Libya; Ho Hum......

A 49 page parliamentary report from the Foreign Affairs Committee published today draws some pretty damming conclusions on David Cameron's ill advised and poorly planned and executed foray into Libya in 2011. 

Drawing all the critical strands together in the report we can neatly summarise them with the technical phrase which is often used on these occasions, it was a clusterfxck.

The failure of the half hearted enterprise was hard coded in it's very inception. We had no business being there and the policy of doing so at minimum political and military risk with no thought to nation building at the conclusion of the operation was either naive or simply stupid. Perhaps it was both. 

Now, Crumble is no Kissinger and I hate to say I told you so....... but I told you so. In what I thought at the time were some pretty good posts, I repeatedly articulated what was plain to any passing bystander but not to the genius's in Whitehall who failed to soak in any lessons from other recent interventions in Iraq and Afghanistan and seemed oblivious to events in the rest of the Middle East. Sometimes I think you could hammer six inch nails into their foreheads and it wouldn't make any difference to their ability to reason.

Just for the record, here are the posts from February to August 2011,

Unrest in Libya and Haslemere                      February 22nd, 2011

Libya; The Wrong Issue For Britain                March 4th 2011 

Libya; No-Fly Zone Issues                               March 11th 2011

Libya; Who's The Nutty One?                         March 31st 2011

Libya; Straight Talking At Last                       April 4th 2011

Another Fine Mess.........                                 April 14th 2011 

Libya; Coalition Fragments                            July 15th 2011

Bless                                                                August 23rd 2011

What is to be done then to assist the Prime Minister of the day in making a balanced foreign policy decision thereby avoiding reckless interventions such as Libya. We can't go on leaving entire countries in a bigger mess than they were before we turned up uninvited. In my view, the Prime Minister needs a sanity check mechanism in his decision making process. One that is unencumbered with domestic political or career mindsets and definitely no policy wonks straight from the PPE course at Oxford. What I have in mind is a panel of six or eight clever folk who have an expertise in looking at problems in four dimensions, obliquely and from the inside out. They could be specialists in given fields but it isn't a hard requirement. Their task on being given a briefing paper would simply be to figure out the unintended consequences if the paper became policy. Their job would be to ask the 'what if's?' that others are either too timid, too inexperienced or too stupid to ask. Their input might just assist the Prime Minister and his or her Cabinet in coming to better judged decisions, or at least be more conversant with risk. The team could work from a basement in Whitehall or from their home locations. All they need is the highest security clearance, be politically agnostic and without any career ambition in government. You could say that I've just described MI6 but that hasn't worked out so well over the past twenty years has it?  

Back to the blog in 2011 and this post,  Libya, The Black Watch & Spike was my favourite, mostly because of this concluding line from Spike Milligan, 'How long was I in the Army?...... Five foot eleven!'

Europe

Back after a parents trip to Auschwitz-Birkenau. It does make you think about many things…. Europe amongst them.

A visit to any of the camps is always going to be emotionally challenging. It does though, give pause for moments of reflection on many things, the current state of Europe and “could it happen again?” amongst them. Of course genocide has indeed continued to be inflicted on people across the world since 1945 and there seems to be no end, or sense, to the steady stream of racial, religious and ethnic murder and cruelty in the world. Growing divisions in Europe will not take us back to the 1930’s but the shadow of the Second World War is never far away and traditional cross border suspicions are again bubbling under the surface and are not helping; not one little bit.

Angela Merkel took office ten years ago in 2005 when Europe was enjoying the pinnacle of its success. German integration was complete, the Russians were picking themselves up off the floor, Europe was united with a queue of new entrants to the EU project and the global economy was blazing. The world though has very much changed. Europe is in crisis with many members blaming Germany for their problems. Few countries now want to join the EU and the EU doesn’t want any new members. Ukraine is plunging deeper into the abyss and fear of Russia is growing. US politicians are discussing arming the Ukrainians and storing arms for US troops in the Baltic States.

The combination of economic and political stress has led to an increase in nationalism. Those flames are being fanned by the actions of extremist Islamic terrorists. Germany then, finds itself in the unwanted and uncomfortable position of being forced to take a leading economic and political role. The good thing about that is there is no other country more unlikely to change a political problem into a military one. The bad thing is that institutionally, Germany is not experienced or adept in the handling of cross border crisis.

Reluctantly, probably the most important politician in the world today but with no easy options.

Playing in the Russians backyard and encouraging demonstrations was never going to have an elegant end. As is often the way with liberal minded democracies when shots were fired the Germans backed off and instead of supporting the Ukrainians they joined in with sanctions. Germany will not ever get involved in military action in the East but is now being forced because of its earlier political engagement to seek compromise and to cool the situation down, much to the chagrin of a number of US politicians.

Merkel’s US visit was designed to persuade the US to soften its approach to Ukraine but a deep rooted suspicion of the Russians and their intentions does not easily change in Washington and Putin meanwhile, has his own constituency to serve which will not easily accept Russia backing down without significant concessions.

Equally, the Greek situation is creating unease in Berlin. The Germans have massively benefited from free and open markets with more than 50% of GDP going to export. Growing nationalism and protection may come to threaten Germany’s dominant export position, especially if the Euro is threatened by a Greek default and expulsion with others following. Germany has been forced to adopt a tough public stance with Greece yet the new Greek government was elected specifically with a mandate to challenge Germany.

From a German perspective, they’ve been doing all the right things, including lowering their leverage ration from 80% to 76% of GDP in the last four years. The rest of Europe though has its foot on the floor and is accelerating toward the fiscal cliff edge. Of Greece’s $350bn debt, a mighty $210bn is owed to the Eurozone bailout mechanism. Germany’s share of that is some $57bn. The problem is not the burden which may be placed on German taxpayers, it’s the share which other countries have signed up to and their ability to pay. Italy for example has a debt to GDP ratio of 132.6% and so is borrowing to pay interest. But Italy’s share of the Greek liability is $37bn while France is on the hook for $42bn. France is well down the road of becoming a financial basket case with the state taking 60% of GDP and with a debt to GDP ratio of 92%, (Maastrict supposedly limited debt to GDP at 60%). The problem with these stats is that a Greek exit will be met with a storm of protests from voters when they figure out what the bill means for them and there is little doubt the political map of Europe will undergo further rapid change.

None of this is good for markets. Increasing numbers of strategists are going underweight US equities and overweight European equities. These people don’t learn quickly. In fact, they probably don’t learn at all or are so glued to their valuation models they just don’t see the storm clouds rolling in. True and transparent price discovery of debt instruments in Europe is currently non-existent. That will happen when a central bank quadruples its balance sheet over ten years as the ECB has done. This of course was a necessary requirement to save European banks which had become insanely leveraged into the 2010-12 peripheral debt crisis, (DBK @ 56x for example with $1.9tr of assets and only $36bn of tangible equity).

As I wrote at the time, the unwillingness to force speculative investors to take losses and to underwrite them would simply store problems for the future. The future has arrived but paying the piper is now going to have a political cost and not just an economic one. Of the two alternatives, allowing Greece to go and watching the whole experiment unwind at great cost to the German taxpayer, or appeasing Greece, and subsequently other countries, at great cost to the German taxpayer neither is particularly palatable. The problem with both is that Germany probably ends up stronger and that is as unwelcome in Berlin as it is outside. Germany will probably allow Greece to go, if only because the domestic political cost will be lower than allowing them to stay.

It will however, set in train a sequence of events that none of us can know the outcome of. According to a new McKinsey study, global debt has grown by $57tr since the crisis. Government debt has grown by $25tr and only in the UK, US, Ireland and Spain has domestic, (but not government), debt deleveraged. China meanwhile went postal and increased leverage by 4x and now has a debt to GDP ratio at a stomach churning 282%. Zero interest rates will not hold the wall forever and disruption from FX markets resulting from political breaks are one likely route to what we refer to as real “price discovery.”  You could though, just call it an almighty crash, harsh bear market and economic depression and it’s that last word, depression, that haunts historians and anyone else who has had a reflective thought at any one of the camps.

Understanding War

Bad guys

President Obama has just finished talking at the UN where he said the world must act to "reject the cancer of violent extremism." He also talked about the Ukraine, Ebola and the Israel / Palastinian problem but it is clear that minds are focused on clearing out ISIL.

I think many Western and Middle Eastern countries view the Arab Spring as a lucky escape. This new and very different fundamentalist threat though has them very concerned. Many players, or the way they present it, view ISIL as a pestilence that can be eradicated. I'm not so sure it will be that simple. What the papers here haven’t explained is that ISIL are well organised and well led to an extent that is little understood. They have a command structure and operate tactically on the ground to a strategic plan with strategic goals. They have many Chechen's in their leadership so any view of them being a bunch of bloodthirsty mad rag-heads is misplaced.  Its going to take a lot more than air strikes to clean this up.

Recent ISW update

Well informed reporting however is difficult for the passing observer to come by, I'm here to help. These guys, The Institute for the Study of War, send regular updates on the situation on the ground. You can also find updates on other security matters pertaining to the Middle East and Afghanistan and also some reports. The one below, A Strategy to Defeat the Islamic State, written by Kimberly Kagan, Frederick W. Kagan, and Jessica D. Lewis, is well worth a read. Knowledge dispels fear!


HMS Prince of Wales

Queen Elizabeth Class aircraft carrier

I suppose I ought not to call it HMS given it's some way from being named and launched or whatever the conventions of our naval chums are. Anyway, I spend enough time bashing the government they ought to be congratulated when they do something good. The decision to not mothball the Prince of Wales on delivery is a welcome respite to years of grinding cuts. We'll then have two! Remarkable isn't it that Great Britain having two aircraft carriers is a cause for rejoicing?

Given all the other news this week, mostly bad, I'm surprised that few commentators appear to have grasped the significance of the decision. At a stroke it sends a powerful and resolute message to our allies, "oh, so you are serious," and will keep us at the geopolitical top table. Nor will it be unnoticed by our enemies and it is an overdue shot in the arm to the Navy who for too long, have been the poor relation. Their morale has suffered somewhat with relentless reductions in scale and capability in the past two decades and this news ought to encourage more experienced men to stay on given their potential career paths just broadened.

don't worry son, the Royal Navy's out there to look after Christmas

I know there are other considerations, such as aircraft which we haven't yet sorted out but for the moment, we should take what's on offer. Clearly, the Navy are in the ascendant and I would think too, so are the Royal Marines. I'm not the only one who thinks its good news. There is a statistic that rolls around out there that says 90%+ of all Christmas presents under the tree come by sea. Little boys and girls can sleep safe then; the Royal Navy is there to protect Christmas for all children.....

 

Flight MH 17 row continues to escalate

The Defence Ministers of Norway, Sweden, Netherlands and Germany and their Russian opposite number, Sergei Shoigu

The Defence Ministers of Norway, Sweden, Netherlands and Germany and their Russian opposite number, Sergei Shoigu

The Flight MH 17 row continues to escalate; why is it so difficult for someone to get on a plane and go and talk to Putin? The traditional mediator at such times, Germany, has excused and absented themselves from the process. Mrs Merkel must swing into gear, far from protecting Germany's interests she will achieve the opposite in sacrificing the long term good for short term industrial interests.

My view from the beginning of the Ukrainian crisis is that I wouldn’t trust either side as far as I could throw them and propaganda and misinformation continues to stream from both sides. The EU are absolutely culpable in precipitating the crisis in making impossible demands while making unfulfillable promises. Like it or not, EU meddling resulted in the overthrow of an elected government and having lit the fuse the EU stood back, turned and ran away. Now we have nigh on 300 innocents dead, and many thousands more in Ukraine itself and the European economy under threat of being destabilised.

Meanwhile, the rest of the world has accepted at face value the assertion that rebels downed the civilian aircraft. That may transpire to be fact but should be left to clinical investigation. Russia’s Defence Ministry is challenging the allegations and has produced evidence suggesting a Ukrainian fighter jet had tracked the airline despite early assertions from the Ukrainians that no fast jets were in the air. The Russians have also challenged the Americans to produce the satellite imagery they say they have showing that the missile was launched by the rebels. There are many more conflicting assertions and pieces of supposed evidence out there, such as the report of a Spanish air traffic controller working in Ukraine who said the Boeing was under escort by two Ukrainian fighters, and I know not which may or may not be accurate. I would simply encourage a healthy scepticism of the output of both sides. We’ll get the truth, eventually.

As an aside, I'm no fan of John Pilger and am diametrically opposed to just about everything he stands and has stood for but its a funny old world. So warped and pliable have political principals become in our modern world and so diluted has the integrity of journalism become that I find myself in almost absolute agreement with his thoughts on the Ukraine in this pretty searching and articulate piece from his blog. Worth a read.

One further point. Much has been made of lack of respect for the dead. If looting has taken place its unforgiveable but amongst the swaggering gangsters it is also clear that many local volunteers, firemen, miners and the like, have collected bodies and body parts. That is a traumatic experience. My old company was at Lockerbie, (after I had left them), and did just that job. The legacy of social problems and PTSD among those men lingers on and in fact I attended a funeral just two weeks ago, the cause of which may well stretch back down the years to Lockerbie. People who haven’t been handed a plastic bag and been asked or told to “go and collect” shouldn’t be so quick off the mark to criticise. It’s not a nice thing to have to do.

Syria; Chemical Weapons Disposal

Odd how tense things were a few weeks ago but now the media and politicians have moved on; it's as if the 800lb gorilla never showed up to rain on everyone's parade in the first place. Unfortunately, that much is now beyond reasonable doubt and he's still lurking out there. The issues aren't going away anytime soon no matter how much it would suit Washington.

The percieved relaxation in tension across the political and media environment, and reflected in global markets, is predicated on the agreement by Syria to list and subsequently dispose of its chemical weapons by mid 2014. It is perhaps useful to remember though, that this will very likely take years in practice. Further, it is worth noting that in reality, the manouvering of Russia to outwit and reposition itself against the United States in an effort to regain lost ground since the Cold War is hardly lost on the United States and it's allies.

The preferred method of disposal then is incineration which is a complicated technical process involving the separation of the delivery munitions from the toxic payload. This is made more laborious the older and more unstable the components are. Moreover, it is unlikely to be conducted on site. More probably the munitions will be moved to specialist international disposal sites, of which there are few, and delivering 1,000 tons of chemical and biological weapons to any given embarkation point is expensive, time consuming and requires many specialists, not to mention the security risks of movement in the midst of a civil war.

Destroying them within Syria is an option but would take many, many thousands of men to provide security for the operation in the midst of a civil war. The US DoD estimate up to 75,000 which would probably make Obama choke on his cornflakes. It is possible that destruction could be left to the Syrians with foreign technical help under the watch of UN inspectors. One estimate puts the number of inspectors required at 2,000 and all of those would need close protection. Of course, this option is also fraught with the risk that not all weapons will be recovered and the security of the weapons could easily be compromised during what would anyway, be a long operation.

In summary then, the Syrian chemical weapons problem is not going away. We’re now into a long term phase of negotiated disposal, (to be conducted amidst a civil war). It will be costly in time and money and be fraught with political risk at every level.

Mr Cameron, please note.

 

Syria; Not Our Sandpit

Keep Calm..............

Syria has long been a rogue state with no love lost between us and them. It was a location for Provisional IRA training camps and a source of weapons for PIRA and indeed other terrorist organisations. Nonetheless, the logic for British involvement is flaky at best. David Cameron and William Hague cannot grandstand and assume moral ascendancy when we lack the resource to back it up. We don’t have the resource mostly because Cameron’s government followed a well established pattern over the past 22 years of squeezing Defence in favour of other departments. Currently, the UK has amongst its local assets Cyprus, but with no aircraft on it and the HMS Illustrious group.... with no aircraft. Interesting that the most vocal opponents of involvement in a barely understood conflict are current  and former people from the military and intelligence community. The most pro is apparently the Prime Minister’s wife.

That much of the current instability can be traced back to our previous interventions seems lost on our leaders. Those interventions, achieved very little indeed, especially Iraq. It’s also popular to make comparisons with Kosovo which is extremely misleading, given the huge difference in size of the countries and the ferocity of the current civil war in Syria as opposed to the low intensity conflict in the Balkans.

 

aving avoided involvement so far neither the US or the UK really want to become embroiled in an inter Arab 50 year religious civil war. Based on outrage from the most recent atrocities, (although gas has been in use in limited quantities since March), the “something must be done,” calls don’t take us anywhere beyond lobbing some cruise missiles through the ether to “teach them a lesson,” in some fantasy aspiration that only bad guys will die, (including no doubt a bunch of Russian advisors which could be awkward), and the rest will just give up. Given we haven’t even confirmed the “who,” bit never mind the “what then,” part none of this is credible. Certainly, one question that enquiring minds ought to be asking is “who had most to gain,” by murdering innocents by the foulest of means?” Assad? Really, when he was winning the civil war?

The US of course has plenty of war toys in theatre with another 2 carrier groups on route

Attacks on air defences, military installations, command and control centres and chemical storage and production plants from the air don’t in themselves remove bad regimes. That requires men on the ground. There is no appetite for that either here or in the US, (and with an Army falling to 80,000 we couldn’t do it anyway), both populations being tired of constant war for 20 years. Moreover, the scale of munitions required to destroy and suppress such assets is of a much higher magnitude than was used in Libya. Of passing note of course is that hits on chemical sites are likely to release said chemicals into the atmosphere which would create the collateral damage nightmare of all nightmares. Meanwhile, the largest supporters of the rebels, the Saudi’s, will, along with their allies, be nowhere to be seen. The British Army are not mercenaries to be used to further the geopolitical aims of a bunch of rich sheiks in a country that we don’t know, don’t much care about and have no immediate national interest which actually lies in supporting regional allies, not doing their job for them.

An assumption that we can be involved in an attack on a foreign country with no fear of retaliation is just plain stupid. Syria has always had a sophisticated security network and, potentially with the help of Iran, retaliatory action must be expected, both on the mainland UK and abroad against UK and US assets and individuals. Indeed, rumours to the effect that Hezbollah will begin taking hostages are already circulating in Beirut.

A Reuters/Ipsos poll on August 19-23rd found that only 9% of Americans support US military intervention in Syria, while 90% of British people polled opposed any intervention in Syria. While a re-elected second term US president can afford to ignore public opinion, this is not true of a British prime minister, particularly if a single western weapon goes astray.

Those most opposed to intervention then, could God forbid, end up being casualties of war....... in any of our towns or villages. Do not underestimate the violence which these people are easily capable of perpetrating. A senior figure in the Intelligence community told me three years ago that it was only a matter of time before a European city suffered a significant attack from a rogue state or terrorist group using WMD. He then, was counting the years on the fingers of one hand.

Markets, who are smarter than politicians, have figured all this out and its the uncertain path forward and unknown outcome in the Middle East which is increasing volatility across asset classes. European stress points appearing, Asian contagion and budget issues in the US don’t help an already difficult situation. That any action would likely be propped up by more QE is though, slightly irrelevant at this point. Historically, we do tend to sell off prior to conflict and then rally hard during and in its aftermath but that previously was based on quick and decisive victories. This will be anything but.

LetterME.png

Euro Exit; An Elegant Solution

 

 

Markets have been preoccupied all week with how the trauma in European debt markets will be resolved. Will Germany capitulate from their hard line stance and allow the ECB to print, or will France capitulate and be drawn in to stronger German led political union? Meanwhile, the Southern European members are being squeezed hard as global investors derisk their exposure throughout the Euro zone with a commensurate deterioration in trust and confidence. There is at this point, little clarity about the outcome. 

One enquiring mind has popped up with an elegant solution. Mark Tinker at Framlington Asset Management, and occasional contributor, takes the lead, 

 

 

“My tone is somewhat light hearted, but the intent is very serious. 

An obvious analogy is China and the US. We know that China, as a manufacturing nation, has pegged its currency to the US, an economic zone running a large current account deficit and has benefited to the extent that there are regular calls to have it named as a "currency manipulator". The resulting capital account surplus of China was then recycled through the debt markets of the US as Germany's has been through the convergence trade in the Euro zone. Is not Germany then guilty of exactly the same thing as China? If we agree that it is so, then should we not expect Germany to float the DM in the same way as China will float the RMB? 

Germany should with immediate effect re-denominate all assets into a new DM, which would almost certainly appreciate rapidly against the "Old" euro, probably by around 25%. It could then do as the Swiss have done and make it quite clear that it will target a new informal peg of around 120 (hence my flip comment about pegging itself to the Swiss Franc). This would then enable a lot of the capital currently hiding in bunds to flow back into the eurozone and relieve the liquidity crisis there, for

that is the real issue in Italy and Spain, a fear of a Euro break up meaning a 25% haircut in all assets. 

The German population would love to have the DM and the Bundesbank back and while the Eurozone would have slightly higher yields than now, so long as the ECB makes it clear that ultimately it will print to guarantee repayment of principal - as every other sovereign nation can - there is no reason why their bonds should trade worse than, say the UK. 

The euro survives, just with Germany now in the same position as the UK and Sweden, in Europe but not the Euro. The only losers are German Banks with assets now denominated in a depreciated currency, but as we know, the solvency issues of Greece, Portugal and Ireland are more than accounted for in Banks balance sheets already. This was never a solvency crisis, it has been a liquidity crisis triggered by fears of a currency crisis. Remove Germany and all your problems are solved. If they won't leave, then the other 26 should vote them out.” 

One can only hope that this cracking originality in approach also catapults Mr Tinker to the front of the pack for consideration in the Wolfson Economic Prize which will be awarded “to the person who is able to articulate how best to manage the orderly exit of one of more member states from the European Monetary Union.” With a prize of £250,000 we can simply be certain that his will not be the only entry!

 

 

You Couldn't Make It Up..

 

Two Pigs died and met their maker this morning. I refer not to insolvent states in the Olive Oil zone, but to Mac & Mabel who were dispatched quietly by the mobile slaughter man, (his other job is as an undertaker and no, I’m not making it up), this morning and are, as I write, in the back of the car being driven to the butchers by Mrs Flashbang to be turned into cuts, sausages and bacon as part of her latest thrust toward total food security at Crumble Towers. As it happens, my soft and fluffy wife also dispatched three chickens this week because they weren’t laying in sufficient abundance to justify the odd bit of corn they eat, which seemed a bit brutal to me but that chaps, is what I live with.

It’s unfortunate that European leaders and bankers are not possessed of similar backbone. Perhaps I should send the wife to Brussels; that would show ‘em and be a welcome relief to the surviving domestic livestock.

Unfortunately, Europe continues to edge toward the danger zone and the horrible inevitability of financial meltdown at the sovereign, municipal and corporate level in Europe threatens to drag is all down. I'm not going to write about it at length here given I do enough of that in the day job but I would draw your attention to one dramatic step the Greeks are making to protect themselves from fallout.....

 

From the Hellenic Defence & Technology Magazine we learn that U.S. authorities have approved to grant 400 M1A1 Abrams tanks to the Greek Army, which will include options between simple refurbishment – worth tens of millions dollars for all the tanks- and upgrading to a higher level of operational capability, with a higher corresponding cost. That’ll go nicely then with the hundreds of Leopard tanks they already have of various vintages.

Shame they can’t afford to fuel the buggers, unless of course; they’re the new vehicle fleet for government ministers or to defend Athens when the Germans come asking for their money back. Then again, if they keep cutting Greek army pensions the barrels might be pointing more in than out…..

The truth of course, us that Greece is acting exactly the same way as a bloke from a Liverpool estate who’s maxed his credit cards out, has a bailiffs notice and has gone straight out and bought a new car.

You couldn’t make it up.

 

 

Football & Rugby

Happy Friday and excitement is quietly growing as we head into the weekend for a stunning conclusion to the Six Nations in what should be a monster festival of international rugby with the three deciding games tomorrow.

Our footballing friends though, appear to be struggling with the more mundane things in life as Manchester City's most expensive signing Mario Balotelli appears unable to dress himself,

Never let it be said though, that the rugby world can't laugh at itself...................... enjoy!

 

Japan, The Persian Gulf and Energy

 

Japan, to put it mildly, is in an uncomfortable place. Notwithstanding the immediate and urgent requirement to rescue survivors, house and feed the displaced, protect against further seismic shocks and get the reactors under control they must also look to and plan their future. The disaster however, has rammed home some very uncomfortable historical and geographical truths for the nation with regard to energy and access to natural resources.

It also reminds us all how interlined and interdependent is the world in which we live. For example, at the nuclear sites, fuel rods and the entire plant will be checked for potential damage. This will take about 4-5 years. The safety systems on all Japanese plants will be upgraded to withstand a 9.0 earthquake and tsunami (or worse). The most significant problem will be a prolonged power shortage. About half of Japan's nuclear reactors will probably have to be inspected, reducing the nation's power generating capacity by 15%. This will probably be covered by running gas power plants that are usually only used for peak loads to cover some of the base load as well. That will increase your electricity bill, as well as lead to potential power shortages during peak demand in Japan. 

In the excellent article below, by George Friedman at Stratfor, he discusses Japan's energy security and vulnerability to flash points in the Gulf which for us all; is the 800lb gorilla in a bad mood banging around the kitchen. 

 

 

JAPAN, THE PERSIAN GULF AND ENERGY

Over the past week, everything seemed to converge on energy. The unrest in the Persian Gulf raised the specter of the disruption of oil supplies to the rest of the world, and an earthquake in Japan knocked out a string of nuclear reactors with potentially devastating effect. Japan depends on nuclear energy and it depends on the Persian Gulf, which is where it gets most of its oil. It was, therefore, a profoundly bad week for Japan, not only because of the extensive damage and human suffering but also because Japan was being shown that it can't readily escape the realities of geography.

Japan is the world's third-largest economy, a bit behind China now. It is also the third-largest industrial economy, behind only the United States and China. Japan's problem is that its enormous industrial plant is built in a country almost totally devoid of mineral resources. It must import virtually all of the metals and energy that it uses to manufacture industrial products. It maintains stock piles, but should those stockpiles be depleted and no new imports arrive, Japan stops being an industrial power.

The Geography of Oil

There are multiple sources for many of the metals Japan imports, so that if supplies stop flowing from one place it can get them from other places. The geography of oil is more limited. In order to access the amount of oil Japan needs, the only place to get it is the Persian Gulf. There are other places to get some of what Japan needs, but it cannot do without the Persian Gulf for its oil.

This past week, we saw that this was a potentially vulnerable source. The unrest that swept the western littoral of the Arabian Peninsula and the ongoing tension between the Saudis and Iranians, as well as the tension between Iran and the United States, raised the possibility of disruptions. The geography of the Persian Gulf is extraordinary. It is a narrow body of water opening into a narrow channel through the Strait of Hormuz. Any diminution of the flow from any source in the region, let alone the complete closure of the Strait of Hormuz, would have profound implications for the global economy.

For Japan it could mean more than higher prices. It could mean being unable to secure the amount of oil needed at any price. The movement of tankers, the limits on port facilities and long-term contracts that commit oil to other places could make it impossible for Japan to physically secure the oil it needs to run its industrial plant. On an extended basis, this would draw down reserves and constrain Japan's economy dramatically. And, obviously, when the world's third-largest industrial plant drastically slows, the impact on the global supply chain is both dramatic and complex.

In 1973, the Arab countries imposed an oil embargo on the world. Japan, entirely dependent on imported oil, was hit not only by high prices but also by the fact that it could not obtain enough fuel to keep going. While the embargo lasted only five months, the oil shock, as the Japanese called it, threatened Japan's industrial capability and shocked it into remembering its vulnerability. Japan relied on the United States to guarantee its oil supplies. The realization that the United States couldn't guarantee those supplies created a political crisis parallel to the economic one. It is one reason the Japanese are hypersensitive to events in the Persian Gulf and to the security of the supply lines running out of the region.

Regardless of other supplies, Japan will always import nearly 100 percent of its oil from other countries. If it cuts its consumption by 90 percent, it still imports nearly 100 percent of its oil. And to the extent that the Japanese economy requires oil -- which it does -- it is highly vulnerable to events in the Persian Gulf.

It is to mitigate the risk of oil dependency -- which cannot be eliminated altogether by any means -- that Japan employs two alternative fuels: It is the world's largest importer of seaborne coal, and it has become the third-largest producer of electricity from nuclear reactors, ranking after the United States and France in total amount produced. One-third of its electricity production comes from nuclear power plants. Nuclear power was critical to both Japan's industrial and national security strategy. It did not make Japan self-sufficient, since it needed to import coal and nuclear fuel, but access to these resources made it dependent on countries like Australia, which does not have choke points like Hormuz.

It is in this context that we need to understand the Japanese prime minister's statement that Japan was facing its worst crisis since World War II. First, the earthquake and the resulting damage to several of Japan's nuclear reactors created a long-term regional energy shortage in Japan that, along with the other damage caused by the earthquake, would certainly affect the economy. But the events in the Persian Gulf also raised the 1973 nightmare scenario for the Japanese. Depending how events evolved, the Japanese pipeline from the Persian Gulf could be threatened in a way that it had not been since 1973. Combined with the failure of several nuclear reactors, the Japanese economy is at risk.

The comparison with World War II was apt since it also began, in a way, with an energy crisis. The Japanese had invaded China, and after the fall of the Netherlands (which controlled today's Indonesia) and France (which controlled Indochina), Japan was concerned about agreements with France and the Netherlands continuing to be honored. Indochina supplied Japan with tin and rubber, among other raw materials. The Netherlands East Indies supplied oil. When the Japanese invaded Indochina, the United States both cut off oil shipments from the United States and started buying up oil from the Netherlands East Indies to keep Japan from getting it. The Japanese were faced with the collapse of their economy or war with the United States. They chose Pearl Harbor.

Today's situation is in no way comparable to what happened in 1941 except for the core geopolitical reality. Japan is dependent on imports of raw materials and particularly oil. Anything that interferes with the flow of oil creates a crisis in Japan. Anything that risks a cutoff makes Japan uneasy. Add an earthquake destroying part of its energy-producing plant and you force Japan into a profound internal crisis. However, it is essential to understand what energy has meant to Japan historically -- miscalculation about it led to national disaster and access to it remains Japan's psychological as well as physical pivot.

Japan's Nuclear Safety Net

Japan is still struggling with the consequences of its economic meltdown in the early 1990s. Rapid growth with low rates of return on capital created a massive financial crisis. Rather than allow a recession to force a wave of bankruptcies and unemployment, the Japanese sought to maintain their tradition of lifetime employment. To do that Japan had to keep interest rates extremely low and accept little or no economic growth. It achieved its goal, relatively low unemployment, but at the cost of a large debt burden and a long-term sluggish economy.

The Japanese were beginning to struggle with the question of what would come after a generation of economic stagnation and full employment. They had clearly not yet defined a path, although there was some recognition that a generation's economic reality could not sustain itself. The changes that Japan would face were going to be wrenching, and even under the best of circumstances, they would be politically difficult to manage. Suddenly, Japan is not facing the best of circumstances.

It is not yet clear how devastating the nuclear-reactor damage will prove to be, but the situation appears to be worsening. What is clear is that the potential crisis in the Persian Gulf, the loss of nuclear reactors and the rising radiation levels will undermine the confidence of the Japanese. Beyond the human toll, these reactors were Japan's hedge against an unpredictable world. They gave it control of a substantial amount of its energy production. Even if the Japanese still had to import coal and oil, there at least a part of their energy structure was largely under their own control and secure. Japan's nuclear power sector seemed invulnerable, which no other part of its energy infrastructure was. For Japan, a country that went to war with the United States over energy in 1941 and was devastated as a result, this was no small thing. Japan had a safety net.

The safety net was psychological as much as anything. The destruction of a series of nuclear reactors not only creates energy shortages and fear of radiation; it also drives home the profound and very real vulnerability underlying all of Japan's success. Japan does not control the source of its oil, it does not control the sea lanes over which coal and other minerals travel, and it cannot be certain that its nuclear reactors will not suddenly be destroyed. To the extent that economics and politics are psychological, this is a huge blow. Japan lives in constant danger, both from nature and from geopolitics. What the earthquake drove home was just how profound and how dangerous Japan's world is. It is difficult to imagine another industrial economy as inherently insecure as Japan's.

The earthquake will impose many economic constraints on Japan that will significantly complicate its emergence from its post-boom economy, but one important question is the impact on the political system. Since World War II, Japan has coped with its vulnerability by avoiding international entanglements and relying on its relationship with the United States. It sometimes wondered whether the United States, with its sometimes-unpredictable military operations, was more of a danger than a guarantor, but its policy remained intact.

 It is not the loss of the reactors that will shake Japan the most but the loss of the certainty that the reactors were their path to some degree of safety, along with the added burden on the economy. The question is how the political system will respond. In dealing with the Persian Gulf, will Japan continue to follow the American lead or will it decide to take a greater degree of control and follow its own path? The likelihood is that a shaken self-confidence will make Japan more cautious and even more vulnerable. But it is interesting to look at Japanese history and realize that sometimes, and not always predictably, Japan takes insecurity as a goad to self-assertion.

This was no ordinary earthquake in magnitude or in the potential impact on Japan's view of the world. The earthquake shook a lot of pieces loose, not the least of which were in the Japanese psyche. Japan has tried to convince itself that it had provided a measure of security with nuclear plants and an alliance with the United States. Given the earthquake and situation in the Persian Gulf, recalculation is in order. But Japan is a country that has avoided recalculation for a long time. The question now is whether the extraordinary vulnerability exposed by the quake will be powerful enough to shake Japan into recalculating its long-standing political system.