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Osama bin Laden was living not just within the borders of Pakistan, but within a mile of arguably the heart of the country's military establishment. Conspiracy theories abound, but it seems clear that Pakistan knew a lot more than it was letting on to its U.S. and NATO 'allies' operating in the region.

From 2002 to 2010, the U.S. gave $20 billion in aid to Pakistan ($13.3 billion in military and $6 billion for economic development). Over $3 billion has been requested for 2011.

At a time when Congress is sharpening its fiscal pencil, it's no surprise to see that Senators are pushing to cut Pakistan's aid. Expect calls for U.S. forces to pull-out of Afghanistan to only grow louder, which in turn will have a destabilizing effect on Pakistan and the wider region.

Investment Implications

Pakistan is classified as a 'frontier economy', and the range of pure play investment options that foreigners can easily make are limited. At present there are no U.S.-exchange traded Pakistan ETFs. However, the Aberdeen Emerging Markets Telecommunications and Infrastructure Fund, Inc. (ETF), and Guggenheim Frontier Markets ETF (FRN) both have Pakistan allocations. And not surprisingly, both have traded down since Monday's news.

While the Karachi Stock Exchange lists various Pakistani issues, most brokers are not well-equipped to help the average retail investor with shorting on the KSE. However, one can construct an investment thesis around the idea that any destabilization of Pakistan will have a knock-on effect with India, and perhaps the wider region, where investors can choose from a number of dedicated ETFs. Individual issues listed on local exchanges are also much easier to trade against through U.S. and European internationally focused brokers (e.g., Interactive Brokers).

In the short and medium term, Bin Laden's death will have a material adverse effect on the attractiveness of Pakistan, and Central Asia as a whole, for investment. But that's not the really big investment story here.

How Do You Bring Down the Most Powerful Nation in History?

Al-Qaeda pulled-off the Sept. 11 attacks for approximately $500,000, according to the 9/11 Commission report. By the end of fiscal 2011 the U.S. will have spent $1.3 trillion, or 9% of the national debt, fighting the wars in Afghanistan and Iraq according to the Center for Defense Information.

But when it's all said and done the total cost of the wars will make Bin Laden's 2,514,000:1 return at the time of his death multiply dramatically. It has been projected by Nobel prize winning economist Joseph Stiglitz and others that the lifetime cost of the Iraq and Afghanistan wars will run at least $3 trillion, or over 20% of current federal public debt, when long-term medical care for the wounded and other costs are factored.

“We, alongside the mujahedeen,” bin Laden was reported to have said in a speech delivered right before the 2004 presidential election, “bled Russia for 10 years until it went bankrupt and was forced to withdraw [from Afghanistan] in defeat. So we are continuing this policy in bleeding America to the point of bankruptcy.”

“Every dollar of al-Qaida defeated a million dollars, by the permission of Allah, besides the loss of a huge number of jobs,” he added.

In assessing the economic war Al Qaeda has waged against the U.S. one can't help but conclude that Osama bin Laden has received terrific bang-for-the-buck.

Pillars of Power

In his biographies of the Rothschild banking dynasty, as well as The Cash Nexus and The Ascent of Money, Harvard Professor Niall Ferguson makes a strong case that a nation's ability to borrow in the bond market is a reflection-- and perhaps key wellspring-- of the state's power.

To take one historical example, the British Empire's ability to borrow more, and at cheaper rates of interest, was key in its defeat of Napoleonic France. In contrast, her crippling post-WWII debt signaled the dawning of a new era for Britain which consisted of economic malaise, a fear of the bond market (e.g., 1956 Suez crisis), and periods of currency instability which resulted in dramatic devaluations of pound sterling in both 1949 and 1967.

Today the U.S. Treasury market is the deepest, most liquid bond market in the world. It also serves as a cornerstone of the U.S. dollar's privileged reserve currency status. In times of panic, as we saw in the 2008 financial crisis, the world flees other assets for U.S. dollar denominated ones like T-bills.

Whether or not the U.S. bond market is in fact the key pillar of American power is open to debate. What is irrefutable, however, is that displacing the dominant role played by the U.S. dollar and treasuries in the world's financial system would deal a mortal blow to what remains of America's financial hegemonic power.

There may be several different approaches, but one surefire way to weaken a nation state's currency and ability to borrow is for its government to run persistently large deficits, just as the U.S. has done for the past decade in part to fund the War on Terror and now successful hunt for bin Laden.

Timing the Decline of the U.S. Financial Hegemony

Bin Laden's death was publicly hailed by the U.S.'s largest creditor, China, and it may represent a significant milestone towards winding down the War on Terror. However, there is no assurance that the U.S. Congress will be able to get a handle on the nation's long-term fiscal problem. And time is running out.

At best, investors can expect a steady, longer-term deterioration in the value of U.S. Treasuries and the U.S. Dollar, as outlined by Professor Barry Eichengreen. At worst, we may see Niall Ferguson's prediction of a U.S. fiscal crisis, along the lines of what happened in Greece, striking in the next 1-3 years.

Source: Identifying Investment Implications of Bin Laden's Death

Additional disclosure: I maintain a brokerage account with Interactive Brokers.