Real Issues Driving Fundamentals

We are all aware by now of the fact that the shrill dispute in the Ukraine/Crimea is driving gold prices higher. Today silver grabbed some of the same luster, after having had a rugged handful of sessions on a drop in industrial demand from China.

We discussed during the week how it is not the threat of an actual war hat is boosting precious metals, but rather the tightening of the noose around Russia's neck that sanctions and their aftermath will bring. Russia has a fair amount of foreign reserves to cover short term issues - not quite $500 billion.

However, a country as big and as doddering economically as Russia cannot deplete its reserves to any large extent. Without a massive belt-tightening, the ruble will fall another 25 to 35% on top of the 12% it has dropped recently. This would be catastrophic for them.

And, while the Russians can threaten to shut off the rest of Europe's gas, a shrug of the shoulders is a good response. Except for energy and a handful of agricultural commodities, Russia has no way to earn money other than energy.

Europe would suffer in its $120 billion trade with the lumbering giant, but $120 billion is not an enormous hit for a combined economy of nearly $18 trillion. And, all the credit and marketing to Russian markets could be turned to domestic consumption, North America, and another emerging economy such as Brazil. Russia needs Europe much more than Europe needs Russia.

This reportage from Bloomberg News says it in a nutshell: "Tensions surrounding Ukraine have knocked European markets down to five-week lows, and the Russian Micex stock index fell to the lowest level in nearly four years. The RTS index, a basket of Russian stocks, is down 2.1% Friday and has shed 16.7% this month."

An even more worrisome scenario is beginning to play out in China.

All major measurements of growth in China declined in the first quarter.Industrial growth, retail sales, exports, and most bothersome - investment.

Where has the money gone? Industrial investment is down 20% in the last six weeks.

The other numbers are down around 10%. We spoke many months ago about merging economies hitting a glass ceiling on growth.

To avoid this, developing economies need much more than technical infrastructure. They need non-technical or "social" infrastructure. We all know what technical means. But what non-technical infrastructure means is having political, cultural and historical systems in place to support and encourage the more technical side of society.

A good way to consider this is to think of the period in western European history from roughly 1400 to 1600. The Renaissance began in Italy and spread slowly to France, the Netherlands, Germany and the British Isles.

The freest "states" at the time were Italian city-states. The ferment that we associate with Dante, daVinci, Michelangelo, and so forth spawned revolutions in science, math, art, writing, bookkeeping, shipbuilding, instrument making and so forth. Oh, and business families like the deMedici - they invented credit banking, investment banking, mortgages, and structured stock offerings. 

Importantly, people were free to think and do what they wanted (within strictures, of course).

But, the fact is - and this is a lesson for Russia and China as we face more complex years in the 21st century - there has not been in relatively modern times a dominant economic power that was not largely based on democracy and freedom of thought and action. Central planning and repression of citizens usually spells doom one way or another.

It may take decades, but success in unfree modern societies is a rarity. 

Keep your eye on the FOMC next week. But don't expect any big jack-in-the-box to pop out. 

As always, wishing you good trading,