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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Capitalism is a system of risk taking, investment, research, and opportunismH. KEPHART WAR IS HELL. General Shermans dictum applies to those who actually fight in it and to those unfortunate civilians whose losses are reported as collateral damage. Mere survival became the overarching objective for millions of people in the last century, known as the Century of Total War. For investors, war is Purgatory. It can include the sudden shock to asset values that comes from the sudden shock of war. The three most recent examples have been the three Arab surprise attacks: the Yom Kippur War of 1973, Saddam Husseins invasion of Kuwait in 1990, and al Qaedas attacks on 9/11. Stock prices were part of the collateral damage from those shocks. But by themselves, those assaults did not inflict lasting damage to stock prices. It was not the 1973 war that savaged the global economy and stock prices, it was the oil boycott and the trebled prices of oil. Saddams invasion hit stock prices hard and oil soared to $40 per barrel, but the sudden victory of Desert Storm unleashed a spectacular stock market rally and drove oil prices to lower levels than they had been prior to the attack. Stock prices collapsed after 9/11, but then rallied when it became apparent that the economy was going to bounce back. These short, sharp shocks are not the most important challenge to investor survival in wars. War is regarded as nothing but the continuation of state policies with other means, said von Clausewitz, and when politics sucks much of the air out of the economy, there is little breathing room for equities. Capitalism is a system of risk taking, investment, research, and opportunism; it flourishes best when government creates a healthy environment based on the rule of law that offers the widest range of choice for businesses and consumers. That means peace, not war. Hikers and campers may fear a sudden attack from a bear or cougar, but few fatalities occur. A surprise bite, however small, from a rabid raccoon or bat is to be feared: Unless inoculated promptly, the victim will die an agonizing death, and yet such outcomes are almost unknown in our time because the vaccines are so readily available and so effective. More insidious, and therefore more dangerous, is the bite of a mosquito carrying West Nile virus, malaria, yellow fever, or encephalitis. The immediate pain is trivial and short-lived. In many cases the victim may not even notice it. The real damage comes later, and can be prolonged and debilitating, if not fatal. For equity investors who dont serve in the military or whose property is not damaged in fighting, the effect of modern wars is prolonged debilitation of portfolio valuationsfor which there is no known cure except peace. PEACE AT REASONABLE PRICE In general, stocks are worth much less in wartime than in peacetime. That should be obvious, but there is a (to me, at least) surprising amount of conviction that war is great news for capitalists. The source of this conspiracy theory of history is, of course, Marx and Lenin, and the dwindling band of self-styled intellectuals who consider their analyses relevant. Wars are double trouble for equity investors: They reduce corporate profits and they reduce the price-earnings ratios paid by the market on those profits. First is the twofold effect on corporate profits: Wars may force governments to raise taxes, and excess profits are ripe fund-raising targets; and war-driven strains imposed on the economy (as discussed below) reduce pretax profits. As for price-earnings ratios, according to a Hansberger Global Investors study, the S&P has only experienced six years in which the yearend p/e ratio ranged between 5.2 and 7.4: Two of those years were 1916 and 1917. Of the 15 years in which the p/e was between 7.4 and 9.7, two years were in World War I, one was in World War II, three were in the Korean War, and two1973-1974covered the period that included the Yom Kippur War. In contrast, every year in which the p/e closed above 21 was a peacetime year in which the threat of war seemed minimal: 1894, 1921, 1933, 1961, 1991, 1992, 1993, 1997, 1998, 1999, and the first 20 months of this millennium. Note that 1961 was the only year of the Cold War in which the S&P closed at a high p/e. That was the first year of the Kennedy presidency, a time of optimism about the magical Camelot personalities who would blow away the stale frost of the Cold War. After Kennedys troubles in the summit meeting with Khrushchev and the Cuban missile crisis, the S&P multiple went back to its normal Cold War range: 16 to 19. Why are stocks worth less in wartime? Because war is one of the two completely inflationary things modern governments undertake on a grand scale. The other is the debauching of the nations currency through reckless printing of money, a problem among many unstable new nations. The advanced industrial nations, in a temporary spasm of panic, collectively seemed to try to adopt banana republic monetarism in 1974 after the oil boycott, and the outcome was double-digit inflation and stagflation. Thankfully, hyperinflation like that of the Weimar Republic (see Paper Promises, in Chapter 6) is rare. Apart from foolish monetary policies, governments only contribute to inflation by misconceived spending (such as the 2002 U.S. farm bill), protectionism, and forcing wages higher than the market would dictate. Nevertheless, even grand-scale absurdities such as the European Unions Common Agricultural Policy (which spends nearly half the total E.U. budget on farm subsidies) do not spawn painful inflation because they also contribute to the creation of goods and services. (Both the U.S. and E.U. farm programs drive down global food prices, hurting Third World producers but benefiting consumers elsewhere.) War is different . . . uniquely different. War is about taking men and women from civilian production and sending them to kill other men and women and destroy the enemys means of production. It is the antithesis of the production, distribution, and selling that are the roots of capitalist wealth building. Governments manage wars on the three C system: command, control, and cost-plus. Railroad cars, transport ships, and planes are requisitioned, sometimes without warning, causing disruptions and supply shocks across the economy. The intense demand encourages strategically positioned unions to make potentially inflationary wage or staffing demands (such as the U.S. West Coast longshoremens job actions in 2002). Prices for essential goods and services are sometimes frozen, creating black markets. The multitudinous variety of goods needed to fight the war are ordered, and if suppliers cannot meet the militarys demands, they can be put on a cost-plus basis as long as the emergency continues. (The rebuilding of the outer ring of the Pentagon within 12 months after 9/11, for example, an astonishing accomplishment, doubtless imposed inflationary pressures on the construction industry in the Washington area.) When governments get big, they become arrogant and inefficient. When governments become gigantic, they become even more arrogant and inefficient. When governments are at war, and move into a command position across the economy, there are no constraints on their arrogance and inefficiency except the individual patriotic and moral impulses of public servants. Those impulses are not distributed equally or universally, either through nature or nurture. Of the many stories that could be told about the inefficiencies of governments in wartime, a good one is the account of how a patriot took great personal risk in confident reliance on those tendencies. Bill Rickenbacker, my officemate at the National Review, chuckled when he told me his tale of cheekiness and audacity in counting on the Pentagon to behave bureaucratically. He enlisted as a pilot at the outbreak of the Korean War. He won his wings at a base in Arizona and was ready to be shipped to war. Then his father, the legendary Captain Eddie, Americas leading air ace in World War I, came through the base on his barnstorming tour to build enthusiasm for the war effort. The next day, Bill was assigned a desk job. He knew his father would never have asked the base commander to exempt his son from war, but concluded that the commander had made a unilateral decision that the Rickenbacker family had already done enough for the nations war effort. Bill pondered his alternatives, then reached a decision. The Pentagon, after all, was just a branch of government, so it was unlikely to be much more efficient. Relying on the slowness of bureaucratic response, he walked out the front door of the base, hitchhiked to the Northeast, doffed his uniform, and won his wings all over again. By the time they caught up to him, he had already participated in air action over Korea. The Air Force blustered about his defiance, but on reconsideration, decided to close its already large file prepared for submission at his court-martial. |
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