Hoy volvemos a la
carga con el tema de la guerra encubierta entre el Imperio, la potencia
marítima del último siglo, y su contendiente China, la potencia terrestre
imperial en ciernes. Países clave en esta contienda son: Rusia, Alemania y
Arabia Saudita. A ver si les gusta esta interesantísima nota de Charles y
Louis-Vincent Gave para el sitio web de finanzas Gavekal Research.
Título: Gavekal
On The Coming Clash Of Empires: Russia's Role As A Global Game-Changer
Texto: Carthago
Est Delenda. “Carthage must be destroyed”. Cato the elder would conclude his
speeches in the Roman Senate with the admonition that salt should be spread on
the ruins of Rome’s rival. Listening to the US media over these summer holidays
from Grand Lake, Oklahoma, it is hard to escape the conclusion that most of the
American media, and US congress, feels the same way about Russia. Which is odd
given that the Cold War supposedly ended almost 30 years ago.
But then again, a
quick study of history shows that clashes between land and sea-based empires
have been a fairly steady constant of Western civilization. Think of Athens
versus Sparta, Greece versus Persia, Rome versus Carthage, England versus
Napoleon, and more recently the US versus Germany and Japan (when World War II
saw the US transform itself from a land-based empire to a sea-based empire in
order to defeat Germany and Japan), and of course the more recent contest
between the US and the Soviet Union.
The maritime
advantage
Such fights have
been staples of history books, from Plutarch to Toynbee. Victory has mostly
belonged to the maritime empires as they tend to depend more on trade and
typically promote more de-centralized structures; land-based empires by
contrast usually repress individual freedoms and centralize power. Of course
the maritime power does not always win; Cato the elder did after all get his
wish posthumously.
With this in
mind, consider a mental map of the productive land masses in the world today.
Very roughly put, the world currently has three important zones of production,
with each accounting for about a third of world GDP.
North and South
America: This is a sort of island and is not reachable by land from the rest of
the world. It constitutes the heart of what could be called the current “maritime”
empire.
Europe ex-Russia:
This is an economic and technological power as large as the US but a military
minnow. Its last two wars have been fought between the then dominant maritime
power (the US), first against Germany, then the Soviet Union to gain the
control of the so called “old continent”.
A resurgent Asia:
Here China is playing the role of the “land-based challenger” to the “maritime
hegemon”.
A visiting
Martian who knew little about our global geopolitical make-up, except for the
above history books, would likely conclude that a new version of the age-old
drama is being set up. This time, however the contest would be between a
China-dominated “land-based empire” and a US controlled “maritime power”, with
Europe (and to a lesser extent Africa) as the likely “prize.”
To have a chance
in the fight, the continental empire would have to “keep” a massive land mass
under its control. This would require building extensive lines of communication
(rail, roads, telecoms, satellites…), linking its own land-mass to the other
“productive” land masses, avoiding as much as possible the use of sea links to
communicate with other nations. The land empire would need to develop an
economy which would not need to trade through the seas.
This is what is
happening today and why we gave carte blanche to Tom Miller, leaving him free
to roam through Central Asia and Eastern Europe over a couple of years and
report on the capital that China was pouring to build such links (readers who
have not done so should pick up a copy of Tom’s book, China’s Asian Dream,
available at all good bookstores and of course, through our website).
Now for China’s
“dream of empire” to work, China would need to convince two important
countries, and maybe three, to at least become “neutral”, instead of
quasi-hostile, for these new communications lines to work. Those two countries
are Russia and Germany. The 3rd is Saudi Arabia, which has an interesting hand
to play.
1. Russia
Russia is the
main land bridge between China and Europe. So logic says that the US should be
very nice to Russia and seek to establish some kind of military alliance, if
only to control the movement of people and goods between China and Europe, and
from Europe to China. However, in its immense wisdom, the US Senate and the
entire US diplomatic corps have decided that America’s interests are best
served by imposing sanctions on Russia for crimes—not even proven at the time
of writing—that the Central Intelligence Agency routinely commits inside countries
that are nominally allies of the US!
It seems that US
policymakers have forgotten Lord Palmerston’s dictum that nations don’t have
friends, just permanent interests. And instead of following policies to
maximize its national interest, the US would rather cut off its nose to spite
its face. The end result is that the US seems to be working as hard as possible to make Russia
join forces with China. But why would the US so consciously make an enemy out
of Russia?
A starting point
is that it is a little odd that a country that cannot conceivably be invaded
spends more on defense then the next ten nations combined (see chart overleaf).
It is also odd that the US has been involved in wars, somewhere around the
globe, with very few interruptions, ever since President Dwight Eisenhower
warned his countrymen about the growing clout of the “US military industrial
complex”.
Of course, we
fully realize that even mentioning the “US military industrial complex’ makes
one sound like some kind of tin-potted, conspiracy-theorist prone loon. This is
not our intention. But we do want to
highlight that, in order to justify a budget of US$622bn, soon heading
to US$800bn, the US military industrial complex needs a bogey-man.
Now the natural
bogey-man should logically be China. After all, China is now sporting the
second biggest military budget in the world (US$192bn in 2016), is rapidly
expanding its global presence (Belt and Road, Asian Infrastructure Investment
Bank, Silk Road Fund) and increasingly treats the South China Sea as a mare
nostrum. Still, the past few months of broad US hysteria toward Russia make it
fairly clear that US military interests would rather pick on Russia then China.
Why so?
The first, and
most obvious explanation, is simply institutional inertia. After all, Russia
was the main enemy between 1945 and 1991 and entire institutions were built
(NATO, OECD, the International Monetary Fund and the World Bank) with either
the stated, or unstated, goal of containing Russia’s influence. Such government-led
institutions usually turn around as easily as a cruise ship captained by
Francesco Schettino.
Predictable
France
There are
historical precedents for this. Take France as an example: from Cardinal
Richelieu onward, the sole purpose of French diplomacy was to destroy the
Austro-Hungarian empire. This left successive French rulers blind to the rise
of Prussia; at least until 1870 and the pummeling of Paris. Still, even after
losing Alsace and Lorraine, France continued its anti-Habsburg crusade until
1919, and the final destruction of the Austrian empire with the 1919 Versailles
treaty. This treaty left France vulnerable should the Russians and Germans ever
ally (a key policy goal of the Habsburgs was to prevent such an alliance) or
the Brits decide that they’d rather head home (which duly occurred in 1940 at
Dunkirk and is perhaps happening again today).
The bottom line
is that the sheer force of institutional inertia means the “smartest people”
are often incapable of adjusting to new realities. It happened in France, and
it could easily be happening in the US today.
A second
explanation is that there exists tremendous resistance within the broader US
community to making China a scapegoat. US corporations have huge interests in
China and relatively limited exposure to Russia. Thus attempts to cast China in
too bad a light are habitually met with concerted lobbying efforts (Lenin did
say that the “Capitalists will sell us the rope with which we will hang them”).
As no-one in the US business community cares deeply about Russia, Moscow makes
for a good, “compromise bogey man”?
A third
explanation is tied to a theme we have discussed in the past (see The
Consequences of Trump’s Syrian Strike), namely the unfolding civil war in the
Middle-East between Sunnis and Shias. On the Sunni side of the war sits Saudi
Arabia. On the Shia side of the war is Iran. And behind Iran stands Russia, who
would like nothing more than to see the Saudi regime implode. Indeed, a
collapse of the House of Saud would be an immense boon for Russia. The price of
oil would likely surge (which would be great for non-Arab producers like
Russia) and Europe would find itself wholly dependent on Russia for its energy
supplies, thereby giving Moscow more geopolitical clout than it has enjoyed in
decades.
At the same time,
a collapse of the House of Saud would be terrible news for US, French and
British arms suppliers (for whom the Middle-Eastern monarchies are big clients)
and for all big oil companies which have huge contracts in Saudi Arabia and
across the Middle-East to protect.
This brings us to
the current make-up of the US administration which, to say the least, is
somewhat skewed towards military officers (military men and the merchants of
death tend to get along) and oil-men. Is it too much of a stretch to think that
an administration loaded with oil and military men would, almost by default,
fight Saudi Arabia’s corner? Now this may be unfair. After all, it’s not as if
the first trip of the current US president was to Saudi Arabia, or as if that
trip yielded many lucrative deals for US weapons manufacturers, US oil
companies, and US financiers, was it?
Russia as a
game-changer
Whatever the
reason for the current anti-Russia hysteria in the US, it is now clearly in
Russia’s interest for it to play a very active role in the coming Chinese
efforts to reduce the power of the dominant “maritime empire”. This means that
Chinese and European products will be able to travel through Russia for the
foreseeable future, so avoiding possible threats created by the US navy should
Washington ever act to disrupt trade between the two economic centers.
The reason that
the US’s approach to Russia is so short-sighted is that Russia’s role in the
coming clash between the two empires may go far beyond it facilitating
communication and transport across its territory. Indeed, Russia (along with
Qatar and Iran) could already be helping China break the monopoly that the US
has on the payment of energy all over the world through the US dollar (see The
Most Important Change And Its Natural
Hedge).
For the past 100
years, the US dollar has been the world’s major reserve and trading currency.
Needless to say, having the ability to settle one’s (rather large) trade and
budget deficits in one’s own currency is a competitive advantage of huge
proportions. Greater than its edge in finance, tertiary education, technology,
biotech, weapons manufacturing and agricultural productivity, this “exorbitant
privilege” may be the US’s single biggest comparative advantage.
Now our starting
point when looking at China is that the guys who run the show in Beijing are
basically control freaks. After all, what else do you expect from career
technocrats steeped in Marxist theory? So with that in mind, the question every
investor should ask themselves is: why would control freaks yield control of
their country’s exchange rate and interest rate structure? Why liberalize the
bond and currency markets?
For let’s face
it, there are few prices as important to an economy as the exchange rate and
the interest rate. So if the politburo is willing to gradually lose control
over them, it must be because it hopes to gain something better on the other
side. And the something better is to transform the renminbi into Asia’s
deutschemark; the “natural” trading (and eventually reserve) currency for Asia
and even wider emerging markets. In fact, internationalizing the renminbi is
the lynchpin on which the whole “Belt and Road” empire rollout rests. If this
part fails, then China’s imperial ambitions will most likely crumble over time
(for one cannot have an empire on somebody else’s dime).
The rise of the
renminbi
Which brings us
to a key change in our global monetary system that has received scant
attention, namely, the recent announcement by the Hong Kong exchange that
investors will soon be able to buy and settle gold contracts in renminbi (see
release). This initiative has the potential to be a game-changer for the
architecture of our global monetary system.
Imagine being
Russia, Iran, Qatar, Venezuela, Sudan, Uzbekistan or any other country liable
to fall foul of US foreign policy, and thus susceptible to having Washington
use the dollar as a “soft weapon” (see BNP, Big Brother And The US Dollar).
Then China comes along and says: “Rather than trading in dollars, which leaves
us both exposed to US sanctions, and US banks’ willingness to fund our trade,
let’s deal in renminbi. I can guarantee that ICBC will never pull the rug from
under your feet”.
If you are
Russia, or Qatar (which have already signed renminbi deals for oil and natural
gas), this may be an interesting proposition. However, the question will quickly arise: “What will I do
with my renminbi? Sure, I can buy goods in China, but I only need so much cheap
clothing, tennis shoes, and plastic junk. What do I do with what is left
over?”. And the answer to that question is that the US dollar remains the
world’s reserve currency since the US offers the deepest and most liquid asset
markets. From real estate (as shown by the Russia-Trump investigation), to
equities, to bonds, there is no shortage of US assets that Americans will sell
foreigners so that foreigners can park their hard earned dollars back into the
US.
This brings us
back to China and the main constraint to the renminbi’s rise as a reserve
currency. Simply put, foreign investors do not trust the Chinese government
enough to park their excess reserves in Chinese assets. This lack of trust was
crystallized by the decision in the summer of 2015 to “shut down” the equity
markets for a while and stop trading in any stock that looked like it was
heading south. That decision confirmed foreign investors’ apprehension about
China and in their eyes set back renminbi internationalization by several years,
if not decades.
Until now, that
is. For by creating a gold contract settled in renminbi, Russia may now sell
oil to China for renminbi (already signed), then take whatever excess currency
it earns to buy gold in Hong Kong. As a result, Russia does not have to buy
Chinese assets or switch the proceeds into dollars (and so potentially fall
under the thumb of the US Treasury). This new arrangement is good news for
Russia, good news for China, good news for gold and horrible news for Saudi
Arabia as it leaves the Middle-Eastern kingdom in between a rock and a hard
place.
2. Saudi Arabia
The fact that
China wants to buy oil with its own currency will increasingly present Saudi
Arabia with a dilemma. It could acknowledge that China is now the world’s
largest oil importer, and only major growth market, and accept renminbi
payments for its oil. However, this would go down like a lead balloon in
Washington where the US Treasury would (rightly) see this as a threat to the
dollar’s hegemony. In such a scenario,
it is unlikely that the US would continue to approve modern weapon sales to
Saudi and the embedded “protection” of the House of Saud that comes with them.
And without this US protection, who knows
which way the Sunni-Shia civil war may tip (most likely in favor of the
Iran-Russia axis).
Unfortunately for
Saudi Arabia, the alternative is hardly attractive. Getting boxed out of the
Chinese market will increasingly mean having to dump excess oil inventories on
the global stage, thereby ensuring a sustained low price for oil. But with its
budget deficit stuck at about 16% of GDP, with half its population below 27 and
needing jobs, and with reserves shrinking by around US$10bn a month, just
maintaining the current status quo is not a long-term viable option.
So which way will
Saudi turn? Will Riyadh accept low oil prices forever and the associated costs
on Saudi society? Or will it change horse and move to accept renminbi in order
to ensure more access to the world’s largest oil importer, even at the risk of
triggering Washington’s wrath? Investors who like to bet on form may wish to
consider the second option. Indeed, King Ibn Saud (the current King Salman's
father) was once a loyal British client as the Brits had helped suppress the
Wahhabi brotherhood, so cementing his power. Yet in 1936, Ibn Saud's adviser
Abdullah Philby (father of British traitor Kim Philby), persuaded the king
to switch his allegiance to the US, by
offering Saudis exclusive oil concession to Chevron/Texaco rather than BP. This
is why the Saudi oil company is called Aramco (the Arab-American oil company)
rather than Arbroco.
Could the House
of Saud pull off the same stunt again? One indication may be who lines up as
cornerstone investors in the coming Aramco IPO. If those end up as China
Investment Corporation, Petrochina and the PRC’s State Administration of
Foreign Exchange, than perhaps Aramco will be on its way to becoming Archoco.
And with that, the pricing of Saudi oil could shift from US dollars to
renminbi.
Incidentally,
such a move would likely solve Saudi’s biggest macro hurdle; specifically, the
defense of the Saudi Riyal peg to the US dollar. Indeed, with reserves
shrinking so rapidly, the arrangement looks to be on a slow-moving death watch
(admittedly, at the current pace of reserve depletion, Riyadh could hold out
three years and possibly five). But should Saudi announce that Aramco (or
Archoco!) will now accept renminbi for oil payments, the dollar would likely
tank while oil prices would shoot up (as Saudi would have a willing buyer for
its oil in China). A lower US dollar/ higher oil combination would, needless to
say, make the Saudi peg that much easier to sustain.
Lastly, if you
were King Salman and thought that the long-term sustainability of the House of
Saud depended on dumping the US and engaging China, what would you be doing
right now? Would you be buying as many top-end US weapons as you possibly
could, knowing that, in the future, such purchases may no longer be as easy as
they are today? But let us now move to the third major player in this many-part
drama, namely Germany, where the situation is even more complex.
3. Germany
Unencumbered by
its own “heavy” history, Germany— being at heart a “continental” nation—would
probably have joined the “continental alliance” and left the maritime alliance
(which may explain why the “maritime alliance” tapped Angela Merkel’s phone;
arguably a greater intrusion then anything the US has accused Russia of). After
all, consider the advantages for Germany of joining the “land-based empire”:
Politically,
Germany could finally develop its own diplomacy and stop taking orders from
Washington.
Economically,
German industry would have unlimited access to develop not only Russia but also
all the populations north of the Himalayas set to join the modern world through
the creation of the “New Silk Road”.
Geopolitically,
let us first state the obvious: a Middle-East ruled by the Sunnis under the
control of the US diplomacy has not been a resounding success. Worse yet, the
incredible mistakes made by the last two US administrations across the
Middle-East have led to a very old religious war (Sunnis vs. Shiites) again
erupting. As we write, it seems that the Russians and Iranian allies are
gradually succeeding in taking the control of the Middle East. Now the return
to some form of peace (under a Russia/Iranian yoke) would offer new markets for
German industry, provided Germany immediately allied itself with Russia and
broke away from the American sanctions imposed by the US Senate. Failing that,
Germany could lose a Middle-Eastern market which has historically been
important for its exporters.
Domestically: A
German-Russian alliance would crimp Turkey’s resurgence as Ankara would find
itself isolated due to Iran and China being on its eastern borders and Russia
on its northern frontiers. As a result, Turkey would most likely stop rattling
Europe’s cage, which would be a boon for Merkel as Recep Tayyip Erdo?an has
been a significant thorn in her side. In other words, Merkel would outsource
her “Turkey problem” to Russia.
Energetically, a
Russian-dominated Middle East would still provide gas from Russia and oil from
the Middle-East. The implication is that Germany would no longer need to have
its energy imports “protected” by the maritime empire’s fleet (Merkel’s
short-sightedness on the energy front, from the end of coal, to the banning of
nuclear power, has fitted in the category of being “worse than a crime, it is a
mistake”).
Many people in
Germany—business people and public servants such as ex -chancellor Gerhard
Schroeder—understand the above and have lobbied for such an outcome. The recent
trend of US prosecutors trying to export the supremacy of the US legal system
over local ones, and imposing egregious fines on all and sundry (Deutsche Bank,
Volkswagen) can only push German business leaders further down that path.
Of course, as
Frenchmen, we know that nothing good comes of:
* Germany and
Russia getting along like a house on fire.
* Britain retreating
back to its island.
And we would
suggest that President Emmanuel Macron is also keenly aware of this. Which
explains he is so far the only Western leader to have gone out of his way to be
nice to President Trump; aside from the Polish President of course (more on
that later).
Macron has bent
over to accommodate Merkel. And let’s face it, his task is not easy. For as
good as our president may be with the older ladies, he needs to convince Merkel
to walk away from the above win-win and keep Germany committed to the greater
European integration exercise, and Germany wedded to its role inside the
broader “maritime empire”.
Germany as the
sole paymaster
Now, to be fair,
the German population has enthusiastically supported the European integration
project, partly out of historical guilt (now abating as the share of the
population alive in World War II fast shrinks) and partly because it has been a
boon to German exporters. However, recent years have highlighted that the low
hanging fruit of European integration has been harvested. And to stay afloat,
the European project now needs Berlin to transfer 2%-6% of GDP to poorer, less
productive, European Union countries (especially as the UK will soon stop
paying into EU coffers). This is a hard sell, even for a politician as gifted
as Macron. Soon, Germany may be the only meaningful contributor to French
agricultural subsidies; and that is unlikely to go down well with the average
Bavarian housewife.
Which brings us
to the only other Western leader who has publicly embraced the current
incumbent of the White House, namely Polish president, Andreszj Duda. After
all, History suggests that France should not be the only country worried about
a German rapprochement with the new “land-based empire”. Most Eastern European
countries, in particular Poland, have similar reactions to such a hook-up. In
fact, threat of a German-Russian rapprochement may already be creating the
birth of a new, Austro-Hungarian empire, aka the Visegrad Group alliance of the
Czech Republic, Hungary, Poland and Slovakia.
Historically, the
role of the Austrian empire was to protect Europe from the Turks and also to
stop an alliance between Prussia and Russia. For the time being the Visegrad
group is negotiating (rather unsuccessfully) with Berlin about how to handle
thousands of “Turks” (at least migrants entering Europe through Turkey, whether
those migrants come from North Africa, the Middle-East, Afghanistan, Bangladesh
or elsewhere is almost irrelevant). This Eastern grouping may have to address,
sooner than they think, a German-Russian rapprochement.
Just as
importantly, the re-emergence of the Austrian empire is incompatible with the
“Europe as a Nation” project. In the world we are describing Poland, followed
by Hungary and the Czech Republic, may be the next countries to leave the EU.
Although in so doing, the Visegrad Group would almost guarantee the feared
rapprochement between Germany and
Russia. Of course the Eastern European nations would only make such a move if they
were militarily guaranteed by the US. And, by an amazing coincidence, this is
exactly the promise that President Trump just delivered in Warsaw!
For the “maritime
empire”, a loss of Germany would have to be rapidly compensated by an increased
presence in Poland, the Czech Republic, Austria, Lithuania and almost every
country East of Berlin and West of Moscow. Of course, this is what France and
England (the “maritime empires of the day”) did in the 1930s— with limited
success.
Conclusion
History shows
that maritime powers almost always have the upper hand in any clash; if only
because moving goods by sea is cheaper, more efficient, easier to control, and
often faster, than moving them by land. So there is little doubt that the US
continues to have the advantage. Simple logic, suggests that goods should
continue to be moved from Shanghai to Rotterdam by ship, rather than by rail.
Unless, of
course, a rising continental power wants to avoid the sea lanes controlled by
its rival. Such a rival would have little choice but developing land routes;
which of course is what China is doing. The fact that these land routes may not
be as efficient as the US controlled sealanes is almost as irrelevant as the
constant cost over-run of any major US defense projects. Both are necessary to
achieve imperial status.
As British
historian Cyril Northcote Parkinson highlighted in his mustread East And West,
empires tend to expand naturally, not out of megalomania, but simple commercial
interest: “The true explanation lies in the very nature of the trade route.
Having gone to all expenses involved… the rule cannot be expected to leave the
far terminus in the hands of another power.” And indeed, the power that
controls the end points on the trading road, and the power that controls the
road, is the power that makes the money. Clearly, this is what China is trying
to achieve, but trying to do so without entering into open conflict with the
United States; perhaps because China knows the poor track record of continental
empires picking fights with the maritime power.
Still, by
focusing almost myopically on Russia, the US risks having its current massive
head-start gradually eroded. And obvious signs of this erosion may occur in the
coming years if and when the following happens:
- Saudi Arabia
adopts the renminbi for oil payments
- Germany changes
its stripes and cozies up to Russia and pretty much gives up on the whole
European integration charade in order to follow its own naked self-interest.
The latter two
events may, of course, not happen. Still, a few years ago, we would have
dismissed such talk as not even worthy of the craziest of conspiracy theories.
Today, however, we are a lot less sure. And our concern is that either of the
above events could end up having a dramatic impact on a number of asset classes
and portfolios.
And the possible
catalyst for these changes is China’s effort to create a renminbi-based gold
market in Hong Kong. For while the key change to our global financial
infrastructure (namely oil payments occurring in renminbi) has yet to fully
arrive, the ability to transform renminbi into gold, without having to bring
the currency back into China (assuming Hong Kong is not “really” part of China
as it has its own supreme court and independent justice system… just about!) is
a likely game-changer.
Clearly, China is
erecting the financial architecture for the above to occur. This does not mean
the initiative will be a success. China could easily be sitting on a dud. But
still, we should give credit to Beijing’s policymakers for their sense of
timing for has there ever been a better time to promote an alternative to the
US dollar? If you are sitting in Russia, Qatar, Iran, or Venezuela and
listening to the rhetoric coming out of Washington, would you feel that
comfortable keeping your assets, and denominating your trade, in dollars? Or
would you perhaps be looking for alternatives?
This is what
makes today’s US policy hard to understand. Just when China is starting to
offer an alternative—an alternative that the US should be trying to bury—the US
is moving to “weaponize” the dollar and pound other nations—even those as
geo-strategically vital as Russia—for simple domestic political reasons. It all
seems so short-sighted.
