The Emerging New World Disorder: Faultlines, Fissures, Fractures, and Failures

THIS PRESENTATION DOES NOT REPRESENT THE VIEWPOINT OF CNAS©NOT FOR QUOTATION, CITATION, OR CIRCULATION

Dr. David Asher Senior Fellow, Economics & Security, CNAS

Presentation to the Niagara Institutional DialogToronto, CanadaJune 11-13, 2012

Overview

• The Social Development Revolution and the Convergence of Growth, Wealth, and Health

• Rise of China and India• Echoes of History – The Great War and the End

of Globalization Version 1.0• Worrisome Indicators of Global Economic and

Financial Stress• Asian and Middle East Flashpoints and Faultlines• Emerging possibility of Hegemonic Conflict and

the end of the long cycle? 2

Until 19th century life wasn’t always solitary,nasty, or brutish, but it was universally poor and short

gapminder.org

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The Social Development Revolution

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Trend growth of labor productivity (GDP per person employed)

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Source: The Conference Board Total Economy Database™, January 2012

This ain’t your father’s “third world”

June 26, 2012

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China

India

US

UK

Japan

Second Opium War

Mao dies

WW II

IndianIndependence

The Rise of Asia:Growth in Asian Per Capita Income

gapminder.org

ASIA RISING

US National Intelligence Council 7

The 2025 Global LandscapeRelative Certainties• A global multipolar system is

emerging with the rise of China, India, and others.

• The relative power of non-state actors - businesses, tribes, religious organizations, and even criminal networks—also will increase.

• Continued economic growth—coupled with 1.2 billion more people by 2025—will put pressure on energy, food, and water resources.

• The potential for conflict will increase owing to rapid changes in parts of the greater Middle East and the spread of lethal capabilities.

Likely Impact• By 2025 a single “international community”

composed of nation-states will no longer exist. Power will be more dispersed with the newer players bringing new rules of the game while risks will increase that the traditional Western alliances will weaken. Rather than emulating Western models of political and economic development, more countries may be attracted to China’s alternative development model.

• Shrinking economic and military capabilities may force the US into a difficult set of tradeoffs between domestic versus foreign policy priorities.

• Unless employment conditions change dramatically in parlous youth-bulge states such as Afghanistan, Nigeria, Pakistan, and Yemen, these countries will remain ripe for continued instability and state failure.

• The need for the US to act as regional balancer in the Middle East will increase, although other outside powers—Russia, China and India—will play greater roles than today.

• Source: US National Intelligence Council 8

Why be worried about the global system?• The pre-WW I breakdown in the long cycle, balance of

power, and hegemonic stability may be repeating itself.• There is no historical precedent for a stable transition to

multi-polarity among competing powers.• China is on course toward a “militarized hegemony” in

Asia, while America is a “reclining power” whose actions don’t match its rhetoric.

• The dark side of globalization is expanding.• The world of warfare is flattening.• Much depends on whether the US can become a

“globalist power” again and not just a power trying to shield itself from a dangerous globe…

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1870 – 1914: The Era of Convergence 1.0

• 1870 to 1914 represented the high water mark of 19th century globalization. Globalization involved increasing transfers of commodities, people, capital and ideas between and within continents.

• Intra-imperial tariff reduction and the widened use of the gold standard deepened trade• Intra-European and extra-European trade reached a high point in 1913. European

trade roughly quadrupled in real terms between 1870 and 1913• Prices for everything from commodities , such as wheat, to manufactured good steadily

converged. • Cross-border capital flows and foreign direct investment boomed. Foreign assets

accounted for 7% of global GDP in 1870 but nearly 20% by 1900-1914 (a level of integration not met again until 1970).

Globalization, 1870-1914, Daudin, Morys, and O’Rourke 10

UK / US / GermanyLog PPP$ Per Capita GDP 1870‐1914

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GDP in 1990 million Geary-Khamis dollars; Source: Maddison, 2008

GLOBALIZATION 1.0

Anglo-German Naval Race, 1904-1914 “It is generally admitted that the present rivalry in armaments in Europe—notably such as that now in progress between England and Germany—cannot go on in its present form indefinitely.” Norman Angell, The Great Illusion

HMS Dreadnought, 1906

Summary - Dreadnought Class Ships Completed or Completing

by August 1914Countries in order of first dreadnoughts - totals exclude German

Blucher, French Dantons and Russian Black Sea Fleet dreadnoughts building.

Britain 34 5 lostGermany 24 (Blucher lost)

Japan 8 1 lostU.S.A. 8 -

Austria 4 2 lostFrance 4 (Danton lost)

Italy 4 1 lostRussia 4 (1 Black Sea ship

lost)Total 90 9

(50 Allied, 28 Central Powers, 12 later Allies)

(plus 3)

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British Growth Before and After the Great War

Matthews, Feinstein, and Odling-Smee. British Economic Growth, 1858-1973. 13

The Great Pre WW IRecession

The Decline in British Pre WWI Productivity and Growth

Matthews, Feinstein, and Odling-Smee. British Economic Growth, 1858-1973. 14

Trend growth of total factor productivity

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Source: The Conference Board Total Economy Database™, January 2012

Source: The Conference Board Total Economy Database™, January 2012

Sign of Long Cycle Peaking Out?

Weakest Recovery in US History

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World Trade Remains Suppressed

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Services Trade Recession Returning?

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World exports of commercial services by selected region, Q1 - Q4 2011

(percentage change, year-on-year)

Source: WTO

American Hegemony is Waning Globally

US Hegemony Under Stress:• Free trade system in decay • Global financial status diminished• Declining use of the dollar• Bulging fiscal imbalances• Anemic economic recovery compared to norm• Involvement in long, costly wars • Fraying alliance systems in Europe and Asia• Increased isolationist thinking• Rising strategic rivals in Asia and Middle East• Shrinking US naval power

June 26, 2012

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What forces and scenarios could set the free world back?

War • Historically wars have had the greatest impacts on global

economic conditions and broken long cycles• War is the most likely of the most impactful forces but often

hardest to foresee. • Potential scenarios:

• Israel vs. Iran – Gulf Conflict = “Muddle East Meltdown”• “Implosive Conflict” on the Korean peninsula• South China Sea - Chinese “Monroe Doctrine” vs. US/Japan• India vs. Pakistan nuclear war• India vs. China conflict• Catastrophic cyber attack

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Previous War Shocks to the Long Financial Cycle

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WWI and 1973 shocks may be best analogies

Source: Anthony Boeckh, The Great Reflation

The World of Warfare is Getting Flat

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http://www.akamai.com/dv1 23

Chinese Defense Spending

“For the first time, in modern history at least, Asia’s military spending is poised to overtake Europe’s…China is doubling its defence budget every five years and India has just announced a 17% rise in spending this year, to about $40 billion.” Economist, March 24, 2012

China is not a status quo power. It will seek to dominate the South China Sea as the U.S. has dominated the Greater Caribbean Basin

inssblog.wordpress.com/2012/03/26/chinas-2012-defense-budget-steady-as-she-goes/ 24

Disruptive Chinese Military Modernization 2000-2010

“…An increasingly powerful China is likely to try to push the U.S. out of Asia, much the way the U.S. pushed European powers out of the Western Hemisphere… Why should we expect China to act any differently than the United States did? Are they more principled than we are? More ethical? Less nationalistic?” John Mearsheimer to Robert Kaplan, Atlantic Monthly, January 2012

Percent of Chinese forces considered modern by Pentagonstandards

Source: DoD OSD 201125

South China Sea Incidents Rising

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Asia Flashpoints

North Korea: Global Menace • Under a “gang of four” leadership arrangement, the

regime is inherently unstable, from top-down• Paying the price of the 100th anniversary of Kim Il

Song’s birth, the funeral of Kim Jong Il, and the anointment of Kim Jong Eun has pushed a bankrupt state economy to the brink

• North Korea is the #1 proliferation threat in the world• North Korea’s growing stockpile of enriched uranium is

sufficient to manufacture dozens of weapons in the coming years

• There is no internal need for HEU bombs, there is a sufficient plutonium bomb arsenal. NK HEU is for sale…

• How much would Iran pay for a nuclear arsenal? 27

Asia Flashpoints

Flash Points: The New “Muddle East”• Despite the promise of democratic reform, the “New Middle East” has gone

from miracle to muddle in the last 24 months. • The new Middle East economies are broke, broken, or breaking down.

• Popular anger is expanding, not contracting. Democratization is fusing, not containing, nationalist umbrage, which is undergirded by deep socio-economic problems.

• Further Middle East instability poses a major geo-strategic stability threat.• The world economy runs on Middle East oil and spiking gasoline prices—driven by

ME instability—impact consumer confidence globally.• Potential for intra-state conflict over oil and water is growing.• Growing danger of trans-regional nuclear proliferation.• Potential for breakdown/breakup of Syria, Iraq, and Libya is growing • Iran-Israeli confrontation OR Iran nuclear peace with P5 (but not Israel) is 50:50 in

next 12 months • The US broke the Middle East balance of power but isn’t “owning up”

Dependence on Middle East Oil Rising

Source: EIA

The US economy still runs on oil30

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Gasoline and Confidence Go Together

US Real Change in Crude Prices vs. Real Change in GDP

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10 out of the last 11 recessions were preceded by oil price spikes

Effects of Previous Oil Shocks on US Economy

Size of Quantity and Price Changes in Historical Oil Shocks

Episode Supply Reduction Price Change Implied Elasticity

Oct 73 - Mar 74 4.0% 41.3% 0.10

Nov 78 - Jul 79 1.3% 38.7% 0.03

Oct 80 - Mar 81 1.2% 25.3% 0.05

Aug 90 - Oct 90 2.9% 71.6% 0.04

Average Annual GDP Growth Rates Under Alternative Scenarios

Period Actual Without AutosWithout Oil Shock (Blanchard-Gali)

Without Oil Shock (Hamilton)

1974:Q1-75:Q1 -2.5% -2.0% -0.1% 2.3%

1979:Q2-80:Q2 -0.4% 0.4% 0.4% 2.5%

1981:Q2-82:Q2 -1.5% -1.3% -2.0% 2.0%

1990:Q3-91:Q3 -0.1% 0.2% 0.5% 3.6%

2007:Q4-08:Q3 0.7% 1.2% 1.4% 4.2%

2007:Q4-08:Q4 -0.7% 0.0% -0.2% 3.2%

Source: James D. Hamilton, "Causes and Consequences of the Oil Shock of 2007-08,“ Brookings March 2009

According to Hamilton, the US economy would have grown 3.2% between Q4 2007 and Q4 2008, not contracted by -.7%, had there not been an oil price shock

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Sufficient Spare Capacity? And trapped in the Gulf...

34The Rapidan Group – Not to be quoted or distributed without the author’s permission

Flashpoint Iran: • Iran is a thresh-hold nuclear power. According to the IAEA, Iran

currently has enough 3.5% low enriched uranium that if highly enriched could make up to 4 nuclear bombs. It also has conducted core testing work for developing a nuclear device.

• Sanctions, Stuxnet, and economic stagnation have eaten into Iran’s strength but have not yet broken its will to resist.

• Nonetheless, in Tehran’s view cutting a North Korea nuclear deal while keeping core nuclear capabilities may make sense.

• “Nuclear peace” agreement 50:50 by fall of 2012. Iran agrees to cap enrichment at 5%, export its 20% “LEU,” and the world lifts sanctions and normalizes with Tehran (this North Korean-style “want it bad, get it bad” strategy ultimately would fail).

• Or “October surprise” Israel attacks Iran nuclear facilities? –Protracted “Black Swan” conflict scenario becomes possible.

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How real is the Iranian oil threat?June 26, 201236

Iranian Black Swan Oil Shock ScenarioOil as a Weapon of Economic Warfare

• Iran mines the gulf and attacks tanker traffic in retaliation for Israeli strike; Iranian terrorist and missile attacks against oil infrastructure/port facilities in Saudi, UAE, and Iraq (if Saudi’s Abqaiq refinery gets attacked with radioactive weapons we would see 6m/bd severely impacted…)

• Short-term sympathy embargos: Iraq, Venezuela?• Net Effect: 10-12 million mb/d supply shock lasting

3 months (global demand is around 90 mb/d)• PRC comes to Iran’s defensive aid??....• Oil price spikes to ???• Extreme implications for global GDP growth…….

June 26, 2012

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Simulating Economic Impact of Oil Shock Scenarios

© CNAS

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Note: This model projects straight-line (asymmetric price jump) effects

The Coming Clash

“AS THE influence of the United States in Baghdad wanes, that of Iraq’s three beefiest neighbours—Iran, Saudi Arabia and Turkey—has begun to wax. All three fear lest the vacuum left behind be filled by a regional rival.”

The Economist, “Iraq- A Regional Cockpit,” 19 Nov 2009

Flashpoint Iraq: • Maliki has become an autocrat in Tehran’s pocket. He has

alienated the Sunnis and the Kurds, arresting his own Vice President and cutting funds flowing north, while also disenchanting the Sadrists.

• Iraqi oil output is booming but oil-rich Kurdistan is in economic crisis and is seeking to connect its oil pipelines to Turkey, vice central Iraq.

• 50:50 Further shift towards a pro-Iranian posture leads to revived outbreak of a limited civil war/ Kurdish demands for independence. If a repeat of 2005-2007 AQI insurrection, potential Turkish intervention in the north and (potentially) even Iran invading the south (taking Najaf and Karbala down to Basra). Sunni Baghdad aligns with Ankara?

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Flashpoint Syria:

• 50%: Assad, using Hezbollah and Iranian help to crack down and aided by Russian guns and butter – survives sanctions and isolation, while tens of thousands are slaughtered.

• 25%: Assad is deposed or assassinated. Regime implodes, civil war ensues and Syria breaks up into a Salafi north, Iranian-Hezbollah allied Alawite enclaves in west, and Damascus east tied to Iraq. Turkey invades taking the Euphrates line east and “Turk-Syria”ensues.

• 25%: US and Turkey intervene, Assad is toppled and democratic Sunni-led government takes power.

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Flashpoint Lebanon• 50% status quo somehow holds in this beautiful and

alluring global money laundering safehaven increasingly run by Iran’s terrorists lackeys

• 25%: Hezbollah moves to take power from Mikati and associated partners in crime. Lebanon becomes an Iranian satrap with IRGC presence, and seeks “reunification” with Assad’s Syria. Hezbollah terrorist actions on behalf of Iran trigger Israeli massive counter-strike, obliterating Beirut and leading to destruction of Hezbollah.

• 25% Civil war breaks out as Hezbollah tries to take control; Lebanon breaks up with Sunnis in north allying with Sunni Islamists in Turk-Syria.

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Flashpoint Jordan• 60% King Abdullah holds onto power with a major infusion

of US development assistance, joins GCC protection racket, announces further anti-corruption and economic reforms.

• 25%: The “Tunisian and Egyptian hurricane” comes to Jordan as tribal leaders withdraw backing of the King. MB wins first popular elections forges alliance with Egypt.

• 15%: A Palestinian state is formed and without an option for expansion to the West, demands for “unification” with Jordan based on Palestinian irredentism on both sides of the Jordan River emerge. The Islamic movement topples the Hashemite regime and begins to export revolution, Irredentism gives rise to "Jordan for the Jordanians" sentiment among East Bankers and descent into civil war.

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Flashpoint Saudi:• 70% Political reform combined with Islamic

nationalism create shift toward “real Saudi-ism.”Saudis bond with Turkey and Egypt to defend Middle East against emerging Iranian “Shia-stan.”

• 20% To maintain power regime stages national crack down, arresting problem princes. Saudis import small nuclear arsenal from Pakistan (defense against Shia threat) and declare strategic independence.

• 10% Popular insurrection produces overthrow of House of Saud; Iran starts an intifada in Shia east, arms groups to occupy oil fields. Country breaks apart.

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Flashpoint Egypt:• 50%: (Ironically) the military party prevails

in popular elections and new “democratic Nasserism” emerges around Mubarak stalwart Shafiq. Egypt, suffering from severe economic woes seizes East Libya oil area or invades Sudan due to conflicts over the sources of the Nile.

• 35%: Muslim Brotherhood (Morsi) wins narrow victory, breaks Arab-Israeli peace agreements; establishes formal relations with Hezbollah, Hamas, and PIJ and sends Army into western Sinai.

• 15%: Muslim Brotherhood launches violent resistance against new military government allying with McQaeda Salafi Jihadists. Egypt descends into Algeria-style insurrection.

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Flashpoint Pakistan• 25% A failing state undergoes a "vertical meltdown?" - not only losing control over peripheral

territories but over its own state organs which are now "doing their own thing.”• Economy approaching bankruptcy (still ravaged by flood impact and dependent on US war) and

in desperate need of reform (privatization of “military Inc.”).

• Nation-wide protests against Zardari’s corruption on the way?

• 50% World’s largest state sponsor of terrorism -- home of Al Qaeda, Taliban, Haqqani Network, Laska e-Taiba, D-company; ISI – launches attacks against Mumbai and Kabul this summer

• 25% “Diversionary” India-PAK nuclear crisis in 2013?...

Prospects for a Poly-nuclear Middle East

Nuclear Suppliers:•Pakistan•North Korea•China?

Prospective Nuke Buyers:•Iran•Saudi Arabia•UAE•Turkey•Egypt•Syria

• The credibility of America's extended deterrence (seen as "regime deterrence" previously) is shredded in Saudi and significantly weakened in UAE. A dangerous “every man for himself” mentality has set in.

• A poly-nuclear Middle East would be fundamentally unstable -- with an insufficient “MAD mentality” (MAD=mutually assured destruction”)

• Sides are likely to be drawn between Sunni and Shia, ironically more Arab versus Persian than Muslim versus Israel. Wikileaks should have made clear the remarkable degree of antipathy toward Iran in the Arab states.

• Given weak command and control structures in the region, nuclearweapons may filter down to quasi-states (such as Kurdistan or the Palestinian Authority), terrorist organizations, and rival ethnic groups for whom the acquisition of nuclear weapons by a hostile state would be an incentive to acquire at least a limited WMD capability.

• The countries of the region will probably be more predisposed than the Cold War protagonists to brandish their nuclear weapons not onlyrhetorically but through nuclear alerts or nuclear tests, leading to situations of multilateral nuclear escalation. However, such multilateral escalation will not be mitigated by Cold War-type hotlines and means of signaling, and the absence of a credible second-strike capability may well strengthen the tendency to opt for a first strike.

Where the World Could End…48

• The US has propelled regime failure in the Middle East but is not actively supporting new regime construction for fear of being perceived as interventionist…

• We’ve created two major pockets of geo-political instability at central crossing points for rising powers in SW Asia and the Middle East and are retreating…

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Conclusions: History doesn’t repeat itself, it just rhymes

• China/India rising in all dimensions of national power – but face headwinds that could cause them to be more nationalist and mercantilist.

• As a “policing power,” the US in recline, potentially in decline. • Europe is on the ropes, enfeebled, and turned inward.• The world remains leveraged to Gulf oil and the Middle East is a

deteriorating muddle with an Israel-Iran conflict OR a “nuclear peace accord” with Tehran 50:50 in next 12 months.

• There are many endogenous reasons for the long economic growth and financial market cycle to be peaking out – a major oil shock could cause much more rapid decline.

• A breakdown in the balance of power/ multi-polarity is not inherently benign• Does a pre WWI-like downturn of an economic long cycle matter to the

future of the world system or “is this time different?”• A US globalist renaissance is possible (America’s economy remains resilient

and technologically dynamic) but would require an unprecedented political, economic, and cultural shift outward ala post-WWII.

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