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George Friedman on the witching hour in China as a region from the Atlantic to the Pacific, and from the Arctic to the Indian Ocean, destabilises

George Friedman on the witching hour in China as a region from the Atlantic to the Pacific, and from the Arctic to the Indian Ocean, destabilises

By George Friedman*

The Chinese stock market fell dramatically last week. That sounds significant but it actually isn’t.

First, the Chinese stock market doesn’t serve the same function as Western markets. The equities that are sold there do not allow shareholders to control companies, nor are the underlying values of these companies correlated to the price of the stocks in any way. Second, the percentage of China’s wealth that flows through the markets is relatively small compared to the size of China’s economy. Market capitalization has little to do with value of Chinese companies. 

The really significant news last week related to China’s foreign reserves. The People’s Bank of China revealed on Jan. 7 that the country ended 2015 with less foreign reserves than it started the year with. It was the first time reserves shrank over the course of a year since 1992. In effect, China saw its first decline in reserves since the Chinese boom really got under way. The surprising part of this development is not the contraction, since that’s been going on for at least a year, but the fact that it was announced. And this announcement told us that China entered a new era in 2015 and is now in uncharted waters. 

There are more important implications stemming from the decline in reserves than the Chinese stock market’s panic. The government’s anxiety was shown by aggressive assertions of confidence, demands for greater discipline, and an intensification of arrests of Chinese officials, businessmen, and others. The government is worried and is clamping down. Indeed, it has been worried for several years, and President Xi Jinping has been trying to maintain social stability in the face of a sea change in China’s economy. Now, as he attempts to reform - and control - the People’s Liberation Army, which is the key to China’s regime, we are in the witching hour in China. Whether the regime can maintain stability in the country while it undergoes managed change is at issue.

Growing instability sweeping Asia, Europe & the Middle East

I wrote last week about China’s reality and strategy in anticipation of this sort of crisis. The task this week is to step back and take a look at the global reality. China is not the only nation in Eurasia facing social and political instability as a result of economic shifts. Almost all of Asia, with the major exception of India, is undergoing growing instability of different sorts. The Europeans are struggling to deal with massive economic and political divergences within the European Union. The Russians are simultaneously attempting to deal with an economic crisis stemming from declining oil prices, but rooted in their inability to use oil revenues to build a more robust economy. The Middle East is in political and military chaos, due to reasons ranging from US attempts at disengaging from the region to deep animosity between Shiite and Sunni Muslims. And Central Asian countries, caught between Russian and Chinese dysfunction and the lapping waters of Muslim discontent, are struggling to contain the resulting unrest. 

What we are seeing is a region - from the Atlantic to the Pacific, and from the Arctic to the Indian Ocean - destabilizing. Of the 7 billion souls alive today, 5 billion live in this region. In most of Eurasia, the realities that have been taken for granted for the past generation are no longer certain. There has been a belief in much of the region that, at some point, everything will go back to normal. It was assumed that China’s economy would flourish; that Europe would sort out its problems; that, without the US presence, conflicts in the Middle East would subside; and that Russia would, in due course, accommodate itself to its new liberal democratic principles. However, none of those things are going to happen. Instability, uncertainty, and increasingly impotent regimes trying to find their way out of the crises they have stumbled into, are the new normal.

The different parts of Eurasia will not experience the same type of crisis. China’s problems are not the Middle East’s, and the Middle East’s are not Europe’s, but these regional crises have a common cause and interact with each other, complicating them enormously. I wrote a recent article for Mauldin Economics about an emerging crisis for major exporting countries. I want to expand on this in order that we might understand the root cause of the Eurasian crisis - interdependence. Interdependence has been seen as a panacea for humanity’s problems. However, it solves problems, but also creates them. Its most important weakness is that a systemic failure in one region rapidly spreads to other regions. The attempts to solve problems in some nations also affect other countries. Therefore, a byproduct of an interdependent system actually turns into the most dangerous reality of all. This byproduct is conflict among nations, as they struggle to stabilize their own crises and are constrained by the behavior of other countries. The conflicts brought on by interdependence are the most dangerous because they breed the greatest desperation. 

The current Eurasian crisis began in 2008, a crisis that resulted in recessions that had a global impact. The United States and Europe reduced the amount they imported from around the world. China was in a particularly vulnerable position because its economy was heavily dependent on exports. It had been expanding dramatically for over a generation and, as ought to have been obvious, such an expansion was not eternally sustainable. By 2008, China was reaching the limits of its economic model. But as many do, China sought to extend the model, not so much out of greed, as out of fear of what slow growth might mean socially, in an extremely poor country. The Chinese sought to sustain the economy through various forms of subsidies that continued to support growth in GDP - although not at the same level as before - but pyramided the growing irrationalities of the economy. It was cushioned by its financial reserves, but that could last only so long.

China's bursting bubble

China’s economy has continued to slow. The last update from China’s official statistics agency reported 6.9 percent growth in the third quarter of 2015. I suspect, although can’t prove, that the real growth rate is substantially less than what Beijing claims. And to the extent that the growth was real, it was likely not very profitable. China has many competitors who sell the same products at a lower price. Because of this slowing growth, the amount of industrial commodities China could buy, from iron ore to oil, declined. As always, there was a failure of the markets to grasp that the Chinese economy was not going to return to the old normal, but that a new normal had been in place for several years and, therefore, the price of these commodities was irrationally high. The inability of markets to see what was obvious was critical over the past two years or so. But this is a normal feature of financial markets, which have a great deal of trouble identifying discontinuities. It is the true irrationality of markets, but a dangerous one to try to exploit. The market’s ability to delude itself collectively for extended periods of time is part of one of the fundamental realities of geopolitics: the interaction between economics, politics, and war, which is the place we all live our lives. And certainly where Eurasia is now. 

The illusion of China, which I once called the China Bubble, burst in 2014. I should emphasize that this was not the result of China’s economic shift. That had been going on for years. Rather, 2014 was when the markets realized that China’s downturn was now a permanent feature of the international system. Interestingly, the positive effects of lower oil prices on consumers were not trivial, but not nearly as significant as they would have been 30 years ago. Efficiencies and alternatives had decreased the importance of oil to consumers. But they did not decrease oil’s importance to producers. And, as important as the economic consequences of declining profits for mineral producers (it’s important to go beyond oil) have been, their political consequences have been critical. 

Last week, the son of the Saudi king said that Saudi Arabia was interested in selling part of the state-owned oil firm Saudi Aramco. The only reason to put this on the table is that the Saudis need money badly. The potential political consequences of the sale of Aramco are enormous. For decades before the 1970s, European and American interests had owned most of the region’s oil. This had been a sore point in the region; however, the Saudis and others changed this dynamic following the 1973 oil embargo. Nevertheless, the hostility toward the West in the Arab world has increased and, more importantly, the two groups are fighting a war in the region. For the Saudis, at any moment… but particularly at this moment, to raise the possibility of selling part of Saudi Arabia’s oil resources (however small the amount) back to Western interests, represents the deep crisis that falling oil prices have created.  

Russia's woes

A similar problem exists for Russia. The Russians fumbled the Ukrainian crisis. They went from having a light but real control of all of Ukraine, to seeing the country governed by a pro-Western government, while Russia clings to Crimea and a small strip of support in the east. They were in the middle of confronting the West on this issue when the oil crisis hit. Oil revenues were a major component of Russia’s national budget and the driver of the economy. Their dramatic contraction led to a significant financial and economic crisis for which the Russians have no solution. There are many reasons for why they became more assertive in their foreign policy, but maintaining domestic confidence in the government is the key. The decline of oil prices and its impact on the economy will remind most Russians of the events prior to the fall of the Soviet Union. By appearing to be a major player in Syria (Russia actually has deployed relatively few aircraft and fewer troops), the government has maintained its popularity in spite of the emerging hardships. 

The point here is that not only is Eurasia as a whole in crisis, but the crises in individual countries and regions are increasingly interacting. The Middle East crisis is interacting with Russia. It is also interacting with Europe, both in terms of the refugee crisis and European deployments in the Middle East. The refugee crisis - where an extra million people on a continent of about 700 million people is hardly overwhelming - has revealed deep fault lines within Europe over the question of borders. Borders are the single central issue of the European Union, and it was thought to have been settled. In addition, Europe’s ongoing inability to solve its economic malaise - and I don’t expect a solution for a long time - has intensified China’s problems. Europe was China’s largest customer. Also, the crisis in Ukraine has focused Poland and Romania on the perceived threat from the east, much to the indifference of the rest of Europe, but drawing in the United States as the guarantor of the eastern frontiers. And as mentioned, our forecasting model at Geopolitical Futures points to serious instability in Central Asia as a result of Russian, Chinese, and Middle Eastern problems. 

Disruption caused by interdependence

Trade is another potential source of disruption brought on by interdependence. Exports constitute about 23 percent of China’s GDP. They make up almost 50 percent of Germany’s GDP and 30 percent of Russia’s. In Saudi Arabia, it’s 52 percent. However, in Japan it’s 16 percent. And, in the United States, exports are only 13.5 percent of GDP and only about 8 percent is attributed to countries outside of NAFTA. When we look at the export levels, we are measuring a nation’s vulnerability to the international system. I would draw the boundary of excessive dependence on exports at about 20 percent of GDP. It is important to add that I evaluate the consequences of dependence, not so much in economic terms, but in their impact on social and political stability. High exporters are not necessarily unstable, but their risk is higher. 

Based on this, and looking only at a handful of major powers, we can see one - though not all - of the drivers of the crisis in Eurasia. We can also see why Japan, as economically hard-pressed as it may be, has not destabilized. In looking at the American numbers, and at the geography of its exports, it is also evident why the United States, which may have triggered 2008, has generally not suffered much of the social chaos. It is least exposed to what happens in Eurasia because it depends least on those markets. There are other reasons, of course, but it is important to bear these export numbers in mind. 

George Soros said this week that we are heading for a crisis similar to 2008. I disagree with him to this extent. First, the 2008 crisis never ended. It just merged with political, social, and military processes and became part of them. Second, the economic crisis, while there may be one, is trivial compared to the conflicts within Europe and along the European-Russian borders. It is trivial compared to the chaos in the Middle East and the economic dysfunction in China. Ultimately, the 2008 crisis never ended. Indeed, it defines the new Eurasia, a place where most human beings live, where stability is increasingly hard to find.

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*George Friedman is editor of This Week in Geopolitics at Mauldin Economics. This article first appeared here and is used with permission.

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6 Comments

What we are (now) seeing is a region -
From the Atlantic to the Pacific, and from the Arctic to the Indian Ocean - destabilizing

Typical US opinionated misdirection

Wonder what the Americano opinion-spruikers called the GFC - and who they held responsible

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I tend to agree..
not alot of substance in this artice..

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I agree too. A better balance of account is called for.

How's Chicago doing?

Borrowing to pay interest on previous IOU obligations Read more

History is not kind to the citizens and their politicians that manage Chicago and the state they are responsible for.

The bankers continue to make a fortune from taking advantage of the city's dire financial circumstances. Every time Chicago repays a massive loan only to take out a new one, the banks collect huge transaction fees--and impose ever-higher interest rates as the city's credit rating falls Read more

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Growing instability in Eurasia? Eurasia has clearly been destabilised by the USA with the willing help of NATO who it controls. They destabilised Ukraine by fomenting a coup there. Destabilised Libya and Syria by fomenting coups there and destabilised Europe with the resultant refugee hoards that have swamped European countries already in economic difficulty.
They attempted to destabilise Russia with sanctions, which had the reverse effect of impacting Europe more. Sanctions that stopped the French completing a very lucrative helicopter carrier deal with Russia but when the USA requires Russian rocket engines for its space program..... oh we can overlook those sanctions.
They prosecute French and German banks at the drop of a hat but completely neglect to meaningfully prosecute their own corrupt institutions
I guess if you are going to have a collapse of the American dollar it is important that Eurasia is taken down ahead of time because with Russian energy and German know-how they would be a very powerful geopolitical entity.
With friends like that who needs enemies.
These are the 'friends" the government wants us to voluntarily subjugate ourselves to under the TPPA.

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I rather like George Freidman's analysis. It took me a while to appreciate it as he looks at very uncomfortable subjects from the point of view of geopolitical stategy. His viewpoint is very much US based but it does give a good idea how the CIA and their equivalents think. Part of this is the importance of manipulation of the populace to see the world a particular way. The US, Russia, and China are extremely adept at this. To us it is offensive as we like to think the world is a nicer place than it really is. We are more civilised than most places and easily fall into the trap of thinking other regimes are reasonably decent too.

I find his analysis of export dependency fascinating as I have recently started to question the desirability of New Zealand's excessive reliance on exports. There is a lot to be said for the resilience that comes from a measure of self sufficiency in all things.

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Agree: Friedman not only 'writes for' various economic commentaries but founded Stratfor - a major non-governmental strategic forecasting agency. He currently heads up Geopolitical Futures. https://geopoliticalfutures.com/about/

His recent book 'Flashpoints' is an essential primer read for the Eastern Europe and ME tangles.
http://www.amazon.com/Flashpoints-Emerging-Crisis-George-Friedman/dp/03…

So the opinions of local common taters need to be read with that deep background in mind.....and weighted accordingly.

Essential reads are Geopolitical Futures' 'Reality Checks'. https://geopoliticalfutures.com/tag/reality-check/

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