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Mike Holt is a Senior VP, Wealth Management Strategist with The MDE Group, an innovative Wealth Management Firm located in Morristown, NJ that manages over $1 billion for corporate executives and other high net worth individuals located across the US. Mike's diverse background includes auditing... More
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  • Currents and Catalysts: The Macro Pressures Investors Must See 4 comments
    Feb 24, 2011 9:21 AM
    Although the outbreak of civil unrest in Egypt seemed to spring from nowhere, in hindsight it seems as easy to predict as the 2007-2009 financial meltdown. Of course, everything is much clearer with the benefit of hindsight, but would it really have been possible to predict either of these supposed “Black Swan” events? I’d like to make the case that these events could have been anticipated, and that future events triggered by the same underlying forces should be expected as well. 
    The mistake most investors make in response to any signs of political unrest in the Middle East is to immediately assume that the risk is unique to this region, and then to search only for signs of political unrest in other countries within this region, particularly those that might impact oil prices.  Rather than neatly compartmentalizing risks and then assuming that they are geographicaly contained, investors should instead seek to recognize the common threads running through seemingly disparate and random events in an effort to determine whether there are any broader destabilizing forces at work. What acted as a catalyst for this outbreak, and could similar pressures serve as the catalyst for other types of instability elsewhere?
    Furthermore, when it comes to political risk, it is often argued that identifying potential political risk is easy, but predicting timing is nearly impossible. For example, we have known about political dissatisfaction within Egypt for years, but who could have predicted this sudden popular uprising? The answer is not to focus on the political condition, but rather on the potential catalysts for change, which can be more readily monitored. 
    As it turns out, there were three catalysts that contributed to the unrest in Egypt:
    1. The pending transition of power from Hosni Mubarak to his son, Gamal.
    2. Demographic conditions, which are often among the most important contributors to both political unrest and economic conditions, but which are too often overlooked, (ironically, because they are so obvious). 
    3. Higher food prices and lack of opportunity, both of which are felt more severely in stagnant, lower income countries such as Egypt relative to more vibrant, higher income countries where the cost of food represents a smaller percentage of most people’s budgets, and where income opportunities allow individuals to more readily adjust to higher prices.
    Now let’s take a brief look at each of these catalysts and assess their broader implications.
    The first catalyst, the pending transition of power, gets media coverage but is obviously unique to Egypt, and so is of much less significance to investors attempting to identify potential risks elsewhere.
    Of much greater relevance to investors are demographic conditions, in particular the distribution of a country’s population according to age. As noted by Paul Collier in his book, “The Bottom Billion: Why the Poorest Countries are Failing and What Can Be Done About It,” the three most important characteristics of a sample population of Nigerian individuals that made them more likely to engage in political violence were: (1) being young, (2) being uneducated, and (3) being without dependents. Those with a sense of grievance were no more likely to take part in violent protest than those who were not aggrieved. While the Egyptian population is relatively well educated, and the demonstrations were generally not characterized by violence, about two-thirds of the population is under age 30, and the median age is only 24 years. This is quite low relative to the population of the United States, for example, where the median age is 36.8 years, and contrasts even more sharply with Japan where the median age is 44.6 years.

    But there are more complex interactions with respect to demographics than just the tendency of younger populations to agitate for change. For example, aging populations present economic growth concerns in developed countries, which in turn prompts fiscal and monetary policies that can export inflationary pressures. These inflationary pressures can have a destabilizing impact, particularly in countries with lower income levels, which generally makes them more sensitive to rising food and energy prices.
    As indicated above, a rise in food prices, coupled with a lack of opportunity, was the third catalyst for political unrest in Egypt, at least indirectly. This unrest was first experienced in Tunisia about two weeks earlier, when anger over high food prices and a lack of opportunity finally tipped the population into revolting against Zine el Abidine Ben Ali’s corrupt and dictatorial regime. Higher food prices and rising unemployment arguably played a less important role in Egypt, but the revolt was nonetheless orchestrated under the guise of anger over these economic concerns. In other words, regardless of any interest the military may have had in staging an uprising (which is an interesting discussion I will not get into here) it would not have been possible if a sufficiently large population of mostly younger Egyptians were not catalyzed by their anger over food prices and a stagnant economy.
    Higher food prices are the result of both supply and demand factors. On the supply side are the well-documented droughts, floods, and crop failures in various parts of the world over the past year. The growing use of corn as a source of ethanol for fuel, rather than as a source of food, has also had an impact.
    On the demand side, rapid economic growth in emerging market countries, particularly China and India, places upward pressure on prices – especially when demand is driven by government policies that don’t respond as readily to the discipline that higher prices impose on potential buyers in more market-oriented economies. There is also the predictable increase in demand that results from stockpiling whenever the future availability of any market good is questionable. Less appreciated, but possibly of equal or greater importance, is the accelerated purchasing that accompanies an increase in inflationary expectations. When such expectations grow, there is a tendency for market participants to buy now before the purchasing power of their currencies is diminished. Speculators may do the same, especially while borrowing costs remain low.
    Distorted prices for food, energy, and other commodities, growing inflationary expectations in general, and higher unemployment are common threads permeating the outbreaks of political unrest that we have recently witnessed in the Middle East and surrounding region, and that we are likely to witness in other parts of the world as well.
    Interesting as it may be to watch the action in Tahrir square, the root causes of recent developments are what should be commanding the majority of our attention. As investors delve into these macro pressures, it becomes clear that there are deeper currents involved. My goal in this and future articles is to help investors identify and understand the implications of these currents. Stay tuned.
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  • Mike Holt
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    Author’s reply » Food and energy costs make up a larger portion of spending budgets for lower income individuals. As such, higher food and energy costs tend to be felt more severely by lower income individuals. All else being equal, it might therefore seem that the most relevant parameters within which to conduct a search for potential sources of political unrest would be GDP per capital and existing levels of political stability in various countries. Although this may lead to somewhat meaningful results, such an analysis would likely yield more telling results if an additional factor was overlaid upon this analysis. This factor would be the extent to which individuals in various income groups share other affinities that could be potentially divisive, such as ethnicity and.political or religious affiliations. Rifts along such lines could magnify tensions stemming from income disparities alone.


    However, rather than dwelling further upon such differences, I believe it would be more productive to remind ourselves of the principles upon which America was founded, namely liberty, justice, and tolerance of human differences (indeed, the embracement of human diversity), and to appreciate how our commitment to these principles has served to strengthen our union, and has benefitted others throughout the world who were inspired to adopt these same principles. Where the value of such principles is not recognized, thus preventing these principles from taking hold, political unrest and divisiveness are likely to be much more problematic. This explains why Friedrich Hayek, who was passionately opposed to the coercion of human beings by the arbitrary will of others, placed liberty above welfare, but with the expectation that greater welfare would thereby result.
    26 Mar 2011, 04:28 PM Reply Like
  • Mike Holt
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    Author’s reply » The Wall Street Journal today (Friday, July 8) published an Opinion piece by Fouad Ajami titled "The Road to Serfdom and the Arab Revolt.". This documents some of the longer term trends that have caused the global market reforms (described in Daniel Yergin's excellent book, "The Commanding Heights") to bypass the Arab World, preventing it from sharing in the growing prosperity, and individual liberty, that many other parts of the world have enjoyed.


    If one simply steps back and views recent developments within the framework that Daniel Yergin describes in "The Commanding Heights" many recent trends and their inevitable outcomes become painfully clear. Increased intervention by governments and central banks in developed countries, which can't be properly understood unless it is recognized that they are in large part a response to the heavy government involvement in some of the largest, most rapidly growing emerging market countries that now represent a much larger share of the global economy, has further distorted market prices for essential goods such as food and energy, and these price distortions have served as a primary catalyst to destabilize the stable disequilibrium that autocrats in many countries (including, but not limited to those in the Middle East and Africa) had attempted to maintain in order to preserve their own wealth and power.


    Naseem Talib, recently wrote an article in Foreign Affairs magazine, and has also made comments in an interview made available through Knowledge@Wharton.com, in which he disputes that these trends could have been predicted, (as I have claimed) if attention was given to the catalysts for change, rather than focusing only on the long standing conditions in those countries in which large segments of the population don't share in the prosperity enjoyed by those closely associated with government officials who have seized control over the Commanding Heights of their economies. Nadeem Talib rejects this notion in part on the grounds that the Arab Spring represents a rebellion of the lower class, while his review of European history shows that revolutions in those countries succeeded only when they were led by individuals in the Middle Class who had more at stake and greater wherewithal to run the country after they had taken control. Although there is truth to this observation, it may not translate directly to the situation in many Middle East and African countries in which wealth and power is currently concentrated among a Sunni minority, and there are religious leaders among the poorer Shiite majority who could administer government positions if they were successful in inciting unrest along both economic and religious lines. Admittedly, the resulting transfer of power to a handful of religious elites would not lead to the individual liberty and justice needed in order to achieve a more sustainable society characterized by a more vibrant economy and flourishing ideas leading to advances in science, literature, arts, culture, etc. But, it could allow a revolt among the lower classes to take hold at least temporarily. It may be for this reason that the Chinese Communist Party has been so careful to control religious organizations within China (and Tibet), which is ultimately where we should set our focus. As Wayne Groetsky once said, successful planning requires that you focus less upon where the puck is, and more upon where the puck will be.
    8 Jul 2011, 09:20 AM Reply Like
  • Mike Holt
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    Author’s reply » Whoa, how does that puck suddenly travel from the Middle East to China, you might ask. In the words of The Eurasia Group, a prestigious political risk consulting firm, "we'll see a shift in the highest levels of global conflict to the region where globalization and geopolitics collide with greatest force: for the past 20 years, the sharpest geopolitical tensions were to be found in the Middle East; we'll now see a decisive and long-term shift of those tensions to Asia."


    This is due to potential changes in the world order itself, and the rise of this new order will have a profound impact on nearly all of the world's big-picture, long-term trends. In their Top Risks 2011 (which can be found at www.eurasiagroup.net/ ) the Eurasia Group further explains that,


    "After the financial crisis, the G7 was replaced by the G20. This change brought no challenge to America's global military supremacy. But the rules of the economic road area different story and the new gopolitical order is shaped not by a military balance but by an economic one. This new world order marks the end of a decades-long agreement on how the global economy should function. This is world-changing indeed, because the dominant economic trend of the last half century, globalization, now faces a direct challenge from geopolitics."


    In the "G-Zero" era to follow, we may witness the metamorphosis of globalization into state capitalism and a transition of economic power from a group of developed countries more or less cooperating with one another under what was known as the Washington consensus to a free for all among individual countries focused only on advancing their own national interests. This emphasis on each country's national interests will cause corporations to become more aligned with governments, reversing their course away from the supra-government levels that they had previously acheived. And, in my view, the increased role of governments and central banks, whether they are "here" or "there," will lead to artificialities that will lead to significant distortions in markets and asset prices, which is a trend that has already emerged -- and can be easily monitored (sorry Naseem).


    To make sense out of this, it will be important for investors to view the world from a different perspective -- one that focuses more on global macro trends over longer, albeit compressing, time periods than those that they typically have considered in the past. For example, rather than focusing on the individual significance of discrete events such as the August 2 deadline to raise the US debt ceiling, investors should view the ongoing trends in increased global debt among virtually all developed countries, which will not be significantly altered regardless of the exact terms of any political compromise that the Democrats and Republicans in Washington DC might reach.


    Investors also need to consider how all these trends affect the balance of economic power across the globe. In sum, rather than viewing the world like a chess board, in which the outcome is ultimately decided by a single event at a specified location, investors must now view the world like a wei chi ("Go") board in which individual pockets of power accumulated across the board over time in aggregate provide one opponent with greater relative power. These cumulative sources of advantage collectively allow that opponent to negotiate from increasingly more powerful positions of strength, allowing dominance to be attained in an insidious manner -- with important implications for investors on many fronts.
    18 Jul 2011, 01:55 PM Reply Like
  • Mike Holt
    , contributor
    Comments (1869) | Send Message
    Author’s reply » The Arab Spring raised concerns about a Jasmine Revolution in China whereby Chinese citizens would likewise revolt against an autocratic government.


    However, the more recent uprising in Egypt should be less of a concern to the Chinese Communist Party because this time around, the revolt is against a government controlled by a religious group. Although China is too intolerant of religion--for example, witness their actions in Tibet (although that also serves to create a geographical buffer to mainland China)--China has avoided the problem facing Egypt and many other countries in the Middle East, namely control of government by powerful religious groups.


    Limiting concentrations of power is a delicate task. Attaturk successfully turned Turkey into a modern, secular society, but the Shah of Iran, trying to follow the same playbook, failed in his attempt to achieve the same in Iran largely because he attempted to exercise too much control himself (and because his limitless spending on advanced weapons nearly bankrupted the state). As was the case in Egypt more recently, the resulting power void was filled by a religious group. Now, "the people" are relying on Egypt's powerful military as their stepping stone to greater personal freedoms, economic prosperity, and a fair and just society.
    15 Jul 2013, 08:45 AM Reply Like
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