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Slowly Beat The Drums Of August

Tradition dictates that nothing much happens in August - at least on the surface. The ministers of state in the chancelleries of Europe were supposed to take a break from their plans to wreak havoc on their neighbours and retreat to their chateaux, villas and palaces. In the meantime, skeletal groups of mandarins continued to flesh out the details of their autumnal offensive. The middle and lower classes, that would bear the brunt of their leaders aggressive plans, retreated from their dark satanic mills for a final wakes week at the local equivalent of Blackpool. The media propagated a conspiracy of silence about the impending doom. If it encroached on the silly season at all, the message was that there is no need to worry about a thing, we are the greatest, we'll whip the heathen and the boys will be home by Christmas in any case.

But these attitudes were from the dark ages of the nineteenth and twentieth centuries. We are all so much more sensible and sophisticated now - aren't we?

Well the rhythm of life continues, only the players and locales change. Human motives - fear, greed, and revenge remain the motivating forces. Substitute Washington for Whitehall and middle Europe, and Waco for Tuscany and the Alps and you have the old playbook modernised for the twenty-first century. Add a devil figure, a volatile mix of the three major religions amidst the world's most important oil fields and the world's sole superpower with a messianic mindset and you have today's dog days of August.

Hollywood could not script it better. The trouble is it may not have a happy Hollywood ending.

Official Washington has found its devil in Iraqi President Saddam Hussein and the pressures for war are growing inexorably. There are reported US troop build ups in neighbouring countries of the Middle East, and also reserve call ups in the US for troops with war making (as opposed to peace keeping) skills whose enlistment terms cover the period through March/April of next year.

In Washington itself, the military is the institution, supported by the likes of Brent Scowcroft and General Schwartzkoff, urging caution whilst the civilian hot heads such as Cheney, Rumsfeld and Wolfowitz, who are in ultimate charge, dismiss them as wimps. The public, lulled into complacency, supports action confident, as Britain was in 1914, of the inevitability of easy victory seeing Iraq as yet another Kosovo to be knocked into shape by the forces of reason and light.

But Iraq is no Kosovo and selected voices on the left and right are now beginning to raise questions about the wisdom of the rush to war. Leaving aside questions of the morality of the whole adventure, the potential for the adventure to go wrong are greater than any such venture since Vietnam and the global impact could be severe and protracted.

Clearly, Bush's electoral politics are driving the timing and the agenda. Early next year is his last real window, if he wants to avoid war in his re-election year 2004. Victory would help his position but victory in the Gulf war did not help his father a year after it was over.

Neighbouring countries to Iraq, especially Saudi Arabia, are becoming destabilised as a power struggle for succession intensifies between forces friendly to and those opposed to the infidels. Indeed, some believe the US wants control of Iraq's oil in case Saudi goes over to the fundamentalists. The mindset in Washington is the Arabs just happen to be temporary custodians of 'our' oil.

European support for the US is virtually non-existent at this point although the French and the probable next German Chancellor are likely to become supportive if the US looks like winning. The war-loving, Bush poodle, Blair, will again blindly follow America right or wrong, and will be the US' only real European supporter. But he could end up splitting his party. The majority of the British public are firmly opposed to military action against Iraq.

An unintended consequence of globalisation is that it has succeeded in making weapons of mass destruction available to unsavoury elements. The problem has to be effectively addressed. But there must be a sense of foreboding that the US is making a dogs breakfast of the challenge and will create a far greater mess than the one it intended to address.

The shadows of August 1914 loom over the masses drinking themselves stupid on the Mediterranean beaches. But if they have no control over the actions about to descend upon them that may not be so stupid after all.

This month marked the 88th anniversary of the commencement of World War I. We took the next generation of the family to pay homage to an uncle we never knew who was sent to France at the beginning of the conflict, and like millions more never returned. That war started and then escalated out of control because of a series of miscalculations and blunders by incompetent politicians and military leaders. Let us hope a similar situation does not recur. But the Indo-Pak front in Kashmir remains an unstable nuclear-armed tripwire. Instability in the Islamic world could have unintended consequences there: an overthrow of Musharreff and nukes being placed in the hands of fundamentalists there and the Middle East. The possibilities are endless and less than cheerful.

Investment Implications
We maintain our cautious stand on the global equity markets. Clearly, prices offer better value than for many years and if nightmare scenarios are avoided - as they have been to date - many markets will probably not go significantly lower.

The problem is that the most important market in the world, the US, remains generally overpriced. The US dollar is also similarly over-priced. The current account deficit remains in deficit by about USD 450 billion a year. This is the net figure that the US has to attract from the rest of the world to finance the deficit. The gross figure to be attracted, to offset capital outflows by American residents is probably twice as large. The deficit can only be corrected by a significantly lower dollar.

In addition, the US growth in the money supply, particularly money of zero maturity MZM, has started to reaccelerate into double-digit figures again. That must be bad for the dollar's exchange rate.

Finally, the US housing bubble seems to be leaking in some places, especially the top end of the market. This spells bad news for personal consumption that has been buoyed by refinancing. It also spells bad news for financiers dependent on the refinancing boom, such as Fannie Mae and Freddie Mac. Their charts indicate they are going south.

But what continue to trouble us are the major banks particularly JP Morgan Chase and Citicorp. They have bad loans galore from every busted bubble in telecoms or high tech as well as Argentina and now possibly Brazil. The IMF programme for Brazil is a con intended to buy time till the Presidential election in October. Then it will be up to the new President to decide whether to put his country through several years of economic contraction to suit the international financial community or to take a more radical path. If it is the latter, then the situation of the money centre banks becomes even grimmer. We cannot hazard a guess what will happen in Brazil right now - the situation appears balanced on a knife-edge - but we would expect the Bush Administration to try and avoid a default at all costs. In no way has Brazil been as irresponsible as Argentina and it is six times larger. Latin America is threatening to descend into chaos even without a Brazilian default.

We therefore maintain our view that precious metals are in the early stage of a mini bull market. If a war economy develops then commodity producers - both countries and companies - will benefit. That includes the long despised Mango markets - Thailand, Philippines and Indonesia. But it also includes companies in Japan, Taiwan and Korea that supply essential electronics components for the US military machine. East and south eat Asia have always boomed in previous periods of US military activity such as the Koran and Vietnamese conflicts.

Finally, China and particularly India continue to grow solidly and are much more self-contained and less dependent on the US economy. With India, the P/Es are low by any standards, and corporate governance is improving. If nuclear war can be avoided on its border then the markets will eventually respond.

A year ago we wrote that Asian markets looked as if they would outperform developed markets. That has proven to be the case. Thailand, for instance is up almost 30 percent in USD terms whilst the S&P is down over 20 percent. US PEs are what you want depending on how you calculate earnings, but they are generally at least in the mid to upper twenties whereas 15 might be a more historically viable number. Despite frequent and often violent bear market rallies, there remains plenty of opportunity for further declines in US share prices.

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