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The Fall Of Baghdad

In the end it was really no contest. After all what would one expect when a first world superpower takes on a third world country and outspends them on military 300 to 1. The ease in which this was accomplished reminds us of a victory by another world power in another period. Roughly 1900 years ago (113-117) the legions of Rome under the Emperor Trajan invaded the ancestors of today's Iraqis.

Iraq, then known as the ancient kingdoms of Mesopotamia and Parthia, were equally incompetent in the face of an overpowering force. But even as the conquest of the Parthian kingdoms was being completed revolts occurred among the recently subjected people to the rear of Trajan's advancing legions. The legions were forced to backtrack and recapture several cities that had already fallen. Trajan became ill during the campaign and eventually died. Still Trajan had pushed the boundaries of pax Romana to its furthest and gazed upon the Persian Gulf just as Alexander the Great of Greece had centuries before. But the conquests of the Eastern world led the Romans into a new and unfamiliar world and the Roman presence was regarded as utterly alien. The empire retreated.

Of course trying to compare the results of an earlier empire with today is extremely difficult but some of the same problems are still present. There are different tribal factions each of who have no love for the other. There are different religions who often been at odds with each other. There is the potential difficulty of bringing democracy to a land that has known no democracy. There is the potential for animosity between the occupiers and the inhabitants as the US is a foreign power in a foreign land that has not tolerated in the past foreign occupiers. Then there is the potential for problems between the Kurds of Northern Iraq and the Turks and there is Shiite Muslims in the South more closely aligned with the Iranians. The peace may prove more elusive then the war.

One interesting potential comparison is, however, with Afghanistan. While we have mentioned this before it is worth repeating. Both the British and the Russians learned that while conquering Afghanistan was easy, holding it proved considerably more difficult. While initially there seemed to be considerable hope in Afghanistan it is quickly being frittered away. The warlords once again control most of the country and they are again financing themselves through the heroin trade that had been largely eradicated under the Taliban. Assassination attempts have been made on President Harmi Karzai and some have been successful on other key Afghan officials. There is little order outside of Kabul. Due to a lack of pay numerous people recruited for the new Afghan army have been deserting.

It has been reported by Human Rights Watch that the brutal repression of the Taliban is being re-instituted particularly in the western province of Herat by a Northern Alliance warlord that was a key ally of the Americans. There have been increased attacks on aid workers and civilians. Guerilla factions are successfully executing the hit and run tactics against the Americans or UN forces that worked to such effect against the Russians. Little of the aid that was promised to Afghanistan has been forthcoming. US congress had to add aid for Afghanistan recently when the Bush budget that promised considerable delivered nothing.

Iraq, after the fall of Baghdad quickly descended into chaos of looting and reprisals. The institutions of a functioning civil society have been destroyed just as it was in Afghanistan. Parliament, courts, much of the civil service and most of the educational and health systems lie in ruins. In a sad case Baghdad's National Museum that housed priceless ancient artifacts some dating back to the cradle of civilization was plundered. These treasures not only belonged to the Iraqi people they belonged to the world. A cleric closely aligned with Tony Blair and expected to be a key leader in the new Iraq was assassinated shortly after arriving in Iraq. An assassination attempt has already been made on the US Pentagon designate Ahmad Chalabi, an Iraqi who has not lived there for over 40 years. Numerous factions are divided against themselves and many remain divided against the US. Little of Iraq is truly secure but it is worth noting that the oil fields are.

Now threats, rightly or wrongly, are being directed at Syria. Former CIA director James Woolsey told us that we are in World War IV and that it began on September 11, 2001 (the Cold War was WW III). He said the current war would last for decades. This comes against the backdrop of a fracturing world with major world institutions such as the United Nations, NATO and even the European Union in disarray and an ongoing weakening of civil rights in the US through such vehicles as the Patriot Act and the coming Patriot Act 2. Despite the pronunciations of many pundits that with the ending of the war in Iraq we sit on the cusp of a new economic boom we wonder where this is coming from against this ongoing background of geopolitical and economic uncertainty.

While upwards of 70% in the US are supportive of the war a similar number are dismayed about the sinking economy. And so they should. Over 2.5 million job losses have been recorded in the past few years. The unemployment rate sits officially at 5.8% but it is undoubtedly considerably higher as it does not count those that have dropped out and are no longer looking. Earnings season is upon us and it seems that many hope that we will see improved numbers. That will probably be wishful thinking.

Long-term studies have shown that stock market has grown on average by 2.48% annually since 1871. The economy by contrast has grown on average 3.7% per annum in the same period. So to think that we will return quickly to new growth is not based in reality. Corporate profits are still undergoing their years of overstatement as they wean away from not recording stock options and pension expenses. Pro forma earnings as a measure needs to go the way of the dodo bird and write-offs need to be accounted for. The years of financial jiggery pokey epitomized by the Enron's and others is hopefully a relic of the past but attempts to reform are often merely half hearted measures with considerable pontification but little in the way of action. Meanwhile more Enron's are still popping up but with the focus on the war they may glide under the radar screen.

For years a normal index Price Earnings (P/E) ratio was in the area of 15-17 with peaks at 20-22 and troughs at 8-10. In the most recent bubble P/E's rose to almost 40 on the S&P 500 and over 200 on the NASDAQ. Even the vaunted Tokyo Nikkei Dow only reached to just over 80 at its peak. Today the S&P 500 still sits at a P/E of almost 30 despite the fact that it has fallen over 40% from its peak. Such vaunted tech icons as Amazon, eBay and Yahoo trade today at P/E's of 80, 65 and 69 respectively, levels clearly not justified by current growth rates.

In the early 90's when the great bubble got underway S&P 500 P/E was in the 15-17 range. The current P/E could be cut in half by either the market falling or earnings growing at a rate that allows it to catch up to the current market valuations. We are betting more on the former as history does not support earnings growing at levels that are on balance more than the growth rate of the economy which has we noted has grown on average 3.7% since the last century.

Further growth in the economy has to be a steady stream of new companies coming on the market and growing at rapid rates as they did in the 1990's. Today we are retrenching as bankruptcies continue at record levels. A return to the growth years of the 1990's is merely a pipedream given that the growth seen then was actually a bubble based on false economics of too much money chasing too little product. While stock buybacks can help individual companies with their valuations the fact is that more tend to issue new product rather than buyback.

So if earnings are not going save this economy and can't because reform and the need to catch up on legal pension obligations will remain an albatross for companies for years to come then what will? The economy is over indebted for both corporations and the individual. It is a pipe dream to think that further gains today in the stock are possible. Of course there is no accounting for the willingness of the Federal Reserve to throw money at the problem. Trouble is he needs the banks to lend and they are in a retrenchment mode burdened as they are with bad debts. Debt write-offs in the banking and financial institutions have still not hit the levels seen in the early 1990's during the last recession. Rapid monetary growth will merely result in maintaining the status quo as the economy readjusts to the new realities of ongoing debt liquidation.

If the mountain of debt of corporations and individuals poses a long-term problem the growing budget deficits and the ongoing trade deficit are like a ticking time bomb. Not even accounted for is the potential costs of this war and the occupation of Iraq. The US$ is the world's reserve currency. Yet the twin deficits coupled with low interest rates and a world now moving in the direction of potentially destabilizing trade wars and disagreement about US global hegemony means the US$ will come under increasing pressure.

Baghdad has fallen but the real problems may only now be beginning. The peace may be more elusive. And if we expand this to other countries such as Syria there may be no basis for a recovery. The economy is shaky and unless the US$ can show a sharp recovery against the odds of a divided world, huge twin deficits and an over indebted corporations and individuals than the likelihood of an economic recovery is highly unlikely.

Our chart of the US$ and the Dow Jones Industrials shows this conundrum. Both have clearly broken down. The US$ from a clear two year top and the Dow Jones from an ongoing rolling three year top that culminated in 2001. Both are below their respective 40-week moving averages and the four-year moving average. The Dow Jones has been failing repeatedly at its 40 week moving average over the past several months. The US$ remains below its falling 40 week moving average.

While weekly indicators are still in an up mode, that could change at any time. The US$ in particular appears to be forming a bear pennant. The Dow Jones Industrials appears to be forming a large symmetrical triangle over the past several months. These triangles are rarely bottoms so a break of the bottom end near 7500 would target 5700 as a minimum. If it is a bottom then the triangle break would target 10,000 and the four-year moving average. Given the current economic and geopolitical background, we deem this unlikely but it remains possible.

The rise in the markets over the past number of weeks has been accomplished on weak volume. This is not a market that is forming a bottom. But it is one that is going through a prolonged correction mode. Unless the uncertainty of the war can be translated quickly into sustaining peace the fall of Baghdad may be merely a beginning not an end.

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