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The State of the World: A Framework

February 23, 2012

Companies issue state of the enterprise addresses, and presidents issue state of the union addresses ... but you've got to be pretty confident to address the state of the world. Luckily for us, Stratfor founder and CEO George Friedman is just that confident – and it's well-deserved.

George is the expert in geopolitics, and his company is the best source out there for geopolitical analysis. Thus, his recent article, "The State of the World: A Framework," is well worth a thorough read. It identifies three distinct phenomena the world is facing: the European financial crisis, the Chinese export crisis, and Iran's rise to power in the Middle East.

One of his most interesting points, and one that I'm inclined to agree with, is that the most powerful country in the world – the United States – is currently unprepared to deal with this new reality. Something to keep in mind as we enter election season ...

Some of you may know that Stratfor was hacked several weeks ago. While they rebuild some infrastructure, they've got an open-house website – you can access the content that's usually only available to subscribers. You may want to take advantage of this opportunity by visiting www.stratfor.com before they lock up the house again. I particularly recommend their 2012 Annual Forecast.

Your wondering whether I'll have Greek, Chinese, or Iranian food tonight analyst,

John Mauldin, Editor
Outside the Box

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The State of the World: A Framework

February 21, 2012


Editor's Note: This is the first installment of a new series on the national strategies of today's global power and other regional powers. This installment establishes a framework for understanding the current state of the world.

The evolution of geopolitics is cyclical. Powers rise, fall and shift. Changes occur in every generation in an unending ballet. However, the period between 1989 and 1991 was unique in that a long cycle of human history spanning hundreds of years ended, and with it a shorter cycle also came to a close. The world is still reverberating from the events of that period.

On Dec. 25, 1991, an epoch ended. On that day the Soviet Union collapsed, and for the first time in almost 500 years no European power was a global power, meaning no European state integrated economic, military and political power on a global scale. What began in 1492 with Europe smashing its way into the world and creating a global imperial system had ended. For five centuries, one European power or another had dominated the world, whether Portugal, Spain, France, England or the Soviet Union. Even the lesser European powers at the time had some degree of global influence.

After 1991 the only global power left was the United States, which produced about 25 percent of the world's gross domestic product (GDP) each year and dominated the oceans. Never before had the United States been the dominant global power. Prior to World War II, American power had been growing from its place at the margins of the international system, but it was emerging on a multipolar stage. After World War II, it found itself in a bipolar world, facing off with the Soviet Union in a struggle in which American victory was hardly a foregone conclusion.

The United States has been the unchallenged global power for 20 years, but its ascendancy has left it off-balance for most of this time, and imbalance has been the fundamental characteristic of the global system in the past generation. Unprepared institutionally or psychologically for its position, the United States has swung from an excessive optimism in the 1990s that held that significant conflict was at an end to the wars against militant Islam after 9/11, wars that the United States could not avoid but also could not integrate into a multilayered global strategy. When the only global power becomes obsessed with a single region, the entire world is unbalanced. Imbalance remains the defining characteristic of the global system today.

While the collapse of the Soviet Union ended the European epoch, it also was the end of the era that began in 1945, and it was accompanied by a cluster of events that tend to accompany generational shifts. The 1989-1991 period marked the end of the Japanese economic miracle, the first time the world had marveled at an Asian power's sustained growth rate as the same power's financial system crumbled. The end of the Japanese miracle and the economic problem of integrating East and West Germany both changed the way the global economy worked. The 1991 Maastricht Treaty set the stage for Europe's attempt at integration and was the framework for Europe in the post-Cold War world. Tiananmen Square set the course for China in the next 20 years and was the Chinese answer to a collapsing Soviet empire. It created a structure that allowed for economic development but assured the dominance of the Communist Party. Saddam Hussein's invasion of Kuwait was designed to change the balance of power in the Persian Gulf after the Iraq-Iran war and tested the United States' willingness to go to war after the Cold War.

In 1989-1991 the world changed the way it worked, whether measured in centuries or generations. It was an extraordinary period whose significance is only now emerging. It locked into place a long-term changing of the guard, where North America replaced Europe as the center of the international system. But generations come and go, and we are now in the middle of the first generational shift since the collapse of the European powers, a shift that began in 2008 but is only now working itself out in detail.

What happened in 2008 was one of the financial panics that the global capitalist system periodically suffers. As is frequently the case, these panics first generate political crises within nations, followed by changes in the relations among nations. Of these changes, three in particular are of importance, two of which are directly linked to the 2008 crisis. The first is the European financial crisis and its transformation into a political crisis. The second is the Chinese export crisis and its consequences. The third, indirectly linked to 2008, is the shift in the balance of power in the Middle East in favor of Iran.

The European Crisis

The European crisis represents the single most significant event that followed from the financial collapse of 2008. The vision of the European Union was that an institution that would bind France and Germany together would make the wars that had raged in Europe since 1871 impossible. The vision also assumed that economic integration would both join France and Germany together and create the foundations of a prosperous Europe. Within the context of Maastricht as it evolved, the European vision assumed that the European Union would become a way to democratize and integrate the former Communist countries of Eastern Europe into a single framework.

However, embedded in the idea of the European Union was the idea that Europe could at some point transcend nationalism and emerge as a United States of Europe, a single political federation with a constitution and a unified foreign and domestic policy. It would move from a free trade zone to a unified economic system to a single currency and then to further political integration built around the European Parliament, allowing Europe to emerge as a single country.

Long before this happened, of course, people began to speak of Europe as if it were a single entity. Regardless of the modesty of formal proposals, there was a powerful vision of an integrated European polity. There were two foundations for it. One was the apparent economic and social benefits of a united Europe. The other was that this was the only way that Europe could make its influence felt in the international system. Individually, the European states were not global players, but collectively they had the ability to become just that. In the post-Cold War world, where the United States was the sole and unfettered global power, this was an attractive opportunity.

The European vision was smashed in the aftermath of 2008, when the fundamental instability of the European experiment revealed itself. That vision was built around Germany, the world's second-largest exporter, but Europe's periphery remained too weak to weather the crisis. It was not so much this particular crisis; Europe was not built to withstand any financial crisis. Sooner or later one would come and the unity of Europe would be severely strained as each nation, driven by different economic and social realities, maneuvered in its own interest rather than in the interest of Europe.

There is no question that the Europe of 2012 operates in a very different way than it did in 2007. There is an expectation in some parts that Europe will, in due course, return to its old post-Cold War state, but that is unlikely. The underlying contradictions of the European enterprise are now revealed, and while some European entity will likely survive, it probably will not resemble the Europe envisioned by Maastricht, let alone the grander visions of a United States of Europe. Thus, the only potential counterweight to the United States will not emerge in this generation.

China and the Asian Model

China was similarly struck by the 2008 crisis. Apart from the inevitably cyclical nature of all economies, the Asian model, as seen in Japan and then in 1997 in East and Southeast Asia, provides for prolonged growth followed by profound financial dislocation. Indeed, growth rates do not indicate economic health. Just as it was for Europe, the 2008 financial crisis was the trigger for China.

China's core problem is that more than a billion people live in households earning less than $6 a day, and the majority of those earn less than $3 a day. Social tensions aside, the economic consequence is that China's large industrial plant outstrips Chinese consumer demand. As a result, China must export. However, the recessions after 2008 cut heavily into China's exports, severely affecting GDP growth and threatening the stability of the political system. China confronted the problem with a massive surge in bank lending, driving new investment and supporting GDP growth but also fueling rampant inflation. Inflation created upward pressure on labor costs until China began to lose its main competitive advantage over other countries.

For a generation, Chinese growth has been the engine of the global economic system, just as Japan was in the previous generation. China is not collapsing any more than Japan did. However, it is changing its behavior, and with it the behavior of the international system.

Looking Ahead

If we look at the international system as having three major economic engines, two of them -- Europe and China -- are changing their behavior to be less assertive and less influential in the international system. The events of 2008 did not create these changes; they merely triggered processes that revealed the underlying weaknesses of these two entities.

Somewhat outside the main processes of the international system, the Middle East is undergoing a fundamental shift in its balance of power. The driver in this is not the crisis of 2008 but the consequences of the U.S. wars in the region and their termination. With the U.S. withdrawal from Iraq, Iran has emerged as the major conventional power in the Persian Gulf and the major influence over Iraq. In addition, with the continued survival of the al Assad regime in Syria through the support of Iran, there is the potential for Iranian influence to stretch from western Afghanistan to the Mediterranean Sea. Even if the al Assad regime fell, Iran would still be well-positioned to assert its claims for primacy in the Persian Gulf.

Just as the processes unleashed in 1989-1991 defined the next 20 years, so, too, will the processes that are being generated now dominate the next generation. Still powerful but acutely off-balance in its domestic and foreign policies, the United States is confronting a changing world without yet having a clear understanding of how to deal with this world or, for that matter, how the shifts in the global system will affect it. For the United States strategically, the fragmentation of Europe, the transformation of global production in the wake of the Chinese economy's climax, and the dramatically increased power of Iran appear as abstract events not directly affecting the United States.

Each of these events will create dangers and opportunities for the United States that it is unprepared to manage. The fragmentation of Europe raises the question of the future of Germany and its relationship with Russia. The movement of production to low-wage countries will create booms in countries hitherto regarded as beyond help (as China was in 1980) and potential zones of instability created by rapid and uneven growth. And, of course, the idea that the Iranian issue can be managed through sanctions is a form of denial rather than a strategy.

Three major areas of the world are in flux: Europe, China and the Persian Gulf. Every country in the world will have to devise a strategy to deal with the new reality, just as 1989-1991 required new strategies. The most important country, the United States, had no strategy after 1991 and has no strategy today. This is the single most important reality of the world. Like the Spaniards, who, in the generation after Columbus' voyage, lacked a clear sense of the reality they had created, Americans have no clear sense of the world they find themselves in. This fact continues to define how the world works.

Therefore, we next turn to American strategy in the next 20 years and consider how it will reshape itself.

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Comments

Ned Bright

Feb. 27, 2012, 1:14 a.m.

George Friedman’s essay is a bold attempt to delineate the Big Picture, but it falls far short of its goal in my eyes.  Here is the picture I wish Mr. Friedman had painted.

The genie is showing signs of escaping the bottle.  The natives grow restless.  The Islamic nation which stretches from Casablanca to Karachi has heretofore been kept in handcuffs by local dictators, nearly all paid stooges of the West. The British and French exited the scene years ago leaving Uncle Sam to rule over a gaggle of far-flung provinces belonging to a decayed Western empire. Uncle is clearly losing his grip,

â??Unbalancedâ? when used to describe America’s exercise of its imperial role should read ‘disastrous’ in my opinion.

Why is Iran the dominant power in the Middle East as Mr. Friedman avers.  It is because the U.S. took out Saddam Hussein, thus removing a valuable counterweight to Iran. Saddam’s wars with Iran kept the Ayatollahs in check. Furthermore, Saddam, a Sunni was a natural friend of house of Saud.  Now, thanks to a misguided U.S. intervention, Shia hold the power in Iraq, while Iran, a Shia nation, now enjoys influence right up to Saudi Arabia’s borders.  Mr. Friedman does not seem to be aware of Israel’s nuclear warheads (estimated at 200.) Surely this fact (the source is an Israeli who spilled the beans to an British newspaper years ago. Mordechai Vanunu has spent the last 18 years or so in captivity in Israel.) must figure in the Mideast equation.

Another significant factor curiously missing from Mr. Friedman’s analysis of the Middle East is the petro-dollar.  The worth of the U.S. dollar, with no other backing, is effectively discovered in the market for oil; X-number of dollars equal one barrel of oil. The U.S. dollar is the world’s reserve currency very largely because virtually all oil is traded in dollars.  Despite lip service given to a â??strong dollar’, the dollar is in a secular downtrend reflecting the low interest rates, the quantitative easing, and the large deficits—the New Normal in the States. Consistent dollar weakness and a corresponding higher, dollar-denominated oil price has prompted China and India, for example, to buy oil from Iran and Venezuela in their own currencies.  This shift is of more than casual interest because it threatens the status of the dollar as the world’s reserve currency and equally the considerable privileges which go with it, particularly the privilege of printing money without limit.  â??Its our currency, and it’s your problem.â?  Perhaps not any more.

There is excess credit/debt in China and subsequently a rampant inflation in the country as Mr. Friedman notes.  The inflation is in considerable part imported from the U.S. . Chinese exporters must convert dollar payments to yuan and the Chinese central bank must print more yuan to satisfy this demand.  Yes, the Chinese are carrying a lot of debt, but given China’s growth rate and its trillions of foreign reserves, the Chinese are well able to carry and eventually retire that debt in my opinion.  Additionally they have a large population, the majority of which have yet to get hold of their first credit card.  This puts paid, I think, to the argument that China cannot suffer a contraction in its global export market.

American commentators are too busy, in my view, painting pictures of doom and gloom as respects the EU and China, when they should be studying the ground under their feet.

Even the dogs in the street know that the U.S. economy runs on CHEAP oil from the Middle East just as it runs on cheap food grown at home and cheap hardware from Asia.  Surprisingly those in charge in Washington know this too.  Unlike some however, those who have their hands on the levers want to perpetuate this sorry situation which (1) has made American dependent on oil imports, which (2) has pegged the dollar to the price of petroleum (the ‘petrodollar’), which (3) has caused the rundown of our industrial capacity and the jobs and export earnings which went with it, which (4) has created a corn-fed, obese, diabetic populace and fattened many a fat-cat farmer with subsidies, which (5) has put the country at the mercy of Chinese creditors who are patiently arranging to depose the dollar from its throne and strip the U.S. Treasury of the considerable privileges which go with the unlimited printing of the reserve currency of the world.
I wish that that American commentators, advisers, and policy makers saw the Big Picture, and not ‘as through a glass darkly’, as they say.

DICK CHATFIELD

Feb. 25, 2012, 5:47 a.m.

The collapse of the Soviet Union did indeed present us with unique world leadership opportunities. We surely seem to have “bobbled” the ball with respect to world leadership in ANY arena except militarism. My query is this—-Can we expect to achieve consistent policies with a political system that re-invents itself every 2 and 4 years?  (My first post-go easy on me)

Bill Bowman

Feb. 24, 2012, 1:21 a.m.

The complexity is overwhelming ... To define the forces that will lead to a successful investment strategy will require hours of thoughtful analysis that is beyond the skills of any one person working alone ... I am pleased to be part of this community ... Bill Bowman