John Mauldin's Outside the Box : Geopolitics

Video Dispatch: Israel and Intrigue at the White House

John Mauldin — Thu, 12 Nov 2009 17:53:00 GMT

The closed-door meeting is a prime indicator of unpredictability. It's one of the most difficult elements for even the most savvy investors to encounter and plan for - or against. Usually we know the preemptive measures we need to take in order to protect our assets, and even make a few dollars in auspicious instances. But what about the information we can't access?

Luckily, we have options. Today I'm including an excellent video from my friends at STRATFOR, a global intelligence company. They shed light on a closed-door meeting between the Obama administration and 3 top Israeli officials. When speculation is rampant, there's only one source I trust for reliable insight, and that's STRATFOR. I encourage you to watch this video. Also, sign up to get their two free weekly intelligence reports for more door-opening insights on critical issues.

A Crisis in the Kremlin

John Mauldin — Thu, 29 Oct 2009 14:26:00 GMT

Earlier this week, I sent out a piece that talked about the dangers of ignoring the big picture - even for the "bottom up" investor. Every once in a while, we all have to step away from the Dow Jones Industrial Average, housing prices and other indicators to look at what's going to influence these factors in the long term.

Today I give you a video about Russia and how a plan to fix the economy might throw off the political balance of power. I regard Moscow's situation as a valuable lesson for our country - also in the throes of an economic crisis - and for investors affected by global markets. Click here to watch this great video by my friends at STRATFOR, a global intelligence company. You can also sign up to get free weekly intelligence from them, so you don't have to depend on my occasional mail-out.

John Mauldin

Iran Sanctions (Special Series), Part 3

John Mauldin — Thu, 01 Oct 2009 19:36:00 GMT

Recently I had a discussion with a colleague about university athletes. I was previously unaware that NCAA colleges set up guidance programs that develop the well-roundedness of student athletes. 'Life coaches' ensure that these individuals balance their rigorous athletic commitments with personal and academic accomplishments. I'm not judging your ability to run a mile or catch a football, but well-roundedness is an element to being successful - whatever your area may be.

To be a solid investor, it's important to consider a variety of markets, and you must be well-informed in a myriad of sectors. This is where having the best information comes in, and one of the better places for intelligence is STRATFOR. They offer a straightforward recipe of news about global affairs - causes, outcomes and what to expect next based on a rational, time-tested methodology.

I'm including a STRATFOR report that discusses the possibility of gasoline import sanctions against Iran. It's an absolute must-read for anyone interested in energy, foreign relations, Russia, the Middle East, etc. I'd encourage you to sign up for their free weekly reports here, so you aren't limited to what I send you on occasion. Begin (or continue) your journey to well-roundedness... Now, get to the line and practice your free throws.

John Mauldin
Editor, Outside the Box

Iran Sanctions (Special Series), Part 3: Preparing for the Worst

September 25, 2009

Summary

Iran has long been preparing itself for U.S.-led sanctions against gasoline imports and is confident in its ability to circumvent them. But even if the sanctions did get Iran's attention, they would not necessarily bring it to the negotiating table. Iran takes resistance very seriously, and while extolling the virtues of self-sacrifice it could close the Strait of Hormuz, which would wreak havoc on the global economy.

Editor's Note: This is part three of a three-part series on what sanctions against Iran could mean for Iran, U.S.-Russian relations, Israel and the global economy.

As the Iranian regime continued apace with its nuclear program, it understood that it was only a matter of time before the West would aim for its gasoline imports, a potential Achilles' heel for Iran. Although Iran may be one of the world's top-five crude-oil producers and exporters, its rogue reputation isn't exactly good for business. The Iranian energy industry has been sagging under the weight of sanctions for decades as the foreign energy majors with the technical skill Iran so badly needs wait for the geopolitical storm clouds to clear before tapping the country's vast energy reserves.

To contain domestic political dissent, the Iranian regime has heavily subsidized the population's energy needs. The drawback to such a policy is that ridiculously cheap gasoline prices (gasoline in Iran costs around 9 cents per liter) tend to fuel rapid consumption and rampant smuggling. As Iran's population continued to grow, so did its appetite for gasoline, and the regime has now reached a point where it simply cannot keep up with domestic demand without importing at least one-third of its fuel.

So, while Iran's Arab rivals, such as energy heavyweight Saudi Arabia, profited immensely from record-high crude prices in 2008, the Iranian regime was still struggling to balance its accounts. Then came the global economic collapse, which sliced the country's oil revenues in half. And given the sponsorship by the Islamic Revolutionary Guard Corps (IRGC) of militant and political proxies in Iraq and Lebanon, Iranian President Mahmoud Ahmadinejad's repeated raids on the country's rainy-day oil funds for his political campaigning, and funding for the Iranian nuclear program, Tehran does not have much cash to spare.

Unreliable Allies

Iran is not oblivious to its gasoline vulnerabilities, but it also isn't left without options should Washington become more aggressive with its sanctions campaign. As discussed in detail in part two of this series, Russia — for its own strategic reasons — has developed a contingency plan, most likely involving Russia's former Soviet surrogate, Turkmenistan, to cover the gasoline gap should Iran start experiencing shortfalls. The Russians are certainly not planning to do this out of the goodness of their hearts and sincere loyalty to their allies in Tehran. On the contrary, sabotaging Washington's sanctions regime against Tehran is yet another way Moscow can turn the screws on the United States if the Obama administration refuses to take seriously the Kremlin's demand that the West respect its influence in the former Soviet sphere. Since the Obama administration backed down recently from its Ballistic Missile Defense (BMD) plans in Central Europe, there could be more room for Russia and the United States to engage in serious negotiations. That said, there is no guarantee that Washington would be willing to pay the price of Russian hegemony in Eurasia in return for Russia's cooperation on Iran, and Moscow will drive a hard bargain before it even thinks about sacrificing its leverage with Iran.

Iran could certainly use Russia's help in maintaining its gasoline supply, but Tehran is also quite wary of becoming that much more dependent on Moscow's good graces for its energy security. Russia and Iran have quite a tumultuous history (the Soviets briefly occupied Iran during World War II), and the Iranian leadership is fearful of being abandoned by Russia should Moscow reach some sort of compromise with Washington.

Iran's other energy-producing ally hostile to the United States is Venezuela, which recently announced it would come to Iran's aid in the event of sanctions and supply its Persian friends with 20,000 barrels per day (bpd) of gasoline starting in October for an $800 million annual fee. Beneath the revolutionary rhetoric of oppressed regimes sticking it to their imperialist foes, this Venezuelan-Iranian energy deal is filled with holes. For starters, Venezuela — much like Iran — is facing serious refining problems due to mismanagement and a severe drop in foreign investment. Also like Iran, Venezuela's populist regime heavily subsidizes its constituents (gasoline in Venezuela is even cheaper than in Iran at 4 cents per liter), sending consumption soaring over the past four years. While Venezuela is currently refining around 420,000 bpd, it still needs to import gasoline to help meet domestic demand.

Caracas could always go through a third party to supply gasoline to Iran from a source closer to the Persian Gulf, but finding a willing supplier could prove difficult and costly when insurance premiums and political risks are taken into account. Moreover, should push come to shove, Washington has substantial leverage over the Venezuelan regime given the abundance of assets that Citgo, the refining unit of Venezuelan state oil company Petroleos de Venezuela, has spread throughout the United States. The United States also is the largest recipient of Venezuela's crude exports and one of the few markets in the world with the technological capabilities to process Venezuela's heavy crude, leaving Venezuela without much of a viable alternative market.

Iran has already turned to China to help backfill its gasoline supply. Latest estimates show that starting in September, China began to directly supply up to one-third of Iran's total gasoline imports. Until now, Chinese involvement in the gasoline trade had mostly been limited to shipping companies. In the run-up to the Oct. 1 talks, China now has the extra incentive to poke the United States and profit from these gasoline shipments to Iran. After having boosted its refining capacity this year, China has surplus gasoline to sell on the international market. In August alone China exported 140,000 barrels of gasoline per day. Like Malaysia's Petronas, which began supplying Iran with gasoline in August, China sees an opportunity to profit off of Iran's gasoline trade at a time when political tensions are rising and major energy firms, such as BP, Reliance and Total, have already stopped or are cutting back their shipments to Iran. But Iran may not be able to rely on Chinese aid over the long term.

China currently is in a heated trade spat with Washington over a recent U.S. tariff on Chinese tire imports and could push back against Washington even further by flouting the threatened sanctions regime. However, this is a decision with major strings attached. Washington still has a great deal of leverage over Beijing in the form of Section 421, a U.S. law that was incorporated into China's accession agreement with the World Trade Organization in 2001 and allows the United States to legally impose tariffs on nearly any Chinese export until 2013. Now that Obama has put Section 421 to use in restricting tire imports, the Chinese have to think twice before making any moves that could compel Washington to go even further in slapping trade restrictions on China. Additionally, China is a massive energy importer itself, so shipping any sort of energy product to the Middle East, where its supply lines are unprotected, is something that works directly against most of China's energy security strategies.

The United States has not yet formalized the gasoline sanctions against Iran in the form of legislation or a U.N. Security Council resolution, and this may be providing Beijing a limited opportunity to hit back at the United States during the trade spat and demonstrate the limits of Beijing's cooperation. However, Beijing will be far more cautious than Russia when it comes to blocking sanctions against Iran and will keep a close eye on Russia's intentions in deciding its next steps. China has long been noncommittal when it comes to sanctions against Iran and will align itself with Russia in forums like the U.N. Security Council to demonstrate its opposition to punitive U.S. economic measures. Of course, if Russia folds and reaches some sort of compromise with Washington, China will comply with the sanctions and avoid being left in the spotlight as the sole sanctions-buster allied with Iran.

In short, Iran has friends that it can turn to if necessary, but the reliability of those friends is by no means guaranteed.

Fending for Itself

In the spirit of self-sufficiency, Iran has long been preparing itself for a U.S.-led offensive against Iranian gasoline imports. Over the past two years, as talk of gasoline sanctions intensified, Iran sought out willing suppliers to help stockpile its gasoline reserves. Iranian gasoline consumption currently stands at around 300,000 to 400,000 bpd, but over the past several months, Iran has been importing well in excess of that amount from mostly Swiss suppliers and now newcomers like Malaysia's state-owned Petronas, which are looking to replace the energy majors that are dropping out of the Iranian gasoline trade while political tensions are high. Iranian and U.S. intelligence sources claim that Iran currently has at least three months worth of gasoline needs (estimates average around 30 million barrels) stockpiled. The director of the National Iranian Oil Refining and Distribution Company claims Iran's gasoline storage capacity is about 15.7 million barrels, which gives Iran about four months of in-storage capacity. Some of the surplus gasoline is sitting on tankers off Kharg Island, but the bulk of the supply is stored on land, where it is less vulnerable to airstrikes.

The Iranian government continues to make bold claims about its ability to massively ramp up its refining capacity and become self-sufficient in gasoline production within four years, but this is mostly hot air. Iran simply doesn't have the capability to meet its gasoline production goals on its own without the necessary foreign investment. And even if Iran had willing partners in places like Central Asia, it would still need to overcome its extreme reluctance to actually foot the bill for such projects.

It may strike some as odd that Iran has acquired a capability to develop nuclear technology but still struggles to build and operate refineries on its own. There are a number of reasons for this, but the simple answer is that the technology for a nuclear program dates back to the 1930s and 1940s and has not changed much since, while refining technology is continually updated and Iran has been out of the global oil-and-gas mainstream for 30 years now. A nuclear weapons program requires a couple dozen or so highly trained scientists and engineers to operate it, and these personnel can be trained in any number of institutions around the world. On the other hand, a permanent staff for a refinery producing around 300,000 bpd would require some 1,200 highly trained technicians and petroleum engineers, and most of Iran's intelligentsia — particularly the group with strong technical skills — left the country following the Iranian Revolution. Iran's stated energy goals are full of delusion as well as ambition.

Confronting the Subsidy Problem

Iran thus has little choice but to figure out a way to reduce gasoline consumption at home. The Iranians started on this initiative in June 2007 when the regime implemented a rationing system. Though the move was extremely unpopular and instigated a spate of riots in Tehran, the backlash was swiftly contained and, according to energy industry sources, Iranian gasoline imports dropped from 40 percent of total domestic consumption to about 25 to 30 percent.

The next step is for the regime to start cutting untenable subsidy rates by raising the price of gasoline. This is a plan that has long been in the works but has been put off time and time again due to the regime's deep-rooted fear of sparking major social unrest. This especially became a concern following the June presidential election debacle, which gave scores of Iranian citizens the courage to pour into the streets to voice their dissent against Ahmadinejad. Though the protests have dramatically dwindled in size, they continue sporadically and are a persistent irritant to the regime. Iranian sources claim that the coming gasoline price hike will not be that dramatic in the beginning. The government would likely continue to subsidize domestically produced gasoline while allowing the cost of imported gasoline to rise so it can pass along a portion of the costs to the consumer and further dampen demand.

Besides the potential political fallout, there is another significant issue with this gasoline price-hike plan. Since gasoline prices are heavily subsidized in Iran and are, therefore, much cheaper than the gasoline sold in neighboring countries, Iran has a major problem with gasoline smuggling to these countries. Iranian sources claim that more than 750,000 barrels are smuggled every month from Iran to Turkey, Afghanistan and Iraq, and this puts a considerable drain on Iran's energy revenues. The smuggling rings are run by a variety of actors, from Iranian organized crime entities linked to the IRGC to Balochi tribesmen to Kurdish smugglers, and they are extremely difficult for the regime to dismantle. Moreover, Iranian officials tend to turn a blind eye to these smuggling practices in order to buy political patronage from non-Persian minorities (Kurds, Balochis and Azeris) in the borderlands who could otherwise cause serious trouble for the regime. With the political situation at home particularly dicey right now, the Iranian government will have to proceed cautiously with any future price hikes, which are sure to be applied unevenly across the country.

Natural Gas Relief?

Iran also has an alternative-fuel plan under way that capitalizes on the country's natural gas resources and reduces its reliance on refined crude, but the results have so far been limited. The plan involves encouraging the use of compressed natural gas (CNG) for Iranian motorists. Cars that can run on CNG, which are prevalent in South Asia and Latin America, can be more economical and environmentally friendly. In fact, the price of CNG retails at around 4 cents per cubic meter (roughly equivalent to one liter of gasoline). Moreover, the technology used to compress natural gas is far less complex than that needed to refine crude. Considering that Iran is the world's fourth-largest producer of natural gas, the switch to CNG makes sense, but there is one big drawback. Vehicles must be modified to run on CNG, and CNG stations would have to be built across the country. None of this would be quick or cheap for Iran.

Nevertheless, Iran has made notable progress since kicking off its CNG plan in 2007, when Iran Khodro Industrial Group — Iran's leading automaker — invested $50 million in low-consumption, flexible-fuel engine production lines. Former Iranian Oil Minister Gholam Hossein Nozari said in July that there are currently 880 CNG stations in Iran, with plans to build an additional 400 within the next several months. Since Iran Khodro started ramping up production of CNG-capable vehicles, Iran has become the world's fourth-largest CNG-vehicle producer following Argentina, Pakistan and Brazil, according to the International Association for Natural Gas Vehicles. As of May 2009, Iranian government officials claim the official count of CNG-capable vehicles on the road totaled 1.4 million. The total number of cars in Iran was estimated to be 11.7 million in 2008, according to the Global Market Information Database. All in all, estimated fuel replacement by CNG is currently around 7 percent of Iran's total automobile fuel consumption, up from zero five years ago. While Iran seems to be making steady progress in the CNG arena, it still has a way to go before the switch to CNG would make a significant dent in the country's gasoline imports.

Responding to Pressure

When STRATFOR speaks to Iranian sources, we get the sense that the regime is feeling fairly confident in its ability to slip the sanctions noose while continuing to work on its nuclear program, using the same rhetoric it has used for the past seven years to drag negotiations into a stalemate. This continued confidence may be due to the fact that the Iranians have yet to feel the pinch of Washington's quiet campaign against Iran's gasoline suppliers. Though the energy majors appear to be dropping out of the Iranian gasoline trade, the numbers we have seen indicate that Tehran is importing surplus amounts of gasoline in preparation for tougher days to come. However, should Iran fail to outmaneuver the P-5+1 come Oct. 1, those tougher days could arrive sooner than it thinks.

In the weeks and months ahead, Israel will likely determine whether Iran and the United States are headed for a collision course in the Persian Gulf. The Israelis were promised "crippling" sanctions against Iran by the Obama administration. If that promise goes unfulfilled, and the Iranians (as they are expected to do) refuse to freeze their enrichment activities, the Israelis are likely to turn to the military option and demand Washington's cooperation. Israel understands Russia's leverage over Iran — particularly its ability to arm the Iranians with critical defense systems and sabotage a gasoline sanctions regime — and would rather deal decisively with the Iranian nuclear issue while the program is still several steps away from a critical phase.

Israel, unlike the United States, never had much faith in the sanctions to begin with. The U.S. administration appears to be operating under the assumption that severe sanctions against Iran will create a dire economic situation in the country, galvanize the masses against the clerical elite and thus coerce the regime into making significant concessions on its nuclear program. More imaginative policymakers believe that such economic sanctions could build on the dissent that followed the election and produce a third front to challenge and topple the regime. But Tehran's actual actions are unlikely to mesh nicely with Washington's preferred perception of the regime's mindset. Iran — at least for now — has no intention of meeting the West's demands to curb its nuclear program and takes the idea of resistance very seriously.

A Doomsday Scenario

Israel is willing to see how the sanctions regime plays out, but it also knows that it has a limited menu of options. If the sanctions are blown apart with Russia's help, the Iranians will obviously feel little pressure to negotiate seriously and the Israelis will have to turn to alternative options. If the sanctions prove effective because of Russian cooperation, a U.S. willingness to risk trade spats to enforce the sanctions or a combination of the two, the Iranians will be left feeling extremely vulnerable. However, that vulnerability would not necessarily bring Iran to the negotiating table. On the contrary, the Iranians are more likely to turn increasingly insular and aggressive with their nuclear ambitions. While extolling the virtues of self-sacrifice for national solidarity, the Iranian regime would begin to seriously threaten to use its "real" nuclear option — closing the Strait of Hormuz with mines and its arsenal of anti-ship missiles.

This is an option of last resort for the Iranians, but if Tehran feels sufficiently threatened, either by sanctions or potential military strikes, it could wreak havoc on the global economy within a matter of hours.

Setting ablaze the Strait of Hormuz would undoubtedly inflict intense pain on the Iranian economy, but this may be a pain that the regime is willing to bear while it watches energy prices soar and the world's industrial powers plunge deeper into recession. At such a level of brinksmanship, the United States would have to seriously consider a military campaign to preempt an Iranian move to close the strait, providing Israel with an opportunity to strike at Iran's nuclear facilities. If the United States failed to act in time and Iran succeeded in mining this critical energy chokepoint, then the U.S. military would have to clear the strait. Either way, the Persian Gulf would become a war zone and the global ramifications would be immense.

This may be a doomsday scenario, but it is one of increasing credibility given that the main players — Iran, the United States, Russia and Israel — continue to raise the stakes in pursuing their respective national imperatives. A number of questions remain: Will the United States put its trade relations on the line and aggressively enforce sanctions? Will Russia go the extra mile for Tehran and bust the sanctions regime? Can the United States and Russia reach a strategic compromise that will leave Iran out in the cold? Has Israel's patience regarding Iranian diplomatic maneuvers run out? Will Iran resort to its real nuclear option and threaten the Strait of Hormuz?

STRATFOR does not know the answers, and neither do the main stakeholders in this saga. However, come Oct. 1 these stakeholders must begin making some critical decisions that could dramatically alter the geopolitical landscape.

A German Pre-Election Win and Lingering U.S. Tensions

John Mauldin — Thu, 17 Sep 2009 15:04:00 GMT

You may not think that what happens in Kabul affects the sale of GM's Opel division -- but it's recognizing the connection between seemingly unrelated global events that puts you ahead of the game in investing. This week I'm sending you a video by my friends at STRATFOR. It links cars, jobs, German elections, and the situation in Afghanistan in a way that's truly insightful and informative.

Click here to watch this enlightening video. I've probably never mentioned it, but STRATFOR's founder George Friedman also has a free weekly intelligence report. I strongly suggest you sign up to receive it -- It's just the kind of unique global insight every 'outside the box' investor needs. Click here to get a mind-blowing Friedman analysis each week in your inbox. You'll enjoy it as much as I do.

CAPTION: GM has approved the sale of its Opel division in Germany to a suitor favored by Chancellor Angela Merkel's government, saving thousands of German jobs just ahead of general elections. But the Opel sale has become a symbol of cooling relations between Washington and Berlin -- and the chilling effect has only grown worse as debate over Afghanistan heats up. In the latest STRATFOR Insights video, analyst Matt Gertken provides his analysis of the situation.

Brazil: Reactions to a Proposed Energy Law

John Mauldin — Thu, 03 Sep 2009 17:43:00 GMT

With the current financial crisis, we have to be even more astute in locating worthy investment opportunities. I've written lately about choices we're facing as a country – but we have choices as individuals as well: choices that demand solid insight to make well-informed decisions and recognize opportunities at a time when they're not as plentiful as they used to be. It's not enough to know what's happening on Capitol Hill or Wall Street, we must expand our investigations to a global perspective.

I'm including an article by my friends STRATFOR, a global intelligence company, about a proposed law in Brazil to regulate the country's massive deep-sea oil reserves, which could make it a major oil exporter. It's just one example of the kind of event you need to be aware of if you're at all interested in global energy and investment. I recommend that you browse through the rest of STRATFOR's material, and check out their special offer for my readers. They provide just the kind of exclusive global insight you need.

Brazil: Reactions to a Proposed Energy Law

September 1, 2009 | 1938 GMT

Summary

Brazilian President Luiz Inacio Lula da Silva submitted a proposal for a new oil law to the country's legislature. The proposal favors state-run energy company Petroleo Brasileiro SA (Petrobras) and shows that Brazil intends to protect its national interests when it comes to deepwater oil exploration and development.

Analysis

After a government review that began in 2007, Brazilian President Luiz Inacio Lula da Silva on Aug. 31 unveiled a much-anticipated proposal for a new oil law that will govern the exploration and development of the country's massive deep-sea pre-salt oil reserves. The new regulatory framework was highly anticipated as Brazil's pre-salt reserves — oil deposits located in the sea bed under thick layers of salt — are estimated to contain anywhere from 14 to 100 billion barrels of oil and could turn Brazil into a major oil exporter in coming years.

Stock prices in Brazil's state-run energy company Petroleo Brasileiro SA (Petrobras) plummeted on the release of the proposal, with the company losing 3.6 percent of its market value (about $7 billion) on Aug. 31 alone (though that was mitigated by a 1.4 percent rebound on Sept. 1). Although Brasilia might not actually pass the new energy law until next year, it is clear that Brazil sees its pre-salt oil reserves as a strategic national asset that needs to be protected by the state, even at the risk of slowing the influx of foreign capital and technology that the country is trying to attract to boost the reserves' development.

The most obvious aspect of the proposed law is its (fully expected) favoritism toward Petrobras, one of the world's up-and-coming energy companies and a majority state-owned enterprise. Petrobras would operate all of Brazil's pre-salt oil development projects. The government, through the National Petroleum Agency, would have the option of awarding a contract solely to Petrobras or asking for public bids to bring in other companies to share in projects. In public bids, companies would join in production-sharing agreements with the government rather than only acquiring concessions and paying royalties on revenues, as they did previously. This is meant to ensure that Petrobras gains knowledge and experience from outsiders who may bring better technology and expertise to the table when they sign on to a production agreement. Petrobras would be guaranteed a minimum 30 percent stake in any consortium (though this does not apply to pre-existing contracts). Contracts will be awarded to foreign companies that promise to preserve the greatest share of "profit oil" — a field's production minus the equivalent of costs — for the Brazilian government. The proposal is surprisingly candid about the role of what is, in effect, bribery in companies' bids for contracts, stating that the National Energy Policy Council will assess "subscription bonuses" (which are not required but are no doubt encouraged by the law) on an ad hoc basis.

The Brazilian government will also have the option of handing over to Petrobras certain areas that have not yet been opened to concession to other bidders. Petrobras and the government will work out the specifics of which geographical areas will be eligible and determine their value and the price that Petrobras will pay to have rights to the area transferred to it.

Since Petrobras will be doing a lot of costly and technologically demanding oil production in these deep pre-salt layers, it will need to raise a lot of capital. The government has claimed it will inject around $50 billion into Petrobras upon passage of the new energy law. Moreover, the proposed law allows for Petrobras to issue new shares to get funding, while not calling for the restructuring or reorganization of the company. This preserves shareholders' right to maintain or up their stakes and the government's right to increase its stake, while ensuring that stock increases will not be used to squeeze out foreign investors for arbitrary or political purposes.

The proposal contains a nationalist streak that grants the government great scope for intervention in the development of these strategic reserves. In particular, the law would give birth to a new state-operated company — called Petrosal — that would have a representative, with full rights to vote and veto, on the board of any energy consortium doing business in Brazil's pre-salt deposits. Because this company will not be allowed to invest in projects or take part in upstream development, it will not bring capital or technology or expertise to energy development projects. It will simply be an arbitrary government actor with the ability to put roadblocks along the way for energy producers as it sees fit.

Da Silva submitted the proposal to Congress with much fanfare, calling for it to be put on a "fast track" toward approval. But the proposal, published on the Petrobras Web site, must still go through the legislative process, and it must do so amid the politically charged atmosphere ahead of general elections in October 2010. Nevertheless, it reflects a years-long review by a commission consisting of several government ministries, and thus gives a good indication of what direction Brazil's government wants to take in making energy sector regulations that are in line with its strategic interests.

Iraq Endgame

John Mauldin — Thu, 20 Aug 2009 17:09:00 GMT

As many of have heard, I had the pleasure of partaking in a weekend of fishing and intellectual jousting with some of today's most brilliant minds. We spoke of war, politics, and of course, the economy. Their interconnection seems somehow much clearer sitting on a Maine lake fishing for bass. This week I offer you an article that's key to understanding the U.S. role in Iraq. Futurologist and fellow aspiring fisherman George Friedman at STRATFOR lays out piece by piece U.S. options in the region. If your interests have anything to do with global energy markets -- and whose don't? -- it's enormously important that you grasp the relationships between various sectors in and around Iraq, and the possibilities moving forward.

Staying aware of geopolitical imperatives around the globe is crucial to any comprehensive investment portfolio. I encourage you to check out STRATFOR's Web site for whatever informs your investment area. Plus, my readers get a special membership rate.

John Mauldin, Editor
Outside the Box

Iraq Endgame

August 18, 2009
By George Friedman

Related Special Topic Pages

Iraq, Turkey and the Kurdish Position

Iraq, Iran and the Shia

Turkey's Re-Emergence

U.S. Military Involvement in Iraq

Iraq's Oil

Though the Iraq war is certainly not over, it has reached a crossroads. During the course of the war, about 40 countries sent troops to fight in what was called "Multi-National Force-Iraq." As of this summer, only one foreign country's fighting forces remain in Iraq — those of the United States. A name change in January 2010 will reflect the new reality, when the term "Multi-National Force-Iraq" will be changed to "United States Forces-Iraq." If there is an endgame in Iraq, we are now in it.

The plan that U.S. President Barack Obama inherited from former President George W. Bush called for coalition forces to help create a viable Iraqi national military and security force that would maintain the Baghdad government's authority and Iraq's territorial cohesion and integrity. In the meantime, the major factions in Iraq would devise a regime in which all factions would participate and be satisfied that their factional interests were protected. While this was going on, the United States would systematically reduce its presence in Iraq until around the summer of 2010, when the last U.S. forces would leave.

Two provisos qualified this plan. The first was that the plan depended on the reality on the ground for its timeline. The second was the possibility that some residual force would remain in Iraq to guarantee the agreements made between factions, until they matured and solidified into a self-sustaining regime. Aside from minor tinkering with the timeline, the Obama administration — guided by Defense Secretary Robert Gates, whom Bush appointed and Obama retained — has followed the Bush plan faithfully.

The moment of truth for the U.S. plan is now approaching. The United States still has substantial forces in Iraq. There is a coalition government in Baghdad dominated by Shia (a reasonable situation, since the Shia comprise the largest segment of the population of Iraq). Iraqi security forces are far from world-class, and will continue to struggle in asserting themselves in Iraq. As we move into the endgame, internal and external forces are re-examining power-sharing deals, with some trying to disrupt the entire process.

There are two foci for this disruption. The first concerns the Arab-Kurdish struggle over Kirkuk. The second concerns threats to Iran's national security.

The Kurdish Question

Fighting continues in the Kirkuk region, where the Arabs and Kurds have a major issue to battle over: oil. The Kirkuk region is one of two major oil-producing regions in Iraq (the other is in the Shiite-dominated south). Whoever controls Kirkuk is in a position to extract a substantial amount of wealth from the surrounding region's oil development. There are historical ethnic issues in play here, but the real issue is money. Iraqi central government laws on energy development remain unclear, precisely because there is no practical agreement on the degree to which the central government will control — and benefit — from oil development as opposed to the Kurdish Regional Government. Both Kurdish and Arab factions thus continue to jockey for control of the key city of Kirkuk.

Arab, particularly Sunni Arab, retention of control over Kirkuk opens the door for an expansion of Sunni Arab power into Iraqi Kurdistan. By contrast, Kurdish control of Kirkuk shuts down the Sunni threat to Iraqi Kurdish autonomy and cuts Sunni access to oil revenues from any route other than the Shiite-controlled central government. If the Sunnis get shut out of Kirkuk, they are on the road to marginalization by their bitter enemies — the Kurds and the Shia. Thus, from the Sunni point of view, the battle for Kirkuk is the battle for the Sunni place at the Iraqi table.

Turkey further complicates the situation in Iraq. Currently embedded in constitutional and political thinking in Iraq is the idea that the Kurds would not be independent, but could enjoy a high degree of autonomy. Couple autonomy with the financial benefits of heavy oil development and the Kurdish autonomous region of Iraq becomes a powerful entity. Add to that the peshmerga, the Kurdish independent military forces that have had U.S. patronage since the 1990s, and an autonomous Kurdistan becomes a substantial regional force. And this is not something Turkey wants to see.

The broader Kurdish region is divided among four countries, Turkey, Iraq, Iran and Syria. The Kurds have a substantial presence in southeastern Turkey, where Ankara is engaged in a low-intensity war with the Kurdistan Workers' Party (PKK), members of which have taken refuge in northern Iraq. Turkey's current government has adopted a much more nuanced approach in dealing with the Kurdish question. This has involved coupling the traditional military threats with guarantees of political and economic security to the Iraqi Kurds as long as the Iraqi Kurdish leadership abides by Turkish demands not to press the Kirkuk issue.

Still, whatever the constitutional and political arrangements between Iraqi Kurds and Iraq's central government, or between Iraqi Kurds and the Turkish government, the Iraqi Kurds have a nationalist imperative. The Turkish expectation is that over the long haul, a wealthy and powerful Iraqi Kurdish autonomous region could slip out of Baghdad's control and become a center of Kurdish nationalism. Put another way, no matter what the Iraqi Kurds say now about cooperating with Turkey regarding the PKK, over the long run, they still have an interest in underwriting a broader Kurdish nationalism that will strike directly at Turkish national interests.

The degree to which Sunni activity in northern Iraq is coordinated with Turkish intelligence is unknown to us. The Sunnis are quite capable of waging this battle on their own. But the Turks are not disinterested bystanders, and already support local Turkmen in the Kirkuk region to counter the Iraqi Kurds. The Turks want to see Kurdish economic power and military power limited, and as such they are inherently in favor of the Shiite-dominated Baghdad government. The stronger Baghdad is, the weaker the Kurds will be.

Baghdad understands something critical: While the Kurds may be a significant fighting force in Iraq, they can't possibly stand up to the Turkish army. More broadly, Iraq as a whole can't stand up to the Turkish army. We are entering a period in which a significant strategic threat to Turkey from Iraq could potentially mean Turkish countermeasures. Iraqi memories of Turkish domination during the Ottoman Empire are not pleasant. Therefore, Iraq will be very careful not to cross any redline with the Turks.

This places the United States in a difficult position. Washington has supported the Kurds in Iraq ever since Operation Desert Storm. Through the last decade of the Saddam regime, U.S. special operations forces helped create a de facto autonomous region in Kurdistan. Washington and the Kurds have a long and bumpy history, now complicated by substantial private U.S. investment in Iraqi Kurdistan for the development of oil resources. Iraqi Kurdish and U.S. interests are strongly intertwined, and Washington would rather not see Iraqi Kurdistan swallowed up by arrangements in Baghdad that undermine current U.S. interests and past U.S. promises.

On the other hand, the U.S. relationship with Turkey is one of Washington's most important. Whether the question at hand is Iran, the Caucasus, the Balkans, Central Asia, the Arab-Israeli conflict, Afghanistan, Russia or Iraq, the Turks have a role. Given the status of U.S. power in the region, alienating Turkey is not an option. And the United States must remember that for Turkey, Kurdish power in Iraq and Turkey's desired role in developing Iraqi oil are issues of fundamental national importance.

Now left alone to play out this endgame, the United States must figure out a way to finesse the Kurdish issue. In one sense, it doesn't matter. Turkey has the power ultimately to redefine whatever institutional relationships the United States leaves behind in Iraq. But for Turkey, the sooner Washington hands over this responsibility, the better. The longer the Turks wait, the stronger the Kurds might become and the more destabilizing their actions could be to Turkey. Best of all, if Turkey can assert its influence now, which it has already begun to do, it doesn't have to be branded as the villain.

All Turkey needs to do is make sure that the United States doesn't intervene decisively against the Iraqi Sunnis in the battle over Kirkuk in honor of Washington's commitment to the Kurds.

In any case, the United States doesn't want to intervene against Iraq's Sunnis again. In protecting Sunni Arab interests, the Americans have already been sidestepping any measures to organize a census and follow through with a constitutional mandate to hold a referendum in Kirkuk. For the United States, a strong Sunni community is the necessary counterweight to the Iraqi Shia since, over the long haul, it is not clear how a Shiite-dominated government will relate to Iran.

The Shiite Question

The Shiite-dominated government led by Iraqi Prime Minister Nouri al-Maliki is no puppet of Iran, but at the same time, it is not Iran's enemy. As matters develop in Iraq, Iran remains the ultimate guarantor of Shiite interests. And Iranian support might not flow directly to the current Iraqi government, but to al-Maliki's opponents within the Shiite community who have closer ties to Tehran. It is not clear whether Iranian militant networks in Iraq have been broken, or are simply lying low. But it is clear that Iran still has levers in place with which it could destabilize the Shiite community or rivals of the Iraqi Shia if it so desired.

Therefore, the United States has a vested interest in building up the Iraqi Sunni community before it leaves. And from an economic point of view, that means giving the Sunnis access to oil revenue as well as a guarantee of control over that revenue after the United States leaves.

With the tempo of attacks picking up as U.S. forces draw down, Iraq's Sunni community is evidently not satisfied with the current security and political arrangements in Iraq. Attacks are on the upswing in the northern areas — where remnants of al Qaeda in Iraq continue to operate in Mosul — as well as in central Iraq in and around Baghdad. The foreign jihadists in Iraq hope such attacks will trigger a massive response from the Shiite community, thus plunging Iraq back into civil war. But the foreign jihadists would not be able to operate without some level of support from the local Sunni community. This broader community wants to make sure that the Shia and Americans don't forget what the Sunnis are capable of should their political, economic and security interests fall by the wayside as the Americans withdraw.

Neither the Iraqi Sunnis nor the Kurds really want the Americans to leave. Neither trust that the intentions or guarantees of the Shiite-dominated government. Iraq lacks a tradition of respect for government institutions and agreements; a piece of paper is just that. Instead, the Sunnis and Kurds see the United States as the only force that can guarantee their interests. Ironically, the United States is now seen as the only real honest broker in Iraq.

But the United States is an honest broker with severe conflicts of interest. Satisfying both Sunni and Kurdish interests is possible only under three conditions. The first is that Washington exercise a substantial degree of control over the Shiite administration of the country — and particularly over energy laws — for a long period of time. The second is that the United States give significant guarantees to Turkey that the Kurds will not extend their nationalist campaign to Turkey, even if they are permitted to extend it to Iran in a bid to destabilize the Iranian regime. The third is that success in the first two conditions not force Iran into a position where it sees its own national security at risk, and so responds by destabilizing Baghdad — and with it, the entire foundation of the national settlement in Iraq negotiated by the United States.

The American strategy in this matter has been primarily tactical. Wanting to leave, it has promised everyone everything. That is not a bad strategy in the short run, but at a certain point, everyone adds up the promises and realizes that they can't all be kept, either because they are contradictory or because there is no force to guarantee them. Boiled down, this leaves the United States with two strategic options.

First, the United States can leave a residual force of about 20,000 troops in Iraq to guarantee Sunni and Kurdish interests, to protect Turkish interests, etc. The price of pursuing this option is that it leaves Iran facing a nightmare scenario: e.g., the potential re-emergence of a powerful Iraq and the recurrence down the road of the age-old conflict between Persia and Mesopotamia — with the added possibility of a division of American troops supporting their foes. This would pose an existential threat to Iran, forcing Tehran to use covert means to destabilize Iraq that would take advantage of a minimal, widely dispersed U.S. force vulnerable to local violence.

Second, the United States could withdraw and allow Iraq to become a cockpit for competition among neighboring countries: Turkey, Iran, Saudi Arabia, Syria — and ultimately major regional powers like Russia. While chaos in Iraq is not inherently inconsistent with U.S. interests, it is highly unpredictable, meaning the United States could be pulled back into Iraq at the least opportune time and place.

The first option is attractive, but its major weakness is the uncertainty created by Iran. With Iran in the picture, a residual force is as much a hostage as a guarantor of Sunni and Kurdish interests. With Iran out of the picture, the residual U.S. force could be smaller and would be more secure. Eliminate the Iran problem completely, and the picture for all players becomes safer and more secure. But eliminating Iran from the equation is not an option — Iran most assuredly gets a vote in this endgame.

The Recession in Central Europe, Part 2: Country by Country

John Mauldin — Thu, 06 Aug 2009 20:25:00 GMT

This week I'd like to address the topic of currency. Flip through any business journal and speculation runs deep, though the ups and downs are far from predictable. A year ago everyone who thought they had half a brain and a pile of money comparable to Uncle Scrooge was threatening to transform all of their wealth into the seemingly unstoppable Yuan. Travel agents were pushing dirt-cheap excursions taking advantage of the near-worthless Icelandic krona to suburbanites with inquiries about sunny beaches and palm trees. And this year, if you're looking for a destination that won't hurt your pocket book, one might suggest Central Europe for that romantic second honeymoon.

In the long run though, currency speculation is a serious business that takes patience and an overall understanding of a nation, country or union. IMF reports and debt calculators are a good indicator, but they can be flawed and don't take into account the grand scheme of things. I've said it before and I'll say it again, the bigger picture is the one you want, and nothing prepares you for this kind of commitment than the intelligence you get from my friend George Friedman at STRATFOR. I'm sending you a piece that considers the recession in Central Europe, country by country. I encourage you to read and consider it in your portfolios. Click here to check out STRATFOR as well, as my readers get a special offer.

The Recession in Central Europe, Part 2: Country by Country

August 5, 2009 | 1146 GMT

Summary

No region has been affected by the global financial crisis quite like Central Europe, where a heavy burden of foreign debt, accumulated during the boom years of the 2000s, must be repaid in 2009. Not all Central European states are burdened by the same external debt load, but most face cutting social welfare expenditures as they sign on for relief from the International Monetary Fund and the European Union. Administrations old and new will have a tough time protecting their currencies and stimulating growth at the same time.

Editor's Note: This is part of an ongoing series on the global recession and signs indicating how and when the economic recovery will begin.

Analysis

Related Special Topic Pages

Special Series: The Recession Revisited

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The Recession in Europe

The Recession in Central Europe, Part 1: Armageddon Averted?

Central Europe is at the epicenter of the global financial crisis. The region became the top destination for foreign capital in 2002, overtaking East Asia; but since September 2008, it has experienced a massive outflow of foreign capital that threatens to crash the region's currencies. The region founded its growth largely on the influx of foreign loans that are now in danger of appreciating in real value as domestic currencies depreciate.

Part 1 of this two-part analysis looked at the problems and policy options faced by Central Europe as a whole; Part 2 examines the economic and political situations unique to each country. For the purposes of this analysis, Central Europe is defined as Bosnia, Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania and Serbia. We exclude Austria, Slovakia and Greece because those countries are in the eurozone.

Bosnia

Bosnia's gross domestic product (GDP) is expected to contract by 3 percent in 2009, after nearly 6 percent growth in 2008, with the unemployment rate above 40 percent. A 1.2 billion euro ($1.7 billion) loan from the International Monetary Fund (IMF) will help stabilize the budget, but the austerity measures required by the IMF are sure to increase social tensions. The IMF requires 10 percent cuts in social welfare programs and governmental salaries, and considering that government expenditures in Bosnia total 44 percent of GDP, the IMF cuts will be substantial and have significant social impact. Indeed, the financial crisis already has threatened to reignite old ethnic and political tensions in the country, which has never truly recovered from its brutal 1992-1995 civil war.

Bulgaria

Bulgarian GDP is set to contract by around 6 percent in 2009. This, combined with an expected budget deficit of 2.5 percent of GDP, contributes to some worrisome numbers, although not as dramatic as figures elsewhere in the region.

However, Bulgaria does not have sufficient foreign currency reserves to cover its extremely high external debt coming to maturity in 2009. The problem for Bulgaria is not necessarily foreign currency-denominated lending (household-sector foreign currency-denominated lending is actually quite low), but rather years of high current-account deficits that required trade financing and corporate lending. According to Fitch Ratings, Bulgaria has $26.2 billion of debt coming due in 2009, equal to 64 percent of GDP. Therefore, despite recent assertions by newly elected Prime Minister Boyko Borisov that no IMF loan will be necessary, Sofia may be forced to consider outside funding as the second half of 2009 gets under way. This will put political pressure on the new administration very early on.

Croatia

Croatian GDP is set to plunge by about 5 percent of GDP in 2009, with unemployment expected to reach double digits (10.5 percent) following a rate of 8.4 percent in 2008. This will present new Prime Minister Jadranka Kosor with the unenviable task of picking up the pieces left by her predecessor, Ivo Sanader, who resigned unexpectedly in July.

Most pressing is the need to cut social welfare expenditures, which actually increased more than 10 percent year-on-year in the first quarter of 2009 due to an absolute increase in unemployment benefits. Croatia is also facing considerable private foreign-debt pressures, with the total external debt coming due in 2009 almost twice that of Zagreb's available currency reserves. Also worrisome for Croatia is the high percent of foreign currency-denominated lending, which at 62 percent of total lending is one of the highest percentages in the region.

While Zagreb has not asked the IMF for a loan yet — and the government for the most part is vociferously denying that it needs one — Croatia is on STRATFOR's short list of Central European countries likely to seek one in the second half of 2009. With Sanader's resignation offering a release valve for social angst in the short term, Kosor may have some political room to maneuver in order to implement the IMF's stringent austerity measures.

Czech Republic

Throughout the 2000s, the Czech Republic has been prudent enough to contain external debt, keep inflation low and maintain low interest rates. This has meant that foreign currency lending has not been as popular in the Czech Republic as it has been in other countries in Europe. In fact, lending to Czech households in foreign currency is nonexistent, with consumers perfectly content to borrow cheap koruna instead of euros.

Nonetheless, the Czech Republic will be hit by the economic crisis just as the rest of Central Europe will be hit, with an expected 3.2 percent decline in GDP in 2009. The key issue for the Czech Republic is the return of external demand for its manufactured products, particularly automobiles, which account for 18.96 percent of total Czech industrial output. With 76 percent of its GDP dependent on exports, the Czech Republic is at the mercy of its export markets in Western Europe (particularly Germany, to which it exports more than 30 percent of its goods).

Click image to enlarge

Meanwhile, the imbroglio that is Czech politics continues following the March 24 resignation of Prime Minister Mirek Topolanek, with elections called for October. The Czech Republic has a tendency to produce extremely weak governments that depend on minor parties for a majority in the parliament. Such an arrangement during a recession would severely impair the government from making the difficult decisions that are needed to get the economy back on its feet.

The Baltics (Estonia, Latvia, Lithuania)

Of the three Baltic states, Latvia has thus far suffered the most from the financial crisis. However, in terms of macroeconomic indicators, Estonia is not much different than Latvia. Estonia's gross external debt, most of which is privately held, is 116 percent of GDP, compared to Latvia's 124.6 percent. Furthermore, Estonia and Latvia both have a very high percentage of foreign currency-denominated loans in their loan portfolios (86 percent and 90 percent, respectively). Were Latvia to abandon its currency peg to the euro, Estonia's kroon would likely devalue as well because of investor pressures on the region as a whole.

Meanwhile, unemployment in Latvia is soaring, reaching 17.2 percent in June, compared to 7.5 percent in 2008. With one prime minister ousted in February, the current four-party coalition is looking shaky, especially as it attempts to implement the rigid austerity measures of the IMF.

Lithuania is not doing any better, with a 22.4 percent-of-GDP decline in the second quarter. Lithuania does have less of a reliance on foreign currency lending — 66 percent of total lending is in foreign currency — but it still has enough that a serious currency depreciation caused by a devaluation in Latvia would hurt many consumers and businesses.

The Baltics remain the most volatile region in Central Europe and the most likely flash point for social angst over austerity measures and the effects of the recession. One should not discount the possibility that Lithuania and Estonia could ask for an IMF loan or that further political changes are in store.

Hungary

Hungary is the only country in the region, aside from Poland, with a considerable amount of external public debt (53.2 percent of GDP) — the result of years of overspending in a politically contentious atmosphere between the main right and left wing parties. This is in addition to a considerable level of private debt (39.5 percent), most of which was fueled by foreign currency lending. The IMF and EU 20 billion euro ($28.8 billion) loan has forced Budapest to start cutting into the chronically high budget deficit, but at the cost of reducing social spending that the populace grew used to in the free-spending 2000s.

The ruling Socialists are attempting to hold on to power following the resignation of Prime Minister Ferenc Gyurcsany, with the center-right party Fidesz looking to capitalize on the crisis and come to power in the 2010 parliamentary elections (or earlier if elections could be forced sooner). Much as other countries in the region, Hungary is struggling to protect its currency from depreciation (so as not to appreciate the value of foreign currency loans) and stimulate growth at the same time.

Poland

Despite its high public and private indebtedness, Poland has thus far been remarkably resilient during the crisis. In 2009, Poland has actually experienced positive GDP growth (0.8 percent year-on-year), surpassed only by Cyprus in the European Union, and is expected to have grown (albeit at a slower pace) in the second quarter. The reason for Poland's resilience is the fact that, unlike the other Central European economies, it has a robust internal market with exports accounting for just 40 percent of its GDP (compared to 76 percent of GDP in the neighboring Czech Republic, 80 percent in Hungary, 55 percent in Lithuania and 86 percent in Slovakia). Poland can therefore depend on consumption to spur growth and is not so much at the mercy of demand from neighboring Western Europe for its recovery.

Click image to enlarge

With consumption holding steady, Poland has been able to weather the recession on the back of its $400 billion economy. While high levels of foreign debt are definitely a cause of concern, Poland serves as an instructive example of a Central European country that has not had to depend on Western Europe for both capital and export markets. Two quarters of minimal growth in 2009 at a time when most countries in the region are far worse will also provide Poland relative political stability.

Romania

Romania is another Central European economy that is far too indebted abroad, has relied on foreign currency lending for too much of its domestic credit and is looking at a serious budget deficit. It secured a 20 billion euro ($28.8 billion) IMF standby loan in March, part of which was used to keep the leu stable so as not to allow the real value of foreign loans to appreciate.

Unlike Poland, which is an example of a Central European economy with a robust local market, Romania is the exact opposite. Its trade deficit in 2008 stood at 14 percent of GDP, indicating that not only did it borrow foreign money but also that it used the money mainly to buy foreign products.

Serbia

The Serbian economy is forecast to contract by nearly 5 percent in 2009, with unemployment crossing 20 percent (from around 18 percent in both 2007 and 2008). Because of the crisis, Serbia has been forced to take a 3 billion euro ($4.3 billion) IMF loan and sell a vital part of its infrastructure — state-owned energy company NIS — to Russian energy giant Gazprom at below market value.

The fundamental problem with Serbia is that, because of political instability and tenuous governments that have plagued the post-Slobodan Milosevic era, the country has never been able to cut its expenditures, particularly in public-sector employment. Numerous multiparty coalitions have had to cater to parties looking to advance their interests, while the government essentially raises money through the privatization of state-owned enterprises. Furthermore, the fundamental Central European problem of borrowing abroad to finance expensive Western imports is true of Serbia as well. Foreign currency-denominated loans have made up 68 percent of total loans in 2009, mainly due to the traditional instability (and high inflation) of the dinar.

Russia, Ahmadinejad and Iran Reconsidered

John Mauldin — Thu, 23 Jul 2009 17:13:00 GMT

I've mentioned a couple of schools of thought before: those who look at the big picture and those who pore over the details. Often, the major product is the result of its minor pieces. If you use good meat, good buns, and good vegetables- you're going to turn out a pretty good hamburger. The same goes for cars, businesses and portfolios.

One industry in which this methodology really doesn't seem to work is information. Mainstream sources of information almost always fail to connect the world's events. They do a great job telling you that former Iranian president Rafsanjani addressed his supporters, that anti-Ahmadinejad protestors outside chanted "Death to Russia", and that Israel sent a submarine through the Suez Canal. But they don't show how the incidents fit together in the geopolitical landscape, nor what they mean for the relationships between global powers. They give you the meat, the buns and the vegetables, but there's no hamburger.

This week I'm sending you an article AND a video on the Iran situation, from my friend George Friedman and his team of intelligence analysts at STRATFOR. Click here to watch "Rethinking Iran" and read the article below (They complement each other nicely). George connects the pieces and draws conclusions – so you can make better-informed decisions regarding investments, assets and travels around the world.

John Mauldin, Editor
Outside the Box

Russia, Ahmadinejad and Iran Reconsidered

July 20, 2009

By George Friedman

The Iranian Political Configuration

There are two factions claiming to speak for the people. Rafsanjani represents the first faction. During his sermon, he spoke for the tradition of the founder of the Islamic republic, Ayatollah Ruhollah Khomeini, who took power during the 1979 Iranian Revolution. Rafjsanjani argued that Khomeini wanted an Islamic republic faithful to the will of the people, albeit within the confines of Islamic law. Rafsanjani argued that he was the true heir to the Islamic revolution. He added that Khomeini's successor — the current supreme leader, Ayatollah Ali Khamenei — had violated the principles of the revolution when he accepted that Rafsanjani's archenemy, Mahmoud Ahmadinejad, had won Iran's recent presidential election. (There is enormous irony in foreigners describing Rafsanjani as a moderate reformer who supports greater liberalization. Though he has long cultivated this image in the West, in 30 years of public political life it is hard to see a time when he has supported Western-style liberal democracy.)

The other faction is led by Ahmadinejad, who takes the position that Rafsanjani in particular — along with the generation of leaders who ascended to power during the first phase of the Islamic republic — has betrayed the Iranian people. Rather than serving the people, Ahmadinejad claims they have used their positions to become so wealthy that they dominate the Iranian economy and have made the reforms needed to revitalize the Iranian economy impossible. According to Ahmadinejad's charges, these elements now blame Ahmadinejad for Iran's economic failings when the root of these failings is their own corruption. Ahmadinejad claims that the recent presidential election represents a national rejection of the status quo. He adds that claims of fraud represent attempts by Rafsanjani — who he portrays as defeated presidential candidate Mir Hossein Mousavi's sponsor — and his ilk to protect their positions from Ahmadinejad.

Iran is therefore experiencing a generational dispute, with each side claiming to speak both for the people and for the Khomeini tradition. There is the older generation — symbolized by Rafsanjani — that has prospered during the last 30 years. Having worked with Khomeini, this generation sees itself as his true heir. Then, there is the younger generation. Known as "students" during the revolution, this group did the demonstrating and bore the brunt of the shah's security force counterattacks. It argues that Khomeini would be appalled at what Rafsanjani and his generation have done to Iran.

This debate is, of course, more complex than this. Khamenei, a key associate of Khomeini, appears to support Ahmadinejad's position. And Ahmadinejad hardly speaks for all of the poor as he would like to claim. The lines of political disputes are never drawn as neatly as we would like. Ultimately, Rafsanjani's opposition to the recent election did not have as much to do with concerns (valid or not) over voter fraud. It had everything to do with the fact that the outcome threatened his personal position. Which brings us back to the question of why Rafsanjani's followers were chanting Death to Russia.

Examining the Anomalous Chant

For months prior to the election, Ahmadinejad's allies warned that the United States was planning a "color" revolution. Color revolutions, like the one in Ukraine, occurred widely in the former Soviet Union after its collapse, and these revolutions followed certain steps. An opposition political party was organized to mount an electoral challenge to the establishment. Then, an election occurred that was either fraudulent or claimed by the opposition as having been fraudulent. Next, widespread peaceful protests against the regime (all using a national color as the symbol of the revolution) took place, followed by the collapse of the government through a variety of paths. Ultimately, the opposition — which was invariably pro-Western and particularly pro-American — took power.

Moscow openly claimed that Western intelligence agencies, particularly the CIA, organized and funded the 2004-2005 Orange Revolution in Ukraine. These agencies allegedly used nongovernmental organizations (human rights groups, pro-democracy groups, etc.) to delegitimize the existing regime, repudiate the outcome of the election regardless of its validity and impose what the Russians regarded as a pro-American puppet regime. The Russians saw Ukraine's Orange Revolution as the break point in their relationship with the West, with the creation of a pro-American, pro-NATO regime in Ukraine representing a direct attack on Russian national security. The Americans argued that to the contrary, they had done nothing but facilitate a democratic movement that opposed the existing regime for its own reasons, demanding that rigged elections be repudiated.

In warning that the United States was planning a color revolution in Iran, Ahmadinejad took the Russian position. Namely, he was arguing that behind the cover of national self-determination, human rights and commitment to democratic institutions, the United States was funding an Iranian opposition movement on the order of those active in the former Soviet Union. Regardless of whether the opposition actually had more votes, this opposition movement would immediately regard an Ahmadinejad win as the result of fraud. Large demonstrations would ensue, and if they were left unopposed the Islamic republic would come under threat.

In doing this, Ahmadinejad's faction positioned itself against the actuality that such a rising would occur. If it did, Ahmadinejad could claim that the demonstrators were — wittingly or not — operating on behalf of the United States, thus delegitimizing the demonstrators. In so doing, he could discredit supporters of the demonstrators as not tough enough on the United States, a useful charge against Rafsanjani, whom the West long has held up as an Iranian moderate.

Interestingly, while demonstrations were at their height, Ahmadinejad chose to attend — albeit a day late — a multinational Shanghai Cooperation Organization conference in Moscow on the Tuesday after the election. It was very odd that he would leave Iran during the greatest postelection unrest; we assumed he had decided to demonstrate to Iranians that he didn't take the demonstrations seriously.

The charge that seems to be emerging on the Rafsanjani side is that Ahmadinejad's fears of a color revolution were not simply political, but were encouraged by the Russians. It was the Russians who had been talking to Ahmadinejad and his lieutenants on a host of issues, who warned him about the possibility of a color revolution. More important, the Russians helped prepare Ahmadinejad for the unrest that would come — and given the Russian experience, how to manage it. Though we speculate here, if this theory is correct, it could explain some of the efficiency with which Ahmadinejad shut down cell phone and other communications during the postelection unrest, as he may have had Russian advisers.

Rafsanjani's followers were not shouting Death to Russia without a reason, at least in their own minds. They are certainly charging that Ahmadinejad took advice from the Russians, and went to Russia in the midst of political unrest for consultations. Rafsanjani's charge may or may not be true. Either way, there is no question that Ahmadinejad did claim that the United States was planning a color revolution in Iran. If he believed that charge, it would have been irrational not to reach out to the Russians. But whether or not the CIA was involved, the Russians might well have provided Ahmadinejad with intelligence of such a plot and helped shape his response, and thereby may have created a closer relationship with him.

How Iran's internal struggle will work itself out remains unclear. But one dimension is shaping up: Ahmadinejad is trying to position Rafsanjani as leading a pro-American faction intent on a color revolution, while Rafsanjani is trying to position Ahmadinejad as part of a pro-Russian faction. In this argument, the claim that Ahmadinejad had some degree of advice or collaboration with the Russians is credible, just as the claim that Rafsanjani maintained some channels with the Americans is credible. And this makes an internal dispute geopolitically significant.

The Iranian Struggle in a Geopolitical Context

At the moment, Ahmadinejad appears to have the upper hand. Khamenei has certified his re-election. The crowds have dissipated; nothing even close to the numbers of the first few days has since materialized. For Ahmadinejad to lose, Rafsanjani would have to mobilize much of the clergy — many of whom are seemingly content to let Rafsanjani be the brunt of Ahmadinejad's attacks — in return for leaving their own interests and fortunes intact. There are things that could bring Ahmadinejad down and put Rafsanjani in control, but all of them would require Khamenei to endorse social and political instability, which he will not do.

If the Russians have in fact intervened in Iran to the extent of providing intelligence to Ahmadinejad and advice to him during his visit on how to handle the postelection unrest (as the chants suggest), then Russian influence in Iran is not surging — it has surged. In some measure, Ahmadinejad would owe his position to Russian warnings and advice. There is little gratitude in the world of international affairs, but Ahmadinejad has enemies, and the Russians would have proved their utility in helping contain those enemies.

From the Russian point of view, Ahmadinejad would be a superb asset — even if not truly under their control. His very existence focuses American attention on Iran, not on Russia. It follows, then, that Russia would have made a strategic decision to involve itself in the postelection unrest, and that for the purposes of its own negotiations with Washington, Moscow will follow through to protect the Iranian state to the extent possible. The Russians have already denied U.S. requests for assistance on Iran. But if Moscow has intervened in Iran to help safeguard Ahmadinejad's position, then the potential increases for Russia to provide Iran with the S-300 strategic air defense systems that it has been dangling in front of Tehran for more than a decade.

If the United States perceives an entente between Moscow and Tehran emerging, then the entire dynamic of the region shifts and the United States must change its game. The threat to Washington's interests becomes more intense as the potential of a Russian S-300 sale to Iran increases, and the need to disrupt the Russian-Iranian entente would become all the more important. U.S. influence in Iran already has declined substantially, and Ahmadinejad is more distrustful and hostile than ever of the United States after having to deal with the postelection unrest. If a Russian-Iranian entente emerges out of all this — which at the moment is merely a possibility, not an imminent reality — then the United States would have some serious strategic problems on its hands.

Revisiting Assumptions on Iran

For the past few years, STRATFOR has assumed that a U.S. or Israeli strike on Iran was unlikely. Iran was not as advanced in its nuclear program as some claimed, and the complexities of any attack were greater than assumed. The threat of an attack was thus a U.S. bargaining chip, much as Iran's nuclear program itself was an Iranian bargaining chip for use in achieving Tehran's objectives in Iraq and the wider region. To this point, our net assessment has been accurate.

At this point, however, we need to stop and reconsider. If Iran and Russia begin serious cooperation, Washington's existing dilemma with Iran's nuclear ambitions and its ongoing standoff with the Russians would fuse to become a single, integrated problem. This is something the United States would find difficult to manage. Washington's primary goal would become preventing this from happening.

Ahmadinejad has long argued that the United States was never about to attack Iran, and that charges by Rafsanjani and others that he has pursued a reckless foreign policy were groundless. But with the Death to Russia chants and signaling of increased Russian support for Iran, the United States may begin to reconsider its approach to the region.

Iran's clerical elite does not want to go to war. They therefore can only view with alarm the recent ostentatious transiting of the Suez Canal into the Red Sea by Israeli submarines and corvettes. This transiting did not happen without U.S. approval. Moreover, in spite of U.S. opposition to expanded Israeli settlements and Israeli refusals to comply with this opposition, U.S. Secretary of Defense Robert Gates will be visiting Israel in two weeks. The Israelis have said that there must be a deadline on negotiations with Iran over the nuclear program when the next G-8 meeting takes place in September; a deadline that the G-8 has already approved. The consequences if Iran ignores the deadline were left open-ended.

All of this can fit into our old model of psychological warfare, as representing a bid to manipulate Iranian politics by making Ahmadinejad's leadership look too risky. It could also be the United States signaling to the Russians that stakes in the region are rising. It is not clear that the United States has reconsidered its strategy on Iran in the wake of the postelection demonstrations. But if Rafsanjani's claim of Russian support for Ahmadinejad is true, a massive re-evaluation of U.S. policy could ensue, assuming one hasn't already started — prompting a reconsideration of the military option.

All of this assumes that there is substance behind a mob chanting "Death to Russia." There appears to be, but of course, Ahmadinejad's enemies would want to magnify that substance to its limits and beyond. This is why we are not ready to simply abandon our previous net assessment of Iran, even though it is definitely time to rethink it.

The U.S.-Russian Summit Turns Routine

John Mauldin — Thu, 09 Jul 2009 16:46:44 GMT

This week saw a 2-day summit between the United States and Russia that looks to be the first in a trend of subtle push and pull that will shape economic agendas for both states. Just as at the height of the Cold War, these two superpowers are jockeying for global attention and prospective untapped markets. But while the communication between the two is at the same volume and frequency as it was back in the days of Kennedy and Khrushchev, the tone has taken on a different level - as Obama flexes his newly appointed muscle and plants a possible seed of discontent between Medvedev and Putin concerning the future of the former USSR.

Hands-down the most important thing in Russia is energy. It's not the headline on CNN these days, but come less than 6 months from now the cold European winters will make natural gas supply lines and shipping an unavoidable talking point. Today's U.S./Russia relationship lays the groundwork for the future of global energy markets.

I'm sending you an article by my friend George Friedman at STRATFOR, a global intelligence firm, discussing what's really going on between the U.S. and Russia - at the summit and in the coming months. If energy markets matter to you - and they do, regardless of how you're invested - then you need to understand this pivotal global relationship. Also, STRATFOR is offering special rates to Outside the Box readers. Click here to read more and be sure to take advantage of these low rates for priceless intelligence to help you in your future financial planning.

John Mauldin
Editor, Outside the Box

The U.S.-Russian Summit Turns Routine

July 7, 2009

By George Friedman

The Fundamental Issues

There are dozens of contentious issues between the United States and Russia, but in our mind three issues are fundamental.

First, there is the question of whether Poland will become a base from which the United States can contain Russian power, or from the Russian point of view, threaten the former Soviet Union. The ballistic missile defense (BMD) system that the United States has slated for Poland does not directly affect that issue, though it symbolizes it. It represents the U.S. use of Polish territory for strategic purposes, and it is something the Russians oppose not so much for the system's direct or specific threat — which is minimal — but for what it symbolizes about the Americans' status in Poland. The Russians hoped to get Obama to follow the policy at the summit that he alluded to during his campaign for the U.S. presidency: namely, removing the BMD program from Poland to reduce tensions with Russia.

Second, there is the question of Iran. This is a strategic matter for the United States, perhaps even more pressing since the recent Iranian election. The United States badly needs to isolate Iran effectively, something impossible without Russian cooperation. Moscow has refused to join Washington on this issue, in part because it is so important to the United States. Given its importance to the Americans, the Russians see Iran as a lever with which they can try to control U.S. actions elsewhere. The Americans do not want to see Russian support, and particularly arms sales, to Iran. Given that, the Russians don't want to close off the possibility of supporting Iran. The United States wanted to see some Russian commitments on Iran at the summit.

And third, there is the question of U.S. relations with former Soviet countries other than Russia, and the expressed U.S. desire to see NATO expand to include Ukraine and Georgia. The Russians insist that any such expansion threatens Russian national security and understandings with previous U.S. administrations. The United States insists that no such understandings exist, that NATO expansion doesn't threaten Russia, and that the expansion will continue. The Russians were hoping the Americans would back off on this issue at the summit.

Of some importance, but not as fundamental as the previous issues, was the question of whether Russia will allow U.S. arms shipments to Afghanistan through Russian territory. This issue became important last winter when Taliban attacks on U.S. supply routes through Pakistan intensified, putting the viability of those routes in question. In recent months the Russians have accepted the transit of nonlethal materiel through Russia, but not arms.

Even before the summit, the Russians made a concession on this point, giving the United States the right to transit military equipment via Russian airspace. This was a significant policy change designed to demonstrate Russia's flexibility. At the same time, the step is not as significant as it appeared. The move cost the Russians little under the circumstances, and is easily revoked. And while the United States might use the route, the route is always subject to Russian pressure, meaning the United States is not going to allow a strategic dependence to develop. Moreover, the U.S. need is not as apparent now as it was a few months ago. And finally, a Talibanized Afghanistan is not in the Russian interest. That Russia did not grant the U.S. request last February merely reveals how bad U.S.-Russian relations were at the time. Conversely, the Russian concession on the issue signals that U.S.-Russian relations have improved. The concession was all the more significant in that it came after Obama praised Medvedev for his openness and criticized Putin as having one foot in the Cold War, clearly an attempt to play the two Russian leaders off each other.

What the Summit Produced

Much more significantly, the United States did not agree to withdraw the BMD system from Poland at the summit. Washington did not say that removal is impossible, but instead delayed that discussion until at least September, when U.S. Secretary of State Hillary Clinton will visit Moscow. A joint review of all of the world's missile capabilities was established at the summit, and this joint review will consider Iranian — and North Korean — missiles. The Polish BMD system will be addressed in that context. In other words, Washington did not concede on the point, but it did not close off discussions. The Russians accordingly did not get what they wanted on the missiles at the summit; they got even less of what they wanted in the broader strategic sense of a neutralized Poland.

The Russians in turn made no visible concessions on Iran. Apart from studying the Iranians' missile systems, the Russians made no pledge to join in sanctions on Iran, nor did they join in any criticism of the current crackdown in Iran. The United States had once offered to trade Polish BMDs for Russian cooperation on Iran, an idea rejected by the Russians since the BMD system in Poland wasn't worth the leverage Moscow has with Iran. Certainly without the Polish BMD withdrawal, there was going to be no movement on Iran.

NATO expansion is where some U.S. concession might have emerged. In his speech on Tuesday, Obama said, "State sovereignty must be a cornerstone of international order. Just as all states should have the right to choose their leaders, states must have the right to borders that are secure, and to their own foreign policies. That is why this principle must apply to all nations – including Georgia and Ukraine. America will never impose a security arrangement on another country. For either country to become a member of NATO, a majority of its people must choose to; they must undertake reforms; and they must be able to contribute to the alliance's mission. And let me be clear: NATO seeks collaboration with Russia, not confrontation."

On the surface, this reiterated the old U.S. position, which was that NATO expansion was between NATO and individual nations of the former Soviet Union, and did not — and should not — concern Moscow. The terms of expanding, reforming and contributing to NATO remained the same. But immediately after the Obama-Putin meeting, Russian sources began claiming that an understanding on NATO expansion was reached, and that the Americans conceded the point. We see some evidence for this in the speech — the U.S. public position almost never has included mention of public support or reforms.

In many ways, however, this is splitting hairs. The French and Germans have long insisted that any NATO expansion should be limited to countries with strong public support for expansion, and which meet certain military thresholds that Georgia and Ukraine clearly do not meet (and could not meet even with a decade of hard work). Since NATO expansion requires unanimous support from all members, Russia was more interested in having the United States freeze its relations with other former Soviet states at their current level. Russian sources indicate that they did indeed get reassurances of such a freeze, but it takes an eager imagination to glean that from Obama's public statement.

Therefore, we come away with the sense that the summit changed little, but that it certainly didn't cause any deterioration, which could have happened. Having a summit that causes no damage is an achievement in itself.

The Kennedy Trap

Perhaps the most important part of the summit was that Obama does not seem to have fallen into the Kennedy trap. Part of the lack of serious resolutions at the summit undoubtedly resulted from Obama's unwillingness to be excessively accommodating to the Russians. With all of the comparisons to the 1961 Kennedy-Khrushchev summit being bruited about, Obama clearly had at least one overriding goal in Moscow: to not be weak. Obama tried to show his skills even before the summit, playing Medvedev and Putin against each other. No matter how obvious and clumsy that might have been, it served a public purpose by making it clear that Obama was not in awe of either of them. Creating processes rather than solutions also was part of that strategy.

It appears, however, that the Russians did fall into the Kennedy trap a bit. The eagerness of Putin's advisers to tout U.S. concession on Ukraine and Georgia after their meeting in spite of scant public evidence of such concessions gives us the sense that Putin wanted to show that he achieved something Medvedev couldn't. There may well be a growing rivalry between Medvedev and Putin, and Obama might well have played off it.

But that is for the gossip columns. The important news from the summit was as follows: First, no one screwed up, and second, U.S.-Russian relations did not get worse — and might actually have improved.

No far-reaching strategic agreements were attained, but strategic improvements in the future were not excluded. Obama played his role without faltering, and there may be some smidgen of tension between the two personalities running Russia. As far as summits go, we have seen far worse and much better. But given the vitriol of past U.S.-Soviet/Russian relations, routine is hardly a negative outcome.

In the meantime, BMD remains under development in Poland, there is no U.S.-Russian agreement on Iran and, as far as we can confirm at present, no major shift in U.S. policy on Ukraine and Georgia has occurred. This summit will not be long remembered, but then Obama did not want the word "disastrous" attached to this summit as it had been to Kennedy's first Soviet summit.

We wish there were more exciting things to report about the summit, but sometimes there simply aren't. And sometimes the routine might turn out significant, but we doubt that in this case. The geopolitical divide between the United States and Russia is as deep as ever, even if some of the sharper edges have been rounded. Ultimately, little progress was made in finding ways to bridge the two countries' divergent interests. And the burning issues — particularly Poland and Iran — continue to burn.

Iranian Elections, Israel and the United States

John Mauldin — Thu, 18 Jun 2009 15:13:19 GMT

Dear Friends,

In the midst of an economic crisis, we are inundated with data - information that often, a few years down the line, turns out to be wrong. Forecasts are made based on a single month's set of data or previous trends, and the public often doesn't know how to read the fine print about margins of error.

The problem is faulty methodology. Most media and even government intelligence agencies assume the information they get from leadership figures is 100% correct, no questions asked - leading to defective analyses. Instead, underlying assumptions should be constantly vetted in the face of new facts. I'd encourage you to consider the intelligence produced by my friend George Friedman at STRATFOR - a trusted source in forecasting future geopolitical trends.

Click here to watch this video by George and his intelligence team. It looks beyond the current protests in Iran and delves into what policy changes could be on the horizon in this pivotal Middle Eastern state. George extrapolates what these recent events mean for President Obama's and Israel's options in terms of Iran and the peace process.

Anyone looking to gain a leg up in the world of finance needs to understand geopolitics and foreign investments. Take a look at STRATFOR, which offers a special deal for my readers. Barron's referred to them in a cover-story profile as the "Shadow CIA," but I would say that their methodology gives them much greater accuracy than their government counterpart.

To Intelligence,
John Mauldin

The Geography of Recession

John Mauldin — Thu, 04 Jun 2009 21:16:46 GMT

Dear Friends:

One of the first things you learn about analyzing a company is how to dissect a balance sheet. What assets and liabilities can be deployed by a company to create equity over time? I've enclosed a fascinating variant on this process. Take a look at how STRATFOR has analyzed the "geographic balance sheets" of the US, Russia, China, and Europe to understand why different countries' economies have suffered to varying degrees from the current economic crisis.

As investors, it's precisely this type of outside-the-box thinking that can provide us profitable opportunities, and it's precisely this type of outside-the-box thinking that makes STRATFOR such an important part of my investment decision making. The key to investment profits is thinking differently and thinking earlier than the next guy. STRATFOR's work exemplifies both these traits.

I've arranged for a special deal on a STRATFOR Membership for my readers, which you can click here to take advantage of. Many of you are invested in alternative strategies, but I want to make sure that you also employ alternative thinking strategies. So take a look at these different "country balance sheets" as you formulate your plans.

Your Mapping It Out Analyst,

John Mauldin

The Geography of Recession

By Peter Zeihan

The United States and the Free Market

The most important aspect of the United States is not simply its sheer size, but the size of its usable land. Russia and China may both be similar-sized in absolute terms, but the vast majority of Russian and Chinese land is useless for agriculture, habitation or development. In contrast, courtesy of the Midwest, the United States boasts the world's largest contiguous mass of arable land — and that mass does not include the hardly inconsequential chunks of usable territory on both the West and East coasts.

Second is the American maritime transport system. The Mississippi River, linked as it is to the Red, Missouri, Ohio and Tennessee rivers, comprises the largest interconnected network of navigable rivers in the world. In the San Francisco Bay, Chesapeake Bay and Long Island Sound/New York Bay, the United States has three of the world's largest and best natural harbors. The series of barrier islands a few miles off the shores of Texas and the East Coast form a water-based highway — an Intercoastal Waterway — that shields American coastal shipping from all but the worst that the elements can throw at ships and ports.

The real beauty is that the two overlap with near perfect symmetry. The Intercoastal Waterway and most of the bays link up with agricultural regions and their own local river systems (such as the series of rivers that descend from the Appalachians to the East Coast), while the Greater Mississippi river network is the circulatory system of the Midwest. Even without the addition of canals, it is possible for ships to reach nearly any part of the Midwest from nearly any part of the Gulf or East coasts. The result is not just a massive ability to grow a massive amount of crops — and not just the ability to easily and cheaply move the crops to local, regional and global markets — but also the ability to use that same transport network for any other economic purpose without having to worry about food supplies.

The implications of such a confluence are deep and sustained. Where most countries need to scrape together capital to build roads and rail to establish the very foundation of an economy, transport capability, geography granted the United States a near-perfect system at no cost. That frees up U.S. capital for other pursuits and almost condemns the United States to be capital-rich. Any additional infrastructure the United States constructs is icing on the cake. (The cake itself is free — and, incidentally, the United States had so much free capital that it was able to go on to build one of the best road-and-rail networks anyway, resulting in even greater economic advantages over competitors.)

Third, geography has also ensured that the United States has very little local competition. To the north, Canada is both much colder and much more mountainous than the United States. Canada's only navigable maritime network — the Great Lakes-St. Lawrence Seaway —is shared with the United States, and most of its usable land is hard by the American border. Often this makes it more economically advantageous for Canadian provinces to integrate with their neighbor to the south than with their co-nationals to the east and west.

Similarly, Mexico has only small chunks of land, separated by deserts and mountains, that are useful for much more than subsistence agriculture; most of Mexican territory is either too dry, too tropical or too mountainous. And Mexico completely lacks any meaningful river system for maritime transport. Add in a largely desert border, and Mexico as a country is not a meaningful threat to American security (which hardly means that there are not serious and ongoing concerns in the American-Mexican relationship).

With geography empowering the United States and hindering Canada and Mexico, the United States does not need to maintain a large standing military force to counter either. The Canadian border is almost completely unguarded, and the Mexican border is no more than a fence in most locations — a far cry from the sort of military standoffs that have marked more adversarial borders in human history. Not only are Canada and Mexico not major threats, but the U.S. transport network allows the United States the luxury of being able to quickly move a smaller force to deal with occasional problems rather than requiring it to station large static forces on its borders.

Like the transport network, this also helps the U.S. focus its resources on other things.

Taken together, the integrated transport network, large tracts of usable land and lack of a need for a standing military have one critical implication: The U.S. government tends to take a hands-off approach to economic management, because geography has not cursed the United States with any endemic problems. This may mean that the United States — and especially its government — comes across as disorganized, but it shifts massive amounts of labor and capital to the private sector, which for the most part allows resources to flow to wherever they will achieve the most efficient and productive results.

Laissez-faire capitalism has its flaws. Inequality and social stress are just two of many less-than-desirable side effects. The side effects most relevant to the current situation are, of course, the speculative bubbles that cause recessions when they pop. But in terms of long-term economic efficiency and growth, a free capital system is unrivaled. For the United States, the end result has proved clear: The United States has exited each decade since post-Civil War Reconstruction more powerful than it was when it entered it. While there are many forces in the modern world that threaten various aspects of U.S. economic standing, there is not one that actually threatens the U.S. base geographic advantages.

Is the United States in recession? Of course. Will it be forever? Of course not. So long as U.S. geographic advantages remain intact, it takes no small amount of paranoia and pessimism to envision anything but long-term economic expansion for such a chunk of territory. In fact, there are a number of factors hinting that the United States may even be on the cusp of recovery.

Russia and the State

If in economic terms the United States has everything going for it geographically, then Russia is just the opposite. The Russian steppe lies deep in the interior of the Eurasian landmass, and as such is subject to climatic conditions much more hostile to human habitation and agriculture than is the American Midwest. Even in those blessed good years when crops are abundant in Russia, it has no river network to allow for easy transport of products.

Russia has no good warm-water ports to facilitate international trade (and has spent much of its history seeking access to one). Russia does have long rivers, but they are not interconnected as the Mississippi is with its tributaries, instead flowing north to the Arctic Ocean, which can support no more than a token population. The one exception is the Volga, which is critical to Western Russian commerce but flows to the Caspian, a storm-wracked and landlocked sea whose delta freezes in the winter (along with the entire Volga itself). Developing such unforgiving lands requires a massive outlay of funds simply to build the road and rail networks necessary to achieve the most basic of economic development. The cost is so extreme that Russia's first ever intercontinental road was not completed until the 21st century, and it is little more than a two-lane path for much of its length. Between the lack of ports and the relatively low population densities, little of Russia's transport system beyond the St. Petersburg/Moscow corridor approaches anything that hints of economic rationality.

Russia also has no meaningful external borders. It sits on the eastern end of the North European Plain, which stretches all the way to Normandy, France, and Russia's connections to the Asian steppe flow deep into China. Because Russia lacks a decent internal transport network that can rapidly move armies from place to place, geography forces Russia to defend itself following two strategies. First, it requires massive standing armies on all of its borders. Second, it dictates that Russia continually push its boundaries outward to buffer its core against external threats.

Both strategies compromise Russian economic development even further. The large standing armies are a continual drain on state coffers and the country's labor pool; their cost was a critical economic factor in the Soviet fall. The expansionist strategy not only absorbs large populations that do not wish to be part of the Russian state and so must constantly be policed — the core rationale for Russia's robust security services — but also inflates Russia's infrastructure development costs by increasing the amount of relatively useless territory Moscow is responsible for.

Russia's labor and capital resources are woefully inadequate to overcome the state's needs and vulnerabilities, which are legion. These endemic problems force Russia toward central planning; the full harnessing of all economic resources available is required if Russia is to achieve even a modicum of security and stability. One of the many results of this is severe economic inefficiency and a general dearth of an internal consumer market. Because capital and other resources can be flung forcefully at problems, however, active management can achieve specific national goals more readily than a hands-off, American-style model. This often gives the impression of significant progress in areas the Kremlin chooses to highlight.

But such achievements are largely limited to wherever the state happens to be directing its attention. In all other sectors, the lack of attention results in atrophy or criminalization. This is particularly true in modern Russia, where the ruling elite comprises just a handful of people, starkly limiting the amount of planning and oversight possible. And unless management is perfect in perception and execution, any mistakes are quickly magnified into national catastrophes. It is therefore no surprise to STRATFOR that the Russian economy has now fallen the furthest of any major economy during the current recession.

China and Separatism

China also faces significant hurdles, albeit none as daunting as Russia's challenges. China's core is the farmland of the Yellow River basin in the north of the country, a river that is not readily navigable and is remarkably flood prone. Simply avoiding periodic starvation requires a high level of state planning and coordination. (Wrestling a large river is not the easiest thing one can do.) Additionally, the southern half of the country has a subtropical climate, riddling it with diseases that the southerners are resistant to but the northerners are not. This compromises the north's political control of the south.

Central control is also threatened by China's maritime geography. China boasts two other rivers, but they do not link to each other or the Yellow naturally. And China's best ports are at the mouths of these two rivers: Shanghai at the mouth of the Yangtze and Hong Kong/Macau/Guangzhou at the mouth of the Pearl. The Yellow boasts no significant ocean port. The end result is that other regional centers can and do develop economic means independent of Beijing.

With geography complicating northern rule and supporting southern economic independence, Beijing's age-old problem has been trying to keep China in one piece. Beijing has to underwrite massive (and expensive) development programs to stitch the country together with a common infrastructure, the most visible of which is the Grand Canal that links the Yellow and Yangtze rivers. The cost of such linkages instantly guarantees that while China may have a shot at being unified, it will always be capital-poor.

Beijing also has to provide its autonomy-minded regions with an economic incentive to remain part of Greater China, and "simple" infrastructure will not cut it. Modern China has turned to a state-centered finance model for this. Under the model, all of the scarce capital that is available is funneled to the state, which divvies it out via a handful of large state banks. These state banks then grant loans to various firms and local governments at below the cost of raising the capital. This provides a powerful economic stimulus that achieves maximum employment and growth — think of what you could do with a near-endless supply of loans at below 0 percent interest — but comes at the cost of encouraging projects that are loss-making, as no one is ever called to account for failures. (They can just get a new loan.) The resultant growth is rapid, but it is also unsustainable. It is no wonder, then, that the central government has chosen to keep its $2 trillion of currency reserves in dollar-based assets; the rate of return is greater, the value holds over a long period, and Beijing doesn't have to worry about the United States seceding.

Because the domestic market is considerably limited by the poor-capital nature of the country, most producers choose to tap export markets to generate income. In times of plenty this works fairly well, but when Chinese goods are not needed, the entire Chinese system can seize up. Lack of exports reduces capital availability, which constrains loan availability. This in turn not only damages the ability of firms to employ China's legions of citizens, but it also removes the primary reason the disparate Chinese regions pay homage to Beijing. China's geography hardwires in a series of economic challenges that weaken the coherence of the state and make China dependent upon uninterrupted access to foreign markets to maintain state unity. As a result, China has not been a unified entity for the vast majority of its history, but instead a cauldron of competing regions that cleave along many different fault lines: coastal versus interior, Han versus minority, north versus south.

China's survival technique for the current recession is simple. Because exports, which account for roughly half of China's economic activity, have sunk by half, Beijing is throwing the equivalent of the financial kitchen sink at the problem. China has force-fed more loans through the banks in the first four months of 2009 than it did in the entirety of 2008. The long-term result could well bury China beneath a mountain of bad loans — a similar strategy resulted in Japan's 1991 crash, from which Tokyo has yet to recover. But for now it is holding the country together. The bottom line remains, however: China's recovery is completely dependent upon external demand for its production, and the most it can do on its own is tread water.

Discordant Europe

Europe faces an imbroglio somewhat similar to China's.

Europe has a number of rivers that are easily navigable, providing a wealth of trade and development opportunities. But none of them interlinks with the others, retarding political unification. Europe has even more good harbors than the United States, but they are not evenly spread throughout the Continent, making some states capital-rich and others capital-poor. Europe boasts one huge piece of arable land on the North European Plain, but it is long and thin, and so occupied by no fewer than seven distinct ethnic groups.

These groups have constantly struggled — as have the various groups up and down Europe's seemingly endless list of river valleys — but none has been able to emerge dominant, due to the webwork of mountains and peninsulas that make it nigh impossible to fully root out any particular group. And Europe's wealth of islands close to the Continent, with Great Britain being only the most obvious, guarantee constant intervention to ensure that mainland Europe never unifies under a single power.

Every part of Europe has a radically different geography than the other parts, and thus the economic models the Europeans have adopted have little in common. The United Kingdom, with few immediate security threats and decent rivers and ports, has an almost American-style laissez-faire system. France, with three unconnected rivers lying wholly in its own territory, is a somewhat self-contained world, making economic nationalism its credo. Not only do the rivers in Germany not connect, but Berlin has to share them with other states. The Jutland Peninsula interrupts the coastline of Germany, which finds its sea access limited by the Danes, the Swedes and the British. Germany must plan in great detail to maximize its resource use to build an infrastructure that can compensate for its geographic deficiencies and link together its good — but disparate — geographic blessings. The result is a state that somewhat favors free enterprise, but within the limits framed by national needs.

And the list of differences goes on: Spain has long coasts and is arid; Austria is landlocked and quite wet; most of Greece is almost too mountainous to build on; it doesn't get flatter than the Netherlands; tiny Estonia faces frozen seas in the winter; mammoth Italy has never even seen an icebreaker. Even if there were a supranational authority in Europe that could tax or regulate the banking sector or plan transnational responses, the propriety of any singular policy would be questionable at best.

Such stark regional differences give rise to such variant policies that many European states have a severe (and understandable) trust deficit when it comes to any hint of anything supranational. We are not simply taking about the European Union here, but rather a general distrust of anything cross-border in nature. One of the many outcomes of this is a preference for using local banks rather than stock exchanges for raising capital. After all, local banks tend to use local capital and are subject to local regulations, while stock exchanges tend to be internationalized in all respects. Spain, Italy, Sweden, Greece and Austria get more than 90 percent of their financing from banks, the United Kingdom 84 percent and Germany 76 percent — while for the United States it is only 40 percent.

And this has proved unfortunate in the extreme for today's Europe. The current recession has its roots in a financial crisis that has most dramatically impacted banks, and European banks have proved far from immune. Until Europe's banks recover, Europe will remain mired in recession. And since there cannot be a Pan-European solution, Europe's recession could well prove to be the worst of all this time around.

An Israeli Prime Minister Comes to Washington Again

John Mauldin — Thu, 21 May 2009 13:37:00 GMT

Dear Friends –

Occasionally I need a fast answer. So I'll run a Google search, and 2.54 MILLION responses later I've learned how to handle a Thanksgiving turkey-roasting crisis but nothing useful about Turkey's financial crisis.

There's certainly no shortage of data these days. But what's in all-too-short supply is understanding. As investors, what creates opportunities isn't access to data but to ways of thinking about the world. I created Outside the Box precisely for this reason, to share with you some of the best thinkers in the world and some of the best ways to think about investments.

To understand how geopolitical events impact your investments, there's simply no one better than my friend George Friedman and his team at STRATFOR. They couple objective facts with unbiased context and analysis so you know what it all means for you. This understanding is a critical piece of my investment formula, and I strongly encourage you to click here to take advantage of a special offer that George is offering my readers.

In the meantime, take a look at this article about Israel, the U.S., and the chance for peace in the Middle East. If you've ever wondered why this conflict doesn't have a simple, Hollywood resolution, you'll be blown away by the clarity George provides.

To Understanding,
John Mauldin

An Israeli Prime Minister Comes to Washington Again

By George Friedman

Obstacles to the Two-State Solution

The foundation of the Israeli-Palestinian peace process for years has been the assumption that there would be a two-state solution. Such a solution has not materialized for a host of reasons. First, at present there are two Palestinian entities, Gaza and the West Bank, which are hostile to each other. Second, the geography and economy of any Palestinian state would be so reliant on Israel that independence would be meaningless; geography simply makes the two-state proposal almost impossible to implement. Third, no Palestinian government would have the power to guarantee that rogue elements would not launch rockets at Israel, potentially striking at the Tel Aviv-Jerusalem corridor, Israel's heartland. And fourth, neither the Palestinians nor the Israelis have the domestic political coherence to allow any negotiator to operate from a position of confidence. Whatever the two sides negotiated would be revised and destroyed by their political opponents, and even their friends.

For this reason, the entire peace process — including the two-state solution — is a chimera. Neither side can live with what the other can offer. But if it is a fiction, it is a fiction that serves U.S. purposes. The United States has interests that go well beyond Israeli interests and sometimes go in a different direction altogether. Like Israel, the United States understands that one of the major obstacles to any serious evolution toward a two-state solution is Arab hostility to such an outcome.

The Jordanians have feared and loathed Fatah in the West Bank ever since the Black September uprisings of 1970. The ruling Hashemites are ethnically different from the Palestinians (who constitute an overwhelming majority of the Jordanian population), and they fear that a Palestinian state under Fatah would threaten the Jordanian monarchy. For their part, the Egyptians see Hamas as a descendent of the Muslim Brotherhood, which seeks the Mubarak government's ouster — meaning Cairo would hate to see a Hamas-led state. Meanwhile, the Saudis and the other Arab states do not wish to see a radical altering of the status quo, which would likely come about with the rise of a Palestinian polity.

At the same time, whatever the basic strategic interests of the Arab regimes, all pay lip service to the principle of Palestinian statehood. This is hardly a unique situation. States frequently claim to favor various things they actually are either indifferent to or have no intention of doing anything about. Complicating matters for the Arab states is the fact that they have substantial populations that do care about the fate of the Palestinians. These states thus are caught between public passion on behalf of Palestinians and the regimes' interests that are threatened by the Palestinian cause. The states' challenge, accordingly, is to appear to be doing something on behalf of the Palestinians while in fact doing nothing.

The United States has a vested interest in the preservation of these states. The futures of Egypt, Saudi Arabia and the Gulf states are of vital importance to Washington. The United States must therefore simultaneously publicly demonstrate its sensitivity to pressures from these nations over the Palestinian question while being careful to achieve nothing — an easy enough goal to achieve.

The various Israeli-Palestinian peace processes have thus served U.S. and Arab interests quite well. They provide the illusion of activity, with high-level visits breathlessly reported in the media, succeeded by talks and concessions — all followed by stalemate and new rounds of violence, thus beginning the cycle all over again.

The Palestinian Peace Process as Political Theater

One of the most important proposals Netanyahu is bringing to Obama calls for reshaping the peace process. If Israeli President Shimon Peres is to be believed, Netanyahu will not back away from the two-state formula. Instead, the Israeli prime minister is asking that the various Arab state stakeholders become directly involved in the negotiations. In other words, Netanyahu is proposing that Arab states with very different public and private positions on Palestinian statehood be asked to participate — thereby forcing them to reveal publicly their true positions, ultimately creating internal political crises in the Arab states.

The clever thing about this position is that Netanyahu not only knows his request will not become a reality, but he also does not want it to become a reality. The political stability of Jordan, Saudi Arabia and Egypt is as much an Israeli interest as an American one. Indeed, Israel even wants a stable Syria, since whatever would come after the Alawite regime in Damascus would be much more dangerous to Israeli security than the current Syrian regime.

Overall, Israel is a conservative power. In terms of nation-states, it does not want upheaval; it is quite content with the current regimes in the Arab world. But Netanyahu would love to see an international conference with the Arab states roundly condemning Israel publicly. This would shore up the justification for Netanyahu's policies domestically while simultaneously creating a framework for reshaping world opinion by showing an Israel isolated among hostile states.

Obama is likely hearing through diplomatic channels from the Arab countries that they do not want to participate directly in the Palestinian peace process. And the United States really does not want them there, either. The peace process normally ends in a train wreck anyway, and Obama is in no hurry to see the wreckage. He will want to insulate other allies from the fallout, putting off the denouement of the peace process as long as possible. Obama has sent George Mitchell as his Middle East special envoy to deal with the issue, and from the U.S. president's point of view, that is quite enough attention to the problem.

Netanyahu, of course, knows all this. Part of his mission is simply convincing his ruling coalition — and particularly Lieberman, whom Netanyahu needs to survive, and who is by far Israel's most aggressive foreign minister ever — that he is committed to redefining the entire Israeli-Palestinian relationship. But in a broader context, Netanyahu is looking for greater freedom of action. By posing a demand the United States will not grant, Israel is positioning itself to ask for something that appears smaller.

Israel and the Appearance of Freedom of Action

What Israel actually would do with greater freedom of action is far less important than simply creating the appearance that the United States has endorsed Israel's ability to act in a new and unpredictable manner. From Israel's point of view, the problem with Israeli-Palestinian relations is that Israel is under severe constraints from the United States, and the Palestinians know it. This means that the Palestinians can even anticipate the application of force by Israel, meaning they can prepare for it and endure it. From Netanyahu's point of view, Israel's primary problem is that the Palestinians are confident they know what the Israelis will do. If Netanyahu can get Obama to introduce a degree of ambiguity into the situation, Israel could regain the advantage of uncertainty.

The problem for Netanyahu is that Washington is not interested in having anything unpredictable happen in Israeli-Palestinian relations. The United States is quite content with the current situation, particularly while Iraq becomes more stable and the Afghan situation remains unstable. Obama does not want a crisis from the Mediterranean to the Hindu Kush. The fact that Netanyahu has a political coalition to satisfy will not interest the United States, and while Washington at some unspecified point might endorse a peace conference, it will not be until Israel and its foreign minister endorse the two-state formula.

Netanyahu will then shift to another area where freedom of action is relevant — namely, Iran. The Israelis have leaked to the Israeli media that the Obama administration has told them that Israel may not attack Iran without U.S. permission, and that Israel agreed to this requirement. (U.S. President George W. Bush and Israeli Prime Minister Ehud Olmert went through the same routine not too long ago, using a good cop/bad cop act in a bid to kick-start negotiations with Iran.)

In reality, Israel would have a great deal of difficulty attacking Iranian facilities with non-nuclear forces. A multitarget campaign 1,000 miles away against an enemy with some air defenses could be a long and complex operation. Such a raid would require a long trip through U.S.-controlled airspace for the fairly small Israeli air force. Israel could use cruise missiles, but the tonnage of high explosive delivered by a cruise missile cannot penetrate even moderately hardened structures; the same is true for ICBMs carrying conventional warheads. Israel would have to notify the United States of its intentions because it would be passing through Iraqi airspace — and because U.S. technical intelligence would know what it was up to before Israeli aircraft even took off. The idea that Israel might consider attacking Iran without informing Washington is therefore absurd on the surface. Even so, the story has surfaced yet again in an Israeli newspaper in a virtual carbon copy of stories published more than a year ago.

Netanyahu has promised that the endless stalemate with the Palestinians will not be allowed to continue. He also knows that whatever happens, Israel cannot threaten the stability of Arab states that are by and large uninterested in the Palestinians. He also understands that in the long run, Israel's freedom of action is defined by the United States, not by Israel. His electoral platform and his strategic realities have never aligned. Arguably, it might be in the Israeli interest that the status quo be disrupted, but it is not in the American interest. Netanyahu therefore will get to redefine neither the Palestinian situation nor the Iranian situation. Israel simply lacks the power to impose the reality it wants, the current constellation of Arab regimes it needs, and the strategic relationship with the United States on which Israeli national security rests.

In the end, this is a classic study in the limits of power. Israel can have its freedom of action anytime it is willing to pay the price for it. But Israel can't pay the price. Netanyahu is coming to Washington to see if he can get what he wants without paying the price, and we suspect strongly he knows he won't get it. His problem is the same as that of the Arab states. There are many in Israel, particularly among Netanyahu's supporters, who believe Israel is a great power. It isn't. It is a nation that is strong partly because it lives in a pretty weak neighborhood, and partly because it has very strong friends. Many Israelis don't want to be told that, and Netanyahu came to office playing on the sense of Israeli national power.

So the peace process will continue, no one will expect anything from it, the Palestinians will remain isolated and wars regularly will break out. The only advantage of this situation from the U.S. point of view it is that it is preferable to all other available realities.

The Geopolitics of Pandemics

John Mauldin — Fri, 08 May 2009 16:55:12 GMT

Dear Friends -

If you ever look at the footnotes, you know that "Past performance is no guarantee of future results." That said, by the time you've gotten a bit of gray hair, you realize that there are few teachers as good as history. "But this time it's different!" is the cry of people that are usually just about to lose a bunch of money.

Read the analysis below from my good friend George Friedman at STRATFOR on the latest new thing, the swine flu outbreak. A few points you ought to take away with you:

while the situation is serious, it's not cause to become hysterical or irrational
the way to evaluate the current threat is by benchmarking it against similar historical events
and as investors, if we don't look outside the worlds of finance and economics, we can get painfully blindsided

These three points are precisely why I incorporate STRATFOR insights into my investment planning. STRATFOR provides the narrative of the future by studying the past. Those of you that got to visit with George in La Jolla know what I'm talking about. If you're looking for context and understanding of tomorrow's global events - and if you're not, you're really in trouble! - I heartily suggest you click here to take advantage of the special offer that George makes available to my readers for a STRATFOR Membership.

There aren't any guarantees in life. But there are good, solid principles that you ignore at your peril. That "there's nothing new under the sun" is a lesson to take to heart.

Your Gray(ing) Eminence Analyst,
John Mauldin

The Geopolitics of Pandemics

By George Friedman

May 4, 2009

Related Special Topic Page - Swine Flu Outbreak 2009

Word began to flow out of Mexico the weekend before last of well over 150 deaths suspected to have been caused by a new strain of influenza commonly referred to as swine flu. Scientists who examined the flu announced that this was a new strain of Influenza A (H1N1) derived partly from swine flu, partly from human flu and partly from avian flu strains (although there is some question as to whether this remains true). The two bits of information released in succession created a global panic.

This panic had three elements. The first related to the global nature of this disease, given that flus spread easily and modern transportation flows mean containment is impossible. Second, there were concerns (including our own) that this flu would have a high mortality rate. And third, the panic centered on the mere fact that this disease was the flu.

News of this new strain triggered memories of the 1918-1919 flu pandemic, sparking fears that the "Spanish flu" that struck at the end of World War I would be repeated. In addition, the scare over avian flu created a sense of foreboding about influenza — a sense that a catastrophic outbreak was imminent.

By midweek, the disease was being reported around the world. It became clear that the disease was spreading, and the World Health Organization (WHO) declared a Phase 5 pandemic alert. A Phase 5 alert (the last step before a pandemic is actually, officially declared, a step that may be taken within the next couple of days) means that a global pandemic is imminent, and that the virus has proved capable of sustained human-to-human transmission and infecting geographically disparate populations. But this is not a measure of lethality, only communicability, and pandemics are not limited to the deadliest diseases.

'Pandemic,' not 'Duck and Cover'

To the medical mind, the word "pandemic" denotes a disease occurring over a wide geographic area and affecting an exceptionally high proportion of the population. The term in no way addresses the underlying seriousness of the disease in the sense of its wider impact on society. The problem is that most people are not physicians. When the WHO convenes a press conference carried by every network in the world, the declaration of a level 5 pandemic connotes global calamity, even as statements from experts — and governments around the world — attempt to walk the line between calming public fears and preparing for the worst.

The reason to prepare for the worst was because this was a pandemic with an extremely unclear prognosis, and about which reliable information was in short supply. Indeed, the new strain could mutate into a more lethal form and re-emerge in the fall for the 2009-2010 flu season. There are also concerns about how its victims disproportionately are healthy young adults under 45 years of age — which was reported in the initial information out of Mexico, and has been reported as an observed factor in the cases that have popped up in the United States. This was part of the 1918 flu pandemic pattern as well. (In contrast, seasonal influenza is most deadly among the elderly and young children with weaker immune systems.)

But as the days wore on last week, the swine flu began to look like little more than ordinary flu. Toward the end of the week, a startling fact began to emerge: While there were more than a hundred deaths in Mexico suspected of being caused by the new strain, only about 20 (a number that has increased slightly after being revised downward earlier last week) have been confirmed as being linked to the new virus. And there has not been a single death from the disease reported anywhere else in the world, save that of a Mexican child transported to the United States for better care. Indeed, even in Mexico, the country's health minister declared the disease to be past its peak May 3. STRATFOR sources involved in examining the strain have also suggested that the initial analysis of the swine flu was in fact in error, and that the swine flu may have originated during a 1998 outbreak in a pig farm in North Carolina. This information reopens the question of what killed the individuals whose deaths were attributed to swine flu.

While little is understood about the specifics of this new strain, influenza in general has a definitive pattern. It is a virus that affects the respiratory system, and particularly the lungs. At its deadliest it can cause secondary infections — typically bacterial rather than viral — leading to pneumonia. In the most virulent forms of influenza, it is the speed with which complications strike that drives death rates higher. Additionally, substantively new strains (as swine flu is suspected of being) can be distinct enough from other strains of flu that pre-existing immunity gained from flus of years past does not help fend off the latest variation.

Influenza is not a disease that lingers and then kills people — save the sick, old and very young, whose immune systems are more easily compromised. Roughly half a million people (largely from these groups) die annually worldwide from more common strains of influenza, with the Centers for Disease Control and Prevention (CDC) pegging average American deaths at roughly 36,000 per year.

Swine flu deaths have not risen as would be expected at this point for a highly contagious and lethal new strain of influenza. In most cases, victims have experienced little more than a bad cold, from which they are recovering. And infections outside Mexico so far have not been severe. This distinction of clear cases of death in Mexico and none elsewhere (again, save the one U.S. case) is stark.

Much of what has occurred in the last week regarding the new virus reminds us of the bird flu scare of 2005. Then as now, the commonly held belief was that a deadly strain was about to be let loose on humanity. Then as now, many governments were heightening concerns rather than quelling them. Then as now, STRATFOR saw only a very small chance of the situation becoming problematic.

Ultimately, by the end of last week it had become clear to the global public that "pandemic" could refer to bad colds as well as to plagues wiping out millions.

A Real Crisis

The recent swine flu experience raises the question of how one would attempt to grapple with a genuine high-mortality pandemic with major consequences. The answer divides into two parts: how to control the spread, and how to deploy treatments.

Communicability

The flu virus is widely present in two species other than humans, namely, birds and pigs. The history of the disease is the history of its transmission within and across these three species. It is comparatively easy for the disease to transmit from swine to birds and from swine to humans; the bird-to-human barrier is the most difficult to cross.

Cross-species influenza is of particular concern. In the simplest terms, viruses are able to recombine (e.g., human flu and avian flu can merge into a hybrid flu strain). What comes out can be a flu transmissible to humans, but with a physical form that is distinctly avian — meaning it fails to alert human immune systems to the intrusion. This can rob the human immune system of the ability to quickly recognize the disease and put up a fight.

New humanly transmissible influenza strains often have been found to originate in places where humans, pigs and/or fowl live in close proximity to each other — particularly in agricultural areas where animal and human habitation is shared or in which constant, close physical contact takes place.

Agricultural areas of Asia with dense populations, relatively small farms and therefore frequent and prolonged contact between species traditionally have been the areas in which influenza strains have transferred from animals to humans and then mutated into diseases transmissible by casual human contact. Indeed, these areas have been the focus of concern over a potential outbreak of bird flu. This time around, the outbreak began in Mexico (though it is not yet clear where the virus itself originated).

And this is key to understanding this flu. Because it appears relatively mild, it might well have been around for quite awhile — giving people mild influenza, but not standing out as a new variety until it hit Mexico. The simultaneous discovery of the strain amid a series of deaths (and what may now be in hindsight inflated concerns about its lethality) led to the recent crisis footing.

Any time such threats are recognized, they already are beyond containment. Given travel patterns in the world today, viruses move easily to new locations well before they are identified in the first place they strike. The current virus is a case in point. It appears, although it is far from certain, that it originated in the Veracruz area of Mexico. Within two days of the Mexican government having issued a health alert, it already had spread as far afield as New Zealand. One week on, cases completely unrelated to Mexico have already been confirmed on five continents.

In all probability, this "spread" was less the discovery of new areas of infection than the random discovery of areas that might have been infected for weeks or even months (though the obvious first people to test were those who had recently returned from Mexico with flu symptoms). Given the apparent mildness of the infection, most people would not go to the doctor. And if they did, the doctor would call it generic flu and not even concern himself with its type. What happened last week appears to have been less the spread of a new influenza virus than the "discovery" of places to which it had spread awhile ago.

The problem with the new variety was not that it was so deadly; had it actually been as uniquely deadly as it first appeared to be, there would have been no mistaking its arrival, because hospitals would be overflowing. It was precisely its mildness that sparked the search. But because of expectations established in the wake of the Mexico deaths, the discovery of new cases was disassociated from its impact. Its presence alone caused panic, with schools closing and border closings discussed.

The virus traveled faster than news of the virus. When the news of the virus finally caught up with the virus, the global perception was shaped by a series of deaths suddenly recognized in Mexico (as mentioned, deaths so far not seen elsewhere). But even as the Mexican Health Ministry begins to consider the virus beyond its peak, the potential for mutation and a more virulent strain in the next flu season looms.

Mortality

As mentioned, viruses that spread through casual human contact can be globally established before anyone knows of it. The first sign of a really significant influenza pandemic will not come from the medical community or the WHO; it will come from the fact that people are catching influenza and dying, and are doing so all over the world at the same time. The system established for detecting spreading diseases is hardwired to be behind the curve. This is not because it is inefficient, but because no matter how efficient, it cannot block casual contact — which, given modern air transportation, spreads diseases globally in a matter of days or even hours.

Therefore, the problem is not the detection of deadly pandemics, simply because they cannot be missed. Rather, the problem is reacting medically to deadly pandemics. One danger is overreacting to every pandemic and thereby breaking the system. (As of this writing, the CDC remained deeply concerned about swine flu, though calm seems to be returning.)

The other danger is not reacting rapidly enough. In the case of influenza, medical steps can be taken. First, there are anti-viral medicines found to be effective against the new strain, and if sufficient stockpiles exist — which is hardly universally the case, especially in the developing world — and those stockpiles can be administered early enough, the course of the disease can be mitigated. Second, since most people die from secondary infection in the lungs, antibiotics can be administered. Unlike with the 1918 pandemic, the mortality rate can be dramatically reduced.

The problem here is logistical: The distribution and effective administration of medications is a challenge. Producing enough of the medication is one problem; it takes months to craft, grow and produce a new vaccine, and the flu vaccine is tailored every year to deal with the three most dangerous strains of flu. Another problem is moving the medication to areas where it is needed in an environment that maintains its effectiveness. Equally important is the existence of infrastructure and medical staff capable of diagnosing, administering and supporting patients — and doing so on a scale never before attempted.

These things will not be done effectively on a global basis. That is inevitable. But influenza, even at the highest death rates ever recorded for the disease, does not threaten human existence as we know it. At its worst, flu will kill a lot of people, but the human race and the international order will survive.

The true threat to humanity, if it ever comes, will not come from influenza. Rather, it will come from a disease spread through casual human contact, but with a higher mortality rate than flu and no clear treatment. While HIV/AIDS boasts an extraordinarily high mortality rate and no cure exists, it at least does not spread through casual contact as influenza does, and so the pace at which it can spread is limited.

Humanity will survive the worst that influenza can throw at it even without intervention. With modern intervention, its effect declines dramatically. But the key problem of pandemics was revealed in this case: The virus spread well before information on it spread. Detection and communication lagged. That did not matter in this case, and it did not matter in the case of HIV/AIDS, because the latter was a disease that did not spread through casual contact. However, should a disease arise that is as deadly as HIV, that spreads through casual contact, about which there is little knowledge and for which there is no cure, the medical capabilities of humanity would be virtually useless.

There are problems to which there are no solutions. Fortunately, these problems may not arise. But if they do, no amount of helpful public service announcements from the CDC and the WHO will make the slightest bit of difference.

Second Quarter Forecast 2009: Global Trends

John Mauldin — Thu, 23 Apr 2009 13:31:00 GMT

I've been in this business a long time. Some days it feels like a very long time. But never in all the years that I've been in the financial markets have I felt like business per se has less impact on my investment decisions. Let me explain.

GM shares have gone from being a claim on earnings from car sales to being a call option on whether the US government will extend another lifeline. Banks' capital structures have gone from being the province of Boards of Directors and CFOs to the "expertise" of Congressional committees and appointed regulators. Used to be when I thought about Financial Centers New York and London came to mind. Instead now I have to think about Washington and Brussels.

My friend George Friedman and his team at STRATFOR are where I turn when I need help thinking about these new realities. George's team provides me context and understanding of the environment in which financial developments are going to take place. I may tweak him about his ties, but if you saw George speak at my conference in La Jolla, you know that he's an absolutely compelling speaker. And it's small wonder that his latest book spent those weeks on the New York Times bestseller list too.

Below you'll find STRATFOR's 2Q Forecast. I hope you find it as helpful as I do in formulating my plans. What I can tell you with certainty is that if you're not taking into account the impact of geopolitical events on the markets, it's no different than trading agricultural futures without a weather forecast. George and his team provide their Members - myself included - with forecasts and on-going analysis that's invaluable in understanding the seachange in the global economy. And in exchange for me not teasing him any more, he's offering my readers a special rate on a STRATFOR Membership. Click here to join STRATFOR at this special rate and get access to a full year of the same geopolitical intelligence I use in my strategic planning. You'll be glad you did.

Yours, John Mauldin
Editor, Outside the Box

Second Quarter Forecast 2009: Global Trends

Editor’s note: STRATFOR arranges its primary forecasts — in this case the document below — topically rather than geographically. Thus, the entirety of our South Asia and Global Economy coverage for the quarterly is included in this primary forecast. Those portions of the Middle East and Eurasia forecasts that are not included in this forecast have been appended with the other regional sections.

Executive Summary

STRATFOR’s 2009 annual forecast focused on three broad trends: the global recession, the Russian resurgence and the evolution of the jihadist war.

There are number of indications that the U.S. economy is showing signs of life, but it will be weeks — if not months — before these glimmers may assemble into a firm recovery. At that point, it would be a minimum of an additional three months before a U.S. recovery could foster a global recovery. This means that for the second quarter, STRATFOR is able to take a pass on this part of our forecast. Either this quarter will be the dark before the dawn, or it will be the dark before midnight. Either way, it will be dark. A noticeable recovery will have to wait until the third quarter.

In the first quarter, Russia was convinced that it had the new U.S. president and his administration right where it wanted them: so obsessed with the Afghan war that Russia could demand anything it wanted in exchange for allowing military supplies to enter Afghanistan from the north. Russia miscalculated. It seems the Obama administration puts something above fighting the Afghan war on its priority list: limiting Russia’s resurgence. The second quarter will be Russia’s time to consolidate the advances it has made over the course of the past four years, before the Americans can gain any capacity from their planned Iraqi drawdown. Washington will be looking for ways to bolster allies against Moscow, with a somewhat ambivalent Turkey taking center stage.

Finally there is the jihadist war itself. The U.S. divide-and-conquer strategy has worked reasonably well in Iraq: Some Sunni militants, rather than shooting at U.S. forces, are now being integrated (after a fashion) into the fragile yet strengthening Iraqi federal government. This is allowing the United States to remove some forces from Iraq, and thus to surge some into Afghanistan. The American intent is to rework the divide-and-conquer trick on the Taliban. However, this tactic is not likely to be replicable for a mixture of historical, demographic and geographic reasons. The most likely reason for the plan to not succeed is because in Iraq, the “good” Sunnis the Americans courted were locals — nationalists under pressure from Shiite Iran — while the “bad” Sunnis were foreign Islamists. In Afghanistan, there is no neat factional split within the Taliban. So for the Americans, the next three months will be about trying to force a square peg into a round hole. There will be little if any progress, and the Pakistani government’s lack of enthusiasm for the conflict will allow the region’s militants to expand the scope of the war.

Primary Forecast

Global trend: The Economy

Undoubtedly, there is plenty of bad news — stock market surges tend to be the first major sign that the U.S. economy is healing, but the stock market cannot seem to find its feet, and employment remains well off ideal levels. Yet in the latter half of the first quarter, there were several developments indicating that the credit chokehold that caused the American recession to go global has begun to slacken. The availability of credit is the critical issue when evaluating this recession. Until firms and consumers can reliably borrow, economic growth cannot recover.

There are limited signs that credit is indeed loosening, and that some life is creeping back into the U.S. economy. Recent changes in accounting rules in the United States and Europe should grant banks the confidence they need to resume lending, independent of anything the governments might attempt. The Obama stimulus package — albeit far from perfect for actually stimulating the economy — is beginning to take effect. Retail sales have been surprisingly buoyant and since consumer spending comprises 70 percent of the American economy, this is a critical factor. Even more important is the fact that the stock of inventories has dropped for six consecutive months (September 2008 to February 2009, the latest month for which data is available) in the steepest decline on record. With inventories low, producers will soon be getting orders. That is how economic recoveries begin. There are even flickers of activity in the most moribund U.S. economic sector: housing.

But even if the United States economy is indeed showing signs of life, four caveats must kept in mind.

First, even a robust resumption in U.S. growth will not begin on any specific date. Instead, there will be increasingly bright glimmers of light here and there that will not be fully recognized until six months after the fact. It appears that the second quarter may be a transition quarter for the United States, with the more noticeable growth happening later in the year.

Second, the future of the American automotive industry his shifted from bleak to dark, with General Motors Corp. in particular planning for imminent bankruptcy (and GM is not the worst off of the Detroit Three). The dislocations caused by this industry’s implosion will be felt far and wide and even if they somehow do not delay the recovery, they are certain to have a material impact on how serious the average American views the recession as being.

Third, a resumption in growth in the United States historically does not mean an immediate rebound in either income or employment figures — both tend to be lagging indicators — particularly if the automotive industry breaks apart. Therefore, even if the recession does let up in the second quarter and growth turns nominally positive, that does not mean that most Americans will feel like the situation has improved. Bear in mind that it did not become conventional wisdom that the United States’ 2001 recession — which actually ended in October 2001 — had ended until 2004. Dispelling Americans’ mental gloom required more than two years of strong and sustained growth.

Fourth, while STRATFOR is certain that the U.S. economy will lead the world out of recession — the roughly $10 trillion American consumer market will demand products from, and thus generate growth in, Asia and Europe — STRATFOR is equally certain that there will be a lag of one to three quarters between a U.S. recovery and a global recovery. Most of Asia has suffered export plunges of at least 50 percent, and industrial output is down by a third the world over. Even if the Americans already have eaten through existing inventory, it will take some time for foreign suppliers to spin their industrial bases back up. The global system does not turn on a dime.

This means in the quarter ahead STRATFOR actually gets to opt out of taking a hard stance on this issue. If the United States does not recover, the world will remain mired in recession. If the United States begins to recover, the world will remain mired in recession and will begin pulling out later in the year. Either way, the second quarter is not going to be a comfortable time; it just might be slightly less uncomfortable for the Americans.

Internationally, there will be only one force aside from the U.S. economy to watch: the International Monetary Fund (IMF), which was recapitalized at the April G-20 summit to handle the growing need for bailouts. The IMF’s assistance programs can be split into two parts. First, traditional structural adjustment programs will provide funds to states that have made poor economic decisions. These states then fall under the IMF’s tutelage, and they must make often-wrenching changes to how their systems are run. States tapping this sort of loan program include Ukraine, Hungary, Iceland, Sri Lanka and Pakistan. These states in essence are on a sort of life support while undergoing economic surgery.

The second kind of program — introduced in March — is a bridge loan for states that have been doing a decent job of economic management but are affected by factors related to the recession that lie utterly beyond their control. This second type of program does not require any meaningful changes to a state’s economic management as (in the IMF’s eyes) they have not done anything wrong, and could perhaps be extended to countries like South Korea, Brazil, Mexico and Poland. It is this second sort of program that will have a deeper effect on the system in the short run as it will allow larger states to maintain economic activity independent of the United States, somewhat blunting the effects of the recession without threatening social stability. It is also going to absorb the lion’s share of the IMF’s funding; the first program negotiated under this system — a $40 billion line of credit to Mexico — is two-thirds as large as the combined total of the more traditional loans granted since the crisis began.

Global trend: The Russian resurgence

In STRATFOR’s 2009 annual forecast, we outlined how a dominant issue for the year would be Russia’s effort to force the United States to make a strategic bargain: Russia would grant U.S. forces a northern supply route into Afghanistan in exchange for an expunging of Western influence from the former Soviet space. At a series of summits in the first week of April, the Obama administration broadly rebuffed Russia’s demands, and the two states are sliding quickly into confrontational stances.

From the U.S. point of view, Russia has overreached and has failed to consolidate its position in the key former Soviet spheres it assumed were under its control. From the Russian point of view, the U.S. refusal to accept Russia’s superior position has forced Moscow to redouble its consolidation efforts in order to erode Washington’s confidence and limit Washington’s future options inside the former Soviet sphere.

Russia will make three major consolidation efforts during the next three months. First and most important, Moscow will try to manipulate Ukraine to remove pro-Western elements such as Ukrainian President Viktor Yushchenko from power. Second, Moscow will undermine the Georgian government to destabilize pro-Western elements there. Georgia, unlike Ukraine, is solidly pro-Western, so Russia is satisfied simply to destabilize or neutralize it rather than transform it into something useful to Moscow. The deck is stacked in the Kremlin’s favor in both states due to Russia’s overwhelming energy, intelligence, political, economic and cultural influence, as well as geographic proximity.

But it is the third consolidation attempt where things will get tricky: Armenia.

Turkey and Russia’s spheres of influence overlap in many regions, including the Caucasus. Not only is Russia very active in Georgia, but Turkey — as part of its efforts to relaunch long-dormant geopolitical ambitions — is trying to normalize relations with Armenia. Turkey ended relations with Armenia in 1993 after Armenia began its war with neighboring Azerbaijan over the secessionist Armenian region of Nagorno-Karabakh located inside Azerbaijan — and the Turkish-Azerbaijani relationship has only strengthened (especially against Armenia) since then.

However, the normalization of relations between Turkey and Armenia would open the Caucasus to a flood of Turkish political and economic influence. Until now, Moscow has actually facilitated this process, thinking that a grateful Turkey would not side with Europe and particularly the United States in containing Russian influence. Now that U.S. President Barack Obama has personally forged a partnership with the Turks, the Kremlin is not so sure.

The restoration of ties between Turkey and Armenia was rumored to occur in the first week of April, though now dates for the event range from May to October. Russia has many levers, including energy, which it can use to counter Turkey’s orientation toward the Americans, including Moscow’s power to decide whether its protectorate of Armenia will go forward with any deal with Ankara.

The wild card in talks between Turkey and Armenia is Azerbaijan. Baku — which considers Yerevan its worst enemy — feels that its close ally Turkey has abandoned it and wants to ensure its interests are not overlooked in any deal between Turkey and Armenia. Baku is considering two means of scuttling the talks, both with the intent of severing growing Turkish-Armenian ties: appealing to Russia (the logic being that Turkey does not wish to simply trade energy-rich Azerbaijan for energy-poor Armenia), or directly attacking Armenian-held territory (triggering a war in which Turkey would feel forced to take sides).

Global trend: The U.S.-jihadist war

While STRATFOR maintains that the overall strategic threat posed by the transnational jihadist movement continues to wane, the U.S.-jihadist war, which stretches from Iraq to the Indian subcontinent, remains a dominant theme for 2009.

The United States has no choice but to wrap up the war in Iraq so that it can devote more resources to the war in Afghanistan, but the transition from the Middle East to South Asia will not be easy. A fragile power-sharing deal among the Shiite, Sunni and Kurdish power groups remains intact, and violence levels are still low. Yet, as STRATFOR expected, the United States is facing difficulties ensuring that the Shiite-dominated Iraqi government is integrating into the security apparatus members of the Sunni militia forces that split off from al Qaeda and allied with the United States. Shiite-Sunni tensions will continue to simmer. Al Qaeda in Iraq (AQI), while a much-weakened force, may still appeal to dissident Sunnis — which may allow AQI to regain space and carry out more attacks.

Kurdish-Arab tensions are also likely to escalate over the next several months. Kurdish claims to the oil-rich city of Kirkuk and constant political maneuvering among Sunnis, Kurds and Shia (most notably involving the Iraqi prime minister) could ignite the dispute over Kirkuk’s future for political gain. In addition, political infighting within the Patriotic Union of Kurdistan (PUK) is likely to worsen as PUK leader and Iraqi President Jalal Talabani prepares for his succession.

The United States will try to improve its chances of holding Iraq together internally by laying the groundwork for a more constructive relationship with Iraq’s Persian neighbors. On the surface, the U.S.-Iranian relationship is improving: Obama has made clear his intent to engage Iran; his administration has agreed to direct, multilateral talks with the Iranians on the nuclear issue; and Iran is participating in U.S.-led summits on Afghanistan. But beyond the rhetoric, little has changed between Tehran and Washington. Iran is more likely to ratchet up ambiguity and Western anxiety over its nuclear program than make concessions to Washington. Like AQI, Iran’s influence may have slipped, but it has not evaporated: Iran’s influence with Shiite militants remains strong enough to upset the delicate Sunni-Shiite balance the Americans are counting on holding.

Iran is also unhappy with the developing U.S. strategy in Afghanistan that calls for engaging with “moderate” members of the Taliban — a radical Sunni force that Tehran regards as a strategic threat. Tehran will keep up appearances in the diplomatic sphere but will continue to keep its distance from Washington on any issues of substance in the near term. Iranian presidential elections will be held in June, but regardless of which camp the winner comes from — hard-line, moderate or reformist — Iran’s foreign policy goals and concerns are unlikely to shift significantly.

Meanwhile, Washington will shift its focus to South Asia even though there are evidently many loose ends to tie up in the Middle East. The developing U.S. strategy for this region will focus on bolstering the U.S. forces in Afghanistan, negotiating with moderate Taliban and diversifying supply routes to deny Pakistan some of the leverage it holds in this war. However, this plan suffers from a number of strategic flaws.

The second quarter will be a trying one for U.S. forces in Afghanistan. The initial surge of 21,000 troops into Afghanistan will not be in place until summer’s end. Though European NATO members have contributed additional forces to help secure the country for elections in August, most are temporary commitments and do little to alter the overall U.S. and NATO force structure being directed at a native guerrilla force with superior local knowledge and intelligence. This puts NATO on its heels in combating Taliban and al Qaeda forces, which will use this spring fighting season to shape the battlefield, carrying out operations in the countryside that aim to expand their territorial control and launching complex attacks in urban centers that aim to degrade the confidence of Afghan civilians and security forces.

American attempts to elicit cooperation from Pakistan through aid packages are unlikely to affect Pakistani behavior significantly in the near term. Though Pakistan is threatened by a separate Taliban insurgency at home, it prefers negotiations over force on its side of the border. This gap between U.S. and Pakistani policy in managing the insurgency will become more evident in the coming weeks and months as Pakistan fends off U.S. attempts to overhaul the Pakistani intelligence apparatus and makes agreements that undermine the writ of the Pakistani state in its northwest periphery. Pakistan’s preference to avoid combat will allow Taliban forces to concentrate their attacks on the U.S. and NATO supply routes that originate in the port of Karachi.

The United States had attempted to diversify its supply lines by opening up a northern route that enters Afghanistan through Russian-dominated Central Asia, but talks have frozen as U.S.-Russian relations deteriorate. The United States is now almost completely dependent on Pakistan; the logistical burden is rising with support for the troop surge, and the militants feel emboldened as Pakistan feels it can use a lighter touch in combating them.

India’s concerns will rise as little progress is made in the war.

As STRATFOR forecasted in the 2009 annual, New Delhi has refrained from taking overt military action against Pakistan after the November 2008 Mumbai attacks for fear of destabilizing Pakistan further and giving regional jihadists an excuse to focus their attention on India. Yet the gradual unraveling of command and control within the Pakistani military establishment has enabled many more of Islamabad’s Islamist militant proxies operating in Pakistan and India to team up with transnational jihadists to carry out deadlier and more strategically targeted attacks. Though the timing is uncertain, India is likely to witness another large-scale Islamist militant attack on its soil that will once again escalate cross-border tensions on the subcontinent.

India has thus far stayed on the sidelines of U.S. dealings with Pakistan and Afghanistan. Its involvement is largely limited to two items: first, making clear to Washington that Kashmir is not up for debate as Washington attempts to rehabilitate Pakistan, and second, increasing its presence in Afghanistan, devoting effort to reconstruction projects and perhaps providing covert support to anti-Taliban groups in the north (in part to counter a U.S. strategy to engage “pragmatic” Taliban). Much like the Iranians and the Russians, India has no interest in engaging Taliban forces who share a Pashtun link with the Pakistanis.

India is currently in the midst of a general election that will conclude in mid-May. No party is likely to win a clear majority, and it will be up to the incumbent Congress party and the main opposition Hindu nationalist Bharatiya Janata Party (BJP) to cobble together a ruling coalition of smaller regional parties. STRATFOR will not attempt to predict the outcome of this uncertain election, which will largely be based on the populist votes of India’s lower classes, but should the BJP manage to overcome its setbacks and take the lead, Indian restraint against Pakistan would not be assured in the event of another large-scale militant attack.

Part Two: Second Quarter Forecast 2009: Regional Breakouts

Obama's Strategy and the Summits

John Mauldin — Thu, 09 Apr 2009 16:30:00 GMT

Dear Friends:

A long-time religious land bridge between the Islamic and Western worlds, Turkey now finds itself an economic gatekeeper, a US-backed contender for the EU and the only key that could unlock Europe from dependence on Russian resources. The value of your dollar is intrinsically linked to last week’s summits—the most important multinational summits in history.

I’d like to share with you an article by my friend George Friedman at STRATFOR. It delves into the Summits (G20, NATO, bilaterals) and explores the connections between finance and geopolitics. In this case, it boils down to two string-holding puppeteers: Germany and Russia. Germany, the largest exporter in the world, is happy to up its production while the US spreads its dollar paper-thin by contributing to an IMF fund that will bail out countries who will in turn spend their money in Germany’s already tremendous export sector. Russia, the largest supplier of natural gas to Europe, too stands to benefit from US contributions to the IMF pot, as their slice of the pie gets bigger with the pan—as long as Turkey keeps her pipes closed.

The decisions made and policies enacted at the Summits trickle down to you and me. To make sense of it all, I encourage you to read STRATFOR. George has arranged a special offer for my readers: click here to take advantage of a 2-for-1 deal; you get a 2-year Membership for the 1-year price of $349. STRATFOR is the best global intelligence service in the world, and their unbiased coverage of the G20, NATO, and other extracurricular summits is unmatched by anyone else.

Yours,
John Mauldin

Obama's Strategy and the Summits

By George Friedman
April 6, 2009

The weeklong extravaganza of G-20, NATO, EU, U.S. and Turkey meetings has almost ended. The spin emerging from the meetings, echoed in most of the media, sought to portray the meetings as a success and as reflecting a re-emergence of trans-Atlantic unity.

The reality, however, is that the meetings ended in apparent unity because the United States accepted European unwillingness to compromise on key issues. U.S. President Barack Obama wanted the week to appear successful, and therefore backed off on key issues; the Europeans did the same. Moreover, Obama appears to have set a process in motion that bypasses Europe to focus on his last stop: Turkey.

Berlin, Washington and the G-20

Let's begin with the G-20 meeting, which focused on the global financial crisis. As we said last year, there were many European positions, but the United States was reacting to Germany's. Not only is Germany the largest economy in Europe, it is the largest exporter in the world. Any agreement that did not include Germany would be useless, whereas an agreement excluding the rest of Europe but including Germany would still be useful.

Two fundamental issues divided the United States and Germany. The first was whether Germany would match or come close to the U.S. stimulus package. The United States wanted Germany to stimulate its own domestic demand. Obama feared that if the United States put a stimulus plan into place, Germany would use increased demand in the U.S. market to expand its exports. The United States would wind up with massive deficits while the Germans took advantage of U.S. spending, thus letting Berlin enjoy the best of both worlds. Washington felt it had to stimulate its economy, and that this would inevitably benefit the rest of the world. But Washington wanted burden sharing. Berlin, quite rationally, did not. Even before the meetings, the United States dropped the demand — Germany was not going to cooperate.

The second issue was the financing of the bailout of the Central European banking system, heavily controlled by eurozone banks and part of the EU financial system. The Germans did not want an EU effort to bail out the banks. They wanted the International Monetary Fund (IMF) to bail out a substantial part of the EU financial system instead. The reason was simple: The IMF receives loans from the United States, as well as China and Japan, meaning the Europeans would be joined by others in underwriting the bailout. The United States has signaled it would be willing to contribute $100 billion to the IMF, of which a substantial portion would go to Central Europe. (Of the current loans given by the IMF, roughly 80 percent have gone to the struggling economies in Central Europe.) The United States therefore essentially has agreed to the German position.

Later at the NATO meeting, the Europeans — including Germany — declined to send substantial forces to Afghanistan. Instead, they designated a token force of 5,000, most of whom are scheduled to be in Afghanistan only until the August elections there, and few of whom actually would be engaged in combat operations. This is far below what Obama had been hoping for when he began his presidency.

Agreement was reached on collaboration in detecting international tax fraud and on further collaboration in managing the international crisis, however. But what that means remains extremely vague — as it was meant to be, since there was no consensus on what was to be done. In fact, the actual guidelines will still have to be hashed out at the G-20 finance ministers' meeting in Scotland in November. Intriguingly, after insisting on the creation of a global regulatory regime — and with the vague U.S. assent — the European Union failed to agree on European regulations. In a meeting in Prague on April 4, the United Kingdom rejected the regulatory regime being proposed by Germany and France, saying it would leave the British banking system at a disadvantage.

Overall, the G-20 and the NATO meetings did not produce significant breakthroughs. Rather than pushing hard on issues or trading concessions — such as accepting Germany's unwillingness to increase its stimulus package in return for more troops in Afghanistan — the United States failed to press or bargain. It preferred to appear as part of a consensus rather than appear isolated. The United States systematically avoided any appearance of disagreement.

The reason there was no bargaining was fairly simple: The Germans were not prepared to bargain. They came to the meetings with prepared positions, and the United States had no levers with which to move them. The only option was to withhold funding for the IMF, and that would have been a political disaster (not to mention economically rather unwise). The United States would have been seen as unwilling to participate in multilateral solutions rather than Germany being seen as trying to foist its economic problems on others. Obama has positioned himself as a multilateralist and can't afford the political consequences of deviating from this perception. Contributing to the IMF, in these days of trillion-dollar bailouts, was the lower-cost alternative. Thus, the Germans have the U.S. boxed in.

The political aspect of this should not be underestimated. George W. Bush had extremely bad relations with the Europeans (in large part because he was prepared to confront them). This was Obama's first major international foray, and he could not let it end in acrimony or wind up being seen as unable to move the Europeans after running a campaign based on his ability to manage the Western coalition. It was important that he come home having reached consensus with the Europeans. Backing off on key economic and military demands gave him that "consensus."

Turkey and Obama's Deeper Game

But it was not simply a matter of domestic politics. It is becoming clear that Obama is playing a deeper game. A couple of weeks before the meetings, when it had become obvious that the Europeans were not going to bend on the issues that concerned the United States, Obama scheduled a trip to Turkey. During the EU meetings in Prague, Obama vigorously supported the Turkish application for EU membership, which several members are blocking on grounds of concerns over human rights and the role of the military in Turkey. But the real reason is that full membership would open European borders to Turkish migration, and the Europeans do not want free Turkish migration. The United States directly confronted the Europeans on this matter.

During the NATO meeting, a key item on the agenda was the selection of a new alliance secretary-general. The favorite was former Danish Prime Minister Anders Fogh Rasmussen. Turkey opposed his candidacy because of his defense on grounds of free speech of cartoons depicting the Prophet Mohammed published in a Danish magazine. NATO operates on consensus, so any one member can block just about anything. The Turks backed off the veto, but won two key positions in NATO, including that of deputy secretary-general.

So while the Germans won their way at the meetings, it was the Turks who came back with the most. Not only did they boost their standing in NATO, they got Obama to come to a vigorous defense of the Turkish application for membership in the European Union, which of course the United States does not belong to. Obama then flew to Turkey for meetings and to attend a key international meeting that will allow him to further position the United States in relation to Islam.

The Russian Dimension

Let's diverge to another dimension of these talks, which still concerns Turkey, but also concerns the Russians. While atmospherics after the last week's meetings might have improved, there was certainly no fundamental shift in U.S.-Russian relations. The Russians have rejected the idea of pressuring Iran over its nuclear program in return for the United States abandoning its planned ballistic missile defense system in Poland and the Czech Republic. The United States simultaneously downplayed the importance of a Russian route to Afghanistan. Washington said there were sufficient supplies in Afghanistan and enough security on the Pakistani route such that the Russians weren't essential for supplying Western operations in Afghanistan. At the same time, the United States reached an agreement with Ukraine for the transshipment of supplies — a mostly symbolic gesture, but one guaranteed to infuriate the Russians at both the United States and Ukraine. Moreover, the NATO communique did not abandon the idea of Ukraine and Georgia being admitted to NATO, although the German position on unspecified delays to such membership was there as well. When Obama looks at the chessboard, the key emerging challenge remains Russia.

The Germans are not going to be joining the United States in blocking Russia. Between dependence on Russia for energy supplies and little appetite for confronting a Russia that Berlin sees as no real immediate threat to Germany, the Germans are not going to address the Russian question. At the same time, the United States does not want to push the Germans toward Russia, particularly in confrontations ultimately of secondary importance and on which Germany has no give anyway. Obama is aware that the German left is viscerally anti-American, while Merkel is only pragmatically anti-American — a small distinction, but significant enough for Washington not to press Berlin.

At the same time, an extremely important event between Turkey and Armenia looks to be on the horizon. Armenians had long held Turkey responsible for the mass murder of Armenians during and after World War I, a charge the Turks have denied. The U.S. Congress for several years has threatened to pass a resolution condemning Turkish genocide against Armenians. The Turks are extraordinarily sensitive to this charge, and passage would have meant a break with the United States. Last week, they publicly began to discuss an agreement with the Armenians, including diplomatic recognition, which essentially disarms the danger from any U.S. resolution on genocide. Although an actual agreement hasn't been signed just yet, anticipation is building on all sides.

The Turkish opening to Armenia has potentially significant implications for the balance of power in the Caucasus. The August 2008 Russo-Georgian war created an unstable situation in an area of vital importance to Russia. Russian troops remain deployed, and NATO has called for their withdrawal from the breakaway Georgian regions of South Ossetia and Abkhazia. There are Russian troops in Armenia, meaning Russia has Georgia surrounded. In addition, there is talk of an alternative natural gas pipeline network from Azerbaijan to Europe.

Turkey is the key to all of this. If Ankara collaborates with Russia, Georgia's position is precarious and Azerbaijan's route to Europe is blocked. If it cooperates with the United States and also manages to reach a stable treaty with Armenia under U.S. auspices, the Russian position in the Caucasus is weakened and an alternative route for natural gas to Europe opens up, decreasing Russian leverage against Europe.

From the American point of view, Europe is a lost cause since internally it cannot find a common position and its heavyweights are bound by their relationship with Russia. It cannot agree on economic policy, nor do its economic interests coincide with those of the United States, at least insofar as Germany is concerned. As far as Russia is concerned, Germany and Europe are locked in by their dependence on Russian natural gas. The U.S.-European relationship thus is torn apart not by personalities, but by fundamental economic and military realities. No amount of talking will solve that problem.

The key to sustaining the U.S.-German alliance is reducing Germany's dependence on Russian natural gas and putting Russia on the defensive rather than the offensive. The key to that now is Turkey, since it is one of the only routes energy from new sources can cross to get to Europe from the Middle East, Central Asia or the Caucasus. If Turkey — which has deep influence in the Caucasus, Central Asia, Ukraine, the Middle East and the Balkans — is prepared to ally with the United States, Russia is on the defensive and a long-term solution to Germany's energy problem can be found. On the other hand, if Turkey decides to take a defensive position and moves to cooperate with Russia instead, Russia retains the initiative and Germany is locked into Russian-controlled energy for a generation.

Therefore, having sat through fruitless meetings with the Europeans, Obama chose not to cause a pointless confrontation with a Europe that is out of options. Instead, Obama completed his trip by going to Turkey to discuss what the treaty with Armenia means and to try to convince the Turks to play for high stakes by challenging Russia in the Caucasus, rather than playing Russia's junior partner.

This is why Obama's most important speech in Europe was his last one, following Turkey's emergence as a major player in NATO's political structure. In that speech, he sided with the Turks against Europe, and extracted some minor concessions from the Europeans on the process for considering Turkey's accession to the European Union. Why Turkey wants to be an EU member is not always obvious to us, but they do want membership. Obama is trying to show the Turks that he can deliver for them. He reiterated — if not laid it on even more heavily — all of this in his speech in Ankara. Obama laid out the U.S. position as one that recognized the tough geopolitical position Turkey is in and the leader that Turkey is becoming, and also recognized the commonalities between Washington and Ankara. This was exactly what Turkey wanted to hear.

The Caucasus is far from the only area to discuss. Talks will be held about blocking Iran in Iraq, U.S. relations with Syria and Syrian talks with Israel, and Central Asia, where both countries have interests. But the most important message to the Europeans will be that Europe is where you go for photo opportunities, but Turkey is where you go to do the business of geopolitics. It is unlikely that the Germans and French will get it. Their sense of what is happening in the world is utterly Eurocentric. But the Central Europeans, on the frontier with Russia and feeling quite put out by the German position on their banks, certainly do get it.

Obama gave the Europeans a pass for political reasons, and because arguing with the Europeans simply won't yield benefits. But the key to the trip is what he gets out of Turkey — and whether in his speech to the civilizations, he can draw some of the venom out of the Islamic world by showing alignment with the largest economy among Muslim states, Turkey.