Introduction
The Visible, Yet Invisible Face of Evil
This war will be bloody, brutal and cruel. Lives will be lost, villages and property destroyed, commerce disrupted, and governments toppled. In many ways, it will seem like medieval times. Military and economic functions will start to merge in an effort to wage war. Glory, profit and the spoils of war will be just as important as winning the war. In fact, they may become the objective of war itself. At other times it may seem that the war doesn’t exist. Most of this war will be fought covertly. Battles, victories and skirmishes may not be reported or for that matter, even known. It will be a lot like a chess game, but with real players. It will be fought through intelligence as each side tries to determine what the other side is up to in order to predict what is unpredictable. It will be fought through action as well as words. It will be visible and at the same time, invisible.
The deeds of 19 terrorists on September 11th were visible for all to see. Yet al Qaeda is visible only when it acts. It is not a nation. It has no boundaries. Its few thousand warriors are scattered throughout the world. It is both agile and highly mobile as it is invisible. It doesn’t present an easy target for the generals. This will not be an easy war to win. It will be as long as it is uncertain. There will be no measurable yardsticks for the public to view its progress. An occasional firefight, a sudden explosion, or a downed jetliner will be the only recognition that this war even exists.
Defining The New War - Shifting Plates
We live in a bifurcated world -- part rich, but mostly poor. It is this growing world of the poor where populations are exploding that now confront the modern world. These two worlds can no longer be walled off, separated, and viewed from a distance. The barrier that separates the two worlds is crumbling. In his book “The Coming Anarchy” Robert D. Kaplan states that "To understand the events of the next fifty years, then, one must understand environmental scarcity, cultural and racial clash, geographic destiny, and the transformation of war.” 1 The realism of which Kaplan writes and to which this Perspective Series will be directed may at times appear as unreal as it is heresy. But in Kaplan’s words, “They track well with the analyses of the military and intelligence communities, where accountability is based less on false displays of idealism than on the ability to pinpoint trouble spots a few years down the road.” 2
The Clash of Human Nature
To a western world that has known mostly peace for half a century, a prolonged and faceless war may clash with the idealisms and emotions of a pop culture centered on entertainment. We have in many ways become creatures of the moment. How and what we think, the way we vote, and yes, even how we invest, are the result of the latest news event or public opinion poll. This news is spoon fed to the masses in emotional images designed to entertain and appeal to emotion rather than reason and intellect. The media conglomerates bombard and saturate us with news events that are impassioned by classical liberal values strewn with a tunnel vision that is as narrow as it is lacking in analysis. Because of industry consolidation, what you hear, read, or see is now controlled by a handful of corporations. It is, as many have called it, The Fourth Estate. In reality, it is a power unto itself and accountable to no one. At a time of war, this is dangerous for it clouds issues and prevents real analysis from occurring. It alters public opinion at a time it needs to be marshaled for war by its leaders. The media's views are transnational whereas a president or prime minister's concerns are for their country. The media mainly speak of peace and diplomacy as the solution to the world’s ills. Appeasement is its mantra. Peace is its promise.
However, throughout history, war, not peace is the natural state of man. In the words of Professor Donald Kagan, “…over the past two centuries the only thing more common than predictions about the end of war has been war itself.” 3 The Greek historian Thucydides wrote that nations go to war out of honor, fear, and self interest. In the future, nations will go to war over resources, especially those nations prone to resource scarcity. Of all of the world’s resources, none is more likely to provoke conflict between nations in this new century than oil and water. Oil is the lifeblood of the modern industrialized state while water is the key to sustaining life. Without water, human life would cease to exist. Without oil, industrial nations will die.
Oil Is At The Root of Turmoil
I’m afraid, as this Perspective Series will show, the only supply of cheap and affordable energy for the foreseeable future lies buried beneath the sands of the Middle East. That is where the battlegrounds of this present war are leading us. The Middle East is the land bridge that connects the masses of Europe, Africa, and Asia. On its eastern border, it is flanked by the Caspian states and the oil of the Caspian Sea. The distant drum of war is beating more loudly by the growing buildup of military forces in the region. It is not just the states that border the region that are arming but the Great Powers are building up their military presence in the region. That war is coming to this region is a foregone conclusion. It has not become a question of if, but when.
Resource Scarcity . . . A Harbinger of War
At a time of tremendous population growth and escalating demand for commodities of all types, resource scarcity will become a harbinger of war. The wars of the 21st century will arise over the scarcity of resources like water, oil and food as much as they will religion and economics. National security will become aligned and directed towards the securing and protection of global resource flows. It is become a prominent feature of American national security. As America imports more of what it needs to fuel its industries and economy, its military presence will grow even larger. Carrier battle groups now protect the flow of oil, raw materials and trade routes around the globe. American legions are stationed in over 100 countries and on all the major continents. As a major superpower, America has been both an arbiter and maker of peace. It is that position which is now being challenged.
THREE MAJOR POWERSHIFTS IN THE 21ST CENTURY
There are three major powershifts occurring around the globe that will unsettle and reshape the world of the 21st century. The aftershocks and tremors from these trends will be felt long after the earthquakes that birthed them. The first is oil which is about to deliver a powerful geological truth -- its scarcity. Sooner or later, it is going to become common knowledge that we are running out of this precious resource with nothing at present to replace it. The world is going to face this fact head-on in the next decade as developed and developing nations vie with one another for access and control over a depleting resource.
The second trend that will reshape this century is the current monetary system which has been built and based on a fiat money system. The world is about to relearn a valuable lesson from history. Money is a commodity. This commodity differs from other commodities in that its demand comes mainly from being a medium of exchange. Like all commodities, what determines its price is the same. The price of money is determined by the laws of supply and demand. Increase in the supply of money tends to lower its price, while increase in the demand for money will make its price rise. Governments have sought to meddle with this process by altering its supply while trying to keep its price stable. The result of this meddling has been chaos in the world’s monetary system. From Mexico in 1994, to Asia in 1997, Russia in 1998, Turkey in 2000, Argentina in 2001, Venezuela, Uruguay and now Japan in 2002, the system is breaking down. A coercive money system that is forced on people eventually brings the conflict and chaos which we are now witnessing.
The third shift will be war itself. This shift will be about who fights the war, what the war is about, and how the war is fought. The nation states' monopoly on violence is slowly eroding. Powerful nations must now deal with terrorism which poses a new challenge to its monopoly on power. This new war has just begun. In the words of President George W. Bush, responding to the terrorist attacks against the Trade Center on September 11, “You just witnessed the opening battle of the first war of the 21st century.” 4 In this new century, war will be waged by states, but increasingly by groups we call terrorists, guerrillas, or bandits. It will be fought over resources, over religion and tribe and for the larger players, over economic systems. It is from the shifting of these tectonic plates that a new world order will emerge. Its shape, form and victor at this time are still unknown.
Tremor #1: Oil
“The Great Game” is a term used by politicians and historians to denote the foreign policy of Great Britain from the Napoleonic Wars onward to its fight to shield its Indian Empire from onslaughts by France and Russia. The term was coined by a British officer named Arthur Conolly. Conolly played at this game while serving the British Empire in the Himalayans, deserts and the oases of Central Asia. Conolly met his end through an Uzbek emir who tortured and then beheaded him. The term “The Great Game” was found among his papers. The phrase began to be quoted by historians in reference to the first Afghan War and was later made famous by Rudyard Kipling in his novel, “Kim”. 5 The Game began with the Duke of Wellington when he became Prime Minister as a strategy to keep India from being attacked by Russia through Afghanistan. The Game was played throughout the 19th century and culminated in the creation of what we now know as the Middle East. The Middle East was fabricated in Europe as a result of decisions made by the Allies during and after the First World War.
The Middle East became a cauldron for national economic interests. It became the chess board on which the major powers played their game. Great Britain embarked upon a vast new imperial expansion that would take decades to play out. As a result of the politics of the First World War, Britain and France decided to occupy and partition the Middle East. The great powers thought they could reshape and mold the Middle East in their own image. The result was that they created an artificial state system that ignored a fundamental tenet within the region -- religion.
Today "The Great Game” is still being played. The artificial boundaries which were created as a result of the First and Second World War still exist, but are now unraveling. Another factor has been introduced to The Game -- oil. At the time the Middle East was partitioned by the great powers, oil was not a consideration. The vast oil reserves of the region were not yet known. The United States was the world’s largest exporter of oil. Great Britain imported the majority of its oil from the United States well into the first half of the 20th century. Now it is known that the region contains close to 70% of the world’s known oil reserves. If the Caspian Sea’s reserves are added in, the Middle East contains over 80% of the world’s oil.
In the present time, the region has become a vast political cauldron that mixes oil and religion. Instability has become a part of life in the Middle East as a result of the Islamic Revolution. The only peace and security the West can now have will come only if there is stability in this part of the world. The prosperity of the industrialized West is based on affordable oil from the Middle East. The most serious threat to that stability is the rising tide of fundamental Islam in Middle Eastern politics. Foreign powers are still playing at The Great Game in an effort to shape events in the region to suit their own self interests. But now those self interests are threatened and both major players and lesser players have much to lose. For the West, it is the economy and a way of life. For the residents of the region, it has become a matter of life and death. That death toll is rising each day.
The Game is about to enter its third and final phase with the stakes never higher. If the West does not act wisely and decisively, then The Great Game may be lost with tragic consequences for both sides. The wars and tragedies of the past will pale by comparison to what may lie ahead if radical Islam triumphs in the region. For the West, it will mean the end of cheap oil and a way of life. For the Middle East, it will mean more bloodshed and poverty. And for the Great Powers, it could lead to greater confrontation and the next World War.
Tremor # 2: Money
Loss of Confidence
On August 15th, 1971 President Nixon brought the Bretton Woods system to an end. For the first time in American history, the dollar would become a fiat currency without any gold backing. The threat of European Central Banks demanding gold for dollars ended gold backing of the dollar. From that point forward, the US would begin an era of deficit spending freed from the shackles of gold that had forced fiscal discipline. The world would revert to the fiat system of the 1930’s. From that point in time, the financial system would go through one upheaval after another. The result was a new era characterized by competing currency devaluations and international monetary instability. As the international monetary system moved into an age of freely floating exchange rates new risks were imposed upon the world’s economies. Interest rate and currency risk were added on to business risk. Under a fixed rate exchange system anchored by gold, these risks weren’t as prevalent.
Derivative Models Give Risk a New Game
A "Simple" Money Game
A new system developed in place of the gold-backed systems of the past, and another new experiment with money began. These architects thought they had invented a new way around the failure of past fiat systems. Complex economic models came into vogue in which governments thought they could fine tune the economy. The complex interactions of the marketplace and the interweaving of human action were ignored in favor of mathematical models that predicted certainty. Input “a” mixed with input "b” equaled output “c”. It was that simple and yet, not so simple. To be sure, the models were elaborate in their structure and detailed as to their output. The only trouble was that they weren’t as accurate or controllable on their outcome. They still ignored Adam Smith’s “invisible hand."
A New Breed of Speculators
As this new system was being developed, a new element injected its way into the system in response to a government-imposed fiat system. It was the “speculator” who now emerged to challenge the power of the fiat system and central banks. These financial warriors battle against each other and vulnerable governments in their quest to amass wealth. They move and operate in the world's capital markets. Their weapons are money and on a daily basis, they move trillions of dollars throughout the world’s monetary system. Their battlefield has become the world’s currency market which is the common link to all other financial markets around the globe. They have become the vigilantes of the financial system enforcing economic law against recalcitrant governments. Their motivation is not love of law -- it is the pursuit of profit that propels them into action.
I
These financial ronin have taken on governments wherever they think they are vulnerable. They battled inflationary policies in Mexico in 1994, Asia in 1997 and in the process, they’ve broken down the walls that separate national economies and financial markets. They have become both judge and jury over governmental policies with the ability to punish them financially. At times, they seem invincible. At other times, they seem vulnerable. Many times they win. Other times they lose. And when they lose, they can wreck havoc on both sides of the battlefield as in 1998 when LTCM nearly drove the world’s financial system to its knees. Right now they are engaged in battle in Latin America against the fiat systems of Argentina, Venezuela, and Uruguay and in Asia against Japan.
The Gauntlet Has Been Thrown
A bigger battle has just begun in the U.S. which will become the ultimate battle in the confidence game. The first skirmishes have taken place in the financial markets where over a trillion dollars of investor wealth has disappeared. Opinions still run in favor of the power of the Fed to revitalize the U.S. economy and ultimately the U.S. stock market. The reputation of the U.S. central bank has been elevated to a pedestal where it is thought to be invincible. It is this invincibility that is about to be challenged -- first in the stock and bond markets, and then in the currency markets. It is the dollar that is now most vulnerable. The dollar has become the fulcrum on which the financial markets rest in an uneasy balance. The dollar is about to be devalued and it is the next target for the herd. The U.S. has been running up monstrous trade deficits to the tune of over $1 billion dollars a day. For all of 2001, the U.S. trade imbalance for goods and services was $346.3 billion. 6 The growing trade deficit poses a real threat to the US financial system. No country in history has ever been able to sustain a large trade deficit without paying a financial price.
The dollar and U.S. financial assets like stocks and bonds are headed for a steep fall, contrary to Wall Street hype of another boom. The gross imbalances in corporate debt, consumer debt, and grossly-inflated profits through financial engineering (only now being exposed) are going to lead the world into the steepest recession of the post-World War II era. The root cause of this recession is the financial bubble created by an unmitigated credit boom fed by an expansionist monetary policy of the U.S. Federal Reserve. You can feel the tremors in the financial markets in the U.S. which have begun their third year of decline. It is also visible in the Treasury markets which have failed to rally as short-term rates have plunged. The U.S. markets are held together in a precarious balance made up of numerous financial bubbles waiting for a shock wave that will cause them to burst. This could be the year of “big surprises” and “unexpected events” -- a time when global financial problems are magnified by the introduction of war.
Tremor # 3: War
The flint of war routinely sparks,
No steel need ever strike it.
To arms! is nature’s hearty cry;
We fight because we like it.
-- Art Buck
The study of war has been the primary task of historians, but one can’t help but realize how oftentimes those wars have been unnecessary. In the words of Professor Donald Kagan, “A persistent and repeated error through the ages has been the failure to understand that the preservation of peace requires active effort, planning, the expenditure of resources, and sacrifice, just as war does. In the modern world especially the sense that peace is natural and war an aberration has led to a failure in peacetime to consider the possibility of another war, which, in turn, has prevented the efforts needed to preserve the peace”. 9
Leviathan, The Missing Element
According to Thomas Hobbes, man is in wanton need of a Leviathan. One of mankind’s greatest fears is of violent death or death at the hands of another human being. It is this fear that causes humans to submit themselves to government. They do so willingly in an effort to bring about order. The luxury of freedom is only possible once order has been established. That is why throughout history the greatest periods of peace have been when there was a giant Leviathan that kept order. One of the greatest illusions of the post-Cold War era is that of permanent peace. Since the break up of the former Soviet state, the world has been characterized by greater conflicts. Could it be because the power of the Soviet state to police its sphere has receded? One of the greatest challenges in this new century will be to reestablish of order created by the vacuum of the end of the Cold War. For good or bad, the great European empires of the 19th century kept the world in relative peace. It has been the disintegration of those empires that has now given way to so many of the conflicts of the 20th and now the 21st century.
The Clash of Two Worlds
It is this new challenge of the reestablishment of order out of chaos that confronts one of the world’s last remaining leviathans -- the United States. Many will disagree with this concept out of national, economic, tribal or ethnic loyalty. However, one only has to look at the annals of history to see a world without a Leviathan. The Dark Ages and the battle between city states during the Middle Ages stand in sharp contrast to the peace of great empires. The bifurcated world we live in is a world of opposites that stand in sharp contrast to each other. One world is aging and prosperous, while the other is poor, young, and growing more violent. These two unequal worlds are now confronting each other no longer separated by the vast distances of ocean. They are brought together more closely through the revolution in information. At a time that the power of the nation-state seems to be withering, it remains a challenge of supreme statesmanship to bring about a new sense of order.
Robert D. Kaplan, in his new book “Warrior Politics," quotes the English political philosopher E. H. Carr in saying ”…Power cannot be created out of thin air… every approach in the past to a world society has been the product of the ascendancy of a single Power. There is no sign that this has changed.” 10 Many of American values are in ascendancy around the globe -- from business models to culture and democracy. At the same time, there is another model that is rising to confront it -- Islamic fundamentalism.
The opening battle of this new war began with the bombing of the World Trade Center on American soil. This new war has just begun and is entering its second and deadliest phase. The next phase of the war is likely to be against nation states like Iraq or possibly Iran. The growing power of a fanatical theocracy in Iran is another time bomb on a short fuse, capable of joining other conflicts in the region and turning them into a wider conflagration. The Iraqi dictatorship of Saddam Hussein is of immediate concern. Without the resolution to the Iraqi threat and Saddam’s potential to use weapons of mass destruction, instability in the region will only increase. The growing clash between Israelis and Palestinians is yet another unresolved conflict in this new war. Added to the mix are the issues of the unstable monarchies of Saudi Arabia, Kuwait and other Gulf States. At the same time, there is an arms race within the region that has the potential to destabilize and turn the current Israeli-Palestinian conflict into a much wider scale war. These are just a few of the ticking time bombs in the Middle East that could change the existing order and power within the world.
For Americans, this will be a different kind of war. This war will be personal, viewed up-close and experienced first-hand. The opening battle began on American soil. The vast oceans that surround the U.S. no longer afford the country protection. In the age of travel and mobile missiles, the world has become a much smaller place. Geography is no longer a defensive advantage. In fact, our open borders and freedom only make us more vulnerable. In this new war, the antagonists refuse to play by our rules. America will have to fight this war on two fronts --one on the battlefield and the other in the diplomatic arena. Both are necessary to prosecute this war. At times the burden of power and fighting this war will be experienced alone. At other times, it will mean working with friends as well as adversaries. It is a responsibility from which this nation cannot retreat, if American power is to endure. Unlike the last century, there is no other power to replace it.
The Challenges America Will Face in the 21st Century
Our resolve is about to be challenged. Our commitment to the successful prosecution of this war will be tested by the absence of constant conflict and economic uncertainty. Excluding Osama bin Laden, this war will be fought against an faceless enemy. There isn’t a country, a national leader, an immediate threat or a grand prize on which to focus our attention. For this reason, the memory of September 11th is quickly fading from American consciousness. This makes it more difficult for the Bush Administration to keep the public’s attention focused and in support of the war's efforts. That is why the next phase of the war will be against nation states -- an enemy with a more visible face.
The other test will come from economic uncertainty. Our country is currently in recession. During periods of recession, government expenditures rise as unemployment and transfer payments increase. At the same time, tax receipts shrink as profits decline and unemployment rises. This creates deficits. There is already talk in Congress of reducing our military commitments in favor of domestic consumption, an argument that is now being made as an alternative solution to combating the current recession. The threat of danger recedes with each new week that passes by. For many there is nothing but confusion over foreign policy and defense issues. This is heightened by the fact that the media has trouble understanding it since it is invisible and can’t be televised.
Make no mistake: America is in danger. The major cutbacks in America’s armed forces over the last decade and in particular by the past administration have only encouraged our enemies. The last decade has seen the rise of hostile states and powerful coalitions that threaten America’s peace and security. There are many in power who advocate appeasement and negotiation as the only instruments of conducting foreign policy. However, foreign policy, if not backed by sufficient military force, is doomed to failure. The price of peace is eternal vigilance. There can be no alternative course for keeping the peace than an engaged foreign policy that is backed by an overwhelming military force. It is the equivalent of preventive medicine in that it is far cheaper than the cost of war.
The world we now live in has become a more dangerous place. There are many states and would-be dictators with grand illusions and the need to do great things. The air of despotism is in the air. Each new week brings more evidence of a world that is becoming destabilized. Columbia seems to be plunging into civil war. Neighboring Venezuela, the fourth largest exporter of oil within OPEC, is undergoing a major political crisis. In Iran there is internal dissent between the governed and those who govern them. India and Pakistan are still at odds with each other, while the Israelis and the Palestinians are locked in mortal combat.
These are the matters of immediate political concern. But destabilization is not confined to the political realm. On the economic front, Argentina’ crisis threatens to turn into another Latin American brushfire spilling over into other states. In Asia, you can feel the tremors of a major earthquake coming from Japan, where an already bad situation could spread and become a worldwide contagion.
It appears at the moment that crisis and instability are everywhere. The destabilization process is intensifying and expanding from countries to continents. Economic turmoil has spread like brushfires from the currency markets to the stock and bond markets, while military conflict seems to be cropping up everywhere. There doesn’t seem to be an end in sight to the regional wars that keep on proliferating. Unlike past crises, they are not localized. They can now be found erupting on every continent including North America with the United States. They represent signs of a Powershift that is taking place -- rooted in oil and money and resolved by war.
The events and conflicts that are described in this essay may not unfold in the manner that has been written. The future is unpredictable and is full of twists and turns. History teaches us that terrible storms can appear with little or no warning and when they do they can cause great harm. This Perspectives series is based on my own observations and experience following the financial markets and as both a reader and student of history.
The installments that follow will build on the premises outlined in this introduction. As in previous Perspectives, I hope to stimulate new thoughts on events that are emerging. It is my belief that to prosper in this age of destabilization and economic turmoil, it will be necessary to think in historical terms. In the upcoming segments on oil, I will discuss its importance in the twilight of the petroleum age, the economics behind it, its key role in war, and why I believe it will be a profitable area for investing over this next decade. In the section on money, I will lay out a case why the present monetary system is doomed to collapse, the role that gold and silver will play in restoring stability to the financial system, and the upcoming bull market for precious metals that has already begun. I will also expand on my rogue wave thesis and the danger that derivatives pose to the financial system. Finally, in the section on War, I will talk about future conflicts and the revolution in military affairs (RMA), why this war will be different than any others we have fought before, and the investment opportunities it presents. I leave it to the reader to decide whether it is prudent to stay with the trends of the past or to start thinking outside the box.
-- James J. Puplava, CFP
