Today, the battlelines pit jihadist puppeteers in the establishment against their jihadist puppets outside. The puppeteers have become the targets of those whom they reared for long”. So wrote Brahma Chellaney in The Economic Times on the situation in Pakistan after the raid on the Lal Masjid in Islamabad. The question is whether the roles would reverse soon in Pakistan and if so, what are the global implications.
Since the Pakistan army stormed the Lal Masjid two weeks ago, the Karachi 100 stock index in Pakistan dropped 7% from its peak level. It is an insignificant drop in the light of the fact that the index had gone up by 920% in the last five-plus years—evidence, if any was needed, that investors in the last five years were partial to good news. However, the bigger issue is whether the reaction in the Karachi 100 index portends things to come for other global assets.
The “liberation” of the mosque has been followed by a wave of suicide attacks that have left nearly 200 people dead. Most commentators have limited themselves to speculating on the future of General Musharraf. In the larger scheme of things, that is inconsequential. The real issue is whether there is a possibility that an overtly Islamic fundamentalist regime replaces General Musharraf and forms a government in Pakistan with the support of sympathetic elements in Pakistan army and the intelligence agency.
Experts with whom I spoke do not dismiss the possibility but suggest it could still be some time away. Surely, the storming of the mosque might have brought matters to a head but it might not lead to its inevitable conclusion. Not just yet. Back in September 2001, America warned Pakistan that it would bomb Pakistan back to the Stone Age if Pakistan did not join the US-led war on terror. Pakistan overtly did so and its duplicity is now under the spotlight. If its duality were to be abandoned overtly, then the threat of American bombing resurfaces. That is where the US election cycle becomes crucial.
Once it becomes clear to the fundamentalists that the US would have a government that would not contemplate bombing Pakistan back to the Stone Age, the train to take control of things in Pakistan would be set in motion. In fact, any American response would serve the cause of fundamentalists rather well. The consequences that would flow from the completion of Pakistan’s journey to an openly theocratic regime would be grave. They would be in the driver’s seat in a country that has nuclear weapons and oil installations in West Asia would come within their range rather nicely. The clash of civilization would be just a step closer.
One cannot blame investors for not thinking this far. In the last five years, financial markets have not been for either the thinking investor or for the thinking investors’ managers. They have been egged on by vacuous cheerleaders in Wall Street. They first argued that the problems in the American mortgage industry would be confined just to mortgages. Then, when it spilled over to mortgage finances—securities created on these—they assured us that it would not spill over into the broader credit market. Now that it has spilled over into the broader credit market—credit spreads are widening and bankers are pulling in loan syndication because investors have finally woken up from their slumber—they are telling us that equities would be spared.
On Friday, stocks in the US dropped and the yield on the average emerging market bond widened. Significantly, this was not accompanied by a decline in the price of gold and silver. Prices of both rose on Friday. It is possible that risks are coming back into the analytical framework. There is plenty of it around to contemplate—the rising price of oil, the unresolved question of Iran, mortgage industry woes and strains in the leveraged buyout boom in the US, China’s indifference to economic imbalance and asset price bubbles and the developing troubles in Pakistan.
Further, as 2010 nears, it would be good to remember the problems that US stocks faced in the last century as they approached the end of one decade and the beginning of another. Here is a helpful recollection: 1909-14: -24.8%; 1919-20: -32.9%; 1928-32: -80.0% and 1939-42: -28.3%. The negative returns are from the end of the first cited year to the end of the last cited year for each of these periods.
Publicly available data suggest that the price of gold in dollars remained constant up to the 1930s. Around 1933-34, it jumped from $20 per oz. to $35 per oz. The yearly average US 10-year treasury yield stood at 3.6% in 1929 and rallied all the way to 2.12% in 1941. America’s lost Japan decade still awaits. So, investors desirous of protecting their investments know what to diversify into.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer (Singapore) Ltd. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org