The Cutting Room Files, Part 3: The Future of Canada

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Read the other installments in this series:
 
The CRF Files, Introduction
CRF Files, Part I: The Future of Korea
The Cutting Room Files, Part 2: The Future of Mexico
The Cutting Room Files, Part 4: The Future of Japan
The Cutting Room Files, Part 5: The Future of the United Kingdom
The Cutting Room Files, Part 6: The Future of China
The Cutting Room Files, Part 7: Europe
The Cutting Room Files, Part 8: American Politics
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by Peter Zeihan and Michael N. Nayebi-Oskoui 

This piece is part of the Cutting Room Files, portions of the upcoming Disunited Nations text that were cut for length. Disunited Nations is available for pre-Order now on  Amazon.com, Harper Collins, and IndieBound.

Canada is… not a normal place.

Everything from its settlement patterns to its defense strategy to its national politics to its economic structure is wildly different not just from the United States, but from every other country on the globe. Until now that has not had an overly negative impact upon Canadian-American relations, but times are changing (and from the Canadian point of view, not for the better). To really understand recent shifts, we need to start not in Canada, but in Mexico.

It comes down to demography.

Mexico has a more-or-less standard demographic profile. Lots of children, a good number of young workers, fewer mature workers and very few retirees. Chart it out, children on the bottom and retirees on the top, and courtesy of simple mortality you get a pyramid.

For purposes of the North American market, there are two big takeaways here. First, Mexico is hungry. All those young workers having lots of kids means the country is a never-ending festive parade of spending on education and food and diapers and homes and cars. Second, Mexico isn’t all that skilled. This is less an indictment of Mexico’s educational system, and simply that people below age 40 don’t have all that much experience in their chosen professions. It makes Mexico excel at relatively low-value-added manufacturing and assembly, but the Mexicans are forced to leave the high-value-added stuff and design to others.

For the Americans, this makes Mexico the perfect complement. Its people are ravenous for American exports, the Mexican work force meshes nicely America’s more high-value-added workers, and for the most part the two countries do not compete head-to head. No wonder that Trump’s rhetoric on Mexico has evolved so strongly over the course of the past two years from issues of trade to issues of identity and migration.

Simply put, from American point of view, the Mexican demography is the demography of the perfect partner.

Canada’s is not.

Canada’s population bulge isn’t among the young workers who complement the American economic structure, but instead among the mature-worker demographic who compete. A demographic bulge in the 40-65 bracket means Canada is super-saturated with high-skill workers. This extra supply depresses the cost of skilled labor within the Canadian system, which has a similar impact upon the price of the goods the country’s skilled labor force produces.

Even worse, the lack of 20- and 30-something Canadians means Canada cannot even consume its own production. It must dump that production on foreign markets, and proximity alone means that some 75% of it goes to the United States. Economically, Canada isn’t a partner. It is a competitor, and that’s before one considers the Canadian tendency to subsidize industries as unrelated as dairy and aerospace and timber and electricity.

In a time when the Americans are pulling back from the global system and rewriting all their trade relationships, this alone would be cause for great concern in the Great White North. But the Canadian-American economic mismatch is only the first problem.

The second problem in Canadian-American relations is the Americans are having a change of heart about their northern neighbor not simply in economic terms, but overall.

When the Trump administration started its whole the-world-is-screwing-us-and-we’re-going-to-forcibly-renegotiate-all-trade-deals campaign, the Canadians took it as an opportunity to make demands of the United States. That clearly didn’t fit with TeamTrump’s understanding of what was supposed to be going on. Why in the world would the Canadians believe they have leverage over the government who controls the only market that matters to Canada, and global finance, energy and sea lanes to boot?

Canada’s confidence dates back to the Cold War. The flight path for the feared Soviet nuclear missile strike on the United States would have been over Canada. There was no version of American security that would not by default also guarantee Canadian security. The Canadians could have been security free-riders if they had chosen to, but to their credit they have fought and died alongside American soldiers in nearly every overseas endeavor the U.S. military has undertaken.

That does not mean the Canadians did not use their leverage, they just used it on issues of trade rather than security, leveraging their strategic position to gain concessions on market access for their products. The Canadians had a strong hand and they played it well. Repeatedly. Those trade victories were all folded into the original NAFTA accord back in the early 1990s.

It all fit with the times. The whole concept of the American-led global Order was that the Americans would create and subsidize a security and trade rubric to induce countries to join them in the fight against the Soviets. Guns-for-butter was the rule of the era. Canada’s position meant it had more to offer, and granting Ottawa some extra trade concessions for its cooperation was a price the Americans were eager to pay.

Times change.

Canadian negotiators resisted the Trump administration’s trade goals, thinking Canada’s leverage still existed. But with the Cold War over, the Americans no longer fear Russian attack. Canada is now just another country. Once the Americans had finalized NAFTA2 with Mexico, they turned to Canada and issued a simple ultimatum:

Mexico’s market is growing. Yours is not. Your market is protected. Mexico’s is not. The Mexican labor force is complementary to ours. Yours is not. We have a deal with the country that matters, and that isn’t you. We are leaving NAFTA. You know our terms. Take them or leave them. We are moving on.

In a single searing moment of revelation, everything that had guaranteed Canada leverage over America, everything that granted Canada a place in the world, everything that had generated any meaningful international influence, had evaporated. Canada capitulated within days and signed on for NAFTA2.

All things considered, as emotionally crushing and economically damaging as a forced rejiggering of Canadian-American relations will be, it could be (a lot) worse. Canada is very close to the top of a very short list of countries that the Americans have positive feelings for. Will the Canadian ego and economy suffer under NAFTA2? You betcha. But Canada will still enjoy privileged, security-risk-free access to the American market. In a post-Order world precious few countries can claim the same. Canada may limp, but it will still be able to walk.

Unless the third issue completely overturns the Canadian system from the inside.

Again, Canada is not a normal place. Unlike the United States where the states and federal government exercise roughly equal amounts of power, in Canada the provinces are preeminent and often have the ability to block federal policies they do not like. The country didn’t even get its first comprehensive internal free trade agreement until 2017.

As such, the provinces of Canada function less like components of a common country, and more like a loose clutch of independent countries which compete – oftentimes furiously. That would be problematic enough if the provinces shared a common demographic base. That, they do not.

Quebec is as vitriolically Francophone as the Maritimes are Anglophone. A huge chunk of the population of Toronto is South Asian, while East Asians tend to be overrepresented in Vancouver. The Prairies are as white bread as America’s upper-Midwest. These splits at least partially explain the seemingly never-ending drama of Quebecois separatism, but it is the intersection of demography and economics where the real problems erupt:

The Maritimes’ economies crashed decades ago and its subsequent “recovery” has been anemic at best. Now those provinces have all aged into mass retirement making them de facto wards of the national government. Mighty Quebec is only a few years behind, and is making the transition to demographic basket case right now. Both British Colombia and Ontario are no more than five years behind Quebec. A big piece of the BC economy is serving as the gateway to Asia, and the Trump administration’s trade war is likely to enervate those links. Even worse, the NAFTA-integrated manufacturing and agriculture that makes Ontario and Quebec hum were sectors that specifically benefited from NAFTA1, and which now face far steeper competition from the United States and Mexico under NAFTA2. More specifically, Quebec’s aerospace company, Bombardier, is both one of the most heavily subsidized in the world and is linked into Airbus – a firm that is both the target of extensive American tariffs and one whose fate is locked up in the Brexit drama.

Functionally, that restricts economic dynamism to the demographically young provinces of Alberta and Saskatchewan, a pair of entities whose economies depend upon old-school oil and natural gas production. For years now, funds transfers from the pair – quintuply so from Alberta – to the center is what has enabled Canada to enjoy its much-lauded social welfare state.

That’s not the end of the story, but instead just the beginning.

Canada’s leader is one Justin Trudeau, a scion of a powerful family. Justin’s father, Pierre, was a force of nature. Love him or hate him, everyone acknowledged that Trudeau the Senior was a commensurate politician. Dude could work a room, and it isn’t much of a surprise that he served as Canada’s prime minister for 16 years.

Justin, in comparison, isn’t a particularly smooth operator. His rise to the prime minister’s chair five years ago largely occurred because of circumstance. Many Canadians had tired of a decade of conservative minority rule under the somewhat curmudgeonly Stephen Harper. A coalition of liberal players banded together around the Trudeau name and managed to carry an election.

In that environment, Trudeau the Younger fit the bill. He isn’t very bright, his French is on the weak side, his past work experience was at best mediocre, but he is young and so very very pretty. In a world of social media and an increasing split between modern liberal values and traditional economic sectors, that proved enough.

Under Justin Trudeau’s rule Canada has… gotten by. There have been no disasters, but few serious new policies. Really, Justin Trudeau’s administration has only shifted two things.

First, it has steadily centralized power in Ottawa, making it easier to drain cash from Alberta and Saskatchewan both to balance out the slipping economic performance of the rest of the country, and to push this or that pet policy. Second, the pet policy of the moment is a fairly aggressive environmental program that has proven popular with Justin Trudeau’s base. That program has put ever-more-stringent restrictions on the economies of Alberta and Saskatchewan – specifically on the sectors that make the Canadian national budget possible.

Justin Trudeau’s lackluster performance has cost him. His Liberal Party has been ejected from parliaments in Alberta, Saskatchewan, Ontario and some of the Maritimes in favor of the conservatives; in BC in favor of the left-leaning NDP and Greens; and in Quebec in favor of more nationalist sentiments who are furious with his capitulation to the Americans in NAFTA2.

Within the Liberals, the future isn’t all that bright either. Aside from the Trudeau name, the one characteristic that Justin inherited from his father is the charisma necessary to suck all the air out of the room. Justin is such a big presence that there is no next-generation of young leaders working their way up through the Liberal Party ranks. When Justin falls, so too will the party.

Fast forward to this week.

The Canadians voted in national elections October 21. Justin Trudeau’s Liberals were not exactly gutted, but they lost a lot of seats ending up with just 157, thirteen shy of what’s necessary to form a majority government. That will force the Liberals to rely upon support from the Greens (whose primary concerns are climate change policies) and the NDP (who are like a more math-challenged version of the Greens).

For Canada as a whole, this courts disaster.

Political sentiment in Alberta and Saskatchewan turned sharply anti-Green and anti-Trudeau years ago. The Albertans and Saskatchewanians assert the Greens, the NDP and the Trudeau government are actively conspiring to stymie any and all efforts to get Albertan and Saskatchewan energy exports to the wider world. The Greens and NDP openly say they do, with anti-Albertan policies in the one province they control – British Colombia – having reached the point that BC and Alberta have a hot little inter-provincial trade war going. The Trudeau government attempts to be at least a bit circumspect on the issue, but under Justin Trudeau’s rule construction has yet to begin on a single cross-province pipeline.

Legally, there is an excruciatingly painful route forward. Quebec’s on-again, off-again independence spasms firmly established that Canadian provinces have the right to leave Canada. Paths to secession have been approved – at least in theory – by both the Canadian parliament and the Canadian Supreme Court. We are approaching the witching hour.

There is no modern Canada without Albertan and Saskatchewan financial strength, and there is no Albertan and Saskatchewan financial strength without the two provinces’ energy sectors. Now, with the Liberals needing Green/NDP support to rule, the already-deep political split is taking on more ideological, more hostile overtones.

The vote breakdown is not encouraging. In Monday’s elections the Liberals lost every seat they previously held in both Alberta and Saskatchewan. In an echo of America’s 2016 presidential elections, the opposition Conservatives actually won the popular vote, but because of Canada’s equivalent of America’s electoral college they earned 25 fewer seats than the Liberals. Further mirroring America’s more recent political evolutions, Justin Trudeau claimed a “clear mandate” for stricter climate-change-related policies – an assertion positively Trumpian in its ability to creatively reinterpret the facts on the ground.

We are likely to see two things over the course of 2020.

First, the new federal political alignments are the absolute worst-case scenario for Alberta and Saskatchewan. They have already tried and failed – horribly – to renegotiate their financial relationship with Ottawa, and now they can look forward to ever harsher restrictions on their economic capacity paired with ever more robust siphoning of their wealth to the Canadian center. The formal, open, public debate on secession begins now.

Second, the Americans are likely to take both notice and action.

In the War of 1812 Canadian colonials burned down the American capital. In the war’s aftermath, realizing the Americans would be jonesing for revenge, the Canadians carried out what has arguably been the most successful rebranding effort in history, from trigger-happy arsonists to polite, cuddly socialists.

That effort enabled Canada to avoid American wrath. Later, Canada maintained a bit of protection due to its status as part of the British Empire. In the interwar period the U.S. had bigger fish to fry at home, what with the Great Depression and all. Post-World War II the Americans’ need to maintain the global Order meant that Canada, for all its inconsistencies, was under American protection – which included protection from America.

The Canadian system is splitting along provincial, economic, demographic and ideological lines, and there is no one in the Trump administration who likes Justin Trudeau personally, ideologically or politically. Add in a now-unrestrained America, an America who sees Canada as a competitor, an America who sees the Canadian government as a mix of annoying and ungrateful and self-righteous, and a complete role-reversal is fully in play. Unless the Canadians can get their shit together, it will be eeeeeeasy for Washington to start cutting deals with individual Canadian provinces to hammer preexisting wedges ever-deeper into the Canadian system.

Alberta has the means and motive to destroy Canada. Washington has the means and motive to destroy Canada. And the likely format of the new Trudeau government is providing the opportunity.

The Cutting Room Files, Part 2: The Future of Mexico

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Read the other installments in this series:
 
The CRF Files, Introduction
CRF Files, Part I: The Future of Korea
The Cutting Room Files, Part 3: The Future of Canada
The Cutting Room Files, Part 4: The Future of Japan
The Cutting Room Files, Part 5: The Future of the United Kingdom
The Cutting Room Files, Part 6: The Future of China
The Cutting Room Files, Part 7: Europe
The Cutting Room Files, Part 8: American Politics
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by Peter Zeihan and Michael N. Nayebi-Oskoui

This piece is part of the Cutting Room Files, portions of the upcoming Disunited Nations text that were cut for length. Disunited Nations is available for pre-Order now on  Amazon.com, Harper Collins, and IndieBound.

American-Mexican relations have been…colorful of late. American President Donald Trump has threatened Mexico with a rising tariff system that would constitute the greatest tariff effort in dollar terms by Americans in their history. Mexican President Andres Manuel Lopez Obrador (AMLO) is pushing a change to tax law that would more or less treat businesspeople like money launderers which would throw trade relations into the freezer. Threats and counterthreats on migration and trade and law enforcement and energy and water rights have ratcheted up to near-crisis levels.
 
This is actually… really good. Ever since Mexican independence in the early 19th century, American-Mexican relations have oscillated between cold-shoulders and American invasions. Today, really for the first time in both countries’ histories, the Americans and Mexicans are not talking past one another, but instead speaking with each other. The process is loud and messy, yes, but it is actually a conversation. The United States and Mexico are working out deals, making functional compromises, and finding common ground. What’s been happening the past two years are the sorts of interactions one would expect between two countries who find themselves increasingly intermingled both economically and demographically. We all fight most vociferously with our families.
 
That hardly means it is all well thought out. One of the most frustrating things about working in the geopolitical forecasting space is that sometimes luck plays a role, and that has most certainly been the case of late.
 
Consider the individuals helming both countries.
 
In the United States, Donald Trump rose to power on a wave unapologetic nativism, which expressly included a harsh campaign against Mexico on economic, political, security and racist grounds. On the other side of the border is AMLO, a guy who combined Trump’s disdain of foreigners, Elizabeth Warren’s enthusiasm for dressing down corporate interests, Ted Cruz’s penchant for blind obedience to ideological dogma, a Clinton-esque love-affair with political corruption, and Bernie Sanders’ pathological refusal to engage in basic mathematics. It’s difficult to imagine a set-up that would be less constructive to functional bilateral relations.
 
And yet, here we are, with the Americans and Mexicans enjoying the most positive bilateral relationship ever.
 
The unexpected outcome largely has to do with an olive branch from AMLO. After his election in mid-2018, but before his inauguration in late-2018, AMLO apparently had an epiphany. He realized that if he and Trump engaged in a binational pissing contest over who was more populist, the bad blood would consume his entire presidency. As he had put together a laundry list of tasks to remake Mexico in his own image, that simply would not do. So he reached out to both his predecessor and Trump, and indicated that if they could complete the renegotiation of NAFTA2 before he took office, he would not seek to reopen talks and would ensure the new deal would be ratified in a timely manner.
 
AMLO has since proven to be a man of his word. Mexican ratification occurred on June 19 of this year.
 
While there are obviously portions of NAFTA2 the Mexicans are less than enthused about and the new deal will disrupt a great many industrial patterns across the length and breadth of Mexico, for the most part the new deal is as much a win for Mexico as it is for the United States.
 
Among the Trump administration’s biggest goals in the NAFTA renegotiations was to make sure goods that benefitted from the low tariffs of the NAFTA system were mostly produced inside of it. These “rules of origin” quotas were increased and ensure that a certain percentage of the product’s value was produced within Mexico, Canada, and the United States rather than outside of it. As Mexican manufacturing capacity is both less expensive and more efficient than most manufacturing in both China and Canada, Mexico will certainly pick up a disproportionate share of whatever relocates to the North American market. Add in the general breakdown of the global Order, and Mexico’s now-even-more-privileged access to the American market, and Mexico’s economic future looks brighter and brighter.
 
Merchandise trade is only one of several aspects of a tightening, more constructive, relationship between the two North American powers.
 

  • One of the many aspects of America’s shale revolution is an accidental, incidental oversupply of natural gas prices in the U.S. market. American natural gas prices are now the lowest (unsubsidized) in the world, and a dozen major pipeline networks have been laid down to connect that supply to Mexican demand. All the pipes are now completed and soon about half of the electricity consumed in Mexico will be sourced from American natural gas.
  • One of AMLO’s less-functional plans is an overhaul of Mexico’s state energy monopoly Pemex, a company so badly run and a process so ill-conceived that it would probably be better for Mexico to burn the entire company to the ground, shoot everyone involved, and start over from scratch. The more dysfunctional Pemex is, the less able Pemex will be able to meet Mexico’s growing energy needs… and so the more reliable a customer Mexico is for American energy product exports.
  • Mexico has rapidly developed since the implementation of the first NAFTA accords back in the early 1990s. That has shifted millions of Mexicans off subsistence farms and into urban environments, even as the standard of living of the average Mexican has surged. Less agricultural production plus more disposable income makes Mexico a premier destination for American agricultural products. In particular, when Mexicans get a bit of extra scratch, the first food product they reach for is beef – American beef.
  • Higher living standards within Mexico have gutted immigration from Mexico to the United States – it has been negative for ten straight years. That gives both countries a vested political interest in regulating Central American migration through Mexico to the United States. One of the dirty secrets of the immigration debate in North America is that Mexicans are even more opposed to Central American migration than Americans. Trump has provided the Mexicans with the perfect excuse to crack down on the through-migration, while enabling the Mexican government to rack up a public relations win.
  • While Mexican migration to the United States peaked years ago, past migration has made Americans of Mexican extraction the second-largest minority in the United States. Even if the economic mingling were not occurring – and it has already surpassed that of any other American co-mingling in history – the demographic co-mingling easily puts Mexican cultural influences in third place behind German and British culture.

 
Taken together, Mexico is now America’s second-largest partner in energy, trade, agriculture and security, and is on the cusp of taking the top spot in all categories.
 
So… that’s the good news.
 
Understanding the bad news requires a bit of a step back.
 
Roughly a decade ago Mexican and American authorities were tracking hundreds of small groups involved in moving cocaine and marijuana through Mexico to America’s southern border. Just as mountainous regions help fracture regions among several competing countries, Mexico’s mountainous geography meant no single drug trafficking organization (DTO) could command all that much territory. A small DTO might control a single stretch of highway, or a single city or a local shake-down racket. Violence between these groups and Mexican law enforcement was horrific, but that carnage was nothing compared the violence among the various drug trafficking groups as they battled to expand their role in the drug trade or defend their patches from one another. In that environment, Mexico’s murder rate soared.

But even then, not all DTOs were created equal because not all DTO leaders were created equal. Today’s story involves a 5’ 6” dude by the name of Joaquín Guzmán, aka El Chapo (which roughly translates as “shorty”), who ran his drug group less like the Sopranos or a street gang, and more like a Korean chaebol.
 
Under his hand, the Sinaloa alliance focused on three general themes:
 

  • First, the bread and butter of drug smuggling to the United States. Violence within the alliance was snuffed out, while the sort of petty violence – assaults, rapes and robberies – that characterized other DTOs was frowned upon. Regular Mexican citizens living in Sinaloa territory were not terrorized by the cartel, so they tended to not resist its efforts.
  • Second, experimentation with new business lines that would enable the Sinaloa to deepen and expand its business. Cocaine never went out of fashion, but the cartel also commercialized heroin and methamphetamines. Selling counterfeit pills to profit from Americans’ opiate addition was an easy add. Cash-heavy businesses found favor as a means of assisting in the drug-money-laundering effort: limes, beef, avocados, real estate, tourism. More business lines mean more and more stable profits.
  • Third, oblique cooperation with the Mexican government to help weaken the competition. Officially, the Sinaloa would provide the Mexican government with scads of intel on their competitors’ operations. Unofficially, the Mexican government would turn a blind eye to the Sinaloa’s operations because Mexico City could only prosecute raids on so many targets at a time. The Gulf and Zeta cartels tended to suffer the most from this de facto alliance.

 
El Chapo’s strategies were so successful the Sinaloa grew to become the most powerful organized crime group not simply in Mexico, but the world. As the Sinaloa alliance expanded and deepened, violence among its constituent components plummeted. After all, they were all on the same side, and El Chapo did not tolerate infighting. Mexico’s murder rate fell.

But nothing happens in a vacuum. Sinaloa’s success meant it also became the most powerful organized crime group in the United States, which earned El Chapo a spot at the top of the Obama administration’s most-wanted list. A joint American-Mexican effort resulted in his arrest in 2014. El Chapo promptly escaped… and was re-arrested in 2015. Mexico extradited him to the United States in 2017, where following his conviction on… lots of charges he is now serving multiple life sentences in an American prison.

Without the business-minded El Chapo to ride herd on the Sinaloa alliance, the relative peace of the Sinaloa era quickly collapsed as the DTO’s various factions fought for control. The biggest and baddest of those factions is known as the Jalisco Cartel Nuevo Generacion, a group run by the Sinaloa’s former enforcers. Whereas the Sinaloa expanded by collaboration and diversification, the Jalisco expands by brute violence.

Four things come from this.

First, the Jalisco is not the Sinaloa v2.0. The Jalisco’s leader – Nemesio Oseguera Cervantes aka El Mencho – first instinct is to kill everyone in every room he enters. He absolutely lacks El Chapo’s charisma and management skills. The Jalisco is expanding, particularly in challenging its former patron, the Sinaloa, but it is most certainly not on course to dominate the drug trade.

Second, between the Sinaloa’s fall and the Jalisco’s rise, Mexico’s murder rate is once against setting record after record. El Mencho has also – repeatedly – broken the cartels’ unwritten rule that one does not engage in open violence in tourist areas.

Third, the Sinaloa is not dead and still supplies the majority of drugs that enter the United States. After a year of chaos and breakdown, elements of El Chapo’s family – most notably his sons – have seized control over what was left of the alliance and thrown up substantial roadblocks to El Mencho’s bloody expansion. Los Chapitos may not be the leaders their father was, but they have proven far from incompetent.

To give an idea of just how potent the Sinaloa remains, consider the events of last week. A government raid October 17 on a suspected sniper in the city of Culiacán accidentally captured one of los Chapitos. Shocked by their unexpected haul, the government stammered a bit. Shocked by the loss of one of their own, the entire Sinaloa alliance descended upon the city in a tsunami of carnage, forcing the unprepared government to release El Chapo’s son. In northwest Mexico, the Sinaloa remains the de facto government. The old man would undoubtedly be proud.

Which brings us to the fourth and arguably most important outcome. El Chapo’s business diversification efforts combined with the breakdown in the “peaceful” nature of the Sinaloa’s management strategy combined with the rapidly deepening economic integration between the American and Mexican markets means that the cartels are now becoming part of the North American economic picture and they are bringing their violence levels with them.

At present this expansion has not penetrated manufacturing – that’s an industry that’s simply too high value-add and too finance-heavy for easy links with DTOs. But nearly everything else is game: transport, trucking, energy, agriculture, construction, tourism, real estate. All these sectors and more now have DTO threads woven throughout, particularly in the Sinaloa heartland of northwest Mexico. And it doesn’t take a big leap to link these Mexican sectors with their American peers. First landfall of Mexican DTOs in these veins will be U.S. regions just across the border from Sinaloa strongholds: Tucson, Phoenix, El Paso, San Diego, Los Angeles and the California Central Valley.

It is worth remembering that while the collapse of the global Order has consequences for everyone, and in many cases those consequences will be the determining factor in a country’s future, regional and local factors don’t simple fade away. Countries’ local geographies and local economic trends and local histories remain relevant. Global shifts are likely to favor Mexico more than any other country, but it can still get tripped up on issues closer to home.

And the same goes for the third NAFTA partner…

CRF Files, Part I: The Future of Korea

[mk_mini_callout]
Read the other installments in this series:
 
The CRF Files, Introduction
The Cutting Room Files, Part 2: The Future of Mexico
The Cutting Room Files, Part 3: The Future of Canada
The Cutting Room Files, Part 4: The Future of Japan
The Cutting Room Files, Part 5: The Future of the United Kingdom
The Cutting Room Files, Part 6: The Future of China
The Cutting Room Files, Part 7: Europe
The Cutting Room Files, Part 8: American Politics
[/mk_mini_callout]

by Peter Zeihan and Melissa Taylor

This piece is part of the Cutting Room Files, portions of the upcoming Disunited Nations text that were cut for length. Disunited Nations is available for pre-Order now on Amazon.com, Harper Collins, and IndieBound.

When Donald Trump became president, world leaders fell into two broad buckets. The first thought that if the Americans were going to drop the global mantle of leadership, then perhaps there is some space for us. Russia’s Vladimir Putin became more aggressive throughout the Russian near abroad. France’s Emmanuel Macron tried to become the voice of the West. Canada’s Justin Trudeau became a liberal supermodel.

The second were those leaders who weren’t sure the Americans knew what they were doing in electing an isolationist, and thought the best bet was to not rock the boat. This club included Germany’s Angela Merkel, Australia’s Malcolm Turnbull, and Britain’s Theresa May. All and more bet/hoped that Trump would be little more than a hiccup in normal relations. They kept quiet and aimed to not do anything that might annoy the Americans as a whole, so that when Trump left the stage their relations with America could get back to normal.

There was one exception: South Korean President Moon Jae In. Rather than strike out or hunker down, Moon bluntly asked for the terms of a revised trade deal that Trump would approve of.

Moon’s logic was unassailable. Put simply, Moon recognized that he completely lacked leverage, (correctly) calculating that being an eager first volunteer might allow South Korea to walk away without undue sacrifice as the Trump administration looked for an early win. The revised deal’s technical talks took but a few weeks, and the revised KORUS is already implemented.

Good thing too. “Logic” was about all Moon had going for him. Everything about Korea’s success is exclusively because of the Order.

South Korea imports all its oil and natural gas, and its import/export flows are so large that it is the world’s 5th-largest trading power by value despite having a population of only 51 million. As with many of the world’s developed economies, South Korea cannot look internally for greater economic growth; The country’s population has all but peaked and, again like much the rest of the world, faces a rapidly aging demography supported by an ever-smaller working age population.

South Korea’s largest trading partner today is actually China, but that is the beauty of the Order. South Korea can trade with whomever is willing to buy their goods. For now. It all relies on American guarantees that seem to be crumbling.

That’s the numbers and dollars argument. In strategic terms things are far more complicated.

South Korea sits among Japan, China and North Korea and has adversarial relationships with all of them. The only reason South Korea even exists is because American troops ward off the most salient threat to the north, while preventing Japanese and Chinese imperialism. That security guarantee is not easy to maintain:

North Korea believes the best way to beat a Grand Master at chess is to never let them make a first move. Infamously, North Korea has aimed an untold number of pieces of artillery at Seoul, just across the border and home to nearly half the country’s population. In a real war, by the time the first shell lands in Seoul, tens of thousands of others would already be airborne. But this is only one of its many preparations. Turns out that if you dedicate a country’s entire attention span for 70 years to a seething hatred of what’s on the other side, you can accomplish some pretty impressive things, up to and including an effective nuclear deterrent.

South Korea decided to focus instead on ships and trains and petrochemicals and white goods and electronics and computers and cellular tech. South Korea may be able to prevail against North Korea in a knock-down, drag-out fight, but there is no way the South Koreans can K-Pop themselves out of hideous infrastructure damage and mass civilian casualties. Only American forces – massed in and near Seoul and the DMZ – can provide the hitting power to at least partially preempt and mitigate such carnage.

That’s just North Korea. The South Koreans, accurately reading their history and geography, view China and Japan as even more significant security threats. Japan outpopulates South Korea by well over 2:1, China by over 20:1. The navies of either country could wipe the Korean navy from the seas in days. To the south, east, and west, South Korea is surrounded by waters that either Japan or China could dominate given the right push. South Korea’s second city, Busan, is in a particularly vulnerable spot separated from mainland Japan via the Korea Strait, barely more than 100 miles across. Inchon, the western extremity of the Seoul metro region, isn’t much further away from China. And of course, Korean trade links to the wider world are impossible to maintain without both Japanese and Chinese quiescence.

For decades this has all been moot. South Korea, Japan and China were all members of the U.S.-led global Order. The U.S. Navy has ensured peaceful seas and ample trade. Oil, LNG and raw materials flow in, finished goods flow out, and Korea is one of the world’s largest transshipment and manufacturing nodes. So long as the Americans remain involved, Korea’s economic and security problems remain purely theoretical.

But the Americans – left, right and center – want to slim down America’s global position. The Korean deployment is America’s third-largest (after Japan and Germany), and the one that is by far in the trickiest and riskiest strategic position. And that is what keeps Moon’s administration up at night. The Americans are losing interest, and there is no version of a post-Order world where South Korea continues to survive at all – much less as a wealthy, trading nation – unless Seoul can obtain a powerful, dedicated ally.

So it was all Moon could to do cave in trade talks with the American administration on everything. And not just in trade negotiations. The Trump administration is insisting that South Korea compensate the United States for ongoing troop commitments to the tune of at least $5 billion annually. That’s a lot for a country Korea’s size, but honestly it’s a bargain considering what 26,000 American troops can do when they are suitably motivated.

Is caving to the U.S. on trade and defense reimbursement enough to keep the American troops in-country in this post-Order world? No clue. But Moon, correctly, concluded that without conceding to American terms there was no chance whatsoever. 

That’s hardly the end of the story.

First, in the post-Order world, getting a deal with the Americans on trade or troops or whatever is not the end of the negotiations. It is the beginning. Because the Americans no longer have a global strategy or see a national interest in play aside from getting some better market access, keeping the Americans interested requires giving in not once, but every single time they ask for anything.

If the Yanks are displeased with the Koreans’ response, they will leave and there is no guarantee they can be induced to come back. It’s bad business to allow a homeowner that refused to pay for fire insurance to do so after the house catches fire. The Americans can – and will – watch the neighborhood burn. They won’t feel good about it, but they won’t feel all that bad about it either.

Second, the one item in the neighborhood the Americans really do care about – the North Korean nuclear program – is one that they may have found a way to muddle through. The handshake deal Donald Trump appears to have reached with North Korean dictator Kim Jung Un is that the reclusive country can keep their nuclear program so long as they abandon their ICBM program. The Trump administration seems to think it can live with a localized NorK nuclear threat so long as Pyongyang cannot nuke Seattle and beyond. What North Korea “projectiles” that have been launched since the first Trump-Kim summit are of the decidedly short-range sort, and there are at least some indications that North Korea dismantled a significant portion of their long-range missile testing facilities.

In a world where the Americans are blasé about South Korean issues, in a world where Americans no longer consider North Korea a direct threat, the Americans need a lot fewer forces in-theater. That’s great for the Americans…and the ultimate statement of no-interest in South Korea. The Trump administration appears to have handed off the entire North Korean issue to the local powers. And since North Korea already has the capacity to drop a nuke anywhere in South Korea or Japan or in the parts of China that are home to over 80% of the population, the entire region now has to deal with something that has stymied ten American administrations.

Finally, the Koreans have a hideously distasteful choice to make. They must prepare for a world without the Americans and that means they must find a new security guarantor. The menu of options are not encouraging.

While China is currently Korea’s largest trading partner, China is just as dependent upon the Americans as the Koreans for maintaining its economy and security. With the Americans checked out, China’s future will likely mirror its past; that of a broken, impoverished nation completely unable to maintain its own security or even feed its own people. Culturally, China might be Korea’s closest relation, but a long-term partnership will only bring Korea destitution.

In comparison, the future of Japan is bright. It already maintains the world’s second-most-powerful expeditionary navy and is one of the very few countries that has a chance to maintain its supply lines without active American assistance. The “smart” play for the Koreans would be to find a means of inserting themselves into the Japanese sphere of influence. Unfortunately, the politics of such insertion are wretched. The Koreans charge the Japanese with carrying out a cultural genocide during Japan’s 1905-1945 occupation of the Korean peninsula and, so far, have been unwilling to let the past go. Even then, letting that past go would only be the first step to entering Tokyo’s world. Much kowtowing by the proud Koreans would be required.

The third option is for South Korea to become its own defender. That is impossible with conventional weapons, but it just might work if the Koreans build a few dozen nukes to hold everyone at bay. Technically, the obstacles to South Korea becoming a nuclear power are minimal; it could be done in a few months at most. Operationally, however, it would turn South Korea into a regional pariah of the North Korean type and cut the country off from not just global trade, but regional trade (although post-Order that is unlikely to cause the same problems, as much as it is frowned upon today).

Partnership with China might be somewhat comfortable, but it would end with a starvation diet. Partnership with Japan might preserve the Koreans’ standard of living, but it would be politically toxic. Going nuclear might preserve independence, but it would force mass deindustrialization.

For the South Koreans, the future is a land of fear and want.

But that’s not the case for everyone…

The CRF Files, Introduction

[mk_mini_callout]
Read the other installments in this series:
 
CRF Files, Part I: The Future of Korea
The Cutting Room Files, Part 2: The Future of Mexico
The Cutting Room Files, Part 3: The Future of Canada
The Cutting Room Files, Part 4: The Future of Japan
The Cutting Room Files, Part 5: The Future of the United Kingdom
The Cutting Room Files, Part 6: The Future of China
The Cutting Room Files, Part 7: Europe
The Cutting Room Files, Part 8: American Politics
[/mk_mini_callout]

So…. it’s done!

The final text of my next book, Disunited Nations, is through copy edit and deep into proofing. Within a few weeks advance copies will be heading out for media review. Full publication is scheduled for the first week in March.

I’d like to thank everyone for their support, assistance and endless needling about when the damn thing will be finished. The world is a dynamic, ever-changing place, and nothing that I do happens in a vacuum. Everyone’s questions and comments and threats help shape what I know and what I look at. Please keep it up.

My goal with Disunited is less to sketch out the world as it is or as I would like to see it, and instead as it is about to be. Today’s world is dizzying in its complexity, but at its core it is a single integrated system underpinned by the Americans. This era is ending. Soon the world will fracture into a host of competing systems. Some purely national. Some regional.

My book contract said I would explain this world in 80,000 words. Heh. That didn’t happen. My first draft was 180,000. I was firmly, if politely, informed that wouldn’t happen either. We compromised with about 120,000. The rest ended up on the cutting room floor.

Anywho, as a partial thank you to all you who have directly and indirectly supported my efforts, and to perhaps keep some of those of you who are more intellectually ravenous at least partially sated, I’m happy to announce the launch of the Cutting Room Files. During the next couple of months we’ll be releasing an open-ended series of newsletters cobbled together from various bits that didn’t make it into the final version of Disunited Nations, as well as some embargoed not-quite-pieces of my previous books – The Accidental Superpower and The Absent Superpower – that have been waiting for release for some time.

Should you feel so inclined, you can click the following links to pre-order Disunited Nations on Amazon.com, Harper Collins, and IndieBound. Link options for Accidental and Absent can be found here and here, respectively.

But most of all, thank you all and happy reading!

Goodbye to the Middle East

This day was always going to happen.

On October 7, U.S. President Donald Trump announced a partial withdrawal of U.S. forces from Syria. Soon after, Turkish forces began moving south across the border to strike Kurdish forces which had been until extremely recently under American protection. Two days later the partial American withdrawal was upgraded to a full evacuation of all forces.

Wailing and gnashing of teeth across the American political spectrum quickly erupted, with many condemning the tactical and political aspects of the president’s decision. I’m of mixed minds:

On the one hand, the Kurds – whether in Syria or Iraq – have been America’s only reliable regional allies since America’s first major confrontation with Iraq back in the early 1990s. When we have asked, they have answered. Every single time. In many cases U.S. forces didn’t even do the heavy lifting, but instead relegated themselves to providing intelligence and materiel support. Without the Kurds’ assistance the overthrow of Saddam Hussein would have been far nastier affair, post-Saddam Iraq would have been far less stable, the defanging of ISIS and the destruction of the ISIS caliphate would not have happened. In Syria in specific, the Kurds habitually provided at least five times the forces the Americans did.

On the other hand, the United States was always going to leave Syria. If the Americans were unwilling to commit 100,000 troops to the overthrow of Syria’s Assad government and its subsequent forcible reconstruction, then there was little reason to become involved in a decades-long, grinding multi-sided civil war.

The primary reason American forces remain in Syria at this point is to limit Iranian penetration. That battle was lost six years ago when then-President Obama allowed the Syrian government to cross Obama’s own red line on the use of chemical weapons against Syrian civilians. Obama made it crystal clear that any U.S. military action would be small scale, focused on Special Operations Forces, and largely dedicated to backing up the Syrian Kurds. Whether under Obama or Trump, an American withdrawal has always been inevitable. It’s just taken seven years of Syrian-Russian-Iranian victories on the battlefield and the large-scale dismemberment of the ISIS Caliphate to make it imminent.

Aside from the Iranian vector, American national and strategic interests in Syria are utterly nonexistent. Syria – even backed up by Iran – is a military pigmy that Israel could easily shatter. If Jerusalem really wanted to, it could roll into Damascus in a long weekend. (Sticking around, of course, would be a barrel of shiv-wielding monkeys.) American interests in Lebanon are less than American interests in Syria. Jordan has been a de facto Israeli client state for years. And that is quite literally all she wrote.

The far more important fact – comfortable or uncomfortable depending upon your view – is that the evolving American view of Syria is really little more than a microcosm of an evolving American view of the Middle East writ large. American troop deployments throughout the region have been plunging for a decade and are now down to about one-tenth of their peak. America now has more troops in Afghanistan than the rest of the region combined, and that deployment is well on its way to a complete phase out. CENTCOM HQ in Qatar will almost certainly be closed soon (you don’t need a forward command center if there’s nothing to command). The Iraq advisory force is leaving. Kuwait, once the launchpad for multiple wars, has been reduced to lilypad status. The Turks are certain to eject U.S. forces from the Incirlik base within a year.

Within two years the total regional deployment figure will be in the low-to-mid single digits of thousands, at most one-fifth of what is there today.

That sounds shocking and, considering it wasn’t that long ago that the Americans had a quarter-million troops in-region, it kind of is. But take a step back and look – really look – at the region, and it actually isn’t all that mind blowing.
 
Iraq is falling apart. Mass unrest is now entering its third week and if it continues along its current trajectory it risks bringing down the government. That isn’t “bring down the government” European-style which would mean new elections, but instead “bring down the government” in the post-Arab Spring style, which means an extended period of mass chaos, violence, and very likely a return to some degree of civil war. While it is true that Iraq has experienced cyclical public unrest since 2015, never has the regional climate been more tenuous, with Iran, Turkey, and Saudi Arabia openly involved in regional conflicts – meaning the normal balancing act between Iraq’s Shi’ites, Kurds and Sunnis (and their foreign backers) is over. Stabilizing this mess would require the Americans (re)injecting 100,000 troops. Far more likely, the Americans will remove the five-ish thousand troops which remain, taking the last thin reed of stability with them.
 
Iran is the regional bugaboo that most Americans fear. Since the end of the Clinton Administration American policy has held quixotic goals: we want the Iranian government gone, but we don’t want to use U.S. forces to do it. Under Clinton that meant the dual containment. Under W Bush it meant a forward blocking position in Iraq. Under Obama it meant trying to set up a regional balance of power. Under Trump it means economic sanctions backed by exactly zero military force.
 
None of it has worked. None of it was ever going to work. The Shia clergy is the Iranian political elite, giving the Iranians the deepest bench of political leadership in the region. You’d literally have to kill 10,000 mullahs to induce a shift. Nor is Iran revolution-prone. The first task of the country’s infantry-heavy military is to occupy Iran to ensure domestic unity. There are solid reasons why Iran’s 2009 “Green Revolution” was over in under a month.
 
Nor is knocking Iran off feasible. Iran is a mountain nation, granting it a defensibility which partially obviates the sort of air and tank warfare for which the Americans are renown. Moreover, Iran’s population in 2019 is over triple that of Iraq in 2003. Overthrowing the government would necessitate a force over twice as powerful as the one that took down Saddam’s Iraq, followed by an occupation force three times as large. No thank you. The U.S. military and public has exactly zero interest in putting 400,000 troops back into the Middle East to fight another grinding war of occupation.
 
What about America’s “allies”?

The Persian Gulf

Qatar is the perfect example of a friends-like-these ally. In per capita terms it is almost certainly the top financial supporter of Islamic terror groups in the world (I say almost certainly since Qatar doesn’t disclose their terror accounting). On the nicer end Qatar fundees include the Muslim Brotherhood and Hamas, ramping up to more knifey groups like al Qaeda and ISIS. Doha also has a nuanced-to-positive relationship with Iran for various reasons, not the least of which is its gas wealth stems from the shared North Dome/South Pars gas field. Qatar has hosted the operational headquarters for most U.S. warfighting in the region for the past two decades despite being a place that is in part responsible for the Americans needing to do the warfighting in the first place.
 
That’s nothing compared to Saudi Arabia. A half century from now when today’s headlines are parsed for the history books, the world will remember Saudi Arabia’s current de facto leader – Crown Prince Mohammad bin Salman (MBS) – as one of the evilest individuals in modern history.
 
The sheer volume of public support, money, arms and ideological cover given to religiously-tinted fighters – that’s jihadis or terrorists based on your politics – by various Saudi citizens and royals alike has boomed in step with the Kingdom’s regional ambitions. (Qataris have been implicated in plenty of terrorist financing schemes, but fewer than a relative handful have taken up arms themselves; 9/11 shows that the same cannot be said for Saudis.) Saudi Arabia habitually backs the most extreme, violent interpretation of Islam and regularly exports it far and wide at the end of a gun or leading wave of an explosion.
 
MBS has taken things further. Once he realized the Americans were serious about leaving the region, he shifted tact and instead of simply seeking destabilization of his enemies, he now seeks to burn down the pillars of civilization across the entire field of competition. Much of the Sunni Islamic extremism in Syria can be laid at his feet, as can much of the ongoing violence and chaos in Iraq and Afghanistan. Nor are MBS’ actions limited to the battlefield. About a year ago on MBS’ orders, a hit squad suffocated and dismembered a Washington Post columnist in Istanbul, transported his remains to the Saudi consul general’s house where they were incinerated in a custom-built “barbeque pit” just before the consul hosted a massive party that utilized the same pit to help degrade any lingering forensic evidence.
 
MBS is not a friend, nor is Saudi Arabia an ally. America used to have to put up with this sort of activity from the Saudis during the Cold War because without Saudi oil, the global trading system would have collapsed and taken the American alliance network with it. Courtesy of America’s shale revolution, those days are over.
 
Rhetoric aside, even President Trump doesn’t see the bilateral relationship as all that close. Last month the Iranians launched a drone and missile attack on Saudi energy facilities, taking some 5 million barrels of daily output offline. Under normal circumstances that would have prompted massive American military retaliation. Instead, Trump’s response to MBS’ call for assistance was something along the lines of, “sorry, I have a fundraiser.” For those of you who think oil is a globalized commodity and so the U.S. remains vulnerable to price swings, think again. The president has preexisting authority to limit U.S. crude exports. Should global prices get too crazy, an executive order can keep U.S. shale output at home, splitting the North American energy market off from the global market. The Saudi headache is now optional.
 
Even Israel isn’t what it once was. Within the next decade the country’s mostly-Palestinian Muslim population will become the majority, although about 90 percent of them have no political rights in the Israeli system. The two-state process that sought to generate a country for the Palestinians has been dead for years and we have already seen the Israelis implement a very successful separation plan more than a bit reminiscent of South Africa’s Apartheid.
 
In fact, Israeli ultranationalists in private conversations even welcome the comparison to Apartheid, because they think Apartheid was gentler than what modern Israel has achieved. Under Apartheid, the black South Africans could travel to white-controlled zones for work. Under the Israeli program the Palestinians languish behind 35-foot-tall concrete walls in what are little more than open air prisons with the Israelis controlling Palestinian access to power, food and water. As the thinking goes, who cares if this radicalizes the Palestinians if they are radicalized on the other side of a wall. Arguably, places like Tunisia or Pakistan are now “more equal” democracies than Israel. (Ugh, I’m going to get so much hate mail for these last two paragraphs.)
 
Turkey and the United States have been pulling apart for three decades. In a world where Soviet containment is the end-all be-all, the alliance was everything. Remove the Soviet threat, however, and the Turks have interests in the Balkans, Caucasus, Persia, Mesopotamia and the Levant that have next to nothing to do with American interests. Turkey is reasserting itself as a major regional power, and since the American military position in places like northern Iraq and Syria are largely dependent upon supply routes through Turkey, there is no long-term American strategic position in these regions without express Turkish assistance. That assistance has been removed, so the Americans – regardless of domestic policy preferences – have no choice but to leave.
 
That just leaves the Kurds, a mostly mountain people. That makes them a fractious bunch whose fractured leadership has traditionally been willing to fight to the last Kurd to determine who is in command, while enabling more homogenous ethno-sectarian groups on all sides to easily demonize them, oppress them, and play them off one another. They are the largest ethno-sectarian group in the world without a country, and their entire land-locked population is split among Turkey, Iraq, Iran and Syria. For those familiar with West Virginia, Switzerland or Chechnya, squabbling oppressed mountain people make great fighters, and since they lack a country they have little to lose by allying with, well, anyone. No wonder the Americans depended on them so much.
 
But the Kurdish dream of independence was never going to be more than a dream. Landlocked and partitioned, the only way a real Kurdistan could emerge would be if one of the four countries which house Kurds actively sponsor it. That’s just not in the cards. The Kurds are a lost cause; They were never more than an ally of the moment.
 
They are hardly the only ally of the moment the Americans have abandoned. At the end of the Vietnam War the Americans left the Hmong – another fractious mountain people who allied with the Americans – in the lurch. Their massacre at the hands of the Vietnamese is the stuff of legend. Something similar is about to happen to the Syrian Kurds at the hands of the Turks. The biggest difference between the two groups is there are too many Kurds to resettle them to Minnesota.

So why all the noise back in the United States? Aren’t the Americans exhausted with the Middle East? Shouldn’t they be celebrating?
 
In part it is because the extreme unpopularity of Donald Trump means any decision he makes is going to be parsed for negative sound bites, and there is no end of hypocrisy in play. My personal favorite are the former Obama team talking heads hitting the airwaves who only now find Syria’s murder and mayhem worthy of American military action.
 
In part it is because abandoning an ally is bad form, particularly if you think the U.S. should play a role in preventing genocide, promoting human rights, stymieing traditional rivals, or keeping a hand on the throat of the global economy. Even if you think none of this is the U.S.’ business, you’ve got to admit a lot of stuff happens in the region, and having a finger in the pot does prove useful from time to time. In the grand scheme of things, 2000 troops in Syria isn’t that big of a deal.
 
A deeper (and IMO far more substantive) issue is the fate of America’s national security professionals. Trump initially liked the generals because of their “yes sir” and “can do” attitudes. After all, civilian supremacy means the president is in charge, you do what you are told and if you have a problem with the president’s policy you don’t undermine him, you leave. Well, two years on, pretty much all of them have left.
 
The break has become so extreme that Trump now considers national security-minded Republicans to be greater ideological foes than the Democrats. One of the big outcomes of the 2018 mid-term elections was the wholesale ejection of that faction from Congress as well as from the Republican Party leadership itself. For many of this group, Syria is the prefect example of poor leadership: Trump’s policy not only betrays a loyal ally, it abdicates an American role throughout an entire region. We can debate the pros and cons of that abdication, but for folks in the military, intelligence and diplomatic communities this is a step that unwinds a half-century of painstaking military, intelligence and diplomatic efforts paid for with untold resources and blood. You don’t have to view the world their way to understand why they’re pissed.
 
That doesn’t change the simple fact that if not for the seemingly bottomless volume of TrumpDrama in America these days, most Americans would probably be sighing in relief right now. If the Americans really don’t have an interest in maintaining a global Order, then the Middle East is barren of American national interests and it can now firmly be someone else’s problem. It isn’t nice. It isn’t responsible. It won’t be pretty. But that doesn’t mean it isn’t true.
 
Of course the road from here to there is neither straight nor level. There are still plenty of land-mines to dodge:

  • The evacuation of U.S. forces has been ordered, but it has not been completed. That evacuation has to proceed through the Turkish advance and through Turkey. Things are already looking dicey. Shortly after the initial withdrawal order some Turkish forces apparently (intentionally) dropped some artillery near remaining American outposts, forcing the remaining Americans to scramble lest they find themselves in a shooting war with the Turks. The U.S.-Turkish alliance is over, but based on how events unfold in the next couple of weeks a U.S.-Turkish hostility may emerge.
  • The Kurds of Iraq and Syria are both armed and trained and experienced and on the edge of statehood. Just because they (especially the Syrian Kurds) are doomed to fail does not mean they are doomed to fail today. How they fight back and/or seek alignment with Syria and/or Iran and/or Russia will determine the region’s next set of battle lines. This matters the most for the Turks. The Turks are out of practice, having not fought a meaningful military campaign since World War I. If they perform badly it will reshape their regional ambitions. If they perform well there are lots of regional players – Armenia, Russia, Iran and Saudi Arabia come to mind – who will be extremely worried.
  • Of those, by far the most important one is Russia. Like American forces, Russian forces can really only operate in Syria with Turkish acquiescence. With the Americans gone and the Turks ramping up, it’s probably the Russians’ turn to GTFO of the region. If they don’t, a direct Turkish-Russian clash that leaves the Russians on the wrong side of all their backup will ensue. The climbdown and/or massacre would be globally humiliating.
  • One smallish bit of good news is that the ISIS Caliphate is definitely gone, and the ISIS militant movement is broken and on the run. Many have opined that without the American-Kurdish alliance ISIS in any form would have never been defeated. That is true. But that’s not the same as saying that ISIS is doomed to rebound. Historically, the territory that comprises eastern Syria and western Iraq – the ISIS heartland – has been on the bleeding edge of useless. Rain doesn’t happen and the only crops grown are those in the Euphrates floodplain. In most places that band is less than 20 miles across. Civilizing this region is wildly expensive, and so the powers of the region tend to ignore it…until some wackadoo group like ISIS starts causing problems. Then one of the region’s powers invades and burns everything to the ground. From 2003 until 2018 the region’s powers were non-functional: Iraq and Syria had civil wars, while Turkey was gun-shy. The fact that the ISIS Caliphate lasted as long as it did was testament to how abnormal the region had become. Well, Turkey is now invading. It will burn everything to the ground. The atrocities the world is about to pin on the Turks mean we are returning to something a lot more normal.
  • Europe is… screwed. It is one thing to have to deal with a prickly Turkey who stays at home. It is quite another to have Europe’s largest land army deploying in force in a way that most Europeans have publicly condemned. With the exception of the French, no European power has the capacity of independent power projection to the region. And now Turkey is publicly threatening to herd millions of Syrian refugees to Europe’s doorstep unless the Europeans shut up about Turkey’s new military campaign. After the United States, Turkey ties with Russia for being Europe’s most important partner. Expect those ties to burn in the months to come.
  • Finally, there’s Saudi Arabia. In the aftermath of the Iranian attack on Saudi oil facilities, the Saudis have paid the Americans to deploy 3,000 troops to the Kingdom. Two things from this: First, sooner or later the Americans will internalize just how messed up the Saudis are and will evacuate everything at once, precipitating a whole new regional crisis. Second, the Americans going pseudo-mercenary is about to be the new normal. If you cannot provide something shiny to bait the Americans into your region (cash is shiny), then you are on your own. That development will reverberate far beyond the Persian Gulf region.

Why So Negative?

Bonds are sliding toward negative territory across the developed world.  Among the largest industrialized economies, only the United States is offering over 2% yields on 30-year bonds. And it’s not just the global economic pillars pushing rates down, but even in places like Poland that stretch the definition of “developed” market. Or Italy, which push the boundaries of concepts like “balanced budgets.” And even in Greece, which stretches the definition of… pretty much damn near everything. 

What gives? 

First, the technical answer. 

Part of the shift toward negative territory is quantitative easing (QE). QE is, in essence, the expansion of monetary supply above and beyond what the economy says it needs, and then using the newly “printed” currency to purchase various bonds. This artificially drives down borrowing costs of all kinds and inflates financial markets. The idea behind it is that cheaper borrowing costs and an inflated finance market will boost business and consumer confidence and from that, spending — thereby boosting demand in the real economy. 

Between the American, European and Japanese programs, the equivalent of some $15 trillion has been dumped onto markets through QE since the 2007 financial crisis. One reason for the dollar’s strength under Trump is that the United States’ QE program largely came to an end several years ago and the US has reverted to using more traditional monetary tools. In contrast, Europe has been at near-zero interest rates for a decade (and Japan for twice as long), leaving QE or things like it as their only means of using monetary policy to stimulate economic activity. The Eurozone, after a brief hiatus, just restarted QE again a few weeks ago. Japan never really stopped. 

It all adds up to a lot of money chasing limited investment opportunities. That boosts stock and property markets, while the surge into bonds pushes yields negative. 

Second, we have the traditional answer. 

There is a whiff of instability surrounding everything. Germany is undoubtedly in recession and will drag much of the Eurozone down with it. Japan hasn’t seen reliable, sustained economic growth since the 1980s. The American-Chinese trade war has collapsed global confidence in the Chinese economy while the HK protests have collapsed Beijing’s soft power. Meanwhile, it seems that nearly every country in the Middle East is facing some degree of crisis. Even if you’re an aficionado of my brand of Kool-Aid and believe that the US is largely resistant to global upheaval, “resistant” is not synonymous with “immune.” While I still do not see an American recession on the horizon, the American economy has most certainly slowed. 

Recessions — even fears of recessions — have consequences for capital. Spooked investors tend to push money into assets backed by either long-term income streams, government guarantees, or both. Fewer stocks, more bonds. High bond demand pushes yields down towards, to, and through zero. 

It isn’t so much that either answer is wrong. In fact, they are dead on. But they are not the whole picture. There’s something else going on. Something much bigger than QE and much more structural than the normal ebb and flow of economic cycles. 

It’s demography. 

People act differently depending on their age. There’s aren’t a lot of retirees at spin class, nor do college students frequent buffets that specialize in creamed vegetable products. In a “normal” economy there’s a set balance of roughly four children to three young adults to two mature adults to one revered elder. So long as that proportion holds the economic system has some somewhat straightforward characteristics: young workers spend and borrow, mature workers invest, while retirees shift their financial holdings into decidedly less interesting and volatile holdings. Fewer stocks — more t-bills and cash. 

The problem, if “problem” is the correct word, is that the onset of the Second Industrial Revolution roughly 140 years ago both pushed people off of the farm and into urban environments while vastly, dramatically increasing lifespans. As the decades rolled by our definition of “normal” has shifted. Families became smaller and smaller until most of the developed world slipped below the replacement level of 2.1 children per family. Among the developing world the process started latter, but the downward shift in fertility has been two and three times as fast. The partial exception? The United States. Its wealth of arable land has made it an industrialized country that urbanized slowly. The result? China’s population is already older on average than America’s, while Indonesia and Brazil’s will surpass America’s average ages in about a quarter-century.

The problem (and this time “problem” is certainly the correct word) is that the demographic shift has altered the structure of capital. From roughly 1970 to 2010 the decline in birth rates steadily increased the proportion of mature workers in the population relative to everyone else. It is this block that saves the most both in relative terms and in aggregate. Those savings are the bulk of the world’s working capital. Left unchecked, the growth of the mature worker cohort will eventually oversupply the world with capital.

Well, “eventually” is here. Right now, the population of mature workers as a proportion of global population is at its peak. As this cohort inexorably edges toward retirement, they are shifting their portfolios into less risky assets. Less venture capital, more bonds. The veritable tsunami of capital into the bond space has pushed the safest of those bonds — government debt — firmly into the negative.

Don’t get used to it.

The biggest thing that separates mature works from retirees is time, and in 2022 the majority of the world’s Baby Boomer cadre will have aged into mass retirement. Denied much in the realm of fresh income, the incoming tsunami of government-bond-capital won’t so much recede as evaporate.

Without those inflows, capital costs will — must — rise.

That’s the best-case scenario. It assumes no disruptions. No breaks in global continuity. A rapid climbdown from the trade war. That Italy doesn’t implode. That the Eurozone holds together. That the Brexit debacle calms down. That the Japanese economy can manage its aging and shrinking worker pool via automation and robotics. That the Chinese political center holds. That the broad swathe of the developing world can somehow double their standards of living in under a decade without sacrificing family size. That there’s no shock to energy markets. That the economic contortions of mass aging somehow magically avoid touching banking and finance. That the Americans elect a mild-mannered accountant to be their next president.

Anything that injures either globalization in general or employment and wealth levels specifically immediately imposes burdens, both in terms of raising financing costs directly and preventing capital created in one region from pouring into another. Fragmenting global capital markets will, all by itself, turn regions that have recently become used to ultracheap capital (sub-Saharan Africa, Brazil, and India come to mind) once again into capital deserts.

That’s still a pretty good scenario.

It assumes the global system while beaten and bloodied ultimately holds. Historically speaking, the downturns an instability we’ve experienced to date — and this includes the Great Recession — are pretty minor stuff. The global Order is what has enabled many countries to exist in the first place, and if you cannot exist you cannot issue bonds. A heartily inconvenient fact of economic history is that before the Order (that is, 1946), it was pretty common for markets to not simply fail but go to zero.

The first time that happens the financial markets will come face-to-face with a level of risk and risk pricing that no one alive has any expertise in managing.