Improved diplomatic relations between Egypt and Iran

Saturday marked the first flight between Egypt and Iran since 1979. The election of Islamist President Mohamad Mursi in Egypt in June 2012 significantly thawed relations between the two countries. Diplomatic ties had been cut by Iran in 1979 when the deposed Shah took refuge in Egypt, but the heads of state from the two countries visited in February and the relationship is now largely mended (Reuters).

President Mursi was a leader in the pan-Islamist movement called the Muslim Brotherhood, which has approximately 600,000 members who pay a percentage of their incomes to the organization. It has members worldwide, and promotes Sharia law and the unification of Arab states. These goals are, incidentally, shared by the terrorist group Al Qaeda. The 2011 popular overthrow of President Mubarak in Egypt served as a strong indicator of the Muslim Brotherhood’s growing power. The US announced diplomatic relations with the group immediately following. Egypt was a strong US ally against the Soviets during the Cold War, and was a voice for stability in the Israeli-Palestinian conflict. The manifestation of the Arab Spring in Egypt, which deposed long-time US ally Hosni Mubarak, has not been kind to US foreign policy goals in the region.

Iran and Egypt are the third and sixth largest Muslim countries by GDP. Iran has a GDP of $522 billion and Egypt has a GDP of $231 billion (United Nations 2011). While the economy is half that of Iran, Egypt will attempt to expand its regional power status in the Arab states, Africa, and closely align with Iran and China.

For indicators of balancing against NATO and tilting away from the US, watch for Egypt joining the Shanghai Cooperation Organization (SCO) as an observer state, as has Iran. Watch for increased commercial relations with North Korea and Iran, and improved diplomatic ties with Pakistan. For indicators of nuclear club aspirations, watch for Egyptian efforts to improve types of nuclear power generation that yield fissile by-products for potential use in nuclear weapons. Also watch for increased Egyptian government links to organizations with likely ties to global terrorism. Egyptian political instability will continue until more authoritarian rule is imposed by either the Islamists or the pro-western faction. Expect further loss of value in Egypt-tied investments, including equities, commercial debt, and sovereign debt. Egyptian oil production is less than 1% of global supply, so there should be negligible effects on oil prices.

The Chinese are Playing Us on North Korea, Again

The United States Treasury Department claimed on March 22 that it was confident that China would back new United Nations’ financial sanctions against North Korea. The sanctions punish North Korea for the nuclear tests of February 12. An anonymous Chinese official — almost certainly speaking at the direction of his government – on March 22 revealed that China halted oil exports to North Korea.

Unfortunately, the pro forma Chinese punishment of North Korea for its most recent nuclear test will be intentionally lightweight. China had a similarly weak response to the first North Korean nuclear test on October 6, 2006, and it proved an insufficient disincentive to further nuclear and missile development. It increased backing to UN financial sanctions, and ceased oil exports to the country for a short period. As in 2006, China knows that Iran is likely to supply the energy shortfall to North Korea resulting from any loss from China’s embargo. Without a much stronger set of sanctions and enforcement mechanisms, a network of embargoed, rogue, and failed states have the outside option of trading with each other, and regaining overt Chinese and Russian support when international attention fades.

Anything more than a slap on North Korea’s wrist would chill Chinese relations with authoritarian regimes across the globe. For this reason, China can ill-afford any drastic action against North Korea. China is a long-time supporter of authoritarian governments worldwide, from Uzbekistan to Syria. This support is concretized in the Shanghai Cooperation Organization. China is the key diplomatic supporter of North Korea, and can dictate many North Korean policies based on China’s economic power and physical proximity. Other authoritarian states will watch the magnitude of Chinese reaction to North Korean behavior to calibrate the trust they can place in their own relations with China. These global relations between China and authoritarian regimes are crucial for China to obtain relatively inexpensive raw commodity imports that fuel its present top priority of economic growth. It is inconceivable that China would risk slowing its own economic growth because of a recent uptick in threats to the West from North Korea.

Short-term sanctions, however, will occur. China believes the young Kim Jong-Un, the new leader of North Korea, has overstepped his bounds with recent tests and threats towards the United States and South Korea. The increased Chinese support to sanctions and a decrease in North Korea’s access to oil markets serve China as both a message to Kim Jong-Un to follow a slightly quieter path, and a tool to stave off criticism of China at the United Nations were it not to support sanctions. Time is currently on the side of China and North Korea, leading to a trend of which China is well aware. China’s economy is growing much more rapidly than Western-allied economies, which strengthens China’s military and diplomatic position with respect to the West. North Korea continues tests of its nuclear and missile technology, with no effective response from the West. With the latest sanctions, China is telling North Korea not to rock the boat because the race is being won.

Watch for China’s long and short-term strategies to have an immediate effect on Kim Jong-Un by decreasing his public belligerence. Also watch for China to ease pressure on North Korea as soon as it either complies or public attention goes elsewhere. Without a Chinese-supported embargo on imports and exports to North Korea, plus enforcement by international naval vessels deployed to the East China Sea and Sea of Japan, the latest round of financial and oil restrictions will be ineffective; North Korea will continue to progress in developing and proliferating nuclear weapons and missile technology.

North Korean WMD terrorism as much a threat as nuclear-tipped missiles

Today North Korea put their medium-range missiles on combat alert and repeated threats against US military bases including in South Korea, Guam, and Hawaii. The US Defense Department sent a strong signal by flying two nuclear-capable B-2 Stealth Bombers over South Korea in training exercises, and through comments to the press by the Defense Secretary that indicate a readiness for conflict should that be necessary. A Defense Department spokesman softened those comments by reiterated that the US seeks to deescalate tensions, and that the important goal is to stay ahead of North Korea in terms of its capability to marry a nuclear warhead with a missile delivery vehicle (CNN). However, a potentially greater threat from North Korea is an unconventional or terrorist delivery of nuclear or other weapons of mass destruction (WMD). Were a nuclear device to explode in a major port city, for example, it would likely cause up to one trillion dollars of damages, 500,000 deaths, and $40-70 billion in trade losses  (BloombergCongressional Research Service).

It is unlikely that the North Koreans would follow-through on their most recent threats, and unlikely that were they to try, a missile strike would be effective. The North Koreans are having difficulty with the technical challenges of component miniaturization that would allow them to place a nuclear warhead on a missile. To stave off such an attack in the future, the US must nevertheless maintain robust intelligence, deterrent, and preemptive strike capabilities. North Korea could provide us with an unpleasant surprise. Saddam Hussein surprised the world in 1990 with the progress he had made towards achieving nuclear status, and there is much more technological improvement in rogue state nuclear capabilities twenty years later.

China and Russia are likely sharing, to a limited extent, nuclear technologies with Pakistan, Iran, and North Korea. These rogue states are likely sharing with each other as well. This sharing does not necessarily have to be state-sanctioned. A poorly-supervised agency within a rogue state would have the capability to proliferate nuclear or other WMD technologies without the knowledge of its government. Many individual scientists or government officials in these corrupt countries, if offered sufficient incentive, would likely be willing to share technological expertise or hardware necessary for the making of blueprints or reverse-engineering.

Staying ahead of North Korean improvements is a challenging task, and risky. As Defense Secretary Donald Rumsfeld famously said,  “There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know.” (Press Briefing, February 12, 2002)

The risk is not only that North Korea has a nuclear delivery capability about which we are unaware, but that they could be considering unconventional approaches to delivery. These approaches could include smuggling a nuclear weapon into the United States, Japan, or South Korea. Radiation detection used on all containerized cargo coming into the United States does not effectively detect nuclear materials encased in lead. X-ray scanning, which might detect such encased materials, is only used on 4% of the highest-risk cargo inbound to the United States. The Department of Homeland Security has found it impractical to implement a 2007 Congressional mandate to scan 100% of incoming containerized cargo  (Bloomberg). Implementation of scanning and detection technologies is currently insufficient to guard against nuclear terrorists or rogue states that use containerized cargo as a delivery vehicle.

North Korea could also simply drive nuclear materials and components across the Canadian or Mexican borders, or smuggle them on fast boats from a nearby Latin American country. Such components can be reassembled once in the United States.

Finally, North Korea is in a unique position to use biological weapons of mass destruction. Often referred to as a hermit kingdom, North Korea has the world’s strictest restrictions on immigration and emigration. This makes them relatively invulnerable to blowback from a biological WMD. The most dangerous biological weapons are highly contagious. Contagion through humans is the delivery vehicle. Thus a strong disincentive for use of biological weapons by non-secluded states is the danger that the contagion will spread to one’s own country. This applies to a much lesser degree for North Korea. Biological weapons have the advantage over nuclear weapons in that they cannot be detected by radiation detectors or x-ray scanners, can be produced by small teams of bio-chemists with relatively ordinary lab equipment, and would be easily smuggled in containerized cargo. North Korea certainly has the capability to construct such weapons, and Defense Secretary Rumsfeld’s “unknown unknowns” applies. Finally, unconventional delivery of WMD has the advantage over missile delivery for North Korea in that its origin is less traceable.

The United States came close to a preemptive strike against North Korean nuclear capabilities in the 1990s. While there are certainly risks of retaliation against regional US bases and allies, such a strike is still on the table as a policy option. It could have a salutary demonstration effect for other rogue states and proliferators, including Iran and Pakistan. The option of waiting, and continued technological development by a belligerant and immature North Korea, could make it impossible to take such actions in the future.

 

North Korean closure of Kaesong Industrial Complex is no signal for increased likelihood of military conflict with South Korea

The Wall Street Journal reported today that a North Korean closure of the Kaesong Industrial Complex would be a signal of increased probability of hostilities with South Korea. North Korea hosts the industrial complex a few miles within its boundary, where approximately 50,000 North Koreans work for 123 South Korean companies. On an average workday, about 120 South Korean managers cross the border into the complex. South Korean companies operating in the complex pay $80 million in cash wages directly to the North Korean government, and conduct approximately $2 billion worth of North Korean trade. This is a significant amount considering North Korea’s largest trading partner, China, yields only $6 billion worth of trade. The complex is a source of inexpensive labor for South Korea, rare US dollars for North Korea, and a foundation for pan-Korean economic and political cooperation (Reuters, WSJ).

North Korean threats and provocations are primarily bluster and bluff meant to elicit talks and appeasement payouts from the west. North Korean closure of the Kaesong Industrial Complex would be no different.

More informative signals would be: 1) South Korean closure of the border crossing, or 2) North Korean capture of South Korean complex workers by abruptly closing the border. The first of the two scenarios would indicate that South Korea believes hostility is imminent. The hostility could include the second scenario, or more seriously but less likely, a North Korean attack on South Korea. The capture of South Korean complex workers would be the most serious Korean crisis since 2010, when North Korea sunk a South Korean naval vessel and shelled a South Korean island. It would likely lead to US and Chinese-mediated negotiations, a payout to North Korea, and a definitive end to North Korea’s access to trade through the Kaesong Industrial Complex. Not North Korean, but South Korean closure of the border, is the signal to watch.

 

Fitch upgrade for Philippines will lead to increased investment in electronics and textiles

Today Fitch Ratings upgraded the Philippines to investment-grade, which will substantially increase investment in the country. Expect particularly strong growth in electronics and textiles, which will buttress current export strengths in electronic assembly and garments.

Update 5/22/2013: The Philippines obtained the #3 position in foreign investment among South-East Asian countries so far in 2013 (WSJ).

Counterinsurgency through development in Mali is ineffective, counterproductive, or both

French Foreign Minister Laurent Fabius recently indicated that development would be a priority in Mali as a counterinsurgency strategy. The theory is that after winning the war, an infusion of development funding will solidify gains among the population and strengthen their resolve against Islamist rebels. French and Malian officials are currently in Lyon, France, discussing details of 300 projects that will focus on water, health, education, and job training (BBC, EuroNews).

While providing development to impoverished Malians is intuitively good, the likely small scale of the overall project, combined with its implementation in a conflict zone, pose complications and could even lead to confounding effects. Mali has an overall population of 15.5 million sharing a GDP of $9.6 billion ($619 per capita) (CIA Factbook). While the amount of development funding planned by France has not been revealed, development funding in Afghanistan can be used as a point of comparison: $62 billion over ten years from 2002-2011 (National Defense University), or about $200 per person per year. An equivalent development level for Mali would require $3.1 billion for 2014 alone, which is unlikely given the state of France’s economy.

The impact of $200 of funding per person per year in Mali could actually be negative. Twenty-five percent is probably lost to legitimate administration. Through corruption, government officials could absorb 5-15% of the remaining funding. Through extortion, Islamist rebels could “tax” the development contractors doing the actual construction or service delivery in Northern Mali. This could provide them with access to scarce cash necessary to take their rebellion to a more lethal level. Finally, populations with heightened expectations from advance hearsay of the development projects could have those expectations dashed by the inadequacy of those projects once they reach the villages. While a nice gesture, whatever development funding remains after administration, corruption, and extortion costs (about $120 per capita by my calculation) may seem stingy to a Malian villager who is now intimate with the French rolling around in million-dollar armored vehicles, and streaking across the sky in jets.

Public support for action against Syrian regime

On March 15, 2011, popular protests erupted in Syria as part of the Arab Spring. The Syrian regime brutally suppressed the protests, which grew into armed opposition and civil war. President Bashar Hafez al-Assad’s Ba’athist government fought against a splintered but militant opposition. The United Nations tracked atrocities committed on both sides, including more than 70,000 killed (CNN).

Assad obtains most of his political support from the authoritarian regimes in China, Russia, and Iran. The Arab League previously supported him, but as the atrocities mounted, now supports the opposition. There is substantial public support for action against the Syrian regime in the United States, France and Britain. The types of action palatable to the voting public in the United States and Britain, weary of wars in Iraq and Afghanistan, do not include intervention. The public in newly-interventionist France does support deploying United Nations troops to Syria. All three countries support economic sanctions, and there is increasing support for supplying opposition groups with military materiel  (Council on Foreign Relations). Political leadership in the United States, France and Britain are responding with proxy war proposals consistent with this public opinion.

Expect limited military materiel support to Syrian rebels from the US, Britain and France in the near future. Due to insufficient public support, this will not include deployment of troops, and will only be sufficient to prolong — not win — the war. Over time, limited and therefore ineffectual military support may lead to increasing public support for deployment. If deployment occurs, expect a quick apparent win by the opposition, which turns into a long (5-15 years) and expensive period of nation-building and civil war as in Iraq and Afghanistan. Increased western military expenditures will improve yields in the defense sector, but increase government debt and taxes. Expect lower economic performance overall as defense expenditures aimed at Syria increase.

Opposition groups that will immediately benefit from western intervention in Syria will solicit such intervention in the short term. However, public opinion in Islamic countries find western intervention highly disagreeable, as do China, Russia and Iran. Expect increased global tensions and Islamic terrorism from western intervention in Syria. Expect Syrian opposition groups to quickly spurn their western benefactors as soon as military and other aid ends.

Effect of European political disunity on the Euro and global economy

Today, France joined the UK in publicly threatening to rupture a common approach to European Union (EU) foreign policy by sending arms to Syrian rebels (Bloomberg). This, on the heels of the January 11 unilateral French intervention in Northern Mali. Since the May 2012 election of French President François Hollande, France has increased its political independence with respect to the EU. This distresses Germany, which wants closer political union. Without seeing gains in political unity, Germany could decrease its financial support to the European project (Council on Foreign Relations). This augurs poorly for European monetary union, the value of the Euro, and global economic stability.

Lack of German financial support to Europe would increase the probability that Portugal, Italy, Ireland, Greece, or Spain would be forced out of the Euro. Were this to happen without prior agreement from the rest of the eurozone, the cost to the dropout would be catastrophic in terms of trust and with it, access to money markets. The cost to the remaining eurozone countries would be an increase in eurozone per capita money supply and resulting inflation of the Euro. Confidence in the Euro would fall, and the chance of further dropouts would be reflected in the foreign exchange market. Decreasing confidence and loss of value increases incentives for other EU countries to be the next to leave the Euro, with spiraling downward effects on its value. The massive investment in the Euro — and the amount that could be lost given failure — explains why Germany is willing to prop up the currency through stabilization of economically ailing eurozone members. Ailing eurozone countries milk their wealthier neighbors with the threat of Euro collapse.

Euro collapse is not just a European problem. It would have a disastrous effect on the global economy, including major European trading partners such as the United States and China. Thus, all trading partners with Europe have — at least for economic reasons — a stake in the success of a European common foreign policy. This should be considered when jockeying for short-term diplomatic goals such as arming the opposition in Syria.

Increasing European political integration and unity should give the investor increased confidence in the Euro; decreased integration and unity will have downward effects.  In part because of understandable historical differences based on the subjective experience of World War II, Germany is profoundly leery of military intervention. France and Britain frequently see intervention as an obligation to stop massacre, genocide, and civil war, especially when such intervention involves ancillary benefits such as removing a rogue or terrorist threat. Increased institutional power to overcome foreign policy differences in Europe would assist common foreign policymaking, and thereby improve market confidence in the Euro. Public pronouncements of Britain and France asserting foreign policy independence from the EU are geared towards influencing Germany and other recalcitrant EU states to take the UK-France-Italy approach on Syria. They show that for the moment at least, short-term foreign policy goals are trumping aspirations of a common EU foreign policy, stability of the Euro, and mitigation of risk to the international economy.

Watch for any hedge by the German government against the Euro, which will precede rapid loss of confidence in the Euro and a decrease in German monetary support to the currency union.

 

Nepal milestone towards increased stability

Nepal passed a modest milestone today in its attempts to improve stability . The four top political parties named Supreme Court Chief Justice Khilraj Regmi as head of an interim government. The main goal of Regmi will be to hold elections by June 21 for a new parliament empowered to adopt a constitution (ABC News).

However, we are not overly optimistic. Smaller political parties led violent riots in opposition to Regmi, it is unclear whether elections will actually be held, and even if elections are held, it is unlikely they will lead to a constitution. The last parliament elected for the purpose of deciding on a constitution — in 2008 — was unable to agree on one during its four-year tenure. Nothing fundamental has changed in Nepalese politics to suggest that a constitutional breakthrough will occur in the near future.

Watch for increased socialism in Latin America

Despite the political change that just swept Venezuela — which may indicate a decrease in the promotion of socialism from that country — a more powerful influence for Latin American socialism just arose in Rome. Today Cardinal Jorge Mario Bergoglio became Pope Francis, a name he chose after a Saint known for his asceticism. While socially conservative (e.g., on abortion and gay rights), Cardinal Bergoglio was known to eschew the luxuries of his station for a simple life that included modest quarters, self-cooked meals, and hailing the bus in Buenos Aires. His sermons suggest great sympathy for social justice and the poor, and he comes from Latin America  (Washington Post).

Bergoglia’s reputed historical links to 1970s fascism in Argentina, and his political astuteness, means that he wants to prove otherwise. Regardless of his true feelings, it will be hard for him not to play to his massive constituency of poor Catholics in Latin America — the greatest number of Catholics worldwide. Nearly all of Latin America’s poor will be looking to him to address their plight. Regardless of the position he takes on poverty in the future, the lay Catholic ministry in Latin America, and political entrepreneurs farther up the hierarchy, will gain favor among their largely overlapping constituencies for presenting the new Pope as supportive of socialist endeavors. This points to a revival of the liberation theology of the 1980s, and a greater probability of socialist-inspired coups, revolutions, debt defaults, and nationalizations — especially in Latin America.