On October 26th, as I was preparing for my afternoon radio broadcast, one of the top news stories caught my particular attention. Former Fidelity Magellan alumni and current hedge fund manager, Jeff Vinik, was closing down shop. After leaving Fidelity, Vinik set up his own hedge fund in 1996. In the past four years, Vinik has had returns of 645.8%. This year, when other hedge funds have struggled, Vinik’s hedge fund was up 45.6% after fees. What struck me as significant was the fact that Vinik would be the third hedge fund manager to retire this year following Julian Robertson’s retirement and George Soros’ decision to scale back his investment activities. Vinik was retiring after the maestros of the hedge fund business, Soros, Robertson, and Steinhart had also thrown in the towel.
Something’s Afoot
Long after my show and dinner, the thought lingered until I recalled a similar story involving Warren Buffett. Roger Lowenstein, in his book Buffett: The Making of An American Capitalist, quotes Buffett’s letter to his partners in 1967. Buffett had written, “I am out of step with present conditions”. [1] Early in 1968, Buffett turned to the one person who would understand his unease about the market — his teacher and mentor, Benjamin Graham. Buffett gathered a group of Graham’s students for a meeting at the Hotel Del Coronado across the bay from San Diego. Graham and his former students, many of them prominent money managers, would spend two days sharing their views about the market. Buffett left that meeting with a confirmation of his uneasy feeling. He continued to do well in the market in 1968. With the country caught up in political unrest over the Vietnam War, and the stock market caught up in the throes of a trading frenzy, Buffett would spend the following year liquidating the portfolio he ran. By the fall of 1969, Warren Buffett liquidated his partnership and returned the money to investors. Buffett would remain out of stocks (with the exception of Berkshire and GEICO) until 1974, when he loaded up on undervalued stocks. The 1973-74 bear market has long been forgotten. But it was a major bear market. The Dow lost over 50% and the “Nifty Fifty”, must-own-stocks of the era, fell even more.
With Buffett on the sidelines in 1970, the market entered a high-level, churning phase that lasted for three years. The stock market churned sideways for the entire period. Most stocks fell with the exception of the “Nifty Fifty” stocks like Polaroid, Xerox, and Avon. What finally triggered the bear market of 1973-74 was a series of geo-political events that Wall Street and manic investors had not foreseen. It began with a series of rogue waves: the Yom Kippur War that erupted on October 6, 1973, the Arab oil embargo against the US for supporting Israel in that war, and Watergate with the subsequent resignation of President Nixon the following year. These three exogenous events kicked the remaining legs of the bull and brought the market to its knees. Investor confidence was broken and would not return until the 1980’s under Ronald Reagan.
Déjà vu
Recalling these events I can’t help but reflect on the similarities in today’s current market environment. Like then, today’s market is dominated by a select group of high valuation stocks that mirror the “Nifty Fifty” stocks of the early 70’s. Today we are experiencing déjà vu with current events in the Middle East and oil occupying headlines and the evening news. As with Arthur Burn’s Fed chairmanship in the 70’s, the monetary spigot at the Fed is running at full throttle. Since taking over as Fed Chairman thirteen years ago, Alan Greenspan has allowed the money supply to expand by $3.25 trillion – more than all of his predecessors combined since the creation of the Federal Reserve in 1913.
Today’s Prosperity at Any Price
It is no different today. The “powers that be” are intervening in just about every market. The Plunge Protection Team is active in coaxing a floor underneath a dipping market. Their fingerprints can be observed in the market for the last three consecutive weeks. The Treasury is actively involved in suppressing long-term interest rates buying longer-dated government bonds. The Clinton Administration is trying to control the domestic price of oil through the release of the Strategic Petroleum Reserves. The Bureau of Labor Statistics is busy churning out creative numbers that overstate GDP growth and productivity, while the Labor Department understates inflation. Finally, the bullion banks are busy suppressing the price of gold through their derivative books.
It may be that markets can be manipulated in the short-run by financial and government leaders, but history reveals that markets will exert their own pressure in the long-run. As I wrote in Part 1 of Rogue Wave/Rogue Trader, there will come a day unlike any other – an event the markets don’t anticipate – an incident the manipulators can’t control – it will be a rogue wave. This wave will overwhelm the markets and those in power will be powerless to stop it. It will be beyond their control. It will shatter public confidence in much the same way as the Yom Kippur War, the Arab oil embargo, Watergate and President Nixon’s resignation in 1973 and 1974.
This potential rogue wave is likely to come from two directions. The first is the derivatives market as discussed in Part 1 of this installment and the second is a likely geo-political event. It is the possibility of a geo-political event or series of events that form the essence of this continuation of Rogue Wave/Rogue Trader.
The Geopolitical Stage
It may be hard for many to imagine another war or series of conflicts to appear on the world stage. After winning the Cold War and the Gulf War, the US is the only superpower left on the globe. However, there are now close to 40 low-intensity conflicts (LICs) being waged around this same globe. Most of these conflicts are small, as we’ve seen in the Taliban offensive to capture Taloqan in the Kunduz province in Afghanistan. But many of these LICs have the potential to turn into large-scale conflicts in the Middle East, the South China Seas, the Korean Peninsula, and in the Balkans. Already, the US has a large contingent of troops in the Balkans, Korea, and a sizable force in the Middle East.
The Arc of the Scimitar
Although these LICs are numerous and all have the potential to turn into Category 5 Storms, I want to concentrate on what I call “The Arc of the Scimitar, which encompasses most of Asia to the Middle East and the Balkans. Outside of China and Korea, most of these areas of conflict have become a growing stronghold of militant Islam. The other threat comes from the growing danger of Asymmetric Warfare being developed by rogue nations.
The reader may find the discussion of these topics out of sync with what is reported in the daily newspaper or on network news. The motto of today’s network news is “If it bleeds, it leads.” If it doesn’t, you’re unlikely to hear about it. Only when events get out of control, as in the present situation in the Middle East or the attack on the USS. Cole, do they make headlines.
Our liberal leaders assure us of the obsolescence of war. They tell us that commerce and trade sanctions and policies of appeasement can prevent it from happening again. However, Professor Donald Kagan in his book, On The Origins of War, noted, “Over the past two centuries the only thing more common than predictions about the end of war has been war itself”. [2] Should the reader think otherwise, historians Will and Ariel Durant wrote in The Lessons of History in 1968 that there had only been 268 years of peace in the previous 3,421years.[3] Look at any decade in the 20th Century, and you will find war and conflict. It has been that way since the beginning of man when Cain first killed Abel.
Oceanographers point to areas where rogue waves are most frequent. They are found in areas of troubled waters where strong ocean tides run against strong weather fronts. They are found frequently off the Grand Banks, Cape Horn and Cape Hope. In the geo-political realm they are found to appear most often in those regions of the globe surrounding “The Arc of the Scimitar”. This encompasses most of Asia, the new breakaway states of the former Soviet Union, the Middle Eastern states and the Balkans. Throughout history more wars have been fought along these geographic fault lines than in any other regions of the globe. This area has become a stronghold for new and old Islamic states. The Arc of the Scimitar also encompasses much of the former colonial empires of the European powers. The Middle East, which at one time was considered to be Persia, was redrawn after World War I by European powers through the Sykes-Picot and Balfour Declaration creating the artificial borders of today’s Middle East.
Throughout the centuries, empires have been built through conquest and war. Powerful kings created the Hapsburg Empire in Europe. Sultan warlords created the Ottoman Empire in the Middle East. And the Romanov Dynasty created the vast Russian empire. These empires amalgamated discordant tribes, religions and ethic groups that were held in check by their powerful influence. The Russian Revolution and the World Wars of the Twentieth Century have begun the process of disassembling these empires. Today they have become the epicenter of Low Intensity Conflict (LIC). In the words of Samuel P. Huntington, “Spurred by modernization, global politics is being reconfigured along cultural lines. Peoples and countries with similar cultures are coming apart. Alignments defined by ideology and superpower relations are giving way to alignments defined by culture and civilization. Political boundaries are increasingly redrawn to coincide with cultural ones: ethnic, religious, and civilizational. Cultural communities are replacing Cold War blocs, and the fault lines of civilizations are becoming the central lines of conflicts in global politics.” [4]
It is in these regions of the world that the geo-political rogue wave is most likely to appear. It is a fallacy of the modern western world to think that governmental powers can change or control the physical, social and economic environment. From central planning to central banks, governments and investment bankers believe they can isolate, contain, reformulate and reshape the world in their own ideology. History teaches otherwise. Unfortunately, most investors do not realize the dramatic effect of a new millennial threat in the form of asymmetric warfare.
Asymmetric Warfare
“The place we have chosen to give the enemy battle must be kept from him. If he cannot anticipate us, the positions the enemy must prepare to defend will be many. And if the positions he must prepare to defend are many, then any unit we engage in battle will be few in number…The ultimate skill in taking up a strategic position (hsing) is to have no form. If your position is formless, the most carefully concealed spies will not be able to get a look at it. Just as the flow of water avoids high ground and rushes to the lowest point, so on the path to victory avoid the enemy’s strong points and strike when he is weak.” [5] Sun Tzu
The Emergence of Non-Traditional Warfare
In warfare, the battles and the weapons change. In our era, we are seeing the emergence of Asymmetric Warfare which is war fought by non-traditional means. Its basic form consists of using the strengths of the weak against the weakness of the strong. It involves neutralizing the strength of one’s enemy in such a way that your opponent’s forces cannot be used against you. Today the side of the strong is represented by the West, and in particular the United States. The side of the weak is represented by the Third World. But within that world, a giant is emerging in the form of Red China.
Because lesser-developed countries don’t have the means to take on the West in conventional confrontation, they choose to fight an asymmetric war. The developed world’s weapons are aircraft carriers, nuclear submarines, military aircraft, missiles, rocket delivery systems and special forces. The Third World warrior doesn’t rely on conventional delivery systems to wage war. His delivery system consists of suitcases, private vehicles, small motor craft, and public transportation. In place of special forces, they use the suicide bomber. They don’t wage war on the open battlefield, but in hidden places of their choosing. They fight in cities, on buses, in public buildings, and on commercial airplanes. Terror is their primary weapon and civilians their primary target.
“Warfare is the art (tao) of deceit. Therefore, when able, seem to be unable; when ready, seem unready; when nearby, seem far away; and when far away, seem near. If the enemy seeks some advantage, entice him with it. If he is in disorder, attack him and take him. If he is formidable, prepare against him. If he is strong, evade him. If he is incensed, provoke him. If he is humble, encourage his arrogance. If he is rested, wear him down. If he is internally harmonious, sow divisiveness in his ranks. Attack where he is not prepared; go by way of places where it would never occur to him you would go.” [6] Sun Tzu
At the strategic level, asymmetric threats are designed to exploit fear among the civilian population. Their primary goal is to weaken and undermine the support for democratic governments, to thwart their policies, and disrupt their alliances. They can be used to undermine public support for foreign intervention. Their objective may be to force a government to withdraw from a foreign mission as the US was forced to do in Somalia. The pictures of dead American soldiers being dragged naked through the streets of Mogadishu had a dramatic effect upon the American public. It succeeded. President Clinton, who changed a mission of mercy into a mission of nation-building, abruptly called an end to the conflict. Since then nothing has changed. The Habr Gidr clan still rule Somalia. It is a lesson on the limits of what conventional force can accomplish. Like many of the threats facing the West today, asymmetric warfare is on the rise. We see it in the increase in terrorist activity, the number of peace-keeping missions, the growth in organized crime and economic disruptions.
Tech Terrorism
It is one of the ironies of the technological age that technology advances make us more vulnerable to asymmetric attacks. With travel on the rise, the growing ubiquitousness of the Internet and the digital revolution enveloping business and commerce, the more unprotected we become. A good example is the numerous attacks launched against Internet companies such as Yahoo and Amazon and more recently, against Microsoft. [7] Recent intelligence reports indicate Russian computer hackers may have stolen the code for Microsoft’s software, while other Russian operatives have obtained America’s stealth warfare technology. US military intelligence has become aware that Russian hackers have also entered American computer systems. Their target: America’s power plants, telecommunications systems, bridges, dams, sewage treatment plants, water and other infrastructure installations. The purpose would be to disrupt our economy in the event of war.
When a new weapon is introduced, it becomes fully incorporated into military doctrine. The tank, airplane and aircraft carrier changed how war was fought. When the Gulf War began, precision-guided weapons, remotely-piloted vehicles, helicopters, computers, data-links, and GPS became the instruments of America’s new military doctrine. It stunned our enemies who were unaware of their existence. As a result of our one-sided victory, a new arms race began. Every nation wanted these weapons. With advances in technology, they have become more affordable.
Opposing School of Thought on War in the New Millennium
As this new millennium begins, two opposing views of war are emerging. The first one is framed around Karl von Clausewitz, the 18th century Austrian who defined war as politics fought by another means. The Clausewitzian philosophy long held by the West believes that war will continue to be used as an instrument of policy at the hand of one state against another. [8] It assumes that since there is no defense against nuclear weapons, they will never be used.
The other school believes in asymmetric warfare. They believe that the proliferation of nuclear weapons has all but brought an end to large-scale conflict. The Gulf War changed the rules of war. Large armies amassed on the battlefield would only become an open target for a precision-guided weapon. Therefore, much of present-day armed forces are dinosaurs set for extinction. This does not mean that war has disappeared as evidenced by conflicts in Rwanda, Bosnia, and Kosovo. However, it does mean that the face of war is changing.
This evolution is most visible in the number of LICs around the globe. Which model of warfare will emerge has yet to be decided. What is most evident is the countless failure of the major powers to put down guerilla warfare, stop insurgents like the IRA, or curtail the plans of madmen hankering for immortality. It is more likely that we will see asymmetric threats emerge as described by Samuel P. Huntington in The Clash of Civilizations and The Remaking of World Order with East against West, tribe against tribe, and religion against religion. Since there are more less-developed nations in the world, asymmetric warfare is more likely to proliferate.
The Asymmetric Arsenal
Until a new military doctrine emerges, the West will face more incidents that will attempt to threaten, disrupt and defeat its foreign policies as well as our markets and economy. Our enemies will have at their disposal an an asymmetric arsenal that consists of three potent weapon systems, which could result in a geo-political event or rogue wave upon our economy and markets.
Weapon #1 Weapons of Mass Destruction
The first tool in the asymmetrical arsenal consists of weapons of mass destruction (WMD) in the form of nuclear, chemical, and biological attacks. They are becoming more prolific due to the economies of building them. When acquired they give disproportionate power to those who own them. They become a political leveler and have high impact (politically or militarily) relative to the force level involved. They could be used against major powers to prevent them from intervening in regional conflicts. In 1962, it was the Cuban Missile Crisis. In the late 90’s it was the threat of suitcase bombs. More recently, it was China’s threat against the US when it sent a carrier battle group into the Taiwan Straits.
Weapon #2 Technological Warfare
The second weapon system is made up of information and cyber-based warfare systems. This involves hacking into web sites, scrambling communication systems, and information operations (IO) that disrupt information systems vital to decision making. Offensive IOs can be used to attack information infrastructure such as a computer network. Recently, we saw this used on October 25th, a day of relative calm on the West Bank and Gaza Strip, another war was erupting on the Internet. The Israeli Foreign Ministry’s web site crashed due to cyber attacks from pro-Palestinian forces. At the same time in Beirut, Hezbollah’s web site crashed under a similar attack by Israeli hackers. [9] Israeli and Palestinian hackers have been waging war against each other’s web sites since the outbreak of violence in September. While the shooting war makes the evening news, the cyber war is relatively unknown. The Palestinians call it “e-Jihad” (cyber holy war).
Weapon #3 Psychological Warfare
The third weapon system is psychological. It involves employing deception, misinformation and propaganda to distort, falsify and alter public perception. Terrorists, using the media, conduct urban warfare and target financial institutions. Attacks like Pan Am 103, the sarin gas on the Tokyo subway, the bombing at the World Trade Center, the Federal Building in Oklahoma City, the 1996 Khobar Towers in Saudi Arabia, or the more recent attack against the USS Cole are examples of this form of psychological warfare. It allows terrorists to exploit the international news media to weaken the resolve of western decision makers as witnessed in Somalia and in Kosovo. Terrorism allows an insignificant force the ability to achieve superior results against a larger foe inexpensively and without much bloodshed.
Asymmetric Warfare on the US Stock Market
The importance of asymmetric warfare is that it is designed to use the forces of the enemy against itself by destroying the enemy’s will to fight. Asymmetric attacks generally exploit vulnerabilities. Our financial markets are particularly vulnerable to this type of attack.
Foreign Ownership
In the last eight years due to our expanding trade deficits, foreign ownership of US securities has risen from 20% to 44%. Red China alone has amassed over 5 billion in US debt. [10] Others estimate that amount to be much greater due to our large trade imbalance with the country. Should foreigners choose to liquidate their Treasury or stock positions for economic or political reasons, they could cause our markets to plunge beyond our government’s ability to control. If this seems implausible, the Federal Reserve Bank of New York devoted an entire issue to this potential vulnerability in May of 1998.[11]
Before Bill Clinton took office in 1992, foreign ownership of US securities wasn’t an issue. However, due to the severe economic imbalances in our economy through the expansion of credit, we have allowed economic policy to shift from savings and investment to debt accumulation and consumption. The gap between what we produce and what we consume is being financed by foreign capital. The result has been that we have transferred much of the control of our markets into the hands of foreign powers. It has given our enemies a trump card that can be played at will. Their ownership of so much of our securities market could be used as a weapon to disrupt our financial markets. Author Tom Clancy wrote a fictional account of this type of scenario in his novel Debt of Honor. Colonel John B. Alexander gives another version of this possibility in his book Future War.
Our Financial Bubble Bursting at the Seams
Markets move on the emotions of fear and greed. It may be hard to imagine in a time of prosperity that such threats exist. However, I believe my Storm Series has made the case that much of our prosperity is a financial illusion. It is being fed by the largest credit expansion in our nation’s history. A giant expansion in our money supply, record debt levels, an exploding trade deficit, a negative savings rate, and an overvalued stock market are more reflective of a financial bubble than a new era of prosperity. It is these imbalances that make our economy and markets vulnerable. All it would take is for a rogue wave to burst it.
A Moral Hazard: The Plunge Protection Team
In the financial markets, the risk of moral hazard has come to the forefront. It is delusional thinking that men of power can shape and control monetary policy. As this graph indicates, for the past 30 years all major financial crises have been contained by monetary ease. In fact, in the US a new working group has been created to contain stock market turbulence. Since the October 19, 1987 stock market plunge, when the Dow dropped 508 points or 22.6%, policy makers and regulators have been planning for the unthinkable. In response to the ‘87 stock market crash, an enclave of decision makers was created. This group consists of senior officials from the SEC, US Treasury, the President’s National Economic Council, the Chairman of the Council of Economic Advisors, the Comptroller of the Currency, the Chairman of the Fed Reserve, the President of the New York Fed, and investment banks Goldman Sachs and Merrill Lynch. [12]
Source: Bank Credit Analyst, November 2000
Market Manipulations
These masters of money meet at regular intervals or times of crisis. Their meetings have become the financial world’s equivalent of a war room. They discuss crisis probabilities and contingency plans for a falling stock market. In the event of a crisis, they have a manual called “The Red Book” named after the color of its cover. The Red Book is the battle plan, which coordinates communication links and operations among the US government, foreign governments, members of the investment banking community and various financial exchanges. Their goal is to keep the financial markets operating in the event of a sudden stock market plunge brought on by a panic-driven run on the banks, brokerage firms or mutual funds.
Their greatest fear is that a sudden event could overwhelm the financial markets and dry up liquidity. Their radar screens monitor our financial markets, international markets, multinational brokerage, investment and insurance firms and the currency markets around the globe. Insiders supply them with secret intelligence. So far this group has been through a few skirmishes and minor wars that range from the peso and derivative crisis of 1994, Asia in 1997, Russia and Long Term Capital Management in 1998, and more recently the US stock market this year.
You can see their fingerprints in this year’s stock markets swoons. Their actions were visible in March and April and again in September and October. In the early hours of trading on September 22nd, the Nasdaq Composite Index lurched downward by 14% and by mid-afternoon, the Dow had dropped 350 points. By the end of the day, traders witnessed a rally of several hundred points in the last hour of trading. Word on the street was that someone started to buy large amounts of stock index futures contracts through two major brokerage firms—Merrill Lynch and Goldman Sachs. The financial cavalry had arrived in the nick of time to save the day.
Recent Rogue Wave Interventions
We saw this same type of intervention again on October 12th, when terrorists attacked the USS Cole, a Palestinian mob killed two Israeli soldiers, and Israeli gunships attacked Arafat’s headquarters in response. It happened again on October 26th when IBM announced its earnings and revenues would fall short of Wall Street expectations. The day charts below show a sudden plunge in the stock market followed by an equally sharp rise in the index. The explained source for both turnarounds was a large, unnamed buyer moving into stock futures. To discourage short selling, the buying was widely advertised and the news traveled rapidly throughout the trading community. The Plunge Protection Team was at work in an effort to prop up prices. These maneuvers help to support the illusion of a strong stock market and economy. It also helps to reinforce the “Buy-the-Dip” mentality so prevalently held by the investment public.
These financial war maneuvers help to create a false confidence in our financial markets. In a recent Big Money poll conducted by Barron’s, most pros think the stock market is still heading higher. Most managers view the market’s recent action as nothing more than just a correction. The consensus is that the economy will continue to grow at above-average rates, inflation will remain tame, corporate profits will grow at double-digit rates, and the Fed will soon move to a more accommodative stance.[13] In other words, we will have more of the same – perpetual prosperity.
Outside the Corridors of Control
In my estimation, continued economic prosperity is possible, but unlikely. There are too many structural imbalances created in these last eight years. Remember—the essence of the threat of a rogue wave to our markets is in the tail of the bell-shaped curve as I discussed in Part 1. My hunch is that we have entered a stage of churning similar to the period of 1969-1973.
In the 1980s, Japan’s market grew at a parabolic rate. Their bubble popped in 1990. The Nikkei has never returned to its lofty highs of 1989 when it peaked at close to 40,000. Last Friday, the Nikkei stood at 14,838. The Japanese government has tried everything; from interest rate manipulation, to fiscal spending, to tax increases – all without an energizing effect on their market. Until the imbalances are dealt with, the sun won’t shine on the Japanese market. The US stock market could quite easily find itself in the same boat.
As we begin this new millennium, we have seen the emergence of asymmetric warfare. We have seen the rise of political bodies seeking to manage geo-political issues. We have seen the creation of powerful entities to control and manipulate our markets. We have seen the overall effects of money-pumping, trade deficits, outrageous debt, flagrant manipulation of corporate earnings, and the building of the derivative pyramid. We have seen the agendas of investment bankers, financial analysts and reporters, and dot com pimps. What we have yet to see is the rogue wave … that tail just outside our control.
Our government hopes that they will be able to use monetary policy and the Plunge Protection Team to put out any brush fires that might emerge. However, the next American president, whoever that may be, is going to have his hands full dealing with foreign policy crises. Potentials for crisis are the Middle East, the Balkans, South China Seas, our financial markets and the economy.[14]
As mentioned earlier in this article, when new weapons of warfare are introduced, the rules of engagement change. Asymmetric warfare will transform how war is fought in the future. Unfortunately for some, the reality of this new threat has not struck a responsive chord. An illustration may help to prove this point.
Lest We Forget — The Billy Mitchell Story
At the turn of the last century, we saw the invention of the airplane. Military leaders of the day did not quite grasp the airplane’s significance except for its use in observation. One man, Brigadier General William Mitchell, head of aviation in the Army Signal Corps during World War I, saw it differently. Mitchell knew the invention of the airplane had vast ramifications for the military and the way future wars would be fought. Persuading his doubting superiors to allow him to demonstrate its capability to strike naval warships, Mitchell used an airplane to sink the German warship Ostfriesland in 1921. Tragically, Mitchell’s success in sinking the German warship infuriated those same superiors.
Billy Mitchell returned to the States after the conclusion of World War I as a war hero. But Mitchell “the war hero” soon became Mitchell “the agitator.” He began to criticize the Army and the Navy for their inability to grasp that aviation would change geo-politics and warfare. He warned that World War I was not “the war to end all wars.” He predicted that if an ambitious foreign power used airplanes as a military weapon, it would be able to control the world and not just a continent. He proposed a number of daring innovations for a new branch of service that rattled the Navy admirals and Army generals. He conceived using planes to carry troops over long distances and as long-range bombers with armor-piercing bombs and aerial torpedoes. These were just a few of his proposed innovations. Tired of his persistence, the military brass thought to get rid of this pesky general by sending him to Hawaii, to Europe and to the Far East.
General Mitchell returned with a brilliant 323-page report that was most prophetic. Mitchell believed that Japan was becoming the most dominant nation in Asia and was preparing to do battle with the United States. He also predicted that Pearl Harbor would be attacked by the Japanese using air power. The high command ignored his warnings, which soon became vitriolic attacks against his superiors and Washington. Mitchell was a thorn in side of the military. His scathing attacks were met by a court-martial for insubordination in 1925. Billy Mitchell would continue to lecture and write articles and books appealing for public understanding of the potential of air power in fighting wars. The old warrior died on February 19, 1936.
On December 7, 1941, five years after his death, Mitchell’s warnings came true. Pearl Harbor was attacked by Japanese warplanes. World War II showed Mitchell’s worst critics the importance of air power. Airplanes have dominated warfare ever since. President Harry Truman posthumously awarded him a special Congressional medal in 1948 in recognition for his outstanding pioneer service and foresight in the field of American military aviation.
Conclusion
The significance of Billy Mitchell’s story has relevance for today’s military and political leaders as well as the individual investor. Just as the invention of the airplane changed warfare after World War I, the invention of the guided missile and asymmetric means of conducting war has changed how wars will be fought in the future. With the advent of guided missiles, any city in the US is only 30 minutes away from a missile attack. If a terrorist attack against the USS Cole could bring the market to its knees on October 12th, imagine what a missile attack could do.
Moving from Mitchell’s time to the present day, I find there are many similarities. Like Mitchell’s day, the new threat to the US again comes from the Far East. Instead of Japan, it is China. Instead of the airplane changing military warfare, it is the guided missile and the asymmetric arsenal that poses the greatest threat. Like the 20’s, the investment public is caught up in the frenzy of technology investing with absurd values. But unlike the 20’s, America is no longer a creditor nation. Today we have become the world’s largest debtor nation. We have built our markets on a pyramid of debt and speculation. The arrogance and hubris of Wall Street and Washington has never been greater. In Washington our administration and leaders believe that policies of appeasement and engagement can mollify our enemies and keep peace in the world. On Wall Street, they believe the magic of the Black-Scholes model can contain all forms of risk. And on Main Street, the public remains clueless as to the dangers that lie on either side of the curve.
Many of the topics discussed in this “Storm Series” may be hard to swallow. On the surface it appears that all is well. Investors have confidence in our market and in our economy. The average American still believes that the US military is invincible. There is great faith in our financial institutions and in the Federal Reserve to contain turmoil in the financial markets. Today’s era of American prosperity and our military supremacy is no different than Billy Mitchell’s era of the 1920’s. The stock market of the 1920’s delivered unparalleled prosperity. Technology was advancing at an accelerating pace from electrification of our cities, radio, the airplane, to talking pictures. No one believed that Japan would become a threat to the United States or that our stock markets would collapse, followed by a great depression and another World War.
Holes in the Umbrella of the Curve and Rattles in the Tails
It is my firm belief that we have now entered a time period similar to the markets of the late 60’s and early 70’s. In our day, stock indexes gyrate wildly in a side-way churning pattern with the Fed's monetary policy and the Plunge Protection Team acting as pylons holding the market up like modern-day Samsons. They will try to cushion the losses and keep them contained under the umbrella of the curve. But the risks lie in the tail where the rogue wave lurks. Those rogue waves are geo-political and derivative in nature.
The day will come when the unexpected event occurs. The rogue wave will emerge. Weather patterns are now taking shape. Barometric pressure is dropping and storm fronts are building. Today we see them forming in the Middle East, in the price of oil, in widening credit spreads, and in wild gyrations within our financial markets. Something is definitely brewing.
Seasoned mariners, when confronted with dropping barometric pressure, prepare for a storm. The next Perspectives installment will deal with storm tactics for deflationary or inflationary times.
"He who knows the enemy and himself will never in a hundred battles be at risk." — Sun Tzu, The Art of Warfare[15]
References:
[1] Lowenstein, Roger, Buffett: The Making of An American Capitalist, Company, New York
[2] Kagan, Donald, On The Origins of War and Preservation of Peace, Company, New York
[3] Durant, Will & Ariel, The Lessons of History, Fine Communications, 1997.
[4] Huntington, Samuel P., The Clash of Civilizations and The Remaking of World Order, Touchstone Books
[5] Sun-Tzu, The Art of Making Warfare, Ballantine Books, 1993. Translated by Roger Ames, p. 126
[6] Sun-Tzu, The Art of Making Warfare, Ballantine Books, 1993. Translated by Roger Ames, p. 95, 96.
[7] CNNfn, Microsoft: Big hack attack, 10/27/00
[8] von Clausewitz, Karl, On War, Viking Press, 1983.
[9] NewsMax.com, "Middle East Cyberwar Could Spread to US", November 1, 2000
[10] Blanchard Online, Clinton's Legacy: the Dangerous Decade - Special Report by the Center for Security Policy and The Blanchard Economics Research Unit, 2000 centerforsecuritypolicy.org, economicresearch.net and blanchardonline.com.
[11] Sobol, Dorothy Meadow, Foreign Ownership of U. S. Treasury Securities: What the Data Show and Do not Show, Current Issues in Economics and Finance, The Federal Reserve Bank of New York, Vol. 4 No. 5, May 1998
[12] Fromson, Brett D., The Washington Post, "Plunge Protection Team," Sunday, February 23, 1997.
[13] Crudele, John, FoxMarketWire.com, "Throwing a Lifeline to Sinking Markets Worked; Here's Proof", October 20,2000.
[14] Doherty, Jacqueline, "Ready to Roll," Barron's, October 30, 2000.
[15] Sun Tzu, The Art of Making Warfare, Ballantine Books, 1993. Translated by Roger Ames, p. 96.
Reading Recommendations:
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Perspectives on The American Stock Market: Remembering Agincourt
News Sources: WorldNetDaily.com, NewsMax.com, The Washington Times (Bill Gertz' Column)
Must Read for the Intelligent Investor:
Janes' Intelligence Review
Janes' Defense Weekly
Richard Maybury's Early Warning Report
