Interesting and thoughtful comments about Russia. After reading this, it is difficult to be optimistic:
Subj: Third Quarter Forecast
Date: 7/6/98 12:23:19 AM Eastern Daylight Time
From: alert@stratfor.com
To: alert@stratfor.com
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Global Intelligence Update
Red Alert
July 6, 1998
Forecast for Third Quarter 1998
* Resistance to U.S. Power Grows
The main feature of the international system remains the intensifying
resistance to American global power by secondary powers. This pattern,
described in both our Annual Forecast and our Forecast for Second Quarter
1998, is both inevitable and the defining characteristic of the global
system today. Since the collapse of the Soviet Union, the international
system has been in extreme imbalance. A single power, the United States,
suddenly found itself in an extraordinarily powerful position. Relatively
insulated from international pressure, the United States was not
constrained to act in either a consistent or predictable fashion. The
result was inevitable. U.S. foreign policy was shaped by domestic
political considerations or fell into the hands of politically influential
business interests who worked to shape foreign policy to suit their needs.
Since there was no overarching strategic imperative at work to limit their
interests, U.S. foreign policy became particularly sensitive to these
pressures.
From the standpoint of the rest of the world, U.S. policy has become
peculiarly erratic. It requires a deep understanding of the political
process in Washington to predict U.S. policy initiatives and responses.
The American response to crises and processes seems random and
unpredictable. As a result, resistance to U.S. global domination has been
spreading and intensifying on a global basis. It remains a fragmented
resistance, not yet coordinated due to a lack of a single unifying power
willing to challenge the United States. Nevertheless, its spread and
intensification has been marked in the last quarter and we expect this
trend to continue to intensify with increasing inter-regional coordination.
During the last quarter, resistance has increased in several areas and over
several issues. The growing crisis in Kosovo, for example, has been
defined by Russian unwillingness to allow the United States the right to
dictate policy in an area it regards as within or close to its own natural
sphere of influence. The nuclear tests on the Indian subcontinent
represented direct challenges by both India and Pakistan to U.S. policy, as
neither power was willing to subordinate its own national interests to the
American sponsored nuclear regime. Saudi Arabia has pulled away from its
traditional relationship with the United States. China has taken every
opportunity not only to resist American blandishments over human rights,
but also to make it clear that they are pursuing an independent foreign and
defense policy. Resentment and resistance to the United States, coupled
with an almost sublime American indifference to this sensibility, has been
the dominant theme thus far this year and will continue to dominate in the
third quarter.
It should be remembered that this deterioration of American political power
is inevitable. A unipolar world is untenable unless the dominant nation is
overwhelmingly and indisputably powerful, which the United States is not.
The paradox of the American position has been that, as the world's only
global power, the United States is too weak too exercise an absolutely
definitive authority but too powerful to evade responsibility. As powerful
as the United States was and is, that power is far from sufficient to allow
Washington to impose true global hegemony. As a result, the United States
finds itself with a peculiar responsibility for virtually every event in
the world, without having the resources to influence more than a small
handful. Apart from irritating the world for its seeming indifference and
inability to act, this weakness has created space for secondary and
tertiary powers to assert their own, regional interests. This last quarter
saw a good deal of this, and the next quarter will see even more.
We are also seeing a search for patronage on the part of these powers as
tertiary powers seek secondary powers for political, military and economic
support. Three nations seem to be increasingly undertaking this role.
France, for one, has been particularly aggressive in challenging American
power. For example, the French have been flirting with the Saudis at
precisely the same time that Saudi-U.S. relations are worse than they have
been in decades. Another power is Russia which, following its defeat by
the United States on NATO expansion, has been resisting American policy in
the Balkans and the Middle East. We expect them to increase their
opposition to American power in Central Asia in the near future. Finally,
China has made it clear that it regards itself as a major regional power,
and that it expects the United States to treat it as such. These three
powers serve as the focus of potential anti-American coalitions in the
future. We continue to expect continued cooperation between the three over
the coming months, to the consternation of Washington.
* U.S. Economic Strength Continues Unabated
This ongoing geopolitical process is taking place against the backdrop of
unparalleled American prosperity. The United States is, without a doubt,
in an economic golden age. Given where the international system was ten
years ago, it is odd to say that American economic power is today greater
than its political power. Nevertheless, it is true. The most dramatic
feature of the international system is the robustness of the American
economy. We do not expect the American economy to weaken materially.
American exports represented only about 8.5 percent of Gross Domestic
Product in 1997. Total exports to Asia represented about a quarter of this
total. If the U.S. lost twenty percent of its exports to Asia, this would
represent a loss of less than one-half of one percent. Assuming a
multiplier effect of decreased sales to Europe due to the Asian decline, it
is still hard to believe that a complete disaster in Asia would slice more
than one percent off of America's GDP. Since the economy is growing faster
than this, the worst case scenario would be that Asia will cause a slow-
down in the American market. In an odd way, the lack of Asian leverage on
the United States is due to its own policy of aggressive exports and
protection against imports. These policies mean that the U.S. is not very
vulnerable to Asia's problems and not likely to do much to solve them.
Even the worst case scenario is counterbalanced by a benefit to the United
States from Asian troubles -- capital flows. As Asia has melted down,
money has fled Asia. This includes not only Asian money, but U.S. and
European money being held back or pulled out. This money has tended to
gravitate toward safety, which is represented by the American capital
markets. This process is not over by any means. The tendency of the
conventional wisdom to underestimate Asian problems has meant that many
investors have tried to hold tight to their positions. Successive crises
have shaken loose more and more of this money, but there is plenty left and
it is flowing toward the U.S.. This makes up for lost trade in very
positive ways.
Fleeing Asian money has facilitated new capital formation. This means that
while labor shortages are a real problem, interest rates are
extraordinarily low for this stage of a business cycle, and the Federal
Reserve Bank has had no problem maintaining a positive net reserve
situation. We see no reason to expect the U.S. economic expansion to end
in the next quarter or even this year. Thus, our prediction in our 1998
Annual Forecast stays in place: "The United States has become the safe
haven for investments as well as the lender of last resort on a global
basis. As Asian economies weaken, the flow of money into the United States
increases... This flight to safety will serve to cushion weaknesses in the
American markets and limit the negative phase of the U.S. business cycle."
It has worked thus far and will continue to work.
* Asian Economic Crisis Catches Up With China
At the same time, the Asian economic calamity continues unabated.
Predictions that the worst is over have consistently been proven false. We
wrote in our Second Quarter Forecast that, "The region appears about to
enter phase three of the crisis. The first phase was the long, slow
deterioration of the Japanese economy. The second phase was the sudden
implosion of the Korean and ASEAN economies. The third phase will be the
intensification of the Japanese crisis and its spread to China." This
continues to be our view. We have certainly seen the intensification of
the Japanese crisis. We have not seen the problem spread to China as yet.
More precisely, the problems have spread but the consequences have not yet
followed. As we pointed out in a recent Weekly Update, we remain convinced
that the pressure on Chinese exports will force a devaluation of the yuan,
which will, in turn, trigger economic crisis in China.
China, of course, is working diligently to avoid this. One of its
strategies is to encourage a continued inflow of Western investment. In
order to achieve this, China must create the illusion of invincibility.
Part of this requires that economic statistics be presented in such a way
as to encourage investors. China, for example, has emphasized the
continued growth of industrial production at pre-crisis levels.
Unmentioned has been the fact that inventories in China are soaring, as
unsold products pile up. By emphasizing industrial growth over other
variables, the Chinese are leaning on the one variable they can control, in
the hope that Western investors will continue to pump in hard currency with
which the yuan can be supported.
The other part of this strategy is an extremely aggressive foreign policy
stance, in which China appears to be utterly self-confident and even cocky.
China is doing everything it can to maintain the illusion of the robustness
of the Chinese economy. It has worked so far. We do not believe it can
work indefinitely and we believe that Japan's problems will take down the
Chinese economy in the coming months. We see Chinese management of
Clinton's recent trip to China as part of this strategy. Clinton, by
affirming Chinese power and treating China like America's senior Asian
partner, helped minimize China's risk in the eyes of Western investors.
Now, Western investors already exposed in China are certainly hoping that
the Chinese can pull of their strategy. This is the origin of the heavy
pressure on Clinton to minimize friction with China. The hope is that
China will invest its way out of its crisis. We do not think it will work.
We expect China to join the rest of Asia shortly.
* Economic Failure in Russia Foreshadows Death of Liberal Experiment
Russia has already joined Asia, for all intents and purposes. The Russian
economy simply does not work. Outside of a handful of major cities, Russia
is in the grip of a depression of unprecedented proportions. Now, the
Kiriyenko government is struggling to hold together the fabric of Russia's
urban economy by keeping the banking system afloat. They cannot succeed.
The rates of return on investment nearly a decade after the fall of
communism simply cannot sustain the development of Russia into a modern
democratic society. As we put it in our 1997 Annual Forecast: "The
Russians have given away their empire in return for very little. The
people that Westerners speak to -- English speaking intellectuals and
businessmen -- are not the gauge of Russia. The vast hinterland, with its
mid-sized and small industrial cities and its farms, is an impoverished
disaster. Reforms have created disorder and confusion and have increased
corruption. They have provided precious little rewards beyond uncertainty
and poverty."
Yeltsin's selection of Kiriyenko reveals the bankruptcy of his policies.
Kiriyenko's selection means that Yeltsin sees Russia's problems as
primarily technical -- inefficient tax collection, poor law enforcement,
etc.. The selection of a 35 year-old whiz kid to solve these problems
would make sense if Yeltsin was right. In fact, the problem is not
technical but cultural, historical, and ultimately moral. The
extraordinary poverty of Russia outside of Moscow and St. Petersburg, the
loss of state dignity in the face of profound corruption, and the loss of
the grandeur of the communist empire in exchange for very little, are all
cancers eating at the soul of the post-communist regime. The issue, as we
have been saying for several years, is not whether liberal democracy will
survive in Russia, but what will replace it? The selection of Kiriyenko is
a last ditch effort to save Yeltsin's regime. It cannot be done. In the
meantime, almost imperceptibly, Russia's foreign policy is returning to its
old, imperial paths. We expect Russian activity in the Caucuses and
Central Asia to be particularly intense in the coming quarter, moved by
anti-American sentiment and the desire to get greater control over the
region's oil supply.
* Oil Price Collapse Makes Iran Significant -- And Iraq a Target
Oil has become a driving force for Russia, as well as for other oil
producers. Russia's problems have been exacerbated by the inability of oil
producers to raise prices above historical lows. This has devastated
Russia's economic plans. It has also devastated the economic plans of
other oil producers, particularly Saudi Arabia. For example, Saudi Arabia
has paid some major suppliers with bonds rather than with cash. It had
similar problems in 1993-94. This time the situation is worse, both
because it comes after the debilitating 1993-94 period and because prices
are relatively more depressed. The Kingdom borrows through its private
banks, and these banks have recently financed a $2 billion government
placement. This is, we believe, the tip of the iceberg. The Saudi
situation is truly precarious.
Saudi Arabia, along with Venezuela and Mexico, has agreed to cut
production. As we said in our forecast for last quarter when we discussed
the effect of the Riyadh Pact on oil prices: "This indicates to us that
there is now a floor under the price of crude. However, this does not mean
that the price will rise and without a rather strong rise in the price of
oil, which is not likely to happen by agreement alone, Saudi Arabia is in
serious financial trouble." A floor has been set, but it is not clear that
production cuts alone, particularly unenforceable production cuts, can
raise the price of crude.
The only way to raise crude prices at this point is to force production off
the market. From our point of view, the key problem is that production
levels have been set since 1991 on the assumption that Iraq would not be
exporting oil. Now that Iraq is in fact exporting, a massive overhang
exists in the market. No one can afford to cut production to compensate
for Iraq. It follows, therefore, that by pushing Iraq off the market
again, oil prices would rise, by some estimates, as much as five dollars a
barrel. While this might be excessive, it is certainly a temptation,
particularly for a country as desperate as Saudi Arabia. Of course Saudi
Arabia is not in a position to close off Iraq. The United States and Iran,
however, are in a position to do so.
The recent American opening to Iran was predicted by STRATFOR. We wrote
last quarter that, "It has been our consistent view that American fear of
Iranian participation in the Greco-Syrian-Iraqi entente forced the United
States to seek an accommodation with Iran. That process of accommodation,
which we have tracked since September, continues to intensify. It has been
our view that, to a large extent, American bellicosity toward Iraq was part
of an attempt by the United States to convince the Iranians that the United
States is committed to bringing down Saddam and to rectifying the outcome
of the Iraq-Iran War." This American courtship has broken into the open,
with the Clinton Administration openly stating that they wish to improve
relations with Iran. One of the key reasons for this is tremendous
pressure from Saudi Arabia which, facing serious economic problems from low
oil prices, has been flirting with an alliance with Iran.
The Saudis are as naturally opposed to unilateral Iranian power as they are
opposed to unilateral Iraqi power. But committed though they are to a
balance of power in the region, the oil price situation has become an
obsession that has driven prudence out the door. The issue now is not
whether Iraqi oil will be forced off the market, but who will do it and
what will the consequential power relations turn out to be. One rational
U.S. maneuver would be to precipitate an intense confrontation with Iraq,
designed to isolate Iraq, remove its oil from the market, raise prices and
save the Saudi economy. Another scenario is that Iran will unilaterally
act against Iraq, both to raise the price of oil and consolidate its
position as the dominant power in the Persian Gulf. A third scenario would
be one in which the U.S. and Iran collaborated to isolate Iraq. It is not
clear which of these will happen, but we remain convinced that someone is
going to act against Iraq. Geopolitics and economics have combined to make
Iraq intolerable. Indeed, given Washington's tendency to respond to
pressure from special interests in formulating its international strategy,
we see such an action against Iraq as consistent with this administration's
operating principles. There are a lot of people who would be very unhappy
to see a massive Saudi default. A lot of people want to see higher oil
prices. Iraq is the key to this outcome.
Thus, we expect the next quarter to look very much like the past two. A
robust American economy will parallel a weakening international position,
punctuated by periodic bursts of politico-military activity motivated by
domestic political and economic pressures. Asia and Russia will continue
to deteriorate economically. There will be increasing attention on the
Persian Gulf as the Saudi economic crisis plays itself out. The logical
consequences of the end of the Post-Cold War world continue to play
themselves out. There will, we think, be few surprises but increasing
distress.
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