Hostages, Nukes and Rates

There are three major headlines weighing on the market today and will probably stay in focus for a few weeks to come.

The first is the hostage crisis facing 15 Royal Marines and Sailors from the United Kingdom that were apprehended in Iraqi waters (where they were policing for smugglers and the like) by the Iranian Revolutionary Guard. They have subsequently been brought to Teheran where the possibility exists that they will face charges of treason or espionage in the Iranian courts.

Prime Minister Blair has sought their immediate return via diplomatic channels, but has warned today if talks fail, the process will be forced into a new phase. It does not appear that Teheran’s charges have any merit as witnesses have described the abduction clearly occurring in Iraqi territory.

Many liberals here are already likening this to the Gulf of Tonkin, meaning it would be an easy entrance for the USA into the conflict, to take our rightful place shoulder-to-shoulder with our British counterparts, reaffirming the strong Anglo-American Alliance. Iran has already described a desire to kidnap members of the Multi-National Force (MNF) in Iraq as leverage to their talks, in addition to seeking revenge for the defection of a Revolutionary Guard to the West in Istanbul a few weeks ago.

Iran has a long (and irritating despicably) successful history of kidnapping foreigners in order to achieve national prerogatives. The years 1979-80 in the US embassy and Beirut are fine examples of such behavior being rewarded (not to mention the abduction of British sailors earlier in the Gulf War) with little or no ramifications.

This also happens concurrently with sanctions from the UN Security Council for Iranian nuclear non-compliance with international law for their nuclear program. I would go above and beyond that as the possibility of an offer through back channels for a “quid pro quo” involving the servicemen (and servicewoman) and the dearth of any future council action.

The threat of additional military conflict plus the dramatic rise in oil prices have kept traders nervous and could possibly stymie further recovery in the equity markets from the Shanghai born correction that started at the end of February.

In the Pacific, Japan has once again alluded to the need for rates to go higher—in order to stabilize the economy and help safeguard the nation’s banking infrastructure. This would possibly have the unintended effect of ending the carry trade (institutions borrowing money in Japan at very low rates and investing elsewhere where the rates are higher).

While it is not the official policy line of the Bank of Japan as of yet, it may soon become or simply be a government official attempting to “talk up” rates, ala Greenspan. Should rates move dramatically higher in Tokyo, that would put a serious strain on liquidity in the US and Europe. This is something to definitely watch out for in the coming weeks and months.

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Gentle Ben to the Rescue

Shanghai Surprise

Didn’t take much to get the Shanghai Composite back over 3000 and within striking distance of another record high after the devastating one-day 8.8% loss at the end of February. In fact, over the weekend the Chinese Government raised interest rates by .27% and the market shook it off.

The only question investors should be asking is “will the US and European markets follow suit?”

China’s rate increase will surely help the dollar and euro become more competitive in the manufacturing sector, which is still a major driving force behind our service-based economies. If China’s market can shrug it off (while it’s detrimental to them) than investors here should be cheering the move, despite congressional whining that it’s not enough.

In addition, it should portend that the fears that sprouted over the last few weeks were in fact, fears, not reality. The Chinese economy isn’t collapsing, the carry trade isn’t over and the US’s sub-prime worries are largely confined to the lenders and those that secured them credit. In other words—no reason to panic.

The markets are much like the ocean: some days the gales are howling. Some days the seas are still as glass. Much of the rally has been subdued in nature, as volatility has largely been absent. It was only a matter a time before it returned and with it, some pent up strength.



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We Found It

From the get go, global markets were looking to sell off on Tuesday and weaker-than-expected retail sales figures for the month of February helped justify the negative tone in U.S. futures.

So it seems we have found our reason to sell off for today. Since the bludgeoning at the end of February, market players and the financial press have sparked new fears (and rehashed some old ones) concerning the macro economy. First we had the “Shanghai Flu,” which was followed by a congressional pile-on of foreign-held Treasuries (read: China) endangering the world as we know it. That pored into the seeming “end” of the carry trade, despite the same huge spread which existed the week before when everything was copasetic across the Pacific.

Finally, the sub-prime lender melt-down reached a new low today as New Century Financial Corp. was de-listed. The Wall Street Journal continues to expose the intricate web of dealings between homeowners, lenders and the large banks which provided lines of credit. My feeling is many of the large financial institutions will be forced to take large write-downs precipitating further deterioration in the corporate junk market (and added volatility) but will not be the cause of a financial crisis.

While the losses may be significant, I do not expect liquidity to be a problem, nor would I expect Bernanke to stand idly by and fail his first “real test” as Fed Chairman should warning signs arise.

Since today’s excuse to sell the market is the retail sector (which coincidentally was not abetted by the 28 day month or terrible weather), here is the daily chart for the S&P 500 Retail Composite:

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A Disease with No Known Cure

Protectionism is on track to be the single leading killer of global growth in the 21^st century. For the most part, the last 6 years under President Bush (and the passage of NAFTA under President Clinton prior) has seen a dramatic increase in output, trade and productivity; much of which has stemmed from a more laissez-faire approach to the private sector, combined with a host of tax breaks and new free trade agreements such as CAFTA.

President Bush was smart to basically to bypass congressional oversight and empower his office with trade authority—both the negotiations and the enforcement of such agreements. As a result, America has enjoyed freer, more robust commerce with her neighbors and has seen the creation of some 9.3 million jobs as a result.

It has not been easy, however. Both Chairman Greenspan and Chairman Bernanke have been deployed to Capitol Hill many times in an effort (successful thus far) to keep Senators Graham (R-SC) and Schumer (D-NY) from unveiling a bill that would impose a tariff on China for refusing to float its currency.

More recently, Senator Clinton (D-NY) responded to last weeks market thrashing with a semi-proposal that would place limits on the amount of US debt (Treasury Bonds, Notes and Bills) held by foreign countries; literally picking a magic number based on a percentage of GDP which would trigger a rebalancing. I.e. when foreign held debt approached, say 5%, of GDP we would buy back bonds.

This sort of proposal and more importantly, the underlying assumption that it is based on—that somehow other countries are in control of our economy is scurrilously dangerous, not to mention preposterous.

On the right, politicians like Rep. Tom Tancredo (R-CO) oppose the free movement of labor, which manifests itself in immigration issues. Others like commentator/ former candidate Pat Buchanan would like to stymie any new free trade agreements and renege on those already in effect—in fact, one of Mr. Buchanan’s campaign promises 3 elections ago was to roll back NAFTA.

The world is a dangerous place. Without free trade, the world be far poorer and arguably more dangerous as a result. Free trade will not only continue to ramp up economic expansion and job growth (especially higher paying jobs) domestically, but will aid mineral and natural resource rich nations mired in poverty; especially on the continent of Africa. We can help them and ourselves simultaneously by exchanging goods and services without the burden of tariffs and penalties—which naturally act as a barrier to the free flow of commerce. One obvious positive by-product of the creation of wealth in economically derelict areas would be to bring them back in compliance with their debt covenants to the IMF, World Bank and USA; which would bring down future borrowing costs and reduce the cost of capital for them, while reducing our national debt.

Whether you are a humanitarian, capitalist or both; the benefits far outweigh the costs. While we do not have cures for many of the ailments that plague our society and others, this one is simple to overcome. Free trade leads to freer societies. Freer societies lead to prosperity. And prosperity leads to happiness.