China’s Housing-Market Headache

China’s housing market is on a tear—good news, right? Not exactly

By Nathaniel Taplin

It’s a good time to be a homeowner in China. It’s a bad time to be a Chinese central banker.

Chinese home prices rallied again last month, with prices in small, so-called “third tier” cities shooting up 1.3% according to Wind Info, the fastest pace since at least 2010. That is creating a huge headache for China’s central bank, which is trying to support flagging growth without further inflating a dangerous housing bubble. Ballooning housing prices are one key reason to think this round of stimulus will be modest in contrast to previous easing cycles, despite the current sharp slowdown in investment. 

Residential buildings in Beijing. China’s home prices rallied again last month, creating a headache for Beijing as it tries to boost growth without inflating a housing bubble. Photo: Giulia Marchi/Bloomberg News 

The situation is reminiscent of early 2015, another period of flagging growth and policy missteps by the People’s Bank of China (PBOC) that presaged major market turbulence later that year. Then, as now, one of the central bank’s first policy responses was to push short-term interbank rates lower, hoping to stimulate lending. Then, as now, banks were still reluctant to lend because the government was simultaneously in the midst of a big crackdown on shadow finance, meaning many borrowers were in dire straits. Much of the extra liquidity from the PBOC’s easing moves simply flowed into the stock market instead, resulting in a historic bubble followed by a crash a few months later and large-scale capital outflows.

One reason big outflows haven’t reappeared yet this year is that domestic speculators still have a compelling domestic investment story: though this time it is housing, not the stock market.

That makes regulators’ job doubly difficult. Supporting government bond issuance to stave off collapsing infrastructure investment requires abundant bond-market liquidity. But pushing down rates without further inflating the housing-market bubble will be hard. Administrative measures to curb property speculation, so far, been ineffective at keeping prices in check.

Watching the trajectory of rates and housing prices will be key over the coming months. If regulators can regain control of housing markets and still manage to push borrowing costs down for cash-strapped local governments and small companies, then investment and growth will stabilize.

Otherwise, the choices become far less palatable: a deepening slowdown and even more defaults just as President Trump’s trade offensive shifts into higher gear, or an out-of-control housing bubble whose bursting could ultimately trigger another round of major capital flight. Either way, major market turbulence both at home and abroad wouldn’t be far behind.

Protectionism for Liberals

Robert Skidelsky

LONDON – Liberal revulsion at US President Donald Trump’s mendacious and uncouth politics has spilled over into a rigid defense of market-led globalization. To the liberal, free trade in goods and services and free movement of capital and labor are integrally linked to liberal politics. Trump’s “America First” protectionism is inseparable from his diseased politics.

But this is a dangerous misconception. In fact, nothing is more likely to destroy liberal politics than inflexible hostility to trade protection. The upsurge of “illiberal democracy” in the West is, after all, the direct result of the losses suffered by Western workers (absolutely and relatively) as a result of the relentless pursuit of globalization.

Liberal opinion on these matters is based on two widespread beliefs: that free trade is good for all partners (so that countries that embrace it outperform those that restrict imports and limit contact with the rest of the world), and that freedom to trade goods and export capital is part of the constitution of liberty. Liberals typically ignore the shaky intellectual and historical evidence for the first belief and the damage to governments’ political legitimacy wrought by their commitment to the second.

Countries have always traded with each other, because natural resources are not equally distributed round the world. “Would it be a reasonable law,” asked Adam Smith, “to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland?” Historically, absolute advantage – a country importing what it cannot produce itself, or can only produce at inordinate cost – has always been the main motive for trade.

But the scientific case for free trade rests on David Ricardo’s far more subtle, counter-intuitive doctrine of comparative advantage. Countries with no coal deposits obviously cannot produce coal. But assuming that some production of a naturally disadvantaged good (like wine in Scotland) is possible, Ricardo demonstrated that total welfare is increased if countries with absolute disadvantages specialize in producing goods in which they are least disadvantaged.

The theory of comparative advantage greatly widened the potential scope of beneficial trade. But it also increased the likelihood that less efficient domestic production would be destroyed by imports. This loss to a country’s production was brushed aside by the assumption that free trade would allocate resources more efficiently and raise productivity, and thus the growth rate, “in the long run.”

But this is not the whole story. Ricardo also believed that land, capital, and labor – what economists call the “factors of production” – were intrinsic to a country and could not be moved round the world like actual commodities. “Experience ... shows,” Ricardo wrote,

“that the fancied or real insecurity of capital, when not under the immediate control of its owner, together with the natural disinclination which every man has to quit the country of his birth and connexions, and intrust himself, with all his habits fixed, to a strange government and new laws, check the emigration of capital. These feelings, which I should be sorry to see weakened, induce most men of property to be satisfied with a low rate of profits in their own country, rather than seek a more advantageous employment for their wealth in foreign nations.”

This prudential barrier to capital export fell as secure conditions emerged in more parts of the world. In our own time, the emigration of capital has led to the emigration of jobs, as technology transfer has made possible the reallocation of domestic production to foreign locations – thus compounding the potential for job losses.

The economist Thomas Palley sees the reallocation of production abroad as the distinguishing feature of the current phase of globalization. He calls it “barge economics.” Factories float between countries to take advantage of lower costs. A legal and policy infrastructure has been built to support offshore production that is then imported to the capital-exporting country. Palley rightly sees offshoring as a deliberate policy of multinational corporations to weaken domestic labor and boost profits.

The ability of companies to allocate jobs globally changes the nature of the discussion about the “gains from trade.” In fact, there are no longer guaranteed “gains,” even in the long run, to those countries that export technology and jobs.

At the end of his life, Paul Samuelson, the doyen of American economists and co-author of the famous Stolper-Samuelson theorem of trade, admitted that if countries like China combine Western technology with lower labor costs, trade with them will depress Western wages. True, citizens of the West will have cheaper goods, but being able to purchase groceries 20% cheaper at Wal-Mart does not necessarily make up for wage losses. There is no assured “pot of gold” at the end of the free-trade tunnel. Samuelson even wondered whether “a little inefficiency” was worth suffering to protect things which were “worth doing.”

In 2016, The Economist conceded that “short-term costs and benefits” from globalization are “more finely balanced than textbooks assume.” Between 1991 and 2013, China’s share of global manufacturing exports increased from 2.3% to 18.8%. Some categories of American manufacturing production were wiped out. The United States, the authors averred, would gain “eventually.” But the gains might take “decades” to be realized, and would not be equally shared.

Even economists who concede the losses that come with globalization reject protectionism as an answer. But what is their alternative? The favored remedies are somehow to slow down globalization, giving labor time to re-skill or move to more productive activities. But this is scant comfort to those stuck in the rust belts or decanted into low-productivity, low-paid jobs.

Liberals should certainly exercise their right to attack Trumpian politics. But they should refrain from criticizing Trumpian protectionism until they have something better to offer.

Robert Skidelsky, Professor Emeritus of Political Economy at Warwick University and a fellow of the British Academy in history and economics, is a member of the British House of Lords. The author of a three-volume biography of John Maynard Keynes, he began his political career in the Labour party, became the Conservative Party’s spokesman for Treasury affairs in the House of Lords, and was eventually forced out of the Conservative Party for his opposition to NATO’s intervention in Kosovo in 1999.

Gold And Silver Are Acting Like It’s 2008. They May Be Right 

2008 has special significance for gold bugs, both because of the money they lost in August of year and the the money they made in the half-decade that followed. Today’s world is beginning to feel eerily similar.
Let’s start with a little background. The mid-2000s economy boomed in part because artificially low interest rates had ignited a housing mania which featured a huge increase in “subprime” mortgage lending. This – as all subprime lending binges eventually do – began to unravel in 2007. The consensus view was that subprime was “peripheral” and therefore unimportant. Here’s Fed Chair Ben Bernanke giving ever-credulous CNBC the benefit of his vast bubble experience.

The experts were catastrophically wrong, and in 2008 the periphery crisis spread to the core, threatening to kill the brand-name banks that had grown to dominate the US and Europe. The markets panicked, with even gold and silver (normally hedges against exactly this kind of financial crisis) plunging along with everything else. Gold lost about 20% of its market value in a single month:

Gold price in 2008

Gold mining stocks – always more volatile than the underlying metal – lost about half their value.

HUI gold bugs index in 2008

Silver also fell harder than gold, taking the gold/silver ratio from around 50 to above 80 — meaning that it took 80 ounces of silver to buy an ounce of gold.

Gold/silver ratio in 2008

The world’s governments reacted to the crisis by cutting interest rates to record lows and flooding the financial system with credit. And precious metals and related mining stocks took off on an epic bull market. So it’s easy to see why the investors thus enriched look back on 2008 with nostalgia.


Is History Repeating?

Now fast forward to Autumn 2018. The global economy is booming because of artificially low interest rates and massive lending to all kinds of subprime borrowers. One group of them – the emerging market countries – made the mistake of borrowing trillions of US dollars in the hope that the greenback would keep falling versus their national currencies, thus giving them a profitable carry trade.

Instead the dollar is rising, threatening to bankrupt a growing list of these countries – which, crucially, owe their now unmanageable debts to US and European banks. The peripheral crisis, once again, is moving to the core.

And once again, gold and especially silver are getting whacked. This morning the gold/silver ratio popped back above the 2008 level.

Gold/silver ratio Sept 2018 2008

So are we back there again? Maybe. Some of the big western banks would probably fail if several major emerging markets default on their debts. And historically – at least since the 1990s – the major central banks have responded to this kind of threat with lower rates, loan guarantees and, more recently, massive and coordinated financial asset purchases.

So watch the Fed. If the EM crisis leads to talk of suspending the rate increase program and possibly restarting QE, then we’re off to the races. Just like 2008.

Economy Gives Fed No Reason for Pause

A quiet summer means the Federal Reserve is even more likely to keep raising rates than investors believed at the beginning of the season.

By Justin Lahart

Welcome back from summer vacation! As far as the Federal Reserve is concerned, not much happened while you were gone. That leaves them on track to keep tightening.

Oh sure, there was news. Trade tensions simmered. Turkey and Argentina ran into the shoals. British politicians allowed that next year’s Brexit will be very serious and have taken hard steps toward having more meetings to discuss that seriousness. Controversies swirled around President Trump and were stirred by him. The Mets fell apart. 
But the types of big worries that have rattled markets in summers past weren’t there and the existing, mostly benign trends were. The economy keeps powering along and corporate profits, with the extra sweetener of this year’s tax cut, continue to swell. Inflation is trending right at the Fed’s 2% target, and the unemployment rate keeps drifting lower.

Fed funds futures imply the odds of two more rate increases by the Federal Reserve this year are about 70%.

Fed funds futures imply the odds of two more rate increases by the Federal Reserve this year are about 70%.
Fed funds futures imply the odds of two more rate increases by the Federal Reserve this year are about 70%. Photo: chris wattie/Reuters

Anybody who on Memorial Day thought the Fed might find a reason to hit the pause button on rate increases needs to update his or her thinking. Investors have done that to some extent. Fed funds futures imply the odds of two more Fed rate increases this year—one at this month’s meeting and one at the December meeting—are about 70%. That compares with about 50% after the June meeting when the Fed last raised rates.

Investors may need to further raise those odds as they return to work refreshed. While there are some uncertainties hanging over the economy, the chances of it materially slowing down this year seem slim.

Next year, when the tax-cut stimulus starts to fade, tariff effects become more pronounced and Brexit is scheduled to occur, could be a different matter. But that is next year.

Emerging markets face further pressure before the all-clear

Forced sales and repeated pockets of illiquidity complicate matters for investors

Mohamed El-Erian

Move over Turkey. With a drop of more than 10 per cent last Thursday alone, Argentina displaced Turkey as the worst-performing (relatively widely traded) currency in emerging markets this year — and this for a county that seemingly had done all the right things to counter serious financial tensions.

Unlike Turkey, another EM under the spotlight, Argentina has adhered to the EM playbook for reacting and getting ahead of financial turmoil. But rather than reflect a negation of fundamentals, this highlights how technical and liquidity considerations are driving this market segment — a key issue for investors considering what to do and when.

Earlier this year, Argentina surprised many by announcing it was approaching the IMF to help counter mild pressures on its currency. The government sought to pre-empt further problems by tightening monetary and fiscal policies and securing front-loaded disbursements under a new $50bn programme with the fund.

Adding to the puzzle, last week’s steep drop in the peso came in the context of the central bank hiking interest rates by another 15 percentage points (to an eye-popping 60 per cent). President Macri indicated he was asking the IMF for additional support, and managing director Christine Lagarde signalled receptivity to reworking the programme with Argentina.

The peso, rather than stabilising, extended its losses to more than 50 per cent for the first eight months of 2018, a number approached only by Turkey among the relatively widely traded EM currencies — and a country [Turkey] that has been trying to rewrite the EM crisis management playbook by publicly ruling out the use of higher interest rates and IMF interactions.

This simple compare and contrast points to an important issue for EM investors.

While poor economic fundamentals, such as muted growth and excessive reliance on external debt, have played an important role in revealing vulnerable areas of EM as global financial conditions tightened and the US dollar appreciated, what we are now seeing is overwhelmingly a technical and liquidity phenomenon, including forced sales and repeated pockets of illiquidity.

The big question facing investors — whether they are looking to maintain, increase or reduce exposure — is the extent to which awful technicals and liquidity increases the pain for EM economies and asset prices, thereby sapping investor sentiment further.

You can already see this potential dynamic playing out in Argentina, which also faces an important presidential election next year. The sharp currency drop is aggravating the debt servicing burden for the private and public sector, undermining growth, discouraging new capital inflows and threatening large-scale capital flight. It also pressures domestic banks, further complicating what, for historical reasons, is already a fragile trust relationship with the IMF.

Meanwhile, judging from developments in credit default swaps, the currency disruptions have already translated in an excessive increase in the implied probability of a debt default. With that, last year’s heralded issue of 100-year bonds now trades at less than 70 cents on the dollar.

Given the plunge in asset prices and currencies, there is growing temptation to invest in the sector — and particularly so for diversified “carry trades” that could secure 60 per cent rates in nominal terms in Argentina (or around 30 per cent real rates for domestic investors), together with the potential for a currency rebound. Indeed a small addition of such exposure could turbocharge portfolios already heavily invested in investment grade and high-yield corporate bonds.

In considering such a strategy, investors should be willing to underwrite significant volatility risk associated with two factors.

First, partial market-based indicators suggest that sizeable amounts of “crossover” funds may still be trapped in what constitutes off-benchmark Argentine (and other EM) exposure that is subject to significant mark-to-market losses and higher reputational risk. They will probably take advantage of any favourable development in market liquidity/prices to get out. That means any rallies in prices may be shortlived, keeping several fundamentally driven long-term buyers on the sidelines until this phenomenon abates.

Second, the dismal performance of EM local currency funds (according to Morningstar, the average fund is down some 10 per cent so far this year, with even higher losses for some of the larger ones), will probably result in structural damage to this segment. Investors should expect the unfavourable effects of crossover outflows to be amplified by the exit of more dedicated investors.

These considerations are likely to apply in greater force to Turkey, where fundamentals are more of an issue. It also suggests that other less fragile EMs, such as Indonesia and Mexico, are not yet in the clear. It would not come as a great surprise if they were to experience in the next few months more waves of technical contagion and generalised selling by investors that also challenge the liquidity of their markets.

The good news about technical/liquidity EM disruptions is that, provided the general contamination to economic fundamentals is contained, they tend to fade. They offer investors the opportunity to gain exposure not just to extreme overshoots but also to other fundamentally stronger names selling at bargain-floor prices. But timing is critical, and especially for investors that lack the structural ability to underwrite significant market volatility. The current EM sell-off, while subject to temporary snapbacks, does not appear over yet.

Mohamed El-Erian is chief economic adviser to Allianz and author of the book ‘The Only Game in Town’

The Republic...from 30,000ft

Joel Bowman, writing today from somewhere over America’s Great Midwest…

We’re on the road today, Dear Reader. Or rather, we are in the air… enjoying our morning coffee at 30,000 feet above sea level…en route from Mexico City to Chicago.

To think that, barely a century ago, one would have needed a small fortune and an official title to embark on such a journey. Today, thanks to jet engines and hydrocarbons, it is available to anyone with a last name and a screaming child.

Progress… of a sort. Meanwhile… 
Below us, stretching out toward the bended morning horizon, lays America’s heartland. (That’s “fly-over country” for our coastal readers.)  
The fields are green and yellow. The skies are mostly clear.

What to make of such a serene vista?

The Republic, as we are constantly informed, is lately divided… torn between the Neo-Cons on the right and the Neo-Libs on the left.

Both parties have their stories, of course, their grand narratives and their ready excuses. Both believe themselves to be on the right side of history, too. And both eye the other with a mixture of cautious suspicion and ill-concealed derision.

They are strangers, these two parties, sharing a common land.

And between them, glowing like a rod of radioactive plutonium, stands one man: Donald J. Trump.

To some, the heartland folk, he is the Second Coming. To others, the coastal elites, he is the Devil Incarnate.

To us, he is pure entertainment… a man thrust forth by history to shock and amuse, to play his part in the greatest show of all.

And what a show it is! Hardly a day goes by without some new scandal to ruffle and beguile the masses. Russian probes… trade wars… fake news… secret meetings… public gaffs…

There is nary a newspaper on the shelves or a magazine on the rack that doesn’t mention America’s great political circus and its divisive leading man.

The chattering class has never had it so easy.

But America’s weary electorate needn’t worry too much. For better or worse, Trump too shall pass. And then, what will be left?

A superpower reborn? A republic in ruin?

At 30,000 feet, the answer is as clear as the air is thin. From our window seat we observe neither blue counties nor red districts below. There are no political perforations dotting imagined borders. No gerrymandered bifurcations. No stray donkeys or elephants trampling the cornfields.

Instead, there are small towns and cities, populated by hairdressers and bartenders, lawyers and doctors, schoolteachers and farmers and truck drivers.

There are individuals going about their daily business, in other words, just as they always have. Just as they always will.

In today’s column, below, Bill Bonner takes a closer look at Mr. Trump’s trade war and outlines why he thinks it won’t play out quite as expected. Please enjoy…

Why Trump Won’t Start a Real Trade War

By Bill Bonner, Chairman, Bonner & Partners

Oh boy… the plot thickens.

The New York Times reports:

President Trump escalated his trade war with China on Wednesday, ordering his administration to consider more than doubling proposed tariffs on $200 billion worth of Chinese goods to 25 percent from 10 percent, as talks between Washington and Beijing remain at a standstill.

Mr. Trump instructed the United States trade representative to look into increasing tariffs on Chinese imports like fish, petroleum, chemicals, handbags, and other goods to 25 percent, a significant escalation in a dispute that is beginning to take a toll on industries and consumers in both countries. A final decision on the size and scope of the tariffs is not expected before September.

Fake Wars

The Deep State welcomes war. But, especially in the case of a trade war with China, it must be a phony war.

And here is a good test. We’ll see how well, or badly, we have connected the dots.

According to the picture we see, the Deep State – the more or less permanent, but fluid and schismatic, group of insiders that controls U.S. public policies – uses war to gain public support for policies that actually serve only one purpose… to shift power, wealth, and status from the public to itself.

That’s why the trade war has to be fake. Real wars threaten the Deep State’s survival.

The wars in the Middle East (now also in Africa), for example, help justify trillions of dollars of wealth transfers to the military/industrial/surveillance complex. But the U.S. has nothing really at stake in these fights; no matter what happens, it will not be invaded, bombed, or humiliated.

Likewise, the wars at home – against poor people and drug users – go on for decades. And no one is better off – except the Deep State industries engaged in the wars themselves (welfare agencies, prisons, police, drug pushers, etc.).

The Donald’s new trade war is a delight, too; already, the sidewalks are slick with greasy swamp water; lobbyists line up around the block to ask for special favors and dispensations. The insiders gain power and money by controlling crony trade deals.

But neither the president nor his crackpot advisors may realize the danger. And here is where it gets interesting: They mustn’t allow this war to get out of hand.

Where the Elite Get Money

A real trade war with China would be disastrous – for the Deep State itself. That’s why we predict it won’t happen. The 25% tariffs will more than likely never be fully implemented.

Mr. Trump will follow a pattern that is already familiar. He will talk tough. He will stir things up. He will announce victory. And he will quietly back down.

Or else he will not survive as president to the end of his term.

The world now has nearly $250 trillion of debt. Typically, an economy can comfortably carry about 1.5 times as much debt as it has output (GDP).

Global GDP is estimated to be about $90 trillion. That means anything above $135 trillion of world debt is excess, made possible only by the manipulation of the credit system by central banks that have added some $18 trillion to the world’s monetary foundation since 1997.

Total world debt was about $40 trillion back in the late 1990s. Now, it is more than six times as much. World output was only about $27 trillion two decades ago. It has grown, too, but at $90 trillion today, only half as fast.

Main Street is where ordinary people work. They get their incomes and living standards from GDP. As it grows, they grow.

But Wall Street is where the credit flows… and where the elite get their money – from rising asset prices.

This method is proven to find extraordinary investment opportunities – no matter whether stocks are going up, down or sideways.

Super investor Warren Buffett famously gauges the stock market by comparing Wall Street to Main Street – stock market capitalization to GDP. The stock market value should be about even with annual GDP, he says.

An increase in credit heats up stock prices but leaves Main Street GDP cold. During the dot-com bubble, for example, stocks rose to 145% of GDP – indicating an oversold market ready for a correction.

And now, according to some calculation, the ratio is even more out of whack, with stocks at 149% of GDP.

Out of Balance

Bonds and real estate are similarly overpriced. Wall Street and Main Street have never before been so out of balance. The rich have never been richer, compared to the average guy.

According to classic theory, increasing the supply of money faster than the supply of goods (GDP) causes prices to go up.

Consumer prices did rise in recent years… but not nearly as much as the explosion of the base money supply would imply. Why not?

The answer is in China… where dirt-cheap labor and an export-led economy met America’s fake-money regime.

In effect, the U.S. exported its inflation… It exchanged its major export item – dollars – for cheap Chinese-made goods.

This kept U.S. consumer prices from rising and prevented the working stiffs from noticing that they were getting ripped off.

By contrast, prices rose sharply for things the Chinese couldn’t export – medical care and college educations, for example.

But that’s not the last dot. We need to look at what happened to the dollars sent to China.

They left the country as consumer spending. But they didn’t stay abroad for long. Chinese merchants deposited them at the Bank of China, which used them to buy U.S. bonds.

They went out from the pockets of Main Street households, in other words, and came back into the pockets of Wall Street investors in the form of higher asset prices.

Fake-Money System

And there you have the gist of the whole world economic boom of the last 30 years: Big increases in the money supply, with low consumer prices and low interest rates. The China trade was an essential part of the whole fake-money flimflam.

Fake money was created by central banks… and flowed into the pockets of the elite, where it could be converted to real wealth. (Some reports show the top 10% of families making 100% of the wealth gains in the entire 21st century.)

Meanwhile, the masses were kept quiet with cheap consumer items from China (available from Walmart or Amazon), along with mindless distractions like YouTube and Facebook.

But imagine a real trade war… No more “everyday low prices” at Walmart. Inflation would spike up. And no more low interest rates, either.

China – either by necessity or revenge – would dump its $1.2 trillion worth of U.S. bonds. Bond prices would crash as a massive supply came to the market. Bond yields would soar, forcing stocks down, too.

Commodity prices would collapse. And most of the world would enter a depression – including the U.S.

And which group would lose most? Those with the most to lose, of course – the rich… the well-connected… and the Deep State insiders.

Last week, we noted that economist Martin Feldstein’s estimate that $9 trillion will be lost in the U.S. stock market when prices revert to the mean. But that is just the beginning.

At least that much… and more… would be lost in bonds and real estate, too, in the U.S. alone.

When this picture becomes clear to Mr. Donald J. Trump… our prediction is that he will turn his attention elsewhere.

miércoles, septiembre 05, 2018



Israel Deprives Iran of a Proxy

Israel can no longer afford to have Hamas in the south capable of creating a second front.

By Jacob L. Shapiro

For more than a decade, Iran’s primary tactic for pursuing power in the Middle East has been to empower proxy groups. Most of these proxies have shared a religious or ideological affinity with the Islamic Republic. In Iraq, Arab Shiite factions that believe faith runs thicker than ethnicity have cozied up to Iran. The same is true for Hezbollah and its members in Lebanon. The Assad clan, still in charge of most of Syria, is Alawite – a Shiite offshoot in a sea of Sunnis.

But one of Iran’s proxies has always been a little different: Hamas. Hamas is a Sunni organization, an outgrowth of the Muslim Brotherhood. It is also a thorn in Israel’s side, and that has been enough of a reason for Iran to look past doctrinal disagreements and send Hamas money and weapons. That will soon change.

Israel has sought to neutralize the threat posed by Hamas since the day Israel unilaterally disengaged from the Gaza Strip in 2005. “Disengagement” was supposed to be the first step in a broader plan to pull Israel back to more defensible borders. But in 2006, the plan’s most important supporter, then-Prime Minister Ariel Sharon, was felled by a stroke, and no Israeli politician after him could summon the gravitas to push through the unpopular next steps in the West Bank. Partly that was because of the unimpeachable security credentials of Sharon, a former general. But it was also because soon after Israel disengaged from Gaza, Hamas took over and began attacking Israel with rockets and cross-border raids.

In the years since, Israel has tried several approaches to limit Hamas’ capability to attack it. It fought three wars with Hamas in Gaza – every time the group got too powerful, Israel intervened. It invested heavily in missile-defense technology, like Iron Dome and David’s Sling. It leaned on Egypt to put pressure on Hamas, even approving large Egyptian military deployments in the Sinai Peninsula so that Egypt might help crack down on weapons smuggling into and out of the Gaza Strip. And in recent years, Israel has even had quiet, unofficial contacts with Saudi Arabia and other Gulf Arab states, all of which (except Qatar) see Iran as an enemy and therefore are willing to work with Israel to curtail Iranian influence in Gaza.

Were it not for Iran’s deployment of Islamic Revolutionary Guard Corps soldiers and advanced weaponry in Syria to defend the Assad regime, this state of affairs might have continued indefinitely. The occasional outburst from Hamas was manageable when the threats on Israel’s borders were dormant. But the turning of the tide in the Syrian civil war in 2015 changed matters for Israel, and the threat to the north is no longer dormant. Hezbollah, which was greatly weakened by its participation in the Syrian war, is now pulling back and trying to recuperate. Iranian military bases, soldiers and weapons are now present throughout Syria – and are especially prevalent on the Israel-Syria border.

Given this state of affairs to the north, Israel can no longer afford to have an Iranian proxy in the south capable of creating a second front. Rather than invade Gaza, however, Israel is attempting to quarantine the problem. Israel has discussed building an advanced border wall around Gaza since 2014. In October, Israel stopped talking and started digging, approving the use of around $800 million to construct a new barrier around Gaza. At the time, estimates suggested it would take two years for Israel to complete. In January, however, Israel announced it was accelerating construction with an eye toward completion by the end of the year.

The new barrier also extends deep into the ground to neutralize attack tunnels that Hamas has dug under both the Israeli and Egyptian borders. In addition, Israel is building a maritime obstacle between itself and Gaza, all while installing new sensitive detection systems, investing in naval capabilities and training Israeli military forces to prevent both infiltration into Israel and smuggling into Gaza by land and sea. Israel’s goal is not simply to make it harder for weapons and money to reach Gaza – it wants to cut off the supply entirely. In the past, Israel has knocked out Hamas rockets and missiles, only for Hamas to find ways to resupply itself. The next time Israel intervenes in Gaza, it aims to make it the last.

In effect, the walls are closing in on Hamas. The Gaza Strip borders two states – Israel and Egypt – and both distrust Hamas, and Iran even more. (Egypt, which is dependent on Saudi Arabia for its economic livelihood, has subordinated much of its policy on Iran to Riyadh’s desires.) This is why Hamas, via the United Nations, Egypt and Qatar, has been loudly trumpeting that it is interested in a long-term cease-fire with Israel. Hamas realized that if Israel can complete its various obstacles and make Iranian support for Hamas rhetorical, it will be only a matter of time before Hamas is destroyed – either by Israeli intervention or Gazan popular revolt against worsening conditions and tactical impotence against the enemy Hamas is sworn to defeat. Hamas can no longer afford to be an Iranian proxy if it wants to survive.

Hamas officials claimed on Aug. 3 that they had accepted a long-term truce with Israel. Details remain hazy, but most reports suggest that they involve easing restrictions on goods in and out of Gaza, reconciliation between Fatah and Hamas, a surrendering of Hamas’ weapons and a prisoner exchange. Israel has not confirmed that an agreement was reached, though Prime Minister Benjamin Netanyahu canceled a trip to South America scheduled for Aug. 6-9 to convene his security Cabinet and discuss possible new developments. The Jerusalem Post and other Israeli newspapers reported on Aug. 4 that Hamas and Israel were close to an agreement on a long-term truce. It seemed as if Israel might be on the verge of neutralizing Hamas without firing a shot.

But progress hit a roadblock on Aug. 7, when Israeli forces shelled a Hamas position and killed two Hamas fighters. The Israel Defense Forces said Israeli tanks mistook a Hamas naval exercise for an attack against Israel. The exercise was intended to show off Hamas’ military forces to a visiting delegation of Lebanon-based Hamas political leaders who had traveled to Gaza specifically to discuss the truce with local leaders. An Al-Monitor report said even Egypt had assured the Hamas leaders that Israel would not try to assassinate them during the visit as they tried to sell the truce to officials in Gaza. Hamas retaliated by firing almost 200 rockets at Israeli targets on Aug. 8, and Israel responded in kind with airstrikes on key Hamas positions throughout the Gaza Strip.

Hamas declared a unilateral cease-fire, effective Aug. 10, while U.N. officials traveled to the region over the weekend attempting to put the broader truce back together. Israel, however, maintains it has not agreed to any cease-fires – not to the current round of hostilities or to the longer-term deal that has been in the works for months. Netanyahu convened his security Cabinet again on Sunday, and before the meeting, he told the media that Israel was now in the midst of a wider campaign against Hamas in Gaza. As for a cease-fire, Netanyahu said Israel had one demand – a complete cease-fire – and that as long as Israeli demands were unmet, Israel would continue its operational preparations for an extended campaign.

Israel has not called up any reserves, nor does it appear Israel is preparing to go in on the ground despite the harsh rhetoric coming out of the security Cabinet. Even so, Israel is indeed engaged in a wider campaign against Hamas. Israel can no longer tolerate an Iranian proxy on its southern border. Whether by blockade, diplomacy, invasion or some combination, Israel aims to cripple Hamas and any other potential threat emanating from the Gaza Strip as quickly as possible so it can focus on the emerging threat to the north. As for Hamas, it is out of options. The harder it gets for Hamas to receive weapons and money from Iran, the more Hamas is forced to seek a face-saving compromise with Egypt and Israel. Israel may be willing to let Hamas save face, but it can’t let Hamas save its missiles. Either way, Hamas’ days as a credible Iranian proxy group are numbered.