupply that exists in the markets for some products is exerting strong downward pressure on their prices — for example, with corn and copper. The U.S. Department of Agriculture expects that the country will achieve a record high grain crop this year, while Antofagasta, a Chilean producer of copper, forecasts that the current excess of supply in the copper market will last two or three more years.

According to Lourdes Casanova, academic director at the Institute of Emerging Markets of the S.C. Johnson School of Management at Cornell University, “It is not easy to forecast the price of raw materials, and almost all of us make mistakes.” However, Casanova does not expect production levels to reach new heights over the short or medium term. She also doesn’t expect a short-term increase in the price of petroleum.

Petroleum is the product that is traded the most in the world, “and the rest of the products follow its pattern,” Casanova notes. From a macroeconomic point of view, Casanova also sees no major reason for commodities prices to rise for a sustained period. “The growth of the world economy — except in China and India — are continuing at a lackluster pace. And so I don’t believe that we are facing a cycle such as the one we had in the previous decade.”

Adapting to Circumstances

Now that short- and medium-term expectations for a new cycle of price increases have been shattered, Latin America will have to learn how to cope without depending on this source of strong economic growth, economists agree. That was one of the conclusions noted by the International Monetary Fund (IMF) and the World Bank at the annual conference of the Development Bank of Latin America (CAF) in Washington in September. Top economists at the IMF and the World Bank noted that Latin America is in a “weak” fiscal position and has a “lower margin for maneuvering” to deal with the current context of the economic recession. In July, the IMF forecast that at the end of 2016, Latin America will remain in a recession — for the second consecutive year — with its Gross Domestic Product (GDP) declining by 0.4%.

According to Alejandro Werner, the IMF’s director for the Western Hemisphere, “All of the economies of the region are in a weaker fiscal position than they ought to be.” Werner warned that this situation involves significant risks, especially because “the Latin American political class has gotten used to governing during times of abundance” over the past decade, thanks to the boom in primary products then driven by the industrial expansion of China. That period is over. When commodity prices were high, those who governed were not overly concerned about the efficiency of their expenditures, Werner noted. In the current context, however, it is critical for policy makers to reassess those levels of efficiency and to apply structural reforms.

Long-term Thinking

According to Wharton’s Guillen, “You cannot transform these economies or make them less dependent on the commodity cycle unless you invest in education and infrastructure, and unless you set up a regulatory framework in such a way that you are attracting investments.”

However, such moves require a long-term commitment, he adds. “The useful political cycle is four years and those things don’t give you good results in just four years. You need a ten-year or fifteen-year time horizon. It’s always been easier for any government in the world – not just in Latin America – to try to capitalize on the windfalls and not to invest for the long run. Unfortunately, there’s no magical solution to this.”

How well are major economies of the region managing their efforts to lessen their dependence on commodities? Guillen notes that Mexico has had the most success of any country in the region when it comes to transforming its industrial sector into a significant part of the global value chain for automotive, electronics and other products. “After Mexico, I would put Colombia,” he adds. Further down that list, “Some people mention Chile all the time but I am ambivalent about it. It is true that at the beginning of 1970s, they adopted a long-term perspective; it has helped a little bit. But 30 to 40 years later, the economy continues to be driven by commodities. Copper is still the most important.

They have diversified a little bit but they continue to have problems in the education sector. In the last year, there have been multiple student strikes. They felt that the government wasn’t spending enough on education. Part of the problem is that now the government doesn’t have as much revenue from copper exports as it had.”

As for Brazil, the largest country in Latin America, it is “a world unto itself; a very large economy that is very protectionist,” adds Guillen. “The pity about Brazil is that they didn’t do anything to transform the economy when they had [a] windfall.”

The Case of Brazil

Felipe Monteiro, professor of strategy at INSEAD business school in Paris and senior fellow at Wharton’s Mack Institute, notes that “as Brazil looks at the future, a major question is whether Brazilian companies can be part of the global value chain, and thus less subject to the negative consequences of downward spirals in commodities.”

Monteiro cites two reasons why most Brazilian exports continue to be commodities. First, “It is very comfortable to be a commodity exporter when commodity prices are booming.” Second, many of the Brazilian companies that could have made an effort to compete abroad “are being too lazy” when it comes to globalization. Their experience with the region’s long history of price cycles has led them to believe that commodity prices will eventually bounce back strongly, making arduous efforts to join global value chains unnecessary, he says. Nevertheless, Monteiro is hopeful that, given current circumstances, many Brazilian firms that are focused entirely on the large domestic market will seriously reconsider the long-term advantages of exploiting opportunities abroad. A few leading companies – such as Brazil’s Embraer, the aerospace conglomerate – have built their own global value chains. Embraer is “definitely part of a global value chain. They import so many different parts and work with different suppliers; they assemble, and then they export again.” However, “unfortunately, few Latin American companies pursue this approach. [More commonly], what happens is either they do a lot of local production for local consumption or what they provide to the rest of the world is just commodities.”

Like the U.S., Brazil is a huge nation in which all too few companies have exploited their opportunities to access foreign markets. In 2013, Brazil’s total exports represented only 13% of the country’s GDP, compared with 32% in the case of Mexico’s exports (and 14% in the case of U.S. exports), according to the World Bank. At that time, Brazilian commodity export prices were high. Nowadays, notes Monteiro, “When you look at exports and foreign trade, Brazil is not doing well, because commodity prices are depressed. And when you look at its internal economy – most of which is services — [Brazil] is also not doing well there [either], because in the internal economy, people are not consuming. So this pattern is putting so much pressure on Brazil.”

Adapting to Change

Zuleta argues that countries must learn how to adapt themselves to the constant changes that are produced in markets for primary products. Thus, he says, “the ideal thing would be to use the transitory booms for reducing debt and increasing spending.”  Nevertheless, in many cases, governments have taken the opposite path, which is something he considers very dangerous, and potentially harmful to the future progress of the economy. “One of the risks associated with transitory bonanzas is to bring yourself up to high spending levels that are then unsustainable in conditions of lower prices.”

Zuleta continues, “This has happened in nearly every country in Latin America; in some cases more than in others. The cost is that ‘countercyclical’ policy cannot be made when so many economies fall into a recession. What happens is that public spending and aggregate demand decline when the price of primary products falls and the recessionary effect is magnified.” The “counter-cyclical” or “anti-cyclical” policies defended by Keynesian economic theories defend the notion that the government should maintain or increase public expenditures during a stage of recession in order to try to reactive economic activity as early as possible and, in this way, to reduce the recessionary economic cycle to its bare minimum.

Casanova argues that “an increase in prices is always positive for those economies that are dependent on exports of primary products, including Latin American economies.” Despite that, she believes that countries should limit as much as possible their dependence on these sorts of products in order to prevent themselves from being strongly affected by the volatility of their prices. She is aware that “it is not easy to change the economic structure of a country over a short period of time.” However, she notes that it is possible: Some of the world’s largest economies – including the United States, Canada and Australia – are rich in primary products, but have learned how to diversify their economic structures adequately.

“The problem comes when a country is incapable of developing its manufacturing sector and/or the industries that surround its raw materials — that is to say, its secondary industries and so forth,” Casanova says. “Latin America is such a case. The region has been given to lurching back and forth in its economic policies,” and whatever changes are made, they require stability. “Let’s hope that this is possible in this new stage [of the region’s development].”