The Taliban is Like Japan

Charts: We've seen the 200-day moving average of the S&P 500 repeatedly tested in recent days. Each time it has been tested, it has found support, which is good. Here's the rub, the index is finding support exactly at the 200-day line. The precision is too great for it to be simple technical support. This means there are computerized trading programs moving the market. They will likely dump stocks if the 200-day line does not hold up. And programs like this can be very dangerous: computerized stop losses caused the flash crash 14 months ago that sent the Dow index down nearly 1000 points in a few hours. The flash crash stop losses were put in place because of the Greek debt crisis and we are still grappling with this issue.

Fundamentals: On Wednesday the Greek Parliament will vote on a broad austerity program and on Thursday it will vote on specific legislation to enact the broad program. Greek Deputy PM Pangalos says the Wednesday vote is pretty much a cinch but the Thursday vote is still up in the air. This is because specific cuts will hurt specific Members of Parliament (MPs) while the broad program does not directly do this. If either vote fails, Armageddon will descend upon our portfolios like the wrath of an avenging God (scary). The stock market thinks everything will turn up roses because nobody could be so stupid as to invite the wrath of an avenging God. Who could be that dumb? Keep reading...

The Greek Socialist party is sponsoring the legislation and holds the key for victory. It controls 155 seats out of 300. One Socialist MP has defected and two are on the fence. So right now there is a cushion of only two votes. Last Thursday the EU/IMF/ECB (the so-called Troika) toughened the austerity package. One of the things the Troika did was increase taxes on Greek minimum wage workers. This was incredibly stupid because it won't generate much revenue but it enraged Greek voters.

The Trokia's austerity package is in fact very poorly designed, heavy on job killing taxes and light on privatization. The Greek government owns over $300 billion in hard assets and has only $400 billion in outstanding debt. So massive privatization combined with a lower-tax, business-friendly environment could easily solve the problem. But that is not on the table.

What is on the table will bankrupt Greece and force a default at some time in the future. The term "kick the can down the road" has appeared hundreds of times in financial periodicals to describe this approach. Everybody knows Greece will default, it's only a question of when. The stock market wants the vote to succeed, have the can kicked down the road a couple years, and then rally in relief.

If the vote succeeds, there probably will be a global relief rally. But the market is wrong if it thinks the can will be kicked down the road for years. It might be only months or weeks or even days. Here's why...

The first Greek bail out package over a year ago was also accompanied by an austerity program. The first program did not get off the ground very far. For instance, Greek tax collection is based on Medieval customs where tax collectors are given a territory and tacitly allowed to pocket bribes as they shake down tax payers. This was supposed to have been reformed by the first program but wasn't.

If the vote does succeed, the bond and credit default swap markets will be watching to see if the second austerity program is actually being implemented. Probably it won't be implemented because of the stupid taxes on low income Greeks and all the other garbage put in place by the Troika. If the credit markets start to panic, the equity markets will eventually follow suit.

Long War: There are more American combat deaths in Iraq right now than there are in Afghanistan. American combat deaths in Iraq are at a three year high and as the US troop draw down goes into high gear things are looking dicey. Long War hot spots run by the Pentagon (Iraq and Afghanistan) aren't doing very well. The hot spots run by the CIA (everywhere else) are doing much better. This brings us to Joe Biden's vision.

After the surge troops are withdrawn from Afghanistan there will be 70,000 US soldiers left in country. Biden wants them to stop engaging in "nation building" and instead deploy around huge military compounds that will be home to a fleet of CIA drones. Without nation building, civilian foreign aid will be stopped, saving billions. When the CIA is in charge there is never very much civilian foreign aid.

The CIA knows there is an inverse relationship between GDP growth in developing countries and foreign aid. The more aid, the less growth. Take the Marshal Plan after WW II. Ten times more aid went to Britain than Germany. But Germany's economy grew three times faster than Britain's. Then there's Somaliland, an independent (but unrecognized) country in Africa that receives zero foreign aid. It grows faster than similar countries that get foreign aid. One of the reason why the Libyan rebels are doing better than our Afghan allies is that the Libyan good guys aren't getting any real foreign aid.

Biden says that this CIA-centric structure will be permanent. A low level guerrilla war will be fought in Af/Pak for decades. He is very wise to admit this up front. All in all, Biden's vision is excellent. Here's the problem, Obama doesn't want a permanent war. And this is why we are hearing so much about America's not-so-secret peace talks with the Taliban. Apparently Obama thinks that the Taliban can be talked into peace and the whole problem will just go away. Here is another inverse relationship for you: The greater the number of combat deaths an army is willing to absorb, the less chance there is for a given war to be settled through negotiation.

In WW II, the Italian Army was quick to surrender on the battlefield, unwilling to absorb combat losses, and it was also amicable to peace talks. But the Japanese Army was willing to absorb huge combat losses. Japan had to have not one, but two, Atomic bombs dropped on it, plus face a post nuclear occupation from the Soviet Union, before it was willing to engage in peace talks. The Taliban is like Japan, not Italy.