The Retreat of the Renminbi

Benn Steil, Emma Smith


NEW YORK – “The globalization of the yuan seems remorseless and unstoppable,” pronounced The Economist in April 2014. Indeed, use of the Chinese yuan, or renminbi (RMB), in global payments would double between then and August 2015, to 2.8% of the total, making China’s currency the fourth most used in the world.
Since then, however, this growth has been almost entirely reversed. The RMB’s share in global payments has fallen to 1.6%, knocking it down to number seven. Its use in global bond markets is down 45% from its 2015 peak. RMB deposits in Hong Kong banks are also down by half.

And whereas 35% of China’s cross-border trade was settled in RMB in 2015 (with most of the remainder in dollars), that share has fallen to about 12% today.
The RMB’s reversal of fortune reflects four factors in particular.
For starters, whereas the dollar value of the RMB rose nearly every year from 2005 to 2013 – by 36.7% in total – it has since fallen steadily, discouraging speculators. Since 2014, the exchange rate has weakened by an increasing amount every year, and is now down over 11% since the drop began, despite intervention by the People’s Bank of China (PBOC) to support the currency (not to hold it down, as US President Donald Trump has alleged). As a result, investors have abandoned the idea that RMB appreciation is a one-way bet. Capital inflows driven by that bet are over.
The RMB’s fall against the dollar reflects the slowing of China’s debt-fueled economic growth and the accumulation of default risks. Chinese residents and companies are, not surprisingly, seeking new ways (legal and otherwise) to move money out of the country.
In April, PBOC Deputy Governor Yi Gang tried to reassure nervous investors in a presentation in New York by saying that the level of non-performing loans (NPLs) in the Chinese banking sector had “pretty much stabilized after a long time of climbing.” This was, he said, “a good development in the financial market.”
But Yi was spinning. NPLs have stabilized as a percentage of total bank loans, but only because the number of loans has continued to rise. Many of these new loans are to deadbeat clients, and can be expected to go sour in due course. In fact, in absolute terms, NPLs grew by $35 billion in 2016, reaching $220 billion. Banks are also using accounting tricks to hide trillions in further exposures.
In an effort to stem the weakening of the exchange rate, the authorities have made it more difficult to convert RMB to dollars. Having previously supported Chinese investment abroad, they are now blocking outbound mergers and acquisitions to keep domestic companies from exporting capital. They have simultaneously made capital repatriation more difficult for foreign investors. While this helps keep existing capital in China, it is also discouraging foreigners from committing more.
This is the second factor discouraging accumulation of the Chinese currency. Faced with the choice between short-term economic stability and currency flexibility, Chinese policymakers are choosing stability. This raises questions about their long-term commitment to full convertibility, an important step for the RMB to reach genuine reserve-currency status.
The third factor undermining the RMB is that China has exhausted its export potential. The country and its currency have gained prominence because of China’s extraordinary integration into the global economy since its admission into the World Trade Organization in 2001. China’s share of world exports grew from 1% in 1980 to 14% in 2015, making it the world’s largest exporter. But its share of global exports has since fallen, to 13.3%. Those who saw China as the national equivalent of, selling more to more people year on year, have been disappointed.
The fourth factor is the reversal of globalization itself. Capital flows – in the form of equity and bond purchases, foreign direct investment, and lending – fell by over two thirds, from $11.9 trillion to $3.3 trillion, between 2007 and 2015. Trade barriers are up. Discriminatory measures are spreading faster than liberalizing policies. Merchandise trade is falling, too, contracting 10% between 2011 and 2015, which was the largest drop over any four-year period since World War II. China is therefore not only losing export-market share, but is doing so in a shrinking global market. As a consequence, the dollar value of China’s exports has fallen by 9.1% since its peak in early 2015.
The net result is that, compared to just a few years ago, the world has little, if any, reason to continue accumulating RMB. The globalization of the RMB is no longer “remorseless and unstoppable.” On the contrary, it appears, for the foreseeable future, to be well and truly over.

Happy Birthday, America. One Small Suggestion ...


Credit Jeffrey Henson Scales, photographs by Grove Pashley/Photographer's Choice RF and MarianVejcik, via iStockphoto, via Getty Images 

Let us embark together on an Independence Day thought experiment. It is tendered in a spirit of amity, respect and good will by an Englishman who loves America. It may be dismissed as the ravings of a deranged colonial sentimentalist, but I am confident you will at least be polite enough to hear me out.

It is not hard to understand why America threw off the yoke of British oppression in 1776. The colony had been taxed by a government far, far away without deriving any benefit of representation in its Parliament. At the end of the little unpleasantness that ensued, General Cornwallis surrendered to General Washington and Americans were free of our pettifogging rapacity and incompetent interference, and able to turn toward the construction of a new polity, founded upon a new Constitution. A damned fine stab they made of it, too. For the most part.

They incorporated, in many places word for word, the British Parliament’s Bill of Rights of 1689, a farseeing document that limited the powers of the king and laid out for us the lineaments of what was to be Britain’s enduring (and endearing) constitutional monarchy. But they took a further step — a most egregious and regrettable step, as I hope to demonstrate — founded upon a misapprehension of what that Constitution entailed.

During the heat of the Revolutionary War, Americans looked — as nations at war always will — for a name and a face to represent the hated foe. The prime minister, Lord North, would have made a colorless and feeble icon of enmity, and so, perhaps naturally, they settled on the person and character of King George. With the word “tyrant” attached permanently to him, America had its slogan, its hate figure.

But in fact, George III was far from a tyrant. He was a constitutional monarch with almost no real political power at all. In nearly 60 years, a reign only recently surpassed in longevity by that of the current Elizabeth, he earned the love and respect of his people for his simplicity, kindness, frugality and diligence. The “farmer king” liked nothing better than to wander among his fields, talking happily to peasants, pigs and princes alike, not a tyrannical thought in his amiable, befuddled old mind.

But in the New World the wartime propaganda had done its work and the founding fathers had it in their heads that kingship was akin to tyranny and that their new country should be a republic, with an elected president instead of a monarch. The president was to be the highest citizen in the land, executive head of state and commander in chief of the armed forces. That, I submit, was the mistake.

If you watched the excellent Netflix series “The Crown,” you will remember those scenes in the first few episodes in which the newly acceded Elizabeth received her prime minister, Winston Churchill. During these weekly audiences, the great political lion had to stand before her, explain the conduct of his administration, outline governmental plans and problems and keep her informed as to the state of the nation before bowing himself backward from the room.

Constitutional constraints decreed that she could do no more than “advise and consent.” A powerless monarch, but endued with all the symbolic authority of her nation and its long history. The aura this bestowed apparently caused even Churchill to be nervous and discomfited in her presence.

Now for the thought experiment. Select any American president, past or present. Picture a gracious white-columned mansion on a hill outside Washington. In it lives a tall, bony man with shaggy eyebrows and a wispy white beard. He wears a top hat with stars on its band, a cutaway coat of blue broadcloth and red-and-white striped trousers. His name is Uncle Sam and he is America. He embodies the values, history, character, disposition and hopes of the whole country. He has no power to legislate, but he is the first citizen, above politics. Because he is not elected, he has no lobbyists, PACs or special interest groups to placate.

Every week, the elected president has to call at Uncle Sam’s mansion, stand before him and explain himself and his administration. Uncle Sam can question him, tell him a story about how another president 20 years back had faced a similar quandary, wonder whether things could be better organized, tut, click and sigh, but Uncle Sam cannot command or forbid.

Do you not agree that it would be a very healthy thing for presidents to make such a humble, supplicatory journey every week and be reminded that they serve a bigger idea than power, a nobler entity than a political party or a trending ideology? Perhaps mistakenly we think of theatrical rites and ceremonies like this as primitive throwbacks we can congratulate ourselves on having shaken off. But ritual and pageant, costume and custom are to public life what metaphors are to language; they bring it to life and move it from the abstract to the real.

America has an elected executive, but Britain has an elected executive and something else, too: a head of state who stands above the fray, personifying and representing our nation and its history.

I am far from claiming that Britain is anything other than a ridiculous country, nor am I denying that there are plenty of Britons who don’t buy into the drama of kingship. Rationally, a monarchy is an absurdity. Of course it is. But we British are not rationalists. We are empiricists and seem always to have been. Looking at 10 Downing Street and the American White House now, I wonder which nation is constitutionally most in danger of allowing a tyrant to arise.

My modest proposal on this, America’s great national holiday weekend, is that you choose an Uncle Sam or Aunt Samantha by lottery (which is all the birth of a monarch is) and give this person the powers of a constitutional sovereign, with precedence of state over the elected president. To save face, this person needn’t be called a monarch — “first American” or “sovereign citizen” will do. A reality TV competition can be held to finalize all the details. Americans are awfully good at that sort of thing.

Above all, put in your mind the picture of the current president being forced to bow himself backward out of Uncle Sam’s presence. Wouldn’t that just beat the band? And the fireworks, too.

Happy Fourth of July.

When Everything Is Expensive, Not Investing Is a Great Option

Stocks are at record highs and bond yields exceedingly low. It is time to hoard cash for the next buying opportunity.

By Richard Barley

A trader works on the floor of the New York Stock Exchange in New York City, on Friday, June 23, 2017. Photo: Michael Nagle/Bloomberg News

In a world where many markets look expensive, putting cash to work is hard. Simply hanging on to more of it might be a good idea.

That is particularly the case after the first half of 2017 has delivered good results across the board. Most strikingly, both bonds and stocks are up. The MSCI World index of developed-market stocks is up 9.7% so far this year, while long-dated bonds are also partying, with the 30-year Treasury yield falling around 0.25 percentage point to just 2.73%, boosting prices. Corporate-bond yield spreads are back to their tightest levels since the global financial crisis.

Yet falling bond yields and rising equity markets are sending conflicting signals: the former reflecting the lackluster picture for inflation; the latter hopes for growth. Bond yields are still ultralow, while equity valuations are high, with the S&P 500, for instance, trading for 17.6-times forward earnings. This disconnect only can hold if the path of global growth and inflation don’t change markedly. A divergence in either direction will mean that one of the asset classes will have to rethink its assumptions. The jury is out on what happens from here: hopes of a fiscal bump to growth led by the U.S. have faded, while the recent decline in oil prices may cause new worries about headline inflation.

More significantly, perhaps, the flood of global central-bank liquidity that has supported markets is past its peak: the Federal Reserveis raising rates, and the European Central Bank is inching toward an exit from ultraloose monetary policy.

While policy makers don’t want to shock markets, global output gaps are closing. The need for monetary largesse is therefore no longer as clear-cut as it was. The policy debate at the Bank of England is clear evidence of that, with a sudden and surprising shift toward potential tightening of policy.

In this environment, faced with unappetizing initial valuations, not investing might be a valid strategy. For a long time central banks have sought to make cash as unattractive an asset as possible—going so far as to introduce negative interest rates in Japan and Europe. But the more expensive financial assets like bonds and equities get, the less relatively expensive cash looks. The latest Bank of America Merrill Lynch global fund manager survey shows cash holdings at 5% of assets under management, above the 4.5% long-term average but lower than last year.

Building up cash doesn’t reflect a particular fear that a big shock, like a new recession, is about to hit. And there are still pockets in markets where the picture is fundamentally brighter, such as in European equities or in emerging markets. Instead, it is a tactical play—selling some assets and raising cash here is about locking in profits and creating room for maneuver. There have been big opportunities even as markets have continued their broad upward journey: think of the U.S. high-yield bond selloff that started in 2015, and the swoon in stocks in early 2016, as oil cratered. Or think of when bond yields rose in the wake of Donald Trump’s election. Those turned out to offer attractive buying opportunities as markets rebounded—if investors had cash to exploit them.

Different types of investors vary in their ability to keep some dry powder, of course. The catalyst for deploying it isn’t clear either. But, after a strong first half, raising cash to invest at higher yields or lower prices appears wise.

The economy under Modi

India’s prime minister is not as much of a reformer as he seems

But he is more of a nationalist firebrand

WHEN Narendra Modi became prime minister of India in 2014, opinion was divided as to whether he was a Hindu zealot disguised as an economic reformer, or the other way round. The past three years appear to have settled the matter. Yes, Mr Modi has pandered to religious sentiment at times, most notably by appointing a rabble-rousing Hindu prelate as chief minister of India’s most-populous state, Uttar Pradesh. But he has also presided over an acceleration in economic growth, from 6.4% in 2013 to a high of 7.9% in 2015—which made India the fastest-growing big economy in the world. He has pushed through reforms that had stalled for years, including an overhaul of bankruptcy law and the adoption of a nationwide sales tax (GST) to replace a confusing array of local and national levies. Foreign investment has soared, albeit from a low base. India, cabinet ministers insist, is at last becoming the tiger Mr Modi promised.

Alas, these appearances are deceiving. The GST, although welcome, is unnecessarily complicated and bureaucratic, greatly reducing its efficiency. The new bankruptcy law is a step in the right direction, but it will take much more to revive the financial system, which is dominated by state-owned banks weighed down by dud loans. The central government’s response to a host of pressing economic problems, from the difficulty of buying land to the reform of rigid labour laws, has been to pass them to the states. And at least one of the big reforms it has undertaken—the overnight cancellation of most of India’s banknotes in an effort to curb the black economy—was counterproductive, hamstringing legitimate businesses without doing much harm to illicit ones. No wonder the economy is starting to drag. In the first three months of the year it grew at an annualised rate of 6.1%, more slowly than when Mr Modi came to power.

More an administrator than a reformer
India’s prime minister, in short, is not the radical reformer he is cracked up to be. He is more energetic than his predecessor, the stately Manmohan Singh, launching glitzy initiatives on everything from manufacturing to toilet-construction. But he has not come up with many big new ideas of his own (the GST and the bankruptcy reforms date back long before his time). His reputation as a friend to business rests on his vigorous efforts to help firms out of fixes—finding land for a particular factory, say, or expediting the construction of a power station. But he is not so good at working systematically to sort out the underlying problems holding the economy back.

India does not just need power stations and parcels of land for development. It needs functioning markets for electricity and land—and capital and labour, for that matter. Lending to industry is contracting, for the first time in 20 years; Mr Modi should recapitalise state-owned banks and sell them off, to get loans flowing again. He should be working to simplify the over-exacting labour law, which perversely harms workers by deterring companies from hiring them formally. Property purchases are a forbidding quagmire; the government, at a minimum, should try to improve the quality of registers to reduce the scope for disputes.

Political conditions are about as propitious for reform as they are ever likely to be. Mr Modi’s government is the strongest in decades. It has a big majority in the lower house of parliament and is edging closer to control of the upper house, as well. It runs most big states. The opposition is hopeless.

There are economic tailwinds, too. India is a big importer of oil; the low price of late has been boosting growth by perhaps two percentage points a year. Ageing has long weighed on Western economies and is starting to sap China’s. India, by contrast, is still young. Over a quarter of the people joining the world’s workforce between now and 2025 will be Indian. And there is enormous scope for catch-up growth: India is the poorest of the world’s 20 biggest economies.

By rights, it should be surpassing others’ growth rates for years.

Mr Modi, in short, is squandering a golden opportunity. Some apologists claim that he is waiting until he wins a majority in the upper house before taking on bigger reforms. If so, he has given no inkling of what he is planning. In fact, he has not even made clear that economic reform is his priority.

More a chauvinist than an economist
As prime minister, Mr Modi has been just as careful to court militant Hindus as jet-setting businessmen. His government recently created havoc in the booming beef-export business with onerous new rules on purchases of cattle, in deference to Hindus’ reverence for cows. Yogi Adityanath, the man he selected to run Uttar Pradesh, is under investigation for inciting religious hatred and rioting, among other offences.

The fear is that, if the economy falters, Mr Modi will try to maintain his popularity by stirring up communal tensions. That, after all, is how his Bharatiya Janata Party first propelled itself to government in the 1990s. Mr Modi himself was chief minister of Gujarat in 2002 when rioting there killed at least 1,000 people, most of them Muslims. To this day, he has never categorically condemned the massacre or apologised for failing to prevent it.

Under Mr Modi, debate about public policy, and especially about communal relations, has atrophied.

Hindu nationalist thugs intimidate those who chide the government for straying from India’s secular tradition, or who advocate a less repressive approach to protests in Kashmir, India’s only state with a Muslim majority. One of the few media companies that dares to criticise the government has been raided by police on grounds that would not normally attract such heavy-handedness. Mr Modi himself has become the object of a sycophantic personality cult. The prime minister may intend all this as a way to keep winning elections. But it is not hard to imagine it going disastrously wrong.

Mr Modi’s admirers paint him as the man who at last unleashed India’s potential. In fact, he may go down in history for fluffing India’s best shot at rapid, sustained development. And the worries about a still darker outcome are growing.

How Gold Investors Should Play The Upcoming Big Economic News Week

by: Hebba Investments

- COT speculative positions are now at very attractive levels for entry in both gold and silver
- Despite a bullish COT report, physical demand in gold and silver is very weak
- Asian gold premiums also remain lackluster
- Next week is a big week with the ADP and Nonfarm Payrolls report that has been big movers of precious metals in the past
- Weighing both sides means we are neutral gold and silver but would be buyers on any drop next week
The latest Commitment of Traders (COT) report showed a third straight week of speculative long selling in gold despite an actual rise in price during the week, which is a bit unusual. The addition of new shorts also helped take the net speculative long position in gold down below the 100,000 contract mark for the first time in a month – which is good from a contrarian point of view.
Big economic events loom next week as the market receives the ADP employment and Nonfarm Payrolls reports. In the past these have been some of the biggest movers of the gold market, and with the Fed still expected to raise rates twice more this year (we don’t buy it), weakness or strength in these reports will help confirm or reverse the Fed’s projected interest rate trajectory.
We will get more into some of these details but before that let us give investors a quick overview into the COT report for those who are not familiar with it.
About the COT Report

The COT report is issued by the CFTC every Friday, to provide market participants a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.
Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow the small investors a way to see what larger traders are doing and to possibly position their positions accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts - so you may want to take a long position.

The big disadvantage to the COT report is that it is issued on Friday but only contains Tuesday's data - so there is a three-day lag between the report and the actual positioning of traders. This is an eternity by short-term investing standards, and by the time the new report is issued it has already missed a large amount of trading activity.
There are many ways to read the COT report, and there are many analysts that focus specifically on this report (we are not one of them) so we won’t claim to be the exports on it.
What we focus on in this report is the “Managed Money” positions and total open interest as it gives us an idea of how much interest there is in the gold market and how the short-term players are positioned.
This Week's Gold COT Report
*Gold price data reflects the COT week (Tues-Tues) not a standard week (Mon-Fri)
For the third week in a row, speculative longs cut back on their long positions by a sizable 22,495 contracts, which followed up on last week’s major long divestment. Despite this, the gold price actually rose by 0.59% during the COT week (Tuesday to Tuesday), which is a bit unusual and suggests strength in gold outside of these speculative traders.
Meanwhile, speculative gold shorts added 6,130 contracts on the week, which helped push the net short percentage to over 30% - which is one of our indicators that it is time to potentially start accumulating gold.
Moving on, the net position of all gold traders can be seen below:
Source: GoldChartsRUS
The red-line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, we saw the net position of speculative traders decrease by around 28,000 contracts to 77,000 net speculative long contracts. We are now at much healthier historic speculative long levels in the gold market and that is positive for the gold bulls.
As for silver, the action week’s action looked like the following:
Source: GoldChartsRUS
The red line which represents the net speculative positions of money managers, showed a decrease in the net-long silver speculator position as their total net position fell by around 15,000 contracts to a net speculative long position of 12,000 contracts.
Silver is now looking pretty attractive from the COT perspective as we are starting to see some of the lowest net speculative levels in silver since early 2016. But we do note, which we have mentioned before, the actual fundamentals of silver remain a bit weak as physical demand has been extremely poor with silver bullion sales slow across the board.
The Upcoming Jobs Report and How It Affects the Fed
Thursday and Friday’s jobs related reports are almost certain to move the gold markets if they come in different than expectations. We have no view on if it will be positive or negative, but we do have a view on the economy and we believe that it is not as strong as the stock market suggests, and with the significant weakness in the retail sector, we wouldn’t be surprised to see a negative report. That would be positive for precious metals as it would give the Fed second thoughts about their projected two interest rate increases over the balance of 2017.

Interestingly, Frank Holmes Chief Financial Officer at US Global Investors, pointed out that gold has actually done well following Fed meetings and poorly heading into “interest rate live” meetings.
The next Fed meeting with a press conference is in September, and since we highly doubt the Fed will raise interest rates in any meetings without press conferences, then if gold follows this pattern we may have some strength moving forward. While we wouldn’t give this view too much confidence as the summer hasn’t been strong for gold recently, it is something for investors to note.
Finally, Asian gold premiums have remained lackluster over the past week – though Indian premiums have started to rise. While that’s normally a positive thing for the gold market, in this case, the rise seems to be related to the imposition of a new tax on gold starting July 1st.
That suggests that this is simply gold buying being pulled forward rather than because of the attractiveness of current prices.
Our Take and What This Means for Investors
In summary, it looks like we have reasons to both buy and sell gold this week. On the bullish side, the COT report looks much better than it has in over a month as speculative bulls closed out their positions and we move to the 30% short ratio – which is one of our buying indicators.
Additionally, we think that the Fed wont be able to hike rates twice – maybe not even once the rest of the year and that would probably be positive for gold.
On the bearish side is the fact that physical demand in Asia remains lackluster and bullion sales are extremely weak. Also, with markets near all-time highs, it seems the desire for safe-haven assets like gold is weak.

Putting this all together its causing us to change our short-term view on both gold and silver as we are moving from Neutral-Bearish to Neutral for the upcoming week. But we would be a short-term buyer of gold and silver IF we see any sizable drops next week as it would push us into our short-term bullish territory.
In conclusion, we think a neutral stance means investors with no precious metals exposure should start buying, while investors with existing precious metals positions should hold tight and look for a drop during the upcoming week. That drop would be a buy signal for us and we would be looking to add to gold and silver positions (SPDR Gold Trust ETF (NYSEARCA:GLD), iShares Silver Trust (SLV), Sprott Physical Silver Trust (PSLV), and ETFS Physical Swiss Gold Trust ETF, etc).

Crowded Waters in Southeast Asia

By Phillip Orchard


Cooperation among Southeast Asian states has never come easy, but the surge of Islamist militancy in the region is encouraging Malaysia, Indonesia and the Philippines to give it another try.

This week, the three countries formally launched trilateral patrols in the Sulu and Celebes seas — a vast expanse that has become a hub of piracy, militancy and smuggling. They have discussed the possibility since 2016, when the Abu Sayyaf, a jihadist group aligned with the Islamic State, conducted a string of kidnappings in the Sulu Archipelago. Whatever differences that may have impeded the patrols, however, were put aside during the siege of Marawi city, a provincial capital in the restive Philippine region of Mindanao.

Of course, the patrols alone will not rid the Philippines or its neighbors of jihadists.

The same issues that have routinely hindered collective action throughout Southeast Asia will limit the scope of the program, if not undermine its effectiveness altogether.

But the initiative does amount to a step toward regional integration, even as it proves the indispensability of the United States and its allies in Southeast Asia — playing directly into U.S. strategy in the Asia-Pacific.

A Divided Region

The slow start to the patrols in the Sulu and Celebes seas shows just how elusive integration has been in Southeast Asia. Historically, mountains and island chains, not to mention starkly divided ethnic communities, have tended to produce inward-looking countries too preoccupied by instability and too suspicious of foreign meddling to bother to assimilate. (Singapore is a notable exception.) Today, the region is insufficiently connected by infrastructure but riven by territorial disputes and by unaddressed insurgencies in its farthest reaches. Though the 10-member Association of Southeast Asian Nations has tried to solve these problems, it has held tight to its founding principle of non-interference in members’ internal affairs, opting instead to avoid the joint pursuit of economic and security agendas.

(click to enlarge)

The Malacca Strait Patrols are an important exception. Launched by Singapore, Malaysia and Indonesia in 2006 (Thailand joined in 2008), the joint air and sea patrols have reduced the threat of piracy in one of the world’s most important shipping lanes. The trilateral patrols in the Sulu and Celebes seas, officially at least, will be based on the model established in the Malacca Strait.

But key differences between the two initiatives show why familiar geopolitical constraints on cooperation in Southeast Asia will be more of a problem for the new initiative. In the Malacca Strait, territorial disputes were resolved long ago. Singapore’s willingness and ability to commit the lion’s share of resources — and host an intelligence fusion center at Changi naval base — gave the initiative clear leadership, ensured effective information-sharing, and helped to offset the underdeveloped capabilities of the three (original) participants.

The sailing won’t be as smooth in the Sulu and Celebes seas, where Malaysia has unresolved border issues with both Indonesia and the Philippines. (Particularly problematic is the Philippines’ claim to Malaysia’s Sabah state.) Though the countries have tentatively agreed to grant each other “hot pursuit” rights – which allow countries to follow enemies across borders – they may not be as agreeable in practice. Most pirate attacks, for example, take place close to the shores of islands within Philippine territory, so the responsibility to let in foreign militaries would fall mostly on the government in Manila, which has been the most reluctant to commit to the patrols. It doesn’t want to allow its counterparts to follow militants onshore, where the battle will ultimately be won or lost.

Sovereignty isn’t the only impediment. The three countries may have the military capability to establish relatively secure transit corridors along key shipping lanes. But without effective intelligence coordination or the resources to expand patrols beyond narrow corridors, the program will struggle to stop cross-border flows of militants and weaponry. As it stands, the Sulu-Celebes operation would require separate command centers for each country rather than a single hub for intelligence coordination. (Singapore, which was present at the launch as an observer, has offered to help establish a similar fusion center.) And it’s unclear whether participants have the resources needed to sustain operations in an area that is so much bigger than the Malacca Strait, let alone one with multidirectional shipping lanes.

Thai and Malaysian naval forces pursue a pirate ship in 2007. TENGKU BAHAR/AFP/Getty Images

The initiative will therefore struggle to expand beyond narrowly focused, loosely coordinated operations. Success against the jihadists, as has already been the case, will come down to discrete efforts of each country – both at sea and on land. Indonesia and the Philippines, in particular, both lack the naval capabilities to go at it alone.
Subtle and Steadfast

Despite all these constraints, we expect joint patrols to be modestly successful in their mission. But the initiative is useful in other ways. If the Philippines, Malaysia and Indonesia can resolve disputes or put aside their mutual suspicions, the patrols would be a template for cooperation on other issues – an important consequence for a region historically beset by disunity.

Its disunity also shaped the way foreign powers engaged the region, and in this regard the patrols will be similarly useful. The U.S., for example, has been gradually boosting security assistance and cooperation in the region for years through such programs as the Southeast Asia Maritime Security Initiative. U.S. allies in the Asia-Pacific like Australia and Japan have followed suit. But these efforts have generally been confined to bilateral arrangements. China prefers it this way; Beijing sees bilateral engagement as a way to maximize economic leverage with individual states and to keep ASEAN from unifying against it. The United States has no illusions about ASEAN’s ability to develop into a broad defense alliance. But on issues that require multilateral cooperation, Washington is keen to encourage regional states to stand up to threats as one, supported as they are by its naval fleets.

To be effective, the Sulu-Celebes patrols will need to be multilateral. They will need to expand beyond the trilateral format, first by being willing to let Singapore and neighbors like Brunei and Thailand share the resource burden. (Malaysia’s defense minister said he expects as many as five more countries to join.) They would also need to allow outside powers to contribute where native capabilities are lacking. After all, the Malacca Strait Patrols have relied heavily on U.S. intelligence support and have grown to now include countries such as India.

There is no shortage of candidates in these crowded waters. Japan has expressed interest in contributing to the Sulu-Celebes initiative too, and its newest warship has become a regular visitor to Southeast Asian ports in recent months. And though Indonesia continues to harbor long-standing suspicions about Australia’s strategic ambitions, Jakarta has signaled that it could tolerate an Australian presence in the Sulu-Celebes seas. China is also keen to demonstrate that it can provide the security benefits to Southeast Asian states traditionally provided by the Americans – and thus relieve them of their need for U.S. alliances. But ultimately, only the U.S., with its unmatched navy and the rotational access it secured to eight Philippine military bases through the 2015 Enhanced Defense Cooperation Agreement, is singularly positioned to contribute. In fact, it is already helping Manila address the onshore side of the fight. (The U.S. also stations five littoral combat ships in Singapore and launches surveillance flights from Malaysia.)

Foreign powers won’t participate in the patrols anytime soon. Chinese ships would cause particular unease, but most Southeast Asian states remain wary of outside involvement on principle. The launch of the Malacca Strait Patrols, for example, was motivated as much by concerns that the spike in piracy would invite U.S. intervention as it was by the problem of piracy itself. The U.S. has largely contributed from behind the scenes ever since –  and likely will again. But subtle and steadfast is how the U.S. prefers its power be perceived in Southeast Asia.

July 3, 1863: The Birth of a Nation

By Jacob L. Shapiro

The United States declared its independence on July 4, 1776, but that didn’t make it a nation. Sheets of paper, even ones on which well-intended men pledge their “lives, fortunes and sacred honor” to abandon one government for a new government, don’t create nations. Nations cannot be simply declared to exist. They emerge slowly from the shared experiences, good and bad, of generations.

The United States wouldn’t become a nation for nearly another 100 years, after other, equally well-intended men pledged their own lives, fortunes and sacred honor to abandon one government for a new government. The important distinction, of course, is that these men pitted themselves against what were until recently their fellow Americans, enemies now in a great civil war that would claim almost as many American lives as every other U.S. conflict combined and, by war’s twisted logic, forge the nation the Founding Fathers could not.

The Civil War shaped America’s national character in unforeseeable ways. That a world-dominant power should rise in North America was a consequence of advantageous geography. That the power that came to be was this particular United States of America was not predetermined. Power is predictable in a way that national character is not. The rise of the U.S. was predictable. The birth of an American nation at Gettysburg was not.

The Abdication of Duty

To understand how this was possible, we must begin with the Civil War. It was not a war the South could win by dint of arms alone. The North had more soldiers, more (and better) weapons, and more industrial capacity. The South’s only chance at victory was to protract the conflict long enough to break the Union’s will, forcing Washington to negotiate the South’s freedom with slavery intact.

In May 1863, the situation looked grim for the Confederacy. Gen. Ulysses S. Grant laid siege to the city of Vicksburg, his victory inevitable. Union control of Vicksburg would cut the fledgling Confederacy in half and put the full length of the Mississippi River in the hands of the North. The Confederacy had one hope left: the Army of Northern Virginia, which had time and again defeated, even humiliated, the Army of the Potomac. It was commanded by Gen. Robert E. Lee.

Lee decided that his army, having been properly reinforced, should be deployed offensively into Union territory. He had tried to do so once before in 1862, only to be turned back at the Battle of Antietam/Sharpsburg. Lee believed he failed only because the Union commander, Gen. George McClellan, had intercepted his marching orders. Lee regained his composure, and the general disrepair of the Union command structure only boosted his confidence.

Strategy as much as vanity informed his foray into the North. Lee could not have convinced the president of the Confederacy or his secretary of war to support the plan had it not made strategic sense. Lee knew he couldn’t defend Virginia forever; his army was sustaining far too many casualties. The Confederacy needed something more if it had any chance of peace on its terms. And since provisions for the Confederate army were running low, it needed something quick. Most important, however, was the state of affairs at Vicksburg. Lee could not rescue Vicksburg any more than he could draw Grant away from a foregone victory. The only option he had was to overshadow the Union victory at Vicksburg with an even greater victory of his own.

His was a desperate strategy, but it could have turned the tide of the war if it had succeeded. Defeating the Union on its own ground would bring to the Confederacy much needed international prestige, recognition from Great Britain or even intervention from France. It would crush the morale of the Union and, in turn, the faith it had in Abraham Lincoln, who stood for re-election but would not stand for ending hostilities with the South. Moving the Army of Northern Virginia into Pennsylvania was a bold move, but he had no other choice. Fortune does not favor the bold – misfortune and weakness make the bold necessary.

And so for a second time Lee led his army north, and, for a second time, plans went awry. It is under these circumstances that Union and Confederate soldiers met for three days, beginning on July 1, 1863, at Gettysburg, fighting and dying in what would become the Civil War’s most important battle. The Confederacy had to fight – and it had to win – if it were to survive. Gettysburg would decide the fate of the project started on July 4, 1776.

The men who fought at Gettysburg were brought there by forces they could not control. The U.S. Constitution, ratified in 1788, had only papered over the inherent North-South divide of the original 13 colonies. Now, industrialization threatened the Southern way of life, and secession threatened the Northern. But while the war itself was inexorable, the Battle of Gettysburg was not predetermined. Its result was decided by a single mistake, made by the most brilliant military mind in the war: Lee’s. Had Lee made a different choice, the United States might have been a much different nation. It was a rare moment in history in which the forces that ordinarily shape human civilization abdicate their duties, leaving the work instead to the mortals over whom they otherwise have domain.
The Possible and the Impossible

Lee’s fatal mistake, of course, was the ordering of Pickett’s Charge. On the third day of battle, Lee ordered 15,000 men to march just under a mile, with scarcely any cover, to assault a heavily armed and well-defended Union position along Cemetery Ridge. Hardly any men made it to their destination. One-third of the Confederate soldiers were either killed or captured. The overall casualty rate was more than 50 percent – among officers, that rate was more than 80 percent. Lee ordered the charge despite all the evidence that it would fail.

(click to enlarge)

So why did Lee, intelligent as he was, order the charge? For students of history, this question is as impossible to answer as it is to ignore.

We can rationalize the decision, but only to a degree. The battle began July 1, earlier than Lee meant for it to, at a venue he did not choose. Under his orders, the battle would not commence until the full Confederate force had mustered. But Confederate soldiers encountered and then engaged Union soldiers – soldiers they had not known were there – in the town of Gettysburg.

The Confederates hadn’t known because Lee himself was in the dark. He had been deprived of the use of his cavalry, commanded by Maj. Gen. Jeb Stuart, the person on whom Lee depended for intelligence. Stuart had lost touch with Lee around June 25 while the cavalry was on a raid. Stuart, hoping to make amends for being caught off guard by Union forces earlier in the month, had ridden around the Army of the Potomac to attack a Union supply chain. Stuart’s raid was successful, but it also put the Army of the Potomac between Stuart and the rest of his army. By the time Stuart returned, the Battle of Gettysburg had already begun. Stuart’s tardiness doesn’t explain Pickett’s Charge, of course, but it helps to explain why Lee gave up on one of the most important parts of his invasion plan: choosing the field of battle on his terms.

And yet the Confederates still nearly won – a fact often cited for influencing Pickett’s Charge. The first day of fighting was marked not by Union superiority but by a Confederate mistake. Dick Ewell, the new commander of the Army of Northern Virginia’s reorganized Second Corps, had beaten the Union forces he faced near Culp’s Hill. He had the numbers, not to mention the strategic reason, to take the hill, yet he delayed his assault because in his inexperience, he misinterpreted Lee’s orders. Had he not delayed it, Gettysburg might have been a small skirmish on the way to a bigger battle somewhere else, presumably a battlefield of Lee’s choosing.

Victory was within reach for the Confederacy on the second day too, despite the Union’s formidable defensive position. Gen. James Longstreet, Lee’s most trusted and experienced commander, had counseled Lee to leave Gettysburg after the first day of the battle and to instead position their forces between Washington and the Union army, forcing the Union to take the offensive. But several things militated against their departure. Lee had only limited intelligence on the disposition of the Union’s forces, and in any case, he didn’t believe he could attempt such a maneuver without his cavalry, which would not rejoin the main force for another 24 hours. Furthermore, he had almost won on the first day. His troops were amply supplied. And the Union army, operating under the new leadership of Gen. George Meade, was unsure of itself. In fact, it wasn’t even at full strength. Lee decided, not unreasonably, that the fight would continue in southern Pennsylvania.

And it was nearly the right decision. Even Longstreet, who had been skeptical of the July 2 attack, wrote in a private letter that he had let the offensive go on longer than it should have because of how successful his troops had been. Had it not been for last-minute heroics by Union Cols. Patrick O’Rourke and Joshua Lawrence Chamberlain, Longstreet’s forces might well have seized the strategic high ground of Little Round Top. At one point, Confederate troops even managed to open a gap in the Union lines at Cemetery Ridge but could not afford to punch through it with the numbers they had. From where Lee sat on the battlefield, the Confederates had nearly won. The only thing his army lacked was what he called “proper concert of action.”

Maybe this explains why Lee was tempted to push forward, against the advice of his confidants – Longstreet and Ewell counseled restraint – and against all available evidence that suggested Pickett’s Charge would fail. But it doesn’t explain why he ordered what amounted to a suicide mission. It doesn’t explain why Lee failed to notice his depleted artillery stores – the munitions that would have supported the assault. (What artillery Lee did have ended up shooting too high, doing little to soften the Union’s defenses.) It doesn’t explain the ambiguity of his orders the night before the attack, nor why Ewell began the assault well before Maj. Gen. George Pickett was in position. It doesn’t explain why Lee deployed Stuart’s recently returned but completely exhausted cavalry to attack the Union’s rear instead of sending it to gather better intelligence. (He might have learned that Union reinforcements had arrived.) And it doesn’t explain why Lee, who was smart enough to know that things were going south, didn’t call off the attack.

Ultimately, there is only one explanation for Lee’s actions, and for those of us who believe, as Hegel does, that “to him who looks upon the world rationally, the world in its turn presents a rational aspect,” it’s not a very satisfying answer. Lee was simply blinded by his passions. He saw what he wanted to see, not what was really in front of him, and no amount of intelligence would have changed his mind. Lee was exhilarated because he was in enemy territory. He knew that the future of Virginia – his nation – depended on the invasion’s success. He disrespected Union troops as much as he admired his own. They had come so far and had come so close to victory, and he believed they would not be deterred. In the end, they were not deterred. They were defeated.

A memorial stands at Cemetery Ridge. TIM SLOAN/AFP/Getty Images

If we accept that Pickett’s Charge was unreasonable, then the question is not why Lee did what he did but why a general as skilled and disciplined as Lee would indulge in self-delusion at the most important juncture of his military career. The simple answer is that Lee was human, and humans make mistakes. But the Confederacy couldn’t afford to make the kinds of mistakes Lee made at Gettysburg if it hoped to win the Civil War. With such a small margin of error, the South, short of perfection, was always going to lose. And even perfection might not have been enough to overcome the odds.

Predicting history is easy, of course. To say the South wouldn’t win is to state the obvious. Historical counterfactuals are just as easy in that they’re impossible to disprove and nearly impervious to intellectual rigor. Still, on July 3, 2017, the day before the United States’ 241st birthday, it’s useful to stop and consider that a single man’s mistake in 1863 played a significant role in defining a nation that would become the most powerful the world had ever seen.