Republished from Money and Markets, July 31, 2006

Not long before Dad passed away, we walked in the fields near my home in Florida, debating the likelihood of another world war.

I said it was highly unlikely. The Cold War proved that weapons of mass destruction were a great deterrent. And even the Cold War was over.

He argued that the Middle East crisis had never been resolved, that it was the epicenter of hatred throughout the Muslim world, stretching from North Africa to East Asia.

He did not expect the kind of World War III that we used to fear in the 1950s. But he said he’d be surprised if the world could avoid a low-level world war spreading from region to region.

I tried to dissuade him of that notion. But now it looks like I was wrong and he was right.

Recently, I took another walk, this time by myself. I was in downtown Manhattan, at Ground Zero.

The walk around the cavity is about 12 city blocks. Stopping and starting, it took me about 20 minutes, prompting some thoughts I want to share with you now.

Unfinished Wars

On Church Street, to the east of the cavity, I stop briefly before the WTC Memorial, and I remember the first weeks after 9/11.

That’s when the Taliban in Afghanistan was defiantly refusing to turn over Osama bin Laden. So the U.S. began air strikes against Afghan military installations and terrorist training camps.

Just three months later, the Taliban regime collapsed and its troops fled their last stronghold in the southern city of Kandahar.

Everyone thought that was the end. It was over. We won. But they thought wrong.

Now, here we are, five years later. The Afghan war is far from over. Three new wars have begun. Several more are on the immediate horizon.

Even at this very moment, critical events are taking place that could accelerate the pace of change:

Afghanistan: Right now, it’s close to 8 a.m. in the East, 4 p.m. in Afghanistan, Monday, July 31. NATO troops are in the process of taking over security in the south from the U.S.-led coalition.

But the timing is terrible: The region is going through its bloodiest phase of violence since the fall of the Taliban in 2001.

Just last week, hundreds of Taliban fighters attacked a western Afghan government building with rocket-propelled grenades and machine guns in one of their boldest strikes ever.

Just yesterday, Taliban insurgents threatened to kill an engineer captured in the south.

The new NATO commander, Lt. Gen. David Richards, thinks he has a solution. On Saturday he announced he’s going to do more than just target the Taliban. He says he’s also going after the powerful warlords running the lucrative opium trade.

Problem: NATO has only 9,000 troops to cover rugged mountain terrain the size of Texas.

By contrast, when the Soviets invaded and occupied Afghanistan in the 1980s, they used over 500,000 troops. Their death toll alone — more than 15,000 — was far more than the total number of NATO troops deployed in the country today. And still, the Taliban ultimately won.

Iraq: The Pentagon has just extended the tour of 4,000 U.S. troops, expanding the total number in Iraq. But now the troops have a new, far tougher mission:

Instead of just putting down an insurgency, they also have to stop a civil war. Instead of fighting one amorphous enemy, they’re fighting many — jihadists, Shiite militias and often, even corrupt government forces themselves.

Last week, Iraqi Prime Minister Nouri Maliki told Congress that, if the U.S. loses in Iraq, it will be a monumental victory for worldwide terrorism, an event that could be tragic in its consequences.

What he failed to mention, however, is the corollary tragedy: Even if the U.S. prevails in Iraq, it could be a victory for Iran.

Reason: The U.S. has little more than a short-term alliance with the Shiite leaders of Iraq, based on convenience and expediency. In contrast, Iran has a long-term alliance with the Shiite leaders, based on decades of mutual suffering against Saddam ... long years of joint training exercises ... deeply shared religious beliefs ... and intimate contacts that continue to this very day.

Iran: When most Americans see the news of war between Lebanon and Israel, they still don’t make the connection to the looming conflict with Iran. But others do.

In Tehran this weekend, Iranian officials, former officials and analysts said a conflict with the West is now so likely they’re deathly afraid to even talk about it. Their interpretation: Israel’s war against the Hezbollah in Lebanon is actually America’s first salvo in its coming war against Iran.

The view coming out of Washington this week is very similar, but in reverse: Hezbollah was created by Iran, financed by Iran and armed by Iran. Hezbollah is Iran’s front line. Ergo, Hezbollah’s incursion into Israel is Iran’s way of attacking the West.

This is precisely what I explained here last week. Connect the dots, and you’ll see that, indirectly, Iran and U.S. are already at war.

Syria: Last week, Syria warned it would not allow Israeli planes to approach its borders, threatening to jump into the war if that happened.

But this weekend, Israel bombed targets less than one mile from the Syrian border, destroying the Lebanese immigration office building.

Syrian forces have already been put onto their highest state of alert. Israel has called up 15,000 reservists that could be dispatched as reinforcements to the Golan Heights, disputed between the two countries.

Rockets made in Syria have been discovered among the many fired into Israel. Anger is at the boiling point. Despite diplomatic efforts by Secretary of State Condoleezza Rice, Israel and Syria are edging closer to direct military conflict.

Other possible wars and revolutions. Oil-rich Saudi Arabia, a staunch supporter of the Sunnis in Iraq, could be dragged into the conflict. Turkey, an avowed enemy of the Kurds in Iraq, has sworn to send in troops just as soon as Iraqi Kurdistan splits away from Iraq.

Central Asia is a powder keg, including not only Chechnya, which has been decimated by two wars, but also the former Soviet Republics of Azerbaijan, Turkmenistan, Uzbekistan, Tajikistan, and Kazakhstan. India and Pakistan are on the brink. North African nations are also shaky.

Wall Street Oblivious
To the Real Dangers

I walk down Vesey Street and stop again to peer into the deep pit. Its depth never ceases to amaze me.

Its proximity to the world’s financial core is also impossible to ignore — the New York Stock Exchange just a few blocks away ... the American Exchange even closer ... the New York Mercantile Exchange where energy futures are traded ... the Nasdaq everywhere and nowhere ... the U.S. government securities markets also scattered in many locations.

But strangely, on Friday, investors in most of these markets celebrated.

They seemed to be happy that U.S. the economy has slowed down. They didn’t seem to care about the causes — the fact that the economy is choking on higher interest rates and feeling the pinch of surging fuel costs.

Instead, these investors think the bad news is actually “good news.” Because, they say, it should prompt Fed Chairman Ben Bernanke and his cohorts to be more merciful when they meet on August 8 ... maybe to even leave interest rates unchanged for a change.

Ironic, isn’t it?

The WTC Memorial is just down the street. And from the Memorial, it doesn’t take a great leap of logic to connect the dots to the wars raging in the Persian Gulf and the Middle East ... to surging energy prices ... to the main reason why interest rates are rising ... to the main reason why the U.S. economy is slowing ... and to the threat of still more oil price surges and still more rate hikes ahead.

Yet, investors still don’t get it. They buy what they should sell; shun what they should buy.

Until recently, I could understand the disconnect. Many of the conflicts seemed subdued or suppressed. Or they simply failed to rise to a level of significance that might dent the powerful economic growth engines of the industrial world.

But now, all that’s changing. Now, the conflicts are approaching critical mass, with a far greater impact on our economy and on our daily life than anyone dreamed possible a year or two ago.

So no matter how tired you may be of the drumbeat of CNN or Fox News night after night, you can ignore this danger no more. You must sit up, listen and recognize it for what it really is: Not just a worldwide war on terror ... but also, potentially,

A Low-Level
World War III

I’m referring to a worldwide war on terrorism combined with spreading regional wars like we’ve seen in Afghanistan, Iraq, Israel, Palestine and Lebanon.

Most people, including many experts in many governments, think about these far-away conflicts in just one dimension: Radical Muslim movements; anti-American or anti-Western violence.

In reality, they stem from multi-dimensional, multi-cultural fissures, and many of these fissures have already ruptured ... or seem about to do so soon.

The most critical fissure is economic. With a few notable exceptions, corrupt, filthy-rich despots, monopolists and oligarchs control most of the wealth in the Muslim world.

Even in the richest of them all, Saudi Arabia, thousands of royal princes have a lock hold on the most strategic positions in government, commerce and industry.

At the same time, throughout these regions, desperate, downtrodden urban and rural poor have little or no access to adequate housing and modern sanitation — let alone good health care or education.

The second fissure is ethnic. Within the Muslim world, wealth and power is typically controlled by the Sunnis, the majority sect; while the poor and powerless are more numerous among the minority sect, the Shiites.

Another major fissure is cultural. The elites are modern and Westernized. The masses are not. In a few countries, middle classes are struggling to emerge, but in most areas, they are being squeezed, forced to move out.

A fourth fissure is religious. Islamic fundamentalists clash with more moderate Muslims, and both clash with Christians, Jews, Hindus and others. Even as far East as the island of Mindanao in the Philippines, Muslim fundamentalism is the primary ideological tool used by militants and insurgents to recruit members.

The fifth is historical. The protagonists trace their conflicts through millenniums of battles, wars and massacres. Using a mix of historical fact, legend and myth, they build a pseudo-moral case for revenge and martyrdom.

The sixth and most frightening fissure is military. Virtually all of the hot spots I’ve told you about are like armed camps. That includes established regimes armed to the teeth. Plus it includes ubiquitous stashes of dangerous weapons outside the control of the authorities — in hideaways, places of worship, homes, even schools.

Dangerous Alignment

A wind seems to blow more strongly as I leave the protective barriers of Ground Zero behind me. I remember that all these conflicts and fissures have been with us for many years. So what has really changed?

It’s simply this: In the past, each fissure was on a different plane, with differing consequences, occurring at different times. Now, the globe seems to have rotated in such a way that the fissures — and the anger they generate — are coming into dangerous alignment.

Each of the lines of conflict — the vast economic chasms, the deep cultural voids, the wide political divisions, the die-hard religious and ethnic hatreds — are coming into synch along one axis and with one by-product: violent change.

With the war in Iraq and the latest blow-up in the Middle East, radical movements are gaining far more prestige, public support and financing. Moderate leaders, meanwhile, are losing public support, even becoming a laughing stock.

The impact is self-evident:

First, more inflation. The global conflicts will inevitably disrupt supplies of critical commodities.

Already oil pipelines are being blown up almost daily.

Already, as I showed you last week, even before any significant supply disruptions, most commodity prices have surged.

Reason: Governments all over the world are pumping up the demand for commodities with liberal doses of paper money.

One of the missing elements in the inflation puzzle has been wage inflation. Wages were mostly stable. So economists everywhere said inflation was not a concern.

Now, however, wage inflation is also beginning to kick in. We’ve seen a substantial uptick in average salaries in the most recent government releases. And in the next few days, Congress will approve a substantial hike in the minimum wage.

Last week, the House voted 230-180 to raise it by a whopping 41% from $5.15 an hour to $7.25 by mid-2009. It’s long overdue for the poor. But it’s too much too soon for an economy that’s already suffering from a sinking dollar and out-of-control commodity prices.

Result: Despite the slowdown in the economy, inflation will continue to get worse.

Second, stronger energy stocks. You saw the blow-out earnings. You saw the energy stocks turn sharply higher last week. And you can see that nothing in the long, 3-year-plus trend has changed. This is exactly what we’ve been saying would happen all along. Now it’s moving along according to script.

Third, higher interest rates. If the Fed doesn’t raise interest rates on August 8, it will send a message to the world that it’s not serious about inflation after all. Foreign investors will dump they U.S. dollar. They’ll dump U.S. bonds. And that alone will drive up interest rates regardless of the Fed.

That’s the main reason I think the Fed will raise rates. Fed Chairman Bernanke has already lost credibility by not acting more firmly against inflation a lot sooner. If he wimps out come August 8, he’ll fall even further behind the curve. And later, he’ll be forced to raise rates that much more.

Fourth, major bear markets in key industry sectors. Housing and construction companies. Mortgage lenders. Retail chains.

The silver lining: Higher interest rates also give you the opportunity to earn higher yields — provided you build your savings and you don’t make the mistake of locking in still-low interest rates.

So keep a big portion of your money safe. Stay liquid and flexible. And be healthy.

Good luck and God bless!

Martin

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