An Ounce of Gold and Ounce of Cocaine, a Trillion Dollar Deficit and a War in Vain

During the unprecedented presidential campaign of 2008, in what is now considered the best campaign ever, Barack Obama pledged to create 3.5 million new jobs and cut taxes for 95% of the American population. Lofty goals indeed. Since his brief tenure in office, sobering, even alarming data continue to stream out of government bureaus. To wit: Since December, 2007, 4.4 million American jobs have vanished and unemployment is now at 8.1%, the highest since 1982. GDP fell by 6.2% in the last quarter of 2008 and the Dow Jones has fallen 20% since Inauguration Day in what has become the worst start of a new year in 100 years for world stocks.

On March 6, the S&P 500 closed at 682.50 on 37% less volume than its 2008 peak. Since V shaped market bottoms are characterized by a selling climax, the implication is that the stock market route has not run its course.

This Bear Market is immune to good news. TARP, a $787 billion stimulus package, billions for AIG, billions for Citigroup. A cumulative $9.7 trillion has been pledged by the U.S. to combat the financial crisis, yet financial vital signs remain in critical condition. The Libor-OIS spread,the premium banks charge each other for short-term loans, rose just above 1 percentage point two weeks ago for the first time since Jan. 9. Contracts traded in the forwards market indicate the gauge, which measures banks reluctance to lend, will remain higher for the rest of the year than before Sept. 15, when the bankruptcy of Lehman Brothers froze credit markets. "Libor-OIS remains a barometer of fears of bank insolvency," former Federal Reserve Chairman Alan Greenspan said in an interview. "That fear has been substantially reduced since mid-October, but the decline has stalled well short of any semblance of normal markets." The Fed's quarterly Senior Loan Officer survey released Feb. 2 found that more than 65 percent of banks restricted lending the previous three months even as they received about $200 billion of taxpayer funds from the US government. Interestingly, Maestro Greenspan was absent at Davos last month. I wonder why. In attendance was New York University Professor and prophet of doom Nouriel Roubini, who says U.S. financial losses may reach $3.6 trillion, suggesting the banking system is "effectively insolvent."

The shameless and grossly overpaid corporate chieftains who created this mess are now holding a gun to lawmakers' heads to force government bailouts or else. Last week before Congress, in a rare divergence from his monotone temperament, Fed Chairman Ben Bernanke expressed "anger" that AIG, which effectively exploited its AAA rating to game the system and behave like a hedge fund by selling credit default swaps (insurance) on mortgage-backed securities composed of subprime debt, had to be bailed out by the taxpayer lest the entire world financial system go into cardiac arrest. American International Group appealed for its fourth U.S. rescue by telling regulators the company's collapse could cripple money-market funds, force European banks to raise capital, cause competing life insurers to fail and wipe out the taxpayers' stake in the firm. AIG needed immediate help from the Federal Reserve and Treasury to prevent a "catastrophic" collapse that would be worse for markets than the demise last year of Lehman Brothers, according to a 21-page draft AIG presentation dated Feb. 26, labeled as "strictly confidential" and circulated among federal and state regulators. "What happens to AIG has the potential to trigger a cascading set of further failures which cannot be stopped except by extraordinary means," said the presentation by New York-based AIG. "Insurance is the oxygen of the free enterprise system. Without the promise of protection against life's adversities, the fundamentals of capitalism are undermined." It worked. Regulators revised AIG's bailout last week to ease loan terms and extend $30 billion in fresh capital after the firm posted a $61.7 billion fourth-quarter loss, the worst in all of corporate history. Total US government aid for AIG now stands at US $160 billion. As Lenin put it, "give the capitalists enough rope, and they will hang themselves." What Lenin didn't count on was a benevolent super-state standing by to throw a lifeline once greed had bankrupted the financial system.

Where Will the Money Come From If All the Banks Are Insolvent?

Secretary of State Hillary Clinton thinks the answer is China. China should continue buying U.S. Treasury bonds to help finance Obama's stimulus plan, saying "we are truly going to rise or fall together...our economies are so intertwined. It would not be in China's interest" if the U.S. were unable to finance deficit spending to stimulate its stalled economy. Are you sure, Madame Secretary? Timothy Geithner bashes China as a currency manipulator, the US condemns China over Tibet and maintains a nuclear Navy around Taiwan. Who expects China not to exploit bipolar US policy? At the end of the day, he who pays the piper calls the tune and the US is in hock to China. The only way out is to incur more debt, default on the debt, devalue the dollar or think outside the box. Here is one of my ideas:

What if I told you there is a way to reduce federal and state government spending, increase tax revenue, stabilize friendly foreign governments, fight terrorism and reduce the crime rate, all in one fell swoop? What if I also told you that market forces can be exploited to help achieve these goals without empowering the surveillance society and the national security apparatus, and without confiscation of wealth through taxation and inflation?

Reader, I want you to ponder a few numbers. Enormous anxiety has pushed the price of gold to all time highs in all currencies over the last several months. Its averaging about US$ 950/ounce now, even as the USD has strengthened considerably during the current worldwide stock market panic. Platinum hovers around US $1,000 and silver is at US $13 and change. These precious metals with critical industrial uses are scarce on Earth and very expensive to extract from the ground. They can not be manufactured.

Agricultural commodities are in a different league. Coffee, sugar, tobacco and cotton spring forth from the soil; they are the fruit of sunshine, rain and man's toil. Coffee is sold by the ton; its worth 7 cents an ounce. Cotton is sold by the pound and fetches US$ 2.60/ounce. Corn is US$ 3.66/bushel and a bushel weighs 70 pounds. It makes sense that soft commodities are less valuable than metals, they are much easier to produce. But there's another agricultural "commodity" that we left out. About 1% of the US population consumes it regularly and they comprise about 33% of the world market. The crop is worth hundreds of billions of dollars annually, but since it is unregulated, uninspected, untaxed and duty free, exact figures are hard to come by. Similar in molecular structure to sugar, the plant was used by Aymara shamen decked out in gold finery as they sought to be transformed into avian beings. The alkaloid gave them hallucinations and paradoxically, clarity of thought. Today the plant is grown on primitive plots, chewed and made into tea by the Ameriginal peoples of the Andes and they use it to increase stamina, resist cold, altitude and hunger. Peruvian and Colombian entrepreneurs now market products made from this salutary plant, to great success. What is it? Its coca and it is the active ingredient in cocaine.

Surprised? A box of coca tea is more expensive than Liptons but not outrageously so. Prices are comparable to herbal and green teas at gourmet stores. By comparison, uncut cocaine is worth about US$ 3,000 an ounce, three times its weight in gold! Marijuana, literally a weed, is worth US$100/ounce, seven times its weight in silver. Why is this so? Can coca and marijuana really have intrinsic value in excess of gold and silver? Is their cost of production high? Are they essential to industry or society? I doubt it. They are about as
essential as alcohol and tobacco are, equally or less as addictive, but far less destructive if anti drunk-driving and anti smoking groups' statistics are to be believed. The only answer is that "The War on Drugs," a term coined by president Nixon in 1972, is responsible for the amazing prices...and profits...of cocaine and marijuana. There is just no way that poor Juan Valdez can compete.

But 175 years ago the British Empire and its sidekick the USA had a very different view and fought a very different kind of drug war. At that time, Laissez-Faire reigned supreme. Nothing could stand in the way of colonial expansion through conquest and trade, even trade in drugs. For ages, precious silks, spices and teas had travelled the long Silk Road from China to Europe. But by the 18th century, merchant ships could access China directly and realize superior efficiency and profits. But there were two problems. Due to the Qing Dynasty trade restrictions, whereby international trade was only allowed to take place in Canton (Guangzhou) conducted by imperially sanctioned monopolies, it became uneconomical to trade in low-value manufactured consumer products that the average Chinese could buy from the British like the Indians did. The other problem was that the British Pound (like all currencies) was on the gold standard. Britain had to purchase silver from continental Europe to trade with China, which was a costly process at a time before demonetization of silver by Germany in the 1870s. In casting about for other possible commodities to reverse the flow of specie to China, the British discovered opium. Opium as a medicinal ingredient was documented in texts as early as the Ming dynasty but its recreational use was limited and there were laws in place against its abuse. It was with the mass quantities introduced by the British, that the drug became prevalent in China. British importation of opium in large amounts began in 1781 and between 1821 and 1837 exports increased fivefold. The drug was produced in the traditionally cotton growing regions of India (under British government monopoly (Bengal) and in the Princely states (Malwa) and was sold on the condition that it be shipped by British traders to China. 150 years before the partition of India into India and Pakistan and 200 years before the Taliban would fund their operations through poppy cultivation in neighboring Afghanistan, the British East India Company waxed fat off the narcotics trade.

Alarmed at these developments, the Qing Dynasty government outlawed all trade in opium in 1836, but Anglo, American and Chinese merchants ignored the law and the Chinese government was too weak to enforce it. Finally, war erupted between England and China to settle the issue once and for all. Queen Victoria's navy and army decimated Chinese forces and the 1842 Treaty Of Nanking actually obligated China to compensate England US$6 million for the opium it had confiscated and destroyed. Great fortunes followed the Treaty and in 1865 the Hong Kong Shanghai Bank was founded. We know it today as HSBC.

Today's Drug Wars

Like the War on Terrorism, the War on Drugs is more of a catch-all conglomeration of shifting domestic and foreign policy priorities in the service of state power than an articulate and defined objective to achieve a specific, measurable goal by a certain date. These policy
directives operate under a hazy notion of defending the public safety and invariably expand government bureaucracy, budgets and power to serve the broad, rolling agenda of the national security state. These "wars" have no ending and wear down those who wage them. Today's self-defeating drug wars, along with the War on Terrorism, underpin the surveillance society, the erosion of personal and financial privacy and the presumption of innocence.

Unlike its achievements, the drug war's costs are easy to calculate. While the $70 billion US cocaine market remains stable, more Americans are incarcerated than ever before, most of them for drug crimes. Federal and state governments have spent hundreds of billions of dollars to arrest, convict and incarcerate millions of Americans for very long periods of time. Many of them will lose the most productive years of their lives and become essentially unemployable after their release, reducing GDP, income tax receipts and America's competitiveness. Many convicts are held in for-profit facilities constructed in rural communities far from major cities. Inmates are ineligible to vote. Nevertheless, they increase the population count of the communities where they are detained. Federal and state government spending priorities are set according to population head counts, which include inmates even though they are ineligible to vote. The net result is a budget skewed towards the communities where inmates are held rather than the communities where they come from, exacerbating underfunding of social programs where they are usually needed the most. In addition, many states permanently revoke convicted felons' right to vote even after they have served their time. Since most inmates are men of color, the net result is reminiscent of Jim Crow. John V. Santore wrote an excellent piece in the Huffington Post last month on this topic. I recommend it for all those who remain unconvinced.

Just as more Americans have been killed and wounded in the disastrous invasion of Iraq then were killed on 9/11, more Americans have had their lives destroyed by the war on drugs then have died from a drug overdose or a drug fueled homicide.

The Drug Wars and Geopolitics

Time does not permit me to go into the details of how the drug wars are destabilizing countries such as Mexico, Colombia and Afghanistan. Both the CIA and the State Department have described Mexico as at risk for becoming a failed state due to the breakdown of order and the ability to govern, especially along the US border. Last week, the Mexican government sent 5,000 Army soldiers to restore control of Juarez. Empowered by billions of dollars in revenues, the Mexican drug cartels have unlimited purchasing and influencing power in a country where the minimum wage is two dollars a day for those lucky enough to find work. The low intensity civil war in Colombia is funded by drug profits and ransoms on the one hand (FARC) and US military and economic assistance on the other (the Colombian government). The result is an unsustainable, militarized society drenched in blood. In Afghanistan, the textbook example of a failed state, poppies are the largest cash crop. Drug profits keep terrorists on the go. They also inspire a life of crime. Just this week, Sinaloa, Mexico drug cartel leader Joaquin Guzman's made it on Forbes magazine's Rich List with a fortune valued at US 1 billion. In 1989 Pablo Escober, the seventh wealthiest man on Earth, made the list with US 25 billion. 56 year old Guzman is currently at the top of Mexico's Most Wanted list and Escobar was killed by Colombian police in 1994. Movies have been made about him.

The Solution

First, we need to recognize the lesson bequethed to us by the Soviet Union: the condign powers of nation states are unable to roll back the laws of economics. ( The United States would be well to heed the Soviet lesson of Afghanistan as well. ) Just as protectionism does not stop deflationary recession in the long run, in a market economy and open society prohibition cannot stop commerce; it can only make a commodity more scarce and create more excitement around it. The argument that legalization is tantamount to acceptance and capitulation to drug dealers is false. Legalization will be the death knell of drug mafias as profits dry up. By precipitating a crash in the price of cocaine, lawmakers will deal a body blow to narcotics empires without firing a shot, making an arrest or spending a buck. By regulating and taxing cocaine, consumers will be better protected and revenue raised. A cheapened, legal product will lose its cache, cause less violence and be less tempting to a new generation of Americans no longer enthralled by music-video dreams of an unscrupulous and materialistic pursuit of easy wealth through smuggling. The very profitable glorification of unlearned but wealthy, thuggish drug capos so common in "urban" American television and music, a sign of cultural and spiritual death, will struggle in vain when drug smuggling is less profitable than legitimate labor. Miami Vice will join documentaries on moonshiners and Al Capone as a thing of the past and a curiosity on the History Channel.

Just as Obama has overturned the Bush Era ban on stem-cell research, now is the time to expel the counterproductive, backwards, Puritanical and punitive false morality of the fundamentalist American right from American narcotics laws. The trend towards legalization is already occurring and this writer believes it is inevitable. In March, 2009, the United Nations, the UN Council on Drugs and Crime and the World Health Organization declared that the 1998-2007 anti-drug strategy "did not achieve any of its objectives,"world wide commerce in illegal drugs is worth "320 thousand million dollars a year and is responsible for 200,000 deaths annually."

Courageous Bolivian president Evo Morales, while maintaining a firm stance against cocaine and narco-traffickers, is at the forefront of the push to remove coca, a plant used by the Aymara for centuries, from the UN list of narcotics. On March 11, in front of the UN Commission on Narcotics, he produced and chewed a coca leaf. The plant has been on the UN black list since 1961.

After Legalization

The challenge after legalization, as now, will be to discourage drug use through persuasion and help those in the clutches of addiction and dependency. Like any addiction, it must be treated as a health problem. Addiction, a form of escapism, is usually symptomatic of a deeper malaise in a person's life and society.

Government places heavy restrictions on alcohol and tobacco and raises billions of dollars through taxation of these drugs. Half of the price of a pack of cigarettes is state sales tax. Now, as we confront unprecedented budget crisis and must make choices, it is time for the Congress and the president to get smart about how to fight all addictions. The distinction between alcohol, cocaine, nicotine and marijuana is political. All of these drugs can be terribly destructive to soundness of mind and body. The Drug Wars compound the destruction with fiscal exhaustion, street violence and mass imprisonment. When we finally get over the War on Drugs, we as a society will have compassion for those who seek to fill an inner void with opiates. When the retail price of cocaine falls below that of gold and towards zero for lack of demand, we will know that we have, at long last, won the War on Drugs.

Daniel Bruno Sanz is a foreign exchange fund manager and teaches technical analysis of financial markets. He is the author of Why Obama Will Win in 2008 & 2012.