Investors and Wars
Short History of Markets Amid Great Wars
Investors are the ones to suffer considerably in case of wars, unless the conflict is small and asymmetrical. On the other hand, speculators tend to make a killing if they position themselves according to what will happen.
“Position yourself correctly, and you can make a killing if the dogs of war are unleashed — though if the hellhounds get sent back to their kennels, it’s you who gets killed and the guy who bet on peace gets the champagne.”
Markets are moved by political news during high tension times, there’s no doubt about it. Just look at the price swing from last week. Every single piece of news about the Ukraine conflict could send the market down to the ground or high to the moon.
The price of gold, the price of oil, the exchange rate of the ruble, the European and American stock markets, as well as a host of exchange-traded instruments linked to measures of volatility — all have gyrated as the world’s managers of money have adjusted their probabilities of war upward or downward.
The Legend of Nathan Rothschild
Despite making a fortune after Napoleon’s second and final defeat, Nathan didn’t expect it at all, underestimating the effectiveness of the allied military response.
The worse things went for Britain and her allies, the lower the price of “consols” — the near-perpetual bonds that the British government had been using to fund its large national debt since the mid-18th century — hence the higher the yield on those bonds.
The worse things went for Napoleon, the lower the price, and hence the higher the yield, of rentes, the French equivalent of consols.
By the time of the first defeat of Napoleon, the Rothschild brothers understood that there was money to be made from war. Because of the economic disruption it caused, war tended to push up the price of gold in sterling terms because the gold-standard rule that allowed convertibility of pounds into gold at a fixed price had been suspended for the duration of the hostilities.
When Napoleon returned to France and got back to power, the Rothschild brothers assumed that the wars were back on a daily basis, therefore the price of gold would touch record highs. But they were wrong and Napoleon was defeated again (and this time for good) at Waterloo on June 18.
Understanding the loss they could face, Nathan had no other alternative and made a very bold trade: he bought consols on a massive scale and reaped a huge return as they rallied on the news of peace.
From Napoleon to World Wars
Napoleon’s defeat represented the start of a peaceful period in Europe that ended in 1914. Despite there being smaller conflicts, these weren’t considered major and therefore didn’t pose a major risk for investors.
The Rothschild, despite always paying attention to any sign of a possible conflict, were caught by surprise in 1914 when the guns of August opened fire.
“We have forgotten all about it now, but the financial crisis of 1914 — which began in July, before the war itself broke out — was the biggest in history, bigger even than the crisis of 1929.
So severe was the liquidity crunch as the diplomatic situation deteriorated that trading on all the major stock markets of the world had to be suspended. The New York Stock Exchange remained closed from July 31, 1914, until Nov. 28 (when bond trading resumed) and Dec. 12 (when stocks could be bought and sold again).
The Dow plunged 24.4% that day.”
In contrast, in 1938, everybody anticipated the war to start, so there was no big surprise.
The Cold War
After WW2, the Cold War started and, despite some proxy wars and the threat of Armageddon, there were not high chances for a large-scale war. The biggest play during the Cold War was buying gold, especially in anticipation of inflation.
“That paid off handsomely, especially after President Richard Nixon ended the Bretton Woods link between the dollar and gold. As inflation expectations surged in the late 1960s — and especially after the outbreak of the Yom Kippur War in October 1973 — being long gold was the winning move at a time when investors in bills, bonds and stocks were bleeding out. A second phase of geopolitical instability in 1979 — which saw the Islamic revolution in Iran and the Soviet invasion of Afghanistan — further rewarded the gold bugs’’
When Paul Volker became chairman at the Federal Reserve, inflation came to an end, and so did the gold trade. As the Cold War ended and the dot com bubble gathered steam, war risk faded from investors’ minds.
Present
Despite the Ukraine tensions can’t lead to an “1914 moment”, there is still a lot of risk out there. Russia could consolidate its status as a major military power that could further threaten NATO borders. Furthermore, sanctions on Russia could lead to Putin imposing some counter-sanctions.
The main play this time is represented by shorting Russia’s currency, bonds and stocks and long gold, oil and gas and all those rarer commodities (e.g., titanium and palladium) that Russia exports.
Further conflicts
If Russia gets its way with Ukraine, then China could conclude that it could get away with forcibly ending Taiwan’s autonomy and democracy, consolidating China’s supremacy in the Indo-Pacific region and beyond.
On the other hand, if the U.S. decided to honor its longstanding commitment to resist a non-peaceful change to Taiwan’s status — we might find ourselves in an even bigger war than the Russia-Ukraine conflict.
References: Niall Ferguson: Investors May Be the First Casualty of a Ukraine War — Bloomberg