- A fundamental change in how we think
about the world is about to take place. Ever since the end of the Cold
War, economic and financial news has dominated our thinking. Real men
read the financial pages and studied the stock markets. Politics was for
- All of this is changing, and much of
the change will be visible during the next quarter. The long-brewing economic
crisis is now in place. It is old news. The only remaining question is
how bad it will get and how widely it will spread. The answers to that
are known as well: things are very bad and will get worse. It will spread,
but Russia and Asia will be the hardest hit. As with the Lewinsky story,
how much more can be said?
- Enter politics and its faithful companion,
war. The logical consequence of intractable economic problems is politics.
Economics, particularly free market economics, is a game for individuals
and corporations, all fending for themselves. When economics fails or
even appears to fail, it is time for the state. Where the state intervenes,
politics follows. And where politics and state intervention are employed,
force, both internal and external, is the logical consequence. This is
what happens in the real world, whatever the theologians might prefer.
- All of this does not happen in a moment.
We are at the beginning of this process, when politicians, desperately
in need of short- term solutions to the problems that bankers have left
them, are scrambling to use the tools available to them. These tools,
from regulations to passionate calls for national solidarity, are designed
to create some degree of solidarity in the face of genuine suffering.
They are also designed to control what can be controlled while everything
else is careening toward chaos. In this sense, recourse to politics is
not only comforting, but is a practical, short-term solution to very real
problems. However, these short-term solutions frequently carry with them
unwelcome and unintended long-term consequences. Politics and war go hand
- We believe that the texture of global
relations is about to change substantially. In the past few years, the
politico- military structure of the world has been fixed, while the international
economic system has been dynamic and the focus of attention. As the international
economic system continues to weaken, the forces holding the international
politico-military forces in check are weakening as well. As a result,
focus will shift away from purely economic relations to political and military
relationships. A more traditional world is reemerging. From Russia to
East and Southeast Asia, the fourth quarter of 1998 will see the rise of
political considerations designed to mitigate economic failures.
- * Russia returns to its roots
- The new central figure of Russian politics,
Yevgeny Primakov, is the former head of the First Directorate of the KGB
-- the man who was in charge of the Soviet Union's foreign espionage apparatus.
One of his key deputies is the former director of Gosplan, the Soviet
Union's central planning apparatus. The new head of the Russian Central
Bank is the former head of the Soviet Central Bank. The most powerful
man in the Duma is the head of the Russian Communist Party. The counter-revolution
- In order to understand Primakov, it is
essential to understand his deep distrust and animosity toward the United
States. Along with his new Foreign Minister, Igor Ivanov, who also traces
his roots to the Soviet Union's foreign policy apparatus, Primakov believes
that Yeltsin's policy of subservience to the U.S. in foreign policy has
deeply damaged Russia. Three areas will immediately feel the change of
- The first area will be the Balkans, where
the U.S. and Western Europe have had a free hand since their intervention
in Bosnia. The Russians have long regarded the Serbians as friends, although
they have not been very aggressive in their support of Belgrade. Moreover,
the region is fundamentally important to Russian geopolitical interests.
While money was flowing from the West, the Russians remained quiet. Now
that the spigot has been shut off, Russia has lost its motivation to be
quiet, and is making it very clear that a Western intervention in Kosovo
to block Serbia is unacceptable to Russia.
- As Russian domestic economic reforms
emerge, they will include nationalization, currency controls, and limits
on the repatriation of investments. The U.S. will respond with harsh criticisms,
blocking further assistance. Russia will respond with direct and open
support to the Serbs. Thus, Western intervention in the Balkans will now
involve a confrontation with Russia.
- The second area will be the Middle East,
and particularly Iraq. Primakov and his team are, simply put, pro-Iraqi.
During the Soviet period, Iraq was a key ally of the Soviet Union. The
new Russian government intends to rebuild Russian influence in the Middle
East. There are several reasons for this. First, Russia intends to reabsorb
the Moslem portions of the former Soviet Union. In order to do this, Moscow
needs to create a strong, secular, anti-American element in the Arab world,
so as to counter the region's strong Islamic tendencies that are also anti-Russian.
Second, Russia is deeply concerned about growing Turkish power on what
it regards as its southern frontier. Finally, Russia is committed to reducing
U.S. power and influence globally. Iraq and, to a lesser extent, Syria,
are keys to all three policies. Thus, Moscow will move rapidly to end
Iraq's isolation. This will lead to direct confrontations with the U.S.
- In this context, there is now a new dimension
to the Iranian question. Iran has been asserting its regional power, reaching
accommodation with Saudi Arabia, and threatening the Afghan Taleban with
reprisals for killing its diplomats. Iran has also been projecting its
influence northward into the Islamic portions of the former Soviet Union.
Now that Russia is about to reassert its rights in the region, Tehran
will find a complicated problem. Iran has been allied with the Russians
against the Taleban in Afghanistan, and has publicly asked for support
against the Taleban. Russia is, we believe, unwilling to continue to strengthen
Iran without clear understandings concerning spheres of influence within
the CIS. It is, we believe, the lack of enthusiasm by Russia for an Iranian
attack on Afghanistan that has held up military operations. Therefore,
we expect intensified negotiations between the two in the coming quarter.
The outcome of these discussions will be pivotal for the region.
- Finally, and most important, there is
Cyprus. Moscow has pledged to send surface-to-air missiles to the Greek
Cypriots. If these missiles are delivered, the Turkish air force will
be at risk. Ankara has made it clear that delivery of the Russian missiles
will be intolerable. Athens, in turn, has made it clear that any Turkish
attempt to block deployment of the missiles will lead to war. The Turks
are closely allied with the Israelis. The Greeks are aligned with the
Syrians. The chances of the U.S. dissuading Russia from delivering the
missiles decline daily. The chances of Turkey tolerating the missiles
are minimal. Thus, the probability of confrontation, with Russia backing
the Greco- Syrian bloc and the U.S. backing the Israeli-Turkish alliance,
- Suddenly, there is a real possibility
of U.S.-Russian confrontation on an arc running from the Balkans to the
Persian Gulf. Add to this the possibility of Russian cooperation with
Iran in an attack on Afghanistan, which would be opposed by U.S ally Pakistan,
and we see, like a sudden squall from nowhere, the possible eruption of
a U.S.-Russian confrontation redolent of the Cold War. It must be remembered
that Russia's strategic position is in no way comparable to that of the
former Soviet Union. Russia cannot now wield global influence, and may
never be able to do so again. But it is able to wield powerful regional
influence, particularly within the borders of the former Soviet Union.
And if it is to be successful there, it must also project its power into
the periphery of the former Soviet empire.
- This is terrain in which the U.S. has
roamed unimpeded by any but indigenous forces since the Gulf War. This
situation will end, increasing tensions dramatically. Thus, the economic
crisis that we have been chronicling is now going to be challenged for
first place among our concerns by an old-fashioned politico-military crisis.
Indeed, that economic crisis will adopt increasingly political overtones.
- Many have argued that military power
is linked to economic power, and have therefore asserted that Russia, with
a weak economy, is incapable of military adventure. Powerful military
forces emerge dramatically from essentially productive countries that have
fallen on hard times. We are reminded of Nazi Germany emerging from the
ashes of Weimar. In five years, a massive military force was created.
The creation of that force actually helped restart the German economy.
The key was the existence of skilled manpower ready to form a military
force. Russia certainly has this skilled force and most are still on active
duty. Their training may be a bit rusty and their weapons in need of repair,
many are hungry and all in need of discipline. But this is precisely the
type of force that can be dramatically and quickly improved and deployed
with minimal investment. Utilization of the Russian armed forces will
help Russia's leadership both by legitimizing it in the view of the military,
and by creating a binding myth of nationalism to hold the country together.
This increases the likelihood of military adventure.
- * Asia's Great Political Debate
- There is little left to say about the
collapse of Asia. It is time to think about the consequences. The consequences
will be less economic than political. A great debate is already beginning
to rage throughout East and Southeast Asia. The topic is how to recover
in the aftermath of Asia's financial collapse. Two schools of thought are
- The first school represents the thinking
of the Asia that created the late, lamented economic miracle. This thinking
consists of two parts. First, it is argued, Asia's problems are economic
in nature and require primarily economic solutions. Shifts in macroeconomic
policy, banking regulations, and tax policies, along with the normal business
cycle, will suffice to lift Asia out of its regional depression. The second
half of the argument is that reliance on the international community, including
the IMF and the U.S., regardless of the temporary pain caused, will help
discipline Asia's economies, allowing them to recover under their own power.
This is the view of the Asian economic establishment. It argues that
nothing fundamental has changed, and that the current crisis is a cyclical
event with some minor structural aspects, not a failure of the international
system itself, nor of the governing elite that has nurtured this system.
- Another, more radical school of thought
is emerging to challenge this view. It argues that the central problem
facing Asia is the fundamental structure of the international monetary
system. So long as the dollar remains the only reserve currency, U.S.
monetary and economic policy will control Asia. The current crisis spun
out of control because the underlying productivity of Asian economies became
less important than the relationship of their currencies to the dollar.
As economic problems emerged, dramatic instability in Asian currencies
drained Asia's reserves. The crisis intensified as trade within the region
suddenly collapsed due to the lack of dollars. A downward spiral ensued,
in which the outflow of dollars from the region, and the de- legitimization
of native currencies, made regional and domestic commerce impossible.
Currency instability caused economic activity to collapse, which in turn
caused production to collapse, undermining capitalization and smashing
the region's capital infrastructure.
- For advocates of this theory, the key
problem is dollar dependency. The logical solution is to eliminate this
dependency. For this to happen, an alternative reserve currency must be
found. This is to be done in two stages. First, because the fundamental
problem is the decline in domestic production and consumption, national
currencies must be protected. The goal is to stimulate internal commerce
while still permitting dollar- denominated exports. Thus, the first step
is to impose currency controls that limit the outflow of the domestic currency,
while permitting the inflow of dollars. The next logical step is to channel
the inflow of dollars into the central bank in order to create a war chest
for the protection of the domestic currency. Two countries, Malaysia and
China, are already pursuing variations on these themes.
- The next step is the creation of a regional
currency that will substitute for the dollar in regional trade. This is
a more difficult step, inasmuch as it requires some sort of regional agreement
-- either a regional Bretton Woods or some sort of Asian monetary entity.
Moreover, it requires the leadership of Japan, which has the preeminent
regional currency and the only currency that could serve as a regional
reserve. Japan is reluctant to take on this position for two reasons.
First, Japan is dependent on exports to the U.S., and cannot substitute
Asian markets for U.S. markets. Japan therefore cannot easily cast the
yen free from the dollar. Second, and perhaps more important, the political
implications of economic leadership place Japan is a role vis-a-vis Asia
that neither Japan nor the other Asians want.
- But advocates of this strategy argue
that it is both an essential and a low-cost approach. Waiting for international
support is fruitless -- the amount offered cannot solve the problems, and
the price demanded by the IMF and the U.S. can only create chaos. Because
the amount offered will achieve nothing and the price demanded is far too
high, there is no alternative to economic nationalism. Whatever Japan
wants, this faction argues, is ultimately immaterial. Moreover, they argue,
Japan's fear that its political assertiveness will place it in an unwelcome
leadership position is more than offset by China's politico- military power.
Thus, Japanese economic leadership will be counterbalanced by Chinese
- Who is right in this debate is much less
important than that this debate will soon become the dominant domestic
theme in these nations and throughout the region. This has already happened
in Malaysia, where the political confrontation between the Prime Minister
and his former Treasury Minister is being fought precisely along these
lines. Elements of this debate can also be seen in Indonesia and China.
Some nations, like Singapore, are still firmly in what we will call the
- The key debate will take place in Japan.
It is clear to us that the Obuchi government cannot survive much longer.
Indeed, we do not believe that the current Japanese political alignment
can survive this economic crisis. The ruling establishment is going to
split into two distinct factions, which will define Japanese politics for
many years. Old internationalists will confront new nationalists and Asianists.
The internationalists will dominate the political scene for some time
yet, but their day is done.
- It is our view that the Asianists will
win the debate throughout much of Asia, with the exception of Singapore
and Taiwan. Their approach will provide short-term solutions and create
long-term problems. These long-term problems will include confrontations
with other blocs, particularly that led by the U.S. Indeed, the underlying
theme of resistance to the U.S. will come to dominate the international
- The international system hates imbalance.
It has been terribly imbalanced since the collapse of the Soviet Union,
with only one major power, the United States, dominating the entire system.
The Russian reversal and the Asian crisis have this in common: both will
engender growing resistance to American power. Indeed, it is altogether
possible that we will see Russia, China, and Japan increasing aligned against
- The first tests of this will be primarily
U.S.-Russian confrontations: Cyprus, Iraq, and Kosovo. It will be particularly
interesting to see the manner in which Asian nations deal with issues such
as these, that are peripheral to their core interests. Unless the U.S.
is more forthcoming to Asia, which it cannot and will not be, we suspect
that the U.S. will be stunned by its isolation as it tries to manage regional
crises in the face of Russian resistance.
- * The EMU meets politics
- Europe, relatively unscathed by the Asian
meltdown, has been affected far more by Russia's problems. Germany in
particular has been financially exposed to the consequences of Russia's
economic crisis. Indeed, it has been most exposed to the collapse of the
Soviet Union, being directly responsible for absorbing a part of that empire
directly into Germany, and for underwriting development in much of the
rest of Eastern Europe.
- Today, the architect of German unification
paid the price for only performing with near-perfection and for being on
the political stage too long. Helmut Kohl's defeat also changes the political
equation in Europe in two ways. First, the Social Democrats are, viscerally,
anti-American. Ever since Vietnam and the nuclear freeze debate of the
1980s, the Social Democrats have been profoundly uneasy with the idea of
U.S. leadership. At the same time, the SDP is profoundly anti-militarist
and would be the last ones likely to want to see independent German military
- What used to be an interesting intellectual
contradiction has now become a fundamental policy issue within the German
government. On the one side, the new German government will not want the
Bundeswehr to be a unit in the U.S. Army. On the other hand, it is committed
to quelling the brutality in the Balkans. On the third hand, if you will,
it does not want to act unilaterally. With the Kosovo issue looming, the
first crisis facing this government will be to sort out these visceral
sensibilities into something resembling a coherent policy.
- The second crisis will be posed by the
EMU. The Europeans, having barely managed to work out the management structure
of Europe's monetary authority, are straining over the question of who
will speak for the EMU at the G-7 meetings. Italy, Germany, and France
argue that, since they are already represented there, they will be happy
to take on the burden. The smaller European countries want separate representation,
sensitive to their needs.
- This is not just another tiresome European
wrangle. It cuts to the heart of the new currency. Who exactly controls
it and whose interests will be protected? This debate will now seriously
heat up because the SPD is likely to pursue a very different economic and
monetary policy than did Kohl. The SPD's number one concern is unemployment
in the East, their political base. They will want to have a much looser
monetary policy. They need one. Thus, the carefully hewn unity among the
great powers, which left out the smaller countries, is now to be torn apart
in a new debate between the new German government and the rest of Europe's
major economic powers.
- We continue to believe that the EMU will
be dead on arrival. The EMU is an economic colossus built on a base of
political sand. Each European election now has the potential of undermining
the entire edifice. Even if this German election doesn't, some election
will. The EMU, like Russia and Asia, is going to meet the dark face of
politics sooner rather than later. This last quarter of 1998 may destroy
the EMU, postpone it, or most likely, allow it to go forward with political
constraints that will guarantee its failure.
- * United States and the Lovely Ms. Lewinsky
- What would a quarterly report be without
a mention of President Clinton's problems? There is absolutely nothing
left to say after the torrent of words, save that we do not think that
he will resign over this nor be forced from office. However, this is the
screen behind which a tidal wave lurks. Monica is trivial. The campaign
finance scandals are potentially enormous. It will take about six months
for that crisis to make itself felt. When it does, it will make Monica
- Of more immediate importance is the U.S.
economy. Let's distinguish that from the stock market, about which we
are as confused as anyone else. However, the economy continues to appear
strong. We would not be surprised to see a recession, since one is long
overdue. However, even that does not seem immediately likely, simply because
the numbers do not support a major slowdown. Nevertheless, if a recession
occurs, we do not think that it will be the apocalypse that is being predicted.
What is interesting to us is the extent to which serious people expect
a catastrophe. To us, cranky contrarians that we are, this is the most
bullish sign of all.
- Indeed, what we believe we are seeing
is the segmentation of the global economy into three, marginally related
parts: Asia, Europe, and the United States. If we are correct, then global
meltdowns are most unlikely. One test of this theory will be Latin America.
We started the year bullish on Latin America and remain bullish, even
after the terrible battering its markets have received. However, in our
view, Latin America's fate is linked to the U.S., and the Asian and Russian
meltdowns, quite real, have only psychological effects. Latin America
has been stabilizing in the past weeks, and we believe that the stabilization
- * Conclusion
- Intensifying political crises within
countries, particularly in Russia and Asia, will mark the last quarter
of 1998. Political matters are going to be more important than economic
matters. As the quarter goes on, these internal political matters will
manifest themselves in external political disputes. The same will be true
in Europe. The day of the economist is passing. The day of the politician
is here. Standing in the wings is the soldier.