Charts and technical commentary by David Chapman of Union Securities Ltd.

69 Yonge Street, Suite 800, Toronto, Ontario, M5E 1K3 (416) 604-0533, (416) 604-

0557 (fax) 1-888-298-7405 (toll free) email david@davidchapman.com

Economics and politics are quite intertwined. Always have been. I can recall, however, from my University days that political economy courses were not at the top of the agenda. Too bad. They should be. And so it is as well with markets. Political decisions play a huge role in what markets do. The direction of fiscal, monetary, tax and trade policy is as much determined by politics as it is by anything else. As well, as we have seen, the politics of Iraq has had considerable impact on markets.

One of my favourite weekly reads is The Economist an esteemed British publication that dates from 1843 that covers politics and economics in an intelligent, informative, well researched and fairly balanced manner. This week’s headline was "How deep is the rift?" It was referring to the falling out amongst the western powers over Iraq where the US and Britain continue to insist that Iraq is in arrears to the UN Security Council on resolution 1441 and must now be disarmed by force and those such as France and Germany who say diplomacy has not yet run its course. Siding as well with France and Germany is Russia.

Of course proposed further resolutions may yet be accepted and this very serious rift that had at times degenerated to name-calling may yet be patched back together. Failure to do so may result in the coming apart of the United Nations the one global organization that despite its many flaws remains today the best hope for a peaceful world going forward. But as the Economist article points out this is a potentially huge fracture as attitudes in the world are shifting and the institutions such as the UN and NATO and the EU are shuddering at the shift. It is also because the US sees the world in a much different and more dangerous light then the Europeans that see it as American adventurism that must be calmed or the world will become a more dangerous place.

While on the surface the issue appears to be political regarding the UN weapons inspectors in Iraq and the need for Iraq to disarm and whether they are complying or not, the real reason for the sharp disagreements may really be about economic and oil interests in Iraq. Iraq sits on more than 10% of theworld’s known reserves, the second largest in the world behind Saudi Arabia. Iraqi oil production is far below capacity and much of its equipment is outdated due to sanctions. The US, who is the world’s largest consumer of oil consuming some 25% of global production, while clearly avoiding any overt discussion of the Iraqi oil have made clear plans to secure the oil fields in the event of an invasion. And plans are as well clearly in place to repair and upgrade the Iraqi oil fields and equipment to bring Iraqi oil production up to capacity. Further plans are already in place to explore Iraqi oil fields, as there is a belief that they may hold even larger reserves that would rival the Saudi oil fields.

US companies are supposedly already lining up to get a piece of what could be a huge oil bonanza. But the Russians in particular and as well as the French and Germans have long economic and oil ties with Iraq. And the Iraqis have successfully exploited this as well by granting priority trade status to France, Germany, Russia and Syria. As well Iraq is currently the only country that refuses to accept US$ for oil, accepting instead Euro Dollars thus providing important support for the Euro. An American led invasion of Iraq would threaten these interests and could cost their countries billions of dollars. Russia and France in particular had recently signed oil related contracts with Iraq. The Americans have threatened that unless they line up on their side they will be cut out.

But the threatening does not end there. The US has threatened to pull its troop bases out of Germany and redeploy them in countries, mostly Eastern European countries that have lined up on the US side. They have threatened to boycott French wine. What all this adds up to is old-fashioned trade wars and economic threats involving a commodity that is in increasing scarcity. All wars are ultimately are economic and this one appears to be no different.

The entire Mid East and Central Asia is a potent mixture of oil and religion. The prosperity of the western world is dependent on affordable oil that comes largely from the area. The "Great Game" for control of the region and its vast richness has being playing itself out over the past century. Each has its own interests at stake so he who can control the region will also control the oil. This then may lay the foundation for the next great conflict of which we are merely seeing the first skirmishes today.

As if the threat of the coming apart of the United Nations and other world bodies were not enough the US economy continues to unravel. Recent numbers brought us a rise in the trade deficit now projecting to a yearly deficit of $435 billion. The budgetary deficit is projected to be $300 billion. And none of this takes into account the possible cost of a war in Iraq. Estimates for that are as high as $200 billion. A prolonged military occupation of Iraq would be at least $50 billion per year.

The US economy continues to flounder. Inflation is rising as noted by the recent Producer Price Index (PPI). This is a reflection of the falling US$ coupled with rising commodity prices in a host of commodities that are all priced in US$. The US$ could easily fall another 20% or even more if prolonged trade wars broke out as a result of a fractured UN and NATO. This would be a nightmare for the United States, as they cannot absorb the massive US debt that floats around the world where at least 33% of it is in the hands of foreigners.

Debt levels continue at unsustainable levels but at least are still being serviced despite record bankruptcies. But with $31 trillion in debt against $10 trillion in equity in a $10 trillion economy something has to give. Sitting as well in the background is the potential for a derivatives blowup and a possible bigger concern is the massive growing under funding of Pension Funds due to the stock market collapse. This under funding could prove to be a drag on profits for years or worse just not paid thereby making the pensioners themselves pay for the problem. Mutual funds have witnessed steady withdrawals now for months. It is a matter of time before a major mutual fund is in trouble. Most will just disappear into mergers.

Unemployment continues to rise despite some small improvements in recent numbers. This often is a reflection of the way they count unemployment, which is probably a lot higher than reported. As job losses mount there is pressure on the ability to repay consumer debt. Despite all the problems the economy has continued to grow in a sluggish manner. But rising oil prices could have a severe dampening effect on any nascent recovery. Oil supplies remain low and reserves available in the event of further shortages due to war are also low.

Note: Charts created using Omega TradeStation or SuperCharts. Chart data supplied by Dial Data.

-- Posted Saturday, 22 February 2003 | Digg This Article

- Visit Union Securities
The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.