The Cost of War And The Price Of Gold
The Daily Reckoning (a freebie)
Paris, France
Friday, 20 December 2002
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*** Where did Santa go? No presents under the tree on Wall
Street...
*** But oh là là...gold investors had to rub their eyes and
pinch themselves...
*** 'Ledgy' waves, ledgy markets...the slopes of
Vesuvius...military spending in a bull market..celebrity
CEOs...and more!
====================================
Here comes Santa Claus...Here comes Santa Claus...
Oops...what's this? No Santa! Stocks went down, not up
yesterday.
But over in the gold market, investors rub their eyes.
Santa's sleigh is headed in their direction, and they can
hardly believe it. Gold shot up to $355 an ounce yesterday
on the European spot market. Investors had to pinch
themselves to make sure they weren't dreaming. After 20
years of being wrong, the poor gold bugs' mouths gaped open
and their hearts raced...finally!
Meanwhile, in China it was illegal for ordinary people to
own gold - until very recently. Now, reports the BBC,
people stand in line to buy it - in bars stamped with a
sheep. For Daily Reckoning readers unfamiliar with the
Chinese calendar, the year of the sheep begins in February.
Demand for gold in China is expected to double in the next
year. It seems to be going up elsewhere too - after Fed
governor Bernanke announced to the whole world that the Fed
was ready to ruin the greenback by printing an almost
infinite quantity of them, if need be, in order to prevent
falling consumer prices. Currently, 76% of the world's
central bank reserves are in the form of dollars. By
contrast, gold is a smaller percentage of reserves than at
any time in the last 50 years.
What would you do, dear reader? Imagine that you are in
charge of the central bank or Uruguay or Uzbekistan. You
read Bernanke's speech...and you know what a jam the
Americans have gotten themselves into - needing $1.5
billion in foreign capital every day just to maintain
current spending levels. And you read the headlines from
around the world:
"Argentina's GDP is collapsing at a 10% annual rate..."
"Germany faces more strikes...deflation...aging
population..."
"Italian confidence at 6-year low..."
"Oil soars on war fears..."
Ah, yes...there is always war. Military spending is in a
major bull market - maybe even a bubble - in America.
In November, the U.S. budget gap widened to $59.1 billion,
came the news yesterday. The deficit for the fiscal year -
ending next September - is expected to rise to $145
billion. Included in these numbers is the biggest increase
in defense spending in 2 decades, giving the U.S. a total
military budget of $355 billion. Spending hundreds of
billions you don't have to combat an enemy you can't find,
but who seems to spend almost nothing in comparison, hardly
seems like a winning formula. Like all bull markets, this
one will probably come to grief, too. But who knows when?
Or how?
Central bankers don't read tomorrow's papers anymore than
we do. But if you were a central banker - or merely an
ordinary investor - wouldn't you be tempted to shift just a
little more of your reserves from dollars to gold...just in
case?
Here's our man in New York with the latest news:
-----------
Eric Fry, with his mind on Wall Street (sort of)...
- The bear market anti-rally continued yesterday, as the
Dow slipped 83 points to 8,365 and the Nasdaq shed half a
percent to 1,354. With each new selloff, the "new bull
market" that so many investors eagerly embraced in October
and November looks more like a plain-vanilla bear market
rally - the kind of rally bursts onto the scene like a
supernova and flames out just as quickly.
- But the gold rally refuses to flame out. Instead, it
casts a bright, steady glow that warms the hearts (and
fattens the pocketbooks) of gold bulls and inflation-phobes
worldwide. Yesterday, the yellow metal added $4.10 to its
recent winnings to finish the New York trading session at
$346 (Feb. contracts).
- It looks like Fed governor Ben Bernanke is getting
exactly what he hoped for: reflation...or at least the
symptoms of it. While inflation may be a delight to
investors in the commodity sector, inflation is no delight
whatsoever to most investors, and it shouldn't be a delight
to any clear-headed central banker.
- But here in the States, central bankers think it might be
fun to have a little inflation. Unfortunately, having a
little inflation is a bit like being a little pregnant -
both of these phenomena tend to go "full-term." More
below...
- In the meantime...I have to say, with the markets
settling down for the holidays...it has been hard for me to
get my mind off my stay in Nicaragua.
- The food, for example, was absolutely outstanding. My
long-time friend, Hilaire, joined me on the journey.
Together, we feasted on fried plantains, chicken and fish
prepared in various types of citrus and garlic-based
marinades, thick flour tortillas, heuvos rancheros and, of
course, rice and beans with every meal. Two young
Nicaraguan ladies prepared our breakfast and dinner each
day. It was outstanding...
- Hilaire is a dedicated surfer who toted his "longboard"
along with him, all the way from Laguna Beach, CA. Laguna,
if you're not familiar with it, does not exactly lack for
great surf. But Hilaire gamely decided to give "Nica" a
try. After one day spent surfing all afternoon on a perfect
"left break," I asked him if it was worth the trouble.
- "Absolutely," he replied. "This place is awesome."
- And having arrived back in Manhattan, I can't help but
recall another one of Rancho Santana's principal "awesome"
traits - its utter isolation. There are no casinos, no
McDonald's and hardly any people. Occasionally, a couple of
local fisherman would amble past. But otherwise, no one.
- At one point, we did encounter three globetrotting
American surfers who were "rippin' it up" on one of the
nearby point breaks. "How's the surf?" Hilaire asked them
as they were coming out of the water. "It's pretty ledgy,
bro," one of the surf dudes responded.
- "Oh," Hilaire said, then turned to me and said under his
breath, "Whatever the heck that means."
- With the markets pretty ledgy themselves, Rancho Santana
seems more and more like a good place to ride out the bear
market...alas, reckon we must, and reckon we will...Bill?
-----------
Back in Paris....
*** When celebrity CEO Gary Wendt took over at Conseco in
June 2000, the stock soared from $5 to $20. Gary paid
himself $53 million...the company went bankrupt...and now
you can buy the shares for pennies. Way to go, Gary!
Economist Paul Krugman looks at stories like this and draws
the conclusion he wants. In Krugman's imagination, high
executive salaries illustrate the return of raw, pre-
Rooseveltian capitalism...in which the rich get richer at
the poor's expense.
What it really shows is that real capitalists have almost
disappeared. They've been replaced by small, collectivized
shareholders, who participate through pension funds, IRAs,
401ks, mutual funds and so forth. Few and far between are
real capitalists - such as Warren Buffett - who actually
have a big enough stake in a company to care what the
executives are paid. The small shareholders are more like a
mob of voters - both clueless and powerless. They cheer on
the celebrity CEOs as if they were at a campaign rally with
free beer...and hope their man wins for the same reason, so
that they will get someone else's money without working for
it.
***
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The Daily Reckoning PRESENTS: With the winds of war
blowing, John Myers takes a look at likely costs; how the
government thinks it's going to pay for them...and the
likely investment implications.
THE COST OF WAR AND THE PRICE OF GOLD
By John Myers
How much would a war in Iraq cost? We ask no one in
particular. No one really knows, of course, but there is
reason to think the cost could be far higher than
politicians would have us believe.
A short and successful war, suggest estimates from two
different congressional reports, would cost around $50
billion, compared to about $80 billion (in current dollars)
for the Gulf War. But these costs are likely too low,
suggests William Nordhaus, an economist at Yale University.
Why? One possibility is that leaders are given biased
information; another is that costs are understated to gain
political consensus. "It is much easier to raise the extra
billions of dollars once troops are in the field and
bullets are flying," he notes.
A more prolonged engagement, including an Iraqi urban
defense strategy and a refusal by neighboring countries to
allow the United States to base forces in their
territories, would bump up the cost to about $140 billion,
Nordhaus estimates. Neither scenario includes the costs of
occupation, peacekeeping and so forth, and both assume no
use of weapons of mass destruction and no subsequent
terrorist attacks. They also exclude macroeconomic effects,
like rising oil prices, for example.
Blowing a country apart isn't nearly as expensive as trying
to put it back together again while also working to keep
the peace. The Congressional Budget Office estimates the
cost of maintaining "occupation forces" at $17 billion to
$45 billion a year. So over the next decade, the United
States could be looking at a figure approaching $500
billion for this purpose alone. Add to that anywhere from
$25 billion to $100 billion for reconstruction and nation-
building.
Undoubtedly, the United States would have to pick up the
lion's share of such costs. And even though Iraqi oil
production of 3 million barrels per day would yield about
$25 billion per year at current prices, Nordhaus points out
that these resources would be spread thin meeting a host of
claims ranging from the need to import daily necessities to
the cost of satisfying foreign debts.
As for how the oil markets might be affected, a study by
George L. Perry of the Brookings Institution outlines
possible bad, worse and worst-case scenarios in a supply
shock brought about, for instance, by Iraqi destruction of
its own supplies or a boycott against the United States.
For the record, we doubt that the most pessimistic
scenarios would come to pass. However, if they did, Perry
predicts a drawdown from our strategic oil reserves with
accompanying first-year boosts in crude oil prices to
between $32 and $75 per barrel, and increases in gasoline
prices to between $1.76 and $2.78 per gallon (these prices
would then gradually decline in subsequent years).
A "happy" outcome for the oil markets would be a quick
victory, stability in the region and increased Iraqi
supplies of about 1 million barrels per day over the five
years following the war. But even then, says Nordhaus, "a
major increase in Iraqi oil production has a time frame of
a half-decade to a decade rather than one or two years."
And crude prices would still be flat to gradually rising
over the next decade, using Nordhaus' model.
This is a sobering analysis indeed. Yet I think that even
when the costs of a prolonged military occupation are
factored in, Nordhaus' analysis underestimates the long-
term and ancillary costs of war, particularly a "pre-
emptive" war.
The renewed emphasis on America as the world's policeman
means an accelerated push for even bigger government.
Witness the swift passage of the legislation authorizing
the monstrous Department of Homeland Security, a
reorganization originally advertised as being "budget
neutral." Rest assured, there will be nothing neutral about
it. The bottom line: lots more government spending financed
by the federal government's preferred method of "payment" -
inflation...which leads us, of course, to gold.
Prior to this week, one might have be tempted to ask: Has
gold outlived its usefulness as a hedge in bad times? John
Hathaway, manager of the Tocqueville Gold Fund, concedes
that "the worst bear market in 25 years, corporate
scandals, accounting heresy, and all too evident
geopolitical risks have caused only a modest rise in the
gold price." But, he continues, "this sort of skepticism is
reassuring and supports our expectation that significantly
higher gold prices lie ahead."
Hathaway suggests that other possible triggers include an
event in the mortgage financing market and interest rate
risk concentrated in a small number of banks and
intermediaries. Problems in the mortgage finance sector
might force policymakers to respond with drastic
inflationary measures that could come as a shock to
investors hiding in perceived "safe havens" like bonds and
derivatives.
"Inflation is still a much more serious problem than
deflation," Nobel Prize-winning economist Milton Friedman
said it best in the Wall Street Journal article: "The cure
for deflation is very simple. Print money." It's clear from
Fed rookie Ben Bernanke's much-cited speech they are in
agreement. "Under a paper-money system," Bernanke said
clearly, "a determined government can always generate
higher spending and hence positive inflation." Or in the
words of Stephen Cecchetti, formerly employed by the
Federal Reserve and now a professor at Ohio State: "Ignore
the whining about U.S. deflation."
Ken Rogoff of the International Money Fund hints at
something even broader. He says that if the yen should
overshoot on the downside as a result of aggressive easing
by the Bank of Japan, then "the need for some kind of
international monetary policy cooperation should be
uncontroversial." In other words, let's all inflate
together! Hooray! It's not obvious from the dollar/yen
rate, but against other currencies, such as the euro and
British pound, the yen has started to break down.
During an inflationary period, gold tends to do well
because the alternative, paper currency, is losing value.
[Until this week,] Gold has been marooned at the $320
level, but what stands out in graphs charting the yellow
metal's recent activity is the still-healthy trend upward.
Even a survey of opinions reveals that investment
newsletter editors, if cautious, are clearly eyeing the
gold market with interest. "A subscriber puzzled over a
bearish comment on the dollar," wrote Jim Grant in a recent
issue of his Interest Rate Observer. "He read it and re-
read it. Frustrated, he e-mailed that, while we seemed to be
down on the greenback, we proposed no helpful course of
action. If not dollars, what currency would we have him
hold? We confess that our subscriber has us over a barrel.
We prefer the euro for vacations in France, the yen for
trips to Tokyo and the Swissies for idylls by Lake Geneva
without the children. However, as a store of value, we
favor none of the above. Our best idea is to hedge one's
dollars with gold or the shares of the companies that own
and produce it..."
"I believe gold and gold shares are in the early
accumulation phase of a bull market..." agreed Richard
Russell, speaking at the New Orleans Investment Conference
in November, "[I] tell subscribers, 'Use this area to
accumulate whatever gold and whatever gold shares you want
to hold. Take this obvious gold manipulation as a chance to
buy gold at what I consider dirt cheap levels.'"
"From this, a true bull market in precious metals might yet
develop," remarked analyst Greg Weldon. While somewhat
cautious on precious metals, he is bullish on gold and
silver if the dollar weakens again, "amid a general, and
broader, depreciation of paper money relative to a base
defined by gold and silver."
Weldon also cites the rising probability of institutional
short-covering from bullion banks as a reason to be
bullish, along with the fact that "central banks in Europe
and maybe even in South America...may remain net sellers of
gold. But they are far less willing lenders than they have
been in the past."
"An investment allocation to gold and gold shares makes
sense only if one does not expect an imminent return to the
investment world of the 1990s," says John Hathaway. The
implication, of course, is that he believes an imminent
return to the frothy bubble-era world of the 1990s is
unlikely.
John Myers,
for The Daily Reckoning
Editor's note: John Myers, son of the great goldbug C.V.
Myers, is the editor of Outstanding Investments. Our man on
the scene in Calgary, John has his fingers on the pulse of
natural resource profits - including oil, gas, energy and
gold. For investment ideas consistent with an inflationary
Fed, see the special report:
The Great Money Flood of 2002
<http://www.agora-inc.com/reports/OST/GainToday> |
