- How Shale Is Reshaping The World: Three New Wars
We recently met with geopolitical strategist Peter Zeihan to discuss world events since the American election and his new book, “The Absent Superpower: The Shale Revolution and a World without America.” In the book, Peter credits energy and resource innovations with reshaping the global geopolitical environment.
We covered so much ground in our visit with Peter that we decided to break it into two reports. Last month in part 1, we covered the broad impact of the Shale Revolution, which he calls, “the greatest evolution of the American industrial space since 1970,” and which he expects to accelerate the breakdown of the global order as we know it. Today, in part 2, we examine the major global shifts in geopolitics that will result as the US moves into energy independence. Peter believes this will reshape global geopolitics, leading to three major conflicts – Russia vs. Europe, Iran vs. Saudi Arabia & an Asian Tanker War. It is these conflicts we asked him to discuss in greater detail. We hope you enjoy the discussion.
GAVEKAL CAPITAL: We last left off discussing how the oil export ban could be rescinded if global geopolitical issues flare up. What are you on the lookout for?
PETER ZEIHAN:There are three big conflicts I see that could cause a major schism between what the US pays for oil and what the rest of the world pays for it. I’m talking about a potential global oil price of around $150 per barrel while the US pays only $50 per barrel thanks to shale oil in the US and a resumption of the ban on oil exports. The break-even cost in the United States is around $40. If you put the embargo back in place, you’ve got a functional ceiling on how high the price can be domestically. If shale overproduces and you can’t export the crude, then it’s a question of refining capacity which can’t be built out that quickly.
War number one is Russia vs Europe. The Russian demographic situation is already untenable and it’s moving into catastrophic. By the time we get to about 2020-2022, the size of the Russian army will be less than half of what it was last year. The post-Soviet Union baby bust was that sharp, so if they are going to use their military in an attempt to re-shape their world, they have to do it now. And in many ways they already are. Depending on which scenario plays out -I list several in my book -anywhere from two to seven million barrels per day of crude in the market goes offline. Former Soviet Union oil shipments are in danger in Estonia, Latvia, Lithuania, Eastern Poland, Belarus, Moldova, Ukraine, Northeast Romania, Azerbaijan, Armenia, and Georgia. That list is the entirety of Russia’s western energy exports. The Russians will either use oil as a political tool, or the targeted folks will say, “You’re not going to sell crude through us while you’re conquering us.” Either way it’s going offline. And because Russian energy production is in the permafrost it can’t be shut in safely. If you turn off the wells, they freeze solid and you have to re-drill them, so from the point that the Russians stop production in a field, it’s 10 years minimum to bring it back online.
One of the biggest mistakes I think people make when analyzing Russia is they don’t realize that the Russians are not thinking about money right now. The general consensus is that the Russians won’t do anything to disrupt the flow of oil because they need the oil income. That’s not how the Russians are thinking at all. Their current borders are completely unsustainable, and they only have a short window to do something about it. The Russians see the end of their country on the horizon, and they’d rather have that be 60 years from now than five years from now. There’s no route for withdrawal: they’ve got to get through to the Carpathians, the Caucasus and they’ve got to get to the Polish gap and the Baltic Sea.I believe Russia’s move to extend its border is going to fail, but if I were Putin right now, I wouldn’t have a better plan. And that will take, based on which scenario goes down, between two million and nine million barrels of crude offline, and five BCF and 12 BCF of natural gas.
GC:What do you think of the relationship between Trump and Putin?
PZ:For two men with egos as large and as fragile as Trump and Putin, I can’t imagine they’re going to get along for long. However, for 2017 both of them have a lot reasons to focus on other issues, so burying the hatchet for the moment makes a lot of sense. Also, the United States has no long-term rationale to get involved in a ground war with a nuclear-armed power who’s a shell of its former self, with nothing to lose and who is invading countries that aren’t even defending themselves. I expect the rhetoric to pick back up, but for 2017, I think it’s going to be pretty calm in bilateral relations. This will free up Russia to act more aggressively regionally. That means Ukraine is even more in play. That means breaking up the European Union. That means consolidating the former Soviet space. All of that is going to go into high gear this year and next.
GC:What’s Russia’s interest in breaking up Europe?
PZ:If the Europeans are squabbling –and it’s not a difficult task to get the Europeans to squabble –they can’t form a common front against the Russians unless they’re American-led. So if the Americans step back for their own reasons, and you can keep the Europeans at each other’s rhetorical throats, Russia can take advantage.
GC:What would be the bell that would ring that would announce to the world that Russia is on the move?
PZ:We have the French nationalists saying that the Russians are intervening in French national elections just like they did in the US. So the bells are ringing left, right and center. It’s happening. We’ve already had civil discontent in Latvia and Estonia caused by Russian efforts.
GC:Who goes to bat for these countries?
PZ:Well, if it’s not the United States, if you’re the Baltic countries, it’s Sweden. And I think they will. But Sweden can’t roll back the Russians by themselves. They can make it hurt like hell. For Poland, it’s Germany. The Poles just get the bad end of every stick throughout history, and they’re about to get another one. For Romania and the Caucasus, it might be Turkey. Although the Russians are doing everything they can to make sure that the Turks don’t want to get involved, and so far it’s working. Poland, plus Germany, plus the Scandinavians, plus the Brits are sufficient to roll the Russians back.
GC:Are you starting to see movement of personnel and material in anticipation of this?
PZ:All three of the Baltic states (Estonia, Latvia and Lithuania) have given up on conventional warfare. They have largely, for all practical purposes, disbanded their conventional militaries and they’re training their entire population in guerilla tactics. They know what’s coming. And the number one country to assist them with that is Sweden. The Finns are basically breaking out all their grandfathers’ equipment and getting ready for another Winter War.
GC:Geographically, is it easy to roll into the Baltic states and Poland?
PZ:Estonia and Latvia are nearly as easy to roll into as Poland. Lithuania is a little bit more difficult. There’s a lot of forest; it’s a bit more rugged. But rolling back the Russians on land has to be German-led, and the Germans don’t have an army right now. They’re the only ones who have the demography to potentially fill a force that could do it.
GC:What could Europe do that would be sufficient for Trump to want to get involved?
PZ:If they doubled defense spending in the next 12 months, that could at least get the conversation started. But if the free trade era is over, if Bretton Woods is over, why would you get involved if you are the US? It’s not a ridiculous position, even if Trump makes it sound that way sometimes.
GC:Does the US continue selling weapons to everyone?
PZ:Oh, of course, the US isn’t that crazy! The US will still pick sides, will still provide intelligence and might even rent out a bunch of drones. I don’t mean to suggest there’s no American role, but the idea of the US Army coming to the rescue, that’s off the table. As we discovered in Crimea, NATO’s rapid reaction divisions are only 500 troops each. In the aftermath of Crimea, only four divisions of 500 troops were sent. The US provided one, Canada provided one, Poland finally provided one, and the other one was all the other NATO counties put together.
GC:How many Russian troops are in Crimea, Ukraine, right now?
PZ:It is tough to know exactly but I’d say at least 15,000 Russian troops are in Crimea. On paper, the Russian military is still basically a million-man army. They are not, man for man, nearly as good as American troops, but they’re better than Spanish troops or Italian troops or Polish troops. In order for Russia to pull this off they probably need at least 100,000 troops. You’re talking about two million square miles and 70 million people. You’re not going to do that with 10,000 people.
GC:This is going to take a massive mobilization effort on Russia’s part, right?
PZ: Well, the mobilization won’t take as long as you’d think because there’s already at least 25,000 Russian troops on the Ukrainian border, not counting the ones that aren’t officially in Ukraine proper.
That process has already started. The Ukrainian military has basically been decapitated. You haven’t heard a lot about Ukraine recently because the Russians sent in a few special forces troops to bait the Ukrainians to send out their own best troops –their American-led, American-equipped troops –to the front. Then Russia used regular army and air force to kill all the commanders of all the best units. So all that Ukraine has left now are reservists. When the war comes, unless the Ukrainians resist to the last man, the regular, organized resistance is already over. It’s just a matter of how fast do the Russians want to push into Kiev.
Now, once they get to Kiev and the bridges over the Dnieper River, you enter a slightly different sort of war because you move into Western Ukraine which is not a Russified Ukraine. You’re more likely to have civilian resistance in Western Ukraine. But that first half, if that takes a month, I’d be really surprised. Belarus will welcome Russia in, and Estonia, Latvia and Lithuania combined are only six million people. Moldova can’t manage political opposition to Russia, and the Russians already have an active military base with 10,000 troops. So that just leaves Romania. If Romania and Poland are the great hope for the West in this war, then it is not looking good.
GC:Do you think that war starts this year?
PZ:I don’t know when it will officially begin, but with the way the political relationship is going, and with what I think is about to happen in Europe, it’s a golden opportunity. The Russians can’t maintain this tempo with the demographic situation for very long so the sooner they start it, the better. If you start it before the Europeans start to function like nation-states again, and if the Americans have already exited stage left, it’s a perfect opportunity. Once the ball gets rolling, this will take several years to play out. I think maybe the end play for Russia is to get the Germans to say, “Okay, you can have Ukraine, but you can’t have Poland. Okay, you can have Belarus, but you can’t have Poland. Okay, you can have Estonia, but you can’t have Poland. What? You took Poland? You can’t have Romania.” That’s basically what the Russians are hoping for. It’s not a stupid plan. That would be their preferred path. And it’s worked before. “Okay, you can have Eastern Poland but we draw the line at Western Poland.” That’s World War II.
GC: What is war number two?
PZ:So Russia vs. Europe starts on its own, not over energy security but energy is a clear casualty. Conflict number two is Iran vs. Saudi Arabia in the Persian Gulf. If the Americans remove themselves from keeping those two powers apart because America no longer cares about keeping oil flows out of the Persian Gulf safe then those two countries fall into direct competition. Eventually, that competition turns into an attempted Iranian invasion of Saudi Arabia.
GC: How does that play out?
PZ: There’s a 300-mile desert gap between Kuwait and the oil fields of Saudi Arabia, and it’s not clear that the Iranians can make it across. What the Saudis are doing right now in Yemen is target practice for that, they’re preparing, learning to use their military equipment, particularly their air force, to turn that northern desert buffer into a kill zone. Right now, they are doing it pretty well. Will it be enough? I don’t know. The Saudis would rather not face a war at all, but they know that in a post-Bretton Woods world, without American protection, over time the Iranians will bury them. So just as the Russians feel that they’re on a limited time scale to create more sustainable borders, the Saudis feel they’re on a limited time scale to crush Iran. The 2015-2016 oil price war then wasn’t really about shale, it was about Persia. And to be perfectly blunt, it hasn’t worked as well as the Saudis hoped.
GC: So will the Saudis try to develop nuclear weapons?
PZ: No, if it comes to that, Saudi Arabia will just buy them. They can get them from Pakistan and that conversation has already happened. Pakistan has 150 nuclear weapons, and if they can sell them for $1 billion a pop, they are happy to do it. The Saudis are already providing them with subsidized oil in order to make sure that those lines of communication never close. Assuming no one else gets caught in the crossfire, that’s potentially another 11 million barrels per day of crude off the market when these two countries go at it. And if other countries get caught in the crossfire, it goes up to 20 million barrels per day. So the Persian Gulf is War #2.
GC: Is it connected or disconnected from the Russian war?
PZ: Disconnected. It could start any time, it could start tomorrow. When the Iranians realize what the Saudis are up to and that it can kill them, that’s when this war begins. The Syrian war has taken a turn that is relatively pro-Iranian recently, so Iran isn’t feeling stressed. A year ago, it was going a very different direction. ISIS is probably the calmest, kindest sort of group that the Saudis will form over the next few years because it is proving that it wasn’t enough. Now, I don’t mean to suggest that the Saudis are pulling the strings of ISIS; they just formed it and then let it go off on its own. And as long as ISIS is killing Persians and Persian allies, the Saudis are totally fine with it. And the Saudis will form more groups, they’ve probably already formed a hundred groups in the last six years alone. Most of them are fighting in Syria but not exclusively, some of those groups like Jundallah are already in Iran.
GC: What is the third war?
PZ: The third war is dependent on one of the first two: it doesn’t matter which one happens first, either one will trigger the third war. If you have an oil shortage anywhere in the world — because Russia is on the move toward Europe or because Iran is invading Saudi Arabia — energy security and availability for the rest of the world becomes a question of transport routes. The world’s longest, most vulnerable transport routes are from the Persian Gulf to Northeast Asia. Based on whichever country you are in, that’s anywhere from 5,000 to 7,500 miles. If you have a shortage anywhere, Northeast Asia has to eat the entirety of the shortage because they are furthest from the wells. And, worst of all is that there’s not enough to go around for the Koreans, the Taiwanese, the Chinese and the Japanese. Somebody has to go without, and the country that goes without is the country that cannot physically defend crude oil on a convoy route from the Persian Gulf all the way home. So the third conflict is an Asian tanker war, and that triggers all kinds of different results.
GC: Who will be the winners and losers of the tanker war?
PZ: The countries that have the longest reach, like Japan, will probably be able to protect their transport routes the whole way so they should be OK. Japan has by far the strongest navy in that region of the world. Countries that have a deep and abiding experience at bribing people, such as Korea and Taiwan, will probably pay India to fly cover for them for the first part of the trip through the Indian Ocean. This could work out for them, but it comes with a lot of risks. The Chinese have a serious problem with naval power projection and are going to have to establish bases closer to the oil source. That means China will probably have to invade chunks of Vietnam and the Philippines so that they can turn the South China Sea into an internal lake. If they successfully do that, then that’s a 1,000 miles less they have to worry about transporting and protecting their energy supply.
Ultimately though, I would expect the Chinese to lose the tanker war because of how much oil they need and their relative lack of naval strength. I think the tanker war will be the shortest of the three wars, but it’ll be the most colorful, because it basically breaks down the entire structure that has sustained Northeast Asia’s economic ascension for the last 60 years.
By the end of these wars, I would expect us to see around $50 oil in the US, $150 oil in Paris and over $200 oil in Beijing (assuming any crude can make it to Beijing at all). The whole supply chain model that has made East Asia successful for the last 50 years will be gone. All that manufacturing capacity has to relocate, or because of the global demographic breakdown and the energy crisis, all that capacity may just disappear because of lack of demand.
Peter Zeihanis the best-selling author of “The Accidental Superpower.”
- Exposing The Clinton/Obama System To Discredit Donald Trump
Authored by Thierry Meyssan via VoltaireNet.org,
This article is a warning – in November 2016, a vast system of agitation and propaganda was set up in order to destroy the reputation and the authority of President Donald Trump as soon as he arrived in the White House. It is the first time that such a campaign has been scientifically organised against a President of the United States, and with such resources. Yes, we are indeed entering a post-Truth age, but the distribution of rôles is not what you may think it is.
The campaign waged against the new President of the United States by the sponsors of Barack Obama, Hillary Clinton and the destruction of the Greater Middle East is on-going. After the Womens’ March on 22 January, a March for Science is scheduled to be held not only in the USA, but also throughout the Western world on 22 April. It’s goal is to show that Donald Trump is not only a misogynist, but also an obscurantist.
The fact that he is the ex-organiser of the Miss Universe pageant, and that his third wedding was to a model, is apparently enough to prove that he holds women in contempt. The fact that the President contests the rôle played by Barack Obama in the creation of the Chicago Climate Exchange (a long time before his Presidency) and rejects the idea that climatic disturbances are caused by the expulsion of carbon into the atmosphere attest to the fact that he understands nothing about science.
In order to convince US public opinion of the President’s insanity – a man who says that he hopes for peace with his enemies, and wants to collaborate with them in universal economic prosperity – one of the greatest specialists of agit-prop (agitation & propaganda), David Brock, set up an impressive system even before Trump’s investiture.
At the time when he was working for the Republicans, Brock launched a campaign against President Bill Clinton which would eventually become Troopergate, the Whitewater affair, and the Lewinsky affair. Having changed his colours, he is today in the service of Hillary Clinton, for whom he has already organised not only the demolition of Mitt Romney’s candidacy but also her riposte in the affair of the assassination of the US ambassador in Benghazi. During the first round of primaries, it was Brock who directed the attacks against Bernie Sanders. The National Review qualified Brock as «a right-wing assassin who has become a left-wing assassin».
It is important to remember that the two procedures of destitution of a serving President initiated since the Second World War were set in motion for the benefit of the deep state, and not at all for the benefit of democracy. So Watergate was entirely managed by a certgain «Deep Throat» who, 33 years later, was revealed to be Mark Felt, the assistant of J. Edgar Hoover, Director of the FBI. As for the Lewinsky affair, it was simply a way of forcing Bill Clinton to accept the war against Yugoslavia.
The current campaign is organised in secret by four associations:
Media Matters is tasked with picking up on Donald Trump’s mistakes. You read his bulletin every day in your newspapers – the President can’t be trusted, he got this or that point wrong.
American Bridge 21st Century has collected more than 2,000 hours of videos showing Donald Trump over the years, and more than 18,000 hours of other videos of the members of his cabinet. It has at its disposition sophisticated technological equipment designed for the Department of Defense – allegedly not in working order – which enables it to look for contradictions between their older declarations and their current positions. It should be extending its work to 1,200 of the new President’s collaborators.
Citizens for Responsibility and Ethics in Washington — CREW is a firm of high level lawyers tasked with tracking anything that could create a scandal in the Trump administration. Most of the lawyers in this association work pro bono, for the cause. These are the people who prepared the case for Bob Ferguson, the Chief Prosecutor of the state of Washington, against the immigration decree (Executive Order 13769).
Shareblue is an electronic army which has already connected with 162 million internauts in the USA. It’s job is to spread pre-ordained themes, for example:
- Trump is authoritarian and a thief.
- Trump is under the influence of Vladimir Putin.
- Trump is a weak and quick-tempered personality, he’s a manic-depressive.
- Trump was not elected by the majority of US citizens, and is therefore illegitimate.
- His Vice-President, Mike Pence, is a fascist.
- Trump is a billionaire who will constantly be faced with conflicts of interest between his personal affairs and those of state.
- Trump is a puppet of the Koch brothers, who are famous for sponsoring the extreme right.
- Trump is a white supremacist and a threat to minorities.
- Anti-Trump opposition just keeps growing outside Washington.
- To save democracy, let’s support the democrataic parliamentarians who are attacking Trump, and let’s demolish those who are co-operating with him.
- Overthrowing Trump will take time, so don’t let’s weaken in our resolve.
This association will produce the newsletters and 30-second videos. It will base itself on two other groups – a company which makes documentary videos, The American Independent, and a statistical unit, Benchmark Politics.
The whole of this system – which was set up during the transitional period, that is to say before Donald Trump’s arrival at the White House – already employed more than 300 specialists to which should be added numerous voluteer workers. Its annual budget, initially calculated at 35 million dollars, was increased to the level of about 100 million dollars.
Destroying the image – and thus the authority – of the President of the United States, before he has had the time to do anything at all, can have serious consequences. By eliminating Saddam Hussein and Mouamar Kadhafi, the CIA plunged their two countries into a long period of chaos, and the «land of Liberty» itself may suffer severe damage from such an operation. This type of mass manipulation technique has never before been levelled at a head of state in the Western world.
For the moment, the plan is working – no political leader in the world has dared to celebrate the election of Donald Trump, with the exception of Vladimir Putin and Mahmoud Ahmadinejad.
- Hawaii High School Teacher: "If They Are Here In The U.S. Illegally, I Won't Teach Them"
John Sullivan, a Social Studies teacher at Campbell High School in Oahu, Hawaii, is under fire this week after sending an email to all faculty at his school refusing to teach students who are in the country illegally. A copy of the email was obtained by Hawaii News Now and read as follows:
“This is another attack on the President over deportation. Their parents need to apply for immigration like everyone else. If they are here in the US illegally, I won’t teach them.”
Sullivan’s reply was in response to an administrator email about the number of children across the country staying home from school due to deportation fears (we touched on the topic last week in a post entitled “Parents Fearing Deportation Make Guardianship Plans ‘In Case Mommy Doesn’t Come Home’“). Apparently, this latest “attack on the President over deportation” was just the last bit of propaganda he was willing to take lying down.
Jon Henry Lee, Campbell High School’s principal, confirmed that Sullivan’s actions violated department rules, though the original administrator email, of course, did not, and left open what discipline may be sought over his violation.
“I just reminded him again that we don’t discriminate against any individuals,” said Lee, who referenced the Department of Education’s Code of Conduct. “We’re going to service all students that are registered in our school.”
Lee also said that Sullivan violated school rules concerning the use of the department’s email system by sharing a political opinion.
A Department of Education spokeswoman said the school’s principal has discretion on any disciplinary action that Sullivan may face.
We’re gonna set the over/under on Sullivan’s termination at 2 days…
- A CIA Cyber False Flag
Authored by Federico Pieraccini via The Strategic Culture Foundation,
New revelations from Wikileaks’ 'Vault 7' leak shed a disturbing light on the safeguarding of privacy. Something already known and largely suspected has now become documented by Wikileaks. It seems evident that the CIA is now a state within a state, an entity out of control that has even arrived at the point of creating its own hacking network in order to avoid the scrutiny of the NSA and other agencies.
Reading the revelations contained in the documents released by WikiLeaks and adding them to those already presented in recent years by Snowden, it now seems evident that the technological aspect regarding espionage is a specialty in which the CIA, as far as we know, excels. Hardware and software vendors that are complicit — most of which are American, British or Israeli — give the CIA the opportunity to achieve informational full-spectrum dominance, relegating privacy to extinction. Such a convergence of power, money and technology entails major conflicts of interest, as can be seen in the case of Amazon AWS (Amazon's Cloud Service), cloud provider for the CIA, whose owner, Jeff Bezos, is also the owner of The Washington Post. It is a clear overlap of private interests that conflicts with the theoretical need to declare uncomfortable truths without the need to consider orders numbering in the millions of dollars from clients like the CIA.
While it is just one example, there are thousands more out there. The perverse interplay between media, spy agencies and politicians has compromised the very meaning of the much vaunted democracy of the land of the Stars and Stripes. The constant scandals that are beamed onto our screens now serve the sole purpose of advancing the deep interest of the Washington establishment. In geopolitical terms, it is now more than obvious that the deep state has committed all available means toward sabotaging any dialogue and détente between the United States and Russia. In terms of news, the Wikileaks revelations shed light on the methods used by US intelligence agencies like the CIA to place blame on the Kremlin, or networks associated with it, for the hacking that occurred during the American elections.
Perhaps this is too generous a depiction of matters, given that the general public has yet to see any evidence of the hacking of the DNC servers. In addition to this, we know that the origin of Podesta’s email revelations stem from the loss of a smartphone and the low data-security measures employed by the chairman of Hillary Clinton’s presidential campaign. In general, when the 16 US spy agencies blamed Russia for the hacking of the elections, they were never specific in terms of forensic evidence. Simply put, the media, spies and politicians created false accusations based on the fact that Moscow, together with RT and other media (not directly linked to the Kremlin), finally enjoy a major presence in the mainstream media. The biggest problem for the Washington establishment lies in the revelation of news that is counterproductive to the interests of the deep state. RT, Sputnik, this site and many others have diligently covered and reported to the general public every development concerning the Podesta revelations or the hacking of the DNC.
Now what is revealed through Wikileaks’ publications in Vault 7 is the ability of a subsection of the CIA, known as Umbrage, to use malware, viruses, trojans and other cyber tools for their own geopolitical purposes. The CIA’s Umbrage collects, analyzes and then employs software created variously from foreign security agencies, cyber mafia, private companies, and hackers in general. These revelations become particularly relevant when we consider the consequences of these actions. The main example can be seen in the hacking of the DNC. For now, what we know is that the hacking – if it ever occurred – is of Russian origin. This does not mean at all that the Kremlin directed it. It could actually be very much the opposite, its responsibility falling into the category of a cyber false-flag. One thing is for sure: all 16 US intelligence agencies are of the view that “the Russians did it”. That said, the methods used to hack vulnerabilities cannot be revealed, so as to limit the spread of easily reusable exploits on systems, such as the one that hosted the DNC server. It is a great excuse for avoiding the revelation of any evidence at all.
So, with little information available, independent citizens are left with very little information on which to reliably form an opinion on what happened. There is no evidence, and no evidence will be provided to the media. For politicians and so-called mainstream journalists, this is an acceptable state of affairs. What we are left with instead is blind faith in the 16 spy agencies. The problem for them is that what WikiLeaks revealed with Vault 7 exposes a scenario that looks more likely than not: a cyber false-flag carried out by the Central Intelligence Agency using engineered malware and viruses made in Russia and hypothetically linking them back to hacking networks in Russia. In all likelihood, it looks like the Democrats’ server was hacked by the CIA with the clear objective of leaving Russian fingerprints and obvious traces to be picked up by other US agencies.
In this way, it becomes easier to explain the unique views of all 16 spy agencies. Thus, it is far more likely that the CIA intentionally left fake Russian fingerprints all over the DNC server, thereby misleading other intelligence agencies in promoting the narrative that Russia hacked the DNC server. Of course the objective was to create a false narrative that could immediately be picked up by the media, creating even more hysteria surrounding any rapprochement with Russia.
Diversification of computer systems.
The revelations contained in the Wikileaks vault 7 (less than 1 % of the total data in Wikileaks’ possession has been released to date) have caused a stir, especially by exposing the astonishing complicity between hardware and software manufacturers, often intentionally creating backdoors in their products to allow access by the CIA and NSA. In today’s digital environment, all essential services rely on computer technology and connectivity. These revelations are yet more reason why countries targeted by Washington, like China, Russia, Iran and North Korea, should get rid of European and American products and invest in reducing technological dependence on American products in particular.
The People's Republic has already started down this track, with the replacement of many network devices with local vendors like Huawei in order to avoid the type of interference revealed by Snowden. Russia has been doing the same in terms of software, even laying the groundwork to launch of its own operating system, abandoning American and European systems. In North Korea, this idea was already put into practice years ago and is an excellent tool for deterrence for external interference. In more than one computer security conference, US experts have praised the capabilities of the DPRK to isolate its Internet network from the rest of the world, allowing them to have strong safety mechanisms. Often, the only access route to the DPRK systems are through the People's Republic of China, not the easiest way for the CIA or NSA to infiltrate a protected computer network.
An important aspect of the world in which we live today involves information security, something all nations have to deal with. At the moment, we still live in a world in which the realization of the danger and effect of hacking attacks are not apparent to many. On the other hand, militarily speaking, the diversification and rationalization of critical equipment in terms of networks and operability (smartphones, laptops, etc) has already produced strong growth in non-American and European manufacturers, with the aim of making their systems more secure.
This strengthening of technology also produces deleterious consequences, such as the need for intelligence agencies to be able to prevent the spread of data encryption so as to always enjoy access to any desired information. The birth of the Tor protocol, the deployment of Bitcoin, and apps that are more and more encrypted (although the WikiLeaks documents have shown that the collection of information takes place on the device before the information is encrypted) are all responses to an exponential increase in the invasion of privacy by federal or American government entities.
We live in a world that has an enormous dependence on the Internet and computer technology. The CIA over the years has focused on the ability to make sure vulnerable systems are exploited as well as seeking out major security flaws in consumer products without disclosing this to vendors, thereby taking advantage of these security gaps and leaving all consumers with a potential lack of security. Slowly, thanks to the work and courage of people like Snowden and Assange, the world is beginning to understand how important it is to keep personal data under control and prevent access to it by third parties, especially if they are state actors. In the case of national security, the issue is expanded exponentially by the need to protect key and vital infrastructure, considering how many critical services operate via the Internet and rely on computing devices.
The wars of the future will have a strong technological basis, and it is no coincidence that many armed forces, primarily the Russian and Chinese, have opted in recent years to training troops, and conducting operations, not completely relying on connectivity. No one can deny that in the event of a large-scale conflict, connectivity is far from guaranteed. One of the major goals of competing nations is to penetrate the military security systems of rival nations and be able to disarm the internal networks that operates major systems of defense and attack.
The Wikileaks revelations are yet another confirmation of how important it is to break the technological unipolar moment, if it may be dubbed this way, especially for nations targeted by the United States. Currently Washington dictates the technological capacities of the private and government sectors of Europe and America, steering their development, timing and methods to suit its own interests. It represents a clear disadvantage that the PRC and its allies will inevitably have to redress in the near future in order to achieve full security for its vital infrastructure.
- China Suffers Worst Start To A Year For Retail Sales Growth Since 2002
With its credit impulse wearing off (and inflation spikes stalling any hopes of renewed stimulus anytime soon), it appears China’s always-happy consumer is not so happy as 2017 begins.
Against expectations of a 10.6% year-over-year gain in year-to-date cumulative retail sales, February saw just a 9.5% rise – the weakest February since 2002.
Presumably there is some lunar-new-year adjustment that will rescue this terrible print from its 15 year lows but we note once again that every one of the 37 analysts over-estimated (or forgot to read the calendar).
This was a 4 standard deviation miss…
- China Prepares Countermeasures Against South Korea Missile Shield
The recent deployment by South Korea of the controversial US-made Terminal High Altitude Area Defence (THAAD) anti-missile system in response to potential ballistic threats from North Korea, has led to a furious response by China, whose first-strike ability would be compromised under the existing military configuration. And as BBC reports, “the deployment in South Korea of the US Terminal High Altitude Area Defense (THAAD) missile defense system has been slammed by Beijing. Now the Chinese Communist Party is calling on its people to embrace their ill will towards their neighbours” and notes that as anti South-Korea fever sweep China, local school students chant “Boycott Sth Korea!”, and smash South Korean appliances as the “communist Party unleashes anti-Korea spirit.”
However, while eliciting up a traditional nationalistic response by China was to be expected, what is more troubling is that according to the South China Morning Post, China is set to deploy anti-radar countermeasures which will neutralize the South Korean THAAD. The THAAD system consists of a sophisticated radar and interceptor missiles designed to spot and knock out incoming ballistic missiles.
Speaking to retired PLA general Wang Hongguang, the SCMP reports that China knew it might not be able to stop Seoul deploying a US anti-missile system “and was prepared to counter with its own anti-radar equipment.” The comments came as a South Korean court’s decision to uphold the impeachment of former president Park Geun-hye had fanned hopes Seoul might put plans for the Terminal High Altitude Area Defence system on hold. Park supported the installation of the system to help protect South Korea against threats from North Korea, which Beijing says can peer through China’s defences. However, such a de-escalation does not appear to be imminent.
Wang, former deputy commander of the Nanjing Military Region, said China could not take the chance the next South Korean president would change policy and roll back the deployment, and added that Beijing had measures in place to neutralize THAAD’s radars.
“We will complete our deployment before THAAD begins operations. There is no need to wait for two months [before the election of the next South Korean president],” he said on the sidelines of the political sessions in Beijing. “We already have such equipment in place. We just have to move it to the right spot.”
Going even further, Yue Gang, a military commentator and former People’s Liberation Army colonel, said China could either destroy THAAD or neutralise it. However, he hedged by adding that “destroying [THAAD] should only be an option during wartime.” However, China could and would interfere with the system’s functions through electromagnetic technology, he said. Yue said an ideal place to install the Chinese equipment was on the Shandong peninsula on the country’s east coast, opposite South Korea.
Quoted by SCMP, Fu Qianshao, an aviation equipment expert with the PLA Air Force, said China could also send planes – manned or unmanned – to fly close to THAAD to interfere with its radar signals. All the country’s armed forces had the capacity to interfere with radar signals, Fu said.
Wang said China’s chief concern was not just with South Korea’s deployment of the American system but also the United States’ broader potential to contain the region in a sophisticated web of missile defence systems in Japan, Singapore, the Philippines and even Taiwan.
Stated differently, the ongoing diplomatic escalation between China and South Korea over THAAD is really just China lashing out against the ongoing interefence by the US, which seeks to blanket its allies in the region in a mesh that would eliminate China’s tactical first strike advantage, in the process putting the precariouar nuclear balance of power in the region in jeopardy, the same way that the deployment of the US Aegis ashore anti-missile shielf system in Eastern Europe has put Russia on edge, as it too, has lost its first strike capabilities, if only for now. The question, for both China and Russia, is what deterrence they will unveil in response, as a “game theoretical” layout in which two nuclear-armed superpowers suddenly finds themselves questioning their offensive supriority never leads to favorable outcomes, at least in (game) theory.
- 12 Million Americans Are About To Get An Artificial Boost To Their FICO Scores
Back in August 2014, we reported that in what appeared a suspicious attempt to boost the pool of eligible, credit-worthy mortgage recipients, Fair Isaac, the company behind the crucial FICO score that determines every consumer’s credit rating, “will stop including in its FICO credit-score calculations any record of a consumer failing to pay a bill if the bill has been paid or settled with a collection agency. The San Jose, Calif., company also will give less weight to unpaid medical bills that are with a collection agency.” In doing so, the company would “make it easier for tens of millions of Americans to get loans.” Stated simply, the definition of the all important FICO score, the most important number at the base of every mortgage application, was set for an “adjustment” which would push it higher for millions of Americans.
As the WSJ said at the time, the changes are expected to boost consumer lending, especially among borrowers shut out of the market or charged high interest rates because of their low scores. “It expands banks’ ability to make loans for people who might not have qualified and to offer a lower price [for others],” said Nessa Feddis, senior vice president of consumer protection and payments at the American Bankers Association, a trade group.” Perhaps the thinking went that if you a borrower has defaulted once, they had learned your lesson and will never do it again. Unfortunately, empirical studies have shown that that is not the case.
Now, nearly three years later, in the latest push to artificially boost FICO scores, the WSJ reports that “many tax liens and civil judgments soon will be removed from people’s credit reports, the latest in a series of moves to omit negative information from these financial scorecards. The development could help boost credit scores for millions of consumers, but could pose risks for lenders” as FICO scores remain the only widely accepted method of quantifying any individual American’s credit risk, and determine how much consumers can borrow for a new house or car as well as determine their credit-card spending limit
The transformation is already in proces as the three major credit-reporting firms, Equifax, Experian and TransUnion, recently decided to remove tax-lien and civil-judgment data starting around July 1, according to the Consumer Data Industry Association, a trade group that represents them. The firms will remove the adverse data if they don’t include a complete list of a person’s name, address, as well as a social security number or date of birth, and since most liens and judgments don’t include all three or four, the effect will be like wiping the slate clean for millons of Americans. This change will apply to new tax lien and civil-judgment data that are added to credit reports as well as existing data on the reports.
Civil judgments include cases in which collection firms take borrowers to court over an unpaid debt. Ankush Tewari, senior director of credit-risk assessment at LexisNexis Risk Solutions, says that nearly all judgments will be removed and about half of tax liens will be removed from credit reports as a result of the changed approach. He says LexisNexis will continue to offer the data directly to lenders.
In addition, if public court records aren’t checked for updates on lien and judgment information at least every 90 days, they will have to be removed from credit reports.
The outcome of this change is clear: it “will make many people who have these types of credit-report blemishes look more creditworthy.“
The WSJ notes that the unusual move by the influential firms comes partially in response to regulatory concerns. The three reporting bureaus rarely tinker with the information that goes on credit reports and that lenders consult to gauge consumers’ ability and willingness to pay back debts.
The regulatory push to boost America’s creditworthiness started at the top, under the guise of improving data tracking and collection:
The Consumer Financial Protection Bureau earlier this month released a report citing problems it found while examining credit bureaus and changes it is requiring. Issues the agency cited included improving standards for public-records data by using better identity-matching criteria and updating records more frequently.
Inaccurate information on credit reports, especially if it is negative information, can derail consumers from being able to gain access to credit and even lead to other setbacks like not being able to rent an apartment or get a job.
One in five consumers has an error in at least one of their three major credit reports, according to a 2013 Federal Trade Commission study mandated by Congress. The three credit bureaus received around eight million requests disputing information on credit reports in 2011, according to the CFPB.
It won’t be the first time such an exercise is conducted: in 2015, as part of a settlement with the NY AG, credit-reporting firms were already prompted to remove several negative data sets from reports. These included non-loan related items that were sent to collections firms, such as gym memberships, library fines and traffic tickets. The firms also will have to remove medical-debt collections that have been paid by a patient’s insurance company from credit reports by 2018.
What happens next?
Such changes might help borrowers and could spur additional lending, possibly boosting economic activity. But it could potentially increase risks for lenders who might not be able to accurately assess borrowers’ default risk.
Consumers with liens or judgments are twice as likely to default on loan payments, according to LexisNexis Risk Solutions, a unit of RELX Group that supplies public-record information to the big three credit bureaus and lenders.
For lenders and credit card companies it means one thing: chaos, and the potential of substantial future charge offs: “It’s going to make someone who has poor credit look better than they should,” said John Ulzheimer, a credit specialist and former manager at Experian and credit-score creator FICO.
“Just because the lien or judgment information has been removed and someone’s score has improved doesn’t mean they’ll magically become a better credit risk.”
* * *
So how many US consumers will be impacted by this change? The answer: up to 12 million.
As the WSJ points out “removing this information from credit reports also will lead to changes in people’s credit scores. Roughly 12 million U.S. consumers, or about 6% of the total U.S. population that has FICO credit scores, will see increases in those scores as a result of this change, according to the company that created the FICO system, which is used by lenders in most U.S. consumer underwriting decisions.”
While for many of these consumers, the score increase will be relatively modest, as FICO projects that just under 11 million people will experience a score improvement of less than 20 points, that should be more than sufficient to go out and buy that brand new $60,000 BMW with an 80-month, $0 down, 0% interest rate loan.
Sarcasm aside, ultimately lenders will still be able to check public records on their own to find this information, and since FICO scores will now be “adjusted” just like GAAP, the likely outcome will be the transition of credit vetting in house, as Fair Isaac loses credibility within the loan system, potentially leading to even more draconian credit terms, even if it comes at substantial expense to US-based lenders.
- Legal Marijuana's Social Impact On Colorado
Via ConvergEx's Nicholas Colas,
Believe it or not, there was no change in the number of marijuana users in Colorado between 2014 and 2015 after legalization of the sale of recreational cannabis went into effect. At least that’s what Colorado’s Retail Marijuana Public Advisory Committee reported in their latest research on the effects of marijuana on public health. They also found that calls to poison centers for exposure to marijuana and emergency room visits continue to fall. The State Department of Public Safety also reported that the number of marijuana arrests nearly halved, down by 46% between 2012 and 2014. Moreover, Colorado has one of the lowest unemployment rates in the country, and the legal marijuana industry has certainly helped by adding 18,000 new full-time jobs in 2015 according to the Marijuana Policy Group. Perhaps the most significant benefit to the state is tax receipts, as Colorado received $198.5 million in tax revenue last year from marijuana sales of $1.3 billion.
Bottom line, retail marijuana legalization has had its fair share of pros and cons in Colorado, but it’s not been nearly as bad as critics had forecast.
Note from Nick: Jessica’s note about the legal pot business get a lot of attention and comments from readers and today she looks at the social impact of legalization on the state of Colorado. With other states – most notably California – voting to legalize marijuana, this will become a national issue in coming years. Read on for the details.
We’ve written several notes about the success of legal recreational marijuana businesses in Colorado over the past few years, but our most frequently asked question is: what are the social costs? Many people have heartbreaking stories about the effects drugs have had on their loved ones and with one in five Americans now living in a state where retail cannabis is legal, it’s important to understand the social side of the business as well.
Colorado has a few years of useful data to unpeel the layers given that stores have sold retail marijuana there since January 2014. We put together a list of different angles from which to measure some social ramifications and benefits of legalization. Here’s what we found:
Homelessness
Colorado experienced the third largest increase in the total number of homeless people last year (721 people), following California (4,504) and Washington (1,374). It also had an increase of 231 homeless veterans from 2015 to 2016, marking the largest gain of any state. There were only seven other states with a rise in homeless veterans. HUD link: https://www.hudexchange.info/resources/documents/2016-AHAR-Part-1.pdf
So what’s going on there? The ability for dispensaries to sell recreational marijuana as of January 2014 has certainly entered the debate. A few points:
- Colorado Governor John Hickenlooper spoke about homelessness and the unintended consequences of legalizing marijuana in his annual State of the State address in January 2017: “There’s no question that marijuana and other drugs–in combination with mental illness or other disabling conditions–are essential contributors to chronic homelessness.” He also said “tax revenue from marijuana sales can and should be used to help those who fall through the cracks including hundreds of homeless vets.”
Speech link: https://www.colorado.gov/governor/news/gov-hickenlooper-delivers-annual-…
- In a Denver Post article, spokesman Daniel Warvi for the Department of Veterans Affairs said “a perfect storm” of circumstances is pushing many veterans onto the streets. Veterans are coming to Colorado planning to get a job in the burgeoning legal marijuana industry or because Colorado’s job market is booming… But when they arrive in Colorado, the jobs many of them qualify for don’t pay enough to cover rent, and they learn they must be a Colorado resident for a year before getting a cannabis-related job.”
Here’s the full article, which also includes some vet’s experiences: http://www.denverpost.com/2016/11/18/colorado-spike-homeless-veterans/
- Bottom line, many people moved to Colorado after retail marijuana was legalized, and some may have not had the skills to find a job. Granted there are other factors to consider, such as a low unemployment rate and widespread access to health care. The state’s population grew by 101,000 in 2015, marking the first time it crossed the 100,000 threshold since 2001, for example. In another Denver Post article, state demographer Elizabeth Garner said net migration made up about two-thirds of the gain. Link: http://www.denverpost.com/2015/12/22/colorados-population-jumped-by-1010…
Correlation does not equal causation, of course. With that said, contributing factors in the debate have included homeless people moving to Colorado because they can legally buy marijuana or individuals moving to the state with the hopes of getting a marijuana related job and not finding one in time before they become homeless. Source: https://www.theguardian.com/us-news/2017/feb/27/marijuana-legal-homeless…
Crime and Enforcement
We zeroed in on the “Mile-High City” of Denver since it’s the national epicenter of legal recreational marijuana. Denver’s percentage of statewide marijuana sales was 47% in 2014 and 41% in 2015, and there are more than 1,000 marijuana business licenses outstanding. The city also started tracking marijuana-related crimes reported to the Denver Police Department in 2012. Here are some more stats from their 2016 report:
- The total number of crimes reported to the Denver Police Department that “have a clear connection or relation to marijuana” but don’t “have an incidental relation to marijuana” increased from 256 in 2012 to 270 in 2015 (down from 293 in 2014). Note that it also does not include “violations restricting the possession, sale, and/or cultivation of marijuana.” Marijuana-related crime makes up less than 1% of overall crime in Denver and fell from 0.58% in 2012 to 0.42% in 2015.
- Most marijuana-related crime is simply people breaking into stores to get the drug. There were 191 industry-related crimes in 2012 (0.43% of total crime in Denver) versus 192 in 2015 (0.42%) compared to 65 non-industry crimes in 2012 (0.15%) and 78 in 2015 (0.12%). In 2015, “burglary or attempted burglary accounted for 64% of Marijuana Industry-Related Crime. Larceny (theft) accounted for another 11% of all Marijuana Industry-Related Crime.”
- The report notes the rarity of violent crimes – including homicide, rape, robbery, aggravated assault and arson – related to the licensed marijuana industry. In 2015, there were 8, or “one violent crime related to the marijuana industry for every 1,357 violent crimes overall.”
As for arrests, the Denver PD only started collecting the data in 2014. There was an 11% increase to 1,666 marijuana related arrests from 2014 to 2015, including the unlawful distribution/cultivation/possession of marijuana or a marijuana concentrate, public display or consumption of marijuana, and business license violations.
For crime in Colorado as a whole, the State Department of Public Safety put out a 143-page report last year. They found that the number of marijuana arrests dropped by 46% between 2012 and 2014, and that “marijuana possession arrests, which make up the majority of all marijuana arrests, were nearly cut in half (-47%).” Marijuana accounted for 6% of all arrests in 2012 and 3% in 2014.
Report: http://cdpsdocs.state.co.us/ors/docs/reports/2016-SB13-283-Rpt.pdf
- In terms of driving under the influence of marijuana, DUIDs rose 10% to 73 in Denver during 2015, but “represent a very small portion (2.8%) of overall impaired driving arrests.”
- One last important point from the report: “the implication of a legal commercial market is not that enforcement needs will necessarily decrease.” In fact, “the opposite is true in the short run” as “the black market will not simply vanish” and “people will continue pushing the boundaries and operating outside of the rules.” Criminals still purchase marijuana in bulk from Colorado and sell it across the U.S., for example. Therefore, the “Denver Police Department Marijuana Team’s work around illegal marijuana has increased significantly over the last couple of years.”
To put this in perspective, the Denver Police Department (DPD) crime lab processed 524 pounds of marijuana in 2013. After retail sales went into effect in January 2014, this figure grew to 9,504 pounds in 2014 and 4,738 pounds in 2015. Those numbers don’t even include the DPD’s involvement in other operations when marijuana was processed by the Drug Enforcement Agency. The DPD actually increased the number of officers working on the department’s marijuana team to also monitor home grows to ensure people aren’t developing more plants than is lawful.
Link to report:
https://www.denvergov.org/content/dam/denvergov/Portals/782/documents/An…
Link to graphics: https://www.denvergov.org/content/denvergov/en/denver-marijuana-informat…
Unemployment
Colorado is one of five states with the lowest unemployment rates in the country at 3.0% as of December. This represents a fall from 7.9% in 2012 when it ranked 31st. Of course opportunities working for marijuana-related businesses didn’t make up for the whole decline, but it did help. According to the Marijuana Policy Group in a report published last October:
- The legal marijuana industry in Colorado added over 18,000 new full-time jobs in 2015 and spurred $2.4 billion in economic activity.
- Since it’s a “highly-localized industry” it “generates more local output and employment per dollar spent than almost any Colorado sector” except for government program spending. For example, “each dollar spent on retail marijuana generates $2.40 in state output” compared to $1.88 per dollar for the general retail trade.
Link: http://www.mjpolicygroup.com/pubs/MPG%20Impact%20of%20Marijuana%20on%20C…
On the flip side, even though marijuana is legal on a state level, individuals who use can still fail their employers’ drug tests since it’s illegal on a Federal level. Quest Diagnostics released a report in 2014 that showed the “percentage of positive drug tests among American workers has increased for the first time in more than a decade,” mostly due to marijuana and amphetamines. This followed several years of declines. After recreational marijuana was legalized in Colorado and Washington, marijuana positivity rose by double digits in both states during 2013 compared to a 6.2% increase nationally. The study notes that both states also experienced large increases before legalization so the trend was already underway.
Link: http://newsroom.questdiagnostics.com/2014-09-11-Workforce-Drug-Test-Posi…
- Some employers are removing marijuana from pre-employment drug tests. Sixty-two percent of businesses test for drugs in Colorado compared to 77% in 2014, according to the Mountain States Employers Council. This may be due to the state’s low employment rate rather than friendlier views, however. See here: http://www.denverpost.com/2017/02/03/colorado-business-pot-drug-tests/
Public Health and Marijuana Use
The Retail Marijuana Public Advisory Committee has monitored marijuana and its impact on public health in Colorado over the past few years and just published another expansive report on the topic. Here are some of their key findings:
- Past-month marijuana users: There was no change in past-month marijuana use between 2014 and 2015. Two different Federal surveys showed 13% and 17% of Colorado adults said they use cannabis compared to the national average of 8%. Marijuana use over the past month was highest for males (17%) and individuals aged 18 to 25 (26%).
- Daily marijuana use vs tobacco and alcohol: 6% of adults reported using marijuana daily or near-daily compared to daily or near daily alcohol (22%) and tobacco use (16%).
- Teen use: 21% of Colorado high school students said they had used marijuana in 2015, roughly similar to 20% in 2013 before stores first started selling retail cannabis. It’s also about in line with the national average of about 17% and 22% according to two different surveys.
- Marijuana in Colorado homes with children: 8% of adults with children aged 1 to 14 had “marijuana or marijuana products in or around the home.” In “82% of these homes, marijuana was stored safely, while in 18% it was potentially stored unsafely.” The report also said “it is estimated that approximately 16,000 homes in Colorado had children 1-14 years old with possible exposure to secondhand marijuana smoke or vapor in the home.”
- Hospital visits and poison center calls: Calls to poison centers for exposure to marijuana “appear to be decreasing since 2015, including unintentional exposures in children aged 0-8 years.” Moreover, “the overall rate of emergency department visits with marijuana-related billing codes dropped 27 percent from 2014 to 2015 (2016 data is not available yet).” One point of concern is marijuana edibles, however, as they were “involved in about 40% of marijuana exposure calls to the poison center” and twice as common as calls about smokeable marijuana for children aged 0-8.
Link: https://www.colorado.gov/cdphe/marijuana-health-report
Tax Receipts
Tax revenue from marijuana sales is one of the most significant benefits of legalization for Colorado. The state received $198.5 million in tax revenue last year from marijuana sales of $1.3 billion. The first $40 million each year goes to public school construction projects. The balance includes funding for everything from educational programs about the drug and substance abuse prevention grants to pesticide control and inspection services. This article provides an excellent breakdown for more details: https://www.entrepreneur.com/article/289613
- "2017 Will Be A Tipping Point" – Why Some Think This Is The Next "Big Short"
One week ago we reported that "Mega-Bears Smell Blood As Mall REITs Tumble" in which we wrote that "just like 10 years ago, when the "big short" was putting on the RMBX trade, and to a smaller extent, its cousin the CMBX, so now too some are starting to short CMBS through the CMBX. They are betting against securities backed by malls in weaker locations where stores could close in quick succession, triggering debt defaults."
This morning Bloomberg has followed up our post with a not-so-subtly-titled "Wall Street Has Found Its Next Big Short" in which it writes that "Wall Street speculators are zeroing in on the next U.S. credit crisis: the mall…. It’s no secret many mall complexes have been struggling for years as Americans do more of their shopping online. But now, they’re catching the eye of hedge-fund types who think some may soon buckle under their debts, much the way many homeowners did nearly a decade ago."
The trade, as we discussed before, is not so much shorting the equities where a persistent threat of a short squeeze has burned the bears on more than one occasion, but going long default risk via CMBX or otherwise shorting the CMBS complex.
Like the run-up to the housing debacle, a small but growing group of firms are positioning to profit from a collapse that could spur a wave of defaults. Their target: securities backed not by subprime mortgages, but by loans taken out by beleaguered mall and shopping center operators. With bad news piling up for anchor chains like Macy’s and J.C. Penney, bearish bets against commercial mortgage-backed securities are growing.
To be sure, as we first noted last week and as Bloomberg confirms, the activity surrounding CMBS shorting has soared:
In recent weeks, firms such as Alder Hill Management — an outfit started by protégés of hedge-fund billionaire David Tepper — have ramped up wagers against the bonds, which have held up far better than the shares of beaten-down retailers. By one measure, short positions on two of the riskiest slices of CMBS surged to $5.3 billion last month — a 50 percent jump from a year ago.
The trade itself is similar to those that Michael Burry and Steve Eisman made against the housing market before the financial crisis, made famous by the book and movie “The Big Short.” Often called credit protection, buyers of the contracts are paid for CMBS losses that occur when malls and shopping centers fall behind on their loans. In return, they pay monthly premiums to the seller (usually a bank) as long as they hold the position.
This year, traders bought a net $985 million contracts that target the two riskiest types of CMBS, according to the Depository Trust & Clearing Corp. That’s more than five times the purchases in the prior three months.
Further, based on fundamentals, the trade indeed appears justified: "Sold in 2012, the mortgage bonds have a higher concentration of loans to regional malls and shopping centers than similar securities issued since the financial crisis. And because of the way CMBS are structured, the BBB- and BB rated notes are the first to suffer losses when underlying loans go belly up."
“These malls are dying, and we see very limited prospect of a turnaround in performance,” according to a January report from Alder Hill, which began shorting the securities. “We expect 2017 to be a tipping point.”
Cracks have started to appear. Prices on the BBB- pool of CMBS have slumped from roughly 96 cents on the dollar in late January to 87.08 cents last week, index data compiled by Markit show.
For now, there is little hope of a recovery on the horizon as more and more retailers continue to fail, leaving even more vacant, and thus non-rent collecting, mall space.
Just this morning, Gordmans Stores, the century-old discount department store chain, filed for bankruptcy with plans to liquidate its inventory and assets. According to Bloomberg, the company, which posted losses in five of the past six quarters, listed total debt of $131 million in Chapter 11 papers filed Monday in Nebraska federal court. Gordmans said in a statement that it has an agreement with Tiger Capital Group and Great American Group “for the sale in liquidation of the inventory and other assets of Gordmans’ retail stores and distribution centers,” subject to court approval or a better offer.
Omaha, Nebraska-based Gordmans, which operates over 100 stores in 22 states and employs about 5,100 people, is the latest victim in a retail industry suffering from sluggish mall traffic and a move by shoppers to the internet.
The shift has been especially rough on department stores, including regional chains like Gordmans that once enjoyed strong customer loyalty, but even national concerns like Sears Holdings Corp. and Macy’s Inc. have had to close hundreds of locations to cope with the slump
Gordmans, founded in 1915 by Russian immigrant Sam Richman, was acquired by PE firm Sun Capital in 2008 which took it public two years later. Funds managed by Sun Capital hold about 49.6% of Gordmans’ equity, according to a court filing. Growth slowed in 2014, and losses began to mount. Same-store sales fell more than 9 percent in the most recently reported quarter. The company announced job cuts in January, citing the “sluggish retail environment.”
“Like many other apparel and retail companies, the debtors have fallen victim in recent months to adverse macro-economic trends, especially a general shift away from brick-and-mortar to online retail channels, a shift in consumer demographics, and expensive leases,” Chief Financial Officer James B. Brown said in court papers.
While Gordman's decline was long in the making, its financial conditions deteriorated rapidly in March, when vendors began to refuse to ship new inventory, Brown said. After entertaining various offers, the company concluded that its best recourse was the liquidation deal with Tiger and Great American.
To be sure, Gordman's is hardly the last retailer to shutter and while many of its comps have yet to default, the pain is tangible: retailers had one of the worst Christmas-shopping seasons in memory, J.C. Penney said in February it plans to shutter up to 140 stores. That echoed Macy’s decision last year to close some 100 outlets and Sears’s move to shut about 150 locations.
Meanwhile, delinquencies on retail loans have risen to 6.5%, one percent higher than CMBS as a whole, according to Wells Fargo.
* * *
So does that mean that shorting malls is now accepted as the next "big short"? Some are not convinced.
Take for example Credit Suisse who said last month non-CMBS specialists – perhaps an apt name is "CMBS tourists" – are helping drive the recent run-up in demand for credit protection. That raises concern too many people are chasing the same trade. Of course, it may simply be that Credit Suisse analysts are being paid in CMBS
“The short feels crowded to us,” said Matthew Weinstein, principal at Axonic Capital, a hedge fund that specializes in structured products. “If these defaults start happening soon, the short will work, but if the defaults do not occur quickly, the first guy out could drive the market meaningfully higher.”
Others, such as TCW, say CMBS sold in 2012 and 2013 might fall as low as 20 cents on the dollar, however the firm isn’t betting against them because it’s hard to know when the wagers might pay off. "
Plus, the contracts aren’t cheap. It costs about 3 percent a year to short BBB- rated securities and 5 percent to bet against BB notes, plus an upfront fee to put on the trade.
Consequently, it’s “more speculative than it is the next big short,” according to Sorin Capital Management’s Tom Digan.
Whatever the case, here’s what the endgame might look like. About two hours north of Manhattan, in Kingston, New York, stands the Hudson Valley Mall. It used to house J.C. Penney and Macy’s. But both then left, gutting the complex. In January, the mall was sold for less than 20 percent of the original $50 million loan. Mortgage-bond holders exposed to the loan were partly wiped out.
“When a mall starts to falter, the end result is typically binary in nature,” said Matt Tortorello, a senior analyst at Kroll Bond Rating Agency. “It’s either the mall is going to survive or it’s going take a substantial loss."
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Ultimately, whether or not this is indeed that next big short as we first hinted one week ago, or the skeptics will be proven right, will depend on one thing: access to capital. Ironically, it was that variable that ended up crushing OPEC's plans to wipe out shale, which despite a dramatic downturn in oil prices managed to obtain enough funding and capital from generous, yield-starved creditors, to survive the past year while technological advances caught up and pushe the breakeven point to $50, or in many cases lower.
For now, banks and hedge funds have proven far less willing to be "last resort" sources of distressed funding to retailers, and malls, (perhaps with the notable exception of Sears where Eddie Lampert has expressed a desire to go down with the sinking ship) both of which continue to deteriorate as the US consumer is either tapped out, or simply resorts to online retailers like Amazon. Should that not change any time soon, and should the cash flow profile of retailers continue to deteriorate, it is virtually assured that those who are now rushing into the next "big short" will be rewarded.
Finally, as we noted last week, here is a brief note from Horseman Capital's Russell Clark laying out the latest dangers inherent in the mall space:
MALL RATS
Shopping mall REITS have been a fantastic investment over the years. Not only have they provided investors with large capital gains, they have also typically offered above market dividend yields. My interpretation of the REIT model is that the operator collects rents from a diverse number of retailers. This is then passed on to the end investors after costs and financing. The REIT manager reduces risk by diversifying the retailers paying rent, and by also spreading the risk geographically. If the REIT manager can acquire more real estate assets at a yield higher than what it needs to pay out as dividend yield, then the REIT can issue more shares and grow indefinitely. Mall REITs have generally done well, except during the financial crisis.
However, it seems to me that North America could well have too many shopping malls. On a per capita basis, the US has twice the space of Australia and 5 times that in the UK.
One source of REITs revenue growth comes from acquiring more malls. Intriguingly we have started to see volumes of real estate transactions for shopping malls fall. This means that the number of transactions to buy or sell properties is beginning to decline. Last time this happened, rents began to fall a year later. Perhaps it’s a sign that buyers believe rents have some downside risk?
Many people in the market are aware of the problems that the large department stores in the US are currently facing, and their resultant plans to retrench. This affects two of the largest shopping mall REITs that have the department stores as tenants. The reality is that the shopping mall REITs charge extremely low rents to the department stores. The large shopping malls use the department stores to lure traffic, and then make their money from higher rents charged to speciality retailers. Often the per square foot rent of the specialty retailer can be 30 times or higher that paid by the anchor tenant. Looking at the top 2 shopping mall operators, they disclose their top rent payers. Recent share prices performance of 8 shared tenants has been poor, and management commentary has seeming implied that they may also be looking to reduce store count.
It should also be pointed out that many tenants have a clause in their lease to reduce rents should an anchor close a store. Thus, even though the loss of rent due to an anchor closing is minimal, the knock-on effect of reduced rents from the remaining tenants is a serious concern for the REITs.
One of the other problems that shopping mall REITs face is that the size that the large department stores take up is more than 400 million square feet. The largest and most successfully specialty retailer is TJ Maxx which currently has 100 million square feet. It is difficult to see any single retailer quickly being able to fill the space made vacant by department store closures.
Back in the lead up to the financial crisis we found that the share prices of REITs and their tenants were very closely related. Recently we have seen tenants share price weaken again, but REITS remain relatively strong.
Investors are advised to exercise caution with the shopping mall REITs
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