Debt Alarm Ringing

By John Mauldin


Is debt good or bad? The answer is “Yes.”

Debt is future spending pulled forward in time. It lets you buy something now for which you otherwise don’t have cash available yet. Whether it’s wise or not depends on what you buy. Debt to educate yourself so you can get a better job may be a good idea. Borrowing money to finance your vacation? Probably not.

Unfortunately, many people, businesses, and governments borrow because they can, which for many is possible only because central banks made it so cheap in the last decade. It was rational in that respect but is growing less so as the central banks tighten their policies.

Earlier this year, I wrote a series of articles (synopsis and links here) predicting a debt “train wreck” and eventual liquidation—an event I dubbed The Great Reset. I estimated we have another year or two before the crisis becomes evident.

That’s still my expectation… but I’m beginning to wonder again. Several recent events tell me the reckoning could be closer than I thought just a few months ago. Today, we’ll review those and end with a few suggestions on how to prepare.

Addicted to Debt

As noted, debt can be appropriate—even government debt, in some (rare) circumstances. I am glad FDR issued war bonds to help defeat the Nazis, for instance. Now, however, governments go into debt not because they face existential threats, but simply to keep their citizens and benefactors comfortable.

Similarly, central banks enable debt because they think it will generate economic growth. Sometimes it does, too. The problem is they create debt with little regard for how it will be used. That’s how we get artificial booms and subsequent busts.

We are told not to worry about absolute debt levels so long as the economy is growing in concert with them. That makes sense. A country with a larger GDP can carry more debt. But that is increasingly not what is happening. Let me give you two data points.

Lacy Hunt tracks Bank for International Settlements data that shows debt is losing its ability to stimulate growth. In 2017, one dollar of non-financial debt generated only 40 cents of GDP in the US and even less elsewhere. This is down from (if memory serves) more than four dollars of growth for each dollar of debt 50 years ago.

This has significantly worsened over the last decade. China’s debt productivity dropped 42.9% between 2007 and 2017. That was the worst among major economies, but others lost ground, too. All the developed world is pushing on the same string and hoping for results like we saw 40–50 years ago. As my friend Rob Arnott constantly reminds me, hope is not a strategy.

Now, if you are accustomed to using debt to stimulate growth, and debt loses its capacity to do so, what happens next? You guessed it: The brilliant powers-that-be add even more debt. This is classic addiction behavior. You have to keep raising the dose to get the same high.

At this point, Paul Krugman and others usually call me a debt curmudgeon and argue the debt doesn’t matter. I point them to Ken Rogoff and Carmen Reinhart’s book from 10 years ago, This Time Is Different, which demonstrates that in every prior debt run-up, over centuries of history, accumulated debt clearly eventually made a difference. There is always an eventual Day of Reckoning.

The US economy is so huge and powerful that our current $24.5 trillion government debt (including state and local) could quite easily grow to $40 trillion before we meet that day. We are one recession away from having a $30 trillion US government debt total. It will happen seemingly overnight. And deficits will stay well above $1 trillion per year every year after that, not unlike now.

Some argue the US has almost $150 trillion of personal and corporate assets to offset that debt. That is true enough, but I think there might be some slight resistance if the government demanded 15% of your total assets, including your house, real estate, investment assets, furniture and goods, to pay off the debt. That would be in addition to your regular taxes, and then they begin accumulating more debt.

Even though you are reading about a budget deficit of under $800 billion this year, the actual amount of debt added last year was well over $1 trillion. That is due to “off budget” items that Congress, in its wisdom, thinks shouldn’t be part of the normal budgetary process. It includes things like Social Security and Medicare—which vary from time to time and year to year—and can be anywhere from $200 billion to almost $500 billion.

And here’s the point that you need to understand. The US Treasury borrows those dollars and it goes on the total debt taxpayers owe. The true deficit that adds to the debt is actually much higher than the number you see in the news. It brings to mind the scene in the Wizard of Oz, when they wizard says, “Pay no attention to the man behind the screen.”

Household and corporate debt is growing fast, too, and not just in the US.
Here’s a note from Lakshman Achuthan.

Notably, the combined debt of the US, Eurozone, Japan, and China has increased more than ten times as much as their combined GDP [growth] over the past year.

Yes, you read that right. In the last year, the world’s largest economies are generating debt 10X faster than economic growth. Adding debt at that pace, if it continues, will boost the debt-to-GDP ratio at an alarming rate.

Lakshman continues.

Remarkably, then, the global economy—slowing in sync despite soaring debt—finds itself in a situation reminiscent of the Red Queen Effect we referenced 15 years ago, when tax cuts boosted the US budget deficit much more than GDP. As the Red Queen says to Alice in Lewis Carroll's Through the Looking Glass, “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”

I am trying to imagine a scenario in which this ends in something less than chaos and crisis. The best I can conceive is a decade-long (and possibly more) stagnation while the debt gets liquidated. But realistically, that won’t happen because debtors won’t let it, and they outnumber lenders. Hence, something like the Great Reset will happen first.

The rational course would be to delay the inevitable as long as possible. Yet in the US, at least, we’re hastening it.

Lost Exorbitant Privilege

This month, the US Treasury closed the books on Fiscal Year 2018. It was a success in the sense that the government is still open and doing the things it should. Financially speaking, it was another debt-financed failure.

Source: US Treasury

The federal government spent approximately $4.1 trillion in FY 2018, of which it had to borrow $779 billion on budget and a few hundred billion more off-budget (amount TBD). And over 40% of the on-budget deficit went simply to pay $325 billion in interest on previously-issued debt.

Obviously, the government should spend less. But where to cut? There is no political agreement on that and little prospect of one. Nor, barring an economic boom of a magnitude and duration I think unlikely, are we going to grow out of this. So, I expect continued and even bigger deficits.

Deficits mean the Treasury has to borrow cash, which it does by selling Treasury bills, notes, and bonds. This wasn’t a problem for most of the last decade but is rapidly becoming one as the amounts grow larger.

Thanks to the “exorbitant privilege” I discussed earlier this month, the US has long had many foreigners willing to buy our debt. Now they are losing interest (forgive the pun) because hedging their currency exposure costs more. There are some complex reasons behind this, relating to swaps and the differentials between the US economy and others, but here’s the bottom line: European and Japanese investors can no longer buy US Treasury debt at a positive rate of return unless they want to take currency risk, which most do not. This is a new development.

This might be fine if US investors made up the difference, but that’s not happening, either, and might not be great anyway. Capital that goes into Treasury debt is capital that’s not going into bank loans, corporate bonds, mortgages, venture capital, stocks, or anything else in the private sector, which generates the growth we’ll need to pay off the government’s debt.

Treasury auction data shows it is getting harder to attract buyers. According to Bloomberg, last month’s two-year note auction matched the lowest bid-to-cover ratio for that maturity since December 2008.

Source: Bloomberg

The problem is manageable for now, and Treasury will always be able to borrow at some price… but the price could get awkwardly high, with interest costs rising dramatically.

Given the debt’s maturity structure, it could be sooner than you might think. Treasury took advantage of lower short-term rates in recent years, which reduced interest costs, but also created refinancing risk. Here’s a Torsten Slok chart (via my friend Luke Gromen on Twitter).

Source: Luke Gromen

Looking only at federal debt not held by the Federal Reserve, Treasury will need to borrow something like 43% of GDP over the next five years just to rollover existing debt at much higher interest rates. That’s not counting any new debt we accumulate, which could be quite a lot if we enter recession or (God forbid) another war.

But set aside the hypothetical possibilities. Just the things we know are already locked in, like Social Security and Medicare, are enough to blow up the debt. Somebody has to buy all that Treasury paper. If it’s not foreigners, and not the Fed, and not American savers, we are out of prospects.

Now, buyers will appear at the right price, i.e. some higher interest rate. Barring recession-induced lower rates (which would be a different problem), government borrowing could get way more expensive.

Which is more likely: a double-digit ten-year Treasury yield or a worldwide debt liquidation? Neither will be fun. But I’ll bet that we see one or the other at some point in the 2020s.

My renewed fear comes from the very real possibility the global economy breaks down in the next six months. Anything could trigger a crisis, and it could well be something no one presently foresees, but here are three candidates.

Corporate Credit Crisis: As a whole, US companies are significantly more leveraged now than they were ahead of the 2008 crisis. We saw then what happens when the commercial paper market seizes up, and that was without a Fed in tightening mode. Now we have a central bank both raising short-term rates and slowly ending its crisis-era accommodations. Recent comments from FOMC members say they have no intent of stopping, either. A few high-profile junk bond defaults could ignite fears quickly.

There are trillions of dollars of low-rated corporate debt that can easily slide into the junk debt category in a recession. Since most public pension, insurance, and endowment programs are not legally allowed to own junk-rated debt, I can see where it could easily cause a debt crisis along the lines of the previous subprime crisis.

Trade war: One reason the US economy seems to be booming right now is a surge in imports. Companies are rushing to build inventory ahead of the 25% tariff on Chinese goods that takes effect January 1. Coming on top of usual holiday season stockpiling, it is jamming ports, highways, and warehouses—generating many jobs in the process.

That’s all good right now, but those truck drivers and warehouse workers will no longer be necessary once the shelves are stocked. Working down that inventory will take months, at least, and the resulting slowdown could ease the economy into recession next year.

We might avert that outcome if the US and China reach some trade resolution, but that doesn’t appear likely. The latest reports say the Trump administration is digging in for a long siege and, if anything, may get even more aggressive against China. Nor does China seem likely to bend.

You may have heard the tennis term, “unforced errors.” Those are mistakes of your own,  not a result of your opponent’s good shots. I think the tariffs may be an unforced error in US economic policy that could cause a serious growth decline, or worse.

European Slowdown: This week, we got October PMI reports from Markit. Its eurozone manufacturing and services index dropped to the lowest point since September 2016, with export-dependent Germany particularly weak. Meanwhile, Italy’s new budget is wildly out of line with its revenue and growth prospects. This threatens to set off another euro crisis. And then there’s the serious possibility of a hard Brexit in early 2019.

In short, Europe (at least some of it) is in real danger of entering recession next year. If that happens, the impact will spread around the globe as the continent reduces imports from the US, China, and elsewhere. Not to mention the potential fireworks if Italy or anyone else actually defaults on debt payments to foreign lenders, i.e. German, French, and other European banks with minimal loss reserves.

If the European Central Bank won’t buy Italian bonds, and the Italians won’t do it themselves, then Italian interest rates could jump dramatically, precipitating a crisis. This is essentially what forced the ECB into its first quantitative easing program. In theory, the Italians were then in compliance. That is not the case today. I have been pointing my finger at Italy for years. It is the linchpin in the whole euro experiment on debt and solidarity.

I could go on, but you get the point. The US economy looks fine just ahead, but problems lurk over the horizon. Bad things could happen soon.

So, what do you do? I have three suggestions.

1.   Build a cash reserve: I know every financial advisor says that, but disturbingly few people actually do it. Have several months of living expenses readily available in risk-free cash equivalents. Cash is also an option on buying discounted assets at lower prices in the future.

2.   Deleverage: If you carry business or personal debt, reduce it as much as you can and don’t assume you will be able to refinance. Banks can cut your credit lines in a heartbeat, and they will.

3.   Have a plan for your longer-term investments, whether they are stocks, real estate, or anything else. Decide now what you will sell, and to whom, because buyers may not be there when you need them. At the same time, decide what you plan to hold through any slowdown. I have assets in private companies and even a few public ones that I truly consider “for the long term.”

I sincerely hope I’m wrong. Maybe I’m jumping the gun here and 2019 will be another banner year. But I see major risks ahead, and I want you to be ready for them.

Frankfurt, Cleveland, Golf, and Here and There

I find myself today looking over a golf course in Puerto Rico. The weather is perfect, which is a far cry from what we left in Texas yesterday. Late next week, I catch a plane to Frankfurt where I will speak to a large group of institutional investors at the Lupus Alpha Investment Conference. I am really looking forward to this conference, as I will meet a few people I have always wanted to and hopefully learn more about what is going on in Germany and Europe. I have two brand-new presentations for them with the appropriate trigger warnings. While my host tells me that they don’t want me to pull any punches, I am not sure the audience is going to be happy with the message.

As if I needed more to do, I actually had myself fitted for golf clubs last Saturday. It was a 3½ hour process, and I was amazed at the technology available now. It’s been 20 years since someone stole my last golf clubs right out of my garage. I took it as a sign that God wanted me to quit. And while I’ve played a few times with rented clubs, I have resisted actually buying any.

I had a righteous 29 handicap back when I played regularly. I imagine my legitimate handicap for the next year will be close to 40, so none of you will really want to play with me. But then again, I’ve noticed that when I do play, I am looser for the next few days. I think, combined with my workout routine, this will keep me much healthier in the long run.

And with that, I will hit the send button. Have a great week and hit ‘em straight!

Your going to enjoy a few warm days analyst,
John Mauldin
Chairman, Mauldin Economics

How saving the liberal world order became harder

Political extremism is only one response to failing economic systems

Wolfgang Münchau

© Yorgos Karahalis/Bloomberg

You hear it all the time: we need to defend our liberal, multilateral economic order. If you want to get a roomful of people in places like Davos to keep nodding their heads to exhaustion, this is what you say.

I disagree vehemently with that statement. I believe that we are facing a fundamental choice between solving the problem and solving the crime — between addressing the issues or playing a blame game. The G20 Eminent Persons Group on Global Financial Governance argues that our multilateral institutions need repair. This is no doubt true but I would go further than proposed suggestions for greater efficiency and more inclusiveness.

Politicians like Donald Trump, Viktor Orban and Matteo Salvini have risen to power because of the deep malfunctioning of our systems of global capitalism. Brexit is not the result of Russian meddling or an alleged reporting bias of the BBC, but of a long series of unresolved political conflicts and the rentier business model the UK chose to pursue inside Europe’s single market. The global financial crisis and our policy responses exposed how the system had become unsustainable.

The eurozone is a perfect example of a liberal system that has become complacent and unstable: since it was plunged into crisis, European authorities have made persistent attempts to paper over the cracks. Contrary to the advice of the IMF, the EU keeps pretending that Greek debt is sustainable, and bases its judgment on growth forecasts that are plainly ludicrous. EU member states do not address the issue because they do not wish to recognise losses in their bilateral loans.

The political shocks in Italy stem from a dysfunctional monetary union andan unsustainable immigration regime. I fail to see how Italy and Germany can remain locked in the same monetary system unless we have reforms that both countries reject, whether it is a political union or a single safe asset, or reforms to align economic and judicial systems.

The EU’s legendary tendency to kick the can down the road has left us with a situation in which it makes no sense to talk about the eurozone crisis in the past tense. Greek and Italian debt are less sustainable today than they were in 2010 when the crisis began, and Germany is less willing to support the eurozone today.

Ideally we would fix the system. But instead we are procrastinating and hoping that something comes up. Emmanuel Macron, the French president, had ideas of how to reform the eurozone, but his proposals have deflated to almost nothing. The chance to reform came and went.

As in the early 1930s, libertarian economic systems were self-destructing because of their inbuilt tendency to produce financial and social instability. We are doing better than we did 90 years ago at stabilising gross domestic product. But the observation that many advanced countries have had more or less robust GDP growth and low unemployment misjudges the underlying political dynamic, which is much more influenced by variables such as income inequality, lack of housing and fears of job insecurity among the middle-classes.

Another parallel with the 1930s has been a tendency for the stalwarts of the liberal order to double down — through pro-cyclical austerity, bonus payments for bankers, a monetary policy that drives up asset prices or through free trade agreements that limit the independence of national courts — on harmful policies.

The tell-tale signs of the demise of liberal democracy have been visible long before the more recent electoral upsets. You know you are in trouble when you cannot impose a financial transaction tax because your banks threaten to shift their transactions to a tax haven. Or when countries cannot increase corporation tax for the same reason. Or when large car and chemical manufacturers can engage in persistent criminal behaviour and get away with it. What corrupts liberal systems is a breakdown of checks and balances in our economic life.

But political extremism is only one response to failing liberal systems. You may dismiss cryptocurrencies as just another bubble. But I would not bet my hard-earned bitcoins on our ability to preserve the money-issuing monopoly of the state indefinitely. As the aftermath of the financial crisis demonstrated, that monopoly is critical for liberal financial systems to secure basic macroeconomic stability. It is the one and only policy instrument we have that arguably still works. Saving the liberal world order will become progressively harder the weaker that instrument becomes.

If you really care about the liberal multilateral order, free trade and the EU, the least helpful thing you can do is to defend the status quo and hyperventilate about populists. Our problem is not the other team, but our team.

The Big Blockchain Lie

Nouriel Roubini  

bitcoin value declines

NEW YORK – With the value of Bitcoin having fallen by around 70% since its peak late last year, the mother of all bubbles has now gone bust. More generally, cryptocurrencies have entered a not-so-cryptic apocalypse. The value of leading coins such as Ether, EOS, Litecoin, and XRP have all fallen by over 80%, thousands of other digital currencies have plummeted by 90-99%, and the rest have been exposed as outright frauds. No one should be surprised by this: four out of five initial coin offerings (ICOs) were scams to begin with.

Faced with the public spectacle of a market bloodbath, boosters have fled to the last refuge of the crypto scoundrel: a defense of “blockchain,” the distributed-ledger software underpinning all cryptocurrencies. Blockchain has been heralded as a potential panacea for everything from poverty and famine to cancer. In fact, it is the most overhyped – and least useful – technology in human history.

In practice, blockchain is nothing more than a glorified spreadsheet. But it has also become the byword for a libertarian ideology that treats all governments, central banks, traditional financial institutions, and real-world currencies as evil concentrations of power that must be destroyed. Blockchain fundamentalists’ ideal world is one in which all economic activity and human interactions are subject to anarchist or libertarian decentralization. They would like the entirety of social and political life to end up on public ledgers that are supposedly “permissionless” (accessible to everyone) and “trustless” (not reliant on a credible intermediary such as a bank).

Yet far from ushering in a utopia, blockchain has given rise to a familiar form of economic hell.

A few self-serving white men (there are hardly any women or minorities in the blockchain universe) pretending to be messiahs for the world’s impoverished, marginalized, and unbanked masses claim to have created billions of dollars of wealth out of nothing. But one need only consider the massive centralization of power among cryptocurrency “miners,” exchanges, developers, and wealth holders to see that blockchain is not about decentralization and democracy; it is about greed.

For example, a small group of companies – mostly located in such bastions of democracy as Russia, Georgia, and China – control between two-thirds and three-quarters of all crypto-mining activity, and all routinely jack up transaction costs to increase their fat profit margins. Apparently, blockchain fanatics would have us put our faith in an anonymous cartel subject to no rule of law, rather than trust central banks and regulated financial intermediaries.

A similar pattern has emerged in cryptocurrency trading. Fully 99% of all transactions occur on centralized exchanges that are hacked on a regular basis. And, unlike with real money, once your crypto wealth is hacked, it is gone forever.

Moreover, the centralization of crypto development – for example, fundamentalists have named Ethereum creator Vitalik Buterin a “benevolent dictator for life” – already has given lie to the claim that “code is law,” as if the software underpinning blockchain applications is immutable.

The truth is that the developers have absolute power to act as judge and jury. When something goes wrong in one of their buggy “smart” pseudo-contracts and massive hacking occurs, they simply change the code and “fork” a failing coin into another one by arbitrary fiat, revealing the entire “trustless” enterprise to have been untrustworthy from the start.

Lastly, wealth in the crypto universe is even more concentrated than it is in North Korea. Whereas a Gini coefficient of 1.0 means that a single person controls 100% of a country’s income/wealth, North Korea scores 0.86, the rather unequal United States scores 0.41, and Bitcoin scores an astonishing 0.88.

As should be clear, the claim of “decentralization” is a myth propagated by the pseudo-billionaires who control this pseudo-industry. Now that the retail investors who were suckered into the crypto market have all lost their shirts, the snake-oil salesmen who remain are sitting on piles of fake wealth that will immediately disappear if they try to liquidate their “assets.”

As for blockchain itself, there is no institution under the sun – bank, corporation, non-governmental organization, or government agency – that would put its balance sheet or register of transactions, trades, and interactions with clients and suppliers on public decentralized peer-to-peer permissionless ledgers. There is no good reason why such proprietary and highly valuable information should be recorded publicly.

Moreover, in cases where distributed-ledger technologies – so-called enterprise DLT – are actually being used, they have nothing to do with blockchain. They are private, centralized, and recorded on just a few controlled ledgers. They require permission for access, which is granted to qualified individuals. And, perhaps most important, they are based on trusted authorities that have established their credibility over time. All of which is to say, these are “blockchains” in name only.

It is telling that all “decentralized” blockchains end up being centralized, permissioned databases when they are actually put into use. As such, blockchain has not even improved upon the standard electronic spreadsheet, which was invented in 1979.

No serious institution would ever allow its transactions to be verified by an anonymous cartel operating from the shadows of the world’s authoritarian kleptocracies. So it is no surprise that whenever “blockchain” has been piloted in a traditional setting, it has either been thrown in the trash bin or turned into a private permissioned database that is nothing more than an Excel spreadsheet or a database with a misleading name.

Nouriel Roubini, a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates, was Senior Economist for International Affairs in the White House's Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.


When does the case for long-term investment make sense?

Paul Samuelson showed why time horizons matter less than commonly thought

ONE LUNCHTIME around 1960 a professor proposed a wager to a colleague. Flip a coin and call “heads” or “tails”. If you call right, you win $200. If you call wrong, you pay $100. This is a favourable bet for anyone who would take it. Even so, his colleague refused. He would feel the loss of $100 more than the gain of $200. But he would be happy, he said, to take 100 such bets.

The professor who offered the bet, Paul Samuelson, understood why it might be refused. A person’s capacity for risk could no more be changed than his nose, he once said. But he was irked by his colleague’s willingness to take 100 such wagers. Yes, the likelihood of losing money after that many tosses of the coin is vanishingly small. But someone who takes very many bets is also exposed to a small chance of far bigger loss. A lot of bets, reasoned Samuelson, were no safer than a single bet.

This lunchtime wager was of more than academic interest. It drew the battle lines in a debate on the merits of long-termism. Samuelson challenged the conventional wisdom that his colleague embodied. In later work, he used the bet as a parable. He showed that, under certain conditions, investors should keep the same fraction of their portfolios in risky stocks whether they are investing for one month or a hundred months. But what Samuelson’s logic assumed does not always hold. There are cases where a long-term horizon works in investors’ favour.

To understand the debate, start with the law of large numbers. It means that the more often a favourable gamble is repeated, the more likely it is that the person who takes it comes out ahead. Though a casino may lose on a single spin of the roulette wheel, over a large number of spins its profits are determined by the slight advantage in odds (the “house edge”) it enjoys. But a casino that would take a hundred $100 bets would not refuse a single bet of the same size.

That was part of Samuelson’s beef. If his colleague dislikes a single bet, after 99 bets he should refuse the 100th. By this logic he should also refuse the 99th bet, after 98 bets. And so on until all bets are spurned.

Clouds on the horizon

Only a naive reading of the law of large numbers would support a belief that risk is diminished by more bets, said Samuelson. The scale of potential losses rises with the number of bets. “If it hurts much to lose $100,” he wrote, “it must certainly hurt to lose 100 x $100.” Similarly, it is foolish to believe that by holding stocks for the long haul—taking multiple bets on them—you are sure to come out ahead. It is true that stocks have usually yielded higher returns than bonds or cash over a long period. But there is no guarantee they will always do so. Indeed if stock prices follow a “random walk” (ie, an erratic and unpredictable path), long-term investing holds no advantage, said Samuelson.

This logic begins to fray if you relax the random-walk assumption. Stock prices appear to fluctuate around a discernible trend; they have a tendency, albeit weak, to revert to that trend over very long horizons. That means stocks are somewhat predictable. If they go up a long way, given enough time they are likely to fall, and vice versa. In that case, more nervous sorts of investors are able to bear a higher exposure to stocks in the long run than they would be able to in the short run.

Samuelson’s reasoning also assumes that people’s taste for risk does not vary with how rich or poor they are. In reality, attitudes change when a target level of wealth is within reach (say, to pay for retirement or a child’s education) or when outright poverty looms. When such extremes are far off, it is rational to take on more risk than when they are close. The calculus also changes with a broader reckoning of wealth. Young people, with decades of work ahead, hold most of their wealth in “human capital”, their skills and abilities. This sort of wealth is a hedge against riskier kinds of financial wealth. Indeed the more stable a person’s career earnings are, the greater the hedge. It follows that young people should hold more of their wealth in risky stocks than people who are close to retirement.

Samuelson vigorously disputed the dogma of long-termism, which says that the riskiness of stocks diminishes as time passes. It doesn’t. That is why long-dated options to insure against falling stocks are dearer than short-dated ones. The odds of winning favour risk-takers over time. But they are exposed to big losses in the times when they lose. Still, it would also be dogmatic to say that time horizon does not matter. It does—in some circumstances. What Samuelson showed is that it matters less than commonly thought.

In Yemen, Cracks in the Saudi Alliance Begin to Show

The UAE doesn’t need a unified Yemen to secure its interests, but Saudi Arabia does.

By Xander Snyder


If or when Yemen’s civil war draws to a close, another one may well be waiting. Saudi Arabia and the United Arab Emirates have different end games in mind, despite fighting in the same coalition against the Iranian-sponsored Houthis. In fact, their shared interest in Yemen begins and ends with eliminating, or at least curbing, Iran’s influence on the Arabian Peninsula. Their diverging needs already have led to clashes between Emirati- and Saudi-backed forces in Yemen.

In January, for example, a fight broke out between members of the Southern Transitional Council, a secessionist group supported by the UAE, and forces loyal to President Abed Rabbo Mansour Hadi, head of Yemen’s internationally recognized – and Saudi-approved – government. And on Oct. 3, the STC took aim at the exiled president once again, calling for an uprising against his government. The latest incident highlighted the cracks in the Saudi-UAE alliance, which will probably only grow as the Yemeni conflict continues.
Different Goals
Understanding why the STC and government forces are beginning to turn on each other after fighting on the same side of the civil war requires an understanding of their patrons’ interests in Yemen. The Houthis, an Iranian proxy group, pose an immediate threat to Saudi Arabia, which shares a border with Yemen. To prevent a hostile regime from taking power just across its southern boundary, the kingdom is working to install a more sympathetic government in Yemen. Doing so, however, requires that the state remain unified. With that goal in mind, Saudi Arabia has joined forces with Islah, a Muslim Brotherhood affiliate that also wants to maintain Yemen’s unity.
The UAE, on the other hand, is concerned less with the proximity of the Houthis – after all, it does not border Yemen – than with their access to critical shipping channels in the region. The Houthi presence in the port of Hodeida puts sea lanes in the Red Sea and Suez Canal, which Saudi Arabia and the UAE depend on in their energy trade with North America and Europe, at risk. It also jeopardizes the naval bases that the UAE has established along the Horn of Africa during the course of the Yemeni conflict. (The ports in Assab, Eritrea, and Berbera, Somaliland, offer the UAE some flexibility in case Iran interrupts its trade through the Persian Gulf.) To maintain supply routes to the bases, Emirati forces need control of Yemen’s southern coast, especially the port of Aden, and its western shores on the strategic Bab el-Mandeb strait.
Diverging Strategies
Put simply, the UAE doesn’t need a unified Yemen to secure its interests, but Saudi Arabia does. The UAE is consequently reluctant to stick its neck out to help Saudi Arabia take territory outside southern and western Yemen and content to let the STC push for secession. Saudi Arabia, meanwhile, is willing to pursue the goal of a unified Yemen even if it means working with Islah, an organization that, in the Emirati view, presents nearly as great a threat as the Houthis do. Their differing objectives in the conflict will put increasing strain on relations between the two Gulf states.
It’s difficult to tell at this point whether the UAE is actively encouraging the STC’s opposition to Hadi’s government or simply allowing it. But it doesn’t really matter: The UAE is after control over southern Yemen – whether as a region or as an independent entity – and it already has the forces in place to accomplish that goal. Since the UAE has been far more active on the ground than has Saudi Arabia, which has provided primarily funding and air support, southern Yemen is rife with UAE and UAE-friendly forces, while northern Yemen is still a Houthi stronghold. Saudi Arabia may have to fend for itself in northern Yemen if the Houthis keep focusing their attacks on its southern border, and could have to send in more of its own ground forces or more East African allied forces. As long as the Houthis stay out of southern Yemen and the western coast, and as long as Saudi Arabia itself seems to be holding up, the UAE will be satisfied.
What remains to be seen is whether the alliance between Saudi Arabia and the UAE could survive the split that the STC is advocating. The two clearly share some interests in the region – such as protecting maritime flow – but the war appears to be approaching a phase in which they are jostling for position, anticipating a time when the Houthi presence is greatly diminished, if not eliminated. More broadly, the question remains whether the divisions between Saudi Arabia and the UAE will stay confined to the Yemeni civil war, or whether they will seep out into other areas of potential competition.