The slowly evolving new world order?!

I would like to begin today’s articles with 2 disparate series of current affairs – The Gaza conflict & India PR fiasco. Though these series of events prima facie do not appear to be connected with the theme (money) of this blog, I will make an attempt to connect the dots. In this article I would spend a few paragraphs on Gaza.

The Gaza Saga
Most of the headlines in media today are occupied by the massive assault by Israelis on the Gaza strip. Many questions are being raised. Few of these have been discussed ever since Israel came to the being. Why the conflict? Why is world at large not pressurizing Israel enough to end the war? Why are deaths of thousands of innocent civilians being grossly ignored? While the history of Israel is full of hatred between Arabs & Jews, some of the recent reasons for this assault have relevance to the financial situation in world today.

The invasion plan of the Gaza Strip under "Operation Cast Lead" was set in motion in June 2008. This is a war of conquest – conquest for control of territory & oil reserves! Discovered in 2000, there are extensive gas reserves off the Gaza coastline. The BG Group drilled two wells in year 2000: Gaza Marine-1 and Gaza Marine-2. Reserves are estimated by British Gas to be of the order of 1.4 trillion cubic feet, valued at approximately 4 billion dollars. There is strong belief that these 2 reserves are probably the tip of the iceberg. As soon as you realize this, all the questions begin to answer themselves. Why is Israel launching an assault on a weak neighbor who does not even have a trained army? Why are most sophisticated weapons being used against a country that has only the crude rockets? Why are civilian dwellings the primary target of attack? On the surface, one struggles to find any strong justification for these.

The second set of questions relate to passive approach so far by rest of the world, especially the west. However those questions also start looking too naive once we take a look under the covers:
1) Need of strong ally in Oil rich Middle East. Israel is perfectly placed due to the fact that it is the only democracy in that part of the world.
2) Global leadership in innovation – science, technology, military, health care etc.
3) Controls financial superpowers of the world
4) Most holy site for 3 major religions – Judaism, Christianity, Islam
5) All this present mostly “artificially created war situation” is a perfect excuse to refresh accumulation of weapons, troops & military bases in a possible attempt to tame Iran in future.
6) War is probably a good way of absorbing the pile of new money supply that the current crises have forced, without increasing the inflation too much, at least in the short to medium term.

It is no secret that most of the biggest financial institutions of the world are controlled directly or indirectly by the Jews. In the recent bloodbath in the financial world, many of those financial superpowers collapsed. In many cases petrodollars have saved parts of these fallen superpowers. Which means rise of Arabs while Jews have been losing financial ground. In this light, the current Gaza battle may be the prologue to the bigger conflict in the region.

What currency scenarios could emerge from this point?
Now let’s continue the discussion on financial systems from where I left it in my last article. The Matrix may have been ponz’d & eventually will have to sort itself out. Here is my attempt at various scenarios that may evolve in the long term.
1) USD remains the currency of the world – This means USA will be able to continue influencing all the important countries that matter in global trade scene - to keep their faith in USD. This scenario also assumes that the non backing of USD by gold continues without too much of turbulence in the cross currency rates. USA would continue to convince the world not to relinquish their USD reserves (thereby devaluating the currency). In the long run (5 to 10 years), this scenario becomes more & more difficult to maintain. Please see my earlier articles for understanding why.
2) Some other currency replaces USD – This is an extreme & quite unlikely scenario. If this happens, then the pivot would change for capital flows, Forex market, international trade etc. All countries with USD reserves will go into a tailspin till the valuation of dollar dominated current reserves are revalued at acceptable level. At this point, I do not see any single currency taking the seat of USD.
3) Mixed scenario – Common currency for oil trade combined with USD for other major international trades. This option may emerge in the light of the six countries of GCC (Golf Cooperation Council) objective of coming up with common currency (named Khaleeji) by 2010. However by the speed of execution so far, it appears quite unlikely that the schedule would be met. Could be a long term option though.
Scenarios 2 & 3 have a great potential to cause worldwide aggression. Has a remote chance of a widespread war in the short term. This has a possibility of mass destruction while US would primarily focus on its resources to manufacture, deliver (including sell to allies) & use weapons. One of the major limitations of the third scenario is that this will put 2 very significant powers in the hands of the oil cartel nations – currency control & oil control. For the right balancing of the economic power, it is perhaps very important for the world to decentralize these 2 powers.
4) No single world currency - Each currency would be revalued against Gold. Gold would be the official pivot for all currency markets. The individual central banks would be required to back their own money supply with some percentage of Gold (say 5-10%). Every country would then be free to undertake their international trade in the currency of their choosing. This scenario means that world returns to “partial gold standard”. The partial gold standard is likely given that the full gold std has already been tried & it’s major limitations known.
5) A limited variation of “partial gold standard” - In this scenario, only USD is backed by some quantity of Gold reserves. The current financial system may be treated like a partially bankrupt or sick unit. May lead to big financial restructuring of the world economy. Somewhat similar to revival package for a sick corporation. In this scenario, every country gives up some value of their USD reserves. USD is revaluated against Gold. US treasury may be forced to back the USD supply with some percentage in Gold (say 5-10%). This is the most advisable option in the given situation. All countries help each other in propping up world economy in unison. The biggest advantages of this system are that we will not get into the kind of reckless situation that we are in today. The money supply will be determined by the amount of gold available with US treasury. The disadvantage is that the growth of the world economy would be limited since US treasury/ Fed would not be in a position to issue as much money supply as they wish. However this necessarily is not really a disadvantage. This would mostly truly encourage the market forces to determine the countries to gain comparative advantage over each other. The real disadvantage would be that all countries that have dollar reserves, will have to take an initial hit in revaluating their reserves. The countries that have international debt, would mostly benefit because their liability would go down. However I think this is the price that we need to be willing to pay if we want to correct the huge mistakes we have committed.

Handle with care…
Whatever may be the situation right now or long term evolution, an average individual ought to stay prudent, looking for options all the time. A static portfolio is definitely not the order of the day.

There are few assets that have appreciated despite the slowdown – Gold, high quality corporate bonds, distressed assets, fixed income Govt. securities. Gold has been a strong performer compared to most other assets in 2008. Significantly, gold is the only asset that is outside the credit system and the only asset that has no liability. In 2008, spot prices gained a modest 1% - not much in absolute terms but certainly impressive compared to other plunging assets. Also Gold has appreciated or stayed at the same levels despite sharp decline in oil prices. This indicates a very solid intrinsic value for this metal.

This is not the time to aggressively invest in equities. For those who have compelling urge to invest in stocks, I would suggest very limited exposure. I expect the industries like Security (physical, logical, insurance), Entertainment (includes sports), Energy & Infrastructure to perform relatively ok.

Depending on your risk appetite, keep good quantity (40% or more) of your portfolio in cash or cash equivalents, 10-20% in gold, not more than 5-10% in stocks, rest in high quality corporate bonds & Govt. securities. Cash in hand is required due to two factors – to take care of any impact due to economic uncertainties and to take advantage of buying any distress assets. Also this cash would help you be flexible in balancing your portfolio as we go towards relatively less turbulent era.