While we have seen in our Jan 5, 2008 world forecast, that among others, an assertive Russia is re-emerging and taking advantage of the imbalance in U.S. power resulting from the US-Iraq and Afghanistan war. Oil as we mentioned on Jan. 2, is at historical highs and continued Asian — particularly Chinese — exports have created a massive redistribution of financial might that is reshaping the international financial architecture. Hence we will predict another, less discussed subject on our website so far, that of the world economy during 2008.But first a general overview, as a postscript to our Jan 5, 2008 worldwide overview.Normally in an election year, U.S. attention on global affairs dwindles precipitously, allowing other powers to set the agenda. That will not be the case, however, in 2008. U.S. President George W. Bush is not up for re-election, and there is no would-be successor from the administration in the race; this frees up all of the administration’s bandwidth for whatever activities it wishes. Additionally, Bush’s unpopularity means that each of the White House’s domestic initiatives essentially will be dead on arrival in Congress. All of the Bush administration’s energy will instead be focused on foreign affairs, since such activities do not require public or congressional approval. Contrary to the conventional wisdom, 2008 will see the United States acting with the most energy and purpose it has had since the months directly after the 9/11 attack.
Such energy is not simply a result of this odd hiccup in the American political system but of a major shift in circumstance on the issue that has monopolized American foreign policy efforts since 2003: Iraq. The Iraq war was an outgrowth of the jihadist war. After the 2001 invasion of Afghanistan, the United States realized it lacked the military wherewithal to simultaneously deal with the four powers that made al Qaeda possible: Saudi Arabia, Syria, Iran and Pakistan. The first phase of the Bush solution was to procure an anchor against Afghanistan by forcing Pakistan into an alliance. The second was to invade the state that bordered the other three — Iraq — in order to intimidate the remaining trio into cooperating against al Qaeda. The final stage was to press both wars until al Qaeda — the core organization that launched the 9/11 attack and sought the creation of a pan-Islamic caliphate, not the myriad local extremists who later adopted its name — broke.
As 2008 dawns, it has become apparent that though this strategy engendered many unforeseen costs, it has proven successful at grinding al Qaeda into non-functionality. Put simply, the jihadist war is all but over; the United States not only is winning but also has an alliance with the entire constellation of Sunni powers that made al Qaeda possible in the first place. The United States will attempt to use this alliance to pressure the remnants of al Qaeda and its allies, as well as those in the region who are not in the alliance.
This leaves Iran, the region’s only non-Sunni power, in the uncomfortable position of needing to seek an arrangement with the United States. The year 2008 will still be about Iraq — but in a different way. Iran cares deeply about the final status of Iraq, since every united Mesopotamian government has at some point in its history attempted a Persian invasion. Yet for the United States, the details of intra-Iraqi negotiations and security in Iraqi cities now are irrelevant to its geopolitical concerns. Washington does not care what Iraq looks like, so long as the Sunni jihadists or Tehran do not attain ultimate control — and evolutions in 2007 have made both scenarios impossible in 2008.
Iran recognizes this, and as a result Washington and Tehran are ever less tentatively edging toward a deal. It is in this context — as an element of talks with Iran — that Iraq still matters to Washington, and this is now the primary rationale for continued involvement in Iraq. The United States will not completely withdraw from Iraq in 2008 — indeed, it likely will have 100,000 troops on the ground when Bush leaves office — but this will be the year in which the mission evolves from tactical overwatch to strategic overwatch. (Roughly translated from military lingo, this means shifting from patrolling the cities in order to enforce the peace to hunkering in the desert in order to ensure that Iran does not try to seize Iraq and the Arabian Peninsula beyond.)
In the aftermath of the November 2007 Annapolis, Md., conference and the declassification of a National Intelligence Estimate on the nonexistence of the Iranian nuclear program, the ball is in the Iranians’ court. A U.S.-Iranian deal — no matter how beneficial it would be for both states — is not inevitable. But we find it unlikely that Tehran would choose strategic confrontation with both the United States and the Arab world when the benefits of cooperation — and the penalties for hostility — are so potent. A framework for future relations, as well as for co-dominion of Iraq, is likely to emerge in 2008.
Still, frameworks come slowly, and crafting such a framework will require the bulk of American forces currently in Iraq to remain there for most of the year. The United States will draw forces down and eventually regain its bandwidth for other operations, but 2008 will not be the year that the United States returns to policing the world on a global scale. And considering the still-mounting costs of regenerating military capabilities after six years of conflict, manpower expansion and acquisitions, such force recovery might not even occur in 2009. The United States could have more energy and political freedom to act, but military realities will anchor the lion’s share of Washington’s attention on the Middle East for — at the very least — the year to come. And Afghanistan, and therefore Pakistan, will have to be dealt with, regardless of what happens in Iraq.
This means 2008 will be similar to 2007 in many ways: It will be a year of opportunity for those powers that would take advantage of the United States’ ongoing distraction. However, they will face a complication that was absent in 2007: a deadline. The Iraqi logjam is broken. Unlike in 2007, when Iraq appeared to be a quagmire and other powers therefore sensed endless opportunity, those hostile to U.S. interests realize that they only have a limited window in which to reshape their regions. Granted, this window will not close in 2008, since the United States will need to not only withdraw from Iraq but also rest and restructure its forces; but the United States no longer is mired in an open-ended conflict.
The state with the greatest need to take advantage of this U.S. occupation, bar none, is the Russian Federation. Moscow knows full well that when the Americans are finished with their efforts in the Middle East, the bulk of their attention will return to the former Soviet Union. When that happens, Russia will face a resurgent United States that commands alliances in Asia, Europe and the Middle East. Russia must use the ongoing U.S. entanglement in the Middle East to redefine its immediate neighborhood or risk a developing geopolitic far less benign to Russian interests than Washington’s Cold War policy of containment. Russia needs to move — and it needs to move now.
And there are a host of secondary powers that will be interacting within the matrix of American actions in 2008. Some — such as Syria and Saudi Arabia — want to be included in the U.S. Iraqi calculus and will have their chance. Others — namely South Korea, Taiwan, Australia and Japan — are looking for new ways to work with Washington as they adapt to their own domestic government transitions. All of Europe is shifting back to a power structure that has been absent for two generations: the concert of powers, with all of the instability and mistrust that implies.
Others will be pursuing bold agendas, not because of the United States’ distraction but because they are rising to prominence in their own right. Angola will rise as a major African power to rival South Africa and Nigeria. Brazil will lay the groundwork for reasserting its long-dormant role as a South American superpower. Turkey — now the strongest it has been in a century — will re-emerge as a major geopolitical weight in the eastern Mediterranean, albeit one that is somewhat confused about its priorities.
Quietly developing in the background, the global economy is undergoing a no less dramatic transformation. While we expect oil prices to retreat somewhat in 2008 after years of surges, their sustained strength continues to shove a great deal of cash into the hands of the world’s oil exporters — cash that these countries cannot process internally and that therefore will either be stored in dollars or invested in the only country with deep enough capital pools to handle it: the United States. Add in the torrent of exports from the Asian states, which generates nearly identical cash-management problems, and the result is a deep dollarization of the global system even as the U.S. dollar gives ground. The talk on the financial pages will be of dollar (implying American) weakness, even as the currency steadily shifts from the one of first resort to the true foundation of the entire system.
This will be a year in which the United States achieves more success in its foreign policies than it has since the ousting of the Taliban from Afghanistan in late 2001. But the actions of others — most notably a rising Russia — rather than U.S. achievements will determine the tenor and fury of the next major global clash.The 2008 World Economy
Iran is moving toward an agreement with the United States on Iraq, Nigerian politics have calmed, the market has priced in Venezuelan nationalism, states in the Malacca region have managed to get piracy under control and al Qaeda’s operations have been sequestered in the Afghan-Pakistani border region. The only wild card remaining in 2008 is the Russians, who could limit their exports of oil and natural gas as part of Moscow’s struggle with the West. However, since such restrictions would impact Russia’s own exports, any geopolitical impact on energy prices in 2008 is unlikely.
The expected downward trend in oil prices will not carry over to other commodities, such as food and minerals. The price increases of these products in recent years are the result of rising and more varied demand — such as the new biofuels industry’s increasing need for crops. There is no reason to expect such demand to falter, and there are no new supplies of any minerals expected to come on line that might be large enough to cause prices to substantially drop. The one exception could be foodstuffs, whose supply in large part is determined by the weather (something we do not attempt to forecast).
While energy prices will moderate in 2008, there will not be a collapse. Since the declines will be relatively mild and since most oil exporters have managed to save up vast sums, very few producers will suffer any substantial financial stress. In fact, nearly all oil producers will continue to accrue near-record amounts of income, stabilizing them politically and economically despite the moderate downturn in prices. The two countries to watch are Argentina and Venezuela, which both have been spending their petroleum income as fast as it has come in, and whose lack of long-term investment in production has resulted in steady output drops in output for years.
Yet there is another aspect to this equation. Prices have been strong since 2003 and have given rise to a major trend that will surge forward in 2008: the steady deliberalization of the energy sector.
Producing states — from Venezuela to Kazakhstan — are seeking to rake in as much income from energy production as they can, regardless of how dependent they might be upon foreigners to produce that energy. On the coin’s other side, consuming states — from Malaysia to Argentina — need to assert control over their energy industries in order to head off the social and economic problems caused by sustained high prices. Some countries on both sides — such as China — are afraid of how powerful their energy firms have gotten, and they see deliberalization as a means of combating that challenge. Countries such as Russia see state control of the energy sector as a good thing — and a good thing that allows other policy options. Still, more — most notably Hungary — see such intervention as a means of preventing undue foreign influence.
In 2008, energy deliberalization will be the game of the day, and we expect the following countries to be particularly active in asserting the role of the state: Venezuela, Ecuador, Bolivia, Thailand, Kazakhstan, Russia, Ukraine, Hungary, China, South Korea, Nigeria, Indonesia, Japan and Canada.
Meanwhile, the U.S. dollar — which has slipped by 50 percent in the past six years — will give more ground in 2008, since the trends that have shaped the past few years have not yet run their course. Unconvinced that the euro would succeed, central banks dumped European currencies when it was launched in 1998. They now are dialing back from that position, as well as purchasing more gold. Both of these trends have a negative impact on the U.S. dollar, and both have more room to run.
None of this is a vote of no confidence in the dollar; contrary to the crowing out of Venezuela, Iran and, on occasion, Russia, the dollar is in no danger of losing its status as the world’s de facto currency. In fact, contrary to conventional wisdom, the role of the U.S. dollar in the international economy could be increasing. All of the energy-producing economies sell their products in U.S. dollars. The Chinese yuan is de facto pegged to the dollar, and nearly every other economy in the western Pacific Rim is loosely pegged to it as well. Combine the dramatic increase in the size of the Chinese economy and the pileup of dollars in the Arabian Peninsula from high oil prices (Organization of the Petroleum Exporting Countries members earned more than half a trillion dollars in 2007 from oil alone) and the result is a de facto dollar bloc.
Yet none of these economies boasts sufficient size or sophistication to handle all of this inflow, and how they manage such vast sums will prove a major development of 2008. Many of the Arab oil states have chosen to invest in economic diversification so that they will not suffer as they have in times past the next time oil prices plunge. To this end, they are investing heavily in refining and heavy chemical industry facilities, both at home and in consumer countries. In most cases, the Arabs are providing only the capital for such ventures, with either imported expatriates or foreign hosts providing both the labor and the management for the projects. The Russians, of course, are investing in their own geopolitical push and are attempting to purchase as much energy infrastructure in Europe as possible (something the Europeans are resisting fiercely), while the Chinese are hoping to use at least some of the cash to bail out those of their state-owned enterprises that are worth saving. But even this leaves the vast majority of the accrued monies untouched — in dollars or U.S.-based investments.
Beyond the tactical details, the bottom line is that most of Asia, the Arabian Peninsula and the United States have de facto merged into a single system of exchange that has become more important in purely economic terms than the U.S. relationship with Europe. Not since the heady days of the British Empire has a single currency held sway over so much of the world. Yes, these entities are diversifying their investments, which is reducing the value of the U.S. dollar vis-à-vis the euro, but the more important trend is the strengthening of the dollar’s role as the reserve currency of the world — forming the base of the reserve economy of the world.
Combine weaker energy prices (which free up resources) with a lower dollar (which boosts exports) and the U.S. economy is primed for a strong performance in 2008. A brief slowdown in early 2007 shook out some inconsistencies that built up during the post-9/11 boom, and the stage is set for another extended expansion.
Many will mourn that the subprime lending crisis is about to cause major problems — and perhaps even a recession. We see these fears as overblown for two reasons. First, mortgages that enter default are different from other defaulted loans in that mortgages have their own built-in collateral in the form of houses. Rather than getting back pennies on the dollar, creditors likely will recoup most of their money. This, combined with the fact that not all subprime loans will go bust, drastically reduces subprime’s impact.
Second, every so often, the Western financial sector needs a shock to remind itself that it is not Asia and that loans need to be evaluated on strict economic criteria before being granted. During the 2005-06 subprime surge, this lesson had been forgotten. Now it has been remembered, and banking institutions have forced the mortgage broker industry to rate loans more appropriately. As a result, most of those brokers have gone under, and many construction projects have lost funding. Those who have been hurt worst are those who leveraged subprime mortgage assets (and should have known better).
This rationalization of risk is bad for the housing sector in the short run but excellent for the banking sector and the wider economy in the longer run. Yes, one sector has taken hits and will take more in 2008. But the primacy of economic rationality already has reasserted itself. This is a core strength of the U.S. and Western systems; without it, these economies would look like Japan’s. The knocks resulting from the subprime crisis could indeed take some shine off of growth in 2008, but that would simply change it from a banner year to “merely” a strong year.
The global trade agenda will be somewhat muted in 2008. Talks on the next World Trade Organization round, Doha, have been all but suspended, and no major economy will join the organization in the next year. Neither will there be any progress on other major deals among or within trade blocks — largely a result of European efforts to push through their newest treaty (an echo of the constitution that failed in 2004) and the U.S. presidential election. Trade talks will be limited to ironing out a few minor bilateral deals between the United States and small powers — deals that are now before Congress — and between the European Union and its former colonies.