Gunships and Opium

A war over Taiwan is not just some kooky conspiracy theory, but a credible scenario. First, we published a guest essay by Marc Faber, called Painful Resolutions, published on April 29 2004. Now ourown Dan Denning takes up the story…

On a strange geopolitical note, the Pentagon announced this week that the Navy will be deploying seven aircraft carrier groups around the world in an operation designed to give the "ability to provide significant combat power to the President in response to a national emergency or crisis."

The Navy calls it part of its "surge tactics," the ability to project a lot of force in a lot of places at one time.
Initial reports were that all seven carrier groups would be deployed near the South China Sea. If that were true, it would be a not so subtle attempt to tell China that the U.S. means business about Taiwan.

It would also be a big strategic gamble, putting that many inviting targets in such close proximity to lethal anti-ship missiles.

But it turns out not to be true. That is, not all seven groups are going to be in the same region as an unprecedented "show of force." The Navy’s purpose is to conduct joint operations with other countries and project U.S. force in five separate theaters at the same time. There may be more than one carrier group near China. But there assuredly won’t be seven in the same theater.

Invading Taiwan: When Could It Happen?

If anyone steals the election in 2004, it’s going to be the Chinese. China may be very close to picking a time to go after Taiwan while the U.S is preoccupied in Iraq. That might seem rash. But think about it in terms of winning without fighting.

Question: When could the Chinese attack Taiwan without provoking a U.S. response?

Answer: At a time when political pressure constrains the U.S. from responding. Bush sending carrier groups into the straits of Taiwan weeks before a general election? Is the American media mature enough to see that as a legitimate response to honor our agreements with Taiwan?

Or would critics be right in calling it election year brinkmanship? Either way, it would be a bold challenge and the last thing the President needed at such a time.

It could also happen early in the next term of either President. The same logic applies. Challenge early and get your opponent on his strategic heels.

If this sounds nuts I understand. Do governments really think this way about one another? Yes, apparently, they do, thus operation Summer Pulse. You’d be hard pressed to find two more paranoid defense establishments in the world than the American and the Chinese.

Invading Taiwan: All the Relics Are in Europe

It’s hard to imagine, with $124 billion in trade between them and their economic futures now intimately intertwined, that America and China would go to war over Taiwan. But both appear determined to do just that if they feel they have to. Let’s hope they don’t have to.

Even if the Americans succeed in staring down the Chinese this summer, they won’t have won any points with Chinese policymakers. China has seen this kind of thing before. And it’s still bitter about it.

When I was in the Forbidden City, none of the relics or artifacts were there. Why? They’re all in Britain and France.

In the 1830’s Britain’s East India Company was exporting tons of opium to China. According to Wikipedia.com, it traded the opium for tea and manufactured goods. As you might expect, all that opium created a lot of addicts. The imperial government (Qing Empire) made opium illegal in 1836 and began closing down the dens.

Invading Taiwan: The Treaty of Nanking

And here’s an interesting note if you like looking for historic parallels. According to an essay posted on the
Washington State University website, one of the big grievances that caused the war was that the British refused to hand over British citizens charged with crimes in China to the Chinese legal system. The British considered China’s legal system barbaric. The Chinese, naturally, resented having foreign soldiers exempt from domestic laws.

The British spent two years running their gunships up and down the coast, bombarding the Chinese into submission. And in 1942 the Treaty of Nanking reopened the opium trade and exempted British citizens from Chinese law (it’s all sounding so familiar.) Two years later France and the U.S. also signed similar treaties with China. The war planted historic seeds of resentment that still flower today.

It’s probably hard for English and American students of history to understand this kind of resentment, England and America never having suffered occupation and military defeat in the modern world. My point in bringing this whole interlude up is that China is just now nursing a national sense of growing power. Trying to subdue it by reenacting the kind of diplomacy that’s recalled as a national shame at the hands of the West is likely to fire up even more Chinese nationalism. It’s likely to provoke the Chinese into "doing something" about Taiwan.

Perhaps the strategy is to put military pressure on China and hope that it leads to cracks in the political façade. The first opium war forcibly opened up China for free trade (especially for opium). A new war broke out in the period from 1856 to 1860. This time, the British and French united under one command and pressed for even more advantage. They were joined by Russia and the United States (which was about to have problems of its own.)

In the second opium war the Western powers succeeded in driving the emperor from his palace in Peking and occupying the city. The eventual settlement of the war opened up ten more Chinese ports to trade, made it permissible for foreign ships (including warships) to navigate the Yangtze river, allowed Chinese workers the right to work overseas, gave foreigners the right to travel inside China, and granted Christians the right to own property and proselytize.

The West is still trying to get China to open up, but on Western terms. And we’re still using guns to do it. The Chinese, for their part, are rolling back political freedoms in Hong Kong and rattling sabers at Taiwan.

Who’s going to win this time? And will it take more than an economic war to find out?

Regards,

Dan Denning
for The Daily Reckoning
July 7, 2004

Again, we leave the news to Baltimore while we enjoy our vacation. More from the woods of Nova Scotia…below.

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Tom Dyson, from the mean streets of Baltimore…

– Caution. We have now entered into ‘Red Light’ Mode.

– At one point last weekend, while we were doing our best to observe your Independence Day, we found ourselves sitting on a curb in "the block" (downtown Baltimore’s less glamorous side) drinking cheap red wine with three transsexuals, two gay men and a madam…but, we digress…

– The ‘red light’ we refer to today has nothing to do with the shadowy clubs and street corners of Baltimore’s seedy underbelly, but a stock market ‘sell’ signal. You see, dear reader, we here at the Daily Reckoning will venture far and wide to deliver you the goods…including territory forbidden to brokers, market makers and stock market shills. ‘Sell’, we say, and here’s why:

– World-renowned analyst Dr. Steve Sjuggerud, editor of the industry’s fastest growing newsletter, True Wealth, has created an indicator he calls the 1-2-3 stock market model. The indicator moves into ‘red light mode’ when 1) stocks are expensive and 2) the Fed is raising rates.

– On Wednesday, the second piece of this rather simple puzzle fell into place; Greenspan hiked the short-term cost of money by a quarter-point. As for stock valuations, well, we needn’t tell you how expensive they are – loyal readers will already be aware of the rich valuations – but we will tell you anyway.

– This week Barron’s lists the market’s P/E at 21.6. Dr. Sjuggerud considers fair value at a P/E of 17, making
stocks 21% overvalued at today’s prices. In order for the indicator to move back into yellow light mode, the Fed either needs to lower base rates or leave them unchanged for at least six months. Or stocks must return to fair- value. "We are likely more than a year away from either of these," says the obnoxiously accurate forecaster, "it’s red light mode, get used to it."

– Astute readers will be wondering how this indicator has fared in the past. Well, the results are, of course,
excellent. Going back 80 years, there were 25 instances where stocks were in red light mode for at least 3 months on the trot…stocks fell on 20 occasions at an average rate of 14% a year.

– When Dr. Steve Sjuggerud speaks, the markets listen…apparently. Like clockwork, yesterday, all three
major indices had the stuffing carved out of them with more ferocity than a cosmetic surgeon with a grudge. The Nasdaq received the brunt of the knifing – traders chopped off over 2.1% for a loss of 43 points on the day and moving the index below 2,000 for the first time since June 22.

– It was the most painful drop in tech stocks since September 10th 2003. The blue chips fared better, but only slightly; the Dow sustained at 63-point fall closing the session at 10,219, while the S&P sagged to a 9-point deficit, a loss of 0.8%.

– Your editor has played golf with Dr. Steve Sjuggerud. He is an extraordinarily diligent, hard-working and
intelligent individual…even when lining up the putts. Genuinely, we don’t make a single investment decision before reading his latest newsletter. We recommend you do the same…

True Wealth

– Gold dropped nearly $6 in yesterday’s trade, falling down to $392. But as your editor added the finishing touches to his notes this morning, he noticed that gold had already regained the loss and is now up over the two-day period. The barbarous relic currently hovers at $398.9 and the pound, the euro and the Japanese yen are all making sharp moves to the upside as we write…

– Another obnoxiously accurate forecaster with whom we’ve also had the opportunity to hit the links, James Boric, is on a roll. He has now hit 8 consecutive winning trades using his ‘momentum, strength and trend’ system. James didn’t want us to advertise the fact – and jinx the streak just as he selects his ninth trade today – but we know better.

– We don’t understand his system, and we couldn’t tell you, even if we did, but it works…6 of the 8 trades have been put options, betting on over-valued companies set for a fall. Since the streak started on February 24, our Penny Stock Fortunes editor has averaged 36.7% gains. Your editor keeps pestering James, "What’s the next one going to be?"

– "Well… I’m not sure yet," he keeps saying, clutching a ream of data print-outs within his arms, "I’ve spent all morning creating my short list from over 70 initial candidates and now I have to run the final three stocks through my final six tests and screens…"

– We also note that friend…accurate, and not so obnoxious forecaster…John Mauldin, who has not invited me to play golf yet, has hit #9 on the N.Y. Times Business Best Seller list with his book ‘Bull’s Eye Investing’…

– And the purposefully obnoxious…and, er, wholly accurate…Mogambo Guru, who we are sure is lethal on the golf course, is quoted at length in this week’s issue of Barron’s. See the Market Watch section…

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Bill Bonner, back on the road…

*** Homeland Bound…

If there is a real estate bubble in North America, it has not expanded out to Canada’s maritime provinces. Unlike the hot markets of California and New York, here in Nova Scotia, the property market is as cool as an abandoned corpse. Many houses appear to have not merely been taken off the market, but simply forgotten by it. Grass grows high on the lawns. Trees begin to poke through garage roofs. And prices?

Pity the poor man who tried to get rich leveraging property in the Annapolis Valley. On George Street, in Annapolis Royal, a realtor’s office offers what appears to be a nice 3-bedroom, two bath Victorian-era house near the center of town for only $129,000 – Canadian dollars. That’s less than $100,000 US dollars. Outside town, a farm of 130 acres, including a 4-bedroom, 2-bath house and several outbuildings, is offered for only $199,000 Canadian. The farm is situated on the neck of land between St. Mary’s bay to the east and the Bay of Fundy to the west – with frontage on both.

Nova Scotia must be the West Virginia of Canada. There is no sign of luxury or waste. People drive old cars, often old pick-up trucks with plenty of rust. If they are spending themselves deep into debt, there is no sign of it. Nor is there any need for it – they are already poor, or so it appears.

Then again, a man would have a hard time spending himself into the poorhouse around here; there is nothing to spend on. There are no luxury shops. The only entertainment is movies – shown only in the summer time and only on Thursday and Friday nights. The cafés in Annapolis Royal are modest. You’d have to eat a dozen meals a day to run up a decent tab. You can’t even get a cup of designer coffee.

"Do you have café latte," we asked.

"Nope."

"Do you have espresso?"

"No."

"How about cappuccino?"

"No."

"Well, what do you have?"

"Just regular coffee."

"Well, is it strong?"

"No."

"We’ll have tea."

One of the telltale marks of a returning American euro-snob is that he can’t bear American coffee. It tastes, say the French, like ‘sock juice.’ They regard it as not merely a sign of different tastes, but a sign of laxity…of a lack of discipline and rigor…a cultural failure. A character weakness. Serious people do not drink weak coffee, they believe.

We came up to Nova Scotia out of habit. When we lived in Maryland, we used to drive up for a week or two in the middle of July to escape the heat. This is also the homeland of Elizabeth’s grandparents…whom we came to visit every summer.

Though the grandparents have gone to their eternal rest, this area of Nova Scotia lives on unchanged. Instead, it is we who have changed. The place seems smaller, simpler, and more rustic than we remembered. Besides, Paris was chilly when we left. Here, it is even chillier; we get no sense of relief.

The weather here is often cold, even in July; yesterday, we sat around an open fire reading…hoping the sun would come out. Still, our family holds on to a sentimental attachment, like an old chair that came from a favorite aunt.

"In the United States," wrote de Tocqueville, "the more opulent citizens take great care not to stand aloof from the people; on the contrary, they constantly keep on easy terms with the lower classes: they listen to them, they speak to them every day. They know that the rich in democracies always stand in need of the poor; and that, in democratic times, you attach a poor man to you more by your manner than by benefits conferred."

Of course, the ‘democratic times’ de Tocqueville saw were those of the republic’s humble beginnings. Today, America is an uneasy empire, with millions of opulent citizens in its debt-drenched homeland.

We note in passing that the rich have gotten a lot richer in recent years; their financial assets have gone up. The poor, meanwhile, have made no financial progress in more than 30 years. And as reported in this space just yesterday, last year merely extended the trend – real wages rose less fast than inflation.

For the present, the rich and the poor are on speaking terms. But grievances are building up. Manufacturing jobs are disappearing. Instead of investing their money in new factories and new industries, the rich are putting their money overseas. Even Warren Buffett is moving cash offshore. Foreign holdings by High Net Worth Individuals doubled in 2003.

Meanwhile the poor indulge themselves in the illusions of consumer debt. As long as someone is willing to lend them money so they can buy a new SUV, they seem happy.

But interest rates are probably beginning an epic trend to the upside. And soon the sunny days of debt expansion will turn into the dark night of debt repayment – at higher rates. We don’t know exactly what will happen, but we doubt the poor will like it.