The Reality of War
There is an important point investors should be aware of, which may have been overlooked during the peaceful and financial bubble years of the 1990s: wartimes are common in the history of the world; it is times of peace that are the exception. According to the historian Will Durant, war is one of the constants of history, and has not diminished with civilization or democracy. In the last 3,421 years of recorded history, only 268 have seen no war.
Just look at the period between 1895 and 1918. During this brief span of years, there were continuous conflicts around the world, including the Russo-Japanese War (1895), the war between Turkey and Greece over Crete (1897), the Spanish- American War of 1898, the Anglo-Boer War of 1899-1902, the military expeditions of the great powers in China in 1900, the Russo-Japanese War (1904-1905), the Russian Revolution of 1905, the Turkish Revolution of 1908, the French military expedition in Morocco (1907), the military conflict between Italy and Turkey over Tripoli (1911), the First Balkan War (1912), the Second Balkan War (1913), the Chinese Revolution of 1911, the First World War (1914- 1918), the February Revolution in Russia (1917), the October Revolution and the Russian Civil War (1917-1921).
According to Durant, the causes of war are the same as the causes of competition among individuals: acquisitiveness, pugnacity, and pride; the desire for food, land, materials, fuels, and mastery. The state has our instincts without our restraints. The individual submits to restraints laid upon him by morals and laws, and agrees to replace combat with conference, because the state guarantees him basic protection in his life, property, and legal rights. The state itself acknowledges no substantial restraints, either because it is strong enough to defy any interference with its will, or because there is no super-state to offer basic protection, and no international law or moral code wielding effective force.
As to the causes of the Iraq war, I leave them to the reader to ponder.
Peace Dividend: An Extremely Unusual Time
I am not necessarily suggesting that the next 20 years will be as turbulent as the first 20 years of the 20th century. But we must realize that the late 1980s and 1990s were extremely unusual from a historical point of view, since, aside from some minor conflicts, there were no major wars or revolutions. So, purely from a probability point of view, investors should not expect the relatively peaceful time that has followed the Korean War, and especially the peace dividend we have enjoyed over the last 15 years or so, to continue forever.
The peace dividend that followed the end of the cold war was certainly a contributing factor to higher stock valuations around the world (declining interest rates and rising profits aside). If the world is now moving into an era of increased tensions, then this will be an additional negative factor for equity valuations. Moreover, during the relatively peaceful 50 years that followed the Second World War, trade as a percentage of GDP increased rapidly and peace allowed a truly global capital market to be created, both of which factors were favorable for economic development around the world. As a percentage of the world’s GDP, trade increased from around 5% in the 1950s to over 20% at present.
Moreover, since the creation of a truly global capital market in the late 1980s, international capital flows financed the investment boom in the emerging economies in the early 1990s, and have in the last few years financed the excessive consumption in the U.S., which is reflected by the growing American current account deficit.
If we assume, therefore, that rising global trade and an increase in global financial flows had something to do with peace around the world in the 1990s, we should also assume that in the case of increased geopolitical tensions and, especially, a major conflict, there could be some interruption in these favorable trade and financial trends. In the worst case, severe geopolitical tensions could lead to an interruption of free trade or of international financial flows and bring about supply shortages, trade embargos or outright trade wars, the imposition of foreign exchange controls, and even the freezing of assets held by foreigners or, in an extreme case, their outright expropriation.
Peace Divident: The End of the Derivatives Market
In short, the financial markets and financial intermediaries seem to me to be particularly vulnerable, since they have become so disproportionately large in comparison to the real economy. One point is clear to me. In the next major conflict in the world, the derivatives market is most likely to cease to exist, since financial institutions throughout the world hold derivative positions. Therefore, if one major player somewhere in the world doesn’t settle or fails altogether, a vicious chain reaction could follow, with the result that the markets will be closed.
It is not my intention to sound alarmist, but I think that investors who grew up during the last 50 years have no idea of what unpleasant financial and economic consequences might result from a major conflict. Throughout history, asset freezes, the imposition of foreign exchange controls, and expropriations have been very common, and I have no doubt that sometime in the future we shall experience such emergency measures once again. Therefore, investors should seriously consider diversifying not only their assets, but also how they hold those assets.
To hold all of one’s assets in one country with just one financial institution may be imprudent in an age of rising risks of international conflicts. Consequently, an investor may want to hold some of his assets in the U.S., but also consider the ownership of assets through a foreign bank or the holding of real estate in a foreign country.
Such diversified allocation is an important – if not essential – safeguard against the negative consequences of major conflict.
for The Daily Reckoning
April 10, 2003
The modern-day Parthians, Medes, Seleucians and other rag- tag tribes of Mesopotamia have been nearly subdued. Today’s imperial army is master of Baghdad, just as Emperor Trajan was 1900 years ago, and Alexander the Great several hundred years earlier.
Mommsen’s history tells us that Trajan, like Bush, faced resistance that was incompetent and disorganized.
But the Parthians were treacherous and untrustworthy – even in their enslaved state. Just when the future seemed to be going as planned…and Trajan’s expectations were at their bubble peak…the gods had plans of their own…
“This moment, when Trajan seemed to have achieved all he had set out to do and stood at the peak of his power,” Mommsen explains, “was seized on by all the recently subjugated nations to throw off their allegiance…”
Trajan himself was almost killed…and died not long after…
“…leaving his plans cut off in mid-execution,” Mommsen continues. “Nevertheless, they cannot be accorded much chance of survival; there was a great deal of vain glory in them, and the entire enterprise is not to be taken seriously.”
We have come to Rome…and are sinking deep into the ruins of it. Our apartment overlooks the Capitoline on one side and unidentified old stones and bricks on the other. No empire was ever as long-lived…as grandiose…or as absurdly extravagant as the Roman example. None ever took on so many potential terrorists in so many different areas…and brought most of them to heel.
What can be learned from her? Probably nothing. But here we give readers fair warning: that won’t stop us from reciting various passages as if they were important.
And now what? Have the problems that bedeviled the U.S. economy been blown away by the same Abrams tanks and B1 bombers that liberated Baghdad? Do consumers now have less debt…or more money to spend? Will corporate profits rise…and businesses begin hiring again?
Investors had great expectations. But yesterday’s market suggested that the victory on the Tigris may be a bit of a let-down. Stocks fell, the dollar fell, while gold rose $3.30. Gold is what people buy when their expectations turn a little less great. Over the next few years – as we keep saying – it would not surprise us if they bought even more of it.
Over to Eric in New York:
Eric Fry, reporting from Wall Street…
– The stock market keeled over yesterday like a Saddam Hussein statue. The Dow toppled 101 points to 8,198 and the Nasdaq collapsed 26 to 1,357. Meanwhile, caution re- emerged, as bonds, gold and oil all rallied.
– “Traders are hoping that as the statue of Saddam Hussein comes down, the green arrows will go up,” yelped a hyper- excited Maria Bartiromo yesterday on CNBC’s morning broadcast. Maria was referring to a live TV shot of a couple hundred “Baghdadians” toppling one of the couple thousand statues of Saddam Hussein that dot the Iraqi landscape. The statue’s collapse triggered a brisk 90-point Dow rally. But the exuberance quickly faded, and the green arrows that Bartiromo had breathlessly anticipated turned a brilliant shade of red.
– “At some point, and this moment may already be upon us,” Ken Brown wrote prophetically in Wednesday morning’s Wall Street Journal, “a TV image of soldiers blowing up a statue of Saddam Hussein will no longer set off a 100-point stock- market rally. Instead those annoying little details such as corporate earnings, growth prospects and valuation will reclaim their hold on the market.” That dreaded moment seems to have arrived, as the growth-challenged US economy regains its stranglehold around the throat of the stock market, finger by finger.
– Now that the “shock and awe” phase of the Iraqi war is drawing to a close, investors must acclimate themselves to the somewhat less exhilarating “occupy and reconstruct” phase. We doubt that this latter phase will get the bullish juices flowing on Wall Street. Nor can investors expect too many thrills back on the home front, as the post-bubble economy continues muddling through its “scrimp and save” phase.
– But what about all of the “sideline” cash that has been piling up in money market funds for the last few months? Won’t that rescue the stock market? According to the Investment Company Institute, fund managers have access to some $110 billion of cash sitting in stock mutual funds, and are ready to marshal these reserves at a moment’s notice and charge into the stock market to secure the Dow Jones Industrial Average for the bulls. Furthermore, some $2.2 trillion is parked in money market funds.
– Some market observers point to these billions (and trillions) of dollars sitting in bond funds and money market funds and say, “Aha! Look at all that cash that could storm into the stock market!” We look at that same pile of cash sitting in bond funds and say, “Wow! Look at all the cash that could flee the bond market!” Sure, the money MIGHT go into the stock market. But first, it would DEFINITELY come out of the bond market. In other words, not every bond fund seller will rush to buy 100 shares of Cisco Systems. Some might, instead, pay their taxes or buy groceries.
– Who knows? Some bond fund sellers might even use the proceeds to make a down payment on a house…thereby swapping out of the bond bubble and into the housing bubble, if we may label either market a “bubble”. Let’s consult the experts: Alan Greenspan is no help whatsoever. By his own admission, the Chairman could not spot a bubble, even if it landed on his morning newspaper. By contrast, the International Monetary Fund claims a sort of clairvoyant vision. The august global financial body believes it sees a housing bubble in the making, and isn’t afraid to say so.
– “Housing booms such as those in the US and the UK over the past decade are frequently followed by crashes,” the Financial Times reports. “Ken Rogoff, the [IMF’s] chief economist, warned that the long boom in house prices – up 28 percent in the US since 1996, and 70 per cent in the UK since 1994, adjusted for inflation – put them in danger territory. ‘Forty percent of all housing booms are followed by busts, with housing price drops that typically average 25-30 per cent,’ Mr. Rogoff said.”
– Why worry? According to Rogoff’s statistics, 60% of housing booms are NOT followed by busts…Sleep tight!
Bill Bonner, back in Rome…
*** Our old friend, Rick Ackerman, shares a letter from a reader:
“There may be deflation in hard assets, but my auto insurance just went up 20%, my medical insurance just went up 18%, my homeowners insurance just went up 20%. Gasoline in my area is selling at $2.20 to $2.75 per gallon. The price of food items appears to be coming down in price – until you start to read the per ounce or other unit prices and find that actually, prices are rising. Yes, the price of computers is falling. There is the fool’s belief that there is zero financing for autos, but in fact you are prepaying the interest if you take the deal. Cash or other financing gives you thousands off of the sticker price. Nobody is giving anything away. You may claim deflation, I claim a rising cost of living. What interests me is not what the numbers are manipulated to imply, but what it actually costs me to live from day to day. That is what I call inflation.”
Yes, Rick comments, but what is really happening is that the consumers’ cost-of-living is rising at a time when he can least afford it – when he is carrying more debt than ever before. When he gets a $30,000 college tuition bill, he can’t pay it without either refinancing his house – which increases his debt load – or selling assets. Or going broke. Either way, the effect might be a debt implosion, not inflation:
“For example, take college tuitions and healthcare costs, which have been rising so steeply that, for most households, these necessities have recently come to exceed the limit of affordability. How could we not view surging healthcare bills and tuition costs as inflationary? Well, for those who remember the 1970s, the salient characteristic of inflation was that rising costs could be – and mostly were – readily passed through the system. This is no longer true, however, nor has it been true for more than a decade. For many businesses in the U.S., especially those involved in manufacturing, rising costs cannot be passed so easily on to the consumer; instead, they are ultimately charged against profits. As should be clear in this still-deepening recession, falling profits are deflationary to the extent they lead to lower employment as well as to lower stock market valuations.”
[Editor’s Note: For more on the inflation/deflation debate, see Dr. Hans Sennholz’ article: ““]
*** Standing in line in the Rome airport, we got our first look at the SARS epidemic. A planeload of Chinese tourists waited at the passport control counter – many of them wearing face masks. Immigration officials must have had to think twice before letting them through.