Thursday, December 29, 2016

“The War Hypothesis Is Strengthening”

“The War Hypothesis Is Strengthening”
by Jim Rickards

"At my research service, "Intelligence Triggers," we use a unique method to forecast and invest in markets. We call it the Kissinger Cross. And it’s backed by the same method used at the CIA to forecast terrorist attacks, war and other geopolitical events. It gives you an advantage over everyone else. Here’s what I mean…

War has existed as long as civilization (perhaps longer) and shows no signs of disappearing soon. Veterans and affected populations know the horrors of war firsthand. Even the casual student of history is acquainted with the trauma and tragedy of war. The great irony of armed conflict is that few welcome war but it happens anyway through a complex mix of accident, ambition, revenge and escalation. Despite the headlines, the world has actually been a mostly peaceful place since the end of the Cold War, in 1991. Yet peace is a relative condition in a war-prone world.

We have witnessed major wars in the former Yugoslavia (1991), Afghanistan (2001) and Iraq (2003). The war or terror has persisted throughout this period, including spectacular attacks in New York (1993, 2001), East Africa (1998), Madrid (2004), London (2005), Paris (2015) and Berlin (2016). Civil wars have continued in Colombia, Yemen, Syria and beyond.

Despite this litany of conflict (which could easily be expanded), the world has not recently witnessed conflict on the scale of the two world wars of the 20th century or the Napoleonic Wars of the 19th. The urgent issue for geopolitical strategists and leaders today is whether a period of relative stability is ending. Has the potential for a new world war risen materially? The answer is yes.

Still, that does not mean world war is imminent or inevitable. It does mean that relations among major powers are more fraught, and the military capabilities of those major powers are receiving renewed attention. This geopolitical estimate may seem startling, but it is based on a sound methodology. What tool do we use to formulate our estimate? We do this with a method called inverse probability. This is based on a 203-year-old formula first discovered by Thomas Bayes. The formula looks like this when expressed mathematically:
In plain English, this formula says that by updating our initial understanding through unbiased new information, we improve our understanding. Basically, the probability of any event can be inferred by the conditions related to that event. The power of the theory is that conditions used to estimate probability may arise after the initial probabilities were assessed. This is why it’s called “inverse probability.”

Most statistical methods start with data and end with a thesis. Our method starts with a thesis and then strengthens (or abandons) the thesis based on subsequent events. When you have plenty of data to begin with, it’s fine to use normal statistics. But when you’re trying to solve tough problems with scarce data, our formula is the way to go. The CIA uses this method, and we use it at Intelligence Triggers to hone our investment theses and create our Kissinger Cross indicator for individual investments.

A basic war hypothesis can be formulated against a backdrop of U.S. weakness, Iranian hegemonic ambition, Chinese and Russian expansionism, Islamic extremism and North Korean recklessness. What recent information has come our way that strengthens our war hypothesis? It’s a long list:

• China is aggressively asserting its military influence in the South China Sea, and claiming areas also claimed by key U.S. allies. An isolated incident or accident has the potential to escalate. China has also recently captured a U.S. Navy underwater drone operating in international waters, which by itself will not lead to war. But it is a provocation and similar incidents can be expected
• The U.S. has imposed fresh sanctions on Russian companies, a direct result of Russia’s activities in Crimea and Ukraine. Consequently, Russia has said relations with the U.S. are “frozen.” In a move many may find surprising, a Russian government spokesman has said he doesn’t expect a dramatic reversal when Trump becomes president
• Increased Russian bomber and submarine patrols near the U.S. have approached levels unseen since the Cold War. Russia has also pledged to modernize its nuclear forces. Meanwhile, NATO forces have conducted exercises close to the Russian frontier. Both countries are also backing opposing parties in Syria and the risk of an accidental incident remains
• Turkish forces are now active in strategically important parts of northern Syria and have been engaged ISIL in battle
• Terrorist attacks, like the one we just had in Berlin, tit-for-tat trade sanctions and escalating international tensions are distressingly familiar.

What strikes us as significant about these recent developments? The tempo and the geographic and political breadth (these developments directly involve Russia, China, Turkey and Syria). It’s a mistake to put these stories into the “business as usual” category. The timing, interconnectedness and escalatory dynamic of events look more like a prelude to wider wars than a mere series of setbacks.

At Intelligence Triggers, we look for connections that others miss due to an overly narrow focus on one region or subject area. In this context, a highly significant event not involving geopolitics took place just two weeks before the Islamic State attacks in Paris last year.

Last Oct. 26, the U.S. Congress and White House agreed on a two-year budget compromise that lifted the ceiling on U.S. debt. It also busted the spending caps agreed to in 2011. The acrimonious budget and debt ceiling debates of the past four years were suddenly over (at least until 2017, after the presidential election). This peace treaty between Democrats and Republicans on budget and deficit issues was not without costs. Both parties had been chafing under budget caps enacted in 2011.

Democrats wanted to spend more on social programs. Republicans wanted to spend more on defense. What both parties had in common was a desire to spend more. What’s the point of being a politician if you can’t spend more of the taxpayers’ money? For fiscal years 2012, 2013 and 2014, the budget caps enacted in 2011 were a taboo subject in Washington. Neither party dared to break them. Republicans did not want to risk tea party anger by busting the caps. Democrats did not want to be painted as the party of big spenders. Both sides kept their heads down.

In late October 2015, in a secret, backroom deal, both parties got together to bust the caps. A new Washington spending spree is about to begin in earnest. The only way to make such a backroom deal work is to offer something for everyone. The Democrats will get more money for teachers unions, and the Republicans will get more money for defense contractors.

And now that Republicans are fully in charge of both Congress and the White House, Trump has pledged to raise military spending dramatically, all signs indicate a major increase is on the way. Trump has pledged to work with Congress to repeal the defense sequester and rebuild the military that’s been worn down fighting wars in Iraq and Afghanistan. And it’s reasonable to assume that with pro-defense Republicans in control of both the White House and Congress, the defense budget should rise substantially.

Total U.S. spending for 2016 is approximately $3.5 trillion. Most of that government spending is on autopilot. Entitlement programs such as Social Security, Medicare and Medicaid are not affected by annual appropriations. The money is spent according to a formula that politicians do not want to change. Interest on the national debt is also automatic. It must be paid or the U.S. Treasury market goes into default. Entitlements and interest on the debt together comprise 71% of federal spending.

The part of the budget politicians fight over is actually just roughly 30% of federal spending. Of that, slightly more than half is military spending and the remainder is spent on a variety of domestic programs including education, transportation, science, energy and the environment.

At Intelligence Triggers, it’s not our job to referee the political process or take sides in partisan debates. Voters are smart enough to do that on their own. We are analysts, not partisans. Our role is to help you profit and preserve wealth by staying ahead of powerful trends that affect your portfolio.

Right now we see the convergence of war drums and war spending. Defense and intelligence contractors have been starved of large, discretionary appropriations for almost a decade (defense spending was being cut even before the 2011 budget caps). Now the caps are gone, Trump will soon be president and the need is pressing. It’s a new day for large firms in the defense sector and some of the niche players in national security. No one wants war, but it’s reckless not to be prepared."
Related:
"America Has Been At War 93% of the Time– 222 Out of 239 Years– Since 1776"

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