Iraq fallout is all in the handling

By Neville Bennett

Friday 14th March 2003

"What if this present were the world's last night?" wondered John Donne.

No one suggests the world is on the cusp of an Armageddon, although 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 buildup has begun to shake the economic foundations of the global economy.

And even if it is an easy war, there is no guarantee of an easy peace and interregnum.

I am already certain the share, bond, currency and commodity markets are set for exceptionally volatile trading. That 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 that caused the demise of Long Term Capital Management and threatened the big trading banks. British insurers are already looking very vulnerable to a sharemarket selloff.

Each of these markets has a vast capitalisation. There are huge derivative markets, which investor Warren Buffett knowledgeably calls timebombs.

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 avalanches in motion.

For example, the US dollar is close to ¥115, a point that could trigger explosive selling and a general search for a larger risk premium for holding US assets.

My argument is that Iraq might 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 a deep political schism has opened between the US and UK on one hand and France, Germany and Russia on the other.

This schism seems likely to endure and at the very least to have substantial effects on trade relations. The possibilities of a greater number of EU-US trade wars have increased.

The cost of the buildup and an estimated $US60 billion to stabilise Iraq after a war will also strain economies. Agencies are already rating growth downward.

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.

Sharemarkets 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 5048 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 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 in a shock rise in the US jobless: a net two million jobs 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.

Boardrooms are reputedly buzzing with Mr Buffett'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 capitalisation is down by $US7.9 trillion by far the greatest loss of wealth in history.

The problem is equities are global. The Nikkei fell to 7900 points on Tuesday, 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 Japanese Economics and Financial Services Minister Heizo Takenaka called on his cabinet colleagues to buy shares to prop up the market. Some might think 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 FTSE100 fell on Monday to 3436 points, a seven-and-a-half-year low. It has lost half its value since its high of 6930 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 $US25 billion seep in. Paris's CAC40 has hit a seven-year low.

American investors have caught the jitters. Last week net outflow from funds reached $US3.8 billion; the week before the figure was $US6.1 billion.

Funds are under scrutiny partly because of tax treatments. In the 1990s 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 has liquidated three funds. By winding up the fund, individuals are awarded tax losses that can be offset against gains elsewhere.

Investors who wish to preserve their wealth will face several judgment 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.

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