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Special report: Natural gas
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An unconventional bonanza
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New sources of gas could transform the world’s energy markets, says Simon Wright—but it won’t be quick or easy
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Jul 14th 2012






COLOURLESS, ODOURLESS, LIGHTER than air. Natural gas may not have much impact on the senses, but as a source of heat and power it is transforming energy markets.


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Around 100AD Plutarch, a Graeco-Roman poet, noted the “eternal fires” in what is now Iraq. They were probably methane gas seeping out of the ground, ignited by lightning. Those eternal fires are now proliferating. An unexpected boom in shale gas that has taken off in America may well spread elsewhere and will add massively to global gas supplies.



Shale gas—an “unconventionalsource of methane, like coal-bed gas (in coal seams) and tight gas (trapped in rock formations)—has rapidly transformed America’s energy outlook. At the same time discoveries of vast reserves of conventional gas from traditional wells have pushed up known reserves around the world. Gas is the only fossil fuel set to increase its share of energy demand in the years to come.







And despite its rapid rise in recent years, it will still lag oil as a source of energy by 2035, according to the International Energy Agency (IEA), a rich-world energy club—and overtake coal by then only if the new gas reserves are fully exploited.



The trouble with gas is that it is difficult and expensive to transport. That used to be true of oil too, but since the development of supertankers in the 1960s it can be shifted relatively cheaply to find a customer in the world market. Gas needs a ready buyer and a way of delivering it.


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A priceless commodity



Because of those hefty transport costs, gas does not behave like a commodity. Only one-third of all gas is traded across borders, compared with two-thirds of oil.



Other commodities fetch roughly the same price the world over, but gas has no global price. In America, as well as in Britain and Australia, it is traded freely and prices are set through competition. In continental Europe traded gas markets are gaining a foothold, but most gas is delivered through pipelines and sold on long-term contracts linked to the price of oil, for which it used to be seen as a substitute.



Gas-poor Asia relies heavily on imports of liquefied natural gas (LNG). Stranded gas”, too far from its markets to go down a pipe, can be turned into a liquid by cooling it to -162°C, shipped in specialist tankers and turned back into gas at its destination.But the huge plants needed to do the job at both ends are very costly.



Since gas prices in different parts of the world are set by quite different mechanisms, they vary wildly across the globe. In America, where shale gas is whooshing out of the ground, they recently fell to a ten-year low. In Asia they can be ten times the American level.
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Gas all over



Global reserves have been steadily increasing for at least 30 years. According to a report from the Massachusetts Institute of Technology (MIT), published last year, world production has grown significantly too, rising by two-fifths between 1990 and 2009, twice as fast as that of oil. Only half a decade ago it looked as though the world might have only 50 or 60 years-worth of gas. Now shale and other unconventional as well as new conventional gas finds have increased that period to 200 years or more, by some estimates.





The unconventional-gas bonanza has roughly doubled the gas resource base, a measure of the total gas in the ground rather than what might be economically recoverable. In 2009 the IEA estimated the “long-term global recoverable gas resource base” at 850 trillion cubic metres (tcm), against 400tcm only a year earlier. The main reason for the rethink was shale gas and other unconventionals. Not just America but parts of Europe, China, Argentina, Brazil, Mexico, Canada and several African countries, among others, sit atop as yet unknown quantities of gas that could transform their energy outlook.




Better technology has helped, and so has the high oil price. The spiralling price of crude has caused oil companies to search even harder for it. But before a test well has been drilled, it is near-impossible to be sure whether the geological idiosyncrasies that excite oilmen will yield either oil or gas (or sometimes both, and often nothing). Of late, big oil companies have found plenty of gas.



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Not only have breakthroughs in technology opened up America’s shale beds, but advances in drilling in very deep water have dramatically changed exploration in the sea. Australia will emerge as a gas superpower as it begins to deliver large quantities of LNG from offshore fields. And better technology and global warming is unlocking the Arctic’s natural bounty.





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But there are reservations. Last year the IEA published a report entitled, “Are We Entering a Golden Age of Gas? The question mark reflects the constraints that public disquiet about shale gas might put on its development. That is one reason why Fatih Birol, the IEA’s chief economist, is far from certain that America’s shale boom can be replicated elsewhere.



In the most promising scenario, if shale development goes full steam ahead, the IEA reckons that the share of gas in the global energy mix will rise from 21% today to 25% in 2035. That may not sound much of an increase, but over that period total global consumption will grow spectacularly. If the obstacles can be overcome, more gas and lower prices will mean a rise of 50% in global demand for gas between 2010 and 2035, according to the IEA.



What has made gas so exciting is not just the steep rise in supply but also the wide range of uses for it. It is a flexible fuel, capable of heating homes, fuelling industrial boilers and providing feedstock for the petrochemicals industry, where it is turned into plastics, fertiliser and other useful stuff. It is also making small but significant progress as a fuel for lorries and buses.



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But the biggest advances have been in power generation. A technological breakthrough, the combined-cycle gas turbine, a spin-off from the aviation industry, has transformed the economics of the industry. Not only has it made it cheaper to generate electricity from gas, but the process releases up to 50% less carbon dioxide than does coal. As governments strive to cut greenhouse-gas emissions, replacing coal with gas will bring fairly swift results. Already the share of gas in the overall energy mix, which had remained at 16% from the late 1960s to the 1990s, has risen to 21%.



Gas power stations are a “low-regretoption, according to Michael Stoppard of IHS CERA, a research firm. They are relatively cheap to build, beating nuclear power hands down in terms of capital costs, and in most cases they are also less expensive than renewables. The EU hopes that by 2050 some 97% of power generation will come from renewables, but gas power stations are likely to be needed for decades yet to provide flexibility and security. And if gas is cheap enough and techniques such as carbon capture and storage can be developed to make commercial sense, gas could thrive for much longer even in a world that had radically cut carbon emissions.



Except in America, though, gas is currently expensive, and shifting it is likely to remain costly. Gas markets are regional. The stuff is mainly delivered down pipelines that stretch across countries and even continents, but not between them. Pipelines cost million of dollars a kilometre to build. The business model of developing a gasfield has been to find buyers and lock them into long-term contracts to ensure that the costs of developing and delivering the gas will be paid back. The alternative is to ship the gas in liquid form, as LNG. But projects to liquefy gas also require huge investments, and often finding long-term buyers too.



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Well oiled


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Historical factors have led to another anomaly: much of the gas traded across borders is sold at prices linked to those of crude oil. When gas was first brought to market as a commercial fuel in the 1960s, as an alternative to home heating oil, it made sense to price it against a substitute. But there was also a more subtle reason. Oil was used as an independent price arbiter for Dutch gas in the 1960s and then for Algerian and Norwegian gas in the 1970s because neither side could influence the supply and demand for it. The system persisted as Russian gas came to Europe in the late 1970s. But the economics have changed, and valuing one commodity in terms of another now seems bizarre.
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Britain has had competition based on supply and demand since the deregulation of the energy industry in the 1990s. The fuel is traded at the National Balancing Point, a virtual hub. Similar arrangements are now spreading across north-western Europe as the European Union is switching to hub-based gas trading at the virtual Title Transfer Facility (TTF), as well as at Zeebrugge in Belgium and NetConnect Germany (NCG) and Gaspool in Germany. The model is America’s Henry Hub in Louisiana, where nine interstate gas pipelines meet and from where the gas is distributed to buyers, setting a benchmark for prices across America.



A more competitive market the world over would doubtless make gas cheaper by breaking the link with oil, but that will be difficult to bring about. Gazprom, Russia’s huge state-run gas producer and supplier of 25% of Europe’s gas, is strongly opposed to dropping oil indexation. A tussle is under way between it and the continent’s big buyers. Some pundits say that gas must eventually become a global fungible product like oil, with regional price differences closing as more gas is shifted in the form of LNG, draining gluts and making up shortfalls in regional production in North America, Europe and Asia. But others reckon it will never happen.



Gas producers are naturally happy with the high prices resulting from oil indexation, arguing that without them the economics of big gas projects would never work. But Rick Smead of Navigant, a consultancy, thinks there are good reasons for all concerned to want competitive gas prices. He points out that they would reduce regional price volatility and provide gas producers with a broad and flexible market instead of having to rely on a single consumer at the end of a pipeline. That should offer an incentive to make the huge investments required.



If the “shale galeblowing through America can be replicated worldwide, the huge surpluses it would bring could hasten the advent of a global market. Just as the 20th century was the age of oil, the 21st could prove to be the century of gas.


The New Global Economy’s (Relative) Winners

Dani Rodrik

11 July 2012 .





CAMBRIDGE – The world economy faces considerable uncertainty in the short term. Will the eurozone manage to sort out its problems and avert a breakup? Will the United States engineer a path to renewed growth? Will China find a way to reverse its economic slowdown?


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The answers to these questions will determine how the global economy evolves over the next few years. But, regardless of how these immediate challenges are resolved, it is clear that the world economy is entering a difficult new longer-term phase as wellone that will be substantially less hospitable to economic growth than possibly any other period since the end of World War II.



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Regardless of how they handle their current difficulties, Europe and America will emerge with high debt, low growth rates, and contentious domestic politics. Even in the best-case scenario, in which the euro remains intact, Europe will be bogged down with the demanding task of rebuilding its frayed union. And, in the US, ideological polarization between Democrats and Republicans will continue to paralyze economic policy.



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Indeed, in virtually all advanced economies, high levels of inequality, strains on the middle class, and aging populations will fuel political strife in a context of unemployment and scarce fiscal resources. As these old democracies increasingly turn inward, they will become less helpful partners internationallyless willing to sustain the multilateral trading system and more ready to respond unilaterally to economic policies elsewhere that they perceive as damaging to their interests.



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Meanwhile, large emerging markets such as China, India, and Brazil are unlikely to fill the void, as they will remain keen to protect their national sovereignty and room to maneuver. As a result, the possibilities for global cooperation on economic and other matters will recede further.


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This is the kind of global environment that diminishes every country’s potential growth. The safe bet is that we will not see a return to the kind of growth that the worldespecially the developing worldexperienced in the two decades before the financial crisis. It is an environment that will produce deep disparities in economic performance around the world. Some countries will be much more adversely affected than others.


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Those that do relatively better will share three characteristics. First, they will not be weighed down by high levels of public debt. Second, they will not be overly reliant on the world economy, and their engine of economic growth will be internal rather than external. Finally, they will be robust democracies.


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Having low to moderate levels of public debt is important, because debt levels that reach 80-90% of GDP become a serious drag on economic growth. They immobilize fiscal policy, lead to serious distortions in the financial system, trigger political fights over taxation, and incite costly distributional conflicts.


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Governments preoccupied with reducing debt are unlikely to undertake the investments needed for long-term structural change. With few exceptions (such as Australia and New Zealand), the vast majority of the world’s advanced economies are or will soon be in this category.


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Many emerging-market economies, such as Brazil and Turkey, have managed to rein in the growth of public debt this time around. But they have not prevented a borrowing binge in their private sectors. Since private debts have a way of turning into public liabilities, a low government-debt burden might not, in fact, provide these countries with the cushion that they think they have.


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Countries that rely excessively on world markets and global finance to fuel their economic growth will also be at a disadvantage. A fragile world economy will not be hospitable to large net foreign borrowers (or large net foreign lenders). Countries with large current-account deficits (such as Turkey) will remain hostage to skittish market sentiment. Those with large surpluses (such as China) will be under increasing pressure – including the threat of retaliation – to rein in their “mercantilistpolicies.



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Domestic demand-led growth will be a more reliable strategy than export-led growth. That means that countries with a large domestic market and a prosperous middle class will have an important advantage.


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Finally, democracies will do better because they have the institutionalized mechanisms of conflict management that authoritarian regimes lack. Democracies such as India may seem at times to move too slowly and be prone to paralysis. But they provide the arenas of consultation, cooperation, and give-and-take among opposing social groups that are crucial in times of turbulence and shocks.

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In the absence of such institutions, distributive conflict can easily spill over into protests, riots, and civil disorder. This is where democratic India and South Africa have the upper hand over China or Russia. Countries that have fallen into the grip of autocratic leaders – for example, Argentina and Turkey – are also increasingly at a disadvantage.


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An important indicator of the magnitude of the new global economy’s challenges is that so few countries satisfy all three requirements. Indeed, some of the most spectacular economic success stories of our timeChina in particular fail to meet more than one. It will be a difficult time for all. But somethink Brazil, India, and South Korea – will be in a better position than the rest.


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Dani Rodrik is a professor at Harvard University’s Kennedy School of Government and a leading scholar of globalization and economic development. His writings are a compelling combination of international and development economics, history, and political economy, and often challenge prevailing orthodoxy about which policies best promote growth. His most recent book is The Globalization Paradox: Democracy and the Future of the World Economy.


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Copyright Project Syndicate - www.project-syndicate.org





The media is now fixated on an apparently new feature dominating the economic landscape: a "fiscal cliff" from which the United States will fall in January 2013. They see the danger arising from the simultaneous implementation of the $2 trillion in automatic spending cuts (spread over 10 years) agreed to in last year's debt ceiling vote and the expiration of the Bush era tax cuts. The economists to whom most reporters listen warn that the combined impact of reduced government spending and higher taxes will slow the "recovery" and perhaps send the economy back into recession. While there is indeed much to worry about in our economy, this particular cliff is not high on the list.



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Much of the fear stems from the false premise that government spending generates economic growth (for stories of countries experiencing real growth, see our latest newsletter). People tend to forget that the government can only get money from taxing, borrowing, or printing. Nothing the government spends comes for free. Money taxed or borrowed is taken out of the private sector, where it could have been used more productively. Printed money merely creates inflation. So the automatic spending cuts, to the extent they are actually allowed to go into effect, will promote economic growth not prevent it. Even most Republicans fall for the canard that spending can help the economy in general. But even those who don't will surely do everything to avoid the political backlash from citizens on the losing end of any specific cuts.



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The only reason the automatic spending cuts exist at all is that Congress lacked the integrity to identify specifics. Rest assured that Congress will likely engineer yet another escape hatch when it finds itself backed into a corner again. Repealing the cuts before they are even implemented will render laughable any subsequent deficit reduction plans. But politicians would always rather face frustration for inaction than outright anger for actual decisions. In truth though, only an extremely small portion of the cuts are scheduled to occur in 2013 anyway. If it comes to pass that Congress cannot even keep its spending cut promises for one year, how can they be expected to do so for ten?



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The impact of the expiring Bush era tax cuts is much harder to assess. The adverse effects of the tax hikes could be offset by the benefits of reduced government borrowing (provided that the taxes actually result in increased revenue). But given the negative incentives created by higher marginal tax rates, particularly as they impact savings and capital investment, increased rates may actually result in less revenue, thereby widening the budget deficit.



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In reality, the economy will encounter extremely dangerous terrain whether or not Congress figures out a way to wriggle out of the 2013 budgetary straightjacket. The debt burden that the United Stated will face when interest rates rise presents a much larger "fiscal cliff." Unfortunately, no one is talking about that one.



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The current national debt is about $16 trillion (this is just the funded portion...the unfunded liabilities of the Treasury are much, much larger). The only reason the United States is able to service this staggering level of debt is that the currently low interest rate on government debt (now below 2 per cent) keeps debt service payments to a relatively manageable $300 billion per year.



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On the current trajectory the national debt will likely hit $20 trillion in a few years. If by that time interest rates were to return to some semblance of historic normalcy, say 5 per cent, interest payments on the debt would then run $1 trillion per year. This sum could represent almost 40 per cent of total federal revenues in 2012!



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In addition to making the debt service unmanageable, higher rates would depress economic activity, thereby slowing tax collection and requiring increased government spending. This would increase the budget deficits further, putting even more upward pressure on interest rates. Higher mortgage rates and increased unemployment will put renewed downward pressure on home prices, perhaps leading to another large wave of foreclosures. My guess is that losses on government insured mortgages alone could add several hundred billion more to annual budget deficits. When all of these factors are taken into account, I believe that annual budget deficits could quickly approach, and exceed, $3 trillion. All this could be in the cards if interest rates were to approach a modest five per cent.



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If the sheer enormity of the red ink were to finally worry our creditors, five per cent interest rates could quickly rise to ten. At those rates, the annual cost to pay the interest on the national debt could equal all federal tax revenues combined. If that occurs we will have to either slash federal spending across the board (including cuts to politically sensitive entitlements), raise taxes significantly on the poor and middle class (as well as the rich), default on the debt, or hit everyone with the sustained impact of high inflation. Now that's a real fiscal cliff!



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By foolishly borrowing so heavily when interest rates are low, our government is driving us toward this cliff with its eyes firmly glued to the rear view mirror. For years I have warned that a financial crisis would be triggered by the popping of the real estate bubble. My warnings were routinely ignored based on the near universal assumption that real estate prices would never fall. My warnings about the real fiscal cliff are also being ignored because of a similarly false premise that interest rates can never rise. However, if history can be a guide, we should view the current period of ultra-low rates as the exception rather than the rule.

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Obama’s China Card?

Malcolm Fraser

11 July 2012
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MELBOURNEAccording to the United States Federal Reserve, Americans’ net worth has fallen 40% since 2007, returning to its 1992 level. Progress towards recovery will be slow and difficult, and the US economy will be weak throughout the run-up to November’s presidential and congressional elections. Can any incumbent – and especially President Barack Obamawin re-election in such conditions?




To be sure, the blame for America’s malaise lies squarely with Obama’s predecessors: Bill Clinton, for encouraging the Fed to take its eye off financial-market supervision and regulation, and George W. Bush, for his costly wars, which added massively to US government debt. But, come Election Day, many (if not most) Americans are likely to ignore recent history and vote against the incumbent.



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Given this, it would not be surprising if Obama and others in his administration were seeking non-economic issues to energize his campaign. National-security problems in general, and the challenge posed by China in particular, may be shaping up as just such issues.



Obama’s foreign and defense policies have been assertive, to say the least, especially in the Middle East and the Pacific. He has sanctioned far more unmanned drone strikes than Bush did; extended the security services’ intrusion into Americans’ privacy; allowed the CIA to continue its rendition program; approved trials of accused terrorists by flawed military tribunals; and has not shut Guantánamo Bay.



Moreover, the US is increasing its troop presence in the Pacific at a time when it already has more military force in the region than all other countries combined. Six aircraft carriers, with their accompanying support vesselsindeed, 60% of America’s entire navy – are now stationed in the Pacific.



In addition, Obama’s administration has been conducting talks with the Philippines to increase and enhance naval cooperation. And Singapore has been persuaded to host four advanced naval ships. Australia has established a base for marines in Darwin and another for unmanned spy planes on the Cocos Islands.



That is not all. In a move that has received little or no publicity, congressional Republicans added a clause to the Defense Appropriation Bill for next year requiring the Obama administration to consult with countries in the Western Pacific about stationing even more forces – including tactical nuclear weapons – in the region. Senator Richard Lugar has advised me that since there has been little or no objection to the amendment from the White House, he sees no reason why it will not pass the Senate.



At a recent security conference in Singapore, US Secretary of Defense Leon Panetta emphasized the American military build-up in the region. Afterwards, he went to Vietnam, allegedly for discussions about the US Navy’s use of Cam Ranh Bay, a major American base during the Vietnam War.




The US, like Australia, denies that all of this adds up to a policy of containment aimed at China. But few in the Western Pacific see it that way.



Panetta’s visit to Vietnam followed hard on US Secretary of State Hillary Clinton’s visit to Beijing for strategic and economic talks. Those talks seemed to go well, but it is becoming increasingly clear that the US is pursuing a two-track policy: talks, yes, but a build-up and repositioning of US military power in the Pacific just in case.



All of this is happening at a time when China is preparing for a change of leadership. I happen to believe that the political transition will occur smoothly. Others suggest that it will be – and already is – a difficult period of turmoil and uncertainty.



The Obama administration may believe that toughness directed at China will generate electoral support in the US. During major international incidents or crises, America has seldom voted against an incumbent president. But has he properly reckoned with how provocative his policies are to China?


   
None of this is meant to suggest that the Pacific region does not need America. But, while America obviously has a significant role to play in the region, the US should have learned by now that its political objectives are unlikely to be achieved by military means.



The Chinese themselves do not want the Americans to leave the Western Pacific, as that would make smaller countries on China’s periphery even more nervous about Chinese power. China is mature enough to understand this; nonetheless, a major US military build-up throughout the region is another matter.



These are dangerous days, not only economically, but also strategically. We really do need to ask whether Obama is trying to play a China card to shift the electoral scales in his favor. If that is his intention, it is a move fraught with great danger.




Australia should be saying to the US that it will have none of this. I would sooner abrogate the ANZUS Treaty with New Zealand and the USthat is, I would sooner end defense cooperation with the US – than allow nuclear missiles to be sited on Australian territory.



The current Australian government would not take such a step, and the opposition would be unlikely to do so as well. But more and more Australians are beginning to question the closeness and wisdom of our strategic ties to the US.


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Perhaps our best hope for stability and peace lies in China’s refusal to be provoked. The Chinese understand the game being played. I suspect that they will remain on the sidelines during the US election campaign.


 
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Malcolm Fraser is a former prime minister of Australia.