Tag Archives: nato

American Investors Safe from Nickel’s Boom and Bust

There’s good news on the horizon for the average U.S. retail investor. There’s a bubble coming and for once, Joe Investor is going to miss out on the boom and crash. Two primary stories create the potential for a short-term meteoric rise in prices only to quickly plunge as macro economic forces and political issues sort themselves out. In a world full of financial instruments, global exchanges and products ranging from weather derivatives to technology indexes to silkworm futures, the base metal nickel is inaccessible to the average retail American trader.

Continue reading American Investors Safe from Nickel’s Boom and Bust

Trading Ukraine Uncertainty

Removing the politics of the Russia-Ukraine issue and focusing on the economic implications of Russia’s bloodless annexation of the Crimean peninsula puts some trading opportunities on the table as global risk premiums jump. In order to do this, a couple of suppositions must be declared. First and most importantly, the United States will not actively engage Russian troops. In many ways, this is a replay of the Georgian conflict in 2008. Georgia was in revolt against Russia and wanted closer ties to the European Union and the US. Their cause was quickly championed by Western leaders until it became obvious that neither the European Union, The United States nor, NATO would take any military action to defend Georgia against Russia. This episode set the precedent for the current situation.

Continue reading Trading Ukraine Uncertainty

Paradigm Shift in the Cocoa Futures Market

Cocoa futures are one of the most volatile markets. This has been primarily attributed to three historical variables politics, antiquated farming methods and weather. Two of these three variables are being addressed directly while the third remains a wild card that may pull the trigger on a substantial rally in an agricultural market undergoing a complete paradigm shift.

The Ivory Coast is the world’s largest producer of cocoa. Prior to 2011 it was presided over by Laurent Gbagbo who ran the country in typical West African fashion for more than 10 years. The open elections of 2011 led to a brief civil war when Alassane Ouattara was elected President and Laurent Gbagbo refused to cede the Presidential office and used his cronies in the military to hold off the inevitable. The regime change was inevitable because Ouattara, who is a former International Monetary Fund (IMF) economist, has the full support of NATO as well as the military backing to support a more democratic and transparent government. The installation of Ouattara should eliminate much of the political volatility that has been a hallmark of the cocoa futures market for many years.

President Ouattara, who was educated here in the U.S. at Drexel University, is quickly modernizing the Ivory Coast’s cocoa markets. There’s been rapid development in soil reclamation, fertilization and education. Most cocoa is grown by individual farmers on small plots of land and is harvested by hand as it has been for hundreds of years. The application of modern agronomy techniques will cause the Ivory Coast’s cocoa production to increase rapidly over the coming years. The combination of infrastructure improvement and political stability supporting free trade and as well as modern farming practices will increase yield and depress prices once the changes are fully implemented.

The effects of Ouattara’s Presidency can already be seen in the decline of volatility in cocoa prices. Major chocolate producers no longer have to worry about civil war, the government closing ports or henchman attacking farmers on their way to collection stations to force the price higher. The price range in 2012 was $2,003 – $2,707, a measly 35%. The range for 2011 was more than 90%. In fact, the five-year average range is more than 50%. These wild rides are less likely to occur, as weather becomes the only variable left to move the markets.

This sets the stage for the current battle in the market. Cocoa futures have been on a steady slide since fall. The market appeared to be forming a technical bottom during this period. However, it was clear by the commercial selling that the bullish saucer base pattern, between $2,310 and $2,510, that had been supported by the small speculators had little chance of pushing the market higher. The slide through the 2013 price level is primarily attributable to the small speculators being forced out of their long positions at a loss.

The market has recently traded as low as $2,100. Commercial traders have been covering their short hedges and locking in futures supply line purchases since the market first fell through the $2,310 level. Commercial traders have been net buyers in nine out of the last ten weeks. Recently, weather issues have reduced estimates for the current mid crop harvest due to a lack of rain throughout the Ivory Coast as well as growing regions in Ghana, the second largest producer. These two countries account for nearly 60% of the world’s production.

The key price level is $2,000 per ton. The market traded below here once in 2011 and rallied $500 per ton in just a few weeks. Overall, the market hasn’t spent any time below $2,000 per ton since the commodity boom of 2007. We’ll side with the commercial traders and look for buying opportunities as the last of the weak speculators are forced out of the market. Perhaps, the best way not to miss out on the rally is to place a buy stop order above the market’s recent resistance level around $2,150. If this order gets filled in the May cocoa futures contract, place a protective sell stop at what becomes the low price of this move. We’ll look for a minimum price target of $2,310, the bottom of the old saucer formation.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Outside Views on Obama’s

This blog is published by Andy
Waldock. Andy Waldock is a trader, analyst, broker and asset manager.
Therefore, Andy Waldock may have positions for himself, his family, or, his
clients in any market discussed. The blog is meant for educational purposes and
to develop a dialogue among those with an interest in the commodity markets.
The commodity markets employ a high degree of leverage and may not be suitable
for all investors. There is substantial risk in investing in futures.

Here are a couple of takes on Obama’s new position on
Afghanistan and what it means. The first is from George Friedman of Stratfor Research
and the second is a collection of global quotes on the topic put together by David
Galland of Casey Daily Dispatch.


By George Friedman

U.S. President Barack Obama announced the broad structure of his Afghanistan
in a speech
at West Point on Tuesday evening. The strategy had three core elements. First,
he intends to maintain pressure on al Qaeda on the Afghan-Pakistani border and
in other regions of the world. Second, he intends to blunt the Taliban
offensive by sending an additional 30,000 American troops to Afghanistan, along
with an unspecified number of NATO troops he hopes will join them. Third, he
will use the space created by the counteroffensive against the Taliban and the
resulting security in some regions of Afghanistan to train and build Afghan
military forces and civilian structures to assume responsibility after the
United States withdraws. Obama added that the U.S. withdrawal will begin in
July 2011, but provided neither information on the magnitude of the withdrawal
nor the date when the withdrawal would conclude. He made it clear that these
will depend on the situation on the ground, adding that the U.S. commitment is

Related Special Topic Page

In understanding this strategy, we must begin with an obvious but unstated
point: The
extra forces
that will be deployed to Afghanistan are not expected to
defeat the Taliban. Instead, their mission is to reverse the momentum of
previous years and to create the circumstances under which an Afghan force can
take over the mission. The U.S. presence is therefore a stopgap measure, not
the ultimate solution.

The ultimate solution is training an Afghan force to engage the Taliban
over the long haul, undermining support for the Taliban, and dealing with al
Qaeda forces along the Pakistani border and in the rest of Afghanistan. If the
United States withdraws all of its forces as Obama intends, the Afghan military
would have to assume all of these missions. Therefore, we must consider the
condition of the Afghan military to evaluate the strategy’s viability.

Afghanistan vs.

Obama went to great pains to distinguish Afghanistan
from Vietnam
, and there are indeed many differences. The core strategy
adopted by Richard Nixon (not Lyndon Johnson) in Vietnam, called
“Vietnamization,” saw U.S. forces working to blunt and disrupt the
main North Vietnamese forces while the Army of the Republic of Vietnam (ARVN)
would be trained, motivated and deployed to replace U.S. forces to be
systematically withdrawn from Vietnam. The equivalent of the Afghan surge was
the U.S. attack on North Vietnamese Army (NVA) bases in Cambodia and offensives
in northern South Vietnam designed to disrupt NVA command and control and
logistics and forestall a major offensive by the NVA. Troops were in fact
removed in parallel with the Cambodian offensives.

Nixon faced two points Obama now faces. First, the United States could not
provide security for South Vietnam indefinitely. Second, the South Vietnamese
would have to provide security for themselves. The role of the United States
was to create the conditions under which the ARVN would become an effective
fighting force; the impending U.S. withdrawal was intended to increase the
pressure on the Vietnamese government to reform and on the ARVN to fight.

Many have argued that the core weakness of the strategy was that the ARVN
was not motivated to fight. This was certainly true in some cases, but the idea
that the South Vietnamese were generally sympathetic to the Communists is
untrue. Some were, but many weren’t, as shown by the minimal refugee movement
into NVA-held territory or into North Vietnam itself contrasted with the
substantial refugee movement into U.S./ARVN-held territory and away from NVA
forces. The patterns of refugee movement are, we think, highly indicative of
true sentiment.

Certainly, there were mixed sentiments, but the failure of the ARVN was not
primarily due to hostility or even lack of motivation. Instead, it was due to a
problem that must be addressed and overcome if the Afghanistation war is to
succeed. That problem is understanding the role that Communist sympathizers and
agents played in the formation of the ARVN.

By the time the ARVN expanded — and for that matter from its very foundation
— the North Vietnamese intelligence services had created a systematic program
for inserting operatives and recruiting sympathizers at every level of the
ARVN, from senior staff and command positions down to the squad level. The
exploitation of these assets was not random nor merely intended to undermine
moral. Instead, it provided the NVA with strategic, operational and tactical
intelligence on ARVN operations, and when ARVN and U.S. forces operated
together, on U.S. efforts as well.

In any insurgency, the key for insurgent victory is avoiding battles on the
enemy’s terms and initiating combat only on the insurgents’ terms. The NVA was
a light infantry force. The ARVN — and the U.S. Army on which it was modeled —
was a much heavier, combined-arms force. In any encounter between the NVA and
its enemies the NVA would lose unless the encounter was at the time and place
of the NVA’s choosing. ARVN and U.S. forces had a tremendous advantage in
firepower and sheer weight. But they had a significant weakness: The weight
they bought to bear meant they were less agile. The NVA had a tremendous
weakness. Caught by surprise, it would be defeated. And it had a great
advantage: Its intelligence network inside the ARVN generally kept it from
being surprised. It also revealed weakness in its enemies’ deployment, allowing
it to initiate successful offensives.

All war is about intelligence, but nowhere is this truer than in
counterinsurgency and guerrilla war, where invisibility to the enemy and
maintaining the initiative in all engagements is key. Only clear intelligence
on the enemy’s capability gives this initiative to an insurgent, and only
denying intelligence to the enemy — or knowing what the enemy knows and intends
— preserves the insurgent force.

The construction of an Afghan military is an obvious opportunity for Taliban
operatives and sympathizers to be inserted into the force. As in Vietnam, such
operatives and sympathizers are not readily distinguishable from loyal
soldiers; ideology is not something easy to discern. With these operatives in
place, the Taliban will know of and avoid Afghan army forces and will identify
Afghan army weaknesses. Knowing that the Americans are withdrawing as the NVA
did in Vietnam means the rational strategy of the Taliban is to reduce
operational tempo, allow the withdrawal to proceed, and then take advantage of
superior intelligence and the ability to disrupt the Afghan forces internally
to launch the Taliban offensives.

The Western solution is not to prevent Taliban sympathizers from penetrating
the Afghan army. Rather, the solution is penetrating the Taliban. In Vietnam,
the United States used signals intelligence extensively. The NVA came to
understand this and minimized radio communications, accepting inefficient
central command and control in return for operational security. The solution to
this problem lay in placing South Vietnamese into the NVA. There were many cases
in which this worked, but on balance, the NVA had a huge advantage in the
length of time it had spent penetrating the ARVN versus U.S. and ARVN
counteractions. The intelligence war on the whole went to the North Vietnamese.
The United States won almost all engagements, but the NVA made certain that it
avoided most engagements until it was ready.

In the case of Afghanistan, the United States has far more sophisticated
intelligence-gathering tools than it did in Vietnam. Nevertheless, the basic
principle remains: An intelligence tool can be understood, taken into account
and evaded. By contrast, deep penetration on multiple levels by human
intelligence cannot be avoided.

Pakistan’s Role

Obama mentioned Pakistan’s
critical role. Clearly, he understands the lessons of Vietnam regarding
sanctuary, and so he made it clear that he expects Pakistan to engage and
destroy Taliban forces on its territory and to deny Afghan Taliban supplies,
replacements and refuge. He cited the Swat
and South
offensives as examples of the Pakistanis’ growing effectiveness.
While this is a significant piece of his strategy, the Pakistanis must play
another role with regard to intelligence.

The heart of Obama’s strategy lies not in the surge, but rather in turning
the war over to the Afghans. As in Vietnam, any simplistic model of loyalties
doesn’t work. There are Afghans sufficiently motivated to form the core of an
effective army. As in Vietnam, the problem is that this army will contain large
numbers of Taliban sympathizers; there is no way to prevent this. The Taliban
is not stupid: It has and will continue to move its people into as many key
positions as possible.

The challenge lies in leveling the playing field by inserting operatives
into the Taliban. Since the Afghan intelligence services are inherently
insecure, they can’t carry out such missions. American personnel bring
technical intelligence to bear, but that does not compensate for human
intelligence. The only entity that could conceivably penetrate the Taliban
and remain secure is the Pakistani Inter-Services Intelligence (ISI). This
would give the Americans and Afghans knowledge of Taliban plans and
deployments. This would diminish the ability of the Taliban to evade attacks,
and although penetrated as well, the Afghan army would enjoy a chance ARVN
never had.

But only the ISI could do this, and thinking of the ISI as secure is hard to
do from a historical point of view. The ISI worked closely with the Taliban
during the Afghan civil war that brought it to power and afterwards, and the
ISI had many Taliban sympathizers. The ISI underwent significant purging and
restructuring to eliminate these elements over recent years, but no one knows
how successful these efforts were.

remains the center of gravity of the entire problem. If the war is about
creating an Afghan army, and if we accept that the Taliban will penetrate this
army heavily no matter what, then the only counter is to penetrate the Taliban
equally. Without that, Obama’s entire strategy fails as Nixon’s did.

In his talk, Obama quite properly avoided discussing the intelligence aspect
of the war. He clearly cannot ignore the problem we have laid out, but neither
can he simply count on the ISI. He does not need the entire ISI for this
mission, however. He needs a carved out portion — compartmentalized and
invisible to the greatest possible extent — to recruit and insert operatives into
the Taliban and to create and manage communication networks so as to render the
Taliban transparent. Given Taliban successes of late, it isn’t clear whether he
has this intelligence capability. Either way, we would have to assume that some
Pakistani solution to the Taliban intelligence issue has been discussed (and
such a solution must be Pakistani for ethnic and linguistic reasons).

Every war has its center
of gravity
, and Obama has made clear that the center of gravity of this war
will be the Afghan military’s ability to replace the Americans in a very few
years. If that is the center of gravity, and if maintaining security against
Taliban penetration is impossible, then the single most important enabler to
Obama’s strategy would seem to be the ability to make the Taliban transparent.

Therefore, Pakistan is important not only as the Cambodia of
this war, the place where insurgents go to regroup and resupply, but also as a
key element of the solution to the intelligence war. It is all about Pakistan.
And that makes Obama’s plan difficult to execute. It is far easier to write
these words than to execute a plan based on them. But to the extent Obama is
serious about the Afghan army taking over, he and his team have had to think
about how to do this.


Obama’s Speech – Views from Abroad

One of the more memorable
moments of Obama’s meteoric rise to power was his speech in front of hundreds
of thousands of adoring fans in Berlin.

So, what do the Europeans
think about El Magnifico now?

The following is a quote from
Spiegel Online, one of Germany’s most influential news outlets.

Never before has a speech by President
Barack Obama felt as false as his Tuesday address announcing America’s new
strategy for Afghanistan. It seemed like a campaign speech combined with Bush
rhetoric — and left both dreamers and realists feeling distraught.

One can hardly blame the West
Point leadership. The academy commanders did their best to ensure
thatCommander-in-Chief Barack Obama’s speechwould be well-received.

Just minutes before the
president took the stage inside Eisenhower Hall, the gathered cadets were asked
to respond “enthusiastically” to the speech. But it didn’t help: The
soldiers’ reception was cool.

One didn’t have to be a cadet
on Tuesday to feel a bit of nausea upon hearing Obama’s speech.It was the least
truthful address that he has ever held. He spoke of responsibility, but almost
every sentence smelled of party tactics. He demanded sacrifice, but he was
unable to say what it was for exactly.

You can read
the rest of the article here

Also reporting in was friend
and correspondent Mr. Watson, writing from his cozy pad on the Algarve, with a
rather unique (and, I suspect, unworkable) idea… though I present it anyway as
it may stimulate some further thoughts on the matter of Afghanistan.

Living in Portugal, I had to
stay up to the early hours of the morning to watch President Obama’s much
trumpeted speech. Frankly, apart from the much anticipated increase in troops
and the cost to the taxpayer, there was really nothing new. Just the same old
rhetoric that the president is very good at delivering.

During his speech the
president said that these additional 30,000 soldiers alone were going to cost
the long-suffering taxpayer an additional $30 billion per year. I then thought,
could there be a more cost-effective use of these funds? Most of the Taliban, I
understand, are not hardcore fundamental fanatics. They are referred to as the
“$10 a day Taliban.” These are Afghanis who are just trying to make a
living for themselves and their families. Basically they are mercenaries.

Let’s assume that there are
also about 30,000 Taliban. If you take the same $30 billion dollars, you could
pay these guys $100,000 a year each, for 10 years. The deal is, to get these
funds, they would have to switch to our side and either fight for us, against
the limited number of Al Qaedafanatics, or at the very least stop fighting the
U.S. and NATO troops. If anybody moralizes about the taxpayer paying for
mercenaries, they might want to rethink things a minute. There are still 75,000
so-called “contractors” working for the U.S. in Iraq and Afghanistan. They are
nearly all ex-U.S. service personnel and get paid more than $100,000 a year each.
They are mercenaries.

There are other benefits to
this policy. The Afghanis probably would have no need to grow poppies for the
opium trade. They could feed and provide health services to their families. The
kids could get a good education – at the moment only 7% of Afghanis are
literate. This new program in effect would be “Quantitative Easing”
for Afghanistan, and the economy would take off with this “pump priming”
operation. Against a backdrop of improving economic conditions, the country
would have ten years to develop new business enterprises and to settle into a
stable condition. Also, of course, you can largely bring the U.S. and NATO
troops home and save a lot of lives.

Now, to be clear, I think the
odds of that idea working are scant indeed… but even so, I’d rank the odds a
lot better than continuing to pour troops into the country in the attempt to
beat the Taliban into submission.

Now that the Smoke has Cleared

What can we expect from the financial markets going forward? This is a clearly written piece from Bedlam Asset Management of London. It only seemed fitting to include a piece from a British perspective, since their plan really is the one that saved the day.

Why The Worst Will
Soon Be Over

from Bedlam Asset

“I’ve seen an elephant fly”,
weather forecasts, and why the worst will soon be over

It is almost sad for us that the worst of the world’s largest ever
bank crisis is just about to or may even have passed its peak. It was fun
not to hold any and be thought a crazy, even though if any bank director
was asked the right questions, it was clear the system had to fall over.
Now that it has, we move on (but still hold no financials). There are other
aspects we’ll miss too. The impotence of Politicians revealed — no power
to affect the direction of the business cycle, and even less understanding
of the economies over which they portentously believed themselves in
charge. Who will forget the British Chancellor’s vacant stare whenever
asked a simple financial question, even as his eyebrows squirmed like
caterpillars in their death throes thus betraying his ignorance?

Then there’s the regulators, so far behind the curve it’s
embarrassing. No wonder in recent speeches PM Brown announced that he and
the Treasury would sort out the banks, even though the role is split
between the FSA and the Bank of England. We won’t miss the shocks after
combing through the balance sheets of Bradford and Bingley, Anglo-Irish,
Northern Rock, RBS, Soc Gen and UBS to discover how weak and sloppy were
their business models; and we look forward to illogical panic reactions
ending. For in the midst of the largest financial fire in history, more
effort has been expended on arguing who is to blame, rather than trying to
find the extinguishers. Happy, happy days. Farewell.

If you do not weep uncontrollably whilst watching Dumbo (the movie,
not the people above), then you have no soul. The climax of the story is
that without his white feather he could not fly, and was but a terrified
and rather badly drawn pachyderm at the top of the high dive. With a little
persuasion however, he realised the lack of his comfort blanket did not
preclude him from his destiny, so off he flew. The multiple financial
implosions of September and early October reduced governments, central
banks and regulators into a Dumboesque, catatonic inertia. Fortunately, the
panic in all markets has made them realise that they did have sufficient
powers: if not to fly, then at least to prevent an immediate Depression.
Thus for the first time this century, there is good clarity on the medium
term future, both for the global economy and stock markets. This is one of
a steep recession, followed by several years of a mild and stuttering
recovery. Surprisingly, this is a good result.

The eye of the
storm has just passed over

As long ago as 1999, a long and thoughtful front page article in the New
York Times highlighted the dangers of the world’s two largest mortgage
underwriters, Fannie Mae and Freddie Mac. They had just been blessed by the
regulators, Congress and President Clinton to tear up the risk book: to
offer large and easy mortgage terms to those Americans who could never
realistically hope to own a home. This relaxation of prudent lending rules
was soon widely imitated, particularly in economies with a property owning
mentality. The consequence was a global economic growth chimera,
accelerated by the reduction of the dead hand of bureaucracy in third world
countries such China and India. This allowed them to achieve far better
growth rates.

From 1999 onwards the hurricane started to build, moving ever closer to
the world’s financial system, obvious even to the man in the street. Yet
the near-term gains were so beneficial to individuals and government
budgets that every Finance Minister threw prudence down the well.
Chancellors even became popular. Bizarrely, the only people who did not
recognise the inevitable were the regulators, senior bankers and fund
managers. In 2007, the storm ripped into the banks. There was a brief calm
as the eye came overhead, within which complete regulatory and political
paralysis developed, even as institution after institution imploded. Now
the eye is passing; we’re back into the other side of the storm. Initially
the winds will be extreme, but each crisis will be a little less than the
one before. It is the best possible outcome, for the alternative was an
immediate vertical drop into a deep economic Depression. This would have
made the 1930s look a picnic. The ‘positive’ alternative may not seem that
glamorous as many small countries are already in recession and the major
ones will follow before the end of this year. Yet this recession will be a
45 degree slope, not a 90 degree fall. This is because the correct response
is now in train. It means that as early as 2010, a stuttering recovery
could commence.

The British
solution goes global?

It is a great surprise that three small islands off North Western Europe
have been the cause, and the cure, of the crisis. It was Ireland’s emergency
guarantee of all deposits which set off the nuclear reaction: risible,
because its blanket nature covering all deposits for its six banks worked
out at $576bn, nearly three times gross domestic product, $130,000 per head
or $200,000 per person in employment. Within these numbers was a
sub-liability of nearly $50,000 per head over foreign deposits, mostly
British. Despite now excellent Anglo-Irish relations, if these guarantees
had been called, they could never have been paid. Immediately Germany, Spain,
Greece and smaller countries followed suit. Mildly anti-EU British
politicians then peculiarly started to bleat about supra-national solutions
– an impossible dream – and did nothing. More sensible foreign leaders
reacted nationally to the inevitable consequences of their electorates
seeing their local banks disappear in a puff of smoke. Fortunately, market
mechanisms then kicked in. Large British deposits were being sucked out,
into unreal Irish bank guarantees at an alarming rate. Meanwhile in Iceland,
the third offshore island, the entire bank system finally decided to die.
Although this was assured much earlier (see Pick of the Week No. 48,
“Abdul and Jorvik Go Shopping”), it had staggered on for a
surprisingly long time. The twin Irish/Iceland events resulted in dramatic
falls in British asset prices and even worse gridlock in the lending
markets. Outflows to Ireland were swiftly followed by a sudden realisation
that simply idiotic deposits worth over £5bn had been placed into hopeless
Icelandic-owned institutions and were about to disappear. Depositors
included over 100 UK local government authorities as well as unwise
financial intermediaries. Without warning and in a single bound, the
British governing class leapt from narcolepsy to sprinting at gold medal

The key change has been the rapid implementation of the most
comprehensive bank bail out package ever seen. It should work, because it
addresses the overlapping problems of too little Tier 1 capital, the fear
of bank counterparty risk, the inability to roll over corporate loans and
the risk of deposit flight. The result is state directed capitalism. It has
lead to howls of outrage across the investment and political spectrum, from
the purists who believe market forces should be allowed to work themselves
out, to the mob baying for capitalist blood. The cacophony of noise and
finger pointing will continue for many years, but both arguments are
irrelevant. They are based on old rules. For just as in war habeas corpus
and other rights are torn up, so in a financial meltdown the old rules are

The British decision has been to save the core of the national banking
system and create a more realistic structure than the blanket guarantees of
Ireland. The sums pledged are large enough to meet all the capital required
to support the capital of each major domestic bank. The use of high
yielding preference shares and permanent income bearing securities is
likely to mean the government may end up owning perhaps a mere quarter of
three to six banks, yet its ability to control them all, and their lending,
is a certainty. This multiple approach is already being favourably viewed
in other countries; it is speedy, cheaper and turns the all-important
psychology from one of utter despair to merely gloom. It is more effective,
and overall less burdensome on the taxpayer than any other solution. In the
UK and elsewhere, the previous drip feed of liquidity into the markets,
started by Mr Paulson in the US, simply proved the law of diminishing
returns. Ever larger funds had to be provided to produce ever weaker
results. To be fair, the unique (so far) British solution is almost the
same as Mr. Buffet’s bail-out of Goldman Sachs. His very high yielding
preference stock and presumably many other strings must have provided a

Britain’s Treasury mandarins had also dusted off and absorbed the
lessons of earlier French, Swedish and Japanese models. The result is a
more effective hybrid. Since President Mitterand nationalised the banks in
1980 (later part re-listed), France has had state directed capitalism
dominated by three banks. Inevitably these are ponderous and suffer poor
shareholder returns, but in a whacky way, the system works. In Sweden, the
necessary nationalisation of anything with ‘bank’ on its nameplate also
proved effective; although the stock market did not recover for 18 months,
the economy managed weak growth in almost every quarter. Japan’s Resolution
Trust Corporation initially failed because the government dithered for six
years after the 1990 crash, before taking any meaningful action.
Subsequently, vast amounts of debt were issued to hoover up bankrupt banks
and duff corporate loans. It worked. We believe that most G7 (i.e.
including America) and G20 countries will adopt Britain’s hybrid ruse in
the near future; if so, the storm is passing for sure.


Some are most unpleasant. The authorities will have little control over
these and it would be foolish if they seek to cover every eventuality.
Staying with our three islands, one result is that Britain has probably
exacerbated the Irish banking crisis; the depositors who fled there for
“safety” will soon work out they are better off and better
covered in government controlled banks back home. As the new UK rules bite,
runs on some mutual groups such as building societies or Spain’s
equivalent, the Caixas are likely; in both cases their prime purpose is to
take deposits to fund property purchases. Government guarantees do not and
cannot extend to such groups. Banks like Santander will be forced to absorb
dozens of these local mutuals, as will Commerzbank in Germany. This trend
is extant already with the large banks in America. Most major industrial
countries therefore will end up with a handful of large semi state banks
which will dominate the domestic deposit markets.

Other casualties may include leasing companies. With no deposit base,
often no overall regulator and dependence on wholesale funding, their
future is not exactly bright. More casualties abound in Eastern Europe;
many countries there needed to devalue even before the storm hit. Now
devaluations are imminent. Elsewhere, several larger countries will have
their own particular problems. One we fear for is Australia, ironically
because of a very good policy. After Singapore and Chile, it has one of the
most logical and best funded pension schemes in the world (curiously, this
is a legacy of its most socialist Prime Minister, Gough Whitlam; even more
curious, he was ‘deposed’ by the British High Commissioner and Mr Rupert
Murdoch in 1975). The scheme is beautiful in its simplicity. From the first
day at work, employees and employers put large percentages of salary until
retirement into a personal, untouchable pension pot. Tax-free and
ring-fenced, these huge flows are managed by a host of competitive and
usually efficient ‘Superfund’ managers. Of all reasonably sized advanced
countries, Australia alone has ensured that an ageing population will be
able to fund itself without drawing down from the state. Yet a flaw has
developed. The industry is competitive, Australians are ruggedly
entrepreneurial. Personal pensions are portable at the push of a button.
Recently, some Superfund valuations have been exuberant. Many have as much
as a third of investments in unlisted property, private equity and other
opaque vehicles. Often performance seems remarkable: to June 2008 perhaps
+20% in a year, usually based on internal valuations. Yet similar
investments listed on the public markets have seen large falls in value. It
unlikely there’s much, if any, fraud, merely denial and over-optimism.
Given Australians are well-educated and financially literate, it seems only
a matter of time before some awake and transfer their pensions from the
optimistically priced super funds and switch to those whose prices are more
realistic, and low. It is the smart thing to do. If there is one lesson
from the crisis, it is ‘if there can be a run, there will be one’.

Another country is Italy. It seems to think itself relatively safe.
Italians (and most Europeans) have shown a hubris over financial implosions
in America. It is worth recalling that in absolute terms, and pro rata to
national GDPs, European institutions own more of America’s mistructured and
bankrupt sub-prime debt than the Americans themselves. Where is it? Too
much we believe in Italy. There, opaque bank balance sheets make Japan’s
look as clear as glass. The industry is fractured. Like Iceland (but to a
far lesser extent), there are considerable cross holdings, mystery nominee
companies and asset shuffling by feisty entrepreneurs. These in turn are
often highly geared, with a maze of cross-holding debt structures. When the
giant hornet of the recession flies into this web, it will simply it snap.

Embrace the

A global Depression is likely to be avoided by a whisker; a fast and
vicious recession now is a certainty. Although key forecasts are being
revised lower, they still lag this outlook. The IMF’s latest suggestion
that China will grow next year by 9.6%, and that the volume of World trade
by 4% are but two examples of excess optimism. China will enter a
recession, defined as 4-6% growth. At this level, social unrest tends to
accelerate. The collapse in commodity imports, from copper to steel, show a
slowdown already under way. Another obvious cause is the once insatiable
appetite of American consumers, to import at least five toasters and three
refrigerators for each home has already ceased. As regards growth in world
trade, the 4% forecast is also optimistic, given demand for bulk
commodities, such as oil and iron ore, is tumbling.

Consumer incomes will be squeezed until the pips squeak, because of
correct government actions to focus only on saving the major banks.
National budgets are blowing up into huge deficits. The idea that America,
the world’s most important economy, is sure to have a budget deficit of 10%
of GDP in 2008/9 is simply eye-popping, as is the 40% increase in the last
six months in the public sector borrowing requirement in the UK. To finance
these giant deficits, governments will have to tax more and spend less.
Just as the bank rule book has been torn up, so the global abattoir is
hardly large enough to slaughter the queue of sacred cows. In Britain, the
burgeoning black hole in of state sector pension funds will have to be
minced. Apart from the fact that many have been mismanaged for years (their
leap into Icelandic deposits because they were approved by discredited
rating agencies, or their belief that the higher the deposit rate, the
better the bank, prove the statement), their over-generous terms are now
unaffordable. Whether the government achieves this through a wholesale rise
in the retirement age, increased taxation on pensions, or a cap on the
payout rate like utilities to RPI minus, is a moot point. Another chopper
must be taken by all governments to welfare.

Although welfare abuse is rampant across Europe, statistically it is
worst in British and is both unaffordable and wasteful. As we have reported
before, false unemployment statistics have dominated the last decade.
Unemployment sank from well over two million to under a million. Meanwhile,
those of working age but permanently incapacitated soared from under a
million to well over two million. Cute trick. So Britons are the puniest
people on the planet, according to officialdom. Aggressive steps will have
to be taken to prune the number, if only because of the certainty that
unemployment will rise, thus busting the budget even further. State
directed capitalism must emerge with heavier-handed, state monitoring of
its population.

Whilst liquidity and lending will gradually improve, governments will
want to rebuild ‘their’ banks’ balance sheets as fast as possible.
Globally, official interest rates will be slashed; the unusually
co-ordinated cuts earlier this week by six major central banks is but the
start. Lending rates however, will stay high thus increasing the margin
between deposit rates and the price of loans. Fees will also soar, such as
new extra charges in most economies for arranging a mortgage. Many did not
exist at all even a year ago. Credit card companies will lower credit
limits to individuals, irrespective of true personal wealth, as their
imperative has switched from maximising profits to minimising losses. Only
the best personal balance sheets will get decent-sized limits. If
individuals cannot obtain credit, they are forced to save if they want to
buy a new car, or a home. In the 1970s and early 1990s recessions, savings
rates in advanced countries rose dramatically: in Britain from 2% to 12%,
in America a slightly smaller rise. 12% again seems a good educated guess,
especially as the starting point is record low savings rates (-1.1% in the
UK for the first quarter). Thus the impact on retail economic activity is
dire. As governments tax more and cut expenditure, and the consumer is
forced to save, this is why for 2009 we pencil in at least two quarters of
serious GDP contraction for the UK, US, Spain, Australia, Ireland and


We did not expect that within two weeks of a financial meltdown, Russia
would have achieved a key military ambition. As four Scandinavian
governments dithered over supporting their fifth cousin a window opened, in
through which Putin flew like Count Dracula, with a $4bn lifeline to
Iceland’s government: “no strings attached”. Oh yes? Russia in
Europe has always been “choked”. The Black Sea/Bosporus ext is
tricky. Large naval vessels can leave Petersburg but the Baltic straights
too, are narrow. Hence much of the fleet is in the only other port,
Murmansk. Even from there, the problem has been that to get the navy into
the North Atlantic, it is blocked by other straits such as the English
Channel. In 2005/6, NATO schizophrenically decided to poke Russia in the
eye by putting missiles along its European border, and also to close its
Keflavik Airbase in Iceland (although there are still a few odd American
planes there). It has handed Russia at worst a neutral sea passage, almost
certainly a refuelling base/friendship zone. This makes us slightly dither
about defence stocks. They look cheap but historically in recessions,
governments have slashed military expenditure. The UK could cut back its
still quasi-imperial ambitions and become a Belgian-type power. Even so,
across all Western Europe, so antiquated are many armaments and so poorly
equipped many of the troops, it may be that defence, usually the first cow
to the slaughter is actually fattened up instead.

America too has usually slashed defence budgets in previous recessions,
and could do so now. Any one of the 14 battle fleets has more fire power
than the entire Chinese navy. The totality of America’s naval firepower is
nearly 60% of the entire world’s navies combined; such overwhelming
superiority is unnecessary in terms economic expenditure or national
security. Yet operating in two oceans, with Russia sending off a fleet to
Venezuela in one (we’re amazed the rust buckets got there at all) and a
Chinese naval building programme which is accelerating, we suspect
America’s military will continue to claim its full funding. So too wills
NASA: rocket launches already planned from Asia will allow more communist
cadres to peer down at Houston from space than ever before. This is not
going to be popular.

This is

For all these imponderables and uncertainties, investors can start to do
that ‘light at the end of the tunnel’ thing. If the hurricane had hit in
2005 or 6, the damage would have been less; but this is spilt milk, move
on. The light is that correct actions are now in train. Many savers will
still lose money in those weaker institutions which the governments have
rightly decided to sacrifice, to preserve the core of the system. It will
be unfair and unpleasant, but the right action. More important is that just
as banks in each country will consolidate down to a core handful, so the
same will apply in many other sectors. Consolidation is the new trend.
Normally the advice would be to buy small bombed-out niche companies with
good businesses, knowing that giant multi-nationals, most of whom have
surprisingly strong balance sheets, will be buyers. However, the number of
already wounded, as their banks reduce or refuse to roll over their loans
at all, mean these multi-nationals can be very picky, and wait. Just as
government-induced bank consolidation ensures their balance sheets should
recover far faster than had there been no intervention, so more voluntary
consolidation in other sectors will have a similar result. Consider the
semi-conductor industry (if only for a moment). It is about to be
obliterated. Huge over-capacity and rapidly tumbling demand. By as soon as
end 2009, it is a good bet the number of manufacturers will have halved.
Their profit cycle will then boom. Consolidation in pharmaceuticals has
already started, one of the few sectors with very strong free cash flow and
growth. In telephony, the parasitic companies are about to be sprayed with
DDT. These lived off the incompetence of once state owned incumbents to
move into the mobile market and almost universally, are highly borrowed,
rely on ever-available bank credit and ever-rising sales. The consumer
always foregoes trips to the cinema or theatre in a recession. This time he
will hunker down in front of his broadband-fed, all singing and all da
ncing pc/TV/call-centre/work station. Only the ex-national monopolies can
proved this service, the rest blow away like chaff.

Despite consensus forecasts for corporate profits in 2009 being still
way too happy — we are pencilling profits ex the banks for the MSCI World
Index in 2009 of minus 9% – the return to an almost forgotten world of
national and international cartels to reboot the economic cycle may well
ensure that after a steep recession, a return to mild profit growth may be
none too far away. The ‘death’ of free markets is sad: for a while we were
all rich, it was fun and you didn’t have to work much either; just own a
house and a lot of debt. The imminent brave new world of state directed
banks and cartelisation of sectors is inherently corrupt and less efficient,
but should work. It is certainly the least bad solution for us all; yet
this very different and cartelised world could be rather interesting, and
profitable. Although indices have every chance of a roaring bounce soon, in
2009 many will sink again. Even so, too many large company valuations are
already forecasting a Depression. We think state owned banks are
temporarily rather a good idea, and many company valuations look pretty
interesting, especially versus bonds, property or even cash. Growing huge
ears or sticking a white feather up your nose is another option, but not

Georgia and Iraq – New President’s Nightmare

The following is from a weekly newsletter I read. I think they do a wonderful job of taking the “spin” off of the media’s issue of the moment. They also provide possible strategic reasons for actions taken around the world. This article has nothing to do with trading. However, it does provide some context for my job as a commodity broker and the issues our next President is going to face.    



By George Friedman

The United States has been fighting a war in the Islamic world since 2001.
Its main theaters of operation are in Afghanistan and Iraq, but its
politico-military focus spreads throughout the Islamic world, from Mindanao to
Morocco. The situation on Aug. 7, 2008, was as follows:

  1. The
    war in Iraq
    was moving toward an acceptable but not optimal solution.
    The government in Baghdad was not pro-American, but neither was it an
    Iranian puppet, and that was the best that could be hoped for. The United
    States anticipated pulling out troops, but not in a disorderly fashion.
  2. The
    war in Afghanistan
    was deteriorating for the United States and NATO
    forces. The Taliban was increasingly effective, and large areas of the
    country were falling to its control. Force in Afghanistan was
    insufficient, and any troops withdrawn from Iraq would have to be deployed
    to Afghanistan to stabilize the situation. Political
    conditions in neighboring Pakistan
    were deteriorating, and that
    deterioration inevitably affected Afghanistan.
  3. The United
    States had been locked in a confrontation with Iran over its nuclear
    , demanding that Tehran halt enrichment of uranium or face U.S.
    action. The United States had assembled a group of six countries (the
    permanent members of the U.N. Security Council plus Germany) that agreed
    with the U.S. goal, was engaged in negotiations with Iran, and had agreed
    at some point to impose sanctions on Iran if Tehran failed to comply. The
    United States was also leaking stories about impending
    air attacks on Iran by Israel or the United States
    if Tehran didn’t
    abandon its enrichment program. The United States had the implicit
    agreement of the group of six not to sell arms to Tehran, creating a real
    sense of isolation in Iran.

Special Topic Page

In short, the United States remained heavily committed to a region
stretching from Iraq to Pakistan, with main force committed to Iraq and
Afghanistan, and the possibility of commitments to Pakistan (and
above all to Iran
) on the table. U.S. ground forces were stretched to the
limit, and U.S. airpower, naval and land-based forces had to stand by for the
possibility of an air campaign in Iran — regardless of whether the U.S. planned
an attack, since the credibility of a bluff depended on the availability of

The situation in this region actually was improving, but the United States
had to remain committed there. It was therefore no accident that the Russians
invaded Georgia on Aug. 8
following a Georgian attack on South Ossetia.
Forgetting the details of who did what to whom, the United States had created a
massive window of opportunity for the Russians: For the foreseeable future, the
United States had no significant forces to spare to deploy elsewhere in the
world, nor the ability to sustain them in extended combat. Moreover, the United
States was relying on Russian cooperation both against Iran and potentially in
Afghanistan, where Moscow’s influence with some factions remains substantial.
The United States needed the Russians and couldn’t block the Russians.
Therefore, the Russians inevitably chose this moment to strike.

On Sunday, Russian Prime Minister Dmitri Medvedev in effect ran
up the Jolly Roger
. Whatever the United States thought it was dealing with
in Russia, Medvedev made the Russian position very clear. He stated Russian
foreign policy in five succinct points, which we can think of as the Medvedev
Doctrine (and which we see fit to quote here):

  • First, Russia recognizes the primacy of the fundamental
    principles of international law, which define the relations between
    civilized peoples. We will build our relations with other countries within
    the framework of these principles and this concept of international law.
  • Second, the world should be multipolar. A single-pole
    world is unacceptable. Domination is something we cannot allow. We cannot
    accept a world order in which one country makes all the decisions, even as
    serious and influential a country as the United States of America. Such a
    world is unstable and threatened by conflict.
  • Third, Russia does not want confrontation with any
    other country. Russia has no intention of isolating itself. We will
    develop friendly relations with Europe, the United States, and other
    countries, as much as is possible.
  • Fourth, protecting the lives and dignity of our
    citizens, wherever they may be, is an unquestionable priority for our
    country. Our foreign policy decisions will be based on this need. We will
    also protect the interests of our business community abroad. It should be
    clear to all that we will respond to any aggressive acts committed against
  • Finally, fifth, as is the case of other countries,
    there are regions in which Russia has privileged interests. These regions
    are home to countries with which we share special historical relations and
    are bound together as friends and good neighbors. We will pay particular
    attention to our work in these regions and build friendly ties with these
    countries, our close neighbors.

Medvedev concluded, “These are the principles I will follow in carrying out
our foreign policy. As for the future, it depends not only on us but also on our
friends and partners in the international community. They have a choice.”

The second point in this doctrine states that Russia does not accept the
primacy of the United States in the international system. According to the
third point, while Russia wants good relations with the United States and
Europe, this depends on their behavior toward Russia and not just on Russia’s
behavior. The fourth point states that Russia will protect the interests of
Russians wherever they are — even if they live in the Baltic states or in
Georgia, for example. This provides a doctrinal basis for intervention in such
countries if Russia finds it necessary.

The fifth point is the critical one: “As is the case of other countries,
there are regions in which Russia has privileged interests.” In other words,
the Russians have special interests in the former Soviet Union and in friendly
relations with these states. Intrusions by others into these regions that
undermine pro-Russian regimes will be regarded as a threat to Russia’s “special

Thus, the Georgian
conflict was not an isolated event
— rather, Medvedev is saying that Russia
is engaged in a general redefinition of the regional and global system.
Locally, it would not be correct to say that Russia is trying to resurrect the
Soviet Union or the Russian empire. It would be correct to say that Russia
is creating a new structure of relations
in the geography of its predecessors,
with a new institutional structure with Moscow at its center. Globally, the
Russians want to use this new regional power — and substantial Russian nuclear
assets — to be part of a global system in which the United States loses its

These are ambitious goals, to say the least. But the Russians believe that
the United States is off balance in the Islamic world and that there is an
opportunity here, if they move quickly, to create a new reality before the
United States is ready to respond. Europe
has neither the military weight nor the will to actively resist Russia.
Moreover, the Europeans are heavily dependent on Russian natural gas supplies
over the coming years, and Russia can survive without selling it to them far
better than the Europeans can survive without buying it. The Europeans are not
a substantial factor in the equation, nor are they likely to become

This leaves the United States in an extremely difficult strategic position.
The United States opposed the Soviet Union after 1945 not only for ideological
reasons but also for geopolitical ones. If the Soviet Union had broken out of
its encirclement and dominated all of Europe, the total economic power at its
disposal, coupled with its population, would have allowed the Soviets to
construct a navy that could challenge U.S. maritime hegemony and put the
continental United States in jeopardy. It was U.S. policy during World Wars I
and II and the Cold War to act militarily to prevent any power from dominating
the Eurasian landmass. For the United States, this was the most important task
throughout the 20th century.

The U.S.-jihadist war was waged in a strategic framework that assumed that
the question of hegemony over Eurasia was closed. Germany’s defeat in World War
II and the Soviet Union’s defeat in the Cold War meant that there was no
claimant to Eurasia, and the United States was free to focus on what appeared
to be the current priority — the defeat of radical Islamism. It appeared that
the main threat to this strategy was the patience of the American public, not
an attempt to resurrect a major Eurasian power.

The United States now faces a massive strategic dilemma, and it has limited
military options against the Russians. It could choose a naval
, in which it would block the four Russian maritime outlets, the Sea
of Japan and the Black,
Baltic and Barents seas. The United States has ample military force with which
to do this and could potentially do so without allied cooperation, which it
would lack. It is extremely unlikely that the NATO council would unanimously
support a blockade of Russia, which would be an act of war.

But while a blockade like this would certainly hurt the Russians, Russia is
ultimately a land power. It is also capable of shipping and importing through
third parties, meaning it could potentially acquire and ship key goods through
European or Turkish ports (or Iranian ports, for that matter). The blockade
option is thus more attractive on first glance than on deeper analysis.

More important, any overt U.S. action against Russia would result in
counteractions. During the Cold War, the Soviets attacked American global
interest not by sending Soviet troops, but by supporting regimes and factions
with weapons and economic aid. Vietnam was the classic example: The Russians tied
down 500,000 U.S. troops without placing major Russian forces at risk.
Throughout the world, the Soviets implemented programs of subversion and aid to
friendly regimes, forcing the United States either to accept pro-Soviet
regimes, as with Cuba, or fight them at disproportionate cost.

In the present situation, the Russian response would strike at the heart of
American strategy in the Islamic world. In the long run, the Russians have
little interest in strengthening the Islamic world — but for the moment, they
have substantial interest in maintaining American imbalance and sapping U.S.
forces. The Russians have a long history of supporting Middle Eastern regimes
with weapons shipments, and it is no accident that the first world leader they
met with after invading Georgia was Syrian
President Bashar al Assad
. This was a clear signal that if the U.S.
responded aggressively to Russia’s actions in Georgia, Moscow would ship a
range of weapons to Syria — and far worse, to Iran. Indeed, Russia could
conceivably send weapons to factions in Iraq that do not support the current
regime, as well as to groups like Hezbollah. Moscow also could encourage the
Iranians to withdraw their support for the Iraqi government and plunge Iraq
back into conflict. Finally, Russia could ship weapons to the Taliban and work
to further destabilize Pakistan.

At the moment, the United States faces the strategic problem that the
Russians have options while the United States does not. Not only does the U.S.
commitment of ground forces in the Islamic world leave the United States
without strategic reserve, but the political arrangements under which these
troops operate make them highly vulnerable to Russian manipulation — with few
satisfactory U.S. counters.

The U.S. government is trying to think through how it can maintain its
commitment in the Islamic world and resist the Russian reassertion of hegemony
in the former Soviet Union. If the United States could very rapidly win its
wars in the region, this would be possible. But the Russians are in a position
to prolong these wars, and even without such agitation, the American ability to
close off the conflicts is severely limited. The United States could massively
increase the size of its army and make deployments into the Baltics, Ukraine
and Central Asia to thwart Russian plans, but it would take years to build up
these forces and the active cooperation of Europe to deploy them. Logistically,
European support would be essential — but the Europeans in general, and the
Germans in particular, have no appetite for this war. Expanding the U.S. Army
is necessary, but it does not affect the current strategic reality.

This logistical issue might be manageable, but the real heart of this
problem is not merely the deployment of U.S. forces in the Islamic world — it
is the Russians’ ability to use weapons sales and covert means to deteriorate
conditions dramatically. With active Russian hostility added to the current
reality, the strategic situation in the Islamic world could rapidly spin out of

The United States is therefore trapped by its commitment to the Islamic
world. It does not have sufficient forces to block Russian hegemony in the
former Soviet Union, and if it tries to block the Russians with naval or air
forces, it faces a dangerous riposte from the Russians in the Islamic world. If
it does nothing, it creates a strategic threat that potentially towers over the
threat in the Islamic world.

The United States now has to make a fundamental strategic decision. If it
remains committed to its current strategy, it cannot respond to the Russians.
If it does not respond to the Russians for five or 10 years, the world will
look very much like it did from 1945 to 1992. There will be another Cold War at
the very least, with a peer power much poorer than the United States but prepared
to devote huge amounts of money to national defense.

There are four broad U.S. options:

  1. Attempt to make a settlement
    with Iran
    that would guarantee the neutral stability of Iraq and
    permit the rapid withdrawal of U.S. forces there. Iran is the key here.
    The Iranians might also mistrust a re-emergent Russia, and while Tehran
    might be tempted to work with the Russians against the Americans, Iran
    might consider an arrangement with the United States — particularly if the
    United States refocuses its attentions elsewhere. On the upside, this
    would free the U.S. from Iraq. On the downside, the Iranians might not
    want —or honor — such a deal.
  2. Enter into negotiations with the Russians, granting
    them the sphere of influence they want in the former Soviet Union in
    return for guarantees not to project Russian power into Europe proper. The
    Russians will be busy consolidating their position for years, giving the U.S.
    time to re-energize NATO
    . On the upside, this would free the United
    States to continue its war in the Islamic world. On the downside, it would
    create a framework for the re-emergence of a powerful Russian empire that
    would be as difficult to contain as the Soviet Union.
  3. Refuse to engage the Russians and leave
    the problem to the Europeans
    . On the upside, this would allow the
    United States to continue war in the Islamic world and force the Europeans
    to act. On the downside, the Europeans are too divided, dependent on
    Russia and dispirited to resist the Russians. This strategy could speed up
    Russia’s re-emergence.
  4. Rapidly disengage from Iraq, leaving a residual force
    there and in Afghanistan. The upside is that this creates
    a reserve force
    to reinforce the Baltics and Ukraine that might
    restrain Russia in the former Soviet Union. The downside is that it would
    create chaos in the Islamic world, threatening regimes that have sided
    with the United States and potentially reviving effective intercontinental
    terrorism. The trade-off is between a hegemonic threat from Eurasia and
    instability and a terror threat from the Islamic world.

We are pointing to very stark strategic choices. Continuing the war in the
Islamic world has a much higher cost now than it did when it began, and Russia
potentially poses a far greater threat to the United States than the Islamic
world does. What might have been a rational policy in 2001 or 2003 has now
turned into a very dangerous enterprise, because a hostile major power now has
the option of making the U.S. position in the Middle East enormously more

If a U.S.
settlement with Iran
is impossible, and a diplomatic solution with the
Russians that would keep them from taking a hegemonic position in the former
Soviet Union cannot be reached, then the United States must consider rapidly
abandoning its wars in Iraq and Afghanistan and redeploying its forces to block
Russian expansion. The threat posed by the Soviet Union during the Cold War was
far graver than the threat posed now by the fragmented Islamic world. In the
end, the nations there will cancel each other out, and militant organizations
will be something the United States simply has to deal with. This is not an
ideal solution by any means, but the clock appears to have run out on the
American war in the Islamic world.

We do not expect the United States to take this option. It is difficult to
abandon a conflict that has gone on this long when it is not yet crystal clear
that the Russians will actually be a threat later. (It is far easier for an
analyst to make such suggestions than it is for a president to act on them.)
Instead, the United States will attempt to bridge the Russian situation with
gestures and half measures.

Nevertheless, American national strategy is in crisis. The United States has
insufficient power to cope with two threats and must choose between the two.
Continuing the current strategy means choosing to deal with the Islamic threat
rather than the Russian one, and that is reasonable only if the Islamic threat
represents a greater danger to American interests than the Russian threat does.
It is difficult to see how the chaos of the Islamic world will cohere to form a
global threat. But it is not difficult to imagine a Russia guided by the
Medvedev Doctrine rapidly becoming a global threat and a direct danger to
American interests.

We expect no immediate change in American strategic deployments — and we
expect this to be regretted later. However, given U.S. Vice President Dick
Cheney’s trip to the Caucasus region, now would be the time to see some
movement in U.S. foreign policy. If Cheney isn’t going to be talking to the
Russians, he needs to be talking to the Iranians. Otherwise, he will be writing
checks in the region that the U.S. is in no position to cash.