Markets are only expected to recover once the Iraq situation is resolved but investors must learn to price potential consequences
There are few universal truths in the markets. Do not go to work for Goldman Sachs Group if you want to get out of the office early is one. Do not sink your pension fund into emerging market currencies is another. Currently, there is a third: the markets will not recover until the situation in Iraq becomes clear.
John Snow, the US Treasury secretary, endorses this view, as does Wim Duisenberg, president of the European Central Bank, Sir Edward George, governor of the Bank of England, and Antonio Fazio, governor of the Bank of Italy.
Here is how Snow put it recently: 'There is a recognition the geopolitical situation is an important backdrop, influencing markets and serving as a restraint on capital expenditure and equity markets.' There is, Snow added, 'the expectation that once this issue resolves itself, capital expenditure and equity markets will respond.'
But maybe Snow, Duisenberg and the others are wrong. Maybe a resolution of the situation in Iraq will not clarify the outlook for markets or the economy. There are two reasons this might be so. First, the Iraq war is part of a global war on terrorism; it is not going to end quickly or neatly.
Second, war in one form or another has been a constant of the past decade, and may well be a constant of the decade ahead. If limited military conflict has become a constant of life, and if the economy freezes each time a war looms on the horizon, we may never get a recovery.
To overcome this impasse, the markets need to cope with the prospect of constant, if limited, war. Investors must learn to price the potential consequences of military conflicts and then move on.
This should be possible. War is the most unpredictable of all human activities but markets are all about pricing uncertainty.
Investors are already groping to price the new order of war risks. Market talk goes like this. A short, bloodless war (call it an SBW) and oil could be trading at $10 a barrel by autumn. A long, nasty war (an LNW) and oil could be at $50.
An SBW and Iraq could be the centre of a booming, post-war reconstruction economy spreading across the Middle East. An LNW and the US could be running a massive budget deficit for decades, prompting a collapse of the dollar. An SBW and a victorious Prime Minister Blair could cruise to victory in a snap referendum on joining the euro. An LNW and Blair could fall, plunging Britain and the fate of the euro into uncertainty.
In the face of such talk, it is easy to understand why individual businessmen are holding off acquisitions and other major investment decisions. It is easy to see why investors are biased against risk. There are probably only a few weeks to go until the shooting starts and the range of outcomes is so wide, there is little to lose by taking the least risky option.
Yet, when everyone holds off on decisions, the economy suffers. If conflict in Iraq, along with the war on Afghanistan, is the beginning of the war on terrorism, not the end, what does that mean for economic decision-making beyond Iraq?
Most financial leaders are children of the Cold War. From 1945 until 1990, the world saw the prospect of military conflict as cataclysmic. This view is outdated. In the new reality, war is terrible, but common, and in economic terms, not necessarily of huge consequence.
Since 1990, we have seen Gulf War I, the Balkan wars and Afghanistan, not to mention armed conflict in Africa. Now we are looking at Gulf II. Beyond Gulf II looms a possible conflict in Korea.
The idea that the market outlook will clear up once the situation in Iraq is resolved is a Cold War way of thinking. We need to catch up to the new reality.
Take, for example, stock price weakness stemming from anxiety about the rift between the US, France and Germany. The market needs to understand such debates are likely to become a fixture of international life. From here on, the US and its allies may be arguing almost permanently about starting, fighting or clearing up after a war.
However the situation in Iraq evolves, it is unlikely to bring us back to where we were. Central bankers and finance ministers who encourage us to think differently, who say we will return to some sort of normality once the situation in Iraq is resolved, are making a mistake.
Bloomberg London newsroom
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