very intersting stuff from http://www.prudentbear.com/internationalperspective.asp
some brilliant quotes in here!
International Perspective, by Marshall Auerback
The War Hasn’t Started, But The “War Rally” Has Begun
March 18, 2003
A share buying spree has begun in a market widely expected to remain volatile as it becomes hostage to the vagaries of war with Iraq. By virtually all accounts, war is set to begin this week. So why the rush to buy equities now? It appears that in the imminence of armed conflict is producing a curious euphoria amongst the military insta-pundits on Wall Street, who tell us that victory will come quickly and with comparatively little bloodshed and accompanying instability.
Concurrent with this rally, oil and gold, the so-called “war hedges”, have duly plunged. Markets are beginning to look beyond Iraq, anticipating an era of cheaper oil. Everything happens much quicker in today’s Internet-driven world, including war. In the words of the always eloquent market commentator, John Mauldin: “It was not the postponement of war, which no one believes is really possible, but the possibility of it being swift and painless that got the ‘animal spirits’ of traders moving. If the war does go well, they expect a war rally a la 1991.”
As Mauldin’s characterisation suggests, the current thinking amongst traders is that if victory is likely to be swift and relatively painless then why wait until the fighting commences before charging into the market for the expected “war rally”?
While there is no real doubt that US military might will prevail, we hope these optimistic assumptions are not misplaced. Perhaps the war will be over in a matter of days and experts will be stunned at the ease of victory. Perhaps this will induce further euphoria in the markets. But it is not the war per se as it is the peace aftermath, the full implications of which we doubt the markets have fully discounted.
Consider oil as but one complex factor. A number of oil experts continue to suggest that there will be plenty of supply to offset any potential disruption, with Saudi Arabia and Venezuela both poised to increase production, partly to head off the release of the strategic oil reserves of America and other countries. These optimists argue that we should prepare for a repeat of the 1991 Gulf war, when oil prices surged after Iraq’s invasion of Kuwait but then collapsed as the coalition forces successfully launched Operation Desert Storm. Crude’s sharp drop today – its biggest one day plunge since 2001 – seems to reflect a widely held perception that the conclusion of hostilities will lead to an ample supply of cheap oil. The rosy scenario is given added weight by some on the grounds that there will be a likely change of regime in Baghdad and that a country with the world’s second largest oil reserves will be quickly opened up to Western investment. That alone could have an impact on market psychology, according to Bear Stearns economist, David Brown, who argues that oil prices at $20 are not inconceivable in the event of a quick, decisive victory.
The underlying dynamics of the oil market do not appear to justify such optimism above and beyond a knee-jerk reaction of traders in the immediate aftermath of a successful prosecution of the war. Even assuming the prevailing best case scenario -- a quick US victory without major further damage to Iraq's infrastructure or its oil fields – there is still a huge investment deficit in respect of Iraq’s oil fields to be worked out. In order for such investment to proceed, we must also assume a significant US peacekeeping force will be required throughout Iraq initially to provide order and stability in view of the many conflicting groups and tribes controlled through most of Iraq's modern history by repressive authoritarian regimes. Otherwise, it is hard to envisage oil executives and their western families rushing into Iraq to partake in a new oil investment bonanza.
A key problem is the funding required even allowing for adequate defence and security. Even with an expansion of the oil industry to 7 million barrels per day of capacity over eight years, funding required exceeds export revenue the first five years reaching a cumulative total of approximately $70 billion, according to the latest estimates of Groppe, Long, & Littell, which has been studying the region and the oil industry for the past several decades.
In terms of overall costs, the foregoing does not include the cost of US military action ($50-100bn, according to the most conservative estimates) or any settlement of existing debts or other claims against Iraq.
The UN Claims Commission as of late 2001
* had made payments of approximately $13 billion primarily to individuals and companies,
* has approved another $33.5 billion for payment and
* has another $227 billion pending predominantly from creditors France and Russia and from Kuwait and Saudi Arabian for claims from the 1991 Gulf War.
To be sure, the US might choose to ignore the UN Claims Commission, much as it has ignored the clearly expressed opposition to war on the part of the majority of the Security Council. The claims payments as well as the "oil for food" payments have been made from the UN sanctioned and controlled Iraqi oil exports which were allowed to resume in 1996, a policy with which the American government concurred. How far down the road away from post-war international order to the Hobbesian law of 19th century power politics the US chooses to go is yet another imponderable. That such questions need to be raised suggests a lack of requisite clarity craved by companies were they to commit vast sums to the Iraqi oil fields to expand oil production, let alone resolving conclusively the legality of post-sanctions contracts awarded in recent years to Russian, French and Chinese oil companies for the development of significant new oil fields. It is easy to say that those who do not participate in Iraq’s liberation should not receive the spoils of war, but the abrogation of such commitments hardly bodes well for a stable rule of law, of which American companies have been prime beneficiaries.
The large upfront investments required, and returns only over long periods of time characteristic of the oil industry, mean that contract negotiations with host governments are complex and lengthy. They also require confidence that host governments are stable and will honour agreements over the long term. According to Henry Groppe, it took six years to negotiate the development agreements with the current government in Baghdad. Yes, sanctions invariably complicated such negotiations, but comparable dealings have been underway five years in Iran, four years in Saudi Arabia, were abandoned after four years in Kuwait and have been pursued for the past twelve years in the former Soviet Union. An interim American military administration is not the most stable basis on which to establish long-term agreements for the exploitation of Iraq’s oil fields.
Under the most favourable of circumstances, therefore, US takeover or "custodianship" of Iraq and its oil (even via the UN as is now being mooted by the British) will require major commitment of personnel and resources with significant additional funding beyond expanded oil revenues for many years.
And, of course, all of the above assumes a prompt and decisive victory. Perhaps the “five day victory” is a realistic outcome. But one must also consider the question of logistics. Front page news reports are telling us that the ground attack will be preceded by an intense air campaign designed to weaken Saddam while doing minimal damage to the Iraqi people (the so-called “shock and awe” bombardment). Quickly thereafter, or perhaps simultaneously, according to these reports, we will airlift special operations forces, and elements of the 101st Airmobile Division and the 82nd Airborne Division in the northern reaches of Iraq (presumably to protect the Kirkuk oil fields and prevent the Kurds and perhaps the Turks from fighting each other). Meanwhile several heavy divisions, augmented by Marines and British Forces would roll out of Kuwait in a massive armoured thrust toward Baghdad, which by road, could be as much as 300 miles away.
But here the problem of logistics comes into play, as prominent defence strategist, David Hackworth, tells us (www.hackworth.com). According to Hackworth, sooner of later, given this general line of movement, geography tells us that it will be necessary for the heavy forces advancing from Kuwait to cross the Euphrates and move into Mesopotamia ... or the fertile floodplain between the Tigress and the Euphrates -- which is a swamp waiting to happen, if Saddam blows the dykes, dams, and irrigation systems. Needless this to say, we doubt that the current global surge in share prices adequately reflects this potential problem.
On a longer term perspective, nobody doubts that a vastly superior armed US/UK force will ultimately overwhelm Iraq. From the perspective of markets, however, what is required is decisiveness and clarity. Without the now expected decisive post-war resolution, recovery dynamics in the global economy are likely to be significantly impaired. As Stephen Roach notes, “The downside to oil prices could be limited. The uncertainty factor could persist – leaving businesses reluctant to hire and consumers unwilling to spend.” And recessionary pressures will intensify.
Of course, it is widely acknowledged that, bear markets often bottom as most market participants finally recognise that a recession is under way. However, the lift off in stock prices that typically occurs during recessions is due to a sharp decline in policy interest rates that accompany this recognition. With short term interest rates at 1.25% in the US, zero in Japan, and 2.25% in Europe, things are different than 1991. There is no scope for such a significant decline in interest rates to drive stock prices higher. The risk of a recession is high, and now unlike recessions of the past, it might be a negative for the stock market.
Additionally, Iraq conveniently allows most market participants to ignore the global economy’s ongoing financial fragility, particularly in the US. Last week, St. Louis Fed President William Poole state that Freddie Mac and Fannie Mae may be insufficiently capitalized to weather a possible financial market crisis. He also argued for an end to the widespread market perception that these are institutions with a quasi government guarantee. Though Poole has made such comments before, the timing in this instance was somewhat peculiar and seems to have been completely forgotten in the midst of the pre-war euphoria.
If the Fed were to keep the Fed Funds rate at 1% or so while pegging the long bond rate at a much lower level, as Governor Ben Bernanke suggested in a major policy speech last November, it would be a radical shift in policy as it would imply Fed intervention aimed at narrowly targeting Fed stimulus. For a monetarist with a typical libertarian bent, such a degree of intervention should be objectionable. It is presumably hoped that such a policy will lead to lower mortgage interest rates, more mortgage refis, and a more indebted U.S. consumer hooked on low mortgage interest rates. One can understand how a monetarist central banker with a libertarian bent might object. As Fannie and Freddie are the two institutions needed to increase yet further U.S. household mortgage debt, it would be logical for such a central banker to object to their quasi government guarantee which makes possible yet deeper household mortgage indebtedness.
As noble as Poole’s condemnation of the moral hazard implicit in the conduct of GSE policy, virtually all market analysts, as well as America’s monetary and fiscal authorities recognise that the whole economy today rests on the slender reed of the consumer, which in turn rests to a great extent on exceptionally accommodative mortgage financing conditions and rapid growth in this type of debt. There is no way that the Congress or the Fed will really do anything to undermine the current structure, as there would be a high risk of pulling down the entire domestic (indeed, world) economy in the process. The horse is out of this barn, has jumped the fence and is halfway across the country. No amount of success in Iraq will alter this fundamental Achilles heel in the American economy. Indeed, the oil related “tax” from substantially higher crude prices that have prevailed for almost a year merely exacerbates the problem of minimal discretionary expenditure on the part of private households.
It seems clear, therefore, that there are still considerable uncertainties and unimagined costs ahead, many of which exist independent of Iraq. For all of President Bush’s unilateralist military strength, his country’s debt position still renders his government an economic multilateralist by necessity. France, Germany, Russia, China and Japan do matter in this latter context. The markets, particularly Wall Street, would do well to recall this elementary fact in the aftermath of the Iraqi invasion, when the full consequences of administering a country of 25 million people (many of whom will want to kill each other, or their American liberators) and reconstructing the whole Middle Eastern puzzle become more readily apparent. While US forces can win a war virtually on their own, they cannot win the peace without external assistance. America might therefore find that it needs friends and allies after all, including all of the so-called “Euro-weenies” of “Old Europe”.
some brilliant quotes in here!
International Perspective, by Marshall Auerback
The War Hasn’t Started, But The “War Rally” Has Begun
March 18, 2003
A share buying spree has begun in a market widely expected to remain volatile as it becomes hostage to the vagaries of war with Iraq. By virtually all accounts, war is set to begin this week. So why the rush to buy equities now? It appears that in the imminence of armed conflict is producing a curious euphoria amongst the military insta-pundits on Wall Street, who tell us that victory will come quickly and with comparatively little bloodshed and accompanying instability.
Concurrent with this rally, oil and gold, the so-called “war hedges”, have duly plunged. Markets are beginning to look beyond Iraq, anticipating an era of cheaper oil. Everything happens much quicker in today’s Internet-driven world, including war. In the words of the always eloquent market commentator, John Mauldin: “It was not the postponement of war, which no one believes is really possible, but the possibility of it being swift and painless that got the ‘animal spirits’ of traders moving. If the war does go well, they expect a war rally a la 1991.”
As Mauldin’s characterisation suggests, the current thinking amongst traders is that if victory is likely to be swift and relatively painless then why wait until the fighting commences before charging into the market for the expected “war rally”?
While there is no real doubt that US military might will prevail, we hope these optimistic assumptions are not misplaced. Perhaps the war will be over in a matter of days and experts will be stunned at the ease of victory. Perhaps this will induce further euphoria in the markets. But it is not the war per se as it is the peace aftermath, the full implications of which we doubt the markets have fully discounted.
Consider oil as but one complex factor. A number of oil experts continue to suggest that there will be plenty of supply to offset any potential disruption, with Saudi Arabia and Venezuela both poised to increase production, partly to head off the release of the strategic oil reserves of America and other countries. These optimists argue that we should prepare for a repeat of the 1991 Gulf war, when oil prices surged after Iraq’s invasion of Kuwait but then collapsed as the coalition forces successfully launched Operation Desert Storm. Crude’s sharp drop today – its biggest one day plunge since 2001 – seems to reflect a widely held perception that the conclusion of hostilities will lead to an ample supply of cheap oil. The rosy scenario is given added weight by some on the grounds that there will be a likely change of regime in Baghdad and that a country with the world’s second largest oil reserves will be quickly opened up to Western investment. That alone could have an impact on market psychology, according to Bear Stearns economist, David Brown, who argues that oil prices at $20 are not inconceivable in the event of a quick, decisive victory.
The underlying dynamics of the oil market do not appear to justify such optimism above and beyond a knee-jerk reaction of traders in the immediate aftermath of a successful prosecution of the war. Even assuming the prevailing best case scenario -- a quick US victory without major further damage to Iraq's infrastructure or its oil fields – there is still a huge investment deficit in respect of Iraq’s oil fields to be worked out. In order for such investment to proceed, we must also assume a significant US peacekeeping force will be required throughout Iraq initially to provide order and stability in view of the many conflicting groups and tribes controlled through most of Iraq's modern history by repressive authoritarian regimes. Otherwise, it is hard to envisage oil executives and their western families rushing into Iraq to partake in a new oil investment bonanza.
A key problem is the funding required even allowing for adequate defence and security. Even with an expansion of the oil industry to 7 million barrels per day of capacity over eight years, funding required exceeds export revenue the first five years reaching a cumulative total of approximately $70 billion, according to the latest estimates of Groppe, Long, & Littell, which has been studying the region and the oil industry for the past several decades.
In terms of overall costs, the foregoing does not include the cost of US military action ($50-100bn, according to the most conservative estimates) or any settlement of existing debts or other claims against Iraq.
The UN Claims Commission as of late 2001
* had made payments of approximately $13 billion primarily to individuals and companies,
* has approved another $33.5 billion for payment and
* has another $227 billion pending predominantly from creditors France and Russia and from Kuwait and Saudi Arabian for claims from the 1991 Gulf War.
To be sure, the US might choose to ignore the UN Claims Commission, much as it has ignored the clearly expressed opposition to war on the part of the majority of the Security Council. The claims payments as well as the "oil for food" payments have been made from the UN sanctioned and controlled Iraqi oil exports which were allowed to resume in 1996, a policy with which the American government concurred. How far down the road away from post-war international order to the Hobbesian law of 19th century power politics the US chooses to go is yet another imponderable. That such questions need to be raised suggests a lack of requisite clarity craved by companies were they to commit vast sums to the Iraqi oil fields to expand oil production, let alone resolving conclusively the legality of post-sanctions contracts awarded in recent years to Russian, French and Chinese oil companies for the development of significant new oil fields. It is easy to say that those who do not participate in Iraq’s liberation should not receive the spoils of war, but the abrogation of such commitments hardly bodes well for a stable rule of law, of which American companies have been prime beneficiaries.
The large upfront investments required, and returns only over long periods of time characteristic of the oil industry, mean that contract negotiations with host governments are complex and lengthy. They also require confidence that host governments are stable and will honour agreements over the long term. According to Henry Groppe, it took six years to negotiate the development agreements with the current government in Baghdad. Yes, sanctions invariably complicated such negotiations, but comparable dealings have been underway five years in Iran, four years in Saudi Arabia, were abandoned after four years in Kuwait and have been pursued for the past twelve years in the former Soviet Union. An interim American military administration is not the most stable basis on which to establish long-term agreements for the exploitation of Iraq’s oil fields.
Under the most favourable of circumstances, therefore, US takeover or "custodianship" of Iraq and its oil (even via the UN as is now being mooted by the British) will require major commitment of personnel and resources with significant additional funding beyond expanded oil revenues for many years.
And, of course, all of the above assumes a prompt and decisive victory. Perhaps the “five day victory” is a realistic outcome. But one must also consider the question of logistics. Front page news reports are telling us that the ground attack will be preceded by an intense air campaign designed to weaken Saddam while doing minimal damage to the Iraqi people (the so-called “shock and awe” bombardment). Quickly thereafter, or perhaps simultaneously, according to these reports, we will airlift special operations forces, and elements of the 101st Airmobile Division and the 82nd Airborne Division in the northern reaches of Iraq (presumably to protect the Kirkuk oil fields and prevent the Kurds and perhaps the Turks from fighting each other). Meanwhile several heavy divisions, augmented by Marines and British Forces would roll out of Kuwait in a massive armoured thrust toward Baghdad, which by road, could be as much as 300 miles away.
But here the problem of logistics comes into play, as prominent defence strategist, David Hackworth, tells us (www.hackworth.com). According to Hackworth, sooner of later, given this general line of movement, geography tells us that it will be necessary for the heavy forces advancing from Kuwait to cross the Euphrates and move into Mesopotamia ... or the fertile floodplain between the Tigress and the Euphrates -- which is a swamp waiting to happen, if Saddam blows the dykes, dams, and irrigation systems. Needless this to say, we doubt that the current global surge in share prices adequately reflects this potential problem.
On a longer term perspective, nobody doubts that a vastly superior armed US/UK force will ultimately overwhelm Iraq. From the perspective of markets, however, what is required is decisiveness and clarity. Without the now expected decisive post-war resolution, recovery dynamics in the global economy are likely to be significantly impaired. As Stephen Roach notes, “The downside to oil prices could be limited. The uncertainty factor could persist – leaving businesses reluctant to hire and consumers unwilling to spend.” And recessionary pressures will intensify.
Of course, it is widely acknowledged that, bear markets often bottom as most market participants finally recognise that a recession is under way. However, the lift off in stock prices that typically occurs during recessions is due to a sharp decline in policy interest rates that accompany this recognition. With short term interest rates at 1.25% in the US, zero in Japan, and 2.25% in Europe, things are different than 1991. There is no scope for such a significant decline in interest rates to drive stock prices higher. The risk of a recession is high, and now unlike recessions of the past, it might be a negative for the stock market.
Additionally, Iraq conveniently allows most market participants to ignore the global economy’s ongoing financial fragility, particularly in the US. Last week, St. Louis Fed President William Poole state that Freddie Mac and Fannie Mae may be insufficiently capitalized to weather a possible financial market crisis. He also argued for an end to the widespread market perception that these are institutions with a quasi government guarantee. Though Poole has made such comments before, the timing in this instance was somewhat peculiar and seems to have been completely forgotten in the midst of the pre-war euphoria.
If the Fed were to keep the Fed Funds rate at 1% or so while pegging the long bond rate at a much lower level, as Governor Ben Bernanke suggested in a major policy speech last November, it would be a radical shift in policy as it would imply Fed intervention aimed at narrowly targeting Fed stimulus. For a monetarist with a typical libertarian bent, such a degree of intervention should be objectionable. It is presumably hoped that such a policy will lead to lower mortgage interest rates, more mortgage refis, and a more indebted U.S. consumer hooked on low mortgage interest rates. One can understand how a monetarist central banker with a libertarian bent might object. As Fannie and Freddie are the two institutions needed to increase yet further U.S. household mortgage debt, it would be logical for such a central banker to object to their quasi government guarantee which makes possible yet deeper household mortgage indebtedness.
As noble as Poole’s condemnation of the moral hazard implicit in the conduct of GSE policy, virtually all market analysts, as well as America’s monetary and fiscal authorities recognise that the whole economy today rests on the slender reed of the consumer, which in turn rests to a great extent on exceptionally accommodative mortgage financing conditions and rapid growth in this type of debt. There is no way that the Congress or the Fed will really do anything to undermine the current structure, as there would be a high risk of pulling down the entire domestic (indeed, world) economy in the process. The horse is out of this barn, has jumped the fence and is halfway across the country. No amount of success in Iraq will alter this fundamental Achilles heel in the American economy. Indeed, the oil related “tax” from substantially higher crude prices that have prevailed for almost a year merely exacerbates the problem of minimal discretionary expenditure on the part of private households.
It seems clear, therefore, that there are still considerable uncertainties and unimagined costs ahead, many of which exist independent of Iraq. For all of President Bush’s unilateralist military strength, his country’s debt position still renders his government an economic multilateralist by necessity. France, Germany, Russia, China and Japan do matter in this latter context. The markets, particularly Wall Street, would do well to recall this elementary fact in the aftermath of the Iraqi invasion, when the full consequences of administering a country of 25 million people (many of whom will want to kill each other, or their American liberators) and reconstructing the whole Middle Eastern puzzle become more readily apparent. While US forces can win a war virtually on their own, they cannot win the peace without external assistance. America might therefore find that it needs friends and allies after all, including all of the so-called “Euro-weenies” of “Old Europe”.
