Debt Bugs and Windshields 

By John Mauldin

"There is no means of avoiding the final collapse of a boom brought about by credit expansion."

—Ludwig von Mises

Economic recovery is coming, we are told, because the economy has found a new equilibrium. We are supposedly adapting to the new-normal pandemic world, with monetary and (some) fiscal stimulus filling any gaps. Except that’s not what the data says.

Last week I laid out the case that US government debt would be $50 trillion by 2030. 

That was using straight-line CBO projections but using the 2008 recovery pattern for government revenue plus adding in off-budget debt which averages about $269 billion a year. is now projecting off-budget deficit to rise by over $1 trillion this year. Most of my feedback didn’t dispute the amounts; the disagreement was whether so much debt is a serious problem.

Today, rather than just stating the recovery will be slower, I will try to make the case for a much slower recovery thus much higher debt by 2030. Note first, I’m not saying there will be no recovery. I am simply postulating it will look like the slow recovery from the Great Recession, unless the government makes it worse, which is a nontrivial possibility

Let’s quickly review the two charts that were at the end of the last letter.

To be fair, there are reasons to think a $50 trillion debt load is “manageable.” 

It depends on what you consider “manageable” is. 

Maybe survivable is a better word. 

But it will clearly slow or kill GDP growth. 

Think Japan and Europe.

Unreliable Assumptions

“Net Interest” is a significant and growing slice of federal spending. When your debt balance is measured in trillions, even tiny interest rate differences matter. Uncle Sam gets a good deal because investors believe their Treasury purchases carry no credit risk. The main concern is inflation, enough of which could drive rates higher and raise the government’s borrowing costs.

Even the CBO’s optimistic projections show tax revenue barely covering “mandatory” entitlement spending and net interest in the next few years. Congress will have to either find more revenue or make big cuts to “discretionary” spending—which includes most of what we think the government does: defense, diplomacy, regulation, etc. That could get ugly.

However, the CBO projections are likely wrong. Their borrowing cost estimates depend on interest rate assumptions that have been unreliable, to say the least. The dotted lines below show CBO’s annual projections vs. the actual yield. You can see reality has been almost always lower than it thought.

Of course, when you’re planning a budget you want to err on the side of caution. It helps avoid nasty surprises. The government’s interest costs have been mostly lower than expected because interest rates were lower than planned. The deficit might have been even higher otherwise.

 Here’s a closer look at CBO’s best guess.

CBO expects a steady rise in the 10-year bond yield after 2021. Note, the government’s borrowing costs depend heavily on the maturity at which debt is issued and then rolled over (since no one expects the government to actually pay it down). With long-term yields now at historic lows, it seems to me it should back up the truck and sell as much 10-year paper as the market will buy. That’s what any CFO would do in this environment: Borrow as much as you can for as long as you can.

Let me make it an even more aggressive assumption. If the government really thinks the 10-year is going to 3% in 2030 it should be selling every 30-year bond it can at 1.45% or 20-year bonds at 1.23%. Perhaps see if the market would take 50-year bonds as some countries have. While I don’t think we will do it in the next year, it would not surprise me that in the future we will sell something that looks like the old British consols, which were interest-only perpetual bonds. (Historical trivia: The US sold consols in 1870 at 4%. They have all been redeemed.)

Source: Wikimedia Commons

The Federal Reserve is another factor in the government’s favor. It uses excess bank reserves and its own balance sheet to buy Treasury debt, then gives the interest it receives right back to the Treasury. So that part of the federal debt is effectively at 0% interest.

I believe the Federal Reserve will engage in Yield Curve Control if long-term interest rates move too high. That is, of course, financial repression and a monster body blow to the retiring Boomer generation.

All this leads many smart people whom I greatly respect, like Samuel Rines, to conclude the federal debt isn’t a problem for now. Looking at the numbers as a percent of GDP, and considering the CBO long-term forecasts out to 2050, Sam writes this:

In its latest round of projections, by far the most intriguing portion of the analysis related to the dynamics around the US federal debt load. The US debt load has increased dramatically due to the response to COVID, but the ability to service the US debt load is actually improving. Measured by interest payments on the debt relative to GDP, the US's fiscal situation is set to improve for the better part of the next decade. In fact, the figure is set to hit 1.1% in 2024. That is the lowest level of interest payments to GDP since at least the early 1960s.

But that is where the projections become a bit less sanguine. Instead of going lower and remaining lower, interest payments then begin to rise, and continue to do so until the end of the projections in 2050. At 8.1%, the CBO is projecting interest payments on debt will grow to be more burdensome than Social Security as a percent of GDP. That is quite the assertion.

But that is not the entirety of the story. There are a few assumptions made by the CBO that are rather suspect.

The obvious reason for increasing interest payments is a projection of rising borrowing costs. And that is where the CBO's analysis begins to show a few potential holes.

Sam thinks the federal debt will become a bigger problem when the economy improves and interest rates rise. I would argue much of that rise is already built into CBO’s high-side rate projections. But there’s another wrinkle.

Suppressed Growth

Based on CBO’s past record, their forecast for 3% ten-year yields in 2029 looks dubious to me. It has been well below that level for most of the last decade. What would make rates rise that much?

The only answer is some combination of a stronger economy and higher inflation. The Fed recently revised its policy framework to “let” inflation run higher for longer. That’s the same Fed which has targeted 2% inflation for years now without success, at least on its own preferred benchmark. (The Fed has certainly generated asset price inflation)

There is good reason for this. The kind of broad inflation the Fed says it wants can’t happen unless the economy outstrips productive capacity for key goods and services. Without that, general price levels simply can’t rise. Certain prices (rent and healthcare, for example) can rise enough to cause significant discomfort, but price weakness elsewhere keeps it from affecting the benchmarks too much.

Lacy Hunt and others have long argued, and been proven correct so far, that rising debt actively suppresses economic growth. Debt service prevents everyone (government, businesses, and households) from investing enough capital to generate long-term growth. This is why each new dollar of debt is producing less additional GDP. We are borrowing to fund consumption instead of production.

It gets worse. The Fed thinks it can encourage growth by keeping interest rates low. But in fact, its “forward guidance” (pledging low rates long into the future) gives no one any reason to act now. With no fear of rising rates as motivation, you might as well wait. Peter Boockvar has been saying this for a long time and he’s absolutely right.

Add our aging population and other demographic challenges, and there’s no reason to expect substantially higher GDP growth by 2030. Some sectors will prosper, of course, as technology has in recent years. But others will suffer, leaving the macro growth outlook no better than it has been. Even the CBO’s rosy scenarios show the economy spending 2021 and 2022 simply digging out of the 2020 hole, then a return to the same sluggish growth as almost every year since 2005.

But if that’s what happens, we should be grateful. Let’s look at why it will likely be worse.

An Ever-Deeper Recession

Economists who expected a quick recovery from this recession have been revising their forecasts. Mounting evidence suggests the May/June bounce was just that, a bounce, and not a return to prior trends.

I’ve been following Homebase, a payroll/HR data provider for small businesses, whose data gives us high-frequency and nearly real-time information This is from their September report:

You can see a sharp decline during the initial lockdown period and then improvement as many states reopened. 

But since then, activity has flatlined except for some holiday dips.

There’s a great deal of local variation.

Not surprisingly, work hours dropped the most in places with the deepest and longest-lasting lockdowns, like New York and California. But even the best metro areas show a 5–10% drop, with many down 20% or more. 

This points to a much longer recession than bulls think.

The official unemployment rate is now 7.9% but is certainly understated. Even 10% is likely optimistic. There are 25 million+ people who are still getting some type of unemployment claims and job postings are down. From Friday’s Daily Feather (courtesy of my friend Danielle DiMartino Booth):

Source: Quill Intelligence

Worse, even the small businesses that are hanging on are in major distress. A Lending Tree survey shows 43% have seen revenue drop by half or more, and 6% have already dissolved.

Source: The DailyShot

We have never seen anything like this in history, with a possible exception (percentage wise) during the Great Depression. This is not the material from which V-shaped recoveries are created.

Worse, this recession has been inordinately destructive for the bottom 25% of income earners.

Source: The Washington Post

That is why it is absolutely critical that Congress pass some type of Phase IV relief bill. Consumer spending has held up due to the initial pandemic relief. Now many live on savings, if they have any. We are getting ready to fall off an economic cliff without more relief.

Obviously, much depends on how much the coronavirus case load increases/decreases over the winter, and whether a working vaccine can be approved and distributed. The logistics will take enormous coordination. It is doable but not guaranteed.

What if 2021, instead of being the start of recovery, takes the economy even deeper into recession? Mind you, I’m not predicting that, but it is a significant possibility that would need far more fiscal support than even the $2T+ Phase IV bill Democrats passed in Congress yesterday. And because lower growth will mean lower tax revenue, we will add trillions more to the debt. We can easily see another $3 trillion worth of debt in 2021. Easily.

Even if we see an effective vaccine widely distributed by spring to mid-2021, I think continued stagnation is the best case for GDP in the coming decade. If we have another recession the national debt will rise to $60 trillion by 2030. That’s just the nature of recessions.

I think we will probably see tax increases and maybe a major restructuring of the tax code, especially when we get to The Great Reset. We will be open to new innovation at that point, which may prove helpful in the long run. I think some kind of consumption tax (like the VAT used in almost every other country in the world) paired with an income tax only on high earners would be far less economically distorting than the current mishmash But the transition will be disruptive at best, and our political heroes could easily turn it into a fiasco. But a $60 trillion debt could force us to take actions that we would otherwise not consider.

Rosenberg: We Are in a Depression

I’m going to quote at length from my friend David Rosenberg in his Wednesday letter. I believe he is absolutely spot on and he says it better than I would. We’ll jump in where he cites a Chicago Fed survey of distressed business sectors:

You tally up these sectors and before the crisis, they supported 32 million jobs, or about a third of the private sector workforce, and it looks to me as though half of them are not going back to their old jobs.

And I’m not sure many people understand that amusement parks, airlines, hoteliers and restaurants cannot stay in business at 50% capacity (or even 75% in the case of restaurants).

…As it stands, the US Chamber of Commerce said that 25% of small businesses have already shut down. Another survey by Ipsos concluded that two-thirds are still nervous about leaving their homes; 59% say they intend to remain locked down on their own until signs emerge that the virus is “fully contained.” A YouGov/CBS poll concludes that 85% of American households say they wouldn’t get on an airplane even if they could. That’s why the industry needs a bailout!

A Washington Post/University of Maryland poll shows that only 56% of consumers across the nation intend to shop at the supermarket, which I suppose is a continuous bullish data point for delivery services but that’s about it. Just 33% say they are comfortable entering a retail store. And a mere 22% say they are willing to dine in a sit-in restaurant.

All these polls say basically the same thing—it will not be “business as usual,” as the bulls will try and convince you, and the best we can hope for is a partial recovery. I mean, at best. What we had on our hands was a vertical down economic decline with job losses an order of magnitude higher than anything we have witnessed since the Great Depression. So, even as the stock market is telling you it has it all figured out, I can assure you that what we face at this very moment is a very uncertain economic future. And unfortunately, most of the longer-term risks are to the downside.

We are in a depression—not a recession, but a depression. And I think the dynamics of a depression are different than they are in a recession because depressions invoke a secular change in behavior. Classic business cycle recessions are forgotten about within a year after they end—the scars from this one will take years to heal.

Disney said this week it is laying off 28,000 workers. American Airlines and United Airlines plan to cut 31,000 workers. Today’s disappointing unemployment report shows that we have a long way to go. Even though the unemployment rate went down to 7.9%, that was largely due to a drop of almost 700,000 in the labor force. We have regained just over half the jobs lost between February and April. The pace of gains, both total and private, slowed for the third consecutive month and looks to get slower.

There will be a recovery. Those hundreds of thousands of entrepreneurs who have closed their businesses? They’ll open new ones. But not in six months. Where will they get capital? It’s one thing to bail out airlines with multiple billions of dollars. What about the local bakery with 15 employees? Where do they get the capital to reopen when the time is right? And you can repeat that story a million (or more) times.

Which brings us back to my conclusion: That which can’t go on, won’t. We can’t keep piling on debt at this rate forever, and we can’t repay what we have.

I used to say Japan was a bug in search of a windshield. Now it’s not just Japan.

Banana Cake Recipe and Birthdays

As I file this letter, news just broke about President Trump and First Lady Melania Trump testing positive for COVID-19. Let me express my sincere wishes they (and all others afflicted by this awful virus) make a speedy recovery.

I have no idea what this means for the election and I think speculation would be inappropriate. But as Rosie mentioned above, the reason for his depression call and my deep recession and slow recovery projection is the fact that this COVID pandemic is significantly changing behavior. I can’t imagine this making those behavioral changes any better.

On a lighter note, I turn 71 on Sunday. When I was in my 20s, 70 sounded and even looked really old. Not so much anymore. In more idyllic times, and especially in my youth, my one birthday cake request was my mother’s banana nut cake. I mentioned it a few weeks ago and a large number of readers asked for the recipe. We have just kept putting it off but finally, here it is:


  • ½ cup butter
  • ½ cup sugar
  • two eggs
  • three medium bananas
  • ½ cup chopped pecans
  • 2 cups flour
  • 1 teaspoon soda
  • pinch of salt
  • 4 tablespoons of buttermilk
  • 1 teaspoon of vanilla

Cream the butter, sugar and eggs, then bananas, buttermilk and vanilla. Mix until smooth. Sift flour, salt and soda, then add to other ingredients in a mixer and beat well. This makes two layers (9” square pans). Grease and flour the pans. Cook at 325° until brown. Use a toothpick to make sure it is cooked throughout.

Now, changes I’ve made: We were poor when we grew up. Seriously. Mother cut back on every recipe she ever made. (She used oatmeal in her meatloaf and hamburgers because hamburger meat was expensive at three pounds for a dollar.) Many times she used oleo in the cake rather than butter. I use three eggs and double the chopped pecans. I am more generous with the butter. Remember bananas are bigger today than they were 60 years ago. I like to use brown sugar but when Tiffani makes the recipe she uses white sugar which is more like what mother’s cake tasted like.

Of course, banana cake needs icing. That is simply ¼ pound butter (typically a stick), two medium bananas, one box of powdered sugar and a cup of chopped pecans. I might add a little extra butter and pecans. Note: You have to let the bread cool before you can put the icing on. I typically put the icing in the refrigerator for an hour. And don’t forget to put the icing between the layers.

Shane is making me a small banana cake for my birthday Sunday. Maybe a few friends will be there. I will have a Zoom birthday call with my kids. In any event, you have a great week.

Your 71 but making 15-year business plans analyst,

John Mauldin
Co-Founder, Mauldin Economics

European banks load up on government bonds, raising concerns over ‘doom loop

S&P says rapid build-up is different to period before eurozone crisis but long-term risks loom

Tommy Stubbington in London

S&P said banks in the eurozone’s former crisis-hit ‘periphery’, such as Italy, Greece and Spain, have the highest exposure to their governments’ debt © Bloomberg

European banks have loaded up on more than €200bn of their own governments’ bonds since the start of the Covid-19 pandemic, in a move that could reawaken fears about the sector’s growing stockpiles of risky sovereign debt.

According to research by S&P Global Ratings, banks had increased their holdings of home-country government bonds to nearly €1.6tn by the end of June, up 15 per cent from the end of February. The rating agency said the pace of purchases was seven times faster than in the same period in 2019.

S&P said banks in the eurozone’s former crisis-hit “periphery” — such as Italy, Greece and Spain — have the highest exposure to their governments’ debt, along with those outside the euro area in central and eastern Europe.

The figures are likely to revive concerns about the effect that wild swings in the price of government bonds could have on banks’ balance sheets. During the eurozone crisis, sell-offs in sovereign debt repeatedly dragged down profits and share prices in the banking sector, in turn raising the prospect of a further hit to the economy — a dynamic labelled the “doom loop”.

“The surge in home-government bond investment in Europe is a temporary response to excess market liquidity, in our view. We think this time is different than in the run-up to the European sovereign debt crisis starting about 2011,” said Cihan Duran, a credit analyst at S&P Global Ratings.

“If this turns out not to be true and the trend persists in Europe, overlooking sovereign risks could unleash a new ‘doom loop’ in the distant future, particularly where banks have built up extremely large exposures to sovereign debt,” he said.

The spread of the pandemic in March triggered a sell-off in global bond markets, which was particularly acute in the countries on the periphery of the eurozone. The European Central Bank helped to avert a new debt crisis with a €750bn emergency asset purchase programme, which was later expanded to €1.35tn in June. 

The central bank followed up with a fresh round of super-cheap loans to banks, resulting in a rush to borrow €1.3tn at negative rates.

While the injection of cash has increased the financial sectors’ ability to lend to households and businesses, much of it has ended up parked in sovereign debt, according to S&P. Banks in the EU do not have to hold any capital against their own governments’ bonds, which are considered a “risk-free” investment by regulators.

“We believe the central bank’s policies are unintentionally acting as an incentive for banks to add to their sovereign debt holdings. The ECB may take additional accommodative measures that might accelerate this trend,” the report said.

However S&P added that the huge run-up in government bond holdings is likely to unwind once the recovery from the Covid crisis kicks in. 

The president unmasked

Donald Trump’s illness may shorten the odds of his losing the election

Even if the president recovers from covid-19, he is running out of time to close the gap with Joe Biden

BETWEEN OCTOBER 2ND and election day in 2016, Donald Trump held more than 60 rallies and events in 19 states. That sort of breakneck pace was always going to be impossible during an epidemic. 

But now it is an open question whether he will be able to hold a single rally. On October 2nd of this year, Mr Trump was admitted to Walter Reed Hospital after testing positive for covid-19. How sick he is, when he was infected and when he might be released from hospital remain unclear.

This is partly because the White House’s messaging has been contradictory. At a press conference on Saturday October 3rd, Mr Trump’s doctor, Sean Conley, said that the president was “72 hours into the diagnosis”, which would mean he was diagnosed on Wednesday September 30th. 

If true, Mr Trump would have held a rally in Duluth, Minnesota, and two fundraisers, one in Minnesota and the other at one of his clubs in New Jersey, after his diagnosis.

A couple of hours later, Dr Conley issued a statement saying he “incorrectly used the term” 72 hours, and that Mr Trump was diagnosed on the evening of October 1st. One attendee at Mr Trump’s New Jersey fundraiser that night, which was held indoors, said the president “seemed lethargic” and had come into contact with around 100 people. Mr Trump announced his diagnosis later that night (technically, early on the morning of Friday October 2nd, at 00:45).

As for the question of Mr Trump’s condition, Dr Conley has also been evasive. At the Saturday press conference he dodged questions as to whether Mr Trump had ever been on oxygen, confirming only that he was not on oxygen that day. 

On Sunday Dr Conley confirmed that Mr Trump had in fact received supplemental oxygen on Friday, when he also registered a “high fever”. Dr Conley explained that he was “trying to reflect the upbeat attitude” of the White House and noted: “It came off like we were trying to hide something, which wasn’t necessarily true.”

Also on Saturday Dr Conley said the president was “doing very well”. But just minutes later Mark Meadows, Mr Trump’s chief of staff, told reporters that “the president’s vitals over the last 24 hours were very concerning, and the next 48 hours will be critical in terms of his care...We’re still not on a clear path to a full recovery.” (Mr Trump is reportedly furious with Mr Meadows for these comments.)

Mr Trump is being treated with remdesivir, an antiviral drug shown to improve outcomes for some hospitalised covid-19 patients; dexamethasone, a steroid generally prescribed for severe cases of covid-19; and an experimental antibody cocktail not yet authorised by the Food and Drug Administration. 

Mr Trump tweeted out a video on Saturday in which he sounded slightly hoarse but said he was “starting to feel good,” and that “we have things happening that look like they’re miracles coming down from God.” On Sunday he appeared in person, apparently keen to show his supporters he is on the mend. The presidential motorcade drove him to greet well-wishers outside the hospital. 

Wearing a mask, he waved through the window of his limousine. (A doctor at Walter Reed tweeted his dismay that Secret Service agents in the “hermetically sealed” limousine had been “commanded by Trump to put their lives at risk for [political] theater” and would have to quarantine for 14 days.)

Mr Trump is one of several White House officials and others to test positive recently for covid-19. Many attended a reception for Amy Coney Barrett, Mr Trump’s new Supreme Court nominee, held at the White House on September 26th both indoors and out, at which many of the guests were hugging, shaking hands, and sitting and standing close together without wearing masks. 

Others who have fallen ill include Bill Stepien, Mr Trump’s campaign manager; Kellyanne Conway, a former adviser; Chris Christie, an ally of Mr Trump’s and a former governor of New Jersey; and Mike Lee and Thom Tillis, two Republican senators.

Another Republican senator, Ron Johnson, tested positive but did not attend the event. Another three Republican senators are quarantining over fears of possible exposure. These absences raise the spectre of a delayed vote for Ms Barrett, though the Judiciary Committee plans to keep to its schedule and hold hearings beginning on October 12th.

As for Mr Trump, one of his doctors at Walter Reed has said he may be released as early as October 5th, to continue his treatment at the White House. But that risks infecting others there; most people remain contagious for ten days after the onset of symptoms. Mr Trump also risks having to return to hospital should his condition worsen, which would prolong and intensify this story.

Falling victim to a virus he had long downplayed (indeed, the day before entering hospital Mr Trump said “the end of the pandemic is in sight”) is precisely what Mr Trump’s campaign does not need. His illness may not upend the race, as so much commentary has it, so much as calcify it.

An NBC/WSJ poll taken after the first presidential debate (but before Mr Trump’s diagnosis) showed Joe Biden leading Mr Trump by 14 percentage points, up from eight before the debate. 

That includes a 27-point lead among older people, whom Mr Trump won by eight percentage points in 2016; a 25-point lead among suburban women; and a one-point advantage among men over 50. 

An ABC news poll taken after the diagnosis showed that 72% of voters, including 43% of Republicans, think that Mr Trump failed to take the risk of contracting covid-19 seriously and failed to take appropriate personal precautions.

Just as his debate performance offered nothing to reassure wavering voters anxious about his character, contracting covid after holding crowded, maskless events for months and mocking those who wore protective gear reinforces the impression that Mr Trump has been cavalier at best about a disease that has killed more than 200,000 Americans and infected at least 7.5m. 

It also keeps voters’ focus on covid-19, rather than on Mr Biden’s age, lefty protesters or anything else that might change the dynamics of the campaign.

Mr Biden, having tested negative, was in Michigan on October 2nd and will be in Florida on the 5th, speaking to voters in battleground states. More than 3m Americans have already voted. 

In less than a month, the election will be over. Mr Trump is running out of time to change America’s mind.

China Is Paying a High Price for Provoking India

For Xi Jinping, the COVID-19 pandemic – which has preoccupied the world’s governments for months – seemed like an ideal opportunity to make quick progress on his expansionist agenda. But by provoking India, he may have bitten off more than he can chew.

Brahma Chellaney

NEW DELHI – China’s foreign minister, Wang Yi, recently declared that aggression and expansionism have never been in the Chinese nation’s “genes.” It is almost astonishing that he managed to say it with a straight face.

Aggression and expansionism obviously are not genetic traits, but they have defined President Xi Jinping’s tenure. Xi, who in some ways has taken up the expansionist mantle of Mao Zedong, is attempting to implement a modern version of the tributary system that Chinese emperors used to establish authority over vassal states: submit to the emperor, and reap the benefits of peace and trade with the empire.

For Xi, the COVID-19 pandemic – which has preoccupied the world’s governments for months – seemed like an ideal opportunity to make quick progress on his agenda. So, in April and May, he directed the People’s Liberation Army (PLA) to launch furtive incursions into the icy borderlands of India’s Ladakh region, where it proceeded to establish heavily fortified encampments.

It wasn’t nearly as clever a plan as Xi probably thought. Far from entrenching China’s regional preeminence, it has intensified the pushback by Indo-Pacific powers, which have deepened their security cooperation. This includes China’s most powerful competitor, the United States, thereby escalating a bilateral strategic confrontation that has technological, economic, diplomatic, and military dimensions. The specter of international isolation and supply disruptions now looms over China, spurring Xi to announce plans to hoard mammoth quantities of mineral resources and agricultural products.

But Xi’s real miscalculation on the Himalayan border was vis-à-vis India, which has now abandoned its appeasement policy toward China. Not surprisingly, China remains committed to the PLA’s incursions, which it continues to portray as defensive: late last month, Xi told senior officials to “solidify border defenses” and “ensure frontier security” in the Himalayan region.

India, however, is ready to fight. In June, after the PLA ambushed and killed Indian soldiers patrolling Ladakh’s Galwan Valley, a hand-to-hand confrontation led to the deaths of numerous Chinese troops – the first PLA troops killed in action outside United Nations peacekeeping operations in over four decades. Xi was so embarrassed by this outcome that, whereas India honored its 20 fallen as martyrs, China refuses to admit the precise death toll.

The truth is that, without the element of surprise, China is not equipped to dominate India in a military confrontation. And India is making sure that it will not be caught off guard again. It has now matched Chinese military deployments along the Himalayan frontier and activated its entire logistics network to transport the supplies needed to sustain the troops and equipment through the coming harsh winter.

In another blow to China, Indian special forces recently occupied strategic mountain positions overlooking key Chinese deployments on the southern side of Pangong Lake. Unlike the PLA, which prefers to encroach on undefended border areas, Indian forces carried out their operation right under China’s nose, in the midst of a major PLA buildup.

If that were not humiliating enough for China, India eagerly noted that the Special Frontier Force (SFF) that spearheaded the operation comprises Tibetan refugees. The Tibetan soldier who was killed by a landmine in the operation was honored with a well-attended military funeral.

India’s message was clear: China’s claims to Tibet, which separated India and China until Mao Zedong’s regime annexed it in 1951, are not nearly as strong as it pretends they are. Tibetans view China as a brutally repressive occupying power, and those eager to fight the occupiers flocked to the SFF, established after Mao’s 1962 war with India.

Here’s the rub: China’s claims to India’s vast Himalayan borderlands are based on their alleged historical links to Tibet. If China is merely occupying Tibet, how can it claim sovereignty over those borderlands?

In any case, Xi’s latest effort to gain control of territories that aren’t China’s to take has proved far more difficult to complete than it was to launch. As China’s actions in the South China Sea demonstrate, Xi prefers asymmetrical or hybrid warfare, which combines conventional and irregular tactics with psychological and media manipulation, disinformation, lawfare, and coercive diplomacy.

But while Xi managed to change the South China Sea’s geopolitical map without firing a shot, it seems clear that this will not work on China’s Himalayan border. Instead, Xi’s approach has placed the Sino-Indian relationship – crucial to regional stability – on a knife edge. Xi wants neither to back down nor to wage an open war, which is unlikely to yield the decisive victory he needs to restore his reputation after the border debacle.

China might have the world’s largest active-duty military force, but India’s is also massive. More important, India’s battle-hardened forces have experience in low-intensity conflicts at high altitudes; the PLA, by contrast, has had no combat experience since its disastrous 1979 invasion of Vietnam. Given this, a Sino-Indian war in the Himalayas would probably end in a stalemate, with both sides suffering heavy losses.

Xi seems to be hoping that he can simply wear India down. At a time when the Indian economy has registered its worst-ever contraction due to the still-escalating COVID-19 crisis, Xi has forced India to divert an increasing share of resources to national defense. 

Meanwhile, ceasefire violations by Pakistan, China’s close ally, have increased to a record high, raising the specter of a two-front war for India. 

As some Chinese military analysts have suggested, Xi could use America’s preoccupation with its coming presidential election to carry out a quick, localized strike against India without seeking to start a war.

But it seems less likely that India will wilt under Chinese pressure than that Xi will leave behind a legacy of costly blunders. With his Himalayan misadventure, he has provoked a powerful adversary and boxed himself into a corner.

Brahma Chellaney, Professor of Strategic Studies at the New Delhi-based Center for Policy Research and Fellow at the Robert Bosch Academy in Berlin, is the author of nine books, including Asian Juggernaut, Water: Asia’s New Battleground, and Water, Peace, and War: Confronting the Global Water Crisis.

The New Middle East Alliance 

The truly historic moment in the Middle East will come when the U.S. and Iran resolve their standoff. 

By: Hilal Khashan


During his visit to Saudi Arabia in May 2017, U.S. President Donald Trump announced a plan to establish the Middle East Strategic Alliance, a group ostensibly meant to combat terrorism but in reality meant to counter Iran. 

The plan would have comprised the Gulf Cooperation Council, Jordan, Egypt and the United States, but after Egypt withdrew in 2019 over objections to joining a military pact arrayed against Iran, momentum for the alliance died.

But now it’s back, courtesy of the recent peace accords that normalized Israel's relations with the United Arab Emirates and Bahrain. The U.S. expects Israel and the UAE to play a crucial role in the new alliance, which will likely attract additional Arab countries. 

However, the complexity of Middle Eastern politics makes it unlikely for the new coalition to take off, not only because regional powers – such as Turkey, Iran and Egypt – will oppose it but because Israel and the UAE have different agendas for getting into it in the first place.

The UAE and Saudi Perspectives

After the first Gulf War, the GCC signed the 1992 Damascus Declaration with Egypt and Syria to defend the Gulf states against foreign attacks. The deal floundered, though, because the Saudis eventually decided it was better for them to develop their own military capabilities rather than invite foreign troops onto their shores. 

The war in Yemen has shown the failure of Saudi Arabia to build a competent military that can defend the country, let alone venture outside its national borders.

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Saudi policy has always eschewed military involvement outside the Arabian Peninsula and instead focused on domestic stability, security and predominance in the GCC. (In 1950, it even leased two islands in the Red Sea to Egypt so that it could abstain from hostility against Israel.) 

The spread of Iranian influence to Iraq, Syria, Lebanon and Yemen, however, directly threatens Saudi Arabia, which worried that it would be next in line if Middle Eastern governments were to fall. Bahrain's minister of foreign affairs, whose statements usually echo the official Saudi position, made it clear that the primary reason for signing a peace treaty with Israel was his country's quest for security vis-a-vis Iran. 

As for the Saudi royals, when the Trump administration declined to answer Iran's attacks in 2019 on two Aramco oil facilities, they began to think twice about their security relationship. They concluded they could no longer rely on American protection and, therefore, needed a new partner.

The UAE has two primary security reasons for signing a peace accord with Israel. First, its leader, Mohammed bin Zayed, is unsure about the future of the Saudi government. Saudi Crown Prince Mohammed bin Salman has antagonized senior members in the royal family, the religious establishment and the National Guard. 

If MBS were forced out, it would expose the UAE’s western flank. MBZ wants to nip this in the bud by partnering with a strong ally like Israel. The UAE reasons that the Israel vs. Iran conflict will end sooner or later. 

When it ends, the two countries will resume their strong ties of friendship and cooperation that were disrupted by Iran’s 1979 revolution, exposing the UAE's eastern flank because Israel considers Iran an established power and prefers to foster a strategic relationship with it instead of the small and new UAE state. 

MBZ does not want to leave the Emirates' fate to chance and prefers to be proactive rather than reactive.

And to be clear, it is very much a matter of security. In fact, the UAE exaggerates the financial benefits of the peace deal. Business transactions with the UAE probably won’t exceed $6.5 billion, which would not add much to the wealthy UAE economy. It cannot contribute to the high-tech and Western-style Israeli economy, whose exports exceeded $114 billion in 2019. 

The fact that the director of Israeli intelligence drafted the accord articles suggests that security is the basis for cooperation, just as it was with Egypt, Jordan and the Palestine Liberation Organization.

The Israeli Position

Strategically, peace between Israel and the GCC adds little to regional stability because it involves countries that do not share borders – and that are not even at war. The only Gulf state that existed at the time of Israel's establishment in 1948 was Saudi Arabia, which had neither a developed government nor a standing army. 

But the move makes a little more sense for Israel, which never really abandoned the concept of David Ben-Gurion's 1950 Alliance of the Periphery, which he struck with Turkey, Iran and Ethiopia. 

The Arab world may be in turmoil for the foreseeable future, but the periphery was less so. Relations with them were smooth, predictable and unencumbered with ideology or notions of fairness and justice, and seem likely to make a strong comeback.

Israel's diplomatic relations with Iran have been bad for the past four decades, but there is no reason to think they will be bad forever. Despite exchanging threats, relations between Iran and Israel are far from hostile. 

Dozens of Israeli companies, mostly in the energy and agriculture sectors, operate in Iran directly or via subsidiaries. Israeli businesses buy Iranian marble, nuts and dried fruit through agents in Turkey and Jordan. During its war with Iraq in the 1980s, Iran turned to Israel for weapons. In 1987, former Israeli Prime Minister Yitzhak Rabin described Iran as "Israel's best friend." 

His remark was not random and driven by the spur of the moment. Historical relations did not intend Iran and Israel to be enemies. Jews have lived in Iran without interruption since their emancipation from Babylonian rule by Cyrus the Great, who founded the Achaemenid Empire in the sixth century B.C. and allowed them to return to Jerusalem. Iranian Jews helped Cambyses II defeat the Egyptians in the Battle of Pelusium in 525 B.C. 

The 10,000 Jews still living in Iran are served by more than 100 active synagogues, whereas millions of Sunnis living in major Iranian cities are not allowed to build mosques Iranian Supreme Leader Ayatollah Ali Khamenei personally sees to it that the Jewish community receives fair treatment. In 2015, Iranian Foreign Minister Mohammed Javad Zarif said there was no inherent problem with Israel and that Iran would be willing to exchange diplomatic missions with the Jewish state if it agreed to establish a Palestinian state.

Iran views Israel as a representative of the West. Iranian Jews living in the U.S. use their influence to prevent attacks on Iran because of its nuclear and long-range missile programs. Israeli politician Shaul Mofaz, born in Tehran, staunchly opposed striking Iranian atomic facilities when he was minister of defense from 2002 to 2006. The ongoing conflict between Israel and Iran is not about recognition, as it is with Arabs, but about regional power status and influence. 

Israel needs Arabs to recognize its legitimacy, and Iran wants Israel to accept it as a partner on equal footing. The Iranians believe the West and czarist Russia humiliated them over the past two centuries. They want to reclaim their glorious past, and, at heart, they do not view Israel as their enemy.

Gulf Arabs want peace with Israel because they are afraid of Iran and because it is what the U.S. wants. But if they believe Israel will defend them against Iran, they should think again. In 2017, Israeli Energy Minister Yuval Steinitz revealed a well-known secret about his country's relations with Arab and Islamic countries. 

He said that "the one who wants those ties to be discreet is the other side." Israel is keen on bringing these relations out into the open to become accepted by the public. It is uncomfortable with maintaining discreet ties with Arabs because it creates a sense of embarrassment, hardly a good foundation on which to build lasting relations. The Iranians would behave differently in the event of peace.

Unlike the UAE, Israel lacks the motivation to become involved in the region's counterrevolutions, and it does not expect to benefit much from expanding its economic transactions with the GCC. Israel is interested in consolidating its legitimacy in the Middle Eastern regional order by making friends, not enemies.

Regional Outlook

U.S. presidents having problems at home tend to occupy themselves with foreign issues either as a distraction or as a way to improve their public opinion ratings. Media reports frequently link Trump's Middle East peace drive to an effort to galvanizing his evangelical base of support ahead of the forthcoming presidential election. But the desire to win a second presidential term is insufficient to account for the Trump administration's push for peace. 

Indeed, the frenzy to sign treaties between Israel and peripheral Arab countries is not about peace. Instead, it is mostly about building a military alliance to activate Washington's new offshore-balancing doctrine and ensure that no anti-American hegemon would rise in the Middle East. The U.S. has no intention to quit the region, but it wants to redefine its core interests and avoid significant military deployment there.

Regional political shifts are frequent in the Middle East, and they can quickly dissolve alliances. Regional peace cannot happen without engaging Iran. 

The truly historic moment in the Middle East will come when the U.S. and Iran resolve their standoff, which would pave the way for the restoration of relations between Iran and Israel. It is unlikely that peace accords between Israel and the GCC countries would stabilize the Middle East. 

The key to regional stability rests in an entente that includes Turkey in addition to Iran and Israel.