Thursday, November 20, 2014

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Breakfast with a Lord of War

By David Galland, Partner, Casey Research

For reasons that will become apparent as you read the following article, I was quite reluctant to write it.
Yet, in the end, I decided to do so for a couple of reasons.

The first is that it ties into Marin Katusa’s best selling new book, The Colder War, which I read cover to cover over two days and can recommend warmly and without hesitation. I know that Casey Research has been promoting the book aggressively (in my view, a bit too aggressively), but I exaggerate not at all when I tell you that the book sucked me in from the very beginning and kept me reading right to the end.

The second reason, however, is that I have a story to tell. It’s a true story and one, I believe, which needs to be told. It has to do with a breakfast I had four years ago with a Lord of War.

With that introduction, we begin.

Breakfast with a Lord of War

In late 2010, I was invited to a private breakfast meeting with an individual near the apex of the U.S. military’s strategic planning pyramid. Specifically, the individual we were to breakfast with sits at the side of the long serving head of the department in the Pentagon responsible for identifying and assessing potential threats to national security and devising long term strategies to counter those threats.

The ground rules for the discussion—that certain topics were off limits—were set right up front. Yet, as we warmed up to each other over the course of our meal, the conversation went into directions even I couldn’t have anticipated.

In an earlier mention of this meeting in a Casey Daily Dispatch, I steered clear of much of what was discussed because frankly, it made me nervous. With the passage of time and upon reflection that it was up to my breakfast companion, who spends long days cloaked in secrecy, to know what is allowed in daylight, I have decided to share the entire story.

During our discussion, there were four key revelations, each a bit scarier than the last.

Four Key Revelations


Once we had bonded a bit, the military officer, dressed in his civvies for the meeting, began opening up. As I didn’t record the discussion, the dialogue that follows can only be an approximation. That said, I assure you it is accurate in all the important aspects.

“Which country or countries most concern you?” I asked, not sure if I would get an answer. “China?”
“Well, I’m not going to say too much, but it’s not China. Our analysis tells us the country is too fractured to be a threat. Too many different ethnic and religious groups and competing political factions. So no, it’s not China. Russia, on the other hand…” He left it at that, though Russia would come up again in our conversation on several occasions.

As breakfast was served, the conversation meandered here and there before he volunteered, “There are a couple of things I can discuss that we are working on, one of which won’t surprise you, and one that will.”
“The first is precision guided weaponry.” Simply, the airplane and drone launched weaponry that is deployed so frequently today, four years after our breakfast conversation, that it now barely rates a back-page mention.

“The second,” he continued,” will surprise you. It’s nuclear armaments.”

“Really? I can’t imagine the US would ever consider using nuclear weapons again. Seriously?”

“Yes, there could be instances when using nukes might be advisable,” he answered. “For example, no one would argue that dropping atomic bombs on Japan had been a bad thing.” (I, for one, could have made that argument, but in the interest of harmony didn’t.)

“Even so, I can’t imagine a scenario that would warrant using nukes,” I persisted. “Are there any other countries doing the same sort of research?”

“Absolutely. For example, the Russians would love to drop a bomb that wiped out the people of Chechnya but left the infrastructure intact.”

“So, neutron bombs?”

“Yeah, stuff like that,” he added before turning back to his coffee.

“Okay, well,” I continued, “you at least have to admit that, unlike last century when hundreds of millions of people died directly or indirectly in world wars, pogroms, and so forth—most related to governments—the human race has evolved to the point where death on that scale is a thing of the past. Right?”

I kid you not in the slightest, but at this question the handsome, friendly countenance I had been sitting across from morphed as if literally a mask had been lifted away and was replaced with the emotionless face of a Lord of War.

“That would be a very poor assumption,” he answered coldly before the mask went back on.

I recall a number of thoughts and emotions coursing through my brain at his reply, most prevalently relief that I had moved with my family to La Estancia de Cafayate in a remote corner of Argentina. We didn’t move there to escape war, but after this conversation, I added that to my short list of reasons why the move had been a good idea.

Recapping the conversation later, my associate and I concurred that Russia was in the crosshairs and that if push came to shove, the US was fully prepared to use the new nuclear weapons being worked on.

Four Years Later


As I write, four years after that conversation, it’s worth revisiting just what has transpired.

First, as mentioned, the use of precision-guided weaponry has now firmly entered the vernacular of US warmaking. Point of fact: there are now more pilots being trained to fly drones than airplanes. And the technology has reached the point where there is literally no corner on earth where a strategic hit couldn’t be made. Even more concerning, the political and legal framework that previously caused hesitation before striking against citizens of other countries (outside of an active war zone) has largely been erased. Today Pakistan, tomorrow the world?

Second, instead of winding back the US nuclear program—a firm plank in President Obama’s campaign platform—the Nobel Prize winner and his team have indeed been ramping up and modernizing the US nuclear arsenal. The following is an excerpt from a September 21, 2014 article in the New York Times, titled “U.S. Ramping Up Major Renewal in Nuclear Arms”…,,

KANSAS CITY, Mo. — A sprawling new plant here in a former soybean field makes the mechanical guts of America’s atomic warheads. Bigger than the Pentagon, full of futuristic gear and thousands of workers, the plant, dedicated last month, modernizes the aging weapons that the United States can fire from missiles, bombers and submarines.

It is part of a nationwide wave of atomic revitalization that includes plans for a new generation of weapon carriers. A recent federal study put the collective price tag, over the next three decades, at up to a trillion dollars.

Third, the events unfolding in Ukraine, where the US was caught red handed engineering the regime change that destabilized the country and forced Russia to act, show a clear intent to set the world against Putin’s Russia and in time, neutralize Russia as a strategic threat.

So the only revelation from my breakfast four years ago remaining to be confirmed is for the next big war to envelope the world. Per the events in Ukraine, the foundations of that war have likely already been set. Before I get to that, however, a quick but relevant detour is required.

The Nature of Complex Systems


Last week the semiannual Owner’s & Guests event took place here at La Estancia de Cafayate. As part of the weeklong gathering, a conference was held featuring residents speaking on topics they are experts on.
Among those residents is a nuclear-energy engineer who spoke on the fragility of the US power grid, the most complex energy transmission system in the world.
He went into great detail about the “defense-in-depth” controls, backups, and overrides built into the system to ensure the grid won’t—in fact, can’t—fail. Yet periodically, it still does.

How? First and foremost, the engineer explained, there is a fundamental principle that holds that the more complex a system is, the more likely it is to fail. As a consequence, despite thousands of very bright people armed with massive budgets and a clear mandate to keep the transmission lines humming, there is essentially nothing they can do to actually prevent some unforeseen, and unforeseeable, event from taking the whole complex system down.

Case in point: in 2003 one of the largest power outages in history occurred. 508 large power generators were knocked out, leaving 55 million people in North America without power for upward of 24 hours. The cause? A software defect in an alarm system in an Ohio control center.

I mention this in the context of this article because, as complex as the U.S. power grid is, it is nothing compared to the complexities involved with long-term military strategic planning. This complexity is the result of many factors, including:
  • The challenges of identifying potential adversaries and threats many years, even a decade or more, into the future.
  • New and evolving technologies. It is a truism that the military is always fighting the last war: by the time the military machine spins up to build and deploy a new technology, it is often already obsolete.
  • The entrenched bureaucracies, headed by mere mortals with strong biases. Today’s friend is tomorrow’s enemy and vice versa.
  • The unsteady influences of a political class always quick to react with policy shifts to the latest dire news or purported outrage.
  • The media, a constant source of hysteria making headlines masquerading as news. And let’s not overlook the media’s role as active agents of the entrenched bureaucratic interests. In one now largely forgotten case, Operation Mockingbird, the CIA actually infiltrated the major US media outlets, specifically to influence public opinion.

    All you need to do to understand the bureaucratic agenda is to take a casual glance at the “news” about current events such as those transpiring in the Ukraine.
  • And, most important, human nature. We humans are the ultimate complex system, prone to a literally infinite number of strong opinions, exaggerated fears, mental illnesses, passions, vices, self-destructive tendencies, and stupidity on a biblical scale.
The point is that the average person assumes the powers-that-be actually know what they are doing and would never lead us into disaster, but quoting my breakfast companion, that would be a very poor assumption.

Simply, while mass war on the level of the wholesale slaughter commonplace in the last century is unimaginable to most in the modern context, it is never more than the equivalent of a faulty alarm system away from occurring.

Those history buffs among you will confirm that up until about a week before World War I began, virtually no one in the public, the press, the political class, or even the military had any idea the shooting was about to start. And 99.9% of the people then living had no idea the war was about to begin until after the first shot was fired.

Back to the Present


It is a rare moment in one’s life when the bureaucratic curtain falls away long enough to reveal something approximating The Truth. In my opinion, that’s what I observed over breakfast four years ago. That, right or wrong, the proactive military strategy of the US had been turned toward Russia.
Knowing that and no more, one can only guess what actual measures have been planned and set into motion to defang the Russian bear.

Based on the evidence, however, the events in Ukraine appear to be a bold chess move on the bigger board… and to be fair, a pretty damn effective move at that. The problem for the US and its allies is that on the other side of the table is one Vladimir Putin, self made man, black belt judo master, and former KGB spy master.

And that’s just scratching the surface of this complicated and determined individual. One thing is for sure: if you had to pick your adversary in a global geopolitical contest, you’d probably pick him dead last.
Which brings me to a quick mention of The Colder War, Marin’s book, which was released yesterday.
I mentioned earlier that the book had sucked me in and kept me in pretty much straight through until I finished. One reason is that while you can tell Marin has a great deal of respect for Putin’s capabilities and strategic thinking, he doesn’t shy away from revealing the judo master’s dark side. As you will read (and find quoting to your friends, as I have), it is a very dark side.

But the story is so much bigger than that, and Marin does a very good job of explaining the increasingly hostile competition between the US and Russia and the seismic economic consequences that will affect us all as the “Colder War” heats up.

Before signing off for now, I want to add that it is not Marin’s contention that the Colder War will devolve into an actual shooting war. In my view, however, due to the complexities discussed above, you can’t dismiss a military confrontation, even one involving nukes. Every complex system ultimately fails, and the more the US pushes in on Putin’s Russia, the more likely such a failure is to occur.

I recommend Marin’s book, The Colder War; here is the link.

We’ll leave the lights on down here in Cafayate.

Casey Research partner David Galland lives in La Estancia de Cafayate (www.LaEst.com).
The article Breakfast with a Lord of War was originally published at casey research.com.


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Monday, November 17, 2014

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The Return of the Dollar

By John Mauldin


Two years ago, my friend Mohamed El-Erian and I were on the stage at my Strategic Investment Conference. Naturally we were discussing currencies in the global economy, and I asked him about currency wars. He smiled and said to me, “John, we don’t talk about currency wars in polite circles. More like currency disagreements” (or some word to that effect).

This week I note that he actually uses the words currency war in an essay he wrote for Project Syndicate:

Yet the benefits of the dollar’s rally are far from guaranteed, for both economic and financial reasons. While the US economy is more resilient and agile than its developed counterparts, it is not yet robust enough to be able to adjust smoothly to a significant shift in external demand to other countries. There is also the risk that, given the role of the ECB and the Bank of Japan in shaping their currencies’ performance, such a shift could be characterized as a “currency war” in the US Congress, prompting a retaliatory policy response.

This is a short treatise, but as usual with Mohamed’s writing, it’s very thought provoking. Definitely Outside the Box material.

And for a two-part Outside the Box I want to take the unusual step of including an op-ed piece that you might not have seen, from the Wall Street Journal, called “How to Distort Income Inequality,” by Phil Gramm and Michael Solon. They cite research I’ve seen elsewhere which shows that the work by Thomas Piketty cherry-picks data and ignores total income and especially how taxes distort the data. That is not to say that income inequality does not exist and that we should not be cognizant and concerned, but we need to plan policy based on a firm grasp of reality and not overreact because of some fantasy world created by social provocateur academicians.

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The calls for income redistribution from socialists and liberals based on Piketty’s work are clearly misguided and will further distort income inequality in ways that will only reduce total global productivity and growth.
I’m in New York today at an institutional fund manager conference where I had the privilege of hearing my good friend Ian Bremmer take us around the world on a geopolitical tour. Ian was refreshingly optimistic, or at least sanguine, about most of the world over the next few years. Lots of potential problems, of course, but he thinks everything should turn out fine – with the notable exception of Russia, where he is quite pessimistic.

A shirtless Vladimir Putin was the scariest thing on his geopolitical radar. As he spoke, Russia was clearly putting troops and arms into eastern Ukraine. Why would you do that if you didn’t intend to go further? Ian worried openly about Russia’s extending a land bridge all the way to Crimea and potentially even to Odessa, which is the heart of economic Ukraine, along with the Kiev region. It would basically make Ukraine ungovernable.

I thought Putin’s sadly grim and memorable line that “The United States is prepared to fight Russia to the last Ukrainian” pretty much sums up the potential for a US or NATO response. Putin agreed to a cease-fire and assumed that sanctions would start to be lifted. When there was no movement on sanctions, he pretty much went back to square one. He has clearly turned his economic attention towards China.

Both Ian Bremmer and Mohamed El Erian will be at my Strategic Investment Conference next year, which will again be in San Diego in the spring, April 28-30. Save the dates in your calendar as you do not want to miss what is setting up to be a very special conference. We will get more details to you soon.

It is a very pleasant day here in New York, and I was able to avoid taxis and put in about six miles of pleasant walking. (Sadly, it is supposed to turn cold tomorrow.) I’ve gotten used to getting around in cities and slipping into the flow of things, but there was a time when I felt like the country mouse coming to the city. As I walked past St. Bart’s today I was reminded of an occasion when your humble analyst nearly got himself in serious trouble.

There is a very pleasant little outdoor restaurant at St. Bartholomew’s Episcopal Church, across the street from the side entrance of the Waldorf-Astoria. It was a fabulous day in the spring, and I was having lunch with my good friend Barry Ritholtz. The president (George W.) was in town and staying at the Waldorf. His entourage pulled up and Barry pointed and said, “Look, there’s the president.”

We were at the edge of the restaurant, so I stood up to see if I could see George. The next thing I know, Barry’s hand is on my shoulder roughly pulling me back into my seat. “Sit down!” he barked. I was rather confused – what faux pas I had committed? Barry pointed to two rather menacing, dark-suited figures who were glaring at me from inside the restaurant.

“They were getting ready to shoot you, John! They had their hands inside their coats ready to pull guns. They thought you were going to do something to the president!”

This was New York not too long after 9/11. The memory is fresh even today. Now, I think I would know better than to stand up with the president coming out the side door across the street. But back then I was still just a country boy come to the big city.

Tomorrow night I will have dinner with Barry and Art Cashin and a few other friends at some restaurant which is supposedly famous for a mob shooting back in the day. Art will have stories, I am sure.
It is time to go sing for my supper, and I will try not to keep the guests from enjoying what promises to be a fabulous meal from celebrity chef Cyrille Allannic. After Ian’s speech, I think I will be nothing but sweetness and light, just a harmless economic entertainer. After all, what could possibly go really wrong with the global economy, when you’re being wined and dined at the top of New York? Have a great week.

John Mauldin, Editor
Outside the Box
subscribers@mauldineconomics.com

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The Return of the Dollar

By Mohamed El-Erian
Project Syndicate, Nov. 13, 2014

The U.S. dollar is on the move. In the last four months alone, it has soared by more than 7% compared with a basket of more than a dozen global currencies, and by even more against the euro and the Japanese yen. This dollar rally, the result of genuine economic progress and divergent policy developments, could contribute to the “rebalancing” that has long eluded the world economy. But that outcome is far from guaranteed, especially given the related risks of financial instability.

Two major factors are currently working in the dollar’s favor, particularly compared to the euro and the yen. First, the United States is consistently outperforming Europe and Japan in terms of economic growth and dynamism – and will likely continue to do so – owing not only to its economic flexibility and entrepreneurial energy, but also to its more decisive policy action since the start of the global financial crisis.

Second, after a period of alignment, the monetary policies of these three large and systemically important economies are diverging, taking the world economy from a multi-speed trajectory to a multi-track one. Indeed, whereas the US Federal Reserve terminated its large-scale securities purchases, known as “quantitative easing” (QE), last month, the Bank of Japan and the European Central Bank recently announced the expansion of their monetary-stimulus programs. In fact, ECB President Mario Draghi signaled a willingness to expand his institution’s balance sheet by a massive €1 trillion ($1.25 trillion).

With higher US market interest rates attracting additional capital inflows and pushing the dollar even higher, the currency’s revaluation would appear to be just what the doctor ordered when it comes to catalyzing a long-awaited global rebalancing – one that promotes stronger growth and mitigates deflation risk in Europe and Japan. Specifically, an appreciating dollar improves the price competitiveness of European and Japanese companies in the US and other markets, while moderating some of the structural deflationary pressure in the lagging economies by causing import prices to rise.

Yet the benefits of the dollar’s rally are far from guaranteed, for both economic and financial reasons. While the US economy is more resilient and agile than its developed counterparts, it is not yet robust enough to be able to adjust smoothly to a significant shift in external demand to other countries. There is also the risk that, given the role of the ECB and the Bank of Japan in shaping their currencies’ performance, such a shift could be characterized as a “currency war” in the US Congress, prompting a retaliatory policy response.

Furthermore, sudden large currency moves tend to translate into financial-market instability. To be sure, this risk was more acute when a larger number of emerging-economy currencies were pegged to the U.S. dollar, which meant that a significant shift in the dollar’s value would weaken other countries’ balance of payments position and erode their international reserves, thereby undermining their creditworthiness. Today, many of these countries have adopted more flexible exchange-rate regimes, and quite a few retain adequate reserve holdings.

But a new issue risks bringing about a similarly problematic outcome: By repeatedly repressing financial-market volatility over the last few years, central-bank policies have inadvertently encouraged excessive risk-taking, which has pushed many financial-asset prices higher than economic fundamentals warrant. To the extent that continued currency-market volatility spills over into other markets – and it will – the imperative for stronger economic fundamentals to validate asset prices will intensify.

This is not to say that the currency re-alignment that is currently underway is necessarily a problematic development; on the contrary, it has the potential to boost the global economy by supporting the recovery of some of its most challenged components. But the only way to take advantage of the re-alignment’s benefits, without experiencing serious economic disruptions and financial-market volatility, is to introduce complementary growth-enhancing policy adjustments, such as accelerating structural reforms, balancing aggregate demand, and reducing or eliminating debt overhangs.

After all, global growth, at its current level, is inadequate for mere redistribution among countries to work. Overall global GDP needs to increase.

The US dollar’s resurgence, while promising, is only a first step. It is up to governments to ensure that the ongoing currency re-alignment supports a balanced, stable, and sustainable economic recovery. Otherwise, they may find themselves again in the unpleasant business of mitigating financial instability.

How to Distort Income Inequality

By Phil Gramm and Michael Solon
Wall Street Journal, Nov. 11, 2014

The Piketty-Saez data ignore changes in tax law and fail to count noncash compensation and Social Security benefits.

What the hockey-stick portrayal of global temperatures did in bringing a sense of crisis to the issue of global warming is now being replicated in the controversy over income inequality, thanks to a now-famous study by Thomas Piketty and Emmanuel Saez, professors of economics at the Paris School of Economics and the University of California, Berkeley, respectively. Whether the issue is climate change or income inequality, however, problems with the underlying data significantly distort the debate.

The chosen starting point for the most-quoted part of the Piketty-Saez study is 1979. In that year the inflation rate was 13.3%, interest rates were 15.5% and the poverty rate was rising, but economic misery was distributed more equally than in any year since. That misery led to the election of Ronald Reagan, whose economic policies helped usher in 25 years of lower interest rates, lower inflation and high economic growth. But Messrs. Piketty and Saez tell us it was also a period where the rich got richer, the poor got poorer and only a relatively small number of Americans benefited from the economic booms of the Reagan and Clinton years.

If that dark picture doesn’t sound like the country you lived in, that’s because it isn’t. The Piketty-Saez study looked only at pretax cash market income. It did not take into account taxes. It left out noncash compensation such as employer-provided health insurance and pension contributions. It left out Social Security payments, Medicare and Medicaid benefits, and more than 100 other means-tested government programs. Realized capital gains were included, but not the first $500,000 from the sale of one’s home, which is tax-exempt. IRAs and 401(k)s were counted only when the money is taken out in retirement. Finally, the Piketty-Saez data are based on individual tax returns, which ignore, for any given household, the presence of multiple earners.

And now, thanks to a new study in the Southern Economic Journal, we know what the picture looks like when the missing data are filled in. Economists Philip Armour and Richard V. Burkhauser of Cornell University and Jeff Larrimore of Congress’s Joint Committee on Taxation expanded the Piketty-Saez income measure using census data to account for all public and private in-kind benefits, taxes, Social Security payments and household size.

The result is dramatic. The bottom quintile of Americans experienced a 31% increase in income from 1979 to 2007 instead of a 33% decline that is found using a Piketty-Saez market-income measure alone. The income of the second quintile, often referred to as the working class, rose by 32%, not 0.7%. The income of the middle quintile, America’s middle class, increased by 37%, not 2.2%.

By omitting Social Security, Medicare and Medicaid, the Piketty-Saez study renders most older Americans poor when in reality most have above-average incomes. The exclusion of benefits like employer-provided health insurance, retirement benefits (except when actually paid out in retirement) and capital gains on homes misses much of the income and wealth of middle- and upper-middle income families.

Messrs. Piketty and Saez also did not take into consideration the effect that tax policies have on how people report their incomes. This leads to major distortions. The bipartisan tax reform of 1986 lowered the highest personal tax rate to 28% from 50%, but the top corporate-tax rate was reduced only to 34%. There was, therefore, an incentive to restructure businesses from C-Corps to subchapter S corporations, limited liability corporations, partnerships and proprietorships, where the same income would now be taxed only once at a lower, personal rate. As businesses restructured, what had been corporate income poured into personal income-tax receipts.

So Messrs. Piketty and Saez report a 44% increase in the income earned by the top 1% in 1987 and 1988—though this change reflected how income was taxed, not how income had grown. This change in the structure of American businesses alone accounts for roughly one-third of what they portray as the growth in the income share earned by the top 1% of earners over the entire 1979-2012 period.

An equally extraordinary distortion in the data used to measure inequality (the Gini Coefficient) has been discovered by Cornell’s Mr. Burkhauser. In 1992 the Census Bureau changed the Current Population Survey to collect more in-depth data on high-income individuals. This change in survey technique alone, causing a one-time upward shift in the measured income of high-income individuals, is the source of almost 30% of the total growth of inequality in the U.S. since 1979.

Simple statistical errors in the data account for roughly one third of what is now claimed to be a “frightening” increase in income inequality. But the weakness of the case for redistribution does not end there. America is the freest and most dynamic society in history, and freedom and equality of outcome have never coexisted anywhere at any time. Here the innovator, the first mover, the talented and the persistent win out—producing large income inequality. The prizes are unequal because in our system consumers reward people for the value they add. Some can and do add extraordinary value, others can’t or don’t.

How exactly are we poorer because Bill Gates, Warren Buffett and the Walton family are so rich? Mr. Gates became rich by mainstreaming computer power into our lives and in the process made us better off. Mr. Buffett’s genius improves the efficiency of capital allocation and the whole economy benefits. Wal-Mart stretches our buying power and raises the living standards of millions of Americans, especially low-income earners. Rich people don’t “take” a large share of national income, they “bring” it. The beauty of our system is that everybody benefits from the value they bring.

Yes, income is 24% less equally distributed here than in the average of the other 34 member countries of the OECD. But OECD figures show that U.S. per capita GDP is 42% higher, household wealth is 210% higher and median disposable income is 42% higher. How many Americans would give up 42% of their income to see the rich get less?

Vast new fortunes were earned in the 25-year boom that began under Reagan and continued under Clinton. But the income of middle-class Americans rose significantly. These incomes have fallen during the Obama presidency, and not because the rich have gotten richer. They’ve fallen because bad federal policies have yielded the weakest recovery in the postwar history of America.

Yet even as the recovery continues to disappoint, the president increasingly turns to the politics of envy by demanding that the rich pay their “fair share.” The politics of envy may work here as it has worked so often in Latin America and Europe, but the economics of envy is failing in America as it has failed everywhere else.

Mr. Gramm, a former Republican senator from Texas, is a visiting scholar at the American Enterprise Institute. Mr. Solon was a budget adviser to Senate Republican Leader Mitch McConnell and is a partner of US Policy Metrics.

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Important Disclosures

The article Outside the Box: The Return of the Dollar was originally published at mauldineconomics.com.


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Saturday, November 15, 2014

New Video: How You Can Profit with ETFs from the Unexpected Move in the Dollar

You've seen us talking about a new Options strategy that John Carter was working on recently...and he is finally sharing it with us.

Video: My Favorite Way to Trade Options on ETFs

This strategy is the "sleep at night as you trade options" strategy. And we ALL need that!

Here's just a taste of what John shows you in this video:

*  Why trading options on ETFs cuts your risk so you can sleep at night

*  How you can profit with ETFs from the unexpected move in the dollar

*  Why you avoid the games high frequency traders play by trading ETFs

*  Why most analysts have the next move in the dollar wrong and how to protect your investments

*  What are some of the markets that will be impacted by the dollars next move

Here's the link to watch the video again

Enjoy the video,
Ray's Stock World


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Tuesday, November 11, 2014

The Madness of the EU’s Energy Policy

By Marin Katusa, Chief Energy Investment Strategist

The stakes couldn’t be higher. Vladimir Putin has launched a devastating plan to turn Russia into an energy powerhouse. And Europe, dependent on Russian natural gas and oil for a third of its fuel needs, has fallen right into his hands: Putin can bend the EU to his will simply by twisting the valve shut.

Considering how precarious Europe’s economic security is, one would have thought that now would be a good time for the EU to reassess its energy policy and address the effect crippling energy costs are having on its struggling economy. But the EU is never going to agree to a rational reappraisal of its policies, because eco-loons like its new energy commissioner, Violetta Bulc, have taken over the asylum.

A practicing fire walker and a shaman, she’s the sort of airy fairy Goddard College type who only believes in the power of “positive energy.” What will guide us in this frightening new era is, according to her blog, the spirit of the White Lions:

The Legend says that White Lions are star beings, uniting star energy within earth form of Lions. The native ancestors were convinced that they are children of the Sun God, thus embodying Solar Logos and legends say that they came down to Earth to help save humanity at a time of crisis. There is no doubt that this time is right now.

With the European Commission stuffed with green anti capitalist zealots, it’s not surprising that the EU’s response to the challenges of a resurgent Russia is a complete break with reality.

The EU has come up with an aggressive climate plan—just like Obama’s. In defiance of all logic—if not Putin—it’s agreed to cut greenhouse gas emissions by 40% and make clean energy, like wind and solar, 27% of overall energy use by 2030. Instead of guaranteeing the “survival of mankind,” this would cause the extinction of Europe’s industry—unless there’s a secret plan to massively expand nuclear power.

Fortunately for Europe, its leaders haven’t yet lost all their marbles.

These climate goals are just a bargaining chip in the runup to next year’s UN climate summit in Paris. They’re not legally binding. Unless the whole world commits to an equally radical policy of deindustrialization—which seems rather unlikely to say the least—the EU will “review” its climate targets.

This is just as well. In trying to meet the so-called 20:20 target—a 20% reduction in emissions by 2020—Germany and the UK have already discovered that renewable energy is too costly to maintain a competitive industry. As electricity prices skyrocket, Germany’s industrial giants are either having their power costs subsidized or are relocating to the US.

Both countries are struggling with the inability of wind and solar energy to provide reliable baseload power, which is threatening to cause blackouts.

The UK is putting its faith in fracking—and has managed to head off any EU legislation to ban shale-gas. But Germany and its fellow travelers, who have no qualms about reverting to coal, are simply overriding the EU Commission and its zero emissions utopia.

Knowing that EU climate policy would destroy international competitiveness and crush their economies, Poland, which depends on coal for 90% of its energy needs, and other low-income countries have taken a different approach. They've forced the Commission to give them special exemptions from any emissions reduction plan.

Unlike in the U.S.—where Obama is taking executive action to wipe out the coal industry—lignite, or brown coal, is set to become an increasingly important part of Europe’s energy supply, as it is in much of the rest of the world. There are 19 new lignite power stations in various stages of approval and construction in Bulgaria, Czech Republic, Greece, Germany, Poland, Romania, and Slovenia. When completed, these will emit nearly as much CO2 as the UK.

Which is ironic. The UK is the only member of the EU to have been insane enough to impose a legally binding carbon dioxide reduction target intended to take it to 80 percent of 1990 levels by 2050. It’s also the only modern industrial nation where there’s serious talk of World War II style energy rationing.

As you’ll discover in my new book, The Colder War, Europe and America need to wake up. They’ve never been so economically vulnerable. The time for indulging environmental fantasies and putting one’s faith in White Lions is over—unless, that is, you want to see Putin controlling the world.

Click here to get your copy of my new book. Inside, you’ll discover exactly how Putin is orchestrating a takeover of the global energy trade, what it means for the future of America, and how it will directly affect you and your personal savings.

The article The Madness of the EU’s Energy Policy was originally published at casey research


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Friday, November 7, 2014

Mark Twain: History Doesn't Repeat Itself....But it Does Rhyme. Gold, Vanderbilt and More

By John Mauldin


“The significant problems that we have created cannot be solved at the level of thinking we were at when we created them.”– Albert Einstein

“Generals are notorious for their tendency to ‘fight the last war’ – by using the strategies and tactics of the past to achieve victory in the present. Indeed, we all do this to some extent. Life's lessons are hard won, and we like to apply them – even when they don't apply. Sadly enough, fighting the last war is often a losing proposition. Conditions change. Objectives change. Strategies change. And you must change. If you don't, you lose.”– Dr. G. Terry Madonna and Dr. Michael Young

“Markets are perpetuating a serious error by acting on the belief that central bankers actually know what they are doing. They do not. Not because they are ill-intentioned but because they are human and subject to the limitations that apply to all human endeavors. If you want proof of their fallibility, simply look at their economic forecasts. Despite their efforts to do so, central banks can’t repeal the business cycle (though they can distort it). While the 2008 financial crisis should have taught them that lesson, it appears to have led them to precisely the opposite conclusion.

“There are limits to knowledge in every field, including the hard sciences, and economics is not a hard science; it is a social science whose knowledge is imprecise, and practitioners’ ability to predict the future is extremely limited. Fed officials are attempting to guide an extremely complex economy with tools of questionable utility, and markets are ignoring their warnings that their ability to manage a positive outcome is highly uncertain. Markets are confusing what they want to happen with what is likely to happen, a common psychological phenomenon. Investors who prosper in the long run will be those who acknowledge the severe limits of economic knowledge and the compelling evidence that trillions of dollars of QE and years of zero interest rates may have saved the system from immediate collapse five years ago but failed to produce sustained economic growth or long-term price stability.”– Michael Lewitt, The Credit Strategist, Nov. 1, 2014

As I predicted months ago in this letter and last year in Code Red, the Japanese have launched another missile in their ongoing currency war, somewhat fittingly on Halloween. Rather than being spooked, the markets saw it as just another round of feel good quantitative easing and climbed to all-time highs on the Dow and S&P 500. The Nikkei soared even more (for good reason). As we will see later in this letter, this is not your father’s quantitative easing. The Japanese, for reasons of their own, will intervene not only in their own equity markets but in foreign equity markets as well, and do so in a size and manner that will be significant. This gambit is going to have ramifications far beyond merely weakening the yen. In this week’s letter we are going to take an in depth look at what the Japanese have done.

It is something of a cliché to quote Mark Twain’s “History doesn’t repeat itself, but it does rhyme.” But it is an appropriate way to kick things off, since we are going to look at the “ancient” history of Mark Twain’s era, and specifically the Panic of 1873. That October saw the beginning of 65 months of recession (certainly longer than our generation’s own Great Recession), which inflicted massive pain on the country. The initial cause was government monetary intervention, but the crisis was deepened by soaring debt and deflation.
As we seek to understand what happened 141 years ago, we’ll revisit the phenomenon of October as a month of negative market surprises. It actually has its roots in the interplay between farming and banking.

The Panic of 1873

Shortly after the Civil War, which saw the enactment of federal fiat money (the “greenback” of that era, issued to finance the war), there was a federal law passed that required rural and agricultural banks to keep 25% of their deposits with certain certified national banks, which were based mainly in New York. The national banks were required to pay interest on those deposits, so they had to put the money out for loans. But because those deposits were “callable” at any time, there was a limit to the types of loans they could do, as long-term loans mismatched assets and liabilities.

The brokers of the New York Stock Exchange were considered an excellent target for such loans. They could use the proceeds of the loans as margin to buy stocks, either for their own trading or on behalf of their clients. As long as the stocks went up – or at the very least as long as the ultimate clients were liquid – there wasn’t a problem for the national banks. Money could be repatriated; or, if necessary, margins could be called in a day. But this was before the era of a central bank, so actual physical dollars (and other physical instruments) were involved as reserves, as was gold. Greenbacks could be used to buy gold, but at a rate that floated. The price of gold could fluctuate significantly from year to year, depending upon the availability of gold and the supply of greenbacks (and of course, market sentiment – which certainly rhymes with our own time).

The driver for October volatility was an annual cycle, an ebb and flow of dollars to and from these rural banks. In the fall when the harvest was ready, the country banks would recall their margin loans in order to pay farmers or loan to merchants to buy crops from farmers and ship them via the railroads. Money would then become tight on Wall Street as the national banks called their loans back in.

This cycle often caused extra volatility, depending on the shortness of loan capital. Margin rates could rise to as much as 1% per day! Of course, this would force speculators to sell their stocks or cover their shorts, but in general it could drive down prices and make margin calls more likely. This monetary tightening often sent stocks into a downward spiral – not unlike the downward pressure that present-day Fed tightening actions have exerted, but in a compressed period of time.

If there was enough leverage in the system, a cascade could result, with stocks dropping 20% very quickly. Since much of Wall Street was involved in railroads, and railroads were nothing if not leveraged loans and capital, falling asset prices would reduce the ability of investors in railroads to find the necessary capital for expansion and maintenance of operations.

This historical pattern no longer explains the present-day vulnerability of markets in October. Perhaps the phenomenon persists simply due to market lore and investor psychology. Like an amputee feeling a twinge in his lost limb, do we still sense the ghosts of crashes past?

(And once more with Mark Twain: “October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.”)

It was in this fall environment that a young Jay Gould decided to manipulate the gold market in the autumn of 1873, creating a further squeeze on the dollar. Not only would he profit off a play in gold, but he thought the move would help him in his quest to take control of the Erie Railroad. Historian Charles R. Morris explains, in a fascinating book called The Tycoons

Gould’s mind ran in labyrinthine channels, and he turned to the gold markets as part of a strategy to improve Erie’s freights. Grain was America’s largest export in 1869. Merchants purchased grain from farmers on credit, shipped it overseas, and paid off the farmers when they received their remittances from abroad. Their debt to the farmers was in greenbacks, but their receipts from abroad came in gold, for the greenback was not legal tender overseas. It could take weeks, or even months, to complete a transaction, so the merchant was exposed to changes in the gold/greenback exchange rate during that time. If gold fell (or the greenback rose), the merchant’s gold proceeds might not cover his greenback debts.

The New York Gold Exchange was created to help merchants protect against that risk. Using the Exchange, a merchant could borrow gold when he made his contract, convert it to greenbacks, and pay off his suppliers right away. Then he would pay off the gold loan when his gold payment came in some weeks later; since it was gold for gold, exchange rates didn’t matter. To protect against default, the Exchange required full cash collateral to borrow gold. But that was an opening for speculations by clever traders like Gould. If a trader bought gold and then immediately lent it, he could finance his purchase with the cash collateral and thereby acquire large positions while using very little of his own cash.

[Note from JM: In the fall there was plenty of demand for gold and a shortage of greenbacks. It was the perfect time if you wanted to create a “corner” on gold.]

Gould reasoned that if he could force up the price of gold, he might improve the Erie’s freight revenues. If gold bought more greenbacks, greenback-priced wheat would look cheaper to overseas buyers, so exports, and freights, would rise. And because of the fledgling status of the new Gold Exchange, gold prices looked eminently manipulable, since only about $20 million in gold was usually available in New York. [Some of his partners in the conspiracy were skeptical because…] The Grant administration, which had just taken office in March, was sitting on $100 million in gold reserves. If gold started suddenly rising, it would hurt merchant importers, who could be expected to clamor for government gold sales.

So Gould went to President Grant’s brother-in-law, Abel Corbin, who liked to brag about his family influence. He set up a meeting with President Grant, at which Gould learned that Grant was cautious about any significant movements in either the gold or the greenback, noting the “fictitiousness about the prosperity of the country and that the bubble might be tapped in one way as well as another.” That was discouraging: popping a bubble meant tighter money and lower gold.

But Gould plunged ahead with his gold buying, including rather sizable amounts for Corbin’s wife (Grant’s wife’s sister), such that each one-dollar rise in gold would generate $11,000 in profits. Corbin arranged further meetings with Grant and discouraged him from selling gold all throughout September.

Gould and his partners initiated a “corner” in the gold market. This was actually legal at the time, and the NY gold market was relatively small compared to the amount of capital it was possible for a large, well-organized cabal to command. True corners were devastating to bears, as they generally borrowed shares or gold to sell short, betting on the fall in price. Just as today, if the price falls too much, then the short seller can buy the stock back and take his losses. But if there is no stock to buy back, if someone has cornered the market, then losses can be severe. Which of course is what today we call a short squeeze.

The short position grew to some $200 million, most of it owed to Gould and his friends. But there was only $20 million worth of gold available to cover the short sales. That gold stock had been borrowed and borrowed and borrowed again. The price of gold rose as Gould’s cabal kept pressing their bet.

But Grant got wind of the move. His wife wrote her sister, demanding to know if the rumor of their involvement was true. Corbin panicked and told Gould he wanted out, with his $100,000+ of profits, of course. Gould promised him his profits if he would just keep quiet.

Then Gould began to unload all his gold positions, even as some of his partners kept right on buying. You have to keep up pretenses, of course. Gould was telling his partners to push the price up to 160, while he was selling through another set of partners.

It is a small irony that Gould also had a contact in the government in Washington (a Mr. Butterfield) who assured him that there was no move to sell gold from DC, even as that contact was personally selling all his gold as fast as he could. Whatever bad you could say about Gould (and there were lots of bad things you could say), his trading instincts were good. He sensed his contact was lying and doubled down on getting out of the trade. In the end, Gould didn’t make any money to speak of and in fact damaged his intention of getting control of the Erie Railroad that fall.

The attempted gold corner didn’t do much harm to the country in and of itself. But when President Grant decided to step in and sell gold, there was massive buying, which sucked a significant quantity of physical dollars out of the market and into the US Treasury at a time when dollars were short. This move was a clumsy precursor to the open-market operations of the Federal Reserve of today, except that those dollars were needed as margin collateral by brokerage companies. No less than 14 New York Stock Exchange brokerages went bankrupt within a few days, not including brokerages that dealt just in gold.

All this happened in the fall, when there were fewer physical dollars to be had.

The price of gold collapsed. Cornelius Vanderbilt, who was often at odds with Jay Gould, had to step into the market (literally – that is, physically, which was rare for him) in order to quell the panic and provide capital, a precursor to J.P. Morgan’s doing the same during the Panic of 1907.

While many today believe the Fed should never have been created, we have not lived through those periods of panics and crashes. And while I think the Fed now acts in ways that are inappropriate (how can 12 FOMC board members purport to fine-tune an economic cycle, let alone solve employment problems?), the one true and proper role of the Fed is to provide liquidity in time of a crisis.

People Who Live Too Much on Credit”

At the end of the day, it was too much debt that was the problem in 1873. Cornelius Vanderbilt was quoted in the epic book The First Tycoon as saying (emphasis mine)

I’ll tell you what’s the matter – people undertake to do about four times as much business as they can legitimately undertake.… There are a great many worthless railroads started in this country without any means to carry them through. Respectable banking houses in New York, so called, make themselves agents for sale of the bonds of the railroads in question and give a kind of moral guarantee of their genuineness. The bonds soon reach Europe, and the markets of their commercial centres, from the character of the endorsers, are soon flooded with them.… When I have some money I buy railroad stock or something else, but I don’t buy on credit. I pay for what I get. People who live too much on credit generally get brought up with a round turn in the long run. The Wall Street averages ruin many a man there, and is like faro.

In the wake of Gould’s shenanigans, President Grant came to New York to assess the damage; and eventually his Secretary of the Treasury decided to buy $30 million of bonds in a less clumsy precursor to Federal Reserve open market operations, trying to inject some liquidity back into the markets. This was done largely as a consequence of a conversation with Vanderbilt, who offered to put up $10 million of his own, a vast sum at the time.

But the damage was done. The problem of liquidity was created by too much debt, as Vanderbilt noted. That debt inflated assets, and when those assets fell in price, so did the net worth of the borrowers. Far too much debt had to be worked off, and the asset price crash precipitated a rather deep depression, leaving in its wake far greater devastation than the recent Great Recession did. It took many years for the deleveraging process to work out. Sound familiar?

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

Important Disclosures

The article Thoughts from the Frontline: Rhyme and Reason was originally published at mauldin economics


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Thursday, October 30, 2014

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Tuesday, October 28, 2014

Total War over the Petrodollar

By Marin Katusa, Chief Energy Investment Strategist

The conspiracy theories surrounding the death of Total SA’s chief executive, Christophe de Margerie, started the second the news broke of his death. Under mysterious circumstances in Moscow, his private jet collided with a snowplow just after midnight. De Margerie was the CEO of Total, France’s largest oil company.

He’d just attended a private meeting with Russian Prime Minister Medvedev, at a time when the West’s relationship with Russia is fraught, to say the least.

One has better odds of being struck by lightning at an airport then a snow plow, or any other ground support vehicles hitting a plane and killing all inside the plane, in my opinion. And I say that as someone who’s familiar with airports, having worked at Vancouver International Airport when I was in university; I was the one who would bring the plane into its parking bay.

If it weren’t for those short odds, a snowplow on the runway with an allegedly drunk driver would be the perfect crime. But who would benefit from his death?

De Margerie was one of the few business leaders who spoke out against the isolation of Russia. On this last trip to Moscow, he railed against sanctions and the obstacles to Russian companies obtaining credit.
He was also an outspoken supporter of Russia’s position in natural gas pricing and transportation disputes with Ukraine, telling Reuters in an interview in July that Europe should not cut its dependence on Russian gas but rather focus on making the supplies more secure.

But what could have made de Margerie a total liability is Total’s involvement in plans to build a plant to liquefy natural gas on the Yamal Peninsula of Russia in partnership with Novatek. Its most ambitious project in Russia to date, it would facilitate the shipping of 800 million barrels of oil equivalent of LNG to China via the Arctic.

Compounding this sin, Total had just announced that it’s seeking financing for a gas project in Russia in spite of the current sanctions against Russia. It planned to finance its share in the $27 billion Yamal project using euros, yuan, Russian rubles, and any other currency but US dollars.

Did this direct threat to the petrodollar make this “true friend of Russia”—as Putin called de Margerie—some very powerful and dangerous enemies amongst the power that be, whether in the French government, the EU, or the US?

In my book The Colder War, one chapter deals with “mysterious deaths” and how they are linked to being on the wrong side of the political equation. Whether it’s going against Putin or against the petrodollar, there are many who have fallen on both sides.

If Total doesn’t close the $27 billion financing it needs to move forward with the Yamal LNG project then we’ll know someone stepped in to prevent an attack on the petrodollar.  The CEO of Total, before his death and his CFO were both strong supporters of Total raising the $27 billion in non U.S. dollars and moving the project forward with the Russians.  But, this could all change if the financing does not complete.

How many other Western executives who dare to help Russia bypass sanctions—and turn it into an energy powerhouse—will die under suspicious circumstances?

Marin Katusa, is author of The Colder War, manager of multiple global energy-exploration hedge funds, and co-founder of Copper Mountain Mining Corporation. Click here to get a copy of his must-read new book, The Colder War. Inside, you’ll discover exactly how Putin is taking over the energy sector, how far ahead he is, and how alarming it is that no one in the US or Europe has even entered the race.

The article Total War over the Petrodollar was originally published at casey research



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Monday, October 27, 2014

Blood in the Streets to Create the Opportunity of the Decade

By Laurynas Vegys, Research Analyst

Gold stocks staged spring and summer rallies this year, but haven’t able to sustain the momentum. Many have sold off sharply in recent weeks, along with gold. That makes this a good time to examine the book value of gold equities; are they objectively cheap now, or not?

By way of reminder, a price to book value ratio (P/BV) shows the stock price in relation to the company’s book value, which is the theoretical value of a company’s assets minus liabilities. A stock is considered cheap when it’s trading at a historically low P/BV, and undervalued when it’s trading below book value.

From the perspective of an investor, low price to book multiples imply opportunity and a margin of safety from potential declines in price.

We analyzed the book values of all publicly traded primary gold producers with a market cap of $1 billion or more. The final list comprised 32 companies. We then charted book values from January 2, 2007 through last Thursday, October 15. Here’s what we found.


At the current 1.20 times book value, gold stocks aren’t as cheap as they were when we ran the numbers in June, 2013, successfully pinpointing the all-time low of 0.91 (the turning point before the period in gray). Of course, that P/BV is hard to beat: it was one of the lowest values ever. And while the stocks not quite as cheap now, the valuation multiple still lingers close to its historical bottom. Remember, we’re talking about senior mining companies here—producers with real assets and cash flow selling for close to their book values.

In short, yes, gold stocks are objectively selling cheaply.

The juniors, of course, have been hit harder. It’s hard to put a meaningful book value on many of these “burning matches” with little more than hopes and geologists’ dreams, but valuations on many are scraping the bottom, making them even better bargains, albeit substantially riskier ones.

What does this mean for us investors?

It’s no surprise to see that every contraction in the ratio was followed by a major rally. In other words, the cure for low prices is low prices:
  • The August, 2007 bottom (2.2) and the momentary downtrend that preceded it were quickly erased by a swift price rally leading to a January, 2008 peak (3.8).
  • The bull also made a comeback in 2009-2010, fighting its way up out of what seemed at the time to be the deepest hole (1.04) in October, 2008.
Stocks have been on a long slide since the ratio last peaked at 3.24 in October, 2010, with the downturn in 2013 pushing multiples to previously unseen lows.

No one—us included—has a crystal ball, and so it’s impossible to tell if the bottom is behind us. We can, however, gauge with certainty when an asset is cheap—and cash-generating companies selling for little more than book value are extraordinary values for big-picture investors.

Now let’s see how these valuations look against the S&P 500.


Stocks listed in the S&P500 are currently more than twice as expensive as the gold producers. That’s not surprising given how volatile metals prices can be and how unloved mining is—but is it rational? Note that despite the downtrend in the last month, the multiple for the S&P500 remains close to a multiyear high.

In other words, yes, the S&P 500 is expensive.

This contrast points to an obvious opportunity in our sector.

So is now the time to buy gold stocks? Answer: our stocks are good values now, and, if there is a larger correction ahead, they may well become fantastic values, briefly. Either way, value is value, on sale.

As the most successful resource speculators have repeatedly said: you have to be a contrarian in this sector to be successful, buying low and selling high, and that takes courage based on solid convictions. Yes, it’s possible that valuations could fall further. However:

The difference between prices and clear-cut value argue for going long and staying that way until multiples return to lofty levels again—which they’ve done every time, as the historical record shows.

With a long term time frame in mind, whatever happens in the short term is less of a concern. Building substantial positions at good prices in great companies in advance of what must transpire sooner or later is what successful speculation is all about. This is how Doug Casey, Rick Rule, and others have made their fortunes, and it’s why they’re buying in the market now, seeing market capitulation as one of the prime opportunities of the decade.

That’s worth remembering, especially during a downturn that has even die hard gold bugs giving up.
Bottom line: “Blood in the streets” isn't pretty, but it’s a good thing for those with the liquidity and courage to act.

What to buy? That’s what we cover in BIG GOLD. Thanks to our 3 month full money back guarantee, you have nothing to lose and the potential for gains that only a true contrarian can expect.




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