Defeat in Iraq

I’m in London, in transit for our return flight to Florida, and I have a brief, but painful, message for you this morning:

We’re going to lose the war in Iraq.

This is hard to swallow, I know. But it seems blatantly obvious to everyone except those who have the most to lose.

Every single newspaper on this side of the Atlantic is headlining the deepening chaos in Iraq. Even the sentencing of Saddam on Saturday, heralded in the U.S. as a victory, is likely to deepen the sectarian strife and inflame the anti-American insurgency, according to the Wall Street Journal’s Europe edition this morning.

In Washington, most politicians now seem vividly aware of the crisis — not to mention the sweeping impact it’s likely to have at the polls tomorrow.

But, strangely, the movers and shakers on Wall Street still seem oblivious to the impact the war could have on investors.

The Iraq war is the elephant in the living room. Investors look at it but don’t see it. They feel its presence but don’t want to touch it.

The Most Likely Scenario

Among the various scenarios that U.S. military strategists are now painting, here’s the one I believe to be the mostly likely:

Phase 1. In the wake of spreading violence, the moderate, pro-American government factions fall from power in Baghdad. In their place, Moktadr al Sadr, leader of the radical anti-American factions in the current government, comes to power.

He compels the U.S. army to pack up and leave.

He transforms all, or most, of Iraq into a fundamentalist Shiite Republic similar to Iran’s.

He forges a holy Shiite alliance with Iran’s Mahmoud Ahmadinejad, and they aim for religious, political, military and economic supremacy over the entire region.

Phase 2. Between them, Iraq and Iran control more petroleum reserves than Saudi Arabia. Their combined armies, including the U.S.-trained and U.S.-equipped forces in Iraq, also challenge Saudi’s military might.

Together, they aggressively pursue an agenda to depose traditional Sunni leaders in nearly a dozen Muslim nations.

Phase 3. There thus emerges a new axis of power — extremely radical, extremely destabilizing and powerfully resistant to foreign pressure.

This axis of power, in turn, wields tremendous leverage over the global oil market and the financial destiny of the West as a whole.

How likely is this scenario? Highly likely! And those that agree with me are no longer such a small minority …

Nearly Unanimous
Warnings of Chaos

I now count over a dozen warnings of chaos, many from the highest-placed sources:

Three weeks ago, a special briefing by the U.S. Central Command declared that Iraq is “on the brink of chaos,” slamming home four tough-to-swallow-but-hard-to-dispute conclusions:

Conclusion #1. Iraq’s urban areas are suffering wave after wave of ethnic cleansing, the fundamental driver behind civil war.

Conclusion #2. Violence in Iraq has reached an all-time high and is spreading geographically.

Conclusion #3. The massive U.S. effort to hastily recruit and train a large Iraqi army and police force is backfiring. These forces, overtly and covertly loyal to warring militia leaders, are no longer part of the solution. They’re the focal point of the problem.

Conclusion #4. The pivotal event that sealed the fate of America’s enterprise in Iraq was the bombing of the Golden Dome Shiite mosque in Samara — precisely what I told you in Money and Markets on the day that it happened.

Similarly, just around the time the Central Command report was being presented to the top brass at the Pentagon, the head of the British Armed forces and Chief of the British General Staff, General Sir Richard Dannatt, told the Daily Mail that British forces should leave Iraq “soon.”

His reason: Rather than helping to quell the violence, the sheer presence of foreign armed forces “exacerbates the security problems.”

Even Senate Armed Services Committee Chairman John W. Warner (R-Va.), newly returned from a tour of Iraq, has declared that the country is “on the verge of chaos.” But he’s not the only Republican breaking ranks with the administration:

Republican Senator Lindsey Graham (S.C.) says “the current plan is not working.”

Sen. Kay Bailey Hutchison of Texas, a key Bush supporter, announced last week that she would not have supported the Iraq War had she known that there were no weapons of mass destruction hidden in the country.

James A. Baker III, former chief of staff and secretary of state under Ronald Reagan and campaign manager for President Bush’s father, has joined a bipartisan commission recommending a fundamental change in U.S. strategy in Iraq.

National Review founder William F. Buckley, Jr., writes that the American objective in Iraq has “failed” and that the Bush Administration has to decide how best to “cope” with this failure.

Conservative columnist George Will calls the war a “fiasco” and insists that “stay the course” on Iraq means “Americans dying to prevent Shiites and Sunnis from killing each other” — a policy that will result in “100 fewer Republicans in Congress” if it’s blindly pursued for another two years.

Cleary, Politicians See the Handwriting
On the wall. So Why Don’t Investors?

Why are most investors so complacent? Why do they see only the rosy side of the news?

A key reason is that investors have so far been shielded from the economic impact of the war because the U.S. government has failed to raise taxes to pay for it. Instead …

Virtually the entire cost — a whopping $200 billion or so each year — is being financed by debt, and …

Nearly all of that money is being borrowed from overseas — China, Japan and Europe.

But this doesn’t reduce the war’s economic impact. It only postpones it.

What will happen when the war ends in defeat?

First, worldwide confidence in the U.S. will plunge, prompting foreign investors to sell their U.S. investments. The U.S. dollar and U.S. bonds will plunge.

Second, due to fears of the Iran-Iraq axis, oil prices will go berserk, likely surpassing the $100-per-barrel level.

Third, gold will skyrocket, as investors flee the dollar for safety.

My recommendation: Don’t be deceived by the false optimism that has overcome Wall Street. Stay the course.

Good luck and God bless!

Martin

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