From Macau: A Weather Eye on the Event Horizon

Remarks to China Renaissance Capital Investors

I’ve been asked me to look around the world’s horizons and to venture a prediction or two as we prepare to enter a new year.  This is never an easy task.  We rarely, if ever, understand our past properly, still less our present.  So, even in the dullest of times, when we project the future, we are almost always wrong.  And November 18, 2011 is an especially fluid and uncertain moment.  We can’t be sure what will happen five days from now, let alone over the next twelve or thirteen months.

This year’s uprisings in the Middle East, financial crises in Europe and North America, Chinese fears of contagion from both, and political paralysis in the developed world’s democracies startled even those who had foreseen the possibility of some of these phenomena.   2011 has been a year of sudden political change, exceptionally volatile markets, widespread leadership failure in both domestic and international affairs, and a growing sense everywhere that established systems and institutions are out of order.  For the most part, humanity will not enter 2012 with high hopes or bright spirits.

2012 looks to be even more turbulent than 2011.  It will see a generational dislocation in the leadership of China, an ongoing struggle for policy coherence in Europe, and a year-long attempt by right-wing populists to engineer regime change in the United States, amidst continuing financial earthquakes, shifts in the global balance of economic power, and receding American political influence.  Some in the newly superstitious West believe the Mayan calendar foretells the return of Quetzalcoatl next year, ending the long historical cycle that the European invasion and conquest of America began  five centuries ago.  Some in the Middle East anticipate the emergence of the Hidden Imam from eleven centuries of “occlusion.”  They and a few people in Texas and related places predict that 2012 will end in rapture as the Messiah walks amongst us.  Here in Macau, people expect a ban on smoking in casinos and another year of double digit growth in the gaming and gambling industries.  Elsewhere, everyone expects lots of trouble.

We’re already in plenty of trouble, of course.  Those of you from Europe hardly need to have that pointed out to you.  Europe used to be boringly predictable, which was good for business.  Now bits of it have reverted to being excitingly unreliable, which is bad.  Repeated crises have addicted European leaders to summits, where they agree on partial solutions to problems and create new ones, then go home to think up still more ways to unnerve each other and investors.   The year ahead seems certain to feature more summits and more Eurotorture of the world’s financial nervous system.  The fiscal sobriety and punctiliousness of northern Europeans will not soon prevail over the bouzoukinomics and bunga bunga politics of Europe’s exuberantly irrational and overly indebted south.

More fundamentally, however, as a club of clubs, Europe has just shown itself to be much less than the sum of its far too many movable parts. In some of the clubs that make up Europe, members are seriously tired of each other as well as of the way responsibility is apportioned.  The mismatch between the eurozone’s membership and that of the European Union, in particular, makes German creditworthiness, not the EU, central to the credibility of the euro.  And there is an obvious contradiction between a bureaucratically administered supranational currency and the democratically exercised sovereign authority of Europe’s many nation-states. 

As Greece has just demonstrated, the European project is seriously incomplete and vulnerable to disruption by reckless acts of political brinkmanship.  In the absence of Europe-wide democracy, national democracy and multinational community-building no longer seem compatible.  Decisions based on local interests, no matter how legitimately they are arrived at, can threaten both pan-European and global interests in market stability and economic revival.  Sadly, in many ways, Europe remains more colloquium than commonwealth — more a confederation of small minds and big egos than a federal union of peoples.  The incongruities and incompetencies of a still far-from-united Europe have become a problem not just for Europeans but for the world. 

The destabilizing effects of financial uncertainty may now be Europe’s most notable export.  But the United States seems determined to one-up the perversity of European indecisiveness.  Europe has the will to act, but not the political machinery to act coherently.  America has the mechanisms and the resources needed to make decisions and implement them.  It lacks the wit, the will, and the spirit of political accommodation to do so.  In effect, the United States now suffers from fiscal anorexia — economic self-starvation born of an obsession with curing the imagined obesity of government.  But America’s civilian public sector is already too lean to sustain the nation’s socio-economic health and competitiveness.  The United States is disinvesting in its human and physical infrastructure — consuming its sinews — at the very moment when it most needs to rebuild its strength.  India may be the world’s largest functioning democracy but America is now seen everywhere as its largest dysfunctional one.

Ideological delusion, self-indulgence, arrogance, and unbridled greed got America — and the world economy — into their current mess.   Devotion to fanciful concepts, despite their catastrophic results when actually applied, has undermined the credibility of the “full faith and credit” of the United States.  Many Americans remain wedded to the bizarre notions that the redistributive functions of government are a net drag on the economy, that reducing government investment and outlays will somehow generate jobs, that financial engineering adds real value to the economy, and that unequal income distribution stimulates economic growth.  In a less narcissistic political environment, people would laugh at the idea that cutting public spending — and thereby contracting the economy — could possibly create jobs and stimulate growth or that a “SuperCommittee” of the finest politicians that vested interests can keep in office could magically balance a budget that is 40 percent in the red solely by cutting non-defense expenditures, without raising revenues.

We live in anxious times.  Having briefly been taken hostage by grandstanding Greeks, the future of the global economy and the international monetary system is now mortgaged to the wisdom of the United States Congress, the generosity of the Germans, the considered judgments of Italian parliamentarians, and other questionable factors.  The U.S. Congress, acting through its “SuperCommittee,” will impose its budget-balancing proposal (or fail to do so) next Wednesday (November 23rd).  A misstep could bring on fiscal thrombosis in the United States and a global economic convulsion.  A chaotic collapse of the European project is also no longer unthinkable.  Such a collapse would destabilize much more than Europe.  It is no help now to repeat the warnings that some of us voiced some time ago¹ and it is no satisfaction to have sounded the alarm when it went unheeded.

Europe’s disunity and America’s congestive politics have sidelined both the EU and the United States as global leaders.  Many are promoting China as a successor to both.  The past decade’s demands that China support the status quo as a “responsible stakeholder” have given way to respectful calls for Beijing to offset the irresponsibility of other stakeholders by funding their recovery from their own mistakes.  It’s remarkable that Europeans are now calling on the Chinese Communist Party to save global capitalism, and it’s even more remarkable how quickly the world has come to see China as central to global governance. 

But the hopes and expectations now placed on China are unrealistic.  China is neither able to take up the global leadership role once played by the United States nor is it willing to attempt to do so.  China is a semi-developed country.  Its political culture reflects its turbulent history.  A few hotheads carried away by rapid economic growth notwithstanding, China’s leadership is highly risk averse.  China remains focused on lifting itself from poverty.  Its capital markets are still underdeveloped.  Its currency is only partially internationalized.  Its economic model is rapidly coming to the end of its useful life and its economy is slowing. 

China is in the midst of a difficult transition to a less export-oriented, more consumption-driven economy.  And it is making this transition under a government that is demonstrably fearful of popular reaction to any misstep it might make.  The Chinese Communist Party has been unnerved by the admittedly rather unlikely prospect of regime-threatening popular protests and uprisings, along the lines of the so-called “Arab Spring.”  China is too timid and too self-absorbed to present itself as a global leader now.  It has barely begun to think how it might play such a role in the future.

Then, too, China is at an awkward moment of political transition.  Within a year, the senior-most ranks of the Chinese government and party will undergo a massive turnover, as a new generation takes power.  Seven of the nine members of the Chinese Communist Party’s Politburo Standing Committee will retire, as will its chairman.  China will be led by men and a few women in their fifties.  All of them will have significant previous experience in government and over half of them will have advanced degrees, but they will still be new to their jobs.

The new Chinese leadership will inherit a country that has made tremendous progress.  Still this leadership will have its work cut out for it — even if the SuperCommittee saves the American economy and the dollar, and Germany and others save the euro and the European Union.  China has an inflation problem, a banking crisis in its vitally important private sector, a property bubble, major imbalances in income distribution, and other urgent socio-economic issues to address.  With high unemployment in China’s major export markets, it faces a serious threat of protectionism if it does not rapidly reduce its trade and balance-of-payments surpluses. 

China also has somewhat strained relations with many of its neighbors at present.  The Chinese have long recognized that they need a peaceful strategic environment in which to develop.  2012 will bring a host of challenges in this arena. 

Taiwan will hold a combined presidential and legislative election on January 12.  Depending on how these elections turn out, 2012 could be a year of accelerated progress toward cross-strait integration or the beginning of setbacks that renew cross-strait tensions.  The Taiwan issue has more than local significance.  It remains a major factor driving the United States and China toward a militarily hostile relationship, with all of the potential for naval and other confrontations that this implies. 

Changes on the Korean Peninsula could also be unsettling. The leadership transition in North Korea is at a delicate stage amidst unstable intra-Korean relations.  China’s relationships with both North and South Korea have ridden a roller coaster in recent years.  South Koreans will elect a new National Assembly in April and a new president in December.  This promises to change their relations with China and their northern compatriots in unpredictable ways.   Meanwhile, to China’s southwest, Myanmar has adopted a more assertively independent stance, raising uncertainties about its future relationship with China.

China’s rise as a military power in the Indo-Pacific region is also stimulating a loose coalition among Japan, Vietnam, and India directed at balancing it.  How China handles the current tensions in the South China Sea, along the Sino-Indian border, and in Korea will decide how much this coalition solidifies, whether it broadens to include others (like Indonesia), and how actively it seeks American support to counter China.   China must also consider how to deal with the destabilizing consequences of Pakistan’s deteriorating relationship with the United States as America prepares to retreat from Afghanistan.  And it must decide how to cope with the challenges posed by the collapsing American position in the Middle East and the leadership vacuum in international organizations that this has catalyzed.

The bankruptcy of American policy on the Israel-Palestine question has led to an effective U.S. decision that it is more important to frustrate Palestinian self-determination than to continue to pay for and participate in many aspects of global governance.  This decision reflects the passionate attachment of the U.S. Congress to Israel, which is currently under exceptionally short-sighted, self-destructive, and repellent management.  The United States is at odds with almost all of the international community, where the Palestinian cause enjoys overwhelming sympathy and support.  If the Palestinians continue to press their case internationally, as most expect them to do, the American exodus from UNESCO promises to be merely the first of many such U.S. withdrawals from United Nations organizations.  In some cases, other countries will seek to increase their influence by making up the resulting funding shortfalls; in some they won’t.  Without at all intending to do so, the United States is forcing the international community to re-engineer global institutions to function without it or its money and without reference to American views or interests.  The failure of U.S. diplomacy in Palestine thus risks translation into a definitive American retreat from global political participation and relevance.

Meanwhile, the United States is extricating itself from the strategic ambush and politico-economic shambles of Iraq, which it forcibly occupied in 2003.  Eight years and a couple of trillion dollars later — six weeks from now — all U.S. forces, as such, will have departed, having transformed Iraq from a nastily ruled strategic balancer of Iran into a traumatized society under Iranian political influence.  The violent sectarianism that the U.S. occupation catalyzed continues to spread beyond Iraq to other parts of the Arab and Islamic worlds. 

The U.S. invasion of Iraq was a strategic boon to Iran; the U.S. withdrawal from Iraq comes amidst renewed Israeli and American threats to bomb Iran to set back its nuclear programs.  Some dismiss these threats as yet another attempt to ratchet up international pressure on Iran while diverting attention from Israel’s ongoing operations to ensure that any Palestinian state is stillborn.  No one can be sure.  The departure of the U.S. military from Iraq only adds to the uncertainties affecting the prospects for stability in the Persian Gulf region.  More than any other factor, what happens there determines global energy prices. 

The United States is also attempting to screw up the courage to end its failed ten-year pacification campaign in Afghanistan.  The culling of al-Qa`ida’s leadership cadre and the execution of Osama Binladin aside, the principal results of the American-led intervention in Afghanistan and adjacent areas have been unfortunate.  They have stimulated the spread of Islamist theologies that justify and generate terrorist acts against non-Muslims and their Muslim collaborators by isolated individuals and groups.  These theologies are now entrenched not just in Pakistan and in a widening circle of other failed or failing states but in their foreign diasporas as well. 

Terrorism born of these theologies demands a moral and political retort that has yet to be articulated.  Islamist terrorism cannot be halted by the decapitation of command and control systems.  It is by and large wrong to attribute to it a coherent paramilitary structure that can be described in an “order of battle.”  Its ideology identifies and legitimates targets that those inspired by rage then attack largely on their own.  The potential for terrorist attacks, not just in the West, but in China, Russia, and other societies with aggrieved Muslim minorities, continues to wax, not wane, as Muslim grievances mount.  Addressing or at least mitigating these grievances is essential to restoring peace.  Innocent bystanders become committed enemies when they are attacked.  Calling such bystanders “collateral damage” does not prevent their transformation into highly motivated participants in a struggle from which they once stood apart.

The most damaging consequences of the past decade of war in Afghanistan have been the destabilization and radicalization of Pakistani politics and the exacerbation of the Indian and Pakistani competition for influence in Afghanistan.  The U.S. withdrawal from Afghanistan, now in stealthy progress, will do nothing to cure these effects of the protracted war there and may well aggravate them.  Pakistan was dismembered in war before it acquired nuclear weapons to forestall its complete erasure from the map by India.  Were it not for Pakistan, India’s dominance of South Asia would be absolute.  (That’s why Delhi seeks to undermine Islamabad and Beijing to shore it up.) 

Pakistan has a history of using terrorists to weaken India as well as to support Kashmir’s self-determination and secession from Indian rule.  Deeply estranged from America, tormented by the religiosity of its politics, and mired in economic torpor, Islamabad has recently accepted the reality that India is the inescapable economic center of gravity in South Asia and that it must acknowledge this.  But Pakistan is now, more than ever, a strategic accident waiting to happen.  It is looking for Arab sponsors and hoping that China will double down as the United States cuts its losses and prepares to leave.

The new world of the 21^st Century is one in which there is little, if any apparent willingness to sacrifice now to gain later.  For most countries, the immediate gratification of policies that promise short-term advantages greatly outweighs the delayed and intangible benefits of decisions that serve the longer-term national or global good.  Politics is now about who gets what now.  To be farsighted is to be out of office.  Europeans are divided and confused.  Americans seem more  inclined to dispute the rise of China and other non-European great powers than to hitch a ride to renewed prosperity on their progress.  Chinese lack confidence in their current system of governance and are off their game in how they relate to the rest of the world.  Others are more self-absorbed than internationally engaged.

There is no global leadership or central authority to call the shots.  Transnational rules do not constrain national actors as they once did.  Hence the crisis of global governance that impedes common solutions to common challenges like climate change, reform of international financial and monetary systems, energy and food security, and the worsening environmental damage caused by imbalances between expanding human needs and the limited capacity of the world’s ecosystem to satisfy them.  This is an era in which policies that do not yield immediate benefits for key constituencies have no prospect of being adopted.  It is also a world in which unwise and unpredictable things are more likely to happen than not.

In sum, the year to come promises to be a very challenging one.  Whether or not 2011 ends with a politically induced global economic seizure, 2012 will see continuing turbulence in Europe and the United States and some degree of redirection under new management in China.  It will witness continuing turmoil in West Asia and North Africa and the progressive isolation of both Israel and its American protectors in that region and in the international community at large.

In the United States, an administration that has delivered hardly a single major promise it made to achieve election in 2008 seeks reelection against an opposition that seems more intent on repealing the 20th Century than addressing the challenges of the 21st.  The Republican pre-primary debates have seemed more like a series of vaudeville performances scripted by the Three Stooges than efforts to grapple with the multiple factors that now dispirit the American nation and threaten the world order. 

Unless something unexpected happens, the 2012 presidential campaign promises to set a new nadir in terms of the absence of relevant substance and the prevalence in public discourse of slander, innuendo, and issue distortion.  No one expects a serious discussion of the challenges now facing the world and the United States itself.  2012 will therefore see new pressure on China and other reemerging great powers, like India, to step into the vacuum created by the continuing retreat of American leadership or the failure of Europe to rise to the occasion.

It is, as always, easier to discern the factors that will guide the future than to anticipate the twists and turns the future will actually take.  Subject to correction by the ever-optimistic Ambassador Schurtenburger, however, one is left to conclude that there is an urgent need for America and Europe to get their acts together.  The global economy is performing at the speed of stall.  By a process of elimination, it would appear that China is now the closest thing there is to a safe haven for investors.  But the world needs to set its sights higher than a mere search for sanctuary from setbacks.  It needs to rediscover how to harness national selfishness to the global good.  That way lies global prosperity.  There is no prosperity or safe haven to be found in the dysfunction and denial that now prevail in Europe and America or the timidity that rules in China.

Ambassador Chas W. Freeman, Jr. (USFS, Ret.)

Macau, China