Last Days

March 14, 2003

Dr. Neville Bennett, Christchurch, New Zealand
n.bennett@hist.canterbury.ac.nz.

"What if this present were the world’s last night?" wondered John Donne. No one suggests that the world is on the cusp of an Armageddon. But a local war is probable as the US and UK cannot keep their forces on the alert indefinitely. But there is always uncertainty in war, and the build up has begun the shake the economic foundations of the global economy. And, even if it is an easy war, there is no guarantee of and easy peace and interregnum.

I am already certain that the share, bond, currency and commodity markets are set for exceptionally volatile trading. That fact alone is worth considerable contemplation, as volatile trades set up ripples in delicately poised markets. This can lead to structural failures especially in financial institutions, as was the case with the Russian default which caused the demise of Long Term Capital Management and threatened the big trading banks. British insurers are already looking very vulnerable to a share market sell- off.

Each of these markets has a vast capitalization. There are huge derivative markets, which Warren Buffet knowledgeably calls time bombs. The future markets are also vast. Wrong guessing in any of these markets can be savagely punished. Moreover, sharp price movements, in this age of computer programming, can set in movement avalanches. For example, the US dollar is close to 115 yen, a point which could trigger explosive selling, and a general search for a larger risk premium for holding US assets.

My argument is that Iraq may seem to be the problem. It is not. The problem is how the Iraq question is handled.

Thus, whatever happens in a military campaign, it is clear that a deep political schism has opened between the US/UK on the one hand, and France, Germany, and Russia on the other. This schism seems likely to endure, and at the very least have substantial effects on trade relations. The possibilities of a greater number of EU/US trade wars have increased.

The cost of the build-up and an estimated US$ 60 billion to stabilize Iraq after a war, will also strain economies. Agencies are already rating growth downwards. Large new debts will pose problems. Doubts about the Anglo-American ability to fund their war and its aftermath, have already put great pressure on their currencies and credit markets.

Stock markets have been similarly affected. They were already in bear mode since the NASDAQ collapsed exactly three years ago. On March 10, 2000 the NASDAQ closed on 5,048 points. Within a year it lost 39 %( the most devastating drop in history). Worse followed, so that by March 6, 2003 it closed at 1305. That is a fall of 74% from its zenith, and more will occur this week.

Only wild-eyed optimists and sales-men disguised as "Wall Street Analysts" claim that the market is poised for a significant rise. War will bring a brief relief rally, but weak fundamentals preclude any sustained activity. The economic slowdown is apparent is a shock rise in the US jobless: 2 million jobs net have been lost since March 2001. Companies are adjusting, not by hiring or increasing investment, but by cost cutting as a means of improving profits. Consumers are becoming more conservative, and the sharp rise in oil prices is eating into the discretionary dollar.

Board rooms are reputedly buzzing with Warren Buffet’s condemnation of equity values. A growing number of commentators are advising caution as the broad-based Wilshire 5000 has lost 46% from its high. Its capitalization is down by US$ 7.9 trillion- by far the greatest loss of wealth in history.

The problem is equities are global. The Nikkei fell to 8144 points last week, which is a 20 year low. One wonders how investors will ever recover from their losses occurred since the Nikkei peaked at 39,000. (Perhaps a fund manager can explain). The situation is so glum that the Japanese economy minister called on his cabinet colleagues to buy shares to prop up the market. Some might this is not a clever ploy as the Bank of Japan has been instructed to do this too. It might imply that the Bank does not have enough money to do the job.

Meanwhile the FTSE 100 fell on Monday to 3,436 points, a seven and half year low. It has lost half its value since its high of 6,930 in December, 1999. Frankfurt’s Dax fell to a seven year low too, and may fall further as the consequences of Deutsche Telecom’s record loss of US% 27 billion seep in. Paris’s CAC 40 has hit a seven year low.

American investors have caught the jitters. Last week net outflow from funds reached US$ 3.8 billion, the week before the figure was 6.1 billion. Funds are under scrutiny partly because of tax treatments. In the 1990’s investors happily paid tax on their capital gains. Three years of losses have not brought any compensation to individuals. Sometimes liquidation is a good option for investors. Van Wagoner have liquidated three funds (the best of which lost only 53% each year, for three years!). By winding up the fund, individuals are awarded tax losses which can be offset against gains elsewhere.

The investor who wishes to preserve their wealth will face several judgement calls in the coming weeks: Will war be good or bad economic news? If it is not good, just how bad will it be? Oil is a key factor. It can be expected to rise, even if briefly. State finances will be battered. Markets will be very volatile. Consumer spending (a key driver) may sharply decline. Tourism and aviation could suffer unduly. There may be a stampede for safe havens, of which the gold and bond markets are the most likely beneficiaries.

Gold, Inflation and the Dollar

Here are extracts from recent commentary posted at www.speculative-investor.com.

The Gold Bull Market

Towards the end of last year the Fed confirmed that it would increase the supply of dollars by whatever extent was necessary to cause prices to rise. At the time that Fed representatives Greenspan and Bernanke made this promise the US$ had already been trending lower and the US$ gold price trending higher for 2 years, but having the Fed spell-out its intention to devalue the dollar should have been a wake-up call to the markets. In particular, it should have been a wake-up call to those who perceive deflation to be a clear and present danger. Those who expect deflation to occur in the US over the next 2 years must think Greenspan and Bernanke were lying when they promised to do whatever it took to de-value the dollar or they must not understand the power the Fed possesses in the field of currency creation.

If the Fed stuck to its traditional modus operandi and simply adjusted bank reserves in order to maintain a short-term interest rate (the Fed Funds Rate) at some arbitrary target level, then under certain conditions Greenspan and Co. would not be able to facilitate an increase in the supply of money. This is because they would necessarily be relying on individuals and corporations borrowing more money into existence in response to the lower short-term rates. But, if people were already 'tapped out' or returns on investment were very low then even a zero percent interest rate might not prompt significant new borrowing. The Fed's power is not, however, limited to the targeting of short-term interest rates. In order to increase the supply of money the Fed could, if it chose to do so, purchase private assets such as stocks, corporate bonds and real estate using newly-printed dollars. So, the question isn't whether the Fed has the power to inflate, the question is whether it will choose to inflate and by how much. Fortunately we don't need to guess the answer to this question because the Fed has already given us the answer. We can therefore be very confident that the price of gold is going much higher over the next few years and just concern ourselves with the path it is going to take to get from where it is now to that much higher price.

The Dollar - current market situation

After the Dollar hit the trend-line shown on the above chart in early-February we said that the decline did not appear to be complete and that another test of the trend-line would likely happen in the near future. That test has just occurred, so from this perspective the Dollar is very close to an intermediate-term bottom.

From an Elliott Wave perspective an important bottom also appears to be close at hand. It looks like the Dollar is in the 5th (final) wave of the decline that began in July of 2001. This 5th wave has, in turn, evolved in a clear 5-wave pattern with the Dollar now being in the final wave (labeled as (v) on the above chart).

Further to the above, the current phase of the Dollar's bear market (the phase that began in July of 2001) is probably almost over and a multi-month correction should soon begin. However, we are confident that the Dollar will trade significantly lower before this year is over (we expect that the October-1998 low (around 92) will be tested this year). Also, the fact that the US current account deficit has not yet begun to improve indicates that the Dollar index will trade well below 90 during 2004 (based on historical precedent, the Dollar's exchange value will keep trending lower until the US is running a quarterly current account surplus).

Note that although the Dollar is probably close to a low it is yet to provide any technical confirmation that a low is in place. As is the case with the stock market we expect that a low will be in place before the end of this month, but a final downward spike (to around the 95 level) is possible over the coming 2-3 weeks.

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