Tuesday, April 14, 2009

Of Pirates and Pakistanis

In life and in the (small) subset of life known as investing, it is important to pay attention to other matters than "they" want you to watch.  Thus, the so-far successful diversion of the public's attention to some AIG executives to cover up AIG's disclosure of its (the Government's) payment of tens of billions of dollars to counterparties for unclear reasons.  On a bigger picture, everyone knows about the economic banana and the difficult financial position of the large financial companies.  One of the areas that has largely receded from the consciousness of investors is, however, geopolitics.  

It is thus worth pointing out how strong a correlation geopolitics, and especially military (mis)adventures, has with the economy and investing.

Here's a brief summary.

In a "relief rally" after the end of hostilities after WW I, the U. S. boomed.  Unfortunately, Germany had been subject to literally unending "reparations", monies the U. S. "lent" it so that gold could flow to England and France.  As this crisis came to a head in the early 1930s, Germany began to remilitarize and the world's financial system fell into chaos due in part to massive indebtedness similar to what has happened recently.  

After the U. S. dominated a suddenly peaceful world (Korea excepted), the geopolitics were great for America.  Its population had real physical needs, money and resources were plentiful and cheap, and the economy and stock market boomed.

The Dow Jones peaked, adjusted for inflation, in 1965, more or less exactly as LBJ pushed through both the Great Society programs and a major escalation of war in Viet Nam.  Alone, the Great Society was not especially inflationary, but the prolonged and very expensive war broke the camel's back.  The other major geopolitical event that worked against the U. S. was another Cold War-related event, the 1973 war between the U. S. proxy Israel and the Soviet Union Arab proxies, led to the oil embargo and the sharp recession of 1973-75.  The Soviet Union was on the march, and the U. S. economy managed to grow only with the help of massive money-printing.  

No one could know it at the time, but by 1982, the geopolitics were beginning to go the way of the U. S., and the stock and bond markets embarked on sustained rallies along with the real economy.  By the triumph of the West with the breakup of the Soviet Union and conversion of most of Eastern Europe to capitalism, the 1990s were fated to be a time of prosperity.  When technology in general, and the formerly military technology of the Internet started booming in the mid-1990s, the stage was set for one of the greatest stock and investment bubbles in history.

With the 9/11 attacks and the twin wars in Afghanistan and Iraq, the geopolitics changed; all readers are familiar with recent political and market events.

Where are we now?

One the one hand, war against African pirates is a "Good War", and presumably a winnable one. Victory will increase corporate profits, increase national security, and certainly feel morally right.  These sorts of wars cement American prestige and leadership, with the civilized world once again following our lead.  USA!  USA!  (Obviously, execution of a successful plan is key to victory.)  

On the other hand, there is a more important War going on in Pak-ghanistan (or, "Af-Pak" theater), which has the potential to be another Viet Nam.  It is expensive enough to fight a war in a mountainous, almost roadless country of 25 million (Afghanistan); it is another to begin an aggressive drone war in a populous, nuclear-armed neighboring country.

If you want to understand Afghanistan, you should consider reading "Caravans", by James Michener.  Great powers have quarreled over this tribal country for a long, long time.  The people are far more conservative than Iraqis.  The average American has no idea what life is like there, and really doesn't care. 

EBR's investment advice:  Watch what is going on in Pak-ghanistan closely to see how much it will or will not resemble another Viet Nam.  Because "everyone" is watching the economic banana unfold, there is little your also watching it will do to provide you a competitive advantage in the investment front.  Just as those who caught on early to the debt bubble (of which the housing bubble was the key part) were appropriately bearish on the economy and the markets, the smart money is going to be the money that correctly identifies trends that are not yet priced into the markets.

What goes on in North Korea is of little investment interest (absent war).  If the stock market sells off allegedly due to some routine news item out of North Korea, that would tend to be a "buy" point. 

On the other hand, America and its money were horribly harmed by a land war in Asia that Charles de Gaulle warned JFK against pursuing.  One may have noticed little European enthusiasm at the recent London G20 meeting for the Obama ramp-up in Pak-ghanistan.

Victory by the U. S. against the Taliban/fundamentalists in the Af-Pak region will bring no great riches a la Arab oil or the productivity of the conquered Japan and Germany following WW II, but a draining war or a loss will be quite bad.  Thus, EBR is concerned about the early risk-reward of the escalation from an investment standpoint, whether or not it is the "correct" strategy from a national security standpoint.

Copyright (C) Long Lake LLC 2009  

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