1-Jan-13 WV-2013 Forecast: Financial Crisis and China Threat

[solomani]

At this point, all it would take is one miscalculation.

I agree, and said something similiar. But China is no Japan. Japan was a much larger threat and had greater capability vs the USA in 1945 than China does now vs USA (especially + allies). But who knows. I hope for peace!

If there was a war I expect China would lose badly, be dismanteled and whatever is left handed back to the ROC since they are still seen as a the governement in exile by the USA.

[John]

> With interest rates at near zero, I don't see how stocks could
> fall that far. Wouldn't interest rates have to rise first?

You're thinking of how economics worked between 1945 and 2000.
Today's economics follows the rules of the 1930s, which were
different. Today's deflationary spiral is caused by the
collapse/deleveraging of the real estate and credit bubbles, and
that's still going on. Nothing like that was going on prior to 2000.
The Fed and the ECB today are pouring trillions of "printed" money
into the banking systems, something that would have caused explosive
hyperinflation prior to 2000, but which is having little or no effect
today. So the rules are different.

> I have to disagree with any chart or data that uses P/E anymore
> ever since 2009, when the FASB GAAP requirements were suspended
> and companies, especially financial companies, could mark their
> assets to pretty much pure fantasy. Also, who knows how many
> companies out there cooking their books just like Enron and
> Worldcom.

> I wouldn't be surprised if the true P/E is right now higher than
> the peak of 120.

It's not clear to me why fantasy valuations of existing assets (which
I've been writing about for years) would affect earnings, Joe.
Perhaps you could explain that connection.

> Clearly something weird went on with that chart during the peaks
> between the mid 1990s and today, but there could be a number of
> explanations that do not include makings sweeping conclusions.

> When large corporations are audited something strange happens when
> either profits, or losses are very close to non-existent.

What happened that was weird was the biggest real estate fraud in the
world's history, with tens of trillions of dollars in fraudulent CDOs
and hundreds of trillions of dollars in interest rate swaps and credit
default swaps. Given that the entire U.S. GDP is only $14 trillion,
we have a situation where the tail of the dog is many times bigger
than the dog.

You're right that the very high (123.8) values were caused by
near-zero or negative earnings, but if you're really bothered by the
specific figures in 2007-2010, then ignore them. That still doesn't
change the fact that P/E1 has been historical high continuously since
1995, and it's that fact that leads to the "sweeping conclusions."
The high peaks are part of the picture, but even if the peak had been
30, it wouldn't change the conclusions.

> Little Brother makes another great point, during recessions like
> the one in the early 1980s interest rates sky rocketed sucking
> money out of the stock market in to various triple AAA rated bonds
> and other investments that were favorable during high interest
> rate periods. That does not describe the recension and extremely
> weak expansion period after 2007.

Once again, today's economy can only be compared to the 1930s, not to
the 1980s. In today's economy, we've gone through a period where AAA
rated bonds turned out to be fraudulent, and few people trust the AAA
rating any more.

I remember talking to a corporate CFO after August 2007, telling him
that his investments may have a problem. He told me that there was no
problem, since he only invested in AAA rated securities. Despite my
warning, he was completely blindsided by what happened. No one would
make that mistake today.

> That is that companies stock price can be justified on both asset
> value and/or and the perceived rise in future earnings.

> The rise in future earnings expectation after the deep V downside
> recession after 2007 could explain part of it.

This is where you get into a lot of fraud. When you talk about
"future earnings," you're talking about data published in press
releases by people paid to lie, if necessary, to keep stock prices
high.

When you're talking about the P/E1 computation, you're talking about
very different kind of data. P is the current price of the stock, and
that can't be fudged. E1 is the earnings for the previous year,
produced by the company's accountants, audited by the company's
auditors, and checked by the IRS. Unlike "future earnings," when a
company lies about E1, then they're committing a crime with
significant civil and legal penalties.

That's why P/E1 is, in my opinion, the best measure available for how
a stock is doing, or how the entire stock market is doing. If the S&P
500 P/E1 index has been historically high for 17 years, then you know
that the stock market is dysfunctional, and headed for a major crash.

John

[John]

With regard to the question of a pre-emptive war by China, be careful
about applying logic to the issue, because logic doesn't apply.

Crisis wars are like sex. You don't do them because it's logical.
You do them because you can't help yourself.

If logic applied, then the South never would have fired on Fort
Sumter, and Japan never would have bombed Pearl Harbor.

The Chinese government is just as dysfunctional as the American
government, and in just as much denial. They believe that America is
weak and confused, and therefore will not fight back, rather than risk
having our cities destroyed. A number of people who posted comments on
other sites believe this. That belief is 100% dead wrong. If, for
example, China invades Taiwan, we'll be at full scale war within six
hours.

[vincecate]

If, for example, China invades Taiwan, we'll be at full scale war within six hours.

With just about any other president I think that would be a safe prediction. With Obama I am not so sure.

[Guest]

If, for example, China invades Taiwan, we'll be at full scale war within six hours.

With just about any other president I think that would be a safe prediction. With Obama I am not so sure.

That is not one of his powers. Besides, we're bound by treaty.

[at99sy]

The same thing could have been said about Japan seventy years ago. We outnumbered them about 2 to 1, could outproduce them ten to one and even if everything went perfectly, there was no chance in hell that they could possibly win against us. However, they attacked us anyway because they deluded themselves into thinking that they were stronger than they really were. I'm seeing the same thing happening in China. They've become a major military power over the past several years, but at the same time, they're overestimating their capabilities.

At this point, all it would take is one miscalculation.

However, Japan had a much different culture pre-WWII than China has today. The near and sometimes complete fanaticism of the Bushido perhaps required the Japanese respond to the actions America had taken to essentially force their hand. If your nation is built on the bedrock of honor and someone is freezing your accounts and enforcing a trade embargo which was "starving" them of many essential resources, you can't not respond. Much like If you're with your girl and a much bigger guy starts macking on her, even if you know you'll get smacked down you have to bring the pain.

I don't think honor is a part of Chinese politics, more fear and rigid expectations of loyalty. John is right that logic will not play a part in what kicks thing off. Never is. If nothing legitimate happens before long, something will be fabricated. USS Maine, Lusitania, WMD's, etc.......

Cheers

SY

[solomani]

Crisis wars are like sex. You don't do them because it's logical.
You do them because you can't help yourself.

I like the anaology

As a student of warfare through history I don't disagree. But China is a very conservative culture and I hope cooler heads prevail. Having said that any attack by China on Taiwan, Japan or the Philippines would suck the USA and Australia/NZ in at a minimum. I am not sure what the treaty obligations of places like Canada and Europe/NATO are when it comes to a conflict in Asia. But I would expect some support from the UK at a minimum.

On the other hand if China attacked Vietnam or India (both unlikely in my opinion) I don't think many people would raise much fuss.

[Reality Check]

As a student of warfare through history I don't disagree. But China is a very conservative culture and I hope cooler heads prevail. Having said that any attack by China on Taiwan, Japan or the Philippines would suck the USA and Australia/NZ in at a minimum. I am not sure what the treaty obligations of places like Canada and Europe/NATO are when it comes to a conflict in Asia. But I would expect some support from the UK at a minimum.

On the other hand if China attacked Vietnam or India (both unlikely in my opinion) I don't think many people would raise much fuss.

There are many ways a war could start. But, if one just says the people are illogical and do not think like rational, logical human beings, then you never know what they will do and there is no way to have a rational discussion about it.

What ever China does, they will believe it is both logical and rational, regardless what the opinion of their actions are half way around the world.

Japan prior to World War II was a World Class Naval power in terms of Air Craft Carriers and Battle Ships. Those were the measure of strategic military power before World War II.

Japan was a serious strategic player in 1941.

Except for poor leadership they should have won the Naval Battles of Guadalcanal and Coral Sea and exploited those victories to clear the U.S. from Guadalcanal and the other Solomon Islands. Midway without the Coral Sea surviving carrier and without broken Japanese codes could have been a very different battle.

China is not a serious strategic player in 2013 in the same way Japan was in 1940. Japan had defeated and destroyed the Russian Navy. Japan had combat hardened pilots flying from the decks of their air craft carriers.

China observed what happened to Japan in World War II and to suggest they learned nothing from that may be stretching it a little.

China, in 2013, is no where near where Japan was in 1941, relative to the other major world military powers.

The Strategic superiority that both Russia and the United States has over China remains daunting to any Chinese General considering a war with just the United States or just Russia. Air Craft Carriers and Battle Ships counted as Strategic Power before World War II. In 2013 Thermo-nuclear war heads and the intercontinental bombers and missiles to carry them constitute strategic power. China is an also ran in that category in the year 2013.

Even in fantasy land no Chinese General would hope to defeat the U.S. Navy anywhere other than very near the Chinese mainland, unless they used nuclear weapons, and that opens up the who strategic inferiority problem.

China launching a surprise attack on the United States in 2013, the way Japan did in 1941, would certainly start World War III, but the other scenarios seem less likely, even if China went to war with neighbors.

Obama could compromise with China on Taiwan. After all it is Chinese territory and a Hong Kong type of settlement could be reached ( autonomy with Red Chinese troops stationed on Taiwan ).

The Philippines, I am not sure Obama would go to war over them. They could be dismembered and carved up like Czechoslovakia before World War II.

A minor shooting war over Islands claimed by both Japan and China, I can see Obama smoothing that over as well as long as the Japanese main Islands were not invaded and nuclear weapons were not used.

China initiating a major war in 2013 still seems a long shot, even if we want to label them illogical and irrational.

[Reality Check]

As a student of warfare through history I don't disagree. But China is a very conservative culture and I hope cooler heads prevail. Having said that any attack by China on Taiwan, Japan or the Philippines would suck the USA and Australia/NZ in at a minimum. I am not sure what the treaty obligations of places like Canada and Europe/NATO are when it comes to a conflict in Asia. But I would expect some support from the UK at a minimum.

On the other hand if China attacked Vietnam or India (both unlikely in my opinion) I don't think many people would raise much fuss.

There are many ways a war could start. But, if one just says the people are illogical and do not think like rational, logical human beings, then you never know what they will do and there is no way to have a rational discussion about it.

What ever China does, they will believe it is both logical and rational, regardless what the opinion of their actions are half way around the world.

Japan prior to World War II was a World Class Naval power in terms of Air Craft Carriers and Battle Ships. Those were the measure of strategic military power before World War II.

Japan was a serious strategic player in 1941.

Except for poor leadership they should have won the Naval Battles of Guadalcanal and Coral Sea and exploited those victories to clear the U.S. from Guadalcanal and the other Solomon Islands. Midway without the Coral Sea surviving carrier and without broken Japanese codes could have been a very different battle.

China is not a serious strategic player in 2013 in the same way Japan was in 1940. Japan had defeated and destroyed the Russian Navy. Japan had combat hardened pilots flying from the decks of their air craft carriers.

China observed what happened to Japan in World War II and to suggest they learned nothing from that may be stretching it a little.

China, in 2013, is no where near where Japan was in 1941, relative to the other major world military powers.

The Strategic superiority that both Russia and the United States has over China remains daunting to any Chinese General considering a war with just the United States or just Russia. Air Craft Carriers and Battle Ships counted as Strategic Power before World War II. In 2013 Thermo-nuclear war heads and the intercontinental bombers and missiles to carry them constitute strategic power. China is an also ran in that category in the year 2013.

Even in fantasy land no Chinese General would hope to defeat the U.S. Navy anywhere other than very near the Chinese mainland, unless they used nuclear weapons, and that opens up the who strategic inferiority problem.

China launching a surprise attack on the United States in 2013, the way Japan did in 1941, would certainly start World War III, but the other scenarios seem less likely, even if China went to war with neighbors.

Obama could compromise with China on Taiwan. After all it is Chinese territory and a Hong Kong type of settlement could be reached ( autonomy with Red Chinese troops stationed on Taiwan ).

The Philippines, I am not sure Obama would go to war over them. They could be dismembered and carved up like Czechoslovakia before World War II.

A minor shooting war over Islands claimed by both Japan and China, I can see Obama smoothing that over as well as long as the Japanese main Islands were not invaded and nuclear weapons were not used.

Much more likely, however, is China just throwing their military weight around in the South China Sea to intimidate their neighbors and prove the U.S. would not come to the rescue of Vietnam or Indian military ships trying to protect their ( Vietnamese or Indian ) civilian and commercial interests in the South China Sea.

China initiating a major war in 2013 still seems a long shot, even if we want to label them illogical and irrational.

[solomani]

China initiating a major war in 2013 still seems a long shot, even if we want to label them illogical and irrational.

I know you are quoting me but I assume you are doing that out of convenience since I said pretty much what you said in my previous two posts:

• Comparing Japan WWII to China 2012 is not a fair comparison. Japan was by far in a better position to wage war on the Western Allies than China is today against a Western/democratic coalition.
• I also think war is a long-shot apart from something accidentally happening (or seemingly minor) and dragging everyone in (Archduke Ferdinand type incident).

I wonder what would happen to places like HK as well? Half the people here are not natives and the other half hold dual citizenship or passports with potentially enemy states in any kind of general war with China.