Strategic Surprise and Tactical Warning: A Personal View

Presentation to the Gyro Club

Denver Athletic Club

Thank you for inviting me here today and making such good arrangements for my visit. I am always happy to be in Denver, where I have lots of family and friends and have spent a great deal of time since I lived here as a small boy in the late 1950s and early 1960s.

When we turned on the lights in 1998 for my public policy think tank, which is the Lexington Institute, my associates and I agreed that we should build up a significant cash balance as a cushion for a rainy day. As someone who had previously managed a Congressional campaign that ran out of money 3 weeks before the election, that seemed like a pretty good idea to me.

Then one of my partners, a fellow named Loren Thompson, said we should be prepared for a stock market melt-down, a recession or a terrorist attack.

That seemed a little extreme, but we went ahead and built up our cash balance, through deferring some compensation and tight controls on expenses. And guess what? Within three years there was a stock market melt-down, a recession, and a big terrorist attack less than one mile from our office.

I had always been a rose-colored optimist, and you may have gathered Loren Thompson is a bit of a pessimist, and that makes a pretty good balance for two business partners starting a new operation. In fact Loren is such a pessimist his wife says he is always predicting the end of the world, and one of these years he is going to be right.

But I was taken aback when he started complaining about our internal banking practices. I like to keep things simple and efficient, and we had been putting that cash balance I told you about in one account with a big financial institution. We had built it up to about $2.5m, and Loren said we were making a huge mistake. We had to diversify our holdings into numerous accounts at numerous institutions, and make sure they were all federally insured. Our accountant and I looked at each other, rolled our eyes, thought what a hassle this is going to be with all these different accounts, and America had the deepest, widest financial markets in the history of the world.

But being a good partner, I went ahead and changed the accounts.

And we all know what happened in 2008 to America’s banking sector.

After 31 years in the policy trenches I thought I had gotten used to the zigzags of history and politics, but I have to say this decade has been one heckufa ride. And there are still 87 days left.

Because America is so big, so rich, so powerful and so open, the one thing we can count on is strategic surprise. And that surprise does not always have to be on the downside. If you were looking out at the horizon in 1933 from the bottom of the Great Depression, you probably would not have forecast that in 1945, only 12 years later, America would have 50% of global output and be the dominant military power in the world. And if you heard Ronald Reagan say in 1982 that communism would end up on “the ash heap of history” you probably thought, well, that’s a nice line, but the Old Man may be going a little far.

Strategic surprise is part of the landscape, and aside from a handful of prophets like Lincoln and Churchill and Reagan I am afraid there is not much we mortals can do about it. Lots of people like to think our multi-billion dollar intelligence agencies should be able to forecast strategic surprise, but they can’t. They are pretty darn good at tactical responses to identified threats, like Nazi submarines or Soviet military plans or the global Al Qaeda network, but all that money is not buying the taxpayer a bureaucratic fortune-teller.

Just about every decade something absolutely unimaginable happens to America. In the 1940s we had the Pearl Harbor attack. In the 1950s the North Korean attack on South Korea, and the Sputnik 1 launch. In the 1960s the Tet offensive, and in the 1970s the Yom Kippur war, the oil shocks, and the Soviet invasion of Afghanistan. Sure there was an analyst here or there who foresaw one or two of these in isolation, but perhaps the greatest intelligence operation of all time—the Israeli Mossad—had no idea the Egyptians were coming across the Suez Canal on 6 October 1973. And that may have been the closest we came to World War 3 with the Soviet Union.

What about the 1980s? In the late 1970s the US economy was given up for dead by the experts, and the Carter Administration forecast we would have oil shortages by the mid-1980s. But the US economy lifted off, and from 1980 to 1999 grew from 20% to 33% of global output, while the price of plentiful oil fell through the floor. Then we capped off the 1980s with the collapse of the Soviet empire, another big shocker to the policy community and the world.

In the 1990s, as I watched all my stocks going up, I constantly reminded my wife and kids that “these are the good old days. You better enjoy them.” But I didn’t really listen to my own advice. I used to call my Dad about once a year and brag about the latest split in my Intel shares. Finally on the third call he paused and said, “Mac, maybe its time to sell.” I am probably not the only one in this room who would have significantly more assets if he had just listened to his father.

This decade has had two big shockers: the September 11th attack, and the global debt bomb explosion. It’s been quite a decade. But because of the size and complexity and openness of the United States, we Americans no doubt have more surprises, on the up and on the down side, in store for us.

I fell in love with politics when I was 15 years old, and there was no looking back. I now have three decades in this business, and I have noticed a few things. While it is impossible to predict the big strategic surprises, we do have some pretty good tools for tactical analysis. I’d like to mention three: one is political, one military, and one in economics.

My favorite political tool is the President’s job approval rating. It is a simple, ideal polling question. “Do you think the president is doing a good job?” Or “do you approve of the job the president is doing?” That polling question will tell you a whole lot about where we are heading politically, and there are so many polls now that you get a constant, rolling, huge population sample. There is a website, realclearpolitics.com, that does a nice job averaging all those polls on a daily basis.

If the President is above 50 in the polls he is probably in good shape. If he is below 50, he is in trouble. In February 2006 I was having lunch with a Capitol Hill lobbyist, and I blurted out that I thought the Republicans would lose the Congress that year. The lobbyist was unable to contemplate so big a shift. I knew little about all the individual races or the fundraising or strategies of the political parties. But George Bush’s job approval had just fallen below 40, a terrible number, and it didn’t look like he was getting his act together, so I figured his party was a goner.

So keep an eye on that job approval rating. It tells you a lot, both about party control of the Congress, and a president’s re-election prospects. Truman, LBJ, Ford, Carter, and Bush senior were all well below 50 going into their re-elects. Ike, Nixon, Reagan, Clinton and Bush Jr. were all above 50.

And if you are really interested in Barack Obama’s re-election prospects, couple that job approval rating with the presence or absence of a party primary challenge. Again, all the losers from LBJ to Ford to Carter and Bush senior had ferocious primary fights, while the two-termers skated to their party’s nomination for a second term without a serious internal party challenge.

Here is another tactical truism for you to keep in mind in our interesting times: Do you remember that old cliché about generals always fighting the last war? Well, it is true.

When we finally got pushed out of Vietnam in 1975, one of the absolute truisms of the military world was we would never, ever get trapped in another land war in Asia. You could have wallpapered the Pentagon with it. The most prominent General of the latter 20th century, Colin Powell, even developed a doctrine around it.

Well, in 35 years we have fought 3 more land wars in Asia, and we are still fighting two of them today.

I also remember the 1990s when war was all about air power and speed and mobility, while heavy armor and tanks and holding hostile territory were all dinosaurs from the distant past. This was the space age and the computer age. America had won the first Iraq war, the Bosnia war, and the Serbian war largely through air power and precision attacks, and the Air Force would reign supreme.

Well guess what the American people have spent billions of dollars on this decade? Tanks and other armored vehicles, including thousands of uparmored Humvees. And guess where the United States Air Force is? Politically decapitated, with its airpower modernization program in complete shreds. No new air superiority fighters, no new heavy bombers, no new refueling tankers, and no new strategic airlifters.

So when our current defense secretary says he believes future wars will be fighting insurgencies like we are now in Iraq and Afghanistan, and by implication the Navy and Air Force are not that important, you can put me down as skeptical. Those generals and strategists fighting the last war will probably be proven wrong once again.

What about that sneaky animal, the economy? Can we ever figure out where it is going? Not likely, but there is one rule you have to assimilate: Watch the Fed. The Federal Reserve Board must be the strongest institution in the world except for the US presidency. It is America’s central bank, and it sets interest rates for US dollar creation, which is the domestic currency of the world’s largest economy, and the reserve currency for the rest of the world. Yes there are many other factors in economics like taxes, trade and regulations. But nothing, nothing, trumps the power of the Fed.

Is the Fed all knowing and all seeing? No. It is run by humans like you and me. Actually, it is run by economists.

Once the last vestiges of the dollar’s link to gold were severed in 1971, it became economists that determined our domestic monetary policy and international dollar strategy. Any of you who remember the double-digit inflation of the 1970s, 9% mortgage rates in the 1980s, the relative price stability of the 1990s, and the negative real interest rates of this decade, know it has been a wild ride indeed. And anyone dealing with wildly swinging exchange rates in the international trade arena must wonder if there is a better way.

So keep a close eye on the Fed. Its current Chairman, Ben Bernanke, was first appointed by George Bush, yet re-appointed by Barack Obama. That fact alone might make you a little suspicious. I can almost guarantee you his and the Fed’s decisions will be the single most important factor in our near term prosperity, or lack thereof.

I hope these observations have been somewhat useful to you in helping evaluate that wild, windy city called Washington, DC. Let me close with a brief discussion of the greatest political invention of all time: the Constitutionally-mandated free election every two years. Every day you should be thankful for that invention. It insures that no matter how far off track we get, within months we get another crack at the apple, with new leaders and new ideas percolating up in our big, unruly, but stunningly successful nation.

Our founders viewed America, and self-government, as an experiment. And the nature of that experiment is that it is never over, and always in danger of failing. We have many big challenges and problems facing us now, but based on past patterns we can be quite confident we will handle those well. Those regular elections, which cannot be repealed, insure we Americans will always live the impossible dream: We get a second chance, a third chance, and a fourth chance, until we finally get it right. And one of these elections could harbor that upside strategic surprise we are all looking for.

Thank you very much.