Syria, America and Putin's Bluff

Monday, September 9, 2013 - 17:15 

By George Friedman

In recent weeks I've written about U.S. President Barack Obama's bluff on Syria and the tightrope he is now walking on military intervention. There is another bluff going on that has to be understood, this one from Russian President Vladimir Putin.

Putin is bluffing that Russia has emerged as a major world power. In reality, Russia is merely a regional power, but mainly because its periphery is in shambles. He has tried to project a strength that that he doesn't have, and he has done it well. For him, Syria poses a problem because the United States is about to call his bluff, and he is not holding strong cards. To understand his game we need to start with the recent G-20 meeting in St. Petersburg, Russia.

Putin and Obama held a 20-minute meeting there that appeared to be cold and inconclusive. The United States seems to be committed to some undefined military action in Syria, and the Russians are vehemently opposed. The tensions showcased at the G-20 between Washington and Moscow rekindled memories of the Cold War, a time when Russia was a global power. And that is precisely the mood Putin wanted to create. That's where Putin's bluff begins.

A Humbled Global Power

The United States and Russia have had tense relations for quite a while. Early in the Obama administration, then-Secretary of State Hillary Clinton showed up in Moscow carrying a box with a red button, calling it the reset button. She said that it was meant to symbolize the desire for restarting U.S.-Russian relations.

The gesture had little impact, and relations have deteriorated since then. With China focused on its domestic issues and with Europe in disarray, the United States and Russia are the two major -- if not comparable -- global players, and the deterioration in relations can be significant. We need to understand what is going on here before we think about Syria.

Twenty years ago, the United States had little interest in relations with Russia, and certainly not with resetting them. The Soviet Union had collapsed, the Russian Federation was in ruins and it was not taken seriously by the United States -- or anywhere else for that matter.

The Russians recall this period with bitterness. In their view, under the guise of teaching the Russians how to create a constitutional democracy and fostering human rights, the United States and Europe had engaged in exploitative business practices and supported non-governmental organizations that wanted to destabilize Russia.

The breaking point came during the Kosovo crisis. Slobodan Milosevic, leader of what was left of Yugoslavia, was a Russian ally. Russia had a historic relationship with Serbia, and it did not want to see Serbia dismembered, with Kosovo made independent.

There were three reasons for this. First, the Russians denied that there was a massacre of Albanians in Kosovo. There had been a massacre by Serbians in Bosnia; the evidence of a massacre in Kosovo was not clear and is still far from clear. Second, the Russians did not want European borders to change. There had been a general agreement that forced changes in borders should not happen in Europe, given its history, and the Russians were concerned that restive parts of the Russian Federation, from Chechnya to Karelia to Pacific Russia, might use the forced separation of Serbia and Kosovo as a precedent for dismembering Russia. In fact, they suspected that was the point of Kosovo. Third, and most important, they felt that an attack without U.N. approval and without Russian support should not be undertaken both under international law and out of respect for Russia.

President Bill Clinton and some NATO allies went to war nevertheless. After two months of airstrikes that achieved little, they reached out to the Russians to help settle the conflict. The Russian emissary reached an agreement that accepted the informal separation of Kosovo from Serbia but would deploy Russian peacekeepers along with the U.S. and European ones, their mission being to protect the Serbians in Kosovo. The cease-fire was called, but the part about Russian peacekeepers was never fully implemented.

Russia felt it deserved more deference on Kosovo, but it couldn't have expected much more given its weak geopolitical position at the time. However, the incident served as a catalyst for Russia's leadership to try to halt the country's decline and regain its respect. Kosovo was one of the many reasons that Vladimir Putin became president, and with him, the full power of the intelligence services he rose from were restored to their former pre-eminence.

Western Encroachment

The United States has supported, financially and otherwise, the proliferation of human rights groups in the former Soviet Union. When many former Soviet countries experienced revolutions in the 1990s that created governments that were somewhat more democratic but certainly more pro-Western and pro-American, Russia saw the West closing in. The turning point came in Ukraine, where the Orange Revolution generated what seemed to Putin a pro-Western government in 2004. Ukraine was the one country that, if it joined NATO, would make Russia indefensible and would control many of its pipelines to Europe.

In Putin's view, the non-governmental organizations helped engineer this, and he claimed that U.S. and British intelligence services funded those organizations. To Putin, the actions in Ukraine indicated that the United States in particular was committed to extending the collapse of the Soviet Union to a collapse of the Russian Federation. Kosovo was an insult from his point of view. The Orange Revolution was an attack on basic Russian interests.

Putin began a process of suppressing all dissent in Russia, both from foreign-supported non-governmental organizations and from purely domestic groups. He saw Russia as under attack, and he saw these groups as subversive organizations. There was an argument to be made for this. But the truth was that Russia was returning to its historical roots as an authoritarian government, with the state controlling the direction of the economy and where dissent is treated as if it were meant to destroy the state. Even though much of this reaction could be understood given the failures and disasters since 1991, it created a conflict with the United States. The United States kept pressing on the human rights issue, and the Russians became more repressive in response.

Then came the second act of Kosovo. In 2008, the Europeans decided to make Kosovo fully independent. The Russians asked that this not happen and said that the change had little practical meaning anyway. From the Russian point of view, there was no reason to taunt Russia with this action. The Europeans were indifferent.

The Russians found an opportunity to respond to the slight later that year in Georgia. Precisely how the Russo-Georgian war began is another story, but it resulted in Russian tanks entering a U.S. client state, defeating its army and remaining there until they were ready to leave. With the Americans bogged down in Iraq and Afghanistan, no intervention was possible. The Russians took this as an opportunity to deliver two messages to Kiev and other former Soviet states. First, Russia, conventional wisdom aside, could and would use military power when it chose. Second, he invited Ukraine and other countries to consider what an American guarantee meant.

U.S.-Russian relations never really recovered. From the U.S. point of view, the Russo-Georgia war was naked aggression. From the Russian point of view, it was simply the Russian version of Kosovo, in fact gentler in that it left Georgia proper intact. The United States became more cautious in funding non-governmental organizations. The Russians became more repressive by the year in their treatment of dissident groups.

Since 2008, Putin has attempted to create a sense that Russia has returned to its former historic power. It maintains global relations with left-wing powers such as Venezuela, Ecuador, Bolivia and Cuba. Of course, technically Russia is not left wing, and if it is, it is a weird leftism given its numerous oligarchs who still prosper. And in fact there is little that Russia can do for any of those countries, beyond promising energy investments and weapon transfers that only occasionally materialize. Still, it gives Russia a sense of global power.

In fact, Russia remains a shadow of what the Soviet Union was. Its economy is heavily focused on energy exports and depends on high prices it cannot control. Outside Moscow and St. Petersburg, life remains hard and life expectancy short. Militarily, it cannot possibly match the United States.

But at this moment in history, with the United States withdrawing from deep involvement in the Muslim world, and with the Europeans in institutional disarray, it exerts a level of power in excess of its real capacity. The Russians have been playing their own bluff, and this bluff helps domestically by creating a sense that, despite its problems, Russia has returned to greatness.

In this game, taking on and besting the United States at something, regardless of its importance, is critical. The Snowden matter was perfect for the Russians. Whether they were involved in the Snowden affair from the beginning or entered later is unimportant. It has created two important impressions.
The first is that Russia is still capable of wounding the United States -- a view held among those who believe the Russians set the affair in motion, and a view quietly and informally encouraged by those who saw this as a Russian intelligence coup even though they publicly and heartily denied it.

The second impression was that the United States was being hypocritical. The United States had often accused the Russians of violating human rights, but with Snowden, the Russians were in a position where they protected the man who had revealed what many saw as a massive violation of human rights. It humiliated the Americans in terms of their own lax security and furthermore weakened the ability of the United States to reproach Russia for human rights violations. 

Obama was furious with Russia's involvement in the Snowden case and canceled a summit with Putin. But now that the United States is considering a strike on the Syrian regime following its suspected use of chemical weapons, Washington may be in a position to deal a setback to a Russia client state, and by extension, Moscow itself.

The Syria Question

The al Assad regime's relations with Russia go back to 1970, when Hafez al Assad, current President Bashar al Assad's father, staged a coup and aligned Syria with the Soviet Unión. In the illusion of global power that Putin needs to create, the fall of al Assad would undermine his strategy tremendously unless the United States was drawn into yet another prolonged and expensive conflict in the Middle East. In the past, the U.S. distraction with Iraq and Afghanistan served Russia's interests. But the United States is not very likely to get as deeply involved in Syria as it did in those countries. Obama might bring down the regime and create a Sunni government of unknown beliefs, or he may opt for a casual cruise missile attack. But this will not turn into Iraq unless Obama loses control completely.

This could cause Russia to suffer a humiliation similar to the one it dealt the United States in 2008 with Georgia. The United States will demonstrate that Russia's concerns are of no account and that Russia has no counters if and when the United States decides to act.

The impact inside Russia will be interesting. There is some evidence of weakness in Putin's position. His greatest strength has been to create the illusion of Russia as an emerging global power. This will deal that a blow, and how it resonates through the Russian system is unclear. But in any event, it could change the view of Russia being on the offensive and the United States being on the defensive.

Putin made this a core issue for him. I don't think he expected the Europeans to take the position that al Assad had used chemical weapons. He thought he had more pull than that. He didn't. The Europeans may not fly missions but they are not in a position to morally condemn those who do. That means that Putin's bluff is in danger.

History will not turn on this event, and Putin's future, let alone Russia's, does not depend on his ability to protect Russia's Syrian ally. Syria just isn't that important. There are many reasons that the United States might not wish to engage in Syria. But if we are to understand the U.S.-Russian crisis over Syria, it makes sense to consider the crisis within in the arc of recent history from Kosovo in 1999 to Georgia in 2008 to where we are today.

The IMF knows that the Fed is playing with fire in emerging markets

By Ambrose Evans-Pritchard Economics     

Last updated: September 9th, 2013

Photo: Reuters

Listen to the IMF's Christine Lagarde very carefully. While the US Federal Reserve has as a parochial "closed economy" view – and made a series of grave blunders over the last six years as a resulther job is to look at the entire world, and she does not like what she sees.

She warned over the weekend that Fed tapering could ricochet back into the US economy if handled carelessly.

"Very negative spillover effects on the emerging market economies could very much backfire on other economies. So to assume that the domestic economy is totally isolated, that a country is an island, would not be the right approach," she told CNBC at the Ambrosetti Forum on Lake Como, which I have been attending.

"Without necessarily changing the mandate, without reviewing the terms of references, and maybe without even acknowledging it, I cannot believe that central bankers do not take into account what's happening elsewhere in the world," she said.

Unfortunately, that is exactly what the Fed seems poised to do. It is an open question whether the US economy itself has really reached escape velocity, or is strong enough to withstand much tapering, and the European economy is not even close to that point.

One suspects that the Fed is acting for "bad motives" rather than "good motives", by which I mean that it is starting to tighten because of growing (and understandable) alarm about speculative excess, or because the Fed is worried as an institution that it cannot easily extract itself from QE if it waits until 2014 (the Mishkin thesis), not because the US economy is genuinely healthy.

But the Brics are in no fit state to cope with the withdrawal of global dollar liquidity. And remember, emerging markets now make up half the world economy, so we are in uncharted waters here.

Of course, one might say the Brics deserve to be taken down a peg or two, since they seem determined to collude in Assad's chemical weapons attack, blocking any punitive measure at the UN (and there are measures short of missile strikes). Why is India taking this squalid position? Why is Brazil? Why are they allying themselves with the dictator Putin, now the full accomplice in a terrible crime?

Why are they continuing to show such lack of leadership, such an inferiority complex? Why for that matter is Germany – which started the ball rolling with Mustard gas in 1915, and therefore should have a special responsibility so unwilling to go along EU partners in any way? Why is it doing so little to muster proper condemnation? Frankly, I am shocked by Germany's behaviour, since it appears to have no moral content at all.

So if the Brics come pleading for mercy as Fed tapering sets off a faster pace of capital flight, they cannot expect a very friendly response from Washington.

Be that as it may, any satisfaction that the US may enjoy from seeing the Brics humbled a little will not last long if the effects spread contagion to southern Europe again, and then back into the US economy itself.

The IMF is right, but is anybody listening at the Fed?

September 9, 2013 5:37 pm

Japan must be brave – it is time to put up taxes
Raising consumption tax to 20-25 per cent would resolve the fiscal situation, says Takatoshi Ito
Tokyo Stock Market©EPA

It is hardly a secret that Japan’s fiscal situation is much worse than that of some European countries that fell into crisis. In the past few years, less than half of the central government budget has been financed by taxation. The volume of new bond issuance has exceeded tax revenues. It is as if a family were to use credit cards for half of their monthly expenditure. The ratio of gross debt to gross domestic product is more than 200 per cent – the highest among the OECD countries. The situation is clearly not sustainable.

Given the dire financial situation, many economists and investors have been mystified as to why Japanese government bonds have maintained their exceptionally low yield, currently at about 0.7 per cent for 10-year paper. Takeo Hoshi and I have an answer. Since the rate of consumption tax (a value added tax) is a lowly 5 per cent, there is ample room for a tax rise.
Suppose that the Japanese government raised the consumption tax rate to the European level of 20-25 per cent. At that point, Japan’s fiscal situation would become perfectly sustainable. Hence, we conjecture that Japanese investors trust that at some point in the future, some wise political leaders will persuade the public to accept higher consumption tax rates.
They have reason to do so: in 2012, the three major parties agreed to raise this tax. Under the law, passed by both houses of parliament last August, the tax would first move from its current 5 per cent to 8 per cent in April 2014 and, from there, to 10 per cent in October 2015. The legislation was a turning point, the first step towards fiscal sustainability – and one largely accepted by the Japanese public.

However, a year after the legislation and six months before implementation, there are signs that the Liberal Democratic party government of Shinzo Abe is having second thoughts. The prime minister’s personal economic advisers openly oppose the scheduled increase. They have put forward an alternative plan to raise the tax 1 percentage point a year for each of the next five years.
Opponents fear that an abrupt increase would risk repeating the experience of 1997 when an increase of 2 percentage points in the consumption tax was followed by a big recession. They argue that today’s Japanese economy, on the verge of escaping longstanding deflation, is insufficiently strong to withstand the demand shock that a hefty tax increase might imply.

Mr Abe has an escape clause. The law passed in 2012 stipulates that the tax increase should only go ahead if the economy is considered sufficiently robust to merit it. Opponents are arguing that it is not. There are worrying signs that Mr Abe’s resolve is wobbling.

Late last month, 60 representatives of the economic profession, business, consumers, labour and younger generations were interviewed about the likely impact of the tax rate increase. Mr Abe received a report summarising the discussions last week and is scheduled to make his ruling on whether to press ahead with the tax rise shortly after.

The arguments of those who advocate going ahead with the tax increase, including myself, are centred on four main points.

First, the economy is firmly in an expansionary phase. The Japanese economy grew in the first two quarters of this year, at annualised rates of 4.1 per cent and 3.8 per cent respectively. It is very unlikely that the economy would fall back into stagnation or deflation as a result of a 3 percentage point increase in the tax rate next April.

Second, there is no connection between the April 1997 tax increase and the recession that followed. The Sharp economic downturn of 1998 had its roots in the Asian currency crisis and Japan’s own banking problems. The tax rise was irrelevant.

Third, if the current law were to be suspended, a new one would have to be written and argued over in parliament. The tax rise itself is unavoidable. Expending political capital over rescheduling its implementation would be a colossal waste of time and effort. Rather than doing that, Mr Abe should spend the next several months implementing regulatory reform – the so-called third arrow of Abenomics. If he gets distracted on a fruitless round of negotiations over the consumption tax, structural reform vital to Japan’s long-term growth prospects would take a back seat.
Fourth, suspension would probably be interpreted by the markets as a lack of political will. That would be very bad news for the JGB and equities markets. The very real gains accrued through aggressive monetary policynamely a sharp increase in stock prices and a fall in the yen – could be unwound.

It is important for Mr Abe to keep the momentum. Being assured by the new strong growth numbers, he should quickly put the debate to rest by announcing his intention to press ahead with the tax increase as planned. It would be a great mistake if he lost his nerve now.

The writer is dean of the Graduate School of Public Policy at the University of Tokyo and was an economic adviser to the 2006 Abe government

Copyright The Financial Times Limited 2013.

09/10/2013 03:46 PM

Dispute with ECB

European Parliament Delays Banking Union Vote

International Monetary Fund chief Christine Lagarde: "The ship needs to be finished and speed is of the essence."

The European Parliament has delayed an important vote on the euro zone banking union that will see the most important financial institutions placed under the supervisory of the European Central Bank. Members of parliament want greater ECB accountability.

A dispute over Europe's planned banking union -- a key European Union financial reform in response to the 2007 financial crisis -- has broken out between the European Parliament and the European Central Bank (ECB), and an important vote on the issue was delayed from Tuesday to Thursday. In response, the International Monetary Fund (IMF) is calling on the European Union to move more quickly to implement the measures, with criticism coming directly from IMF chief Christine Lagarde herself.

The argument centers on whether members of the European Parliament should be provided with detailed minutes of the proceedings of the new banking supervision board, a provision parliament considers to be a vital accountability measure. The ECB has so far rejected these requests. Reuters reported Tuesday that the ECB is instead offering to provide "summaries."

On Monday, the European Voice newspaper cited an ECB official stating there were "formal restrictions" on what the bank could disclose about its decision-making process. The Economist-owned Brussels paper cited an official at the bank stating that the proceedings were sensitive and there was a fear "we might be jeopardizing the survival of banks" if information were shared with members of parliament.

Intense Negotiations

In its own official statement, the ECB writes: "In advance of the vote in the parliament, the European Central Bank is progressing with its final discussions with the European Parliament on accountability arrangements and looks forward to reaching an agreement shortly. Broad agreements have already been reached."

European Parliament President Martin Schulz is negotiating intensely with ECB chief Mario Draghi, Schulz's spokesperson Armin Machmer said. He added that the two were making progress towards an acceptable agreement. If they are unable to reach a deal, the European Parliament could delay its vote until October, endangering the entire timetable for the banking union.

In Paris ahead of an IMF meeting, Reuters quoted Lagarde as saying, "we very much think of the euro area as a beautiful ship that has been built, nurtured … for the soft seas, but which is not yet completely finished for the rough ones."

"A lot has been done in relation to banking union," she added. "If I have a message today it is that that particular part of the ship needs to be finished, needs to be completed and speed is of the essence."

The euro-zone member-states are hoping the banking union will stabilize Europe's banking system and make it resistant to the kind of turbulence felt in 2007 that almost led the European financial system to collapse after Lehman Brothers folded, an event which launched the ensuing European debt crisis and created an existential threat to the common currency.

Supervisory Role for ECB

The current vote, the first in a series of steps to create a banking union, would create the supervisory role for the ECB. Once it is given parliament's blessing, the ECB is expected to assume supervisory responsibility for the 130 most important banks in the euro zone. The ECB is also expected to complete an audit of the banks' balance sheets by February 2014 in order to identify problems as early as possible. A unified stress test by the ECB and the EU banking supervisory authority EBA is expected to begin in May 2014.

The affected institutions comprise 85 percent of the total assets of banks in the 17 euro-zone member states. The agency, which is to be set up inside the ECB will have around 1,000 employees, including 700 banking supervisors. A supervisory board will be created within the agency, but the ECB's governing council would still have the final say on important matters.

Germany has also placed several barriers to the implementation of a fully fledged banking union in Europe. In Berlin, politicians oppose sharing the financial burdens of failing banks within the euro zone without changes to European treaties.