After having suffered the worst May since 1940 (Dow), equities have continued their sell-off into early June, amidst concerns about spreading European debt crisis, Chinese tightening and fading US recovery. The rally off the March 2009 lows was driven by liquidity, stimulus and improving economic and earnings data, particularly in the US. Now that government stimulus starts to taper off the question is whether economic growth has become self sustaining or not.

A natural slowing in the second half of the year has been expected. However, concerns about a double dip recession now appear to be growing, given the sovereign debt crisis and contagion risks in the eurozone and Europe’s impact on the global economy as countries start implementing austerity measures. Add concerns about Chinese tightening to cool an overheating economy and rampant real estate speculation, plus a weakening recovery in the US… the picture is not pretty.

In the US leading economic indicators have started turning over. The Economic Cycle Research Institute’s (ECRI) Weekly Leading Index has gone negative for the first time in over a year, falling to 123.2 from 124 the week before – the lowest level since July 2009. The ECRI WLI has historically been a good predictor of US economic activity, so its downturn is pointing toward a significant slowing in economic growth in the coming months. The Conference Board’s LEI for the US peaked in March.

China has taken steps to cool growth. China’s LEI (leading economic index) peaked last fall, Chinese PMIs are weakening and property market activity has been declining in response to the authorities’ measures to curb speculation. The worry is how much the world’s growth engine will now slow down; so far the economy remains very resilient (exports jumped 48.5% in May). However, the Shanghai Composite index is off nearly 30%, indicating weaker global growth prospects.

May saw the largest slump in commodity prices since Lehman’s collapse, pointing to potentially disappointing global economic growth. The Journal of Commerce Industrial Price Commodity Smoothed Price Index plunged 57% last month, the most since October 2008. Copper price broke down to a new 7-month low, before a bounce this week.

For now the global business cycle expansion appears intact but growth is starting to soften. A mid-cycle slowdown is not so unusual; however, it’s not immediately clear whether we should expect a normal moderation or indeed a double dip recession.

According to the yield curve a recession is not likely. Having correctly called past recessions when it inverted (short rates higher than long rates), the yield curve presently sees the risk of a recession in the next 12 months or so as near zero.

Buy on dips? Maybe not this time …

So, has the recent panic in the financial markets been overdone? The global economy and financial system are still fragile and vulnerable to further shocks, and confidence is fast evaporating. This is no time for complacency – things could get very ugly very fast.

On top of everything else, policy shock (including US financial regulatory reform outcome) is an additional risk investors have to consider. As is often the case, the authorities have been adding to the uncertainty by increasingly erratic moves (chaotic ECB actions, Germany’s ban of naked short selling of some financial stocks and eurozone sovereign bonds and CDS – likely to be further extended, etc). Such actions are counterproductive; they only heighten volatility, increasing the cost of capital and reducing liquidity.

May proved catastrophic for most assets, including equities, commodities (except gold), the euro. The winners have been the US dollar and Treasuries, reflecting a flight to safety as well as a symptom of a deflationary trend. (Money supply is falling at a pace not seen since the early 1930s!)

Markets went into June very oversold, so the relief rally currently underway was expected, and indeed could last a little longer. However it is unlikely to be more than a short term bounce. The S&P has now closed below its 200 day moving average for 16 consecutive sessions – a clear sign of trend change. Although we can’t yet be 100% certain that this is indeed something far more worrisome than a standard correction, there are signs that the trend has turned negative. Until there is more clarity it may be wise not to buy this market – you will likely be able to pick up most assets at much lower valuations late in the year.

It is true that the market has already priced in plenty of bad news – assuming the global recovery remains intact and there is no contagion from Europe; however, that scenario is increasingly looking too optimistic. Considered there is still a great deal of complacency, the bulls could be in for a nasty shock in the coming weeks and months.

Credit crunch is back!

Furthermore, there is good reason to believe this sell-off is different from the previous ones we have seen since March 2009 – the action in the credit markets. We have not witnessed significant deterioration and widening of credit spreads since the start of the rally – until several weeks ago. This is a fundamental change and a sign that the credit crisis is returning.

Credit is the early warning sign; equities lag deterioration in credit conditions. Decline in commodity and equity prices, and ultimately in economic growth, are a result of weakness in the credit markets. It would be foolish to overlook that the current correction has indeed a differentiating characteristics to it; do pay attention to the funding markets.

The European sovereign debt crisis is not going anywhere, and global credit conditions have been worsening. Cost of credit is rising and credit availability declining, which is affecting the funding needs of corporations worldwide. The economic fallout is only just starting to become apparent.

And it’s not only Europe. Higher cost of capital is also noticeable in the US and emerging markets where corporate debt spreads have been rising and debt issuance slowing. Funding markets are seizing up and capital is becoming more expensive, a consequence of which will be a squeeze in profits and slowdown in global growth.

Credit clearly continues to point to further stress ahead. Some disturbing signs that we may be witnessing the beginning of credit crisis 2.0:

Widening eurozone government bond spreads: yield spreads between German bunds and Club Med bonds have resumed their widening trend in recent weeks and in some cases became wider than before Europe’s mega bailout package was announced (although they tightened somewhat this week). And it’s not just the PIGS’s creditworthiness that has been deteriorating; we have seen huge spikes in CDS spreads on Eastern European sovereign debt and even that of France, Austria, UK and Germany over the last month.

European bank CDS have surged, indicating rising stress in the banking system, loss of confidence and growing risk aversion. It means sharply higher borrowing costs for banks. (European banks have raised less from the capital markets in the past six weeks than in any year since 1995.) Some smaller banks have been reported to be completely shut out of the credit markets. Even more troubling is that some of the world’s largest banks in Spain, Germany and France are now becoming infected. The Markit iTraxx Financial Index of CDS on 25 European banks and insurers soared to the highest level since March 2009 (before improving somewhat this week).

The LIBOR-OIS spread has widened significantly in recent weeks (now standing at 32.4bps). Equally, the TED spread has been deteriorating and is now at 47, up more than 300% in the last three months.

LIBOR-OIS and TED reflect the health of (and perceived credit risk in) the interbank lending markets. They are gauges of financial strength or weakness of banks. A rising spread shows that banks are unsure of the creditworthiness of other banks, hence charging higher interest rates to compensate for greater risk. Due to the European debt crisis counterparty risk is increasing and banks are reluctant to lend to each other once again.

Eurozone banks have been parking record sums in the European Central Bank’s deposit facility. Use of the facility, which pays an interest rate of just 0.25%, reached a new high of 364.6 billion euros (higher level than after the Lehman collapse) – a further sign that banks don’t trust each other’s creditworthiness, opting to instead deposit funds with the ECB.

The uncertainty is also rocking the corporate debt markets. May was the worst month for corporate bond sales for over a decade. Issuance of high-yield company debt nearly halted amid new signs that Europe’s sovereign debt crisis may be spreading; investment grade companies are also finding it more difficult to issue bonds. Both High Yield and Investment Grade spreads have soared in recent weeks.

There has also been substantial deterioration in the US Commercial Paper market (short-term IOUs), which contracted to its lowest level since 1999. Debt outstanding dropped, after six straight weeks of decline, to the lowest level on record as companies pared back on tapping short-term funding.

The European contagion impact and lack of liquidity is being felt in the emerging markets as well. New bond issuance of Brazilian companies halted for a sixth straight week, the longest stretch in 14 months, as Europe’s debt crisis drove up borrowing costs and caused a surge in volatility.

This worrying credit contraction is eerily reminiscent of the situation in summer 2007. Investors are fleeing all but the safest government securities. Poor liquidity and vanishing risk tolerance could see consumers contract, businesses stop hiring and investing and economic activity coming to a halt.

The prospects aren’t so good. A recent ECB forecast (Financial Stability Review, May 2010) that eurozone’s financial institutions may have to write off 195 billion euros of bad debts by 2011 – on top of the 238 billion already accounted for – confirmed fears about the fragility of the financial system.

Deflation and double-dip recession?

Meanwhile, the economic picture in Europe is not encouraging.

On the positive side, European core has been surprising with strong economic data; German manufacturing and exports are booming – exports to non-euro area have now surpassed the pre-Lehman bankruptcy peak (a weaker euro will only supercharge this growth), Germany’s PMIs are at a four year high; IFO Expectations Index is at its highest level since mid 2007.

On the other hand, Greece is insolvent and will unlikely avoid debt restructuring/default, which poses a massive risk for the European banking system. (Could Spain and Portugal also turn out to be insolvent in the end?) The hope is that Europe has bought sufficient time to stabilize the rest of the eurozone before a Greek debt restructuring.

The question is whether the European sovereign debt crisis could bring down Europe’s banking system, causing a collapse in confidence and economic activity similar to the fallout of Lehman in September 2008. It’s too early to tell, but a bank run (and a capital strike against eurozone investments) is looking increasingly more plausible.

(Of course European banks are already in a precarious shape, having made much less progress on writedowns and rebuilding of equity than US banks. They will also have to refinance some 800 billion euros in long-term debt by the end of 2012, and bank borrowing has already suffered a major blow because of sovereign risks – see notes above on deterioration in the credit markets.)

It’s not just the ultimate value of their government bond holdings the banks have to worry about. The deficit reduction and austerity programs much of Europe is embarking on are a step in the right direction but will inevitably kill consumption, investment and growth in the short to medium term. A long and painful deflation and severe recession in the periphery would appear unavoidable. (Defaults down the road are still a likely scenario.)

The fiscal retrenchment under way will see incomes in a number of eurozone countries beginning to fall in nominal terms; this will undermine the ability of households and businesses to service their debts, leading to a surge in private sector loan losses at European banks. Credit growth will also further contract as banks – already burdened with the until recently thought safe government bond holdings – will become even more reluctant to lend to riskier private sector borrowers.

Lack of credit will further reduce investment, job creation and economic growth. Slower growth and lower tax receipts will make it even more difficult for the periphery to get their debts under control. And, slower economic growth will create further problems for the banks, causing higher loan losses as highly indebted eurozone households and companies default on their loans. A vicious feedback loop.

A double dip recession in parts of the eurozone should, on itself, not have a disastrous impact on US and Asian economies, although some industries are companies will be more heavily exposed to diminishing European revenues (Europe is China’s largest export market). However, a potential collapse of the European banking system would undoubtedly have catastrophic consequences for the global financial markets, plunging the world back into recession.

And this time policy makers and central bankers would have little ammunition left to support the economy; interest rates are already at or near zero and there is (for now) little appetite for several more trillions worth of stimuli. That might change, of course, after a severe deflationary period, financial collapse, recession/depression; the Fed, ECB and other central banks and governments would then undoubtedly embark on quantitative easing and stimuli on a never before seen scale.

Deflation followed by hyperinflation, anyone?

Over the past weeks we’ve been digging down into what might, or might not be the real story. Everybody seems to have an opinion or three, from world class money managers to yowling cretins, and none of them seem to fully add up. Whither the economy?

There is a bewildering array of evidence pointing to global inflation, except that it also indicates overcapacity, a la Hyman Minsky, which instead means it should be deflationary, except that supply is creating its own demand, hypothetically, in China at least, which should be inflationary, except that world shipping fell precipitously and is staying down, which means deflation, except that foodstuffs are gaining, inflationary, but Prechter says deflation, which Arun Motianey claims is the precondition for inflation, but consumer confidence plunged and the Politburo hates inflation and the Brits are certainly on the brink of a national collapse because they have collectively drunk themselves to terminal cirrhosis, credit card companies have run amok, people are cutting back like mad and saving every dime, in total contradistinction to the prior era where easy credit proliferated like rats in the New York subway system, which should be deflationary, except flooding the system with liquidity should be inflationary, except the banks won’t lend it to the  businesses that really need it which is deflationary, and China is running an annualized GDP growth of 10.5% which is just nuts…

Baffling…infuriating…the truth is nobody has a firm idea… even Soros has gotten it wrong, way wrong, on occasion. What’s up?

On one level we believe that we are beholden to mental models, or framing mechanisms, that no longer suffice to describe the complexity, nor the potential instability of this new economic condition; we’re tweaking prisoner’s dilemma models when the global economy is beginning to look like a  3D Julia Set in a sped up animation. Could be our metaphors and mental constructs no longer cut it. This baby has plain run off the known map. Some of those mathematical curiosities that we loved to play with more than a decade ago may be getting closer to necessary descriptors of the real world than we realized.

Which leaves us where? The Chicago Fed’s favorite all purpose indicator, the CFNAI, is flashing recovery. And we admit, the CFNAI is probably as good of an all purpose economic indicator as we know of, being a diffusion index of 85 indicators run through a principle components analysis.

The question then becomes, what kind of recovery is this actually? Optimally one recovers into a state of mild inflation, which encourages borrowing and sets into motion a virtuous cycle of credit expansion, hiring, equipment purchasing, product line upgrades, and so on. However, as Richard Koo of Nomura will cheerfully remind his readers, there is another potential scenario, the not so salubrious debt deflation. In this circumstance, even a subtle tilt towards deflation can induce large borrowers to use their profits to first pare down their existing debt load rather than invest in expansion and upgrading. Which, of course, leads to the unhelpful lost decade syndrome. Aided and abetted by a period of low interest rates. Like we have now.

Practically speaking, there is no way policymakers can entertain the idea of a prophylactic increase in interest rates without risking mini-depressions at the state level. But the problem is hardly restricted to the nitty gritty of keeping the street lights on at night in Colorado Springs. Japan too is facing a potential double dip back into grinding deflationary territory which in turn further deflects borrowing behavior into saving behavior (as deflations reward savers and punish borrowers)… only now it seems that the US consumer is finally learning the same lessons that the Japanese consumer learned 20 years ago.

We are of the opinion that economic phenomena often appear as social phenomena, at the level of shared values, ideals, behaviors, and shifts therein before they can be captured and quantified as numerical  sort-of facts that make it to the public by way of the media blatheroons. We look for trends that are slowly working their pernicious ways to the surface. Such as…..

We must admit we find that disturbing on a multitude of levels. We recall that deflations have strong historical connections with phases of breakdown and decay. In the late 19th century nearly the entire agricultural sector was driven to bankruptcy by an extended deflation era. Deflations can be insidiously corrosive, slow moving glaciers that crush everything before them, unlike the swifter moving tsunami of hyperinflation. Each is coupled with a powerful social mood.

We take the prospect of deflation with great seriousness and no small degree of angst. We have noted as well that the Baltic Dry index, which reflects worldwide shipping of dry bulk goods such as ores, cement, grains, and the like, has remained at a surprisingly low level since the great breakdown, in spite of a couple of recovery bumps. Simply judging by the BDI, world trade is not recovering to anywhere near even the 2007 LOW, not the high.

On the other hand, there is China, which seems to be living in an economic universe so disconnected from our own it solicits disbelief. Is this in fact some form of massive decoupling that no one can adequately explain? Is this sustainable, a true breakthrough, a new epoch that makes fools of the naysayers, the great engine that will pull us out of what would have been a deep, cold worldwide depression?

China, India, and the Asian Tigers are, to put it mildly, on some kind of roll. As one writer put it, hot enough to make the devil sweat. But, my friend, when you go from 400 billion Yuan of bank lending to 1.4 Trillion Yuan in 2 quarters, you either really know what you’re doing or you’re about to burn the house down.

China promoters, Dr. Megatrends himself, John Naisbitt, included, seem to have bought the Unstoppable Giant Awakens scenario wholesale and retail. And for all we know he could be completely correct, or not. We have a few statistics that might help us appreciate the impact of China, more of an importer than many realize. Sure, they export manufactured stuff, but they still have a ravenous appetite for raw materials. Which they must buy on world markets. Which explains the extraordinary efforts they go to to insure uninterrupted flows of the elements of manufacture.

Thus we think it is fair to say that the Chinese relationship with the global economy is far more complex that the simplistic model that they sell us stuff and buy our treasury debt with the profits. A lot of that economic activity is leaking back out into the primary producer world, places like Africa. So the model of capital and material flows is
necessarily a more nuanced process of transforming economies they encounter and being transformed themselves by those contacts. China, for all of its legalistic and authoritarian rigidities, may be a novel form of a complex adaptive system that the American founders could not have imagined.

But complex adaptive systems can fall victim to their own contradictions and instabilities as well, and as far as we know, no imperial administrators for the entire duration of history have escaped an encounter with such systems suddenly taking on an unpredictable and frustrating life of their own. No rider has fully mastered the beast, although many have tried, and many have been seduced into the illusion that this time we have finally mastered it. We should be so lucky. And we never will be. Great Moderation, anyone?

With growth come growing pains. With hyper-growth come hyper-growing pains. Lao Tzu warned of this 2,500 years ago. Sudden wealth breeds envy, unfathomable greed, lust for power, ruthlessness, and often, terrible errors of hubris. We have noticed many reports of criminality, of the organized entity sort, and abuses of power.

Does this become a long running institutional struggle between power bases or will a central authority be able to impose a stable, uniform standard and rule of law across the extremely diverse population?

We cannot help but notice that the Western structure, as relatively wealthy as it is, with its excellent university system, with a long history of economic booms and busts, could have gone from the most overweening arrogance and sense of historical imperative to one of confusion and despair in less time than it takes to grow a fairly impressive plant behind one’s house or to put a child through one stage of education. Didn’t we also think that we had conquered risk and parked our vehicle at the end of history ?

Granted,  this World Bank study of per capita electricity consumption is 4 years out of date, however, it is suggestive of how great the development gap actually may be between the USA and China/India. We tend to see this as an indication of the degree of “standard of living arbitrage” that exists between cultures.  Our energy hogging ways speak to an outsized standard of living, just as the Chinese and Indian levels of electrical energy consumption point to the degree to which they are positioned to catch up to our levels of usage, which would be correlated with square footage of living space, the use of heating and air conditioning, lighting, entertainment systems and so on.

Given this metric we would infer that there remains an enormous upside potential for their consumer economies, and perhaps a degree of downside potential for ours as more and more highly skilled, highly educated work migrates East. One might infer as well that we have lifestyle addiction issues that will only be reframed by significant changes in flows of capital, goods, raw materials, and knowledge.

Paul Krugman is clearly concerned about the deflation scenario as well, but perhaps he does not see how intimately this dynamic is tied to the almost steroid driven drive for an improved standard of living in Asia.

We wanted to double check Krugman’s  source of concern, so we composed the following two charts. In the first case, we compared the Dallas Fed’s trimmed mean deflator (the blue line) with the CPI–minus-energy chart for the same period (the red line). In both cases these do show, expressed in % change YoY, what might be taken for the beginnings of a deflationary process.

On the other hand, there is energy, our national equivalent of pure glucose intravenous drip. Here we see an entirely different process unfolding. If everything else is a reasonably steady process slowly trending, energy pricing and energy’s effects on our economy are downright manic-depressive.

We see the deflation conversation in areas like the convenience store industry, where the vice-chairman of Wal-Mart hopes to see deflationary pressures ending soon in his industry.

Hopefully, yes, we’ll be seeing that.

The past week had the unmistakable feeling of an inflection point. Such moments of transition are the coming into awareness of potential realities and possible futures that had been slowly percolating in the collective unconscious. Per Clausewitz, “ it is always out of a mere inkling and foreboding of the truth that a man acts”… if anything, this has been a week of inklings and forebodings. There has been a general sense of expectations coming unglued, coupled with the anxiety that we’re not looking at a V shaped recovery, nor a U shaped recovery, but a long dreary slog through a slough of despond.

Not that we’re exactly shocked. The political class in the United States appears to have succumbed to the corrosive temptations of empires, rather like a primordial tarpit that slowly suffocates anything so unfortunate as to walk into said tarpit.

We also believe that Obama made a cardinal miscalculation by attempting to shift the agenda to health care reform dreadfully prematurely, long before the endemic problems in the financial and manufacturing sectors (and the attendant severe issues of unemployment) were adequately repaired. To have thrown the weight of his political capital into the infinite labyrinth of the health care industry so soon after the market collapse was pure folly.

This brief analysis based on the Fed’s data gives us a rather amazing insight into how extensive, consistent, and programmatic the collapse of the industrial sector in the United States has truly been. More incredible is that this chart showing the true nature of the decline, and the length of the decline, hasn’t made it into the financial media as far as we know. Quelle Surprise.

The first chart is the raw number, dating from 1939, when the average house cost $3,800, the last man was guillotined in France, Hitler invaded Poland, and Tina Turner was born, of people employed in the manufacture of durable goods.

This next chart shows the percentage of the entire US workforce employed in durable goods manufacture. As late as 1969 it consisted of 15% of the workforce, by 1990 it was 10% of the workforce, by December 2009 it was about 5% of the workforce. If it continues in this pattern, by 2030 it will cease to exist altogether.

We predict this has put many Americans in such an economically untenable position that we will see the inevitable return to protectionism, nativism, and paranoia that is part and parcel of American history when fear and loathing of displacement enters the national discussion. These phases are rarely a pretty sight.

State budgets are in absolutely horrible shape. Unlike their federal counterpart, states can’t print money and they are required to run balanced budgets, which has become a technical and practical impossibility. When Montana and North Dakota are the fiscally healthiest states in the nation, you really have to wonder.

The difficulties are hardly limited to the United States. We’ve been wondering mightily about the real significance of the price of gold. Our attention has been drawn to the idea that China is a major purchaser of gold, which we interpret as being motivated by one of two reasons, neither are comforting. One is that there is no currency alternative to dollar based holdings, and at a ministerial level their confidence in the dollar, and perhaps the country that prints dollars, is coming undone.

Interestingly, Robert Prechter at Elliott Wave International has suggested that precious metals may be at a major top, based on a Fibonacci ratio analysis of other historical highs.

Is this time different, and if so, what might be different this time?

We tend to believe that a second scenario might be worth considering, that gold is not only being accumulated at the state treasury level, but also as a hedge by wealthy Chinese in case the Great Expansion doesn’t work out exactly as planned.

When we looked at the Global Integrity Index for 2008 for “practical implementation” of their legal framework, they were graded in the lowest quartile, below say, Serbia, Azerbaijan, and Ecuador. This suggests that, despite enormous strides, there is weak confidence that everything is as stable as it may seem.

In addition, we did a small study of the Consumer Price Index dating from 1914, taking through economics in its Classical, Keynsian, Neo-Classical, and Wherever We Are Now phases. This is very instructive, as it allows us to see American history unfolding in terms of price stability.

This becomes clearer when we convert this data into year-over-year changes and see that we never have dipped into negative territory since the economy stabilized and got moving around 1955. Until last year that is. Clearly deflation is perceived as a danger to be avoided at all costs. Whether it CAN be avoided is another question.

The world is in a most precarious condition when China must figure out a way to contain a potential runaway inflation and we must contrive to do the opposite. Should either zone lose control of the process, the opposing zone may also be thrown into a chaotic condition.

Which is all quite speculative. However, our friends at Petroleum Intelligence Weekly have somewhat ominously noted, American refineries are running at only 80% of capacity, and Japanese refineries are running at about 70% capacity, suggesting very weak demand for energy. China on the other hand is trying to get hands on all available energy sources, with very large refinery runs.

We took the CPI yoy data from 1914 and ran a Fourier transform to see if it might give us some hints about the future. Obviously this is only one possible model based on past economic cycles, so consider it one scenario out of many possibilities.

If there are long term cycles that became ironed out to a degree with the emerging US-China relationship, they may be reasserting themselves in this era.

It may also be worthy of note that a recent Supreme Court ruling on campaign finance reform was poorly received, to put it mildly. President Obama lashed out in language rarely heard directed by a President toward the court.

The intensely populist language points to a growing culture of populist resentment and radicalism in the American electorate, which makes for interesting times and impulsive legislation, typically leading to a reduced appetite for risk, at exactly the time that risk aversion may be leading us into a liquidity trap.

Public debate lurches from the timid to mediocre to the bizarre to the incoherent, a symptom of the intellectual incoherence of our age.

Which leaves us where? The political process appears to be slowly coming unglued, the media incapable of communicating anything like a clear understanding of the realities and perils we face, and the financial system uncertain as to whether there is another boot left to drop.

Although we are in no wise where we were in 1932, history, as Mark Twain said, doesn’t repeat but it rhymes. The core problem of the 1930s was incoherence. Established models such as the gold standard had broken down, the finance ministers and governors were products of an earlier era with no maps to guide them, and the world had entered a procedural vacuum.

Once again a generation of free market philosophers is having to improvise an interventionist strategy with inadequate models from a vastly different set of circumstances.

“A man may be sharper than another, but not all others”

-La Rouchefoucauld

“Nothing on earth consumes a man more completely than the passion of resentment”

-Nietzsche

“People who bite the hand that feeds them, usually lick the boot that kicks them”

-Eric Hoffer

We are well to hold in mind that every political moment is an economic moment is a social moment. Long periods of prosperity create formulaic thinking, banal entertainment culture, speculative energy distracting from a general ennui, a certain nostalgie de la boue, an indifference to corruption, a fondness for idiocy, a displacement of common sense and common courtesy by trivial rules and regulations, by tinpot “outrage” in place of penetrating insight. This won’t be the first time we’ve been in these parts.

So far the Venture Capital Association reports that ventures are still getting funded. That’s a good sign, because it means that there is still great confidence in the long term for America to creatively respond and sophisticated investors do see the long term payoff as deserving of the risk. If venture money had dried up altogether, that would have been a far more ominous long term sign. Assuming that the VCs are better informed and more intelligent than the average investor, and have longer time lines with fewer constituencies to placate, we will take this as a positive sign of confidence in the deeper future.

However, for the moment, VCs don’t seem to be doing IPOs, we assume that their view of the current market is that now is not the time. We take that as a medium term negative. Perhaps a strong negative.

Or a large change in direction.

According to Ari Levy and Dakin Campbell in their January 19 blurb on Bloomberg:

Veteran venture capitalist Dixon Doll predicts that more U.S. technology companies will start holding initial public offerings in other countries as economic growth in Asia outpaces domestic expansion.

“In the next 10 years, I expect more portfolio companies to list on foreign exchanges,” said Doll, founder of Menlo Park, California-based firm DCM, in an interview last week. China “will become a big deal.”

The U.S. venture-capital industry is coming off its slowest two-year stretch for IPOs since the mid-1970s, with only 19 in 2008 and 2009, according to the National Venture Capital Association. Doll said that while U.S. companies may not flock to China in the next year or two, the world’s third-largest economy will be increasingly attractive for technology start-ups as its capital markets mature.

China’s gross domestic product will expand 8.5 percent this year and 9.3 percent next year, according to Bloomberg surveys of economists. That compares with average predictions for U.S. growth of 2.7 percent in 2010 and 3 percent in 2011, according to Bloomberg.

Doll, 67, said he expects 40 to 50 venture-backed companies in the U.S. to go public this year, because the “system is so constipated” from two years of inactivity. The financial crisis wiped out investment banks such as Lehman Brothers Holdings Inc. and Bear Stearns Cos., and forced more than 850 hedge funds to shutter in the first nine months of 2009. That left fewer banks to lead IPOs and fewer investors to buy shares in them.

In the words of Jim Morrison, “the future’s uncertain and the end is always near.” We simply may have to go through a painful schooling in the next few years as we unlearn many of the lessons we took to heart as we moved from what appeared to be a Keynesian orthodoxy undone by a great inflation to a Chicago school era that began brilliantly and ended in chaos. Until the new synthesis of economic theory, social expectations, political frames, and a stable contract between economic stakeholders in in place, we should brace ourselves for a witches ride.

China may successfully break with a historical pattern and successfully manage its’ way through a period of hyper-expansion. It is our belief, however, that stable institutions require a long time to develop, and a longer time to become uniformly internalized beliefs about the nature of social and economic reality.

The great downturn beginning in 2007 forced China to re-imagine itself as a nation of internal markets. Wise policy level figures have long understood the need to gorge expanding social classes on tempting distractions lest they become overly curious about the mechanism of the state itself. Which requires a rapid expansion of credit so that this new class CAN indulge itself in new toys.

We made this error between the Clinton and Bush administrations when we made the political choice to buy off the electorate with a fantasy world of palatial homes and (imported) consumer goods, founded on the substrate of a corrupt and unstable credit allocation mechanism. Will China be capable of discovering another, less Minsky flavored path ?

Two stories have dominated the news over the last few days. The attempt to blow flight 253 out of the sky has caused headlines around the world. The other news, creating as much – if not more – uproar here in the UK was the execution of drug trafficker Akmal Shaikh, a British citizen caught with 4kg of heroin in China. (4kg are apparently enough to kill 27,000 people.)

After an overdose of incessant outrage by all the bleeding heart liberals I simply had to share my thoughts on the matter.

Shockingly, Mr. Shaikh had found fervid defenders in Gordon Brown and other members of the UK government and our liberal elites. According to official sources the government raised the case on 27 occasions, including Gordon Brown’s direct interventions with Chinese president Hu Jintao and Prime Minister Wen Jiabao.  Their repeated calls for clemency were (thankfully) unsuccessful. As a result, our Prime Minister attacked and strongly condemned China this week, while the entire official campaign grew increasingly hysterical.

At a time when the UK is on the verge of bankruptcy thanks to a record deficit and general mismanagement of public finances and the economy, when British soldiers are killed in Afghanistan thanks to a lack of equipment and missing support from the government, Gordon Brown had seemingly nothing better to do than try to save the neck of a rightly convicted criminal.

As has been only too common with British criminals, Mr. Shaikh claimed to be suffering from a mental disease and hence not being responsible for his crimes. The illness he saw as a convenient coup-out was bipolar disorder.

To be fair, I have no way to know if Mr. Shaikh was bipolar or not. (It is interesting, however, that there have reportedly been no medical records of his ‘illness’.) The point is, he was clearly fit enough to conduct his criminal business, travel the world and traffic drugs. He absolutely knew he was committing a crime for which death penalty is the punishment in China and much of the Far East. As far as I know, nobody has forced him to go to China and break their laws.

Anyone who is (mentally, physically) fit to commit a crime is fit to stand trial and be punished. There are millions of people suffering from bipolar disorder, and they would happily attest that it doesn’t make them go out killing, robbing, or selling drugs. Blaming bipolar for a criminal career is an insult to all the law-abiding people who suffer from a mental illness.

I am glad China has not allowed itself to be bullied into reversing the sentence handed out by its courts. I cannot think of any country that has less of a right to criticize China when it comes to criminal justice than the UK.

We all know that our liberal elites view drugs as a fashionable habit and matter of personal choice rather than a serious criminal offence. Drug dealers are free to ply their trade in this country, celebrities openly hooked on drugs are revered as role models, even prisoners have easy access to drugs any time they wish to.

Worse still, drug users are rewarded by our welfare system. An estimated 267,000 drug addicts live off state benefits – addiction is seen as ‘disability’, entitling them to generous welfare payments. As usual, the (shrinking numbers of) hard working taxpayers are condemned to support the useless and destructive lives of criminals and drug users.

The Chinese Government should be applauded, not condemned, for acting to defend its people and society from the drug trade. I have little hope we will ever see our own government do the right thing and act vigorously against crime.

Meanwhile, we witness the workings of UK justice (laughable to even call it such) on a daily basis. The vast majority of criminals – including burglars, robbers, violent attackers, serial criminals with dozens of offences, and at times even rapists and pedophiles -continually escape custody. In fact, hundreds of thousands of crimes that carry a lengthy jail sentence in other countries don’t even make it to UK courts anymore – criminals are instead given on the spot fines and cautions.

Murderers are unlikely to spend more than a handful of years behind bars either. Only yesterday we saw a man who killed his wife – stabbing her 96 times (while their children where playing nearby) – released after just 5 years. (That means serving less than three weeks for each mortal wound.) As unbelievable as it seems, his was still one of the longer prison stays compared to many other murderers.

Offenders, no matter how shocking their crimes, are seen as victims. Victims of their upbringing, social class, environment, society, alcohol or drug use… anything is good enough an excuse. As such, they don’t deserve to be punished, for it would be ‘inhuman’. They must be supported and protected instead. A pity that the true victims seem to warrant no such humanity.

Our rotten justice system, inept government and the liberal intelligentsia with their destructive, ‘progressive’ ideas should learn from China, instead of lecturing and condemning it.

If they did, we might still have a chance of reversing the rampant drug and crime problem and complete social and moral breakdown we have been witnessing here. The reason why we have seen violent crime rates soar is the lack of any punishment, derisory sentencing and shockingly relaxed prison regime.

A society that rewards criminals and punishes the victims (whenever they try to protect themselves amidst a lack of protection from the police or law), while law-abiding citizens are increasingly afraid to walk the streets, is inevitably heading for self-destruction.

If anyone needs a proof that the Chinese justice system works, I can only encourage you to spend some time in Chinese cities. They are safe, with low crime, no anti-social behaviour, no vandalism. Then compare to the mayhem back home. Unlike the UK, China seems to understand that the state has a responsibility to protect the lives of vulnerable and innocent citizens. In failing to do so our government endangers all our lives and is co-responsible for millions of future victims.

Needless to say, I don’t support political imprisonment. However, when it comes to actual crime, China is right.

And for those who have cried out in support of the convicted drug trafficker: Save your sympathy for the victims instead.

And yet more appeasement…

The second story of the week has also much to do with appeasement. For Labour is well versed in that – whether it comes to criminals or, as in this case, radical Islam.

As we now know, Umar Farouk Abdulmutallab, who attempted to blow up Northwest Airlines flight 253 on Christmas day as it approached Detroit, was educated in Britain. It is here he was reportedly radicalized and turned to terrorism, before leaving to train with Al-Qaida in Yemen.

That should have come as no surprise. Although the majority of British Muslims oppose violence, there are many thousands who support the use of terror in the name of the Islamic cause. A number of them travel to places like Yemen to be trained and prepared for suicide missions, just as Nigerian born Abdulmutallab did after ending his studies at the University College London in 2008.

It’s not just British born extremists either. The UK has been a magnet for foreign radicals thanks to the generous welfare state, easy-entry immigration policies and extreme tolerance to expressions of radical Islamist views. The vast number of British connections of known terrorists and dozens of terror plots hatched and uncovered here are evidence the UK has become one of world’s main hubs of radical Islam and terrorism.

British intelligence has long known that many universities across the country have been infiltrated by militant jihadists. It is also no secret that extremists preach hate at many mosques and madrassas and use them as recruitment centres.

The sheer size of the problem is shocking. A 2008 poll by the Centre for Social Cohesion showed that nearly 30% of Muslim students in the UK thought killing in the name of Islam to be justified.

You’d think something was being done about this. Well, you’d be wrong.

British universities, including the University College London where Abdulmutallab was president of the Islamic Society, have been inviting radical preachers to give lectures. These are known extremists who spread anti-Western propaganda, incite killing of gays and violence against infidels. It is astonishing and criminal that this radicalization of students is allowed to go on in this country. No surprise then that a large number of known terrorists have studied at British universities.

And it’s not just universities. Radicals are allowed to openly preach hate and murder in UK mosques and at times even in mainstream media, and extremist Islamic networks can operate freely.

The government, although well aware of the threat, prefers to do nothing. All in the name of diversity, multiculturalism, human rights and other ‘progressive’ ideals.

While most countries arrest, jail, extradite or deport those who are linked to terrorism and incite murder, the UK seems to welcome them with open arms.

What is no less disturbing is that while radical Islamists are allowed to express their criminal views openly, those who come out in criticism of anything that has to do with Islam are rarely treated with such courtesy. For in the best case they are accused of islamophobia and racism and, in the worst, charged with some spectacularly misapplied criminal offence.

Our leaders insist that extremism and terrorism are simply matters of violence and have nothing to do with Islam. They have chosen a path of appeasement, frightened of offending Muslims or making them feel targeted in any way.

Even the concepts of patriotism and national identity have become an inconvenience and increasingly provoke embarrassment or outright derision. Apparently they are unfit for a modern, multicultural society. I have lived in many countries over the last fifteen years. Britain is the only one where patriotism is a dirty word.

But it gets worse still. Not only does our government not fight this widespread radicalization, it often indirectly supports it. Millions of pounds of taxpayers’ money are poured into promoting the ‘real’ (peaceful) Islam, much of it diverted straight to radical groups. Some of the organizations the government supports are known to harbour extremist views. A number of extremists are even on the government payroll as advisors on radical Islam.

Am I the only one who thinks all this is insanity?

It’s important not to demonize those Muslims who oppose violence and extremism. They are just as entitled to live here in peace as any other religious minorities. But isn’t it time to take steps against those who preach hate and violence and openly admit to want to destroy the British society and Western way of life?

That includes prosecuting and jailing those who incite murder, deporting and extraditing the many who are wanted abroad for terror-related crimes, outlawing the extremist networks and tightening up immigration controls. I’d like to think it will happen at some point. Time is running out though, and our ruling class is not exactly known for common sense policies…

Chances are, we’ll get an extra large dose of diversity, multiculturalism and other politically correct ideas instead. And more hassling of old ladies at airports, so that certain groups don’t feel offended for being singled out. After all, profiling those who are most likely to present a threat is terribly un-PC today, and making life more onerous for everyone is so much more ‘fair’.