Monday, July 19, 2010

Geopolitics (Part 1) - by Ari Paul

In this issue:
1) What is Geopolitics?
2) Expect the Absurd
3) Key Trends
4) US Domination
5) The Cold Skirmish

Politicians come and go, economies boom and bust, but geopolitics helps us see the forest for the trees. In this newsletter I'll provide an introduction to geopolitics and explore the key trends that defined the 20th century and will define the 21st. I'll argue that the US' global military and economic dominance will continue to grow over the next 30 years. Next, I'll examine the current "Cold Skirmish" with Russia, similar to the Cold War but more limited in scope. In Part 2, I'll explore the (potential) political disintegration of China, the rise of Turkey and Poland, and how demographic trends will lead to a reversal of immigration politics and kill off "traditional family values" for good.
Much of this newsletter is inspired by George Friedman's, "The Next 100 Years." Friedman is the CEO of Stratfor and he provides keen strategic insight.

1. What is Geopolitics?
Geopolitics is the study of...
the effects of economic geography on the powers of states.
how countries make choices.
patterns of behavior, and understanding why patterns repeat.
the world as a giant chessboard. Like pieces in a chess game, countries can't move at will, rather, they have a small range of reasonable choices.

Geopolitics is a way of describing the world that emphasizes military and economic power and sovereign states as rational actors. Both military and economic power are directly influenced by geography (e.g. defensible borders and access to shipping lanes), demography (e.g. availability of labor), and culture (e.g. xenophobia and tolerance of war casualties).
Many people were surprised that Obama has followed a nearly identical foreign policy to his predecessor, President Bush. A student of geopolitics understands that political leaders have little real power when it comes to foreign policy; they are constrained by the interests of their country, which dramatically reduces their available options.

I probably need to defend one claim in greater detail. Does military power really matter that much today? The US Navy is larger than the next six navies combined; are we wasting our money? The short answer is no. As Americans, we've been relatively immune from war on our soil for two centuries. We occupy land that is hard to attack and impossible to successfully occupy. More recently, our dominant military has extended an umbrella of peace over most of Europe (via NATO), to Taiwan, Japan, South Korea, and many other allies. Nations that were weak militarily and not under our umbrella of protection have not faired so well. In 2008, Russia attacked Georgia. Ask a Tibetan or Chechnyan if military power matters. Humanity is no more "enlightened" today than on the eve of the First and Second World Wars. Nations reasonably believe that without sufficient military power, their national security is at risk.
Military power is about the projection of force. During the Cold War, Russia had a powerful army but lacked the ability to transport it; as a result, the US was unable to conquer Russia but could easily contain it by controlling major ports. The US Navy currently controls every major ocean and sea around the world. Every shipping vessel that leaves a port anywhere in the world does so with US knowledge and tacit permission. Our dominance of the oceans gives us dominance of the air via aircraft carriers. This means that the US, and only the US, is capable of waging a major war across continents.
National defense is quite a bit easier than the projection of force. An airplane can easily cross mountain ranges, but tanks and troops cannot. Natural boundaries like mountain ranges, seas, and jungles remain near-impassable obstacles for armies. Many wars are fought to gain control of natural boundaries so that a country can be safer from invasion (e.g. Russia in the Caucasus)

2. Expect the Absurd
In 1900, the Russian Empire, German Empire, and Ottoman Empire, were powerful players on the world stage. Many European elites believed that war in Europe was impossible because of the interdependent economies. Just 20 years later, Europe faced a devastating world war and the three great empires lay in ruins.
In World War II, Germany and Japan were decimated and their economies obliterated. Just 35 years later they were the 2nd and 3rd largest economies in the world.
Think of 1980. The mighty US had been defeated by communist North Vietnam. The Soviet Union threatened world domination. By 2000, the Soviet Union had collapsed completely and NATO had even expanded into Eastern Europe. "Communist" China was one of the
These examples should demonstrate that the big problems of the day are frequently irrelevant in 20 years. Empires can rise and fall with staggering speed. Most importantly, the consensus can be very wrong.

3. Key Trends
If the big issues of the day often ending up being irrelevant, to what should we pay attention? We need to identify the handful of new trends that will provoke global change. Once we have identified the trends, we can estimate their effects by applying a geopolitical lens to understand how nations will react to changing circumstances. Before I start, let me again give credit to George Friedman who provided many of these ideas.

In the 20th century, the three key themes were:
1. The quadrupling of the world's population. Agricultural technology and transportation infrastructure increased food production and allowed food to be shipped great distances. Better medicine for young and old decreased infant mortality and increased life expectancy. The primary effect of the population boom was to cause tremendous global economic growth with cheap labor and a constantly growing number of consumers. As populations exploded, access to land and resources became more important.
2. The collapse of the European Imperial System. The birth of a modern Germany and Italy in the 19th century set the stage for power struggles in the 20th. As the UK, Spain, and France lost their empires and weakened, Germany and Italy sought greater power in Europe. The result was two world wars.
3. Technology. There was a transportation revolution in the first half of the 20th century, and a communications revolution in the second half. Technological advances allowed labor productivity to rise at tremendous rates. One effect of these technological revolutions were that Japan, with no natural resources and little land for population growth, became the second largest economy in the world.

Analyzing the past is relatively easy compared to predicting the future. So what are the Key Trends that will define the 21st century?
1. Complete US domination. I'll discuss this at length in the next section.
2. The End of the Population Boom. The global population quadrupled in the 20th century and will likely be unchanged in the 21st. More dramatically, the populations of Europe, Russia, and Japan are collapsing. A shrinking population produces huge problems. The most obvious is the issue of growing entitlements supported by fewer tax paying workers. However, another major dynamic is that aging retirees will continue consuming, but there will be far fewer laborers to produce. This generally results in labor inflation. The US will face a similar, but much milder demographic crunch. I'll explore the political and economic effects of this in my next newsletter.

4. US Domination
US geopolitical power is unprecedented in world history. As I discussed in the first section, the US has complete control over the oceans, which means it dominates the globe both militarily and economically. The global economic system is the US economic system. Only a handful of countries choose not to participate and things don't go well for them - take a look at North Korea.

Second, the US outperformed other developed nations for reasons that will continue to lead to its future outperformance. For the last 500 years, the Atlantic Ocean was the avenue of world trade. Trade between Europe and the rest of the western hemisphere defined most of global trade. Around 1980, transpacific trade surpassed transatlantic trade. North America is ideally situated to profit from both transatlantic and transpacific trade. The fastest growing nations are in Asia today so Pacific trade is likely to continue growing faster than Atlantic trade. This means that US growth will likely continue to outperform European growth. Another advantage we have is demographic. The USA remains underpopulated and with easy access to new immigrants from Mexico. In contrast, Japan is facing demographic collapse with no good solution.

Third, our sovereign debt levels are relatively low, compared to other large economies. The US is in better shape than most of the EU and Japan. As money flees those regions, it has to go somewhere. UK, Eurozone, and Japanese debt holders are likely to continue shifting their money into US bonds. In other words, even though our debt levels are high and rising, they are relatively attractive compared to most of the other biggest debt issuers around the world. We may look back on this global crisis as the final transition from a European centered world, to a North American centered world.

Fourth, the upstarts are not doing as well as people think. China's growth in the last decade is reminiscent of Japan's in the 1980s. They've been growing by keeping savings artificially high, interest rates artificially low, and using that cheap money to make artificially cheap loans to companies. Municipalities and banks are accumulating bad loans. It's impossible to come up with accurate estimates, but some smart analysts are guessing that 35% of Chinese GDP is bad debt that will be written off. I think China is likely to do quite well over the next 30 years, but their growth will slow considerably, and they fill face major setbacks like everyone else. In the shorter term, their credit bubble will burst and cause a recession. India's problems are of a different nature. India is one of the most unequal economies in the world, and that tends to produce serious political problems. They are facing double digit inflation. Their worst problem is a political culture of red tape. Starting a company in India is incredibly difficult. Lawsuits, both criminal and civil, routinely take a decade to make their way through the court system. A significant portion of Brazil's growth has come directly from exporting commodities to China. As Chinese demand for infrastructure building wanes, so will Brazil's growth rate.

The economic fate of countries will depend on their relationship with the US. If the US "blesses" a country with technology transfers and special terms of trade (e.g. Israel and Turkey), that country is likely to grow faster than its peers. Similarly, if the US decides to sanction a country (e.g. Iran), it will underperform.
Our position as sole global superpower means that other countries will continue to subsidize our interest rates by buying US bonds and holding US dollars. It also means that the US is likely to remain a breeding ground for international competitive companies.

5. The Cold Skirmish
It's easy to dismiss Russia as irrelevant today, but that would be a huge mistake. Russia has far more power than appears at first glance and they are using that power aggressively.

As the major natural gas exporter to Western Europe, Russia has the power of the pump and are using it to serve their geopolitical aims. In 2007, Russia turned off the Druhzba pipeline over a dispute with Belarus; that pipeline is a major supplier of crude oil to Germany. In 2009, Russia shut off a natural gas pipeline that supplied much of Western Europe in a dispute with Ukraine. By flexing its muscle, Russia demonstrated to Western Europe that they have the power that comes with being a primary source of natural resources, and they are willing to use that power aggressively to pursue geopolitical goals. Russia's control over European energy is a major reason why Europe just sat on the sidelines as Russia invaded Georgia in 2008.

Geographically, Russia is in terrible shape. The Soviet Union had excellent defensible borders. They had the Caucasus Mountains to the south, the Carpathian Mountains to the west, and large tracts of inhospitable land to the east. Now Russia is exposed on its southern and western flank. They're scared and they want to gain defensible borders as soon as possible.

In 2005, Ukraine was on track to join NATO. NATO arose to contain (and potentially go to war with) Russia. The Russians could not allow Ukraine, which shares a border with Russia, to join NATO. They used their intelligent services to politically infiltrate Ukraine and by 2006, NATO membership was off the table. By infiltrating Ukraine and maintaining control over Belarus, Russia mitigates its problem in the Carpathian Mountains to the west. To deal with the Caucasus exposure, Russia attacked Georgia and occupied Chechnya despite great cost.

Unlike in the Cold War, Russia is not competing with the US for global domination. Russia just wants defensible borders, which requires domination of central Eurasia. The flash point is likely to be the Baltics.
Latvia, Lithuania, and Estonia are too close for comfort, and they're NATO. If Russia threatens these countries (either with covert ops, a troop buildup, or barricading their imports/exports), will NATO react? Germany does not want to get involved in any kind of confrontation with Russia and they will feel safe with Poland as a buffer. If Germany blocks NATO action, NATO could dissolve. Alternatively, the US could find a political solution that allows it to pour money and defenses into the Baltic countries without explicitly calling on and perhaps fatally testing NATO support.

Geopolitics is just one lens, but it is a highly useful tool in trying to predict the future actions of countries. In the next installment, I'll apply the geopolitical lens to China, Turkey, Poland, and the Islamic world.

Your "Born in the USA" trader,

No comments:

Post a Comment