Sweeping World Changes
Poised For End Of 1998 -
Ominous Global Forecast
Global Intelligence Update
World Forecast for Fourth Quarter of 1998
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 wimps.
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 in 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 has arrived.
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 Russian policy.
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, is substantial.
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 emerging.
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 politico-military power.
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 internationalist camp.
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 scene.
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 American initiatives.
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 action.
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 a footnote.
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 will continue.
* 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.