Let’s see how close we came (this model was published in May of 2010. Professional subscribers can find this on page 15 of this document: Sovereign Contagion Model – Pro & Institutional (retail subscribers must use this document – Sovereign Contagion Model – Retail (961.43 kB 2010-05-04 12:32:46))
Closest thing you can get to a crystal ball? No, just an objective, empirical approach from a realistic perspective. None of that bull or bear crap, not being pessimistic nor optimistic – just realistic.
Now that it is apparent to all that social unrest is most definitely here (or not quite here yet, but definitely there), it is time to walk both readers and subscribers alike through the thought processes that went into the model and attempt to trace a distinct path of where this may lead.
Instability stems from a government that loses control of its people
Summary of the Contagion Model Methodology
Subscribers can download the current production models here:
Henry Kissenger commissioned the CIA to create a model that attempted to predict the potential for disruption and the liklihood of a government and/or regime being toppled. The request originated from his alleged tiring of being behind the curve of such events and felt the US was best served if it was at the forefront of regime change. In more direct, and less politically correct words, in order for the US to more efficiently maintain control of other countries it had to know what was going on before the fact. I have incorporated many aspects of this model into my own financial analysis for very much the same reasons.
At this point I ask one and all to put their political leanings on the back burner for a minute as I delve into who the man was that commissioned the model from which I constructed a good portion of the socio--political aspect of my financial contagion model. I would like to make note that Kissinger's adherence to Realpolitik is as my dedication to finansense - see . As per Wikipedia:
Henry Alfred Kissinger (pronounced /ˈkɪsɪndʒər/; born May 27, 1923) is a German-born American political scientist, diplomat, and recipient of the Nobel Peace Prize. He served as National Security Advisor and later concurrently as Secretary of State in the administrations of Presidents Richard Nixon and Gerald Ford. After his term, his opinion was still sought by many following presidents.
A proponent of Realpolitik, Kissinger played a dominant role in United States foreign policy between 1969 and 1977. During this period, he pioneered the policy of détente with the Soviet Union, orchestrated the opening of relations with the People's Republic of China, and negotiated the Paris Peace Accords, ending American involvement in the Vietnam War. His role in the bombing of Cambodia during this period remains controversial, as well as other interventions abroad such as the Nixon administration's tacit support of the Pakistani Army in East Pakistan during the Indo-Pakistani War of 1971, with documents showing that US officials working in diplomatic institutions within Bangladesh using the terms selective genocide in reference to the Pakistani Army's atrocities, actions which prompted widespread criticism and condemnation both by Congress and the international press.
... He remains a regular participant in meetings of the annual invitation-only Bilderberg Group. He was honored as the first recipient of the Ewald von Kleist Award of the Munich Conference on Security Policy and currently serves as the chairman of Kissinger Associates, an international consulting firm.
... During the American advance into Germany, Kissinger was assigned to de-Nazify the city of Krefeld, owing to a lack of German speakers on the division's intelligence staff. Kissinger relied on his knowledge of German society to remove the obvious Nazis and restore a working civilian administration, a task he accomplished in 8 days. Kissinger was then reassigned to the Counter Intelligence Corps, with the rank of Sergeant. He was given charge of a team in Hanover assigned to tracking down Gestapo officers and other saboteurs, for which he was awarded the Bronze Star. In June 1945, Kissinger was made commandant of a CIC detachment in the Bergstraße district of Hesse, with responsibility for de-Nazification of the district.
For those not familiar with the concept of Realpolitik, it basically the political science version of the highly realistic version of finance portrayed throughout BoomBustblog. Reference Wikipedia:
Realpolitik (see also Political realism; from German: real “realistic”, “practical” or “actual”; and Politik “politics”, German pronunciation: [ʀeˈaːlpoliˌtiːk]) refers to politics or diplomacy based primarily on power and on practical and material factors and considerations, rather than ideological notions or moralistic or ethical premises. In this respect, it shares aspects of its philosophical approach with those of realism and pragmatism. The term realpolitik is sometimes used pejoratively to imply politics that are coercive, amoral, or Machiavellian. Realpolitik is a theory of politics that focuses on considerations of power, not ideals, morals, or principles. The term was coined by Ludwig von Rochau, a German writer and politician in the 19th century, following Klemens von Metternich's lead in finding ways to balance the power of European empires. Balancing power to keep the European pentarchy was the means for keeping the peace, and careful Realpolitik practitioners tried to avoid arms races.
For my financial version of Realpolitik, let's refer to it as Finansense, reference Amsterdam’s VPRO Backlight and Reggie Middleton on brutal honesty, destructive derivatives and the “overbanked” status of many European sovereign nations. Start at 7:35 in the video. The essence of Realpolitik is espoused at 11:00 in the video. Basically, "If you're pessimistic or optimistic, you'll probably end up being broke very soon!".
I will dig into the British aspect of this with subscribers soon...
Now, after that historical introduction and background, let's peruse today's headlines then delve into the roadmap that I have drawn out for BoomBustBlog subscribers illustrating today's events nearly a year ago.
Bloomberg - ElBaradei Unifies Opposition Support as Egypt Protests Enter a Second Week: Egypt Opposition Urges More People in Streets to Unseat Mubarak
Opposition groups urged more Egyptians onto the streets to help unseat Hosni Mubarak, as the president sought to quell unrest by putting police back on duty in Cairo.
The anti-Mubarak movement, backed by former United Nations nuclear official Mohamed ElBaradei and the Muslim Brotherhood, aims to hold a 1 million-person march in the capital tomorrow to demand the resignation of the 82-year-old ruler, said Mahmoud El-Said, one of the organizers. That would be the biggest demonstration in a week-long uprising that has left as many as 150 dead and sent markets tumbling worldwide.
The opposition has set up a committee, including Elbaradei and the Brotherhood, that will convey the movement’s demands to the government, said Ayman Nour, who was a distant second to Mubarak in Egypt’s first multi-candidate election in 2005. Elbaradei, 68, told CNN television that he’s willing to “serve as a bridge from an authoritarian system into a democracy,” and said Mubarak must leave the country in the next few days.
Mubarak’s response to the uprising -- sacking his Cabinet and appointing intelligence chief Omar Suleiman as vice president -- didn’t halt the protests. Tanks are deployed in Cairo and fighter jets flew over the crowd late yesterday.
Reuters via CNBC: Egypt Protesters Camp Out, Mubarak Turns to Army
... As the unprecedented unrest in the Arab world's most populous nation entered a seventh day, thousands of protesters poured into Cairo's Tahrir Square chanting "Get out ... We want you out" and singing Egypt's national anthem.Soldiers looked on without taking action, which would have been inconceivable just a week ago. World leaders struggled to respond to a crisis that threatens to tear up the Middle East political map. And in global markets, share prices fell across Asia on Monday and Brent oil hit a 28-month high.
A significant aspect of both Kissinger's early model and the BoomBustBlog contagion model is that governments who display weakness to the extent that factions or constituencies actually calculate a material chance of success in an uprising effectively broadcasts an endemic weakness, and as a result the perception of a government that may or will lose control. In many of these instances, perception is reality and it becomes a self-reinforcing loop - potentially creating fact out of fiction. These issues are rarely if ever captured in financial models.
Oil remains the biggest trade — and perhaps the biggest risk for traders — as unrest in Egypt persists. U.S oil prices climbed to over $90 a barrel in the electronic session Sunday night, extending Friday's 4% gain. March NYMEX crude futures rallied over $1.50 to a high of $90.87 in electronic trading. Brent crude nearly touched $100 a barrel, but rose less than $.50 from the previous close. Oil prices have since pared their gains and volume is expected to be light until floor trading begins at the New York Mercantile Exchange at 9 a.m. ET Monday. The volume of oil futures traded at the NYMEX exploded on Friday to an all-time high, according to some early reports. However, the exaggerated reaction to U.S. oil prices is surprising to some analysts.
As volatility is injected into financial and commodity markets, tight inter-nation correlations cause it to spread quickly, as excerpted from Japanese Downgrade Illustrates Potential Paths To Contagion:
Moody's jumps into the fray, late as usual - but better late than never (how much better is up for debate). Once it comes to things financial, predictive is always better than reactive, no??? : Moody's Cuts Egypt's Rating, Warns on Spending. We also have the obligatory obvious statements, Business Leaders See Euro Zone Break-Up or Egypt Protests Negative for Growth: Risks that the troubles in Egypt may spread have increased and the uprisings have a negative effect on growth, as well as contributing to higher prices, economist Nouriel Roubini said.
So, where does this leave us in terms of our proprietary contagion model. Well, let's expound upon the good doctor's proclamation above by walking through the logic of the model.
Now, lets reference the subscription “BoomBustBlog Sovereign Contagion Model“, wherein we spent many analyst man/months to create a realistic model to capture the potential for social unrest, financial and economic contagion as they could skip across sovereign borders, continents, asset classes and hemispheres. Most analysts, investors and financial pundits look at the gross risk as cross claims between countries, very much in this fashion, which to many would be considered high end analysis…
What we set out to do was to adjust the pathways of apparent pure financial contagion with several, real world factors.
On page 10 of the retail contagion report and page 16 of the professional report, you will find this matrix which outlines the various paths of contagion given X,Y,Z factors and occurences. By tracing the path starting with the Middle East and following it to each of the successive countries with the highest total exposure (all model factors taken into consideration - a) government default b) private sector default c) social unrest) you can attempt to predict who may be next. The exposure is amazingly apparent and divergent from that of pure financial claims once you approach it from an objective, analytical perspective. Needless to say, there is a strong chance that some new names may be popping into vogue, outside of the media whipping boys of the past year (ex. the PIIGS group).
Middle Eastern unrest has strong and direct linkages to the most powerful (and indebted) countries in western Europe. The most exposed country is also heavily exposed to probably the most indebted country of size in the sphere, whose banking system has NPAs as a very significant and material percentage of the countries GDP and a vast amount of foreign ownership of its debt. It is quite feasible to see further unrest in the middle east causing material strain on the ECB, the indebted PIIGS group and political stress on those EU member nations who are considered stronger and will have to pony even more to prevent defaults. This leads to the strengthening of the presumption that some of the more profligate members of the EU may default or be asked to take significant shorts.
Next in this series of posts, I will drill down further into correlations than debunk the myth that the EU/ECB has put up enough capital to truly backstop the banks and the countries of the block in the case of another disruption. It is really about the simple math.
See the full Pan-European Sovereign Debt Crisis series here.