Storm Watch Update
TEN-SIGMA
by Jim Puplava
www.financialsense.com
March 13, 2003
|
|
|
Storm Watch Update |
|
How do you write about something that has not yet happened? How do you write about something that is out of the ordinary and lies hidden in the realm of the unexpected? We live in uncertain times and at a point in history where the world is craving normality. What this 21st Century world craves does not exist. Normal has in fact become abnormal. The risks that now surround us are much bigger and more prevalent than once thought. At the same time, they are much harder to isolate and pin down. Although we are taught that most probabilities should occur within the normal standard deviations, it seems our world today is experiencing extreme events that occur more frequently than theories would suggest. Present day financial models and political risk scenarios have ruled out of existence a ten standard deviation event or what is called "ten-sigma." No radar screen or satellite image has been developed to detect their whereabouts or where they will strike next. And yet, the likelihood of a ten-sigma event's occurrence grows greater by the day. Since most models have ruled out their existence, few precautions have been taken and few life preservers and lifeboats are at hand. The captains of the financial industry, the central bankers that control the flow of credit, the politicians that lead nations, and the generals that direct armies have confined all risk to linear probabilities that have been wedded to normal bell-shaped curves. It is the outliers or the tail ends of the curve that should concern us.
Today, Wall Street operates on the non-fictional assumption of mathematical certainty. In the real world, no such certainty exists. Every trading floor, trading system and computer screen has been programmed with the assumption that all models are reliable and predictive about the future. The possibility that markets or political events could depart from the norm would be considered a statistical aberration. In the real world, patterns are constantly changing and emerge out of the chaotic disorder of numerous random events. Only through the passage of time do continuities begin to emerge, and then if only for a brief period. It's All In The Toss Of A Coin Problems emerge when continuities are embedded in models that give the illusion of a perfect, risk-free state of balance. But all models have flaws. One can never assume that the samples of data on which they are based can ever be complete. The theories of randomness lack codification of previous events. Each new coin flip is apt to be different from the previous toss. The fact that heads have shown up three times in a row doesn’t mean the next coin toss will be the same. The odds on the next coin toss still remain fifty-fifty. Just because heads have appeared more frequently doesn’t exclude the next toss from showing up as tails. Financial and political risk models are subject to more discontinuous events than is willingly admitted. That is why when tails show up, the world is taken by surprise. The tail toss shows up as an aberration only because the models are programmed to predict heads. That is why when a tail emerges, it leaps off the charts because charts can't predict them. When in fact they do occur, they are labeled as "The Hundred-Year Storm, "The Five Hundred-Year Storm," or if unexpected and extreme, “The Perfect Storm.” On Wall Street, risk has been confined to volatility around the mean. Volatility has become "The Holy Grail” of modern finance. The quants believe they are protected by their models. In the fundamental camp, risk managers rely on financial statements and the ability to predict the future from the past. Technicians hold on to their charts as if the closing price printed at the end of each day is a reliable predictor of the future. In my opinion, ten-sigma events exist outside the realm of reality in all three camps. To understand the future, we must learn to think three-dimensionally—and more importantly—outside the box. It is inconceivable to most on Wall Street, London, Bonn, Paris or Tokyo that some unforeseen event or rogue wave can capsize the whole ship. The simple fact that the ship has not capsized in the past doesn’t guarantee that an unexpected rogue wave can't suddenly appear and sink it. Rogue waves have a habit of appearing out of nowhere, without warning, and at a time you least expect. Sailors have long known where and when to expect rogue waves and to prepare for them. When the barometer drops suddenly or when weather forecasters call for a Beaufort scale wind force of 10 to 12, sailors immediately take protective action. If out at sea and the Beaufort scale rises to 4 to 5, sail area is shortened to reduce heeling and keep the boat under control. Beaufort scale storms of 7 to 8 mean boats remain in harbor. If at sea, sailors batten down the hatches. If the Beaufort scale rises to 10 to12, there are few options outside prayer.
Scientists understand how waves work, but not exactly how big ones function. The same applies to rogue financial events. The models can predict their likely probability, but not when and where they are likely to occur. Out at sea these rogue waves become a function of how hard and how long the wind blows and the stretch of sea over which the wind travels. Weathermen and sailors even know where they are most likely to appear. The Grand Banks is one of these locations since they lie along one of the worst storm tracks around the globe. In the real world, those rogue waves lie lurking in the Balkans, the Middle East, Latin America and the Korean peninsula. In the financial world, we find them on Wall Street, the trading rooms of hedge funds and on the floor of the COMEX. Sailors and those who make their living by the sea know that small changes in wave height, speed or direction of the sea can suddenly produce freakish effects. We know that they emerge from chaotic patterns that lie outside the realm of predictability. Freak Financial Waves
The reader may wonder what rogue waves and unexpected events may have to do with the financial markets. The fact is everything. The financial markets are operating under the false delusion that outliers and geopolitical events are just a sideshow or momentary event. Most experts vacillate between war and no war with Iraq. If war is considered the most probable outcome, then it will have a positive affect on the financial markets. The war is expected to be brief and in the end good for the economy and the financial markets. At best its impact is considered to be marginal. It reminds me of the Henry Hazlitt's explanation of discredited theories of "The Broken Window” and “The Blessings of Destruction.” Under this misguided theory, which permeates the financial and economic world, war and destruction create jobs, cause production to increase, and marshal resources for the output of war.1 Consumption increases since armaments are used, destroyed and have to be replaced. During war, common items of consumption may be rationed, so there is pent up demand that lies in wait until after the war is over. In short, theoretically, according to this thought process, there is nothing but good things to expect from the outbreak of war. Under the current state of delusion, which permeates much of post bubble Wall Street, there is always a reason to be bullish. To some, war is just another factor as to why you should own stocks. Any weakness in the markets this year has been attributed to unfounded worries over war that will clear up once the war is over. In 2001, 9-11 was blamed for the market's weakness. Last year it was corporate malfeasance. This year it is Iraq. So the reader should not be surprised at the number of articles, charts and comparisons showing war to be favorable towards the financial markets. The fact that war strategies don’t always go as planned or that deadly terrorist attacks may follow in their wake is quickly dismissed. Risk models have hedged and marginalized the risk until it is no longer significant or even nonexistent.
Yet history is replete with examples of exogenous events that change the course of war, the fate of nations, or the direction of financial markets. A Norman prince invades a country and changes the course of that nation. An archduke is shot and the world suddenly finds itself at war. German troops invade the Rhineland and the stage is set for conflagration. Bombs are dropped on Pearl Harbor and a reluctant nation is forced to bear arms. A well-heeled hedge fund gets overconfident, leverages its bets in one direction and nearly brings down the financial system. At the time these events erupted, no one expected them. Their genesis seemed small and insignificant, but isn’t it always this way? Suddenly a tinderbox is lit, a detonator is set off, a crisis follows and the world is suddenly different. The world and its markets are caught off guard when in fact they have been forewarned. Rogue waves appear more frequently under storm conditions. Prior to World War I, nations throughout Europe were caught up in an arms race. An assassination lit the fuse that led to war. In the 1930s war reparations and a change in politics steered Germany towards a course of confrontation. The German buildup of arms throughout the early 1930s was ignored until appeasement no longer worked. By then it was too late and another bloody war would have to be fought. In 1979 a new regime came into power in Iran through a violent revolution, changing the course of the Middle East and setting it on a course of war and a new reign of terror that continues to this day. The overthrow of the Shah and the taking of American hostages took American leaders by surprise. But that seems to be our pattern. America’s weakness is its foreign policy. We always seem to be caught off guard. Although our heritage is to accept pilgrims from every nation, we prefer to be isolationists. Americans have very little interest in the world outside our shores. We are thrown into military conflict reluctantly. When we fight and win, we just as quickly disarm. In the last century we were torpedoed into the first World War, bombed into the second, surprised by Sputnik leading us into the Cold War, and shocked by the invasion of Kuwait and the attacks on September 11, 2001. When we go to war and win, we naively think that we have defeated war itself. After winning the Cold War, we thought the world was safe and no other dangers threatened us. Once again we were surprised by the terrorist attacks of 9-11 and now find ourselves committed to a War on Terror and on the brink of war with Iraq. Financial Storm Warnings Are Ignored In the financial world, the pattern is the same. There are storm warnings, but like our foreign policy, they are ignored. In the 90’s a hedge fund was emboldened to leverage its bets and take large unmanageable positions in a market that had become more volatile. Its models reduced uncertainty to cold calculated odds that marginalized risk. Their models measured and confined risk to volatility. They believed their financial leverage gave them strength, when in fact it multiplied their risk of losing and made that risk more life threatening. Long Term Capital Management sailed right into a storm with no lifeboats on deck because the odds of sinking seemed so remote. In the 1990s investors stopped saving, started borrowing and spending. Surely, the good times will last forever. Sky-high market valuations and mania-like prices were dismissed as irrelevant and ignored until it was too late. 85% of investor tech portfolios have never recovered. To this day, some investors refuse to open their statements.
In the fall of 2000 as part of my Perfect Financial Storm Series, I wrote Rogue Wave/Rogue Trader in two parts, outlining two kinds of risks that threatened our nation and financial system. The first threat was financial and dealt with the risks of derivatives. The second risk was asymmetric warfare and the threat of terrorism. I gave either risk a 50-50 probability. I felt that we were unprepared for both. Something that I wrote back then is just as appropriate for today. There
will come a day unlike any other day, an event unlike any other event
and a
crisis unlike any other crisis. It will emerge out of nowhere at a time
no one
expects. It will be an event that no one anticipates—a crisis that the
experts
didn’t foresee. It will be an exogenous event—a rogue wave. The terrorist attacks on September 11, 2001 was the first rogue wave to appear.
Whenever you are in a storm and are hit by one rogue wave, others are sure to follow. It has not yet dawned on investors and global citizens that the world is now at war. The horrible attacks on 9-11 were the opening battle of that war. Terrorists have declared war on the West—and the United States in particular. This war will broaden and transform the Middle East and reshape borders and countries around the globe. This will be an asymmetric war. It is a war unlike any other war and it will be fought unlike wars in the past. No large armies will gather together in formation to face each other directly on the battlefield. The battles will be fought from the air and in cities and caves against clandestine groups as well as national armies. Our enemy is not an organized army battalion that can easily be confronted and vanquished. Our enemies are terrorist cells that hide within our cities and strike innocent civilians at will. This concealed army is in place, waiting for the right opportunity to strike. They only await their orders. Later on I‘ll address why they fight and why this war isn’t going away. War Is The Natural State of Man It is important at this point to address the very issue of war. Throughout history, war—and not peace—has been the permanent condition of man. In their book “The Lessons of History” written in 1968, historians Will and Ariel Durant calculated that there had been only 268 years free of war in the previous 3,421.2 Their statement attests to the fact that over 90% of recorded human history has involved war. Since that declaration was made thirty-five years ago, war has been a permanent part of our global landscape. We had the Cold War, the Vietnam War, the Gulf War, the Kosovo War, and now the War against Terrorism and the impending conflict with Iraq. There have been other wars around the globe, the Iran-Iraq war, the Russian War in Afghanistan, and numerous smaller wars that are now referred to as LICs (low-intensity conflicts). At the time of this writing, Jane’s Terrorism & Security Monitor lists 17 flashpoints around the globe from the US to Indonesia, Pakistan, North Korea, Columbia and Venezuela.3
In an article by Mike Alexander the author points out that major wars occur around every 50 years. Major wars tend to cluster around fifty-year cycles that coincide with Kondratiev cycle as shown in the accompanying chart above. According to the author wars tend to be more predominant in Kondratiev upwaves as opposed to downwaves.4 Marc Faber confirms this point in his latest book, “Tomorrow’s Gold.” Faber has noted that wars, revolutions and great social upheaval manifest themselves prominently during rising waves of each long cycle. Faber goes on to explain this phenomenon, ”rising waves of the long cycle is associated with the replacement and expansion of basic capital goods, and with the radical regrouping of, and changes in, society’s productive forces.”5 Joseph Schumpeter unified the Kondratiev theory along concepts of creative destruction. Old technology and leading industries are replaced by new emerging technology and innovation. “According to Schumpeter, innovations disturb the economic equilibrium and lead the system into a “ prosperity excursion”, which is then followed by a depression excursion. Schumpeter breaks down these excursions into four phases: prosperity, recession, depression and revival."6 Faber further states that it is difficult to precisely identify at what stage of the cycle we are in. At best, our efforts to clearly identify the phase we are now in is tenable. Given the vast technological innovations of the Information Age, it appears we are now entering a period of rising waves, a time of large social upheaval and radical change when wars and revolutions are more likely. As a result of technological innovation, large-scale conventional war as fought in the past is slowly dying. Few nations outside the United States have the means to fight it. The conventional wars fought during the Industrial Age are becoming outmoded. War itself is alive and well and it is about to enter a new epoch. The industrial wars were conventional wars. The wars of the Information Age will be asymmetric wars fought with weapons of mass destruction. In the past, weapons of mass destruction were ignored because no one had figured out a way to fight with them successfully. Throughout the Cold War neither the West nor the East could formulate a strategy that enabled them to attack and fight a war between superpowers without creating Armageddon. Nuclear weapons made conventional war more prevalent. Nuclear war was unimaginable. When conflicts arose, the only forces used were conventional since nuclear confrontation was unthinkable. The Unthinkable Becomes Thinkable
Contrast the cost of a carrier battle group that may consist of 7-10 ships and 10-12,000 men depending on the mission to the cost of one nuclear missile. A carrier battle group may cost $25-30 billion to build and billions annually to operate. A nuclear bomb or warhead may cost as little as a few million or tens of millions depending on how it is to be deployed. That is far less than building and fielding a conventional force as the US is now doing in preparation for a potential conflict with Iraq. The four or five carrier battle groups involved represent costs of over a $125 billion. The 300,000 plus men of arms, the direct energy weapons, B-1’s, B-2’s, B-52’s, F-117’s, F-18’s, AC –130 Spectre Gunships, Apache Helicopters, Tomahawk cruise missiles, 30,000 pound bunker busters, Blu-118 Thermobaric Warheads, and Abram tanks costs hundreds of billions more. The cost of waging war is estimated to run from as low as $60 billion to as high as $200 billion or more depending on how fast the country can be stabilized. Therefore by comparison, the weapon platforms needed to wage war by unconventional means with nuclear or biological weapons are far less costly. If the goal is massacre or large-scale killing, weapons of mass destruction are far more efficient. They require very few personnel to operate or detonate them. They are hard to defend against especially if they are launched in a stealth manner. In a direct confrontation, if used in a surprise attack, large conventional forces become irrelevant economically and militarily. There is no defense against small nuclear weapons in the hands of a terrorist or rogue state. A small diesel submarine parked 100 miles offshore from any major city can launch and destroy that city in 7-10 minutes without warning. This makes the large conventional forces of major powers increasingly irrelevant in modern asymmetric war. Modern weapons of mass destruction, which are now proliferating, have become a force equalizer. However, the states that use them require surrogates to deliver their attacks, an issue that will be addressed shortly.
What is important to note is that more states are acquiring these weapons be they nuclear, chemical, or biological. According to a January 13 article in The Wall Street Journal, seven states have nuclear weapons capability, one state has undeclared capability and four or more are actively seeking that capability.7 According to the WSJ, the nightmare scenario for the US is if and when these weapons fall into the hands of a terrorist group or rogue nation. It makes conventional warfare irrelevant. Nuclear weapons and materials are in the hands of rogue states that in turn export these weapons and materials to unstable regimes and terrorist groups. There are also the vast stockpiles of Russian nuclear weapons and materials that are open to theft or diversion to terrorist groups. Russia has already reported that not only nuclear materials, but also a large number of nuclear suitcase bombs, and nuclear warheads are missing and unaccounted for. Three decades ago during the Cold War only five states, the US, Russia, China, Britain and France had these weapons. Today that number is 12 and increasing. Soon states such as Iran and Iraq will have them. The lesson learned by smaller states is the best way to be left alone or blackmail others is through nuclear and biological weapons. North Korea is a relevant example of this type of blackmail. During the Cold War, the rational behavior of major powers was expected to prevail. Nuclear weapons are instruments of mass murder. There is no defense against them other than for those attacked to respond in kind, thereby creating the possibility of global suicide. These weapons are suitable only for butchery and beyond the scope of anything ever contemplated before. Wide-scale use of these weapons would bring the history of man to an end. In the past wiser heads have prevailed. Not so today. How do you defend against madmen whose own lives are considered expendable—much less the innocent lives they seek to destroy? It is one thing to negotiate or wage war against a state. It is quite another thing to negotiate or fight with madmen especially a madman with weapons of mass destruction at his disposal. Even worse—what if the use of those weapons were justified in the name of a religious cause? We face a different kind of war today. Because of the accelerating rate and proliferation of weapons of mass destruction, we now face a different kind of war. The risks seem hardly apparent in an Information Age where the mindset is still stuck in the Industrial Age. I can clearly remember watching a Sunday political pundit show a week before the terrorist attacks on 9-11. At issue was the President’s missile defense program. The consensus was that the President’s program was unnecessary and too expensive. In the words of a prominent senator on the program, no one would dare attack us because of our military might. A week later the Trade Towers were leveled. What in the past has always been thought to be unthinkable now seems possible and even justifiable in the mind of a terrorist. Even in this country there are many who think all conflicts can be resolved peacefully through negotiation and appeasement. In his book, ”On The Origins Of War”, Professor Donald Kagan wrote, ”The best way to prevent war is through deterrence, by conveying a message of strength, confidence, and determination. This policy can be especially effective when it leaves the other side an honorable way out.8 When it comes to appeasement Kagan writes, ”Appeasement is a perfectly respectable and often useful instrument of policy. It can be effective when applied from a position of strength, when it is freely taken action meant to allay a grievance and create goodwill. It is unsatisfactory and dangerous device when it is resorted to out of fear and necessity, for then it does not reduce resentment but shows weakness and induces contempt.” 9 Religious Fervor Fuels The Fire Thucydides, the Athenian aristocrat, once observed that man goes to war out of honor, fear, and self-interest.10 To this, I would add religion. There have been no bloodier wars in history then those fought in the name of religion. This is where we now find ourselves today. Those who carry out terrorist attacks do so in the name of religion, which gives justification to their killing. Fundamental Islam, or Islamism, is the fastest growing and coherent ideological movement in the world today. In the view of Middle East expert Daniel Pipes, director of the Philadelphia-based Middle East Forum, Islamism or fundamental Islam threatens us all. Bernard Lewis and Samuel Huntington have labeled this threat as the “Clash of Civilizations.” Pipes disagrees and feels that Islamism is an ideological battle for the very soul of Islam. He distinguishes between Islam and its militant version Islamism or what we refer to as fundamental Islam. “…Militant Islam is a utopian ideology, initiated in the twentieth century, that attracts only a portion of Muslims (perhaps 10-15%), seeks to capture control of governments, and is nakedly aggressive toward all those who stand in its way, no matter their faith.”11
Central to the growth of this radical ideology is the capture of the state. Control of the state is necessary for it is through coercion that this ideology gains power and adherents. It preaches hate and advocates jihad or war. This radical sect of Islam has been in ascendancy since the early 1970s and is becoming one of the most powerful forces to be reckoned with around the globe. It is an aggressive global force that seeks global hegemony in the same way as fascism and Marxist-Leninism did before it. It espouses deep hatred of non-Muslims especially Jews and Christians. Its leaders intend to impose their totalitarian will through force with the objective of becoming the world’s dominant religion. Contrary to popular beliefs, this ideology is not borne out of poverty. This is a common misconception. Empirical evidence finds little correlation between poverty and militant Islam as conventional wisdom would suggest. In surveys conducted among various members of this sect, it is found that they come from the middle classes and are educated, competent and motivated. Many of them come from families in the civil service. Rather than the downtrodden, they represent the leaders of their generation. In fact Islamists that make the ultimate sacrifice of their lives tend to be financially at ease, educated and privileged. Princeton historian Sean Wilentz in his biography of the September 11 killers, described their terrorism was driven by money, education, and privilege.13 Money Is A Useful Means to Acquire Power Westerners tend to look at all social problems from the perspective of economics. If there is a social problem in the world, it can be solved through aid and economic development. Yet history shows that revolutions and wars are initiated and promulgated through the existence of a middle class. It is only when societies become well off that ideological and political change can be pursued. An impoverished society is more concerned about eking out an existence. Political discourse and engagement is more a sign of a prosperous society than one that is poverty-stricken. Islamic achievement in the past has been associated with economic success. Throughout much of Islamic history from the time of the Prophet Mohammad forward to the time of the collapse of the Ottoman Empire, Muslims had more wealth and power than other nations and peoples. In fact, in the past, Islamic society was considered to be more literate, healthy, and better off financially. Many trace the roots of modern militant Islam to the 1970s oil boom. Apostasies in the faith occur when things go badly as in the case when Islam came under Russian rule, and the military defeats in Europe from the fifteenth century forward. So while many well-meaning organizations and experts in the West see militant Islam from the perspective of economics and poverty, others view it from the Islamic perspective of spirituality. The Islamists see money as only a means to an end. They rarely talk in western terms of increasing economic well-being, but they see wealth from the perspective that it can be used to acquire weapons in their quest for power. Militant Muslims want to bring back the Islamic Empire, which it lost to the West over the last five hundred years ago. To quote the Ayatollah Khomeini, “We did not create a revolution to lower the price of melon.”14 Islamists care less about material wealth than they do military and political power. Money is only a means to an end. That end is political and religious power. In the words of Iranian hardliner Ali Akbar Mohtashemi , he predicts that “Ultimately Islam will become the supreme power.”15 The Nexus of Power: Saudi Arabia The wealth and means of spreading that power comes from the Moslem state of Saudi Arabia. Over one-third of the captured prisoners from the war against bin Laden’s al-Qaeda are Saudi nationals. Recent Pentagon and intelligence reports in late November last year showed that a lot of the funding for the 9-11 terrorists came from Princess Haifa bint Faisal, the wife of Saudi Prince Bandar. That money went to fund two of the September 11 hijackers.16
What Went Wrong? Many in the West and in the East are trying to find answers to the question: “What went wrong?” and “Where does the hatred come from?” In the US experts shocked by the terrorist attacks of September 11th looked for answers as to why there is so much hatred against not only the US in particular, but towards the West in general. Many here in the US still see the problem in economic terms, but it has a much wider scope. Even the Arab world is asking that very same question. As recently as last year a joint effort by the United Nations and the Arab League sponsored a study, “The Arab Human Development Report 2002.” It was headed, researched, directed and written by Arabs. Rima Khalaf Hunaidi, director of the UN Arab Bureau is deeply concerned over what is happening to much of the Arab world. He is concerned over "...some very scary signals that were specific to Arab countries and not other regions.”17 The report found six disturbing trends:
In essence the report concludes all progress has been put on hold. Hatred and conflict have replaced introspection and resolution. Human rights and well being are diminished. The only growth is in the movement towards dictatorship, which governs most Arab States. From Egypt to Iran, the Inquisition Courts have become popular with rulers again. The inquistioners break into universities, knock on the doors of houses, and interrogate the body and soul.19 Oil Wealth Displaces The Merchant Class In his book “Oil and Islam”, Professor Oystein Noreng, examined these same issues along economic and social issues that shed additional light as to the turmoil that engulfs much of the Arab world. He arrives at many of the same conclusions of other authors, but from a different perspective. He observes first of all that Islam is not just a religion—it is a political movement that unifies religious power with that of the state. He theorizes that many of the conflicts of the Islamic world stem from the displacement of the merchant class, once the dominant class and reason for Muslim prosperity from the new political class whose power stems from oil. This new political class, whose power comes from oil, has created a new kind of governing power and public sector that has displaced much of the once-dominant, private merchant class. The public sector is made up of technocrats, civil servants and military personnel who are dependent and support the ruling class. The oil revenues enable the state to finance an extensive welfare state, a military class as well as a police state that support and protect the ruler or dictator that rules the country. Much of the oil wealth has gone to support this new ruling class through huge expenditures on armaments, the military, and a police force that keeps dissent and the mass of citizens pacified. However, due to the decline in oil revenues over the last two decades, governments have had less revenue to maintain the welfare state. Unemployment is rising, which is effecting an urbanized, educated and younger generation. Population growth pressures and a need to redistribute wealth is giving way to violent confrontation. The Islamists come from the middle classes—not from the downtrodden. Since political debate is limited and monitored, the mosque has moved in to fill the ideological void through religion that lends itself to political use.20 A key for the West is to understand the new Islamists' goals on economic policies regarding oil policy. The Islamists are against the wasteful use of oil revenues solely for military purposes. Only when that money is used to gain power or spread Islam is it justified. Islamists governments would regulate output and synchronize the depletion of oil reserves with investing in new productive assets to expand the income base. They would break the monopoly of the state oil companies and the ruling military class. In regards to the promise of Islamism, it purports to correct the inequalities created by non-secular rulers, but it also offers a nationalistic and generational promise to make Islam great again. However, this movement is not uniform nor is it completely non-secular such as is the case with Saudi Arabia.21 There Has Been An Unannounced Declaration of War on the West Unnoticed by the West, war has been unilaterally declared on Europe and the United States by militant Islam. The opening battles of this war have been manifested through acts of terrorism throughout the last three decades in terrorists kidnapping of American diplomats in Iran, American military personnel in Lebanon in the mid-1980s, bombed airbases in Germany, a discotheque in West Berlin, Marine barracks in Beirut, a servicemen’s bar in Barcelona, a bus outside Athens, a US military compound in Riyadh, the Khobar Towers, bombings of embassies in Nairobi and Kenya and Dar es Salaam, Tanzania, the U.S. Cole and September 11th. These terrorist attacks include the murder of an elderly American paraplegic on the Achille Lauro, the bombed Fraunces Tavern in Manhattan, TWA flight 840, Pan Am 103 over Lockerbie, Scotland, the original World Trade Center bombing in 1993, the killing of tourists on the deck of the Empire State building and many, many more. There have been similar, if not more numerous, attacks throughout all of Europe and parts of Asia. None, however, have been quite as deadly or destructive as the attacks against the twin Trade Towers and the Pentagon on September 11, 2001.
Michael Ledeen, in his book “The War Against The Terror Masters," sums it up succinctly. “Western intelligence services have long been reluctant to accept the fact that modern Islamic terrorism is above all else a weapon used by hostile nation states against their enemies in the Middle East and in the West."22 These terrorists’ organizations—be they Hezbollah, al-Qaeda, Hamas, PLO or Islamic Jihad—require more than money and guns. They need a safe haven and refuge in which to live, train, and plan future terrorists attacks. Without a safe haven, there is no place to run to after an attack unless that attack is a suicide mission like 9-11. Let us not forget that the mastermind behind the 9-11 attacks, Khalid Shaikh Mohammed, was captured recently. Khalid Mohammed was overseeing plans to attack suspension bridges, gas stations, and power plants in New York and other major US cities.23 The common assumption here in the U.S. was expressed by Larry Johnson, a former State Department counter terrorism expert, in The New York Times. The basic assumption was simple: ”There’s really nothing to worry about. If you are drilling for oil in Columbia, or in nations like Ecuador, Nigeria, or Indonesia, you need to take precautions; otherwise Americans have little to fear.”24 This Is A New Kind of War What is now recognized, at least here in the U.S., is that this is a new kind of war. As President Bush commented on the day of the September 11 attacks, “You have just seen the opening battle of the first war of the 21st century.” As I have written in earlier articles—Rogue Wave / Rogue Trader and more recently in PowerShift— “The next war has just begun. The era of peace and stability that we have come to know is over. We are entering an era in history, not of peaceful economic competition between nations, but a time of warfare between tribes, ethnic groups, religions, and economic systems. This war will be unlike other wars. There will be no major battlefields. Armies won’t line up to face each other and do battle. The 21st century war will be taken to the cities and suburbs as well as the skies. It will be fought with car bombs, small explosives, light armaments, and surveillance. It will be a war of men killing each other at close quarters. Battles will be replaced by skirmishes, bombings, massacres and genocide. It will be fought by regular armies against small groups known as terrorists, guerrillas, bandits and robbers. For the first time in the West, war will become personal. It won’t be watched from afar, but will be experienced first hand as immediate participants, victims or targets. In this new war, age and sex will be meaningless for many of its warriors will have little regard for life."25 The Hidden Hydra The terrorist groups of today are unlike the terrorist groups of the past. They are better financed and better organized. Their weapons are more deadly. Unlike the past, terrorist groups are decentralized so that if their leaders are captured or killed, the organization still goes on and functions. Groups such as al-Qaeda are linked operationally to other allied terrorists groups around the globe. These groups now include Abu Sayyaf Group, Moro Islamic Liberation Front, Kumpulan Militan Malaysia, Laskar Jundullah, Jemaah Islamiah, Al-Takfir wal Hirjra, Salafiste Group for Preaching and Combat, Egyptian Islamic Jihad, Islamic Group, Al-Ittijad al–Islami, Tunisian Combatant Group, Libyan Islamic Fighters Group, and Al Ansar Mujahidin.
Al-Qaeda coordinates attacks, supplies ideology, finances training, provides and pays for weapons and direction through its bases out of Afghanistan. Each group or terrorist cell within a group has its own code sheet. One cell may not be familiar with the next until the day of or just prior to an attack. This is done to prevent interception. So the key to wining this battle is good intelligence, detecting the intermediaries, disrupting their funding, and dismantling their base camps and keeping them on the run. This is difficult to do because they are sheltered and supported by a group of nations often referred to as rogue nations or what Michael Lideen calls “the terror masters.” According to Lideen ”...all of the major terrorist organizations would be crippled without state support. Once the terrorists are deprived of safe havens, training camps, sources of travel documents, the use of diplomatic pouches, and really secure communications, they will be easy pickings. The six states that provide aid and shelter for the terrorist network are Iran, Iraq, Saudi Arabia, Libya, Syria, and Sudan.26 According to Ledeen, this war is caused by "Their fanatical desire to destroy the West grows out of a deep seated Muslim rage, and is buttressed by a powerful Muslim doctrine. Without the rage and the doctrine—the ideology of the terror masters—there might be Islamic terrorists (there have been for centuries), but there would not be a global Islamic terrorist network, resting on an Islamic fundamentalist mass movement."27 Terrorist Threats Are A Clear And Present Danger This war would not be so dangerous if were not for the proliferation of weapons of mass destruction. Just as the mob wars of the 20’s and 30’s were destructive through their use of new weaponry like the Thompson machine gun, so it is today with terrorist acquiring weapons of mass destruction. It is well documented by intelligence sources that al-Qaeda has been trying to obtain weapons of mass destruction, especially nuclear weapons. It has been suggested through tapes from the group and by messages given to journalists that they may now have them. In the aftermath of Afghanistan, the US discovered plans to manufacture radiological weapons for use against western cities in abandoned al-Qaeda and Taliban bunkers. Jane’s reports that the collapse of the Soviet Union made it possible for various groups to acquire a ready arsenal that was for sale to those groups who could afford to pay for them. According to the International Atomic Energy Agency (IAEA), there have been over 400 cases of trafficking in nuclear materials, including radioactive material used for the production of radiological weapons. Stanford University Institute for International Studies also reports that at least 40kg (88lbs) of weapons-grade uranium and plutonium have been stolen from poorly guarded facilities in the former Soviet Union.28 Besides nuclear materials, suitcase bombs and nuclear warheads are also unaccounted for or are missing. According to IAEA since the attacks of September 11th the possibility of al-Qaeda acquiring weapons of mass destruction have increased substantially. The State Department states that almost all nations labeled as “rogue states” are now actively acquiring nuclear, biological or chemical weapons. It is one of the supreme ironies of the 21st century that advances in medicine have eradicated most common diseases that shortened human life spans. Terrorist groups and their terrorist sponsors are now acquiring and manufacturing these same deadly viruses with the intention to use them as weapons of war. Their desire is to use these weapons as a means of mass murder of innocent civilians to achieve their political objectives. They hope to either frighten governments or rulers into making concessions or acceding to their demands. The West will either acquiesce, confront or be vanquished by this struggle. So far, most of their demands have been met by appeasement. The terrorists grow even bolder, for they now believe through mass terror they can defeat the United States. As I sat to write the final pages of this essay, I was caught by a news flash on my other computer screen. Anti-war demonstrators were protesting over the whereabouts of captured terrorist mastermind Khalid Shaikh Mohammed. They were concerned about whether he was receiving humane treatment. The fact that the mastermind of the September 11th attacks was captured was not a cause for celebration. Nor was the fact that he was busy plotting even deadlier attacks of equal concern. Anti-war activists from movie stars to pop singers have taken to the streets to protest the possible confrontation with Iraq. They don’t realize that Hollywood itself is considered to be a prime terrorist target. Contrary to the adulation of pop stars and movie stars in the western world, in the Islamic world Hollywood is looked upon as an abomination. This unwillingness to recognize evil for what it is, and in fact go to the streets to defend it is puzzling. It demonstrates how little understanding we have of the danger that now confronts us. Terrorism is nothing more than organized crime carried out on a much grander scale. Like organized crime families, it is the top bosses who make the decisions to kill. They never pull the trigger. It is the street soldier who carries out the command. In this case, it is the terrorist cells and terrorist groups who have become the instruments of the terror masters. The terrorist groups are the soldiers and the rogue states the mafia dons. Here in the US it is widely acknowledged that these groups are all part of a terrorist network of sleeper cells that have infiltrated the US. They are part of our economic fabric. They live here as doctors, lawyers, teachers or engineers. Like the group that carried out the September 11th attacks, they are comfortable and well educated. They live in cities across this land. From San Diego, St. Louis and Miami, to Detroit and San Jose. They are trained in avoiding surveillance and taught to blend in until such time as they are called upon to carry out their heinous deeds. So here we are once again finding ourselves on the eve of war. It has not yet dawned on many on Wall Street or in Washington that the world is again at war—a war not of our own choosing—but a war that has been thrust upon us reluctantly by an act of terror. That is usually the way the US is dragged reluctantly into war. We get bombed, torpedoed, or attacked and our carefree isolationist life is disrupted. We delude ourselves into thinking it will all go away. Whether we acknowledge it or not the events of 9-11 changed America forever. We can no longer live behind the safety of our borders or be separated from the rest of the world by large oceans. Our once safe and peaceful borders are one of our greatest vulnerabilities. Acts of terror or war are not news events that will be watched from afar in an evening newscast. September 11th brought war home to American soil. Even though US troops now fight on foreign lands this first war of the 21st century will be fought here on our own ground as well.Back Then — And Today What I fear most is that we are ill prepared for this war. This isn’t the same nation as the one that faced the challenges of the depression and a World War. Back then this nation was self sufficient and confident of its own abilities. We were then the world’s largest creditor nation. Today that role has reversed. We are now the world’s largest debtor requiring $1.5 billion a day of foreign capital to feed our desire for consumption. Back then the U.S. was self reliant in energy. During the early part of the last century, we supplied oil to the rest of the world and to our allies during the war. Today we import close to 60 percent of our energy needs and those needs keeps growing. Back then we were a nation that saved, invested, and made things. Today we borrow, spend, consume and import more of what we consume. Back then we weathered a stock market crash. Now we think we are immune to one. Back then this was a nation that believed in God. Now we seem to want to throw Him out.
The Rogue Waves Will Continue and Increase We are in the midst of several storm fronts in our economy, our financial markets, and with our currency. Presently it looks like those storm fronts are about to collide. It is as if we are all on the Titanic and are unaware of the icebergs that surround us. We have survived the first rogue wave and we are grateful that we survived. However, when you are in a major storm, rogue waves come in succession. In 2001 it was 9-11. In 2002 it was corporate malfeasance. The next rogue wave is Iraq and terrorism. It remains to be seen whether the bulkheads of structured finance will be able to survive the coming waves or will they implode. In the words of Warren Buffett, derivatives represent a ticking nuclear time bomb that could wreck havoc on the financial system and the economy. Wall Street seems snug in the belief that the war will end quickly and nothing but good will come of it. It is not the war that worries me, but what comes afterward. This is not the same war nor is it the same mission as the Gulf War. The last war's mission was to repel an invading army. This war is about regime change and a continuation of the war on terrorism. There are going to be additional battles and those battles will not be of our own choosing. Wall Street keeps thinking in terms of the industrial wars of the last century. This is a new era with asymmetric war whose outcome is uncertain and unpredictable. I’ll end on a note that strikes me as more appropriate today than when I first wrote it in Rogue Wave Part 1, October 26, 2000: “John Q. Public is waking up to the fact that inflation is becoming real as he pays his bills the first of every month. Washington is intervening in the oil markets, the stock market, the bond market and the currency markets. The moral hazard argument is now at work. We know about bank deposit guarantees. Now it looks like we'll have financial market guarantees. Hold on to your wallets - this is going to get interesting. If you don't want to be struck by lightning, you don't stand under a tall tree in an open field during a lightning storm. The same wisdom can be applied to the world of derivatives. Our financial markets hang on a thin thread of probability and belief in a bell-shaped curve that such an event will never occur. Yet history reveals otherwise. The lesson of this last decade tell us that rogue waves and rogue traders do hit the financial markets. So far we've managed to survive them. The academics will tell us that their models will help us to avoid them. They have endeavored to convince the financial world of their mathematical certainty. But the real world isn't full of certainty. There will come a day without warning, at a time when nobody expects, when that rogue wave will appear. It will be a day when events overwhelm the financial markets... when the house of paper will fall... when our financial institutions will be put to the supreme test... when the mettle of a man is tested... when faith in our institutions will be called into question. It will only be on that day and in that hour, that we will know if the Holy Grail of Finance truly exists.” ENDNOTES 1
Hazlitt, Henry, Economics In One
Easy Lesson, Three Rivers Press, 1983, p.11-18.
NOTICE: You are welcome to print this article for your personal use. However this article may NOT be reproduced for public distribution without the expressed, written permission of the author. Email Author Selective quotations are permissible as long as the author, Jim Puplava, and this web site are acknowledged through hyperlink to: www.financialsense.com
Copyright
©
James J. Puplava
Financial Sense ® is a Registered Trademark | ||||||||||||||||||||||||||
Despite their rare
occurrence, Beaufort scale storms of 12 or
more do appear more frequently than is commonly admitted. The visible images of
the damage wrought by these storms are common enough news. It is
only when the damage is so severe or the loss of lives is tragic enough, that they appear
as out of the ordinary. In the world of weather, we define them as nor'easters
or hurricanes. We have given these memorable storms names like Hurricane Andrew
and The Perfect Storm. In the financial world, they are known as crises with
particular names
For the financial markets, these freak waves are just as
commonplace. Whether it is the 1987 stock market crash, the peso crisis of 1994,
or Asia or LTCM and Russian in 1998, they are occurring with much more frequency.
They now tend to follow one another in shorter succession. Chaotic patterns
emerge which create outlandish swings of behavior that is translated immediately
into action in the financial markets. With telecommunications now connecting the
world, millions of computer screens and eyeballs are plugged into these same
financial forecasts. Whenever a rogue wave appears without warning, an
interconnected financial world moves collectively in the same
direction. The problem lies when all players are resting on one side of the boat
and a
sudden shift or move to the other side is capable of producing an action
that can capsize the boat.
The
War on Terror Began September 11, 2001
Britain
Israel
Argentina
We
in the West have chosen to ignore them, pretending they were all isolated cases.
Most of these incidents took place overseas. As Americans we chose to view these
events as one-time events. It was only after the horror, destruction and massive
loss of life in the World Trade Center attacks that the U.S. has begun to take
them seriously. Still for many in this country, we have yet to awaken to the
fact that we are now at war. The operations in Afghanistan were looked upon as
"police actions" carried out by our military. Unfortunately future
terrorists attacks will get more serious and more deadly regardless of the
possible war with Iraq. The attacks of 9-11 are just a prelude of bigger attacks
to come. The difference between terrorism three decades ago and terrorism today
is that the terrorists are acquiring weapons of mass destruction. Most
governments are powerless to do anything about it other than police actions in
the hopes of catching or preventing further attacks. Few can muster the will or
have the military means to do anything about it. I have often wondered what
European leaders would have done in France or Germany if the Tour Eiffel, the
Louvre, the Arc de Triomphe, the Brandenburg Gates, or other national monuments
and symbols of national pride would have been blown up with the loss of close to
3,000 lives. Would they be so readily to appease and what response would these
governments take?
Today
our financial markets have turned into gambling casinos where the word "trade"
versus "investment" is heard more often. Our economy is burdened by
over $31 trillion in debt and our financial markets have become highly geared
through paper instruments known as derivatives. Wall Street traders and hedge
fund managers think that they can leverage, control, and manipulate the outcome
of markets. Our central bankers and politicians think that the business cycle
can be tinkered with and fine tuned to fit political objectives. In their own
minds, the business cycle has been eliminated or at least tempered. The
alchemists in Washington and on Wall Street keep experimenting with the
financial system and the economy in an attempt to mold it. In this process they
have created a credit monster that must constantly be fed or the whole system
collapses like a house of cards. The only thing keeping the economy afloat is an
ocean of credit. Governments are running deficits, corporations are weighed down
by heavy debt burdens, consumers are hemorrhaging from debt, and our financial
markets are levered and overvalued. In the process of tinkering with the
markets, they are creating unnatural anomalies. Energy and bullion prices are
up; while energy and precious metals equities are down. Commodity prices are
rising, but interest rates keep falling. Interest rates are down, but so are
stocks. Markets are acting unnatural because of intervention. But as Jim Rogers
once put it, the markets are bigger than governments. In the end, natural market
cycles and economic relationships will reassert themselves with a vengeance.
