Thursday, December 31, 2015

The "New and Improved" Middle East

Updated February 2017

With the massive amount of attention paid to the Middle East and the Islamic world in 2016, I thought it would be prudent to take a look at why this part of the world always seems to be in crisis mode and a possible solution to the region's problems.  While it was published back in 2006, a feature article in the Armed Forces Journal entitled "Blood Borders - How a better Middle East would look" written by Ralph Peters looks positively prescient in its views of how the political boundaries in the Middle East will end up looking in the future.  With the ongoing wars in both Syria and Iraq, the conflict between Saudi Arabia and Yemen getting almost no attention from the world's media and the Turkish involvement in the fight along its borders, it would not be surprising if the region would ends up with significantly changed boundaries.

As a bit of background, Ralph Peters is a retired United States Army lieutenant colonel who is widely published the mainstream media and served in military intelligence in Germany and as a Foreign Area Officer with a specialty in the Soviet Union.  After serving in the U.S. military for 22 years, he retired in 1998.

In his Blood Borders paper, he opens by noting that international borders, as we currently know them, are not always just and, as the British found out when they were the world's main superpower, dividing land masses up does not always take into account tribal and cultural differences.  Keeping in mind that the Shia and Sunni sects of Islam are about as different as night and day and to give you some idea of the complexity of the problems facing the region, here is a map showing the patchwork religious composition of the region between Turkey and Afghanistan:

In fact, some of the world's least culturally sensitive boundaries were drawn in the Middle East during and after the First World War.  The origins of these borders were the product of the Sykes-Picot Agreement, also know as the 1916 Asia Minor Agreement, was negotiated by the French and British governments and divided the Middle East as shown on this map:

Another agreement, the Treaty of Sevres which was signed by Great Britain, France and Italy in August 1920, further carved up the Ottoman Empire after the First World War as we can see on this map:

Lastly, the 1923 Treaty of Lausanne established the current state of Turkey and its present day boundaries as the successor to the Ottoman Empire as shown on this map:

It is this treaty that has played a significant role in Turkey's long history of sensitivity over the Kurds who live in the eastern part of the nation.

From this brief snapshot of Middle East history, we can see how fluid political boundaries have been in the region over the last century.  If we look in more detail at Ralph Peters' analysis, particularly in terms of the recent military actions in the region, we'll see that the boundaries are likely to continue to change.

Mr. Peters' analysis focusses on the region between the Balkan Mountains and the Himalayas.  Let's look at how he would realign the region.

1.) Kurdistan: The author notes that one of the biggest political injustices in the region is the absence of an independent Kurdish state, a so-called Free Kurdistan.  This ethnic group, numbering around 36 million in 2012, live in a more-or-less contiguous region of the Middle East, straddling several nations as shown on this map:

Turkey has the largest population of Kurds, numbering around 18.1 million or 24.2 percent of Turkey's total population.  Both Iran and Iraq have over 7 million Kurds which comprise 10.3 percent of Iran's total population and 21.5 percent of Iraq's total population.  Syria has approximately 1.9 million Kurds which make up about 8.9 percent of Syria's total population.  Obviously, this group has suffered significantly over the past century and a half since they have not been granted their own homeland and have been persecuted for their interests in forming a sovereign nation.  The latest opportunity to offer political stability to the Kurds came and went after the United States defeated Saddam Hussein who took every opportunity available to him to torment the Kurds, part of the reason why the coalition instituted a no-fly zone in Iraq after the Gulf War.

2.) Iraq: Here is a map showing how Iraq is split along the Sunni (light green) and Shia (dark green) lines:

As the coalition found out during Operation Iraqi Freedom, post-Hussein Iraq is far from united.  The two main sects of Islam are mortal enemies and will do everything in their power to eliminate the other, particularly after a decade of control and abuse by the Sunni/Baathist minority in the nation (despite the fact that the Baathists were technically secular).  As a result of the Shia-Sunni split in Iraq, the nation would be ultimately be split into three parts; the aforementioned Free Kurdistan, a Sunni northern Iraq and a Shia southern Iraq.

3.) Saudi Arabia: As we know, the House of Saud dynasty controls the world's two most important Islamic sites; Medina and Mecca.  This control by the Saudis, along with their vast oil wealth, has allowed them to project their Wahhabi vision of intolerant Islam around the globe.  To reduce the Saudi control on the Islamic world, the author suggests that the creation of an Islamic Sacred State (i.e. an Islamic Vatican) would take control of the two sacred sites.  This sacred state would be ruled by a rotating council of Muslims from around the globe.  As well, to reign in the power of the Saudi royal family, Saudi Arabia would lose control of some of its coastal oil fields that would become part of the Shia state that is formed in southern Iraq. 

4.) Iran: While Iran, which practised Shia Islam, would lose some of its territory to a Unified Azerbaijan and Free Kurdistan, it would gain territory in the east where it would acquire the provinces around Herat in Afghanistan, a traditionally Shia region as shown on this map

Lastly, let's take a brief look at what the author has to say about Israel, the elephant in the Middle East room.  He notes that the greatest hope of instilling peace with Israel's neighbours would come with a return to its pre-1967 borders.  That said, he observes that it is highly unlikely that this issue will be solved in our lifetime.

Now, let's close by looking at two maps; the first shows the current political boundaries in the Middle East and the second shows the more culturally and ethnically sensitive boundaries recommended by the author of the analysis:

The long history of imposing boundaries on the Middle East by outside powers has done nothing to make the region more stable or less prone to violence.  As we've experienced over the past decade and a half, interference in the region by the world's sole superpower and its proxies have led to the creation of a political vacuum which has led directly to the deaths of millions and the displacement of millions more.  As the British learned the hard way in the early decades of the 20th century, nobody wins when a colonial power forces a political solution on the Middle East.  Let's hope that Washington and the Trump Administration pay heed to the lessons of history.  With a significant majority of Iraqis and Syrians wanting nothing to do with a redivision of their nations, while Mr. Peters' analysis is interesting and logical, it would appear that steering clear of further intervention would be the path best taken.

Wednesday, December 30, 2015

The Q Ratio and Stock Market Valuations

Updated January 26, 2016

Way back in June, I posted a brief article on Tobin's Q, a measure that gives us a good idea of whether stock market valuations are fair.  Here is an update with more recent data.

As background, Tobin's Q (aka the Q Ratio) was developed by 1981 Economic Nobel Laureate James Tobin, who spent his academic career at Yale University.  In 1961, he was appointed as a member of President John F. Kennedy's Council of Economic Advisors and also acted as an advisor to presidential candidate George McGovern when he ran against Richard Nixon in 1972.  Interestingly, Tobin believed that government regulation often resulted in economic damage and argued that one cannot predict the impact of central bank monetary policies on output and unemployment by knowing the rate of growth of the supply of money or interest rates, rather, monetary policy has its impact on the economy through its impact on capital investments in plants, equipment and consumer durables.

Tobin introduced the concept of Tobin's Q as a measure to predict whether capital investment will increase or decrease with Q being the ratio between the market value of an asset and its replacement cost.  In its most basic form, he hypothesized that companies should be worth what it costs to replace them.  In other words, the total stock market value of a company should not exceed the value of its assets.  Therefore, the ratio of the total market value of a company is divided by the total asset value of that same company to give us Tobin's Q.  Here is the formula:

    Tobin's Q (Q Ratio) = Total Market Value of a Company 
                                        Total Asset Value of a Company

While it seems logical that the Q Ratio would be 1 (i.e. a one-to-one relationship between total market value and total asset value), this is not the case.  Here, I defer to an explanation by Andrew Smithers, the founder of Smithers & Co:

"The long-term average value of Q is below 1 because the replacement cost of company assets is overstated. This is because the long-term real return on corporate equity, according to the published data, is only 4.8%, while the long-term real return to investors is around 6.0%. Over the long-term and in equilibrium, the two must be the same.  The major cause of over-valuation of assets is almost certainly due to their economic rate of depreciation being underestimated."

If we take Tobin's Q to its ultimate level, it can be used to cover the entire U.S. corporate world by using the Federal Flow of Funds data from the Federal Reserves quarterly Z.1 Financial Accounts of the United States with the latest release on December 10, 2015.  This data used to calculate Tobin's Q can be found on Table B.103 Balance Sheet of Non-financial Corporate Business or on the St. Louis Federal Reserve Bank's FRED database.  Using FRED, Tobin's Q can be calculated by dividing Non-financial Corporate Business; Corporate Equities Liability Level by Non-financial Corporate Business Net Worth Level which gives us this graph:

Right now, Tobin's Q sits at 0.93.  This is well above the 65 year average of 0.71 if we use FRED's data back to 1951.  As well, while Tobin's Q is down slightly from its post-Great Recession high of 1.11 seen back in early 2014, it is still significantly higher than it has been going all the way back to 2002.

An interesting analysis of Tobin's Q/Q Ratio can be found on Vanguard's website.  As the author, Jill Mislinski notes, the Federal Reserve's Z.1 data is over two months old when it is released to the public.  As such, she uses the Vanguard Total Market ETF as a surrogate for the Corporate Equities Liability Level.  With this data, she calculates that Tobin's Q is currently sitting at around 1.0.  As I noted above, the current Tobin's Q is substantially above the average over the past six decades.  If we use Ms. Mislinski's data to go back further to 1900, Tobin's Q averages 0.68 over the 125 year period.  If we compare all Q Ratios to the arithmetic mean of 0.68 (the solid horizontal black line on the graph), we come up with this graph:

Currently, Tobin's Q is sitting at 45 percent above its long-term average.  While this is substantially lower than the peak of 136 percent during the tech sector bubble of 2000, it is still among the highest levels seen over the past 125 years.

As I noted at the beginning of this posting, Tobin's Q is another indicator that can be used to measure whether the stock market is fairly valued or not.  While the corrections of the past few months have somewhat reduced stock overvaluations when they are measured using the Tobin's Q yardstick, it is quite clear that the ratio is telling us that it is still "caveat emptor" when it comes to equities.  Perhaps all of that “newly minted” Federal Reserve “money" has found a warm welcome in America's equity markets, pushing equity prices to unrealistic values.

Tuesday, December 29, 2015

What Conservative America Wants

A recent poll by Public Policy Polling looks at American sentiment toward the current crop of presidential candidates and who voters would prefer as the GOP candidate for the 2016 election among other issues.  As background, fifty percent of those polled considered themselves to be Evangelical Christians and 67 percent did not consider themselves to be a member of the Tea Party.  Nearly three-quarters of the respondents considered themselves to be either somewhat conservative (44%) or very conservative (27%).
Here is a summary of their findings:

1.) Out of all of the current GOP candidates for president, who would you most like to see as the candidate for the president in 2016? (in alphabetical order)

Jeb Bush - 7%
Ben Carson - 6%
Chris Christie - 5%
Ted Cruz - 18%
Carly Fiorina - 4%
Jim Gilmore - 0%
Mike Huckabee - 4%
John Kasich - 2%
George Pataki - 0%
Rand Paul - 2%
Marco Rubio - 13%
Rick Santorum - 1%
Donald Trump - 34%
Undecided - 2%

2.) Given the choices of just Ben Carson, Donald Trump, Marco Rubio and Ted Cruz, who would you support for the GOP nomination for President? (in alphabetical order)

Ben Carson 10%
Ted Cruz - 22%
Marco Rubio - 20%
Donald Trump - 40%
Not Sure - 9%

3.) Given the choices of just Jeb Bush, Donald Trump, Marco Rubio and Ted Cruz, who would you support for the GOP nomination for President? (in alphabetical order)

Jeb Bush -  12%
Ted Cruz - 21%
Marco Rubio - 19%
Donald Trump - 40%

In every combination of candidates where Donald Trump is included, he is always the preferred candidate with the closest race coming if there were just two remaining candidates; Ted Cruz (44%) and Donald Trump (45%).

4.) Do you have a favourable or unfavourable opinion of Jeb Bush?

Favourable - 34%
Unfavourable - 49%
Not Sure - 18%

5.) Do you have a favourable or unfavourable opinion of Ben Carson?

Favourable - 61%
Unfavourable - 26%
Not Sure - 12%

6.) Do you have a favourable or unfavourable opinion of Ted Cruz?

Favourable - 59%
Unfavourable - 27%
Not Sure - 14%

7.) Do you have a favourable or unfavourable opinion of Marco Rubio?

Favourable - 49%
Unfavourable - 334%
Not Sure - 17%

8.) Do you have a favourable or unfavourable opinion of Donald Trump?

Favourable - 58%
Unfavourable - 34%
Not Sure - 8%

Let's look at some non-election questions. 

9.) Would you support increasing the minimum wage to $15 per hour, $12 per hour, $10 per hour, keeping it at $7.25 per hour or eliminating the minimum wage altogether?

$15 per hour - 6%
$12 per hour - 11%
$10 per hour - 38%
$7.25 per hour - 26%
Eliminate the federal minimum wage - 18%

10.) Do you support or oppose banning Muslims from entering the United States?

Support banning Muslims - 54%
Oppose banning Muslims - 25%
Not Sure - 21%

11.) Would you support or oppose shutting down mosques in the United States?

Support shutting down mosques - 28%
Oppose shutting down mosques - 47%
Not Sure - 26%

12.) Do you believe that thousands of Arabs in New Jersey cheered when the World Trade Center collapsed on 9/11?

Believe that they cheered - 36%
Do not believe that they cheered - 35%
Not Sure - 29%

13.) Do you think that the religion of Islam should be legal or illegal in the United States?

Legal - 53%
Illegal - 26%
Not Sure - 21%

14.) Would you support or oppose creating a national database of all Muslims in the United States?

Support - 46%
Oppose - 37%
Not Sure - 17%

And, last but not least.....

15.) Would you support or oppose bombing Agrabah?

Support bombing Agrabah - 30%
Oppose bombinb Agrabah - 13%
Not Sure - 57%

For your illumination, here is a bit of background on Agrabah:

Given that mysterious, enchanting and barbaric Agrabah is located near the Jordan River and forms the central location in the Disney film "Aladdin", I would imagine that the residents; Aladdin, Genie, Abu, Carpet, Iago and Princess Jasmine are preparing for an imminent invasion by a cobbled together coalition, particularly with the ongoing hostilities in Syria and Iraq being a short distance away as the Egyptian vulture flies.