How the Great War Shaped the World

November 11, 1918 was the end of the Great War. It was a European war, a war that was a conflict between imperial Europe (France and the United Kingdom) against the constrained Central Powers who saw empire as a path to prosperity. In the breakdown of the Central Powers, you have three countries that each have their own imperatives: The Ottoman Turks were economically weak, having lost their empire in the late 19th century to the French (Algeria, Libya) and British (Egypt), they sought to regain their lost empire; The Austria-Hungarian Empire was sclerotic, with a political class under the Hapsburg Dynasty that longed for a return to the royal system of the 18th and 19th century; and the Germans, unified by the Prussian North into a hegemony under the Kaiser, economically emergent under a strong policy of industrialization. 

The Triple Alliance, meant to maintain the balance of power of Europe, presented a contradiction: France and Britain were at the height of their global empires, while Russia under the Czar was a country stuck in a neo-medieval feudal system, struggling to industrialize. 

The war was disastrous for Europe. When the German Schlieffen Plan failed in the first months of the war, that plan to capture France, then turn resources toward Russia, ended up creating a protracted trench war of attrition that the Germans were destined to lose. The Central Powers were now fighting a war on two front, an unenviable position, but the Germans wanted to do as much damage to the Allied Powers, to ensure a fair peace.

The Price of Peace

When peace was finally achieved on November 11, 1918, Europe was shaken and the systems that had lasted generations began to fail. The Allied Powers were victorious, but at great cost. Even minor players, such as Italy, were left badly weakened by the war.

In 1917, following heavy losses on the Eastern Front, and massive food shortages at home, Russia descended into the darkness of the Russian Revolution as the Bolsheviks took control of the seat of government in Petrograd (St. Petersburg). While this helped bring the war to conclusion, it was disastrous for Russia.

France, having been the battlefield of the Western Front, suffered terribly. As many as 1.6 million French died as a result of the combat, and much of France's industrial capacity was devastated. While new territory was won, France would struggle to maintain its empire because of the war's economic costs.

Britain suffered less, as it was supported with food and supplies from the United States, but paid heavily in loss of life. The aristocracy was decimated by the war, and the Victorian systems began to falter. While the loss of a great many men would result in an increase in the influence of women and the rise of woman's suffrage, the economic effects were systemic. Like France, territorial gains in the Middle East created an additional economic drag that left Britain weak, and ultimately it ceded world economic leadership to the United States as the standard bearer of the Gold Standard. It also took resources away from Ireland, providing the political vacuum that allowed the Irish Independent movement to form in 1921.

The Cost of Loss

For the Central Powers, the Treaty of Versailles was debilitating. The Empires of German, Austria and Turkey were dismantles and new countries were formed: Czechoslovakia, Hungary, Yugoslavia, Rumania, Bulgaria, British Palestine, French Syria.

In the end, the devastation left much of Central Europe in economic and political turmoil until the start of World War two, a decade later.

America's Peace and Prosperity

The end of the Great War, led the United States to power in the global system. The rebuilding of Europe gave America a de facto stimulus program as much of Europe's industrial capacity was destroyed. During this period, the United States even supported counter-revolutionary forces in Russia. Along with the France and Britain, the US supported the Whites against the Bolshevik Red Army, continuing the Russian Revolution and the suffering of the Russian people. Exhausted by the Great War, the Western powers didn't have the political will to fight a long civil war in Russia, and so it was lost to the Bolsheviks and the Union of Soviet Socialist Republics (USSR) was formed.

America during this period was mostly distracted by pleasure and economic growth. The Roaring 20s created a massive boom in America, fuelled by exports to Europe and the power of credit growth as the new global reserve currency. The fledgling US central bank, the Federal Reserve, formed in 1913, was now able to leverage it's status as the Gold Standard.

In the interwar period, to stabilize exchange rates, European currencies were floated against the US dollar. This made the dollar the global reserve currency and provided a massive monetary stimulus to the US as well, which in turn led to the massive stock market bubble of the late 20s.

The Dawes Plan however setup a system that was unstable and unsustainable. A type of global Ponzi scheme of payments based on German war reparations and Allied Power debt payments to the US.

Under the Weimar Republic in Germany, this system led to a period of relative prosperity. The economy began to improve and global trade began to normalize. This system was ultimately untenable (see left). When the US stock exchanged collapsed in 1929, this system unravelled.

Unable to borrow from the US to pay reparations, Germany needed to print money. This led to a period of hyperinflation that destabilized the German economy. Combined with the affects of the US Great Depression on global trade, economic hardship was ubiquitous.

America's Pain is Globalized

In the wake of the 1929 stock market crash, economic policy makers make a number of disastrous mistakes. In a period of deflation, the decade-old Federal Reserve began to contract the money supply, limiting credit and making efforts to sustain the banking system. Between 1929-1932, the world convulsed, and production, prices, trade all declined massively.

	United States	Great Britain	France	Germany
Industrial production	–46%	–23%	–24%	–41%
Wholesale prices	–32%	–33%	–34%	–29%
Foreign trade	–70%	–60%	–54%	–61%
Unemployment	+607%	+129%	+214%	+232%

A weak United States, Great Britain and France left a vacuum in the global system. The pain in Germany would critically weaken the Weimar Republic and pave the way for the National Socialist Party. The seeds of World War II were planted in the peace of 1918.

The Challenge of a Low Interest Rate Environment

In 2001 when G.W. Bush was sworn into office, interest rates were 6.6%. The dot com bubble had popped in 2000 and the economy encountered a short recession. In response to the recession, then Federal Reserve Chairman Alan Greenspan began to cut interest rates to spur economic growth. 

The rate cuts of early 2001 were an effective central bank policy and were working to spur consumer demand, but the black swan event of September 11, 2001 changed the economic paradigm. To address the major economic impact of the terrorist attack, the Federal Reserve continued a policy of lowering interest rates. This policy was important: after 9/11 the United States invaded Afghanistan, in March 2003 it invaded Iraq. The combined cost of these wars was immense, and the Republican-led Congress determined that the economic recovery could not be sustained with tax increases - thus a period of deficit financing began.

Debt-financed wars are not uncommon, but with deficits entering the hundreds of billions, the Federal Reserve had to act to ensure that interest payments on the debt would not be crippling to the US federal budget.

There are long-term impacts to the large amount of debt brought on my the Bush tax cuts and the wars in Iraq and Afghanistan. By 2019, the legacy of those policy decisions will account for nearly half of public debt.

As a result of this massive increase in public indebtedness, the Federal Reserve under Greenspan continued to cut interest rates to assist in financing the tax cuts and wars. This is standard central bank policy dating back to World War I. The interest payments on a low interest rate vs. a nominal interest rate can save billions for the government.

Unintended Consequences

This policy, while prudent, created "externalities". This low rate environment that the Fed perpetuated created a correlated low rate environment in the mortgage market. Between 2001 and 2007 interest rates declined substantially, increasing home affordability and creating increased demand for housing.

Overall, this would be considered a good thing, but President Bush created a problem for central bank policy when he began began promoting the "ownership society". Bush policy fomented the bubble because in a period of historically low interest rates, home affordability was already producing a hyper-cyclical growth rate in house appreciation. Between 2001-2005, the economy and home price increases were actually within historical norms, it was only the creation of the subprime market, as a result of regulatory changes, that in 2005-2007 that created the bubble, which resulted in the crash, credit crunch and financial crisis of 2008.

Global Externalities

This US low-rate environment created challenges for other central banks. The Bank of Canada, the European Central Bank, the Bank of Japan, all cut interest rates in correlation with US monetary policy. They had to. If they had not, US dollar inflation would have increased the price of Canadian, European and Japanese exports. This created a "race-to-the-bottom" with interest rates that have fueled global bubbles. Hot money flowed into emerging markets and the BRIC countries (Brazil, Russia, India, China) saw extraordinary growth between 2002-2012. This hot money also flowed into global housing markets. China, Canada and the Netherlands being the most prominent bubbles.

The Canada Conundrum

In Canada specifically home pricing have increased dramatically as a result of the increased affordability granted by low interest rates as well as hot money inflows from the US, China and Europe.

From 2000-2012 Canadian home prices more than doubled. The average Canadian residential property in 2000 was $152,000. In a decade that home has ballooned to over $350,000 and the growth continues at ~5%/yr.

This makes sense from an affordability standpoint.

For example in 2000, a $150,000 mortgage at 7.2%, cost $1235/mo. in mortgage and interest financing.

In 2012, at $350,000 mortgage at 2.87% cost only $2000/mo. in mortgage and interest. In effect, while the value of the asset increased 200% between 2000-2012, the cost of owning the asset grew at a much slower pace, 62%.

This low interest rate environment is creating bubbles in many markets, but none so obvious as housing. This is a very troubling asset class to have a bubble, because unlike the dot com bubble, this bubble hits consumers most, not speculators. In addition, houses are often used as retirement savings accounts and so any decrease in value can have very deleterious effects on wealth.

The Turn

A low interest rate environment is likely to persist for the foreseeable future. The Bank of Japan is using negative interest rates as the first arrow of Shinzo Abe's plan to exit deflation and return Japan to growth, the European Central Bank is dealing with the sovereign debt crisis in the periphery and requires ultra-low interest rates to ensure the Euro doesn't collapse as a currency, and the US has not even exited "extraordinary measures" and quantitative easing (buying Treasuries with newly printed money). Overall this indicates that ultra-low interest rates will persist for the foreseeable future. However, they can't continue forever and there is a very real risk of stagflation.

What happens when interest rates begin to rise? If you look at the cost of mortgages, you can immediately see the implications. Increase the ultra-low rate of 2.87% to a low 5.5% interest rate and the home affordability index changes substantially. The $350,000 mortgage now increases from $2000/mo. to $2500/mo. If they return to a normalized 7.5% interest rate, $2951. This will leave many people overextended. 

While a 30% decrease in affordability is not dangerous, and will not lead to a crash in the Canadian market, it does change the long-term outlook for housing as most people buy a house based on what they can afford monthly. 

For example, the couple that could afford a $350,000 home at 2.97% interest rates, can only afford a $240,000 home at a normalized rate.

When you look at the cost in the Greater Toronto Area (chart below), or any other metro area, that puts home affordability out of reach for a large segment of the population. As a result, this will lead to a long-term secular bear market for housing in Canada. 

The Soft Landing

While the Bank of Canada is doing what they can to ensure a soft landing for the housing market,  this soft landing is going to be maintained through "asset price stability". What that means is that the cost of an asset will remain the same, but not keep up with the decline in purchasing power as a result of inflation. This way the banks will avoid a downturn in the market, even though fewer people can purchase a home and prices will be falling in real terms. Basically creating a wealth illusion to avoid a hasty rush to the exits.

Hot Money in Canada

The big question is the foreign hot money - when the growth slows, will they stay in the asset class? To date, global central banks have pumped almost $7 trillion in liquidity into the market. That money is chasing returns, as 1% in bonds is not enough for high net worth individuals or institutional investors to counter the inflationary effects of QE. As long as the housing market is growing faster than that, Canadian homes will be viewed as a bit of a safe haven. As soon as growth slows to 1-2% from the current 4-7%, the view of the asset class will change and there may be a meltdown, especially in the condominium market which has absorbed the majority of foreign wealth (Vancouver, for example, has an entire condo development that is sold, but only 25% occupied).

Threading the needle is very difficult, and the meltdown will likely start in 2016-17. Will this lead to a crash or just a long period of stagnation in Canadian housing? Ceteris paribus, stagnation. However, with concerns about shadow banking in China, the Chinese housing bubble, the fate of the Euro, the unwinding of QE the world remains a very difficult place to navigate.

Mark Carney gives a great speech on Inclusive Capitalism

The New Spice Route (and the Role of America)

After the Second World War, the United States was the unrivaled leader of the "free world", with only the economically unstable Soviet Union offering a counter-balance to US global hegemony.

As the post-Soviet world begins to reshape into a  multi-polar world order, with China and the EU as the new main participants, control over the New Spice Route is going to become a continuing theme in global affairs. 

The most existential threat to global economic growth in 2014 is concerns about the global trade in hydrocarbons. Some of the worlds most important economies, and largest contributors to global growth rely on imports of hydrocarbons to fuel their growing economies. This is the great challenge to Asia especially as many Asian nations have very limited domestic supplies of oil and gas.

The existential crisis is most prevalent for Japan, following the Fukushima-Daichi nuclear plant disaster. Much of the Japanese Economic Miracle of the 1970s-1990 is due to relatively low cost of inputs from one of the world's largest systems of nuclear power. Following Prime Minister Yoshihiko Noda's decision to wind-down Japan's aging nuclear power plants, Japan has been spending large amounts importing oil and gas, specifically from the Middle East. This is putting pressure on global oil prices and making Japan's exports less competitive. 

Japan is an example to other Asian nations, like South Korea, Taiwan, Vietnam and Malaysia, as to the importance of the global hydrocarbon trade and the dangers of Chinese militarism in the South China Sea. Essentially, for these nations, if China is able to displace American naval superiority in the South and East China Seas, then they will be completely dependent on China, and face a crisis as China would have the ability to stop economic activity in the Asia-Pacific with an oil embargo.

As much as two-thirds of global trade flows through the Strait of Malacca and is managed through the major international ports of Kuala Lumpur and Singapore. This is trade from Asia bound for European consumers and Middle Eastern hydrocarbons headed toward energy-starved Asian nations.

Control of the Strait, as well as the Adaman Sea and the South China Sea is key for globalization to continue in the 21st century.

This is the most important global pinch-point and a geo-strategic imperative for the United States to ensure remains free to global trade. However, recent discoveries of hydrocarbon fields off-shore in the sea have led to a scramble to harvest those resources. Malaysia, Vietnam, Phillipines and China all claim ownership of the resource rights in the South China Sea. China (not shown on map) claims the entire South China Sea and this will be a cauldron of diplomacy in the coming decades. US and European engagement is necessary to counter-balance Chinese growth and protect the economic interests in the region.

The New Pharaohs 

The second strategically volatile region for global trade is the Red Sea. An overlooked concern of the Arab Spring and the overthrow of President Hosni Mubarak in 2011 was the Suez Canal. While the West received some guarantees from the Egyptian military that access to the canal would be maintained, this remains an concern for global trade as political uncertainty remains.

The Red Sea contains two main choke points, the first at the Suez Canal, the second at the Gulf of Aden. Currently, the Gulf of Aden is the most insecure area to navigate on the New Spice Route. Regional instability in Yemen, Sudan, Eritrea and the failed state of Somalia make this a difficult area of influence for the United States and European allies. This is an area the Global War on Terror has destabilized even further. Adding to the complexity is the question of nuclear negotiations with Iran and the concern in the Persian Gulf and specifically the strategically important Strait of Hormuz. 

As the center of the global hydrocarbon trade, the Arabian Kings in Saudi Arabia, Kuwait, UAE and Oman will continue to wield outsized influence and will become a more important military power in the 21st century as the war-weary United States winds down engagements in the region post-Iraq War.

It would be the expectation that US military-industrial complex will be investing heavily with American regional allies on the peninsula, and that the US Congress will allow a larger amount of arm sales to produce a counterweight to Iran, as well as allow for more domestic counter-terrorism activities.

Maintaining the Balance in the Mediterranean

The final leg of the New Spice Route is Europe's backyard. The Mediterranean is a region traditionally controlled by European powers. While the Strait of Gibraltar is the most secure pinch point in global trade, recent Russian movements have changed the dynamics of the sea and created a geopolitical crisis as Russia's annexation of Crimea can be seen as a threat to the West as it grants the Russians broader access to the Mediterranean basin and the ability to disrupt global trade in any future conflict.

This is where the Crisis in Ukraine extends to become a geo-strategic concern. Incorporating Crimea and the Port of Sevastopol into the Russian Federation grants Russian de facto control of the Black Sea. This creates challenges for NATO, as Turkey is a linchpin of that alliance, and this starts a balance of power situation for the region.

As Turkey continues is economic rise, it may seek broader assurances for its security by acting alone. Turkey faces many challenges on its Eastern flank as nationalist Kurds look to form a state in Northern Iraq and Syria. This is a domestic political concern for Turkey, home to 14 million Kurds.

Turkey also faces a refugee crisis as the Syrian Civil War extends into its third year. Add al Qaeda-linked organizations like Islamic State in Iraq and Syria (ISIS) and continuing unrest in the Levant, and Turkey becomes a more vital ally to the West in the new world order. Not only as a counter-balance to Russia, as it was during the Cold War, but also as a barrier to radical militants in the Middle East en route to Europe.

Overall, this bodes well for the continuation of American economic and political might in the 21st century.

Historical movies in chronical order

Quest for Fire
The Ten Commandments
Troy
The Odyssey
Alexander
Spartacus
Rome
Empire
The Passion of the Christ
Ben-Hur
Nero
Gladiator
Augustine: The Decline of the Roman Empire
Ancient Rome: The Rise and Fall of an Empire
Curse of he Golden Flower
Macbeth
Kingdom of Heaven
Robin Hood
The Name of the Rose
Joan of Arc
Braveheart
The Conclave
Mongol
Marco Polo
Conquest 1453
1492: Conquest of Paradise
The Borgias
The Tudors
The Other Boleyn Girl
Apocalypto
Elizabeth
Elizabeth: The Golden Age
The Merchant of Venice
Shōgun
The New World
The Devil's Whore
Charles II: The Power and The Passion
The Red Violin
Rob Roy
Roots
Marie Antoinette
Amadeus
The Last of the Mohicans
Brotherhood of the Wolf
The Duchess
The Patriot
Marie Antoinette
Farewell, My Queen
The Madness of King George
Vanity Fair
Master and Commander: The Far Side of the World
War and Peace
Amazing Grace
Les Misérables
The Count of Monte Cristo
The Alamo
The Young Victoria
Mrs. Brown
Amistad
Gangs of New York
The Charge of the Light Brigade
Ride with the Devil
12 Years A Slave
Gone with the Wind
Glory
Gettysburg
Cold Mountain
Lincoln
Wyatt Earp
Dances with Wolves
Anna and the King
Deadwood
The Last Samurai
The Assassination of Jesse James by the Coward Robert Ford
Tombstone
Butch Cassidy and the Sundance Kid
Gandhi
1911
Meet Me in St. Louis
The Battleship Potemkin
Titanic
Doctor Zhivago
Ararat
All Quiet On The Western Front
Joyeux Noel
Flyboys
Gallipoli
A Very Long Engagement
Lawrence of Arabia
Michael Collins
The Lost Battalion
Kundun
The Last Emperor
The Wind that Shakes the Barley
Chariots of Fire
Evita
Legionnaire
The King's Speech
Casablanca
Australia
Road to Perdition
The Flowers of War
Schindler's List
The Pianist
Tora! Tora! Tora!
The Pacific
The Bridge on the River Kwai
The Thin Red Line
Empire of the Sun
Letters from Iwo Jima
Paradise Road
Band of Brothers
Enemy at the Gates
The Imitation Game
Patton
The Longest Day
Saving Private Ryan
Valkyrie
A Bridge Too Far
Flags of Our Fathers
Letters from Iwo Jima
Downfall
Nuremberg
Fat Man and Little Boy
Emperor
Seven Years in Tibet
The Reader
The Godfather
LA Confidential
The Shawshank Redemption
The Good Shepherd
The Right Stuff
Good Night, and Good Luck
Che
The Motorcycle Diaries
Quiz Show
JFK
The Godfather: Part II
J. Edgar
Thirteen Days
Ghosts of Mississippi
Mississippi Burning
We Were Soldiers
The Doors
Platoon
The Deer Hunter
Full Metal Jacket
Apocalypse Now
Born on the Fourth of July
The Deer Hunter
Bobby
Nixon
Apollo 13
All the President's Men
Goodfellas
Zodiac
Taxi Driver
Milk
The Last King of Scotland
Munich
Balibo
Frost/Nixon
Summer of Sam
Goodbye Bafana
Catch a Fire
Argo
Charlie Wilson's War
Jarhead
Three Kings
Black Hawk Down
Hotel Rwanda
Invictus
Behind Enemy Lines
Blood Diamond
The Queen
W.
Lions for Lambs
The Hurt Locker
The Social Network
Green Zone
Too Big to Fail
Margin Call
Zero Dark Thirty

Dangers of Japan's monetary policy

In 2012, with the election of Shinzo Abe, Japan embarked on a policy of bond buying which has subsequently taken the dollar-yen back to 95 , it's highest point since the financial crisis started. This is great for Japanese exporters because it makes their exports more competitive and also exerts real wage depreciation on workers, which helps the long-term competitiveness of the country.

The downside to this policy is that Japan is already in a liquidity trap. Demand for money is very low despite interest rates that are touching -(1.5)%. This is creating a temporary bubble in the TSE as hot money starts flowing into the yen to take advantage of the inflationary bull market. The challenge is that as the hot money flows into Japan, the yen rises, making the central bank's bond buying harder and harder to stay ahead of to achieve their desired goal.

The liquidity trap is really dangerous - something Europe may soon learn (the Netherlands specifically). No matter how low interest rates go, the economic engine won't turn over. This is why the easing program that Shinzo Abe has announced is being well received - even if it is 20 years too late to have a real impact.

Japan's real problem is that they have no domestic growth and their exports are being commoditized by other Asian countries like Korea, Taiwan, China, Indonesia and even Malaysia. The question is: without monetary trickery where is growth going to come from?

Japan has a population expected to decline by as many as 50 million people by the end of the century; they have very limited natural resources, which combined with the current anti-nuclear push has created higher production costs for Japanese manufacturers; and they have a "ingenuity gap" as US tech companies continue to dominate the Internet and Korean and Chinese manufacturers handle the gadget manufacturing.

Today the Tokyo Stock Exchange entered into bear market territory, down 10% from it's recent peak. This monetary alchemy needs to stop or else the yen risks a real collapse into an unstoppable deflationary spiral with inflation. This is stagflation 2.0 and could do a lot to derail the good economic news coming out of the US. Trade with caution.

The state of the Republican Party

The most common adjectives to describe today's Republican Party include: obstructionist, anti-women, anti-gay, anti-immigrant or pro-gun. These are not the adjectives that will win seats in the 2014 mid-terms or the 2016 presidential race.

The Republican Party badly needs to change its messaging away from demagoguery towards something inspirational for the country to grasp. As the economist noted in last weeks newspaper, Gen Y is a neo-liberal group encouraged by the values of the Internet: freedom, liberty, anti-statist. I think this is a great opportunity the Republicans. 

The Republicans have lost the culture wars; religiosity is now a net negative to the party. In the mid-1990s it was a way to consolidate the base, but now that base, in form of the Tea Party Caucus is pulling the party in two. The disappointment to many is that Tea Party Caucus economic values are actually mainstream among Gen Y. The idea that the government should regulate and supervise business and protect the environment and otherwise stay out of the private sector economy is a vision that can be easy to grasp. Gen Y is also very much skeptical of the welfare state. The challenge is that the Tea Party Caucus vision for a neo-liberal economic model is blunted by their statist religiousness. If they could advocate freedom of choice, freedom of beliefs and advocate for more state-based decision-making they could have a winning message.

The Republicans also need to avoid their current pattern of disingenuousness. Rolling out Ann Romney to boost her husbands' fortunes with women came of as pandering. After losing the 2012 election, the Republicans have now decided that Latino voters are am important demographic for them. They have now been trotting out Marco Rubio in a blatant attempt to look, not pro-Latino, but at least not anti-Latino. It all has a false feeling to it. Like selecting Michael Steele as the RNC chairman after 2008 to show the Republicans were progressive on civil rights after Obama's victory. The American people know when they are being lied to and when politicians are being disingenuous.

Chris Christie is truly a model for the future of the Republican Party. While he may not make a great presidential candidate, he can be the ideological guide to the party. He has some good ideas: put money in classrooms rather that teacher's unions, ensure the government has no structural deficits by engaging in entitlement reform, invest in infrastructure, etc. Those are very centrist opinions, and Christie has been very shy when wading into any culture war arenas.

Michelle Bachmann is now gone as the philosophical leader of the Tea Party Caucus, Sarah Palin's anti-intelligence dogma has been silenced in the main steam. This is an important opportunity for the Republicans to go away, come up with a platform and a framework for the country that can inspire.