As heated headlines all point to the war in Ukraine, saber rattling is sadly a key topic once again.
The Western media is all about sanctions and finger pointing, and, not surprisingly, is entirely one-sided as to its not-so-nuanced reporting, namely: Putin bad, West good.
Few need or want my own political opinions when it comes to discussing financial markets, so I’ll try to hem those in and stick to the cold truth of math vs. the opinionated vagaries of private politics.
Toward this end, however, history matters as much as math, and below, we look at the history and math of war and markets.
This extremely lengthy report is a necessary prerequisite to next week’s briefer report, where I’ll specifically address the harder questions as to the economic consequences of sanctions against Russia and whether the West has fully thought that through.
For now, however, I have re-heated (and slightly modified) an article written way back in 2018 to address a sadly familiar topic: War’s impact on markets.
What is so eerie about this old report is how remarkably familiar it is today.
So back to the future we go…
The MSM keeps us abreast now and then of horrific images of terrorism and violence, but for the most part, Americans without military ties live isolated from the war-torn realities facing many parts of the world.
Our media is often nothing more than a combination of infotainment and updates on political squabbles between the left and right or the scandal de jour in Hollywood or Washington.
This isolation from current realities, as well as a new generation of Americans who know more about downloading apps than uploading history, can lead to a kind of comfortable ignorance of just how strangely history repeats itself, or at least, as Twain remarked, “rhymes.”
In this isolation, we may not feel like we are in a world war, but as even Pope Francis remarked as far back as 2014, we are in fact already in such a war, even if it doesn’t feel like the days of Eisenhower, MacArthur or Westmorland.
As we canvas the map of the world, however, the evidence is fairly clear that financial as well as military hot and cold wars are in full swing today.
We will look at the evidence of this and consider what that could mean for the financial markets and your future wealth.
The Middle East
Of course, no discussion of a global war can begin without a look at the Middle East…
Israel’s struggles against Hezbollah in Lebanon (to its North), Hamas in Gaza (to its South) are part of a broader Arab-Israeli conflict from which so much of today’s wars are sourced, from Iraq and Afghanistan to a global jihad spanning from Africa and the Caucasus to South East Asia to downtown Manhattan.
As these wars create more victims on both sides, the struggle between West and East, as well as their religious and cultural divides, increases. In simple terms, conflict breeds more recruiting for more conflict. Every side has a story, anger and a reason to fight.
It’s hard to deny that the Middle East is the Balkans of the 21st century. In 2009, the wars in Iraq and Afghanistan were in full swing and Obama was elected in part to bring us out of both. At that time Lebanon, Egypt, Libya, Syria and the entire Arabian Peninsula were relatively stable.
Today, war, as well as conditions, in the Middle East has worsened, not improved.
Of course, the Palestinian-Israeli conflict was raging as it always has and seemingly always will. (Perhaps that is why Dean Acheson warned as early as the 1940’s that the US should not involve itself in Israel’s/Palestine’s wars.)
In light of the growing symmetry between US and Israeli foreign policy, some see such statements (rightly or wrongly) as anti-Semitic; others see it simply as realpolitik.
Regardless, there is no doubt that the perception of Western support as well as intervention in the affairs of the Middle East is a quagmire driven by financial, political, and moral issues lost in a blender of confusion.
Today, Libya and Yemen are essentially collapsed states, “Operation Freedom” in Iraq essentially midwifed ISIS, Al Nusra et el as the millennial split between Shia and Sunni, dating back to 632, is not something the US can simply solve by military force or democratic rhetoric.
Tensions in the Middle East have been fueled by an increasing (rather than decreasing) hatred and distrust of all things Western. Meanwhile, a horrific chess game between Iran on one side and Israel and Saudi Arabia, Qatar and Turkey on the other.
Net result, the Middle East has become balkanized as all five permanent members of the UN Security Council debate policy, commit troops and absorb refuges of mixed intentions, from jihadists whose only aim is destruction to broken families whose only aim is safety.
Where and how things will go between the US, Saudi Arabia and Israel on one side and China, Russia and Iran on the other remains to be seen, as does the potential for internal socio-political strife within EU countries who are losing the economic and moral capital to absorb the masses of refugees streaming in from war-torn Middle Eastern cultures, regions and religions that are not “gelling” in Europe.
The World Has Changed
Whatever one thinks of the war on terror, of the civil liberties (privacy, due process, search and seizure, etc.) sacrificed in the US (nod to the NSA, GSHQ) in the name of security/safety, the world (including our world), has forever changed in what appears to be a never-ending conflict and war on terror.
Today alliances reminiscent of “The Guns of August” in 1914 are being formed by the nations now intertwined in a Middle East whose borders since 1918 were drafted by Western Powers, and whose wars were the direct result of the 1948 birth of our ally, Israel, which all Arab States unilaterally rejected, placing the Israelis in a horrific state of permanent war.
The depth of ethnic hatred and religious conflicts in this region have been severely underestimated for over a century by US and other Western policy makers, who actually and naively believed the “Arab Spring” a few years ago would bring “democracy” and solve the region’s ancient divides in the way an anti-biotic magically cures an infection.
As of this writing, Iran’s mullahs are filled with fears of Israel and anti-Western venom. Iran is poised to be another potential battle ground in a region which is effectively one great Gettysburg—an internal civil war among Muslim sects and a larger war against Israeli and Western dominance.
Such a war is increasingly splitting public opinion in Europe and America, whose debt-ridden populations are growing increasing tired of wars–and the cost of wars— in their own countries.
Expensive Wars—Debated Motives
According to a recent Brown University study, the US has already spent over $6T in its efforts to bring stability to the Middle East, a figure that is 60X what we projected when we first put boots on the ground in Iraq.
In 2003, as M1 tanks and Bradley Fighting Vehicles closed in on Baghdad, Texas-based oil engineers from KBR were mingled among the Army Corps of Engineers in the Basra oil fields and its 115 billion barrels of oil reserves, which are shipped out of the strategically “vital” port of Umm Qasr…
One wonders if the war was moral, financial, political or all of the above. We are not here to enter or answer that debate.
Regardless of one’s views or political ideals, the world is at war even if nothing feels like the beaches of Normandy in the news reels.
In the Middle East today, there are now eight countries officially at war involving over 160 different militia, separatist and anarchist groups.
Other Global Conflicts
In Africa, between the Congo, Mali, Nigeria, Somalia and Sudan, there are 24 countries and 141 groups involved in wars.
In Europe, eight countries are at war with upwards of 65 separatist groups, guerrillas etc.
Even in the America’s we are seeing drug wars escalate in Mexico (prompting a politically debated “wall’), Venezuela is on its knees and more than 25 separatist groups are currently clamoring for revolution south of our borders.
All in, today 61 countries are actively engaged in war, with 540 anarchists, separatist and rebel groups falling beneath this sad, statistical umbrella.
In Pakistan, we’ve seen small victories to North while Sunni extremists expand throughout the rest of the country. The US is still there fighting the Taliban with drones and M-16’s
In Korea, we have 30,000 US troops in DMZ waiting to see what Kim Jong Un will do or not do. In Eastern Europe, the West-leaning Ukraine is fighting Russian-supported rebels as Western sanctions are crushing Russian energy, banking and defense budgets. Hence, we now see Russia pivoting toward China.
In 2014, Russian troops came into the Crimea and Eastern Ukraine, ostensibly to “protect ethnic Russians.” (Interestingly enough, Hitler used similar language to “protect ethnic Germans” when annexing the Sudetenland prior to World War 2).
Some see Putin as protecting Russia, others see his moves as a grab for resources—as that contested area contains essential energy transport corridors linking the oil and natural gas reserves of Caspian basin to Europe and Asia.
If this is the case, one might realistically see that a key reason Russia is fighting in Syria today is to prevent Saudi Arabia from building a pipeline through Syria to Europe and hence cutting Russia out of a key piece of the energy financial pie.
In short, money, survival and commodities can drive war just as much as cultural grievances or moral support.
Putin, meanwhile, has declared that NATO missiles in the Ukraine would mean a declaration of war. As the 1962 Cuban missile crisis reminds, smart leaders need to make smart compromises rather than media and militant driven threats.
Western Europe: More Than Just a Vacation Spot
Not everything in Europe is going as peacefully as our travel brochures suggest. Many weaker countries in the EU have unpayable debts and growing internal problems.
At a fiscal level, the EU has not recovered from the debt crisis of 09. By 2013, as government bonds were tanking, the ECB had to step in and “engineer” a recovery by simply printing money and increasing debts.
This “whatever it takes” solution is fodder for short-term recovery and long term bust. Von Mises warned of this long before the central banks bought our confidences.
It comes down to this: problems solved by debt simply become bigger problems down the road.
In short, debt is not only the four-letter word for the US, but even more so for Europe. The debts there are staggering: Greece, $360B; Spain $1.2 T; Italy $2.4T; France $2.3T; Germany $2.5T…Relatively, the numbers are equally painful in Belgium, Finland and Portugal.
It’s the same sad story: huge debt, no revenue. Total EU debt is well over $12T, and all in the backdrop of increasing and inevitable cutbacks and austerity measure. As borrowing costs there rise, EU banks teeter on different levels of insolvency and are seeing net outflows to the US.
Germany is the keystone—yet it too is worried about a recession, as its debt crisis (like our own) is just pushed down the road. Could the EU see social unrest or even violence? Many who visit its capitals, hotels and famous sites can’t imagine this. I don’t like to imagine it either.
But those who have lived through or studied European history know otherwise. And more recently, events in the periphery of the EU’s tourist sites remind us that things can go from the sublime to the ridiculous quite quickly across the pond—think of: the Croatian war (91-95); the Bosnian war (92-95), the first Chechen Wars (94-96), Kosovo (89-99); Georgia and Dagestan (99), the second Chechen War (09).
Even in the more known/visited countries of Europe, the ice is thinning, financially, socially and politically as Muslim populations expand in countries like Denmark, Sweden and France, slowly testing their liberal/humanitarian ideals. As Spain’s jobless rate hits 26%, its youth unemployment reached 50%, what economists are now calling a “lost generation” teetering toward violence.
Such conditions—debt, immigration tensions and increasing violence—could escalate into internal military conflicts.
China makes headlines for a lot of reasons, most notably for its growing market risks and opportunities. But equally worth note is its military expansion. China is flexing its growing muscle in the East China Sea and Senkaku Islands administered by Japan.
Because… there’s enough offshore oil in these regions to supply China for 45 years, and China needs oil.
Some wars, however, don’t involve battleships and destroyers, but dollars and Yuan. Whether most Americans know this or not, China is slowly gaining greater control over the US economy, having effectively replaced our manufacturing plants with their own, cheaper equivalents.
According to the WTO, the US has lost over 5.6 million jobs to Chinese labor markets. Meanwhile, China is taking controlling interests in US new energy technologies, alternative energy, and equipment manufacturing while imposing lopsided tariffs on US steel, automobiles, and digital products (from video games to audio recorders). Our tariffs are minimal in comparison.
The WTO has also measured at least $48B in pirated software by Chinese entities over US technologies. Meanwhile, the US trade balance favors China by $300B a year. In this economic “cold war,” the US is losing…
Today, China, not the US, has emerged as the world’s greatest creditor.
China is also stepping up to monopolize the world’s natural resources, buying up exploration and production in Kazakhstan, Venezuela, Sudan, West Africa, Iran, Saudi Arabia, Canada and Brazil. At the same time, they are expanding/hoarding food stocks, grains, precious metals, and base metals, while still only using 1/9 as much energy per capita as US.
Once that number climbs to ½, then 60% of world oil would have to go to China, which may explain why China is buying up oil, gold and other resource assets faster than any nation in the world and slowly cornering the market on natural resources.
Another tactic in this international/financial cold war is the subtle move to have the Yuan slowly replace the USD as the global reserve currency—a topic of hot debate with many good arguments on both sides of the issue.
Regardless of the reality, speed or possibility of such a seismic currency shift, there is no doubt China is increasingly curtailing USD purchases while buying gold, silver and other commodities (above) and making Yuan-denominated deals with Russia, Brazil, Australia, India, France, Germany, Japan, Taiwan and South Korea.
Is China a real threat? It certainly has its problems/risks, as we’ve written elsewhere. China has massive credit issues, a housing bubble and deep fears of meltdown within its own markets. Nevertheless, it’s growing faster than any other major power.
In this international musical chair game of war, debt and social divisions, the key question is which part of the world will be standing when the music stops?
How Did We Get Here?
Why so much military and economic strife? Why are so many governments around the world broke or at war and what is potentially happening today and possibly awaiting us around the corner? How does one make sense of all these admittedly depressing observations regarding global war and global debt?
Perhaps, and just perhaps, some of the answers can be found in the past. Economists and historians from von Mises to Edward R. Dewey have objectively shown that as a nation’s debts rise (sovereign corporate, and private), they look first toward their own private banks; when that money dries up, they look toward central banks (i.e. money printing and engineered low rates).
In each of these places, central banks have engineered short-term “stability” at the cost of long-term disorder.
What’s next? Normally, when an individual country reaches peak debt, its last hope is a bailout from another, stronger country or countries—historically Japan, Germany and USA.
But all those countries, today, are broke—saddled in debt. Can you imagine the EU “bailing out” the US today, or visa versa? Can Japan “bail out” any major nation?
When that “hail Mary” solution is not available, then in the last option for broke, overly-indebted nations is default, as we saw in Argentina (01); Russia (98)—and potentially, going forward, in Greece, Spain, Portugal and Italy.
The most desperate stage is when governments turn on their own, as we saw in Cyprus in 2013, (confiscating depositor accounts) and which we’ve seen indirectly in the form of abusive tax regimes and other confiscatory measures in countries like Poland, France, Argentina etc.
Some might contend that even in the US, we are seeing the first signs of this—not necessarily in terms of tax measures, but in the loss of civil liberties accepted as a security need in the war on terror.
But then again, Ben Franklin warned us long before the birth of the NSA, that a country who gives up liberties in the name of security is unworthy of both… (This was written before the COVID crisis…)
Today, the NSA’s spying network (our Turmoil, Dishfire, and Dropoutjeep programs) represent a total breach of the 4th Amendment and closely resembles a Stasi-Eastern Germany.
All our metadata is not private, but subject to aggregation and review.
Meanwhile, many are arguing that FATCA’s tax pitbulls and programs like Obamacare, whether you favor them or not, are just forms of confiscation masquerading as tax laws.
In 1933, FDR confiscated private gold holdings.
In short, it’s fair to ask this: Are debt driven nations slowly eating themselves from the inside?
What Does Such Woe Mean for a Bull Case?
These are inflammatory questions/issues, and we are not here to take a side, but merely, and as argued above, to present a “case”—that is, a possible interpretation.
But we also said that part of this “case” was a bull-case scenario for investors.
How does any of the foregoing gloom and evidence of global war and global debt suggest a bull case for US investors?
The War Dividend
Some have argued that the bull case in the backdrop of international strife all comes down to this: “The war dividend.” Namely, it is based upon a conviction (supported in part by history) that war and destabilization feed US markets.
How? Because conflicts overseas often lead to massive capital flows into the relative safety of US markets.
This may seem simple, but market evidence supports the broader claim.
This is exactly what happened, for example, during the Iraq War, as hundreds of billions in Middle Eastern assets rushed into US markets as NATO bombs landed in Iraq.
Between 2003 and 2008, the Dow rose steadily upwards.
During the Vietnam War (which killed 58,000 Americans and 1.2 million Vietnamese), the Dow gained 53%. When the war ended, the markets promptly fell, and fell hard. In the 1970’s unemployment, inflation and market risks skyrocketed.
During the Great War of 1914-1918, the Dow nearly doubled.
And as for WW2, the Dow rose by 164% between Pearl Harbor in 1941 and VJ day in 1945.
If one were to follow such simplified history/correlations, one might defy logic and be bullish rather than bearish in times of war—especially our modern version of permanent war.
The “War Portfolio”
The bull case would suggest one buy stocks during pullbacks (as Getty did in the 30’s), invest in precious metals and even miners, and stay clear of government bonds as interest rates rise and the USD temporarily climbs (with hiccups) as foreign money seeks “safety” in the greenback.
According to this interpretation of debt and military history, the flow of nervous capital matters more than common sense. Rather than fear the economic destruction of war and global debt, some investors could realistically be bullish in this crazy backdrop.
Do other metrics support such a stance? Currencies are one such consideration. Sovereign currencies today are no longer backed by gold, and as they lose value in purchasing power, stock prices tend to rise as currencies weaken—which is a bull case for what are otherwise bearish fundamentals.
How does this work? Well, countries overstretched by welfare state budgets and global war expenses deflate their currencies via monetary money printing, which is what we have seen across the globe.
Today, be one bear or bull, we can’t deny the evidence of a global currency war and hence crisis, as each sovereign tries to undervalue its currencies to pay down debts and win export advantages.
As currencies weaken and debt rises, a kind of perfect storm blows toward the bond market.
If or when sovereign bonds crash and rates rise, currencies fall in value due to the excessive debt of their sovereigns. In simple terms: collapsing bond markets go hand in hand with collapsing currency markets. This can happen fast and furiously…In 2010, for example, the Euro lost 8% in 3 weeks, and did the same and worse in 2012 and 2014.
We all know that sovereign bonds across the globe are supported by central banks, not natural demand. Faith in government paper is eroding, slowly. We could see flows out of such bonds into stocks.
Right now, however, the flow isn’t fully apparent. Many investors are sitting on cash, including many cash-rich companies like Apple, Microsoft, Google, Verizon, Pfizer, and Johnson & Johnson—corporations who have more cash than the GDP’s of major countries.
Flows into US Stocks
If such a flow out of credit markets occurred, where will it go? Again: some say it goes into US stocks. Why? Because there is no place else to go…
If nervous money flows into US stocks, the Dow will climb. But the same flows could go to India and China, markets hitherto (and perhaps rightfully) avoided due to regulatory concerns.
But for the contrarian investor, buying such markets on pullbacks might feel appealing. As investors lose faith in governments, they also flow toward companies and commodities like gold, silver and copper.
Arguably, we could see similar dynamics play out over the next several years. Additionally, the price of oil and oil stocks (Exxon, Chevron, Conoco-Phillips) could literally give a whole new meaning to the term “volatility.” Imagine what a war in Iran (or Ukraine) could do to oil.
In such a backdrop/thesis, the global battle over energy, politics, and national security could bring a boom to US markets despite all its massive structural, political, debt and monetary distortions deeply felt in the US and of which we’ve written at length.
Short Term Boom before the Bust
But booms also have busts, of course. Eventually, history confirms that global civilizations don’t collapse by conquest, but by debt. The cycle is as familiar as rising and setting suns.
From Rome to the Reichstag, the Greeks to the Ottomans or even Napoleon to Queen Victoria, history confirms that even great nations fall by their own political, financial and military overstretch. In short: debt.
We certainly agree that the US is in debt up to its ears.
According to the Heritage Foundation, the real cause of US debt is not just military budgets, but a welfare state that is 3X the size of all the military wars in US history.
Today, over 50 million American’s live in poverty. The per capita adjustments for the EU are just as bad, if not worse. In short, great countries are rotting from within.
The Last to Rot
But as St. Exupery said of war—be it economic, military or both—the winner is never the winner, “just the last to rot.”
Here in the US, our markets continue to benefit from being the best horse in the global glue factory—i.e., we may just emerge as the “last to rot.” For now, that might pose as an opportunity to be oddly optimistic, but even the last to rot, still rots…
Like any other overstretched nation, the US can follow the cycle of borrowing its way to catastrophe. Since our Lehman moment in 08, the US has thrown more than $15T at the crisis, including a 5X expansion of the Fed’s balance sheet. (Now 10X…)
As per our recent blog on US debt, the numbers are staggering: $67T in combined government, corporate and private debt (today $90T…)
That’s a lot of fiat money and debt. The rest of the world is slowly catching on that our bond market is the biggest bubble in the world. Many argue (despite Buffet’s recently headlined long play on Treasury purchases) that free market forces will eventually punish US credit markets—including Treasuries.
The tides, some argue, are turning for US debt. During the 08 crisis, money poured into US bonds as a source of safety, and thus yields on the 30-year plummeted from 5.4% to 2.4%. Now we are seeing the tide shift, as money leaves bonds in the EU and US.
That’s why some believe that the only place for money to go (as it has to go somewhere) is US stocks.
Some argue that the Fed’s money-printing is a powder keg for inflationary explosions. Yet others maintain that hyper-inflation will not come to the US, but instead to the emerging market countries.
History confirms that even the Roman, Byzantine and British Empires—all massively in debt—didn’t die of hyperinflation. Again, they rotted from within…
Is America rotting? Yes, but likely not first. All the woes and debt overstretch outlined above will likely hit Europe and Japan before the US—which, again, could mean temporary flows (and boom) into US equities and hence a last-hurrah before the inevitable crash.
How big could this last-hurrah become. A Dow at 45,000?
As we consistently report, our role at Signals Matter is to consider such macros with an open mind—bull case to bear case. We are not in the business of predicting, but of tracing flows and signals for our Subscribers.
Could global war and debt be temporarily good for the stock market despite all the problems facing US balance sheets—corporate, private to sovereign?
What do you think?