On War Risk

Photo Credit: Vitor D’Agnoluzzo || Politicians should think more carefully before using violence to achieve foreign policy goals — it is rare that it is ethically justified

Ten years ago, I wrote a short piece called In Defense of Home Bias. International investing is generally a good idea for diversification purposes, though it will work varyingly well over time. The last decade has not been kind to the concept for US investors, but perhaps it has been extra good for foreign investors in US companies.

The first bullet point I wrote with respect to difficulties with international investing was:

There will be no war that changes the amount or terms of commerce.

In Defense of Home Bias

This is one case where being an economic historian will help more than studying market statistics. Most market statistics studied today come from the post-WWII era where no conflict has materially affected the markets for a long time, or done lasting damage.

Contrast that with Italy, Japan and Germany in WWII (this applies to West Germany, not East Germany) — their markets were pounded to the degree where people lost a lot in real terms if they were invested in bonds or paper money, and lost significant value in stocks for a decade, but made it all back. Thos invested in short-term government debt coasted along as did those that held gold.

Though some productive capacity was destroyed, stocks recovered rapidly because they could improve profitability to keep up with post-war inflation. Gold and short debt could tread water, but bonds and non-interest bearing deposits lost value.

But looking back in history, not many wars end with a merciful victor like the US was at that time. After WWI, the demand for reparations and bad monetary policy killed German bonds and paper money. After the Civil War, the South was economically ruined — it too a long time to recover.

So, what to think about war risk?

  • If its not on your home soil, it is not likely to be too damaging, though government policy could lead to inflation, as happened in the Vietnam War era.
  • As Sun Tzu said, “Where the army is, prices are high; when prices rise the wealth of the people is exhausted.” (Quoting from this article here.) Yes, measured inflation is scarce today, but if we had to redirect the economy for a major war, it would be different, particularly when currencies are mere fiat currencies. Think of what happened to the currency of the South during/after the Civil War, or the value of the Continental Dollar during/after the Revolutionary War.
  • Stocks a given society tend to do okay unless a society is wiped out, or taken over by Communism.
  • A balanced portfolio that contains short-term debt and gold, as well as stock and bonds should do okay so long as the society itself is not destroyed… where existing property rights get extinguished.
  • Don’t invest in places where a hot war is going on. Even if speculating on when the war will end, that is a gamblers’ game.

For the most part I would say don’t worry too much about war. As the 34th Ferengi Rule of Acquisition says, “War is good for business.” To which Quark added, “…only from a distance, the closer to the front lines, the less profitable it gets.” Though fictional and humorous, it is for the most part true. If your assets and your society are not destroyed, you have your capital intact to speculate on the rebuilding of places that are destroyed.

Now all that said, there is the risk that a small conflict becomes a big one. Though WWI was inevitable in many ways, no one predicted the chain of events that led to the conflict.

My advice is threefold then. 1) Don’t worry — diversify across asset classes, including hard assets. 2) If you want to remove most of the remaining risk stick to places that have the “rule of law” and are unlikely to be dragged into armed conflict on their home soil. 3) Even if not on home soil, be wary of inflation if a conflict drags on.


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