September 2, 2015; Dr. George Friedman: Strategic Forecast

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“In the Pacific there is always a great low-wage, high-growth economy. It was the Japanese back in the 1980s. It has been the Chinese – that period is over. The cost of Chinese labor has gone up dramatically, so the period when they were able to really overwhelm the markets with localized goods is pretty much over.”

– George Friedman

Kevin: Our guest today is Dr. George Friedman. You have had him on a number of times, Dave, and I think your main motivation – correct me if I am wrong – is that the news sometimes can get cumbersome when you are looking on a daily, weekly or monthly basis. But Dr. Friedman is a man who has said, “We’re going to look at the next ten years. We’re going to look at the next 100 years.” And somehow that birds-eye view gives a different perspective to the whole world.

David: I think that is the word that I come back around to – perspective. When you are looking at financial issues you need to have a perspective which is not entirely financial, but is informed, and a fairly well-rounded approach to the information that is in front of you and how you best understand it. George is the founder of Stratfor which is a global intelligence and advisory firm out of Austin, Texas. And their niche, what they try to do, is open source intelligence analysis, and they provide that to the private market.

So I would encourage anyone who is interested to go to their website and subscribe. Looking at their geopolitical analysis, looking at their forecasting, I think, is very, very helpful, whether you are a public policy wonk or someone who is interested in Wall Street type issues, or just generally curious about the world that we live in and current events as they are unfolding.

The way that you find things reported in normal news media outlets is generally limited to a few factoids and an occasional random and often inaccurate analysis, and I think what you find with Friedman and his whole group that we have had Kamran Bokhari, others on his team, to look at Turkey and other issues, you find depth of analysis that is very, very refreshing.

Kevin: And it is actually pointing out the power differences in the world. We have all played Risk. That is a game from our past. But I have several chess books that I really like to look at because they don’t look at the board piece by piece, they look at it power by power, and how various portions of the board change, and it actually uses other pieces in other parts of the board to change the power structure of the board. In other words, you are looking at maybe two or three large segments of the board rather than just square by square. He looks at Russia and he says, what kind of power is Russia exerting? The Middle East – where are they coming apart and where are they coming together? The United States – what is the overall long-term strategy? You and I can’t sit in the dark rooms of the Pentagon and say, “Okay, we need to look at the United States’ strategy for 50 years, not for 50 days.”

*     *   *

David: Dr. Friedman, I want to cover a lot of ground with you today. Among your many talents is being able to condense the world and take the macro to the micro and then come right back to the macro, and you do that very, very well. You’ve done that in your books, The Next Decade, The Next 100 Years, and of course, in your daily intelligence briefs and weekly intelligence briefs there with Stratfor global intelligence. Would love to allocate our time as wisely as possible today and look at the Middle East, look at the eurozone, look at Russia, and then just briefly skip over to Asia for some of the high points of things that you see developing there.

We appreciate, I think, your strategic insights and again, when we consider Stratfor, we consider you sort of the aerial guys, taking flight and looking down and being able to see things that other people may not be connecting. And so, starting with the Middle East, we have what really has been changing face in the Middle East after a 300-year decline in the scope and scale of the Islamic world following the failed attempt to capture Vienna. It appears that Islam is now moving the other direction, in resurgence. Can you explore the shift from the secular states of the last 100 years in the Middle East, to the re-embrace of Islam, and in some circles, even a desire for the caliphate?

George: I think where we begin is by pointing out that the nation states that we had in the last 100 years were artificial inventions of the British and French. They had no over-arching authority. And now as we see in Iraq, and now as we see in Syria, and yet in other parts of the world, they are collapsing. Without European Imperialism, there is nothing holding them together.

At the same time, we have to remember that what is emerging is a civil war in the Islamic world, a civil war primarily between Sunnis and Shi’ites, but also between various tribes and factions, between Arabs and non-Arabs, the Iranians, the Turks, and so on. We have a very complex and chaotic situation. I don’t think we are ready to talk about the rise of Islam because what we have here is an ongoing stalemate between these factions and complete chaos.

So, while the European nation states have collapsed, nothing else has really emerged to replace them. And it is really questionable whether or not the Islamic disease, which really has been in place since very early in Islamic history, of the inability to form a kind of universal state, to build a caliphate that is more than just a regional power where that is not still in place now, and frankly at this point the caliphate is just a word they use, not a reality.

David: Let’s look at Saudi Arabia. It is one of those nation states. Based on their oil revenues they have a bit more backbone and staying power, perhaps, and this gets to maybe the crux. How do they maintain internal stability?

George: They maintain internal stability in two ways. First, the royal family is not a small group of people, it is a vast tribe, the Sauds, and whatever squabbles they have internally, they all have an interest in maintaining the state. And secondly, they have a great deal of money which they use very wisely to build political support, and they can withstand low oil prices substantially better than other people can. And so, they have survived many prior attempts.

And remember, the Islamic State, which at this moment happens to be the most fearsome thing in the Islamic world, is Sunni, and so are the Saudis. The Saudis are at war, at least ideologically, with Iran. The Islamic State is at war, ideologically, with Iran. There are arrangements that could be made. So, in a very complex world the Saudis have always been in a difficult position, and it is really no more difficult than some of the other things they have experienced.

David: We have the agreements that are coming together with Iran and the Saudis have been against that. Of course, Israel has been against that. Perhaps you could touch on Iran and sort of a shift in the balance of regional power, if we are moving toward sort of a post-sanction era.

George: I think what we have to really do is back off and take a look at what the United States has done. We are the global power this time around. The United States attempted to reshape the Middle East through direct force, particularly in Iraq. It failed. It has made the decision that it is not going to be able to do next time what it couldn’t do this time. And therefore it has adopted a very new strategy, a strategy of maintaining a balance of power in the region.

There are four great regional powers – Saudi Arabia, Israel, Turkey, and Iran. None of them like each other. Particularly, none of them trust each other. Each have different historical roots. The American strategy is primarily to shift support as needed from power to power in order to maintain a balance of power, and also in order to create the kind of order that they would like to see in places like Iraq. At this point, the only power that is facing the Islamic State is Iran. The United States is collaborating with Iran to carry out air strikes while the Iranians are maintaining advisors, and more, with Iraqi troops. So, the American strategy is, instead of attempting directly to control the region, using proxies, including proxies we don’t like very much, pitting them against each other and forcing them into alliances.

So, we see strange things happening. We see the Israelis getting quite close to the Saudis. Both of them are afraid of the agreements that the U.S. has made with Iran, not particularly about the nuclear question. That, they talk about, but they are really afraid the United States is no longer simply wedded to them. With Israel there has developed a significant strain in relations over many issues, but the Saudis also regard the U.S. as the guarantor of their position. Now they are not certain. That means they take more of the burden on themselves of securing their national interests, and it is not something the United States is very unhappy about.

So, given the American shift, we see an entirely new dynamic in place already in the region, of which the Islamic state is only minor, and very frankly, the nuclear question has sort of become far less significant than it was. I have never felt that the Iranians were seriously developing nuclear weapons – that would have been too dangerous. But at this point a hostile relationship with Iran would threaten the future of Iraq, the future of Syria, and that really isn’t something the United States can afford. So, for those people who want to separate out the nuclear issue from every other issue, Iran is not about to allow that to happen, and we don’t want Iran to lose interest in things we want them to be involved in.

David: I want to come to Turkey and Syria in just a minute, but it seems, and perhaps you could comment on, the fiscal impact in Russia, post sanctions for Iran, we are going to assume that we have a certain amount of oil production coming back online. We are already in an over-supplied situation globally, with prices fairly depressed relative to a few years ago and clearly, under what the Russians need to pay for the state. What damages do you think we might see? And is it in the Russian interest to perhaps continue to stoke the flames of distrust between the U.S. and Iran out of self-interest?

George: Well, the Russians right now are over-extended, not just economically, but politically. They have been unable to gain leverage in the Ukraine, which is an area of fundamental national interest to them. And they have been trying to separate out the Ukraine issue from other issues they have in the United States. By all accounts, American and Russian, the Russians were instrumental in getting this treaty settled with the Iranians. They are not prepared for an all out conflict.

As to Iranian oil, yes they have oil, their oil fields are in poor repair, they are pumping far less than they can. It is going to be several years, at the very least, before they become the kind of exporting power they were before. Affecting the oil prices, far more important, is the decline of the Chinese and the European economies. Demand for oil is stagnating. Supply for oil – you are not looking at the Iranians nearly as much as the United States. So I would argue, on the oil issue, Iran is a fairly minor issue. It is not really going to change the dynamic.

Of course, the Russians must have higher prices to about $60, and that is about the least they can manage. Below that they really start running into trouble. But Russia’s ultimate problem is that it depends on the price of oil. It doesn’t control the price of oil, and therefore it can’t predict what its condition is going to be.

David: So then, with Turkey, there are two elements that I would like you to comment on. One is the Justice and Development Party, facing a different environment after the last election, and being under pressure, not having quite the solid power that they have had for close to a decade. And secondly, this issue of the Russian pipeline coming through Turkey. What does that do to change Turkey’s role as you described it in those four powers within the Middle East – Saudi Arabia, Israel, Iran, and Turkey? Does that pipeline factor in, at all, in terms of a raising of their profile?

George: Well, Turkey is by far the most powerful country in the region. It has the largest economy of any Islamic country in the world except for Indonesia. It has an army of a million people. It doesn’t have energy, but it is a strategic point where pipelines have to cross. So, it is a fairly important country, and it is also an enigmatic country right now. There are many, many strange rumors that go around in the Middle East. One is that the Turks are actually supporting the Islamic State. That probably is true for some Turks, but not for the government.

But most important, the Turks have crises all around them. They have a crisis in the northwest, where the U.S. is deploying supplies, at least, forces as well, probably, in Romania. They have a crisis in the Caucasus that starts with the Kurds and then stretches far beyond it. And then they have chaos themselves. The Turks have tried, as far as possible, to stay out of direct involvement, and I think they are going to continue it.

Because what you really see in Turkey is an attempt by Turkey to identify who it is. There is a huge secular – militantly secular – group. There is a moderate to more extreme Islamic group, and somehow or another there is an attempt to create a nation. The secularists have never been very good at being inclusive to the Muslims. Erdogan and the AKP, his party, have tried, probably going slightly the other way. So this is a country that has an internal identity crisis, simultaneously with a series of regional crises all around it. And for that, it is doing fairly well.

As to who will hold the power, or what personalities, that is going to be unpredictable. But it is going to be Turkey that is going to be the critical power that will assert itself when it is time to settle things down. Whenever there has been a large Islamic state, for many hundreds of years, it has been led by Turkey, and Turkey is not quite prepared to make its play yet, but we should watch it.

David: You would watch Turkey more than you would the emerging non-state actors such as the Islamic State, with their stated intention of creating a caliphate? As you said earlier, perhaps that is just a word.

George: It is a particularly brutal organization that behaves brutally in order to draw attention to it. It is also surrounded by mortal enemies, not just the Assad machine, but the Saudis. Certainly the Iranians loathe them. The Americans loathe them. This is what I call the Lebanonization of the region. Lebanon, in the 1970s, fell into a civil war that went on for well over a decade. That meant the government disappeared and what really ruled the country was warlords. The warlords were divided by religion, and sometimes the religions were divided by Christian against Christian, Shi’ite against Shi’ite.

It was a complex thing. No one could win, and really no one could lose. Everybody was strong enough to survive. No one was strong enough to impose their will, and for a very long time this went on. What happened in Lebanon has now spread to Syria, and it has spread to Iraq. The states are gone. Assad, in Syria, is just a warlord. He is not in control of the country. He is too strong to be overwhelmed, too weak to impose his will, and the same goes for the Islamic state. They can’t be overwhelmed, and there are severe limits on their power.

David: As we segue to a conversation on Europe, I want to point out this year’s publishing of Flashpoints: The Emerging Crisis in Europe. And perhaps you could tell us a little bit about your views on the immigration issues from Islamic countries to Europe, and how you think that might shape policy in the eurozone over the next few years.

George: Well, you have to begin by remembering that it was the Europeans that, beginning in the 1950s, urgently invited the Muslims in. They had a labor shortage and they developed programs for bringing in the workers. They also developed a policy called multiculturalism. Multiculturalism sounds very reasonable and liberal and respectful, but what it really meant was, yes you can be here in Germany, or you can be here in Italy, but you are really not part of the main German culture, you are separate, you have your own.

Part of it was, we respect you having your own culture, and part of it was, we don’t want you as part of ours. And so, what really happened there in Europe was, they took a large – not as large as people think, but substantial – movement of Muslims from the Middle East and Turkey, brought them in because they needed them, then segregated them so that their isolation in the country intensified it. Now they are facing another diaspora from the chaos in the Middle East, the chaos in East Africa, people trying desperately to get in, because they really have nowhere else to go.

And at this point, the European view is that they really have enough, they don’t want any more, and they are caught in a very interesting humanitarian crisis, which is that Europe has always been kind of the nanny of the world, scolding others for their lack of sensitivity, their lack of commitment to curing the ills of the world, and now they are forcing people to not come into their country who very desperately need to.

On the other hand, the mood in Europe is intensely anti-Muslim. That is partly driven by economics. Europe is doing much more poorly and they don’t want competition for labor. It is partly driven by the terrorist attacks. But it is also driven by a desire by the Europeans for sovereignty. They feel they don’t control their internal borders, and countries like Denmark have proposed going beyond the European Union to saying, “Okay, we’re in the union as a trade zone, but we get to determine who comes in and who doesn’t,” which is a radical proposal for the EU, and we see those kinds of movements and a sense that they are losing control of their countries.

So, there are a lot of forces converging. It is a very confusing situation. But the one truth is that the Europeans are not about to be overwhelmed by the presence of Muslims. It is in the low double-digits in most countries, below that in others. But there is a sense that they are losing control of their country. It is interesting to watch how they respond.

David: The monetary arrangement that was launched years ago was primarily between Germany and France. Of course, you can start cutting and pasting on the smaller participants, but some have viewed this as the Frankenstein arrangement between Germany and France and then all the peripheral countries. Let’s look at this a little bit. We have the European Monetary Union participation and the consternation over what is a flashpoint right now – a Greek bailout and the participation of other eurozone members. Maybe you can give us your perspective. The eurozone was cobbled together on the basis of monetary union. It was never fiscal or political, purely, and now things are not going quite so well. Where do you see the eurozone going over the next three to five years?

George: First, I have to say that it was a political concept. The idea was that if they banded together in a monetary union they would come that much closer to forming a European federation. But the idea, itself, was extremely poorly conceived. A currency is a tool for a country to manage its trade relations with other countries. In the case of the European Union that was piled on top of the free trade zone where there were no controls on trade, but more importantly, it took countries that had nothing in common and gave them the same currency, so that when Greece fell into problems they couldn’t do what most countries would do in the situation, devalue their currency, or have their currency fall.

So, there is a comparison – the Eastern European countries wound up in a terrifically difficult position many years ago. They were not part of the eurozone, and they simply devalued their currency and they got through it. So, the basic idea of the European Union was a political entity that would bind Europe together. In fact, it crippled many of them. I should also point out that, while it is absolutely true that France and Germany represented the core relationship of Europe, there has been a bit of a falling out between France and Germany. They have very different views of how to handle the crisis in Greece.

So, I see the situation developing very badly. I don’t see how we don’t wind up, not only with defections from the eurozone, but also from the free trade zone, because we have to remember something. The free trade zone has, as its largest exporter, Germany – it exports 53% of its GDP. Over half of its GDP comes from exports to other countries. It is very efficient at it, it is very good at it, there is no reason why they shouldn’t do it, but their economy is twice the size of what their domestic consumption can maintain. And Germany wants to hold on to that free trade zone desperately.

Countries like Greece, and other countries like Italy, Spain, the Eastern European countries – they can’t manage to develop in the face of this avalanche of exports. And so, there is huge tension developing now between Germany and many other countries, and you have heard some extreme statements made by the Germans, you have heard some extreme statements made by the Greeks, and others. And I see the European Union at least redefining itself, if not fragmenting, over the next four to five years.

David: You have the Germans who want to hold on to the trade union. In individual countries there is a rising trend toward populism, and as you pointed out, devaluation, and having currency as a tool to devalue under difficult times, or to manage and increase trade. That has been the go-to in the past. Unfortunately, none of these countries have it. So, how do individual countries deal with national politics and a rise of populism without the tool of devaluation?

George: Well, without the tool of devaluation it is very difficult. You can see what Hungary did, as an example. Many of its citizens had taken out loans, denominated in euros, in yen, what have you. Hungarians ran into trouble, and they devalued their currency, the forint, and their people couldn’t pay their loans. Well, this became a national government policy. The Hungarian government said, “Look, these loans were given out by Swiss banks and Italian banks and German banks, and what have you. But we’re going to repay these loans in forints, and we’re going to pay them 60 cents on the dollar, or we’re not going to give you anything at all. Why don’t you think it over and call me in the morning?” Well, no one complained, they took what they could. By retaining their currency, they could not only devaluate, but they could also negotiate very effectively with lenders.

Now, remember, it is not unusual that a corporation that has loans that have been given it, and can’t quite repay, to renegotiate some restructures. Governments don’t have the laws of bankruptcy to do this, but they do it as well. There is a moral dimension of this that has to be remembered. We all accept the principle that the borrower is responsible for borrowing properly, but there is another one – the lender is consciously taking a risk, and it is up to him to determine whether the risk is prudent.

So, when you have your own currency, and when you have a government that is prepared to intervene to protect its citizens, to negotiate on their behalf, in effect, you wind up in the situation that Hungary came out of, and they are managing the situation quite well. When you don’t have a currency, and when your creditors can demand virtually any sacrifice, and you are not able to print money and pay them back in cheaper money, or what have you, then you get Greece. So, what has happened in Greece, and what happened in Hungary, is a lesson to other small countries. And certainly, the British are congratulating themselves for not getting involved in the euro.

David: Well, as we transition toward our conversation and the topic of Russia, we have the Greek situation very much involved in this, a NATO member representing something of the Eastern flank of NATO, and maybe you can discuss Greece in a larger context, that of Russia and border sensitivity, if you will, as NATO has continued to expand eastward and sort of encroach upon the lands of the old Soviet Union, creating something of an internal instability, or unconscious concern.

George: From the Russian point of view it is very conscious. They see what they regard as primarily an American attempt to create a client state in Ukraine. The Russian view is there would be no reason for the Americans to create this client state except that they are trying to do to the Russian Federation what happened to the Soviet Union – dismantle it. The U.S. may have those intentions, or may not have those intentions, but the Russians can’t afford to assume not.

The Russians are in a fairly weak situation. They have done very badly in the Ukraine. Their intelligence service failed to predict what happened in Kiev. Their intelligence service failed, really, to break the back of the Ukrainian fighters in the southeast, or to have an uprising. This has been a net disastrous loss. People talk about the invasion of Crimea. This was a major Russian base. There was no need, for all it was was an assertion of power.

Now, at the same time, the United States has made the decision that it is going to defend Eastern Europe, what I still call Eastern Europe, a line from the Baltics to Poland to Romania, and hopefully Turkey, where this becomes quite important, and has moved command centers, is moving tanks, armor, prepositioning them there, has training going on. This is the line that they are facing.

And here is where Greece becomes important because this is the southern flank of the line. In 1948 this was the place where the Russians tried an insurgency that led to the Truman Doctrine. The Greeks have always been fairly close to the Soviets. There were a lot of Soviet intelligence agents and terrorists, and so on, moving through Athens a lot. The question here is not whether the Greeks would accept money from the Russians in exchange for allowing Russian ships to port in the Piraeus, to be present there, it is whether the Russians are prepared to spread this crisis. At the moment, the Russians are trying to tamp it down. They are not in position yet, they may be in two or three years, with their military, to confront the United States, and they seem to not want to engage too intensely.

In Eastern Europe where I visited recently, the concern about Greece and Russia is fairly intense. They feel that the Greek government is pretty much committed to the Russians. I think that overstates it, but that is the psychology. So, what I would argue here is how Greece is going to be treated by the Russians, after the Russians make a decision how far they are going to go confronting the United States. If they decide that they are going to confront more broadly, they will bail out at least part of Greece, but so far they have made no signs, and I am reading them as having decided they have lost this round in the Ukraine, they are going to prepare for the next round in a couple of years.

David: Let’s jump back across the pond to the U.S. and our energy policy as we are ramping up liquid natural gas here in the United States. Does this end up being one of our tools, sort of a counterweight to the dependency on Russian energy all throughout Europe? Do we end up coming at them again at yet one more level, that of energy security?

George: It could well be. But here is the problem. There is a lot of infrastructure that has to be built, pipelines in Europe, ships, and so on, to transport natural gas in the quantities required, to Europe. At the same time nobody really knows what the price of energy is going to be in two or three years. We have seen it go down to $40, and it bounced to $60 where it is holding now. But if American energy comes on the line in vast commercial quantities available, at a time when the global economy appears not to be headed to a strong recovery, you are going to plunge the price of oil.

So, it may be strategic, but it’s not really in the clear interest of American energy companies, shipping companies, investors, to assume the risk that the consequence of creating this strategic alternative won’t bankrupt them. The U.S. government is not going to get into the business of selling oil overseas. They’re not going to absorb the risk. So, that’s what is holding this up, which is, given that no one is really sure what kind of price they are going to get, and if they start building now it is going to be several years before they can ship the oil, the risk is substantial that they are going to be exposed at some point to prices they can’t live with.

David: Dr. Friedman, as we wrap up, I don’t want to ignore the Pacific Rim. Clearly, there is the stated objective by our U.S. foreign policy makers of a “U.S. pivot,” suggesting more attention toward Asia and perhaps less toward the Middle East, that probably isn’t borne out in actions. But let’s talk just briefly about China, a transitional economy, Japan, a struggling economy, and what you see as the context. Certainly, the world is looking at China as the next great rising power which has yet to be borne out, may or may not be the case. Maybe you could put the Pacific Rim in perspective for us.

George: I would argue that in the Pacific there is always a great low-wage, high-growth economy. It was the Japanese back in the 1980s. It has been the Chinese – that period is over. The cost of Chinese labor has gone up dramatically so that at this point Mexican labor is less expensive than Chinese labor. So, the period when they were able to really overwhelm the market with low cost goods is pretty much over. If you take a look where your shirts are made, a lot of places, but not China. They have decided that they want to enter the high-tech world. That is a tough place to be, and because you have Germany, the United States, Japan, South Korea, real heavyweights, finding your niche in there and creating quality is difficult.

And so, you have a Chinese economy which is slowing. We have recently seen a 7% rise of the economy for a month and everybody was cheering. Five years ago you would have thought that was a disaster. You have China in a period where it is readjusting, but because it has so many poor people – over a billion impoverished people live in China, most people in other words – the government is now massively cracking down on any potential dissent. We recently saw arrests of lawyers, several hundred lawyers, who were human rights lawyers. This is a government that is very nervous about what is going to happen.

I see Japan as the real power of East Asia. Everybody talks about Japan having economic problems. I look at Japan as for twenty years having maintained the most important thing for the Japanese, not for Western investors, and that would be full employment. And they have done that. And with a declining economy, a stable GDP means a rising per capita GDP.

So, what’s really interesting is that, unlike China, which is moving to the same position, Japan doesn’t have a huge impoverished population. It is socially stable. And it has a very well established high-tech economy, which means that as it moves toward weapons sales and other things that you wouldn’t have imagined, we should keep our eyes on Japan as the major power in the region, and be very cautious about China, not only because of its economic problems, which are real, but because of the political crackdown that is following them.

David: Dr. Friedman, thank you for joining us today. We appreciate the work that you do at Stratfor. That is a place that we frequent daily or weekly, the website, and would suggest that any of our listeners interested in current events and foreign policy and the dots that you so deftly connect, would find you at stratfor.com and plug in to that. And also, we look forward to a full review of Flashpoints: The Emerging Crisis in Europe, your most recent book. I appreciate you joining us today.

George: Thank you very much. Bye-bye.