Part VII: Ms Merkel Goes to Washington

How Merkel and Trump get along (or don’t get along) will determine the world’s path for at least the next three decades.

Here it comes.

German Chancellor Angela Merkel will meet with U.S. President Donald Trump tomorrow (March 15). These are the leaders of the two branches of the free world, and how they get along (or don’t get along) will determine the world’s path for at least the next three decades. I’m not hopeful. Two weeks ago the Trump administration issued its new trade guidance, which calls for nothing less than the unravelling of the global trade order.

The key institution is the World Trade Organization, a grouping formed by the United States expressly to manage global trade, most notably by adjudicating trade disputes. The WTO isn’t just some gathering like the G20, but instead a Senate-ratified treaty at the heart of U.S. economic law. In Trump’s new policy outline, which at a few hundred pages is by far the most detailed anything I’ve seen out of the Trump White House so far, Trump asserts that U.S. citizens are subject to U.S. law, not WTO rulings. When the two clash, U.S. law takes precedence. More than the travel ban or the Dakota Access Pipeline or Russians having conversations with the Attorney General, it is the implementation of this decision that will determine how our world will (d)evolve in the months and years to come. The WTO — indeed, the entire trade order — cannot function without the world’s largest market being open, and without the world’s largest navy making imports and exports of everything from iPods to Toyotas to French cheese to Kuwaiti oil safe for everyone.

I warned in the Accidental Superpower that it didn’t really matter to the United States how things unraveled, but that for everyone else “it truly matters whether the American shift from Bretton Woods occurs slowly over a decade of neglect or deliberately in a single [moment] of panicked fury” after the Americans have a really bad hair day. We are very clearly seeing the latter—no Trump jokes intended.

There are few countries with more to lose than Germany, and Merkel must be preparing for her summit with palpable dread.

Germany is not a normal country. Its territories are cobbled-together statelets that historically have had stronger local and regional, rather than national, identities. But whenever those statelets do start to act as one, their sheer heft tends to scare the bejeezus out of everyone else. A fractured Germany is one that falls prey to its neighbors; a unified Germany is one that its neighbors feel forced to tear down. Most of German (which is to say, European) history has obsessed with how to manage the German Question, and the answer has always been either grueling war or equally grueling occupation.

Except when the Americans were in control, that is. The whole point of the Bretton Woods system of free trade was to unify the world’s once-warring countries under a single rubric in order to contain, beat back, and destroy the Soviet Union. In this order Germany was no longer isolated target, but instead an integrated bulwark. With Germany and France and Spain and Italy and Britain and Sweden and Turkey and more all on the same side, the Germans could for the first and only time in their history expand economically without risk of invasion (except from the Soviets, of course). The time since the Bretton Woods era kicked off has not “simply” been the greatest period of peace and prosperity in human history, but it has been the only period of peace and prosperity in German history.

I say this without hyperbole: without Americans underwriting Bretton Woods, there is no free trade. No free trade, no EU and NATO. No EU and NATO, and suddenly Germany is once again exposed to the broad-spectrum competition that is Europe — a competition that Germany is by default the most powerful player, but equally by default cannot possibly win.

Merkel faces the impossible task of somehow convincing Trump that everything that he knows and believes spells disaster for Germany, Europe, and the global system. And that somehow that makes it bad for the everyday Americans, US strategic goals, and Trump himself as well. And to do so without triggering something worse. After all, it isn’t like it is Trump’s goal to deliberately and explicitly tear Germany down. He just doesn’t care.

I do not envy her that conversation.

The timing for Merkel couldn’t be worse. The entire European fabric is shredding, even before the Americans set sail in the other direction.

  • The United Kingdom is leaving the EU, giving fact to the fear that the EU is not Europe’s inevitable future. As London has already launched free-trade talks with the Americans, Canadians, Turks, Indians, Australians, Kiwis and the European Free Trade Association, there is a building horror that the Brits might not be destroyed by Brexit, and should that happen, then what is stopping other rich members from leaving?
  • Relations within the EU have turned acrimonious. A Polish internal spat is throwing a veritable troop of monkeys (and their wrenches) into EU workings, with Warsaw threatening to upset the entire EU order. At issue is the EU’s decision to override a Polish objection to a change of the EU president (the sitting Polish government is angry that the EU’s titular head is a former Polish prime minister from their domestic political opponents). The last time something like this happened, it was Margaret Thatcher using her anger at EU budgeting to stall all things EU for the better part of a decade.
  • The Dutch government — by far the most effective party at patching together EU unity in trying times — is likely not just to fall in elections this Wednesday, but might actually get replaced by the strongly Euro-skeptic party of Geert Wilders, a man who makes Donald Trump look positively calm and inclusive. Similar firebrands have already taken power in Hungary and Poland, seem posed to assert command in Italy, and that doesn’t even broach the topic of Marine Le Pen’s likely first round victory in France’s upcoming presidential elections.
  • Turkey is on the warpath, both figuratively and literally. First, figuratively: A big topic in current European politics is to prevent Turkish politicians from holding political rallies across Europe (typically with anti-European themes). It has gotten so bad that the Dutch government denied the Turkish foreign minister the ability to land his plane last week. As such, the notoriously prickly Turkish government is screaming it will cancel or subvert every single deal the Europeans have made with the Turks in the past decade—President Erdogan has even accused the Dutch of behaving like “Nazi remnants”. Now for the literally: Anti-ISIS efforts in Syria and Iraq are coming to a head outside of ISIS’ capital of Raqqa, Syria and its largest city of Mosul, Iraq. In both cases the U.S. and Europeans have become deeply involved in alliances that involve Kurds, something that so infuriates the Turks that it cannot help but impact Western-Turkish relations more broadly — and Turkey controls how many Syrian refugees can swarm up from Europe’s southeast.
  • Russia is reinforcing its positions not just in the Ukraine border region, but in Ukraine itself. A serious military effort may well be imminent. Putin sees a government in Washington that is testing the NATO alliance even more than he does, and Putin likes what he sees. Others have noticed. In late February the Swedes formally abandoned their post-Cold War optimism, reinstituting the draft.

And while normally I prefer to leave aside personality issues, they are depressingly relevant here. Merkel has a (well-earned) reputation for being methodical, slow to commit, pensive and in general reserved. Trump has an (equally well-earned) reputation for being the exact opposite. If ever there was a time that personal styles would be needed to help make impossible talks possible, it would be now. Instead, we have the opposite.

About the only thing Merkel (and Europe, and the world writ large) have going for them is the slim reed of hope that Trump’s anti-trade policies might not be finalized. Leaks out of the White House point to a “civil war” within the core Trump team between nationalist/isolationist/anti-trade personalities like Steve Bannon and Peter Navarro and more nuanced pro-business personalities such as Gary Cohn of the National Economic Council.

But the emphasis is definitely on the “slim”. The complete absence of strategists such as National Security Advisor HR McMaster or Defense Secretary James Mattis from the conversation, much less the broader debate, is crushingly telling. The United States is the least integrated major economy into the global system. For Washington the creation of the trade order was a strategic gambit with understood economic costs meant to underpin the Cold War alliance, not a plan perceived to generate economic gains. If Trump’s military advisors don’t see themselves as having a role in this trade debate, then that slim reed of hope is just the proverbial last flash before light vanishes from the sky.

Eyes on an Obscure Russian Minority

In The Accidental Superpower I noted that while the Chechens will always be a thorn in Russia’s side, that a different Muslim ethnic group — the Tatars — are the ever-present dagger to Russia’s heart.

Unlike the Chechens who are a semi-cloistered mountain people nestled in the Caucasus and so rarely leave their homeland, the Tatars are modern and cosmopolitan. They sit at the merger of the Oga and Volga rivers — the pair of navigable waterways elevate Russia to something more than just a wide-ranging country endowed with resources. As Accidental readers know, navigable waterways are the bedrock of economic success. They enable a people to establish internal trade, build their own capital, and move up the value-added scale organically.

Both the Oga and Volga are Russian rivers, but their junction is at the Tatars’ homeland. The Tatars also happen to live atop most of the major infrastructure that connects Russia to Siberia. Should the Russians ever lose control of the Tatars, they cease being a regional power, much less a global one.

In the past couple of years, Tatarstan has been simmering. Economic breakdowns, Kremlin confiscations of the regional oil company (Tatneft), and more recently a banking crisis. It’s been on my list to write about, but last night my former employer, Stratfor, beat me to the punch. Strat and I differ on many things of course, but they’re a great one-stop-shop for international news, analysis and intelligence that is so obviously lacking in national global media these days.

I’m happy to say that Stratfor was lost without me when I left back in 2012, but I’m even happier to say that they seem to have found their way in the years since — and are once again churning out some great work. This article, IMO, is emblematic of that.

Russia’s Eyes Focus on Tatarstan by Stratfor

Part VI: Working for Alliance

 

So I was sitting having dinner on the Queenstown wharf last night, minding my own business, when New Zealand Prime Minister Bill English and Australian Prime Minister Malcom Turnbull walked by. Like literally right by. No more than six fee-, er, two meters from where I was sitting.

What is it with the world not leaving me alone on holiday??

Anywho, rugby rivalry aside, there are no two countries in the world that are closer politically, economically and culturally. New Zealand and Oz are brother countries who face many of the same challenges and so typically choose to face them together. The two primes were having their countries’ annual coordination powwow.

From what I can gather from local press, while their agenda dealt with a fair number of local issues, their top foreign policy concern was dealing with the Trump Effect. Specifically, both New Zealand and Australia were founding members of the consortium of countries that negotiated the TransPacific Partnership trade deal (TPP). As the United States was about half of the TPP’s economic heft, both Australasian states were more than a bit disappointed when President Trump nullified American participation in the process. While in Queenstown, English and Turnbull apparently explored ways to proceed with “TPP minus one”, although English himself noted that it wasn’t likely feasible and his efforts could probably just be chalked up to “naïve Kiwi optimism”.

Whether you are like me and you think that China’s days are numbered, or you’re more with the conventional wisdom and so you fear that we will all be bowing to our Chinese masters before long, you probably think it makes sense to diversify your trade portfolio away from all things Chinese. TPP would certainly help do that, and so it isn’t a surprise that the Kiwis and Aussies are groping for a way forward without the United States’ participation.

But this all brings me to a broader point.

Take a look at the map below; it’s broadly is how Washington saw the world at the height of the Cold War. The deep blue countries are the Americans’ back yard — places they were willing to fling nukes over. The medium blue were the core allies in the Bretton Woods system. The orange was the competition, and the light-blues the field of battle. The Cold War was global in scope, so everything was in play. Everything mattered.

Not anymore.

This next map shows how I anticipate the Americans viewing the world in 2020. U.S. perceptions of the world have been evolving slowly away from global engagement since 1992. It’s a process that picked up speed with the 2007 financial crisis, and is now rocketing into fast-forward under Trump. (Note: I put this map together in in 2015 — before the Trump Effect — so this might all come to pass earlier than I initially expected.)

There’s a lot of grey on this map; places the U.S. just doesn’t have a stake in. Those blue shades are countries that IMO it would behoove the Americans to have a constructive relationship, but that’s not the same as saying that the U.S. must have one. U.S. alignments are shifting, and since the stability that the United States imposed upon the world from 1945 to the present was designed to fight the Cold War, there aren’t all that many pieces of it that are going to hold without deliberate efforts from both the Americans and partners on the other side of the table.

So far Continental Europe has demonstrated vividly its obliviousness in this dawning era, while Britain very clearly understands where its bread is buttered. Japan has showcased it comprehends fully the new era’s more transactional nature.

The Kiwis and Aussies are somewhere in the middle. Australian Prime Minister Turnbull had a disastrous first call with Trump which apparently went something like this:

TURNBULL: So, Australia had this deal with Obama where you’ll take some illegal immigrants from us.
TRUMP: What sort of a dumb deal is that? I hate illegals.
TURNBULL: But you’re still going to take them, right?
TRUMP: *insert TrumpTantrumTM*
TURNBULL: Is that a yes?

Not the right topic to use to break the ice with the Donald.

Anywho, the Australian government has long been a very savvy operator because they have to be. Australia has but 24 million people. Its closest neighbor — Indonesia — has ten times that, and once you look at the teeming masses of South, Southeast and East Asia it is easy for an Australian to feel a bit overwhelmed. Canberra’s only option is excellent relations with the United States. I fully expect Australian-American relations to bounce back from what was reportedly a quite nasty diplomatic snafu, but the botched Turnbull-Trump call serves to underline the point.

NO relationship, NO alliance, NO trade deal, and NO relationship is safe. When the Americans rejigger things, there are no sacred cows. The United States wasn’t involved in the first three years of World War II, and they ended up leading Normandy and nuking Japan. The United States didn’t care about Korea, and then a year later had over 300,000 troops on the peninsula fighting Chinese human waves. The U.S. treated the Middle East like a backwater until 9/11, then it fought two hot wars and intervened unconventionally in over 20 countries.

The U.S. doesn’t care until it does. And the U.S. cares until it doesn’t. Its geographic position and military reach enable it to intervene and/or stop intervening in issues that are of core importance to every other country in the world in a matter of days, and right now everything is up for re-evaluation. Even the American alliance with Australia — probably the most worry-free, strategically-simple, culturally-easy alliance the Americans have — can see change.

Well, that’s my morning rant. I’m off to brunch in Wanaka where who knows who I’ll bump into. (Apparently Oprah is in town!)

Shale Gets Ready to Run

A data dump by the International Energy Agency this weekend indicates that OPEC is enjoying its best compliance showing at least since the 1970s, if not ever. Over 90% of pledged oil production reductions have already materialized, with a few countries – most notably Saudi Arabia – overcutting. All together over the course of the past few months, total OPEC output is down just over 1 million bpd. The past two years of low-ish prices have hit non-OPEC producers as well, forcing reductions in their collective output of another 400kbpd. Stores of both crude and refined products have thus dropped across the world. No wonder oil prices have managed to hold strongly over $50 a barrel of late.

The question now is how positive will the impact upon the American shale industry be? In this there are no good guides. The nature of shale has evolved radically not simply since the industry’s modern inception in 2007 (ish), but even more so since the plunge in the price of crude began in mid-2014.

  • Since then the most productive wells have become multilateral, with multiple horizontal spurs going off every vertical well shaft. Since each of these multilaterals is crafted by a single drill, the rig count watch is utterly irrelevant.
  • Micro-seismic techs are enabling operators to take much — if not all — of the guesswork out of drilling and fracking. Such precision drilling means not only looking at the volume of steel used per well or per barrel of output is immaterial, but also that mass layoffs of rig workers can occur with no reduction in oil production.
  • Water intensity per barrel of output continues to shrink as liquids pits are replaced wholesale by mobile water tanks. Less water usage means less cash flowing through the oil sector, gutting one of the last few “reliable” means of indirectly gauging end-output levels.
All these tech changes (and more) push down the full-cycle break-even cost of oil production, and most certainly steepens the production accelerations for future output. But it isn’t “only” technological innovation that is overhauling the industry. There are other factors in play that will have a much more immediate effect.
  • When prices were low, many operators only fracked minimal bits of their wells to start them up — preferring to wait for a price recovery before fracking them up to full capacity. That time is now, but there is no unified data whatsoever on the size of this “fracklog.”
  • Improved seismic techs enable operators to go back to previous wells and drill additional fairways. Such “indrilling” enables new production into old infrastructure, eliminating the need for new pipes, new leases or new negotiations, while generating new and sustained flows with the newest techs available.

Whereas technological changes impact national output figures over months to years in a sustainable way, these more mechanical characteristics give big one-off increases in weeks to months.

The only potential short-term ointment-fly I see is financing. Nearly all the shale operators who survived the price plunge of the past two years did so at least in part by borrowing. Even with prospects now brightening, many of them will find it difficult to take on yet more debt to expand operations. Yet even here things look surprisingly good. Capital flight out of Japan, China and the Eurozone continues to set new records. Shale bonds grant foreign investors a place to park their cash that is backed both by hard assets and revenue streams.

In my opinion shale’s next surge is going to not just hit much harder, but much sooner, than most expect. And it is likely about to get a lot better.

What do Donald Trump, Brexit, the Iranian Ayatollah, EU dysfunction, Japanese constitutional revisions and Chinese President Xi’s efforts to establish himself as emperor-of-all-he-sees-for-life all have in common? They are all great for the shale sector. Global instability of all stripes means more capital flight. More risk means higher oil prices means more stable American operators. More international recrimination means more interest in commodities both as an asset class and a security blanket.

This doesn’t “merely” mean that the output curve for the shale industry will be steeper now than in 2007-2013, but that adding a fresh million bpd to U.S. oil output in calendar year 2017 is a lazily conservative forecast. Shale isn’t just likely to overwhelm the entirety of OPEC’s cut, but the entirety of the global reduction in output all by itself.

And that’s just the start. By end-2017 all those new techs should have percolated throughout the shale patch. Full-cycle break-even prices for shale are already below $40. Give it a couple more years and $25 will be within reach.

And then the real shale revolution gets started.

As to what that looks like, sorry, but you’ll have to read the book. Check it out at this link.

Part V: Watch Mattis, Not Flynn

While the news focuses on the Flynn scandal, Mattis puts NATO – and the global system – on notice.

So apparently whenever I go on vacation the rest of the world has a busy week.

Let’s focus on the United States.

While I was kayaking in Milford Sound, National Security Advisor Lt. General Michael Flynn was excused from his 24-day-old job. Flynn has a reputation for being a bit…volatile and monochromatic, so his departure from what I consider to be the job in the U.S. government that requires the most calm, far-reaching and level-headed thinking isn’t something I consider to be all that bad.

The political issue surrounding Flynn’s dismissal is that he allegedly discussed national security matters with the Russian ambassador, and then lied to now-Vice President Mike Pence about it. If Flynn indeed told the Russians that a Trump administration would take a softer line on all things Russian over the course of a series of conversations, then this may indeed have altered the Kremlin’s response to the Obama administration’s sanctions. Among Democrats in general and more national-security-minded Republicans, this is certainly the biggest foreign policy issue of the new President’s term.

Under normal circumstances I’d agree wholeheartedly, but as I’m sure everyone with a pulse has noticed, we’re not exactly in normal circumstances these days. Instead, a far more critical evolution is taking place.

A personality I take much more seriously than Flynn is the Defense Secretary, General James Mattis. At a NATO defense minister’s summit the day after Flynn’s dismissal (when I was hiking the Kepler Track near Te Anau), the good general put the entire alliance on notice. He flatly warned the allies that they must raise their defense spending – quickly and sharply – or face the Americans backing away from their alliance commitments. Specifically he noted with a degree of subtlety that only a Marine general could muster: “No longer can the American taxpayer carry a disproportionate share of the defense of Western values. Americans cannot care more for your children’s future security than you do.”

In my opinion, Mattis is deadly serious – hell, in my opinion Flynn was deadly serious – and both were/are executing policy not only with the full knowledge of President Trump, but are doing so because it is policy, not because of some quid pro quo with the Kremlin. The Americans are getting out of the global management business, and a rationalization of its alliance commitments – Europe included – is simply par for the course. All that remains is to see how quick and how deep the changes will be.

We might not have to wait long.

It was also reported in the past days that the Russians have deployed the SSC-8 medium-range missiles in violation of the landmark Intermediate-Range Nuclear Forces Treaty (or INF) signed between President Ronald Reagan and Soviet leader Mikhail Gorbachev. The creatively-named treaty bans all short-to-intermediate range (500-1000 km, or roughly 300-600 miles) nuclear and conventional missiles by either party. The agreement served as a stepping stone to more aggressive nuclear arms reductions, and in no way is it an understatement to say that the INF remains the lynchpin of all post-Cold War U.S.-Russian relations.

Looking at a map, it’s easy to see why. The primary beneficiary is Russia (and its predecessor state, the USSR). After the agreement, U.S. military bases sprinkled throughout NATO countries can not serve as launching pads for missiles designed, essentially, to reach Russia; similarly, the removal of such missiles from Russia’s arsenal directly impacts the security of the United States’ European allies. But these missiles simply cannot reach the continental U.S.

While slight mention was made within American media about the Russian’s violation of the INF, the message is being heard loud and clear by NATO. But for all of the prodding and threats by Mattis and the White House, the reality is clear: as the United States remains determined to reduce its global military footprint, Europe faces a Russia already well into its operational mobilization while most of Europe remains functionally disarmed to respond to such a threat.

This weekend is the Munich security conference. The Munich conference involves leading defense and foreign policy thinkers from both the NATO and greater European communities. It has no direct, formal impact – it’s  just a talk shop – but it has a reputation for not only candid discussions, but being a place where top government leaderships announce fairly startling policy changes. In the past German, American and Russian leaders have indicate shifts that fairly dramatically adjusted the regional centers of power.

And this weekend Vice President Mike Pence will be in attendance.

Part IV: Bribes, Trade and the European Union

Some countries are adapting to Trump and some don’t know the rules of the global system have changed. 

The Japanese government leaked a provisional policy document to Reuters late Jan 31 titled “U.S.-Japan Growth and Employment Initiative,” which noodles over how Japan can invest more heavily into the United States in a variety of economic sectors. The policy was supposedly read out loud to Reuters staff, and it is very clearly in the under-development stage with a great many gaps.It is expressly meant to pave the way for Japanese Prime Minister Shinzo Abe’s upcoming summit with Donald Trump on Feb. 10. Among the document’s noodling includes possible investments into various infrastructure projects and the shale sector. The leaker indicated that the investment would be on a scale that could generate “hundreds of thousands” of American jobs.

(Before you discount that “figure” as ludicrous, keep in mind that the Japanese economy has been so moribund for so long thatthe Japanese regularly force the near-entirety of their pension system — with a huge dose of flat-out printed money — to invest in Japanese government debt, an asset with a zero percent return. It is well within the BOJ’s purview to instead purchase foreign assets if that serves Tokyo’s purposes, and to do so in a volume that quite literally reaches the high hundreds of billions of dollars.)

If this feels like a bribe, you’re thinking about things the right way.

The United States is backing away from the world writ large, a development that spells utter disaster for the many countries that designed their economic, political and military systems around the central concept of American engagement. Every bi- and multi-lateral relationship that the Americans have is in the process of being obviated. That includes everything from the UN to the WTO to NATO … to the Japanese alliance.

In Accidental Superpower I noted that in the coming Disorder there would only be a very short list of countries with which the Americans would choose to remain entangled, largely because the Americans perceive unmitigated benefits. If your country isn’t on that list, and you want to retain American engagement, you have to come to Washington and plead your case. And if you come empty handed the answer will almost certainly be “no”.

Abe apparently intends to try and flat out purchase American involvement. A bit crass for my tastes, but that doesn’t mean it won’t work.

The Japanese understand what’s happening. They know full well that their exposure to global energy markets and the fragility of their manufacturing supply chains makes them vulnerable. The Brits get it as well. The Canadians are desperately hoping that they are on the “unmitigated benefits” list (they probably are). The Mexicans are twisting in the wind, unsure if what’s coming out of the White House is rhetoric, policy or a negotiating strategy (it’s probably the latter). The Chinese are having problems coming to grips with just how bad things are about to get for them.

And the mainland Europeans are in flat-out denial.

American security involvement and American trade access are what ended the European civil war of roughly 1800 thru 1945, and generated the past 70 yoears of peace and prosperity. Europe is only able to import raw materials and export finished products because of American global overwatch, to say nothing for Europe’s (in)ability to defend itself (or in general get along with itself). In fact, without swap lines and loans from the Federal Reserve, it isn’t much of a stretch to assert that the Euro would have failed already. Without express U.S. involvement and strategic sponsorship, there is no European Union.

Rather than start tweaking themselves towards a system that might be sustainable without American overwatch and largess, most European politicians right up to the German and French premiers are engaging in a (not entirely) diplomatic back-and-forth with the Trump administration. It isn’t that I’m taking Trump’s side on any particular ethical, legal, constitutional, economic, strategic or practical issue, but instead that continental Europeans are acting as if the old rules still applied.

And unlike a week ago when the issues at stake didn’t hold immediate implications for the EU, now they do.

Apparently I was wrong. National Trade Council chair Peter Navarro is indeed aware of the existence of countries that are not China. Specifically, he knows where Germany is. On the same day the Japanese were testing the waters with their…consulting fee suggestion, Navarro laid into German trade policy. Specifically, he noted that the euro in essence functions as means of depressing the cost of German exports, constituting an unfair trade advantage.

Navarro is both wrong and right. Wrong in that the German intent for the euro isn’t to facilitate exports outside of the eurozone, but instead to induce economic convergence among the eurozone’s members and thus bulwark all of them against international volatility, and strengthen all of them as an internal trade bloc

But that’s not what has happened. The Europeans have proven completely incapable of grinding down financial, fiscal and political barriers within the bloc, so instead of helping everyone converge, the euro has instead established a dependency system in which Germany is the indisputable center of gravity. Since this is done in the context of a currency union, the weaker members have the effect of dragging the currency’s value down. And here’s where Navarro is dead-on correct: the failure of Europe to federalized has devolved the euro into an “implicit deutschemark that is grossly undervalued”. That was never the Germans’ intent, but it is most definitely the outcome — and will remain so until Portugal and Greece look more like the Frankfurt (which isn’t going to happen in our lifetimes).

It is highly unlikely that the Trump administration will be impressed with a “U.S.-Germany Growth and Employment Initiative”, even if Berlin had the political and economic bandwidth to fashion one. The accruing nature of everything threatening Europe is simply so multi-vectored, entrenched and damning that the Continent is now exactly the sort of commitment that the Americans are not interested in.

Yet if anything, that understates the challenge that Europe now faces.

The primary responsibility of the National Trade Council that Navarro leads is to prosecute trade wars. Which means it isn’t just that the European Union cannot exist without express U.S. support, but now also that the United States seems about to actively kick out the Union’s scaffolding.

Part III: Corporate Tax Reform and Global Trade

The simple tariff being discussed in D.C. might spell the end for global trade and security as we know it.

The Trump administration has requested that Congress focus on two major policies during the next few months. One is Obamacare, as excising Barack Obama’s legacy remains a core issue for Trump’s diehard supporters. The second is tax policy reform, specifically corporate tax reform. Trump has indicated that he wants the process to be more or less revenue-neutral, but he also wants the corporate tax rate to shift from today’s 35 percent (among the world’s highest) to 20 percent (among the world’s lowest). While undoubtedly such a cut would massively expand corporate activity and thus tax receipts, such a lower rate would still require replacement income to come from a new source.

From what I’ve heard from DC of late, it seems that Democrats and Republicans alike (not to mention the Trump team) are zeroing in on a common approach — a tariff system.

Administrating a tariff system can be somewhat tricky. The easiest way to manage one is to simply slap on a “border” tax and tax absolutely everything a set percentage as it comes across. The problem with this, however, is that if you have any manufacturing supply chains that cross the border more than once — like, say, everything Ford and Chevy do — things can get taxed multiple times. Such a turnover tax drastically increases the cost — and diminishes the competitiveness — of goods and smashes any supply chains the U.S. has that rely upon the NAFTA partners. That would — at a minimum — trigger an economic depression in places like Michigan and Texas.

A less disruptive option is to implement some sort of content-origin rule, so only the percentage of value of the product that isn’t American gets taxed, and that only once. This requires a more involved detection and labelling system and requires a degree of trust with your close trading partners, but within the NAFTA system something more or less like this already exists. You’d just need to layer in a new bureaucracy atop what’s already there.

This method has some interesting advantages.

In addition to very strongly encouraging American firms to keep their businesses within the U.S., this sort of tariff system is also fairly modular. Since you are already collecting product origin data you can adjust the tariff country-by-country and product-by-product, for example having tariff levels that favor trade with Honduras but disfavor trade with South Africa. Tariffs and trade access very quickly become a tool of state power. As the U.S. has the world’s largest consumer market, that’s no small factor. The biggest losers from such systems would be countries and industries whose supply chains are almost wholly non-North American in nature. China Inc’s gangly East Asian industries would wither, as would Germany’s fully Central European ones. From the Trump White House’s point of view, these are probably viewed more as features than bugs.

There are, however, two far-from-insignificant problems. First, such a system is flat out illegal under the rules of the World Trade Organization. The whole concept of tariffs are one that the U.S. has been browbeating out of the international system since 1944 as part of the move to globalized free trade. Going the tariff route by definition means either facing a fleet of international lawsuits (which the U.S. would almost certainly lose), or simply walking out of the WTO completely. The ability of the U.S. to export to anyone that it didn’t have a side deal with would almost certainly collapse.

The second major problem is that anything that has such a crushing effect on globalized trade will gut the export-led industries of every country that happens to have an export-led economy. Roughly two-thirds of the world’s population almost certainly would face economic depression.

The United States would definitely feel the pain of this, but it would be manageable. Only 8 percent of U.S. GDP is from merchandise exports, and one-third of that is to Canada and Mexico. Only the United States has a demography that’s full of consuming 20- and 30-somethings, and so only the U.S. has the necessary end-market that makes export-led economies around the world work. If Washington and Mexico City and Ottawa can find a way to forge a non-WTO way forward (three guesses what my next topic will be), then the U.S. would likely only suffer a mild recession.

 

For everyone outside of North America, however, the near-future would hold economic disaster.

The U.S. may be the least involved country in international trade from a trading perspective, but it is the most involved country from a trade-management perspective. Without unfettered access to America’s consumer market, the global market shrinks by about one-third. Without the only global navy providing freedom of access and freedom of the seas, maritime trade — the way four-fifths of global trade moves — is endangered if not outright impossible. That isn’t just a problem for computers and furniture, but for iron ore and, oh yeah, oil too. Like it or not, the U.S. is the indispensable country for the global order in its current form.

Remove the U.S. and we don’t get a new global order, we get disorder because there is no country or coalition of countries that can replace the United States in financial, consumptive or military terms. The world’s rising powers — most notably China — see trade as a plank of security policy that is most definitely a zero-sum game. Any attempt by them to impose their own global (or even regional) preferences would quickly lead to conflict with other powers that would lose out under Chinese management. In China’s case that’s a lengthy list that would involve everyone from Japan to Taiwan to Indonesia to India to Saudi Arabia to the United Kingdom.

The reason the U.S.-based system works is that U.S. has global reach but no global needs. It has been willing to sublimate its economic needs in order to build and preserve a global system. China is the opposite. It has global needs but no global reach. It wouldn’t be willing to sublimate anything for its economic goals, and so no one has any interest in deferring to Beijing.

This tax shift under discussion in Washington very well might be how the whole global structure comes crashing down.

Part II: The End of Europe

EU’s institutions are rearranging the Titanic’s deck chairs during a Godzilla attack with a tsunami on the horizon.

President Donald Trump entertained his first foreign dignitary Friday, January 27: UK Prime Minister Theresa May. The primary outcome of their trip? The two pledged to work towards the formalization of a “quick trade deal.”

This takes us all kinds of interesting places.

First, from a strategic point of view anything that binds the United Kingdom closer to the United States is phenomenal for U.S. power. Britain maintains the world’s third-most powerful navy, and soon will float the only functional supercarriers in the world not in the U.S. fleets. London is the world’s second-largest financial hub, and the chief route out for capital fleeing Continental Europe. London has centuries of bred-in experience manipulating political and economic systems the world over. Add in a wealth of preexisting bilateral political, economic and cultural ties, and if there is one country that is a natural complement to American power projection, it is Britain.

Second, the EU is spotlighting the path to its own end with a bizarre sort of enthusiasm. Technically, the May-Trump summit is illegal; under EU law only the European Commission — the EU’s executive — can engage in trade talks on behalf of its members, and the UK’s exit negotiations haven’t yet begun. Just to be sure that the Europeans know that this isn’t an accidental oversight, May has also announced the commencement of trade talks with Canada, Australia, New Zealand, Turkey and India.

 

 

The Commission and EU Parliament are bubbling with fury about how this won’t be allowed to stand, will poison the UK’s pending Brexit talks with the EU, and that Britain will be punished for it. But considering May has indicated that she prefers simply walking away from the EU to any sort of divorce deal that doesn’t serve London’s interest, the EU is absolutely bereft of leverage.

If there was an issue that could prove that the EU had some flexibility, a flat-out Brexit negotiation was it. It will be a negotiation that is predominantly economic in which the EU has lots of leverage and for which the EU has lots of options to choose from. This should be easy.

Guess not.

Such obstinacy pretty much dooms the EU in its grappling with its far larger problems: the EU faces a demographic implosion, a sovereign debt crisis that only increases by the year, anemic-at-best economic growth, a rising banking crisis, an aggressive Russia, an increasingly belligerent Turkey, waves of refugees as Mideast countries crumble, and so on. Rather that start reimagining the Union or getting on with the very real work ahead, the EU’s institutions are doing the equivalent of rearranging the Titanic’s deck chairs during a Godzilla attack with a tsunami on the horizon. Britain is already moving on, yet it looks like Brexit will consume all the EU’s emotional bandwidth for months (years?). Such ossification makes it scarily easy to predict how this will all go: everything that happens in the EU is now an institutional crisis.

Third, after decades of Continental military downsizing, the UK and U.S. are Europe’s security policy. May still went through the motions of pledging her support for NATO, which literally earned no more than a curt nod from the new American president — a man that, since his election, has made no secret of his belief that the alliance is already over. So long as Europe cannot come to terms with Brexit, it is a mighty reach to assume that the UK will continue going to bat with Trump for the sake of the Continent. Expect American drawdowns of its warfighting capabilities in Europe to begin in the not-too-distant future. The only question now is whether this is done in league with evolutions in U.S.-Russian relations or not.

 

 

Where does this leave Europe? Trump probably put it best by calling the EU a “vehicle for Germany.” That may sound harsh. After all, the EU is nothing if not a constant multi-lateral tug of war among all the EU’s 28 members. But consider what’s happened in the past year: The Brits are leaving. NATO is all-but-gone. There’s political stall — if not outright breakdown — in Italy, Spain, Austria, Belgium and the Netherlands. Poland and Hungary are wallowing in their moves away from democracy. Like it or not, planned or not, Germany is the center that holds.

And a quick glance through history indicates that a German center to Europe never holds for long.

Part I: Executive Action, Obamacare, Regulation and the Obama Legacy

 

Trump’s method for non-enforcement of Obamacare has big implications and may tear apart Obama’s legacy in weeks. 

I’ve spoken before of the danger of Obama choosing to not enforce laws that he did not agree with, in large part because of the dangerous precedent it set as regards not simply to civil liberties, but to the rule of law itself. What good is Congress, after all, if its constitutionally-granted powers of legislation can simply be bypassed by a recalcitrant or capricious executive? I don’t bring this up to forecast that is what Trump will do, although the thought has certainly crossed my mind (repeatedly) in recent weeks.

Instead, Trump seems to have found an… elegant way around my concern. Rather than following Obama’s precedent of simply ignoring preexisting laws he found distasteful, on his first day Trump instead tinkered with executive flexibility in a starkly different way. In his Day One executive action on Obamacare, Trump directed the IRS that whenever it has any discretion with respect to any aspect of enforcement on Obamacare, that it is to exercise that discretion in favor of individuals and not in favor of the government. (Keep in mind that come Tax Day, it is up to the IRS to impose penalties upon anyone who has failed to purchase health care insurance.)

The impact of such an approach is potentially wide ranging to say the least.

First, it does an end-run around Obama’s signature achievement. The IRS already possesses wide latitude at enforcing tax law. For example, when the IRS was having a spat with House Republicans in 2015 which resulted in Congress cutting the IRS’ budget, the IRS responded by using its regulatory latitude to simply not answer its phones. With Trump’s new executive order, the IRS will almost certainly not even bother checking if 22-year-olds have indeed purchased their Obamacare-mandated health insurance because the income from the penalties wouldn’t be worth collection. Such “enforcement” in effect kills Obamacare without even resubmitting the issue to Congress. (Of course, it does not replace Obamacare; that’s a far thornier topic for another time.)

 

Washington, D.C.

 

Second, the new approach potentially signals a very easily-replicable pattern for regulation writ large. Regulatory agencies often use their executive latitude to pick fights with prominent personalities or companies or institutions as a means to induce compliance across the board from folks who would normally resist (think back to how the prosecution of high-profile personalities like Martha Stewart did wonders for dissuading insider trading). If executive orders force the bureaucracy to begin with a presumption against the government, then many existing regulations cease to hold much weight. This holds triply so for regulations rooted in executive privilege as opposed to Congressional law. I anticipate EPA-related regulations — which haven’t had a lick of Congressional law added to them in six years — to face particularly harsh gutting.

And perhaps most importantly, unlike Obama’s preferred method of non-enforcement of laws he disagreed with, there is zero legal recourse for Trump’s enforcement-lite. You could sue the government should the executive agencies not be enforcing the law or magicking up their own regulations and reinterpretations, but you cannot sue the government for implementing laws within Congressionally allowed ranges.

Agencies will still have to go through the motions of formally repealing Obama-era regs, but considering how few laws Obama got through Congress and how heavily he relied upon re-interpretation and executive-originated regulations, this approach could eliminate Obama’s entire legacy in functional terms in a matter of weeks.

Many — including me — arched an eyebrow at Trump’s earlier assertion that he would reduce the federal government’s regulatory burden by three-quarters within a year. Now my other eyebrow has moved up as well.

The Absent Superpower

It’s finally arrived!

I’m happy to announce that The Absent Superpower: The Shale Revolution and a World Without America is finally in print and in stock. Here is a link to the purchase page on Zeihan.com. We will have a digital version ready by February 1st. Additionally, book format issues limit me in terms of graphics capacity to only black & white images but many of the topics I write about are in screaming color, so here is the map room for The Absent Superpower.

Which brings me to my next announcement: the Zeihan on Geopolitics website has had a face lift for the New Year. We’ll be populating it with more material during the next few weeks, particularly as the Know Your World section expands. Feel free to explore.

And if all that wasn’t tease enough, in lieu of a New Year’s newsletter, we’ve instead opted to share the introduction for The Absent Superpower…

Absent-Super-Power-book

INTRODUCTION


The Journey to The Absent Superpower

EVERYTHING IS CHAOS!

At least, that’s what it seems like every time you turn on your TV, radio, computer, or smart phone.

The European Union is falling apart, Syria is in meltdown, cybercrime is an hourly occurrence, the Chinese economy is gyrating wildly, Russia is on the march, the election of Donald Trump has Americans of all political stripes wondering what comes next, and the Kardashians get more press time than Congress. It’s enough to give anyone a panic attack.

Well, not quite anyone. Unlike the average person, all this craziness puts me in my happy place. Where most see the world turning itself upside down and inside out, I see a long-overdue shift in the global order. New trends emerging. New possibilities unfolding. For me, change is good for business.

That’s because my job is a bit…different than the standard. You see, I’m a geopolitical strategist. That’s a fancy way of saying I help organizations understand what challenges and opportunities they will be grappling with across the world in the years to come. As such I’m sort of a professional apprentice, rarely a master of any particular craft but needing to be able to hold my own in conversations about manufacturing and transport and health care and finance and agriculture and metals and electricity and education and defense and such. Preferably without pissing off anyone whose living is based off of manufacturing or transport or health care or finance or agriculture or metals or electricity or education or defense.

In many ways those conversations make me who I am. From the Air Force to the Pickle Packers, every interaction gives me a good hard view of the world, yet each of these interactions originates from a radically different perspective. Combine all those angles and interactions and perspectives and the unique information that comes from them with my private intelligence experience, and I’m granted the privilege of seeing something approximating the full picture — how the world’s myriad pieces interlock — and catch some telling future glimpses to boot. More than anything else, what I sell is context.

That picture and those glimpses and that context formed the bones of my first book, The Accidental Superpower, which was published in November 2014. In Accidental I made the case that the world we knew was at a moment of change: The Americans who had created, nurtured, enabled, maintained and protected the post-WWII global order were losing interest. As they stepped back the world we know was about to fall to pieces.

At any time in history such a shift would have had monumental consequences, but the American retrenchment is but one of three massive shifts in the global the order. The second is the rapid greying of the entire global population. Fewer people of working age translates directly into anemic, decaying economies — enervating global trade just as the Americans stop guaranteeing it. Third and finally, the American shale revolution has changed the mechanics — if not yet the mood — of how the Americans interact with the energy sector. Surging petroleum output within the Lower 48 is pushing North America toward outright oil independence; in the past decade the total continental shortfall has narrowed from roughly 10 million barrels of oil per day (mbpd) to about 2mbpd.

In the two years since Accidental published, I’ve had ample opportunity to re-examine every aspect of my work — some of my critics have been (over) eager to assist in such endeavors — and I fear that I may have been off the mark on a couple of points.

First, the American shale sector has matured far faster and more holistically than I could have ever expected.

Despite a price crash in oil markets, despite ongoing opposition to shale among a far from insignificant portion of the population, despite broad scale ignorance about what shale is and what shale is not, shale has already overhauled American energy.

In 2006 total American oil production had dropped to 8.3mbpd while demand was touching 20.7mpbd, forcing the United States to import 12.4mpbd, more than Japan and China and Germany combined. By 2016 U.S. oil output had breached 15mbpd. Factor in the Canadians and Mexicans, and total American imports of non-North American oil had plunged to about 2mbpd — and that in the teeth of an oil price war. And that’s just oil specifically. Take a more comprehensive view and include everything from bunker fuel to propane, and the continent is less than 0.8mbpd from being a net energy exporter.

The end of American dependence upon extra-continental energy sources does more than sever the largest of the remaining ties that bind America’s fate to the wider world, it sets into motion a veritable cavalcade of trends: the re-industrialization of the United States, the accelerated breakdown of the global order, and a series of wide-ranging military conflicts that will shape the next two decades.

This book’s opening section contains the long and the short of this Shale New World, the greatest evolution of the American industrial space since at least 1970. For the financiers and accountants and policy wonks out there, this was written with your geeky brains specifically in mind.

Second, the isolationist trickle I detected in American politics has deepened and expanded into a raging river. Of the two dozen men and women who entered the 2016 presidential race, only one — Ohio Governor John Kasich — advocated for a continuation of America’s role in maintaining the global security and trade order that the Americans installed and have maintained since 1945. The most anti-trade candidate on the right won his party’s nomination, while the most anti-trade candidate on the left finished a close second in the Democratic primaries to the Clinton political machine. Last night (now President) Donald Trump and Hillary Clinton met in New York to debate economic policy. What struck me as self-gratifying and horrifying in equal measure was that their core disagreement on trade issues wasn’t whether trade was good or bad for the United States, but how much to pare it back and which reasons for paring cut it the most with the electorate. (The pair of them obviously disagreed — colorfully, vehemently and often — on other issues.)

The world has had seven decades to become inured to a world in which the Americans do the heavy lifting to maintain a system that economically benefits all. The world has had three decades to become inured to a world in which the Americans do not expect anything of substance in return. As the Americans back away, very few players have any inkling of how to operate in a world where markets are not open, transport is not safe, and energy cannot be secured easily.

The stage is set for a global tailspin of epic proportions. Just as the global economy tips into deflation, just as global energy is becoming dangerous, just as global demographics catastrophically reduce global consumption, just as the world really needs the Americans to be engaged, the United States will be…absent. We stand on the very edge of the Disorder.

The Disorder’s defining characteristic is, well, its lack of order. Remove the comfortable, smothering American presence in the world and the rest of humanity has to look out for its own interests. As many of those interests clash, expect devolutions that are deeply-felt and disastrous in equal measure. Part II breaks down the breakdown. I’m equally proud and terrified to report that some of the darker shades in Accidental are happening sooner rather than later. For generals — armchair or otherwise — who prefer jumping directly into the fight, Part II is what you’re after.

In the final section we will circle back at take a good hard look at the United States. Energy independent, economically robust, physically secure, and — above all — strategically unfettered, the United States will be taking a break from the world writ large for the most part.

Yet “for the most part” is a far cry from a full divorce from all things international. The Yanks will still find bits of the world worth their time, effort, money and ammunition. Section III explores the American Play: where the Americans will still be found, why they will be there, how they’ll act, and what they’ll be up to.

It may be small comfort, but the acceleration of the shale revolution as well as the American political shift towards populism has illuminated a great deal, sharpening my view of the future. The various glimpses that made up Accidental have somewhat merged, lingering to the point that they now constitute a bit of a roadmap.

That roadmap is the core of this book.

Peter Zeihan
September 27, 2016
Somewhere over Kentucky

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