Wednesday, August 28, 2013

Wednesday, August 28, 2013 - What Could Go Wrong?

What Could Go Wrong?
by Sinclair Noe

DOW + 48 = 14,824
SPX + 4 = 1634
NAS + 14 = 3593
10 YR YLD + .05 = 2.76%
OIL + 1.09 = 110.10
GOLD + 1.80 = 1418.80
SILV - .13 = 24.49

It is now almost certain that the United States, and an as yet unspecified number of its allies, will launch an airstrike against Syria and the forces of Bashar al-Assad. Let's look at how this might happen. We know that it is highly unlikely that US troops will be on the ground in Syria; that would be highly risky, very expensive, and extremely unpopular. The White House has said there will not be boots on the ground.

While the US is trying to cobble together a coalition of the willing to give some legal cover for attacking Syria, American military planners are fine-tuning a playbook that will likely focus on missile attacks and possibly bombing runs. Right now, there are four Navy destroyers waiting in the eastern Mediterranean Sea. It is expected they will lob cruise missiles toward Syrian targets; likely starting the missile barrage at night in order to limit civilian casualties. In the light of day they will assess damage and start the next round of attacks; if they need to hit harder, they'll call in the big bombers, the B-2s, which are capable of flying round trip from their base in Missouri.

The idea is to attack the command posts, communication nodes, troop and delivery systems, things like missile launchers; the command and control centers or the basic infrastructure the Assad regime uses to fight the rebels. The plan is not to bomb the suspected stocks of chemical weapons; there are two reasons why they are not being targeted: first, is because of the potential for collateral damage and second, the specific stockpiles are difficult to track and therefore difficult to declare “mission accomplished”. Also, the plan does not involve dropping bombs on al-Assad, but rather forcing him into submission; even if he is not forced from power.

The idea is that it would be limited and surgical military action. It might also be just weak enough to not change the military situation in Syria yet just enough to get the US deeply involved in a quagmire. And even if the military intervention is quick and effective, there's no idea what comes next for Syria, already torn apart by a 30 month civil war that has killed more than 100,000 and displaced millions more.

The next step is to cobble together a coalition, which would likely include the British, the French, and as many Arab countries as they can manage. The Arab League supports intervention, with the exception of Iran and Lebanon; and yes that means Hezbollah could be a big problem. The UK parliament is convening tomorrow, which means that even though military strikes could begin as soon as tomorrow, it might be a few days yet.

An American president says a Middle Eastern country has weapons of mass destruction. He builds a “coalition of the willing” for a military strike against said country. Sound familiar?

Well, it is different than 2003. This is planned to go more like Libya or Operation Desert Fox; that was the limited military intervention against Iraq in 1998. And like Libya, it would not technically require Congressional approval. And given the hyperpartisanship in Congress these days, I'm not sure what would come out of Capitol Hill. Still, if you look beyond the procedural politeness of involving the rest of government in authorizing military intervention, there is compelling political interest in spreading the responsibility for the decision.

Even if it is going to happen, and even if things go as planned, in war things don't always go as planned; things go wrong in the fog of war. Remember the 1999 bombing campaign in Serbia? Remember the bombing of the Chinese Embassy in Belgrade? Oops.

The unpleasant reality in Syria is that there are no good choices, for the US or much of anyone else. No one knows who the "rebels" are with any certainty, except that we know they are anything but a united, coherent force. We don't even know if any of them have goals worthy of support. There are many rebel groups with as many interests, most of them lethal – to each other, to their neighbors, to everyone. Getting rid of Assad might be a good thing, even if that is not the stated goal. Still, the assumption we can control reality and determine outcomes, is a hallmark of hubris.

Unquestionably we can intervene in any horrific way we choose, and no one can stop us. The US military is incredibly powerful and they will almost certainly put that power on display, but that's where our control of events ends, and the benefits of any intervention are hard to identify because there may not be any actual benefits of intervention. Of course an attack might briefly satisfy the mindless impulse to "do something," even if all we accomplished was showing that we were tough. The problem with being a tough guy is that someone will always take that challenge. Just as Assad has crossed that line in the sand, there will be some other punk that will try to do it. So taking the case to Congress, to let them share in the responsibility, that would be smart.

It looks like this whole situation has passed the point of no return, and there will likely be air strikes within the next few days.

It's been a rough month for the markets, but we can't blame it all on Syria, there were significant technical breakdowns before Syria reared its head. Still, whenever anything happens in the Middle East, the talk turns to oil. On Monday, the markets reacted badly to the growing eventuality of military action in Syria with at least one analyst saying oil prices could surge toward $150 on fears the conflict could affect oil supplies in the Middle East. We're on our way; oil topped $110 per barrel today; the highest level in 2 years. Yes it could drop just as fast, or maybe we could see $150. The global economy has enough problems without having to worry about expensive gasoline, too.

Meanwhile, the Fed's taper talk has hammered stocks and currencies in emerging markets. Traders had taken cheap money from the Fed and pumped it into developing economies that promised high returns. Some of these countries, such as India, had big current-account deficits with the rest of the world and really needed that hot foreign money. Once the Fed started talking about making money a little less easy, the emerging market trade got less profitable, and traders started collecting their winnings.

In some cases, the selling has calmed down recently. Brazil's Bovespa stock index has rebounded by about 10 percent, following a 20 percent collapse between late May and early July. Other countries haven't been so lucky -- particularly India, where the rupee is still under steady attack, falling to new lows against the dollar just about daily.

The problems with emerging markets also pose the risk of a negative feedback loop. The idea is that global capital flows are responding to the Fed's taper talk and emerging economies are slowing their pace of bond buys. As investors bring their emerging market investment back to the US, the bonds and currencies of those countries are weakening, which forces their central banks to intervene, which then accelerates the pace of US Treasury sales. So far the foreign selling of Treasuries has mainly been from private investors, but if or when emerging countries central banks jump on the sales, the result could be a feedback loop.

Here's how it plays out. As yields on US Treasuries push higher, investors pull money from emerging markets currencies and bonds in a hunt for yield subsidies; countries where investors fear ability to finance current-account deficit feel the brunt of the sell-off; and as emerging markets currencies weaken, their central banks intervene, drawing down reserves; followed by foreign central banks accelerating selling of US Treasuries as reserves decline and they sell to position against higher rates; and yields on US Treasuries push higher. Boom, loop complete.

Peace out.

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