A repetitive pattern is plainly visible. Each episode of “quantitative easing” – generates the following sequence:

1. A smooth rise in the markets as long as the money printing continues.
2. A period of uncertainty with sharp up and down swings.
3. A significant market drop

Rough numbers to-date:

1. “QE1” – March 2009 to April 2010: market rise of 4500 points (Dow Jones Industrial Average), followed by a 1400 point drop.
2. “QE2” – August 2010 to April 2011: the market up 3100 points, then a 2000 point drop.
3. “Operation Twist” and European “LTRO” – October 2011 to April 2012: market up 1400 points. The volatile uncertainty phase is apparently now starting.

It is clear from the above numbers that successive rises get smaller, while the drops increase over time. This suggests (1) the liquidity injections show diminishing returns; and (2) market instability appears to increase.

That the “QE” weapon is losing its punch is logical. As equity markets rise, it takes more dollars per share to drive them further. The urge to sell and take profits also gets stronger, building up resistance to further gains.

Market instability is a much bigger issue.

The Wealth Effect assumes that an increase of wealth at the top should work its way downwards, leading to increased spending at lower levels, while money creation translates into easier credit, and thus greater consumption.

In fact there is a growing gap between the top of the wealth pyramid – where income and asset values have risen sharply – and the layers immediately below, where the opposite is taking place – stagnant income and assets (housing) losing value. The middle and lower rungs have neither means nor motivation to follow the lead from the top.

Further, little of the money created by central banks is actually invested in activities producing a broad rise in income. Most goes to speculation in equities, bonds and commodities, when it does not leak abroad seeking higher returns.

This creates a highly unstable situation, with markets floating far above a sluggish and essentially stagnant economy (whatever the official numbers may say).The disconnect between economic reality and market valuation scare retail and institutional investors away, leaving only the traders and speculators. Despite three years of “recovery” and equities within 10% of their pre-crisis highs, trading volume is the thinnest in half a decade.

This is a recipe for disaster.

In the film “Margin Call” the Risk Manager of a Wall Street trading house discovers that the securities the Firm is dealing in have a dangerously inflated value. When the CEO is advised of the situation he orders his traders to liquidate the entire portfolio, knowing full well this will cause a market crash.

This scenario is entirely possible in our current markets. If one major player or group decided to cash in and get out, the resulting stampede might be unstoppable.

The financial authorities, central banks and international institutions will of course fight to prevent it, but they have spent a lot of ammunition already, and no state – from India and China to Brazil and from Russia to the U.S. – is in a truly secure position.

Such was the case of the Titanic. Its design had a flaw that appeared insignificant. Yet it was that very error that doomed the vessel. The best designed ship of its time carried the seed of its own destruction.

Our own economic and financial systems are just as vulnerable. It is high time to review both our direction and our course.

The proposed pipeline would carry oil from the Alberta tar sands to processing and shipping hubs on the Gulf Coast, from where the oil and refined products would be shipped worldwide. There is nothing in the project limiting the oil to American domestic use.

On the environmental side, the fact is that the U.S. is crisscrossed by tens of thousands of miles of oil pipelines. Accidents and spills are rare and generally minor. While it is prudent to take extra precautions in sensitive areas, pipelines are not “dangerous” – and certainly safer than trucking or rail.

Running tar sands oil through the U.S. is actually a business proposition. The alternative route – west through the Rockies to Kitimat on the Pacific – would be far more expensive and harder to operate. In addition a refining and/or shipping complex would have to be built from scratch. Pumping over the Plains to the Gulf is both cheaper and safer.

Building the XL would is a courtesy to Canada. It would provide a number of – mostly temporary – jobs and business for U.S. oil and chemical companies. Those are real benefits, but we do not “need” them.

Far more useful for the U.S. would be a new pipeline from the Midwest to the East Coast. The Northeast is literally running out of fuel, driving up the price of gasoline for the entire country.

The U.S. pipeline system has not been, like the interstate highway network – centrally designed to serve the entire country. Except for some parts built during WW II, it was created piecemeal to serve business interests, moving oil and products from production to market.

The East Coast is a huge fuel market but produces very little oil. In past years it was cheaper to ship oil there from the Middle East or Africa than to pipe it from Oklahoma or Texas – which in any case did not produce enough for the needs of the entire country. No significant pipelines exist to ship oil east from the Middle West or South. It arrives from abroad by tanker and goes straight to the refinery.

This worked well when oil was “cheap”. But in the last five years the price of petroleum has roughly doubled. Furthermore, world benchmark prices are approximately 15% higher than domestic ones. Turning imported oil into domestic gasoline is a losing proposition.

Eastern refineries are going out of business and closing. This tightens the supply, driving gasoline prices higher all over the country. The rule of thumb is that once the oil price is between $100 and $120/barrel the economy starts to degrade. Currently the domestic spot price stands at $107/barrel and the world price $126. We are in the danger zone.

The price pressure is likely to remain high. New oil fields are costly to develop, both in money and time. In the meantime global demand keeps rising – particularly in Asia. In most producing countries the oil industry is now owned by the state, which needs the money and will charge whatever the market will bear.

It is time for a real U.S. energy policy.

In 1941 the bulk of oil and fuel was shipped by tanker from the Gulf to the East Coast. When war broke out German submarines savaged the supply line. We needed a pipeline with five times the flow of the existing ones.

The line was laid and flowing in less than 18 months, including design and delivery of equipment never made before.

That is the spirit we need today – not haggling over XL.

This is wrong for two reasons: first, because such an attitude is unrealistic. Second, because it is un-American.

Our true enemy is not the “other side”. It is ideology, a mental and emotional framework which divides the world into “good” and “evil” parts.

Ideology is a man-made worldview which reduces life to a simple formula. It divides the world into two classes: Us, who know the truth, and Them, who are too dim witted to understand or too corrupt to agree. We are on a mission to perfect the world. They are the obstacle and/or the enemy.

The appeal of ideology is emotional security, born of the certainty of one’s own righteousness and moral superiority. But the end goal of the ideologue is always power, supported by the blind loyalty of one’s followers and the assumed greatness of the cause.

The United States were born out of the rejection of the reigning ideologies of the 17^th and 18^th centuries: “divine-right” monarchy, enforced religious uniformity, superiority of one’s nationality or race. By contrast the United States foundational documents enshrined individual liberty and pluralism. The First Amendment forbade the imposition by the state of religious conformity. The Second gave the citizens the arms to oppose any such effort, be it religious or political. Many other constitutional clauses were directed towards the same end. By both structure and temperament America is so built that its citizens cannot be made to agree.

In a system designed to prevent the imposition of uniformity from above the only orderly recourse is voluntary consensus, and if need be compromise, between free individuals and the groups they choose to form. This has been “the American Way” from the Revolution on, and historical experience supports the validity and strength of this model. But free persons are still imperfect, as the Founding Fathers well knew. The temptations of power – and tyranny – are never far from the political discourse.

The system spectacularly failed in 1860, when radical minorities in North and South, unwilling to compromise, drove the nation to secession and war. The resulting conflict saved the Union and freed the slaves, but at a high price: 600,000 dead (2% of the population); a century of bitter division between winners and vanquished; three generations passing before the ex-slaves finally received their civil rights.

By contrast, the deep and angry political divisions of the Great Depression years were overcome in the common drive to victory in WW II. The “Greatest Generation” did not achieve their title through courage, ingenuity and sacrifice alone. They also had the willingness to recognize that victory against the outside enemies required internal unity.

Today we are faced with a similar choice. While our economy and national spirit weaken, we engage in ideological warfare against our fellow Americans, demanding obedience to our partisan principles while declaring theirs to be heresy. The sorry state of our federal government is a witness to our divisions – though by far not the only one.

In the end none of us profit from this weakening of our ideals. Our enemies – be they authoritarian states or terrorists – can only rejoice at our bickering, while reaping the benefits of our weakness and indecision.

The remedy is not in the implementation of some simplistic and abstract concept – be it liberalism, conservatism, or “small government” – while demanding blind submission from others. It is instead a determined pursuit of the national interest, meaning the interest of the entire American community. We might have differences and retain some of them, but on the fundamentals – economic vitality, freedom, opportunity and fairness, internal and external security – we can and must find agreement, and from there work together.

The time for decision is now: civil strife and its dire consequences, or national cooperation and the continuation of the American Destiny.

Why? The U.S. is in an election year, a time when foreign concerns are usually ignored. Europe has many other problems, and generally takes a neutral stance on Middle East issues. Why would it reduce its own oil supply – and raise oil prices – when its economy is shaky?

The answer may well be on the Iranian side.

First, does Iran want the bomb? By all evidence, it does.

If nuclear power generation were its goal, it could obtain reactors and fuel, at competitive prices, from at least five suppliers. More importantly, there is no non-military use for uranium enriched above 10%. Iran is at 20% and going higher. The “peaceful use” fiction is not tenable.

The timetable is the next unknown. In this area there are two options.

The first is sequential development: procuring the nuclear explosive; building an initial device, and testing it; designing a warhead; testing the delivery system, and finally deploying the weapon(s). This is the reliable route, with each step building on the experience of the previous one. It is also the longest path. Predictions of Iran being “years away” from a working weapon were probably based on this scenario.

The alternative is both faster and riskier. First one determines the date at which the weapon is to be ready. Then, working backwards from that point, one determines when the development of each system component has to start. All programs then proceed in parallel until a weapon is assembled and fielded on the pre-set date.

Management of such a coordinated program is more difficult, as many parallel schedules must be maintained and much more can go wrong. But a switch from a (slow) sequential development to a (fast) parallel one, if kept secret long enough, can shorten the time to deployment and thereby surprise a potential adversary.

In this matter Iran has two main opponents: Israel and its U.S. ally. Of these, only the United States has the military reach to destroy the entire Iranian nuclear program. Therefore, from the Iranian viewpoint, the program must reach its goal at a time the U.S. is least likely to react.

That means a presidential election year, when the United States is absorbed by elections and least likely to “rock the boat”.

The stock market, right on cue, went from negative to an 83-point rise in the Dow Jones Industrial Average. Hong-Kong and European markets followed.

What’s going on here and does it reflect anything in the “real” economy?

This is a recurring pattern. At market bottom in March 09 the Federal Reserve injected the U.S. financial system with more than a trillion dollars of printed money (“Quantitative Easing” # 1). This doubled down on massive government deficit spending, as well as huge liquidity injections directly into banks, both American and foreign.

It had the effect the Fed desired: restored financial system liquidity, and a long, smooth rise in the equity markets. Chairman Bernanke reported that “green shoots” were appearing in the economy, and that recovery was underway.

QE1’s end prompted a mini-crash, aggravated by Euro-zone problems. So “QE2” was announced in August 2009.  Predictably, markets rose smoothly again, though by a smaller amount. The recovery, though “fragile”, was reported as continuing, despite high and persistent unemployment.

A parallel and even larger explosion in the money supply had been engineered in China, resulting in a huge housing construction bubble. This sucked in raw materials from the world over, lifting the global economy. Growth projections were raised, and the crisis was declared to be nearly over.

In the U.S., however, it wasn’t. When the QE2 program ended, a high-volatility, deeper market trough followed, again. Unemployment numbers improved mostly because millions had left the labor force and were no longer included in the statistics. Housing remained depressed, consumer spending anemic, and government deficits correspondingly high. Parallel problems in the Euro-zone weighed down “recovery” in the real economy.

So another money printing episode is apparently on the way. Europeans have already had their version this past December, with $650 billion pumped into the banks. Our Federal Reserve promises interest-free money for another three years, and more if needed.

We are now nearly five years from the crisis start in 2007. By any growth measure our “recovery” is far behind exits from previous recessions.

In the “Wizard of Oz” Dorothy and her three friends seek help from the Great Wizard in the Emerald City. The Wizard puts on an awesome display of his power – but only until Dorothy’s dog Toto finds out he is just a trickster pulling special effects behind a curtain.

It’s “Toto-time”: time to ask, and find out, if the country is genuinely back on track, or if what we are being shown is just smoke and mirrors.

This, more than any election-year theatre, is the key issue before us as voters.

The happy end of Dorothy’s story comes only when she and her friends took a realistic view at their situation. In doing so they discovered how well they could manage without any help from “Wizards”. America can do likewise. All we need is to get together and start to work.

The reality we face every day is different:

• Unemployment figures are (slightly) better, but there are millions fewer jobs and millions have dropped out of the workforce altogether.
• Incomes are lower or stagnant, even for the college educated.
• Whatever Christmas sales there were last year came out of savings.
• This “recovery” is puny compared to exits from past recessions.

Trillions of dollars, all of them borrowed or printed outright, have been pumped into bank and corporate balance sheets, creating a semblance of normalcy. Had such sums been applied in past recessions, massive booms would have followed. In the current case the economy barely budged, and still relies on government life support.

This state of affairs has lasted for over four years. Every possible medicine has been used and the patient is still sick. We have two options: stick with the current diagnostic, or seek a second opinion. In that case, what is the real problem?

For fifty years after WW II America enjoyed a period of steady prosperity. But towards the end of that period we embraced in full the concept of “free trade”, opening our economy, with few restrictions, to all comers. This resulted in a growing trade deficit with the rest of the world.

Between 1998 and 2001 China, already under U.S. most favored nation status, became member of the World Trade Organization. Having earlier pegged its currency at an extremely favorable rate against the dollar, China enjoyed a huge competitive advantage over domestic U.S. industry. This “head start” was later magnified and protected by an elaborate system of taxes, subsidies, quotas and other obstacles to American exports to China.

The result was a rapid and massive exodus of jobs, technology and production from the United States to the Peoples’ Republic. In 2003/2004 the U.S. experienced its first “jobless recovery”. The second one started in 2007 and is still proceeding, even as China’s economy is growing at 8-9%/year.

Economist Martin Wolf of the Financial Times has proposed (with numbers to support him) that within a common currency system it is trade deficits (not fiscal deficits) that disrupt and destroy the shared economy. Trade imbalances reinforce exporting states and weaken importing ones. Money moves out, forcing governments to borrow to cover expenses. Intractable debt issues result, as is the case today with the Euro zone.

China’s manipulation of the dollar-yuan exchange rate is equivalent to a fixed common currency system. Compared to the Euro zone China is Germany, and the U.S. is Spain, Portugal or Greece. The fact that the U.S. economy is bigger than China’s is irrelevant. The only difference is that China has more to gain, and America more to lose. The process might take longer, but the result is the same.

Thus our primary problem is not the federal deficit or the solvency of too-big-to-fail banks. While those do count, the fundamental issue is our monstrous trade deficit.

While many countries and types of merchandize are involved, our trade deficit has two primary components: imports from China and oil. The two are related, since China’s growth and energy inefficiency are major factors in raising the oil price.

If this is the true diagnostic, all the remedies proposed by the Administration and the Federal Reserve are only palliatives and pain killers. They have provided no more than a very relative impression of health while the disease has progressed unabated. The only remaining question is: When will the true state of the patient become evident?

The European Community has fiddled with their internal trade imbalance problem for over two years. We have ignored our own trade deficit far longer. In both cases there are signs that by early summer the game will be up, with the corresponding impacts on the economy, the markets, and the voting public. In the U.S. this would be before the party conventions, throwing the political system into chaos.

There is only one answer: start dealing with the situation now, by developing and applying policies to stop the trade deficit in its tracks; plan for the industrial revival that must follow; and most importantly, rebuild national unity and awaken the spirit of cooperation, initiative and innovation that has served America so well throughout its history.

Nicolai Petrov, Moscow Carnegie Institute, December 2011 – Comment on the popular reaction to the official results of the Duma election.
“Revolution” is no idle word in Russia. Mr. Petrov, for his part, has worked at the highest levels of Russian government and media since the final years of the Soviet Union. Having lived through every upheaval the country has seen in the last two decades he knows what is going on.

His comments do not address an isolated case. In an interview published in France at the end of December, Ms. Christine Lagarde, Managing Director of the International Monetary Fund, similarly upbraided European political leaders for their inability to address the Euro crisis with any degree of effectiveness.

Other examples abound: failure to deal with corruption in India’ Parliament; debt ceiling fiasco in the United States; uprisings in the Middle East. Everywhere governments are sinking, and in some places already underwater.

Popular grievances are similar across the board: oppression, corruption, economic decay, lack of opportunity for young and old alike. This is global phenomenon, leading to a worldwide popular uprising. 2012 appears as a hinge year, when much of the near future will be decided. Elections are due this year in Egypt, Mexico, France, Russia and the United States. A change of leadership is due in China. Nowhere can calm and stability be now taken for granted.

The world is coming to grips with the consequences of economic and financial globalization, into which governments and economic leaders rushed headlong, lured by rosy promises of ever-increasing prosperity and peace. Instead they got:

1)  A massive inflation of the financial sector, itself increasingly addicted to speculative ventures and systemic instability.

2.  Wholesale transfers of industries, resources and know-how to states most willing to “game the system” through mercantilist practices. Left behind is an economic desert.

3.  Rising income disparity between the super-rich elites and the economically sinking populace, with a growing void where the middle class once was.

4.  Entrenched corruption grounded in the merging, at the top, of political and economic interests.

5.  The widening gulf between the elites and the general population has been compounded by technology, which in many cases has eliminated the “routine” jobs that traditionally provided the ladder to economic success.

Up to the recent past the holders of such jobs were the perennial anchor of stability and of national service.

In the two decades since the fall of the USSR we have gone from “peace in our time” to a world in permanent crisis.

Can anything be done?

The solution does not rest with more international institutions and even greater “global integration”. It is precisely these institutions that have failed to foresee and prevent the crisis.

Nor is the answer to be found in the now sterile opposition between right and left, capitalism and socialism. The current situation already embodies the worst features of both: a bloated state with growing inequality; inefficiency with naked greed; stifling regulation and speculative license; oppressive security below with unlimited power at the top. Neither the state nor the market will save the day.

As Mr. Petrov points out, the “colossal social energy” of the budding insurrection must be channeled into constructive solutions. Utopian schemes will not do.

The only way goes through the institutions on which national life is founded; which are embedded, so to speak, in the people’s DNA. Each population knows what these are, and rediscovers them in times of trouble.

In the United States this communal bedrock is our ability, in times of great need, to lay aside individualism and join together, with full freedom of will, to defend and promote the national interest. At such times there is no conflict between government and citizens, but both become a single entity:

We, the people…

We have achieved this unity several times in our history. It is time to do it again.

2011: Seventy years later unequal trade is destroying the global (and U.S.) economy while America clings to the illusion of globalization. Denial translates into blind faith in “free trade”, that the promised pot of gold will appear at the end of the ever receding rainbow. Instead of halting the destruction of the U.S. economy politicians, once again, engage in sterile disputes between Left and Right.

Then, Pearl Harbor shocked the nation into new purpose, initiative and, most importantly, national unity. Common effort and overwhelming victory showed how vain and hollow the adversarial Depression Era politics had been.

The economic attrition America has been now subjected to for two decades is a war without battles. But its effects are the same as those of physical attack: destroyed industries, loss of productive assets, ruined lives and diminished hope. The means to reverse this ongoing economic defeat are the same as those that led to victory in the past: purpose, initiative, and above all unity.

The 2012 election will be the economic equivalent of Pearl Harbor. Either we will bury the ideological hatchets and address the real danger, or meekly submit, and surrender what is left of our dreams, our wealth and our national heritage.

There is no more time.

The massive loss of votes and face by the ruling party, in the midst of apparent popular resignation, suggests parallels with the Middle East. There also regimes in firm control for decades were suddenly upset and/or overthrown by unexpected popular movements – a process that is still underway.

Is Russia next in line?

The popular grievances are very similar: corruption – many describe the government as “swindlers and thieves”; concentration of power at the top, with a parallel growth of income inequality; economic uncertainty; lack of opportunity for youth, and a stagnant economy with a decaying infrastructure.

For the time being police action, the use of pro-government thugs and some “stimulus spending” are likely to restore some degree of order. But time is working against the current regime, and continuation of the status quo until the March 2012 presidential elections is far from guaranteed.

First, a large part of the population now sees the government as illegitimate. Memories of the Soviet police state are still fresh, and repression will only spur the formation of underground opposition networks such as flourished in the late communist period.

Second, government largesse is limited. The national budget is barely in the black and a half of it comes from oil and gas sales. Should the looming recession in the West lower demand for Russia’s raw materials, money for paying off the electorate, will quickly run dry.

Third, the current government, divided as it is between different interest groups, cliques and patronage networks, lacks both effectiveness and room to maneuver. Neither the administration (mostly staffed by ex-Soviet functionaries), nor the oligarchs in control of major economic sectors, show much managerial ability. In a crisis everyone is more likely to look after his own than to serve the common interest.

Finally there is the growing worldwide debacle of globalization, of which post-communist Russia has been an integral part. The Middle East is already on fire, but rumbles of discontent are being heard everywhere. As the crisis grows only an exceptionally capable and dedicated government will be able to navigate the storm – and such qualities are in short supply, in Russia as everywhere else.

An upheaval is thus probable, but here Russia has significant advantages.

It has experienced two revolutions in recent history: 1905 and 1917. Both were precipitated by military defeat, and both involved irreconcilable government models: divine right autocracy versus secular democracy. The resulting stalemate opened the door to bolshevism and Soviet tyranny.

Today war is not an issue, and neither is foreign interference. Russia has a modern economy and is rich in resources. Even in crisis it has the freedom and means to make its own decisions. It has experienced both full-scale socialism and, after its collapse, the worse kind of raw capitalism. Experience teaches.

Russia is also finally free of the split it endured since Peter the Great: the dichotomy between Russian ways and traditions, and imported European rationalism. In past crises Russia looked to the West for solutions. Today the West has its own problems. Russia controls its own destiny.

Its extraordinary success in disposing, almost bloodlessly, of the powerful grip of Soviet tyranny leaves much hope for the future.

This is a crisis, but Russians are a nation of survivors. They have seen much worse, and lived. They have surprised the world many times, and may well do so again.