Thursday, August 04, 2005

The mother of all punch lines

The financial pages of major newspapers usually have plenty of fare to feed, both, bullish as well as bearish moods. What to make of the WSJ's inclusion (in their "Money and Investing" section) of historian Niall Ferguson's comparisons of 1914 with today, recently delivered to a gathering of Merrill Lynch executives and clients? There is a punchline at the very end. But it's worth reading the build-up first.

"The Big Picture: Circa 1914
Historian Sees Similarities In Today's Investment RisksAnd Pre-World War I Era"

"In a world that has become increasingly savvy in understanding and measuring all kinds of risks, investors often ignore what may be the biggest of all -- geopolitics.

"Big mistake, says Harvard University history professor Niall Ferguson.

"In a recent lecture to Merrill Lynch executives and clients, he contends that in analyzing financial and economic risks, forecasters tend to ignore geopolitical ones. And when they do take politics into account, investors usually stick to what they can personally recall.

"We need to go further back than living memory to understand the predicament in which we currently find ourselves," says Prof. Ferguson, according to a transcript of his lecture.

"That 'predicament' is the uncanny similarities between the current era of globalization and the original one of roughly 1880-1914, which first harnessed the powers of global communications and swift transport to link the world economically. That ended with the June 28, 1914, assassination of Austrian Archduke Franz Ferdinand and the onset of World War I.

"Then, as now, fears of inflation were negligible. The difference in yields on corporate and emerging-market bonds and those on benchmark government securities was shrinking. Stock-market volatility was abating. Commodity, especially energy, prices -- then it was coal, today oil -- were rising rapidly.

"Other parallels, notes George Magnus, senior economic advisor at UBS, include deregulated and integrated global capital markets, expanding international trade, strong foreign-direct investment flows and the search for new markets.

"As for geopolitics, the first era of globalization was marked by 'a dominant but financially overstretched global power, rival powers that defined themselves only in opposition to the dominant power, new regional powers with global aspirations, the Great Game in Central Asia [then over access to India, now to oil], a proliferation of 'failed states' and state-sponsored armed groups,' Mr. Magnus says. Then the global power was the U.K., now the U.S. Sound familiar?

"Add in anti-Western armed organizations -- in the 19th century, they followed the teachings of Karl Marx, today Osama bin Laden -- and "there is a striking resemblance between what is happening now and what was happening 100 years ago," Prof. Ferguson says.

"Of course, any parallels go only so far and no one is saying investors should dive under the bed. Still, in the years preceding the First World War, investors chose to ignore the threats that were brewing. The well-oiled global economic and financial machine had fostered a "sense of exaggerated security," Prof. Ferguson says. That's a valuable lesson to remember today.
In fact, back then the mood was so complacent that the first mention of the possibility of even a small war the Harvard academic could find in the financial press was an article in The London Times of July 22, 1914. That was just seven days before the Austro-Hungarian artillery began bombarding Belgrade and less than two weeks before Britain declared war against Germany. Major European financial markets closed for the rest of the year.
'Everybody thinks the biggest financial crisis was the [1929] Wall Street crash and its aftermath,' Prof. Ferguson says. 'But 1914 was far, far worse...if they had allowed the markets to reopen, there would have been a complete wipeout.'

"So what is today's investor to do? 'Gold would be the best thing to have as a long-term store of value,' says Eoin Treacy, a strategist at, a global strategy service. Investment strategists also say that commodities should perform well, along with investments designed to enable investors to bet on increased volatility. Meanwhile, stocks should do poorly, because a catastrophe probably would rattle consumer confidence and in turn economic growth.

"Investors currently regard bonds as largely a haven. Money managers warn that the threat of surging oil prices could fuel inflation, which could sink long-dated bond prices. For instance, bonds failed to offer investors any protection during the 1973 Yom Kippur War. Prof. Ferguson notes that in off-market trading from July 8 to Dec. 19, 1914, Austrian government bond prices plunged 23%, while French securities fell 15%, Russian ones 8.8% and U.K. bonds 9.6%.
To be sure, there have been some improvements in the past 100 or so years. There are many more democracies, and warfare is on the wane. What is more, many economists think policy makers have learned from past mistakes.

"Even so, Prof. Ferguson says, "Globalization could end in our time, not with a whimper but with a bang." The hard part, he acknowledges, is designing "a perfect portfolio for coping with the outbreak of World War III."