Financial Terrorism

Of all the geopolitical events looming on the horizon for America, the largest one is the potential for conflict with Iran – which would certainly cause a major change in the world economy. Dan Denning offers his advice for investors who are willing to prepare for the unexpected…

Contrary to what you see in the press, though, the average Frenchman or woman is not that different from you, except, perhaps, at the dinner table. The French take their food seriously. A cup of coffee or a three hour dinner is not just about the quality of the food or the wine. Eating is a social experience in France. What’s more, serving food is a serious profession for which men and women go to school in France.

That may seem silly to Americans. But you can see why a Frenchman who deals with food professionally chafes at being bossed around by Americans who deal with food recreationally. For the French, food is serious pleasure, to be relished and treated with respect. For Americans, food is serious business, to be consumed and treated with salt.

Americans want prompt service, healthy portions, and plenty of attention for an extra fork, some more napkins, or another Coke. The French want to be left alone to eat, talk, and digest. I am convinced that much of the animosity between America and France stems from the difference in the way we treat food. A lot would be resolved if both nations treated food the way the English do, namely as something to be deep-fried, eaten, and tolerated between cups of coffee or pints of lager.

Investing and Iran: Being Uncomfortable While Investing

This culinary side trip has served a purpose, I hope. When you visit foreign countries, it takes you out of your comfort zone. Other people have different customs. The food is different. Often the language is different. Making yourself uncomfortable causes you to see things you wouldn’t otherwise see. It changes your perspective. It’s also a way of showing yourself that what once seemed too challenging to attempt is actually not as hard as it looks. But what does it mean to make yourself uncomfortable as investors? There are three answers to this question.

First, it means being bold enough to think unconventionally. This, of course, is the whole bull hunter philosophy. You recognize that the world is always changing and that what worked yesterday may not work tomorrow. You are willing to try new approaches to achieve your investment goals.

Second, it means using all the tools at your disposal. This can sometimes be even more difficult than allowing yourself to think differently. Most of us are lazy. We’d do as little as possible to achieve our investment goals, if we could get away with it. But these days, doing as little as possible is the same thing as doing nothing at all.

Finally, you have to be willing to ask the questions no one else wants to ask. In the investment world, thinking about the future can be a dangerous game. You can’t predict the future. If you invest your money based on faulty predictions, you could easily lose it. Yet the investor’s greatest challenge is to figure out what price to pay today for future earnings that are unpredictable. The further you go into the future, the harder it is to tell what tomorrow will bring and what you should be willing to pay for it today.

But the stock market looks ahead, not behind. And so we have to look ahead, too, to try to see what’s coming, if not in the earnings picture, then at least in the bigger picture. You’re going to be investing in a stock market driven by geopolitical events as much as earnings, probably for the rest of your investment life. That means trying to decipher what events like war in the Middle East or high personal debt levels in America might mean for the stock market.

It’s also possible to look into the future and make some intelligent speculations on what might happen. Using options on index funds and exchange-traded funds is one way that modern investors can insure themselves against large, macroeconomic risks. It is not foolproof insurance. And it is not without risk. But in a dangerous and uncomfortable world, it is one practical way to begin putting the tools at your disposal to work.

In a speech I gave in Chicago in 2004, I made the case for $100-a barrel oil to 150 options investors. They were shocked, skeptical, and intrigued, by turns. I told them that event-driven investment moves – the kind where an external event shocks markets and causes a big move up or down in a sector or the whole market – are nearly impossible to predict. But strategic foresight can help you prepare for some of them.

Investing and Iran: A Look at Iran

One of the largest geopolitical events looming on the horizon today is a potential conflict with Iran. Iran is a charter member of President George W. Bush’s Axis of Evil. Iran is near the top of the president’s foreign policy agenda for his second term. At stake is whether Iran will become a nuclear power. It’s not clear how this would change the world. What is clear is that the mullahs who run Iran have a strategic vision of their own. To investors, what ought to be even clearer is what the consequences of a war with Iran would mean: $100 oil.

Any economist worth his or her pocket protector will tell you that $100 oil is not economically sustainable. The world simply could not afford to pay $100 for a barrel of oil – for a sustained period of time. It would create a world of oil haves and have-nots, and might even precipitate oil wars between nations desperately competing over a scarce and expensive natural resource. Not only would it drive U.S. gasoline prices to unimaginable heights, the shock of such a dramatic rise in energy costs would throw the world’s economy into a deep and painful recession, if not a depression. But that doesn’t mean it couldn’t happen anyway – at least for a few days or weeks.

You don’t have to be Dr. Strangelove to envision what the Iranian strategy might be against the U.S. economy. I say economy and not military. The nature of an Iranian counterattack would mostly likely be to strike against U.S. economic interests. And what greater interest than oil? After all, it’s much easier to drive the price of oil to $100 a barrel and instigate a political firestorm in Washington, D.C., than it is to defend against American strategic bombers and precision-guided munitions. Iran knows that America and all of Europe and Japan are addicted to oil.

Much of that oil comes from the Persian Gulf and must physically pass through the Strait of Hormuz to get to its final destinations. By choking off the supply of oil at this strategic point, Iran could exert enormous pressure on the United States, which would itself be pressured by those who desperately count on Middle East oil and want no part of America’s quarrel with Iran.

With such a potentially high economic price to pay for a war with Iran, I’ve been told by some strategic investors that the United States would never risk it. But here is a question to make you uncomfortable: If it is plain for all to see that the way to America’s weakness is through interrupting the flow of oil from the Persian Gulf, isn’t it just a matter of time until someone tries it? Instead of fighting a war conventionally, why not try economic warfare, attacking what makes a country strong to begin with – its economy?

In total economic warfare, you attack a country’s access to natural resources or its currency. By attacking its economy, you indirectly weaken its ability to attack you militarily.

Investing and Iran: An Energy Pearl Harbor

If not Iran, then perhaps al Qaeda? And if not at the Strait of Hormuz, then perhaps at the Saudi oil refinery of Ras Tanura, one of the world’s biggest and most productive? Even the British Broadcasting Corporation (BBC) sees what could happen. In 2004, the BBC aired a docudrama about what’s been called an "energy Pearl Harbor."

Here’s how it works (in the mind of the BBC). A rogue Middle Eastern oil trader works for a major money-center bank. Working in concert with his terrorist conspirators in Saudi Arabia, the trader takes an enormous leveraged position short crude oil, much as a hedge fund or institution might. At the same time, al Qaeda terrorists target the Saudi oil facility of Ras Tanura, the largest oil complex in the world. Ras Tanura cranks out almost 4.5 million barrels per day. Former CIA agent Robert Baer wrote in his book Sleeping With the Devil (Crown, 2003) that an attack like the one on the U.S.S. Cole in 2000 could knock out Ras Tanura for weeks. Baer also speculates that if the oil processing facility of Abqaiq were attacked via a hijacked jetliner, it would reduce Saudi production by as much as 4 million barrels per day for up to seven months.

You get the picture. The trader takes a huge position short. The oil price spikes on the terror attack. The leveraged short position becomes a form of financial terrorism. The banks’ losses mount to the stratosphere. They hit their capital reserve requirements. They must liquidate others’ assets. They are forced to sell, causing a wave of selling by other financial institutions.

The BBC presentation of the story morphed into the trader’s "real" motives. He was upset with his bosses’ focus on profits and turned out not to be in collaboration with al Qaeda. It’s all fiction anyway. But if you were looking for a way to put Western economies in checkmate, sending the oil price sky-high and precipitating a financial crisis at the same time, it’s hard to think of a better way – if you practiced total economic warfare, that is.


Dan Denning
for The Daily Reckoning

June 29, 2005

Dan Denning, editor of Strategic Investments, is one of America’s most respected "big picture" analysts working today. The above essay was adapted from his new book, The Bull Hunter.

In The Bull Hunter, Dan lays out all the details of how to profit in ways most investors never imagined just five years ago. What’s more, he’ll show you why it’s never been more dangerous to put all your investment eggs in the basket of the U.S. economy. It’s a timely warning, along with an exceptional opportunity.

How we would love to read the history books 100 years from now! What will they make of our strange Pax Dollarium with all its bizarre illusions and silly conceits? We’re convinced that they will judge it neither good nor bad, but simply hilarious.

The list of absurdities that Americans will believe is long. What is the short is how long a nation can live with such hallucinations. At the current rate, the United States squanders its national wealth at the rate of more than 6% of GDP and approximately 1% of its total balance sheet annually.

"There is a lot of ruin in a nation," said Lord Keynes. What we’re finding out is how much.

Just last week, China announced a bid for one of America’s oldest oil companies. All of a sudden, China was in North America…threatening to take away resources Americans had taken for granted. We’re watching the puffy indignation in the press.

When the Greeks expanded their empire, they set up colonies in on the coast of Anatolia and around the Black Sea. (Their descendants are still there. After having been cut off from the homeland for more than 2,000 years; they apparently speak a form of ancient Greek, now unintelligible to people in Athens.)

When the Roman Empire was a going concern, Romans built villas all over Europe and the Middle East. You can still see many of them today.

When European empires took over the world, they took whole countries – and seized whatever resources they needed for their factories and industries back in the homelands.

Even the American empire, at its debut, had the right idea. American companies bought up millions of acres of banana-land for example, and oil fields overseas…and minerals.

But now, in the five-year of the reign of George W. Bush, the history of empire has taken an odd and humiliating new turn. Now it is the poor country on the periphery that it taking control of resources in the homeland!

All of these are interesting.

Usually, rich countries buy up natural resources in poor ones. China’s bid for one of America’s oldest and most iconic oil companies is not only novel, it is a signal event – like the entry of America into WWI on April 8, 1917, the closing of the gold window at the U.S. Treasury on August 15, 1971 or Elvis Presley’s appearance on the Ed Sullivan show; it tells us that things have changed.

More news, from our team at The Rude Awakening:


Eric Fry, reporting from Wall Street…

"Last year, China exported 504 million pairs of socks, 73 million cell phones…and 30 million tourists. Wanderlust, it seems, is but one of the many by-products of the flourishing Chinese economy."


Bill Bonner, with more views:

*** *** Now here’s a cause we can get behind: help save Denning from another run in with a green sarong.

A little background…Dan Denning’s book The Bull Hunter is just one spot behind Thomas L. Friedman’s "The World Is Flat" on Amazon’s business best-seller list. Dan wrote with this challenge this morning:

"We just passed ‘The Sisterhood of the Traveling Pants.’ Eventually, we’ll pass Friedman and have to deal with the boy wizard, Harry Potter. One step at a time. But if we don’t pass ‘The World Is Flat’ in the next twenty-four hours, I vow to buy myself a new green sarong in Paris and don it at the Agora Wealth Symposium in Vancouver. It’s not a threat I’d like to have to make good on. But I’ve done it before…"

If you’re not a long-time sufferer of the Daily Reckoning, you may not be familiar with the story. Mr. Denning was once locked out of his apartment in Paris, on Bastille Day, wearing nothing but his boxer shorts. He subsequently borrowed a green sarong from an attractive young French woman, who was apparently as equally lacking in clothing as he.

While you’re there, do the young man a favor and buy the book, so he can zip past Friedman…and avoid having to wear another green sarong in Vancouver this August.

*** "Make no mistake in understanding what is going on," writes our Pittsburgh correspondent, Byron King. "The Unocal takeover effort is a test by the Chinese government of U.S. national will. The Chinese have an energy-based national strategy, and upon it they are acting. You can disregard this at your peril.

"I hold no animus against China, its people or leaders, nor CNOOC. In fact, I have admire them all for their worthy level of logical thinking, their sense of grand strategy, and for their straightforward approach to international competition. There is nothing inscrutable about what is going on here. If you understand what you are observing, there is no subtlety about this event. There is none at all.

"For those who still might not get it, I think that the Chinese may as well be taking out an a full page ad in the Washington Post, stating, ‘We are going to buy up all of your oil and gas. And to accomplish this task, we’re going to use all of those dollars you have been sending us for the past ten years. And just what are you going to do about it?’

"Yes, just what are we going to do about it? My hope is that the Unocal takeover competition will be as much of a wake up call to the United States over its fundamental economic and monetary issues, as was the Union Oil well blowout in Santa Barbara in 1969, which galvanized the current environmental movement. If not, the U.S. has only itself to blame."

*** We wondered months ago what China and Japan would do with all the dollars they were accumulating. They would only hold U.S. Treasuries for so long, we suggested. Sooner or later, they would want something that was of real value to them. "Natural resources," said Dan Denning at the time. "That’s what they need. That’s what they’ll want."

Now, Dan suggests a possible dark new twist to the world economy: a "return to the 1930s option." In the ’30s, Germany and Japan decided that natural resources were critical to their national economies. Japan expanded around the East Rim of the Pacific basin in the name of its "co-prosperity sphere." Its economy needed resources; it saw nothing wrong with taking them. Germany, meanwhile, coveted the "lebensraum" of the East. It intended to make much of Poland and Russian into German-speaking areas. It also targeted the oil fields of Southeastern Europe.

The sale of U.S. energy assets to China are "perfectly legal under market capitalism," Dan explains, "but against the national interest. This is also the "return to the 1930s option" when national imperial ambitions ran up against the growing demand for scarce resources. National interests trumped free markets. Wars were fought."

The nationalists argue that oil companies and natural resources are not what we thought they were. They are not private property; instead, they belong to the nation. Protecting national assets (even those owned by individuals) makes no sense in free market terms. But it made sense to Mussolini. And it is likely to make sense to a lot of Americans as the absurdities of the U.S. system of imperial finance come to light.

Patrick Buchanan quotes Christopher Lasch: "Whatever its faults, middle-class nationalism provided a common ground, common standards, a common frame of reference without which society dissolves into nothing more than contending factions, as the Founding Fathers of America understood so well – a war of all against all."

"Global free trade is a Faustian bargain," writes Buchanan. "A nation sells its soul for a cornucopia of foreign goods. First the nation gives up its independence; then its sovereignty, and finally its birthright -nationhood itself."

We know of no nation that ever lost its soul or its nationhood to free trade. We know of several that went broke under protectionist regimes. But neither free trade nor protectionism will save a nation from the consequences of spending more than it can afford.

*** "Welcome to a typical English summer," said the concierge at our apartment building last night. We had left a sweltering Paris. But in London, it rained. This morning, the rain continues. It is cool. It is windy. It is summer in Britain.

The Daily Reckoning