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Its anger at the success of the new China-led infrastructure bank suggests the United States is still struggling to adjust to China’s rise

The creation of the Asian Infrastructure Investment Bank (AIIB) is a preview of things to come. This is an initiative launched by China; India and 19 other countries joined the official establishment of the new institution in October, 2014; and the United Kingdom, Germany, France and Italy have now decided to join, too.

Guess what? The Barack Obama administration was furious about the initiative. It sees it as competition to the existing, Western-dominated institutions – the International Monetary Fund (IMF), the World Bank, the Asian Development Bank (ADB) – on which neither the United States nor Europe have shown any intention of loosening their grip despite the fact that the world has changed dramatically in the last 25 years. And Washington is seething about the fact that its European allies are adding insult to injury by rallying to the Chinese initiative. Even more injury might be on the way, as it is quite possible that three other close allies of the United States – South Korea, Japan and Australia – could decide soon to join the new bank, which will be based in Shanghai.

The rationale advanced by the Obama administration for its ill-advised, knee-jerk opposition to the AIIB is that it would sidestep and undermine the existing international financial institutions; that it could have much weaker standards than these institutions in terms of governance and environmental concerns; and that it might be used as a tool by Beijing to extend its influence in the region.

These arguments are amazingly flimsy. First, Asian infrastructure development needs are so huge and so urgent that adding financing capabilities to the ones available to the ADB makes a lot of sense; second, one has really to wonder on what basis Washington considers that a priori the new institution will have lower standards or that the United States has a monopoly in terms of standards for governance and environment concerns; third, it is a bit ironic for the United States to express worries about China using the new bank to extend its influence when one remembers how the United States used the IMF during the Asian crisis in the mid-1990s to impose the “Washington consensus” and the US template for financial capitalism. I still remember a top minister from an Asian country coming out of a negotiating session with his US counterparts in the middle of the crisis, and telling me with exasperation: “As they [the US] twist our arm to the breaking point, they should at least stop telling us that they are doing that for our own good, and just be blunt about the fact that they are advancing their interests.”

Unable to prevent the train from leaving the station and confronted with a diplomatic debacle and a loss of face, the Obama administration is now left with two options. The first one is to quietly forget about the issue. But this would show incoherence, after Washington went so far as to publicly berate its closest European ally – the United Kingdom – for its “constant accommodation to China, which is not the best way to engage a rising power”.

The second and more realistic option is to find ways for some accommodation with the new bank. This is the direction that the Obama administration seems now intent on taking, as it talks about the possibility for existing institutions to co-finance some projects with the new bank. However, Beijing has faced resistance from the United States in its attempts to increase its influence in the IMF or the World Bank – with the US Congress repeatedly refusing to endorse the changes decided in 2010 at the IMF, which would give China the third largest share of votes after the United States and Japan. In these conditions, it would be very difficult to imagine that Beijing would agree to give to the United States more influence in the new bank than the United States is so far agreeing to give to China in the existing institutions.

Beyond the specific case of the AIIB, this episode is profoundly illustrative of two very significant elements that will impact perceptions and decisions in the years ahead.

The first is the fact that there clearly is a difference in the way the United States and Europe look at China’s rising power and influence. For the United States, every single decision in any domain related to China is bound to have a geopolitical and strategic dimension – and the same is true for China in dealing with any matter related to the United States. For Europe, whatever is being said, the reality is that the economic and trade dimension is the paramount one when it comes to China. European countries are looking at expanding Chinese investment in their economies; even if they have trade issues with Beijing, they want to make sure that they will not miss a single opportunity to have their economies benefit from China’s momentum – even if it is slowing. The geostrategic dimension is absent from European considerations about China – quite simply because Europe is basically not the kind of geopolitical actor that can do anything about it. This difference of emphasis is bound to lead to additional tensions between the two transatlantic partners, as China’s rise continues to create new challenges and issues on the world scene.

The second element is how much the United States still has difficulties adjusting to the rise of China and getting to grips with the fact that in the years to come, Beijing will be at the same time a stakeholder in, and a challenger of, the existing world order. There was some hope, that a fast-growing giant country claiming to restore its international role would just agree to fit neatly and nicely into the existing world order – an order seen as a kind of “natural” option. But this was just an illusion. Beijing is definitely going to have its say about the way the rules are set, and according to what criteria.

At the same time, this does not mean that China is intent on systematically rocking the boat. Hence, there is an ambiguity between the attitude of being a stakeholder and being a challenger. China’s partners need to adjust to this ambiguity, and to balance the elements of fierce competition and what might be called “cooperation by compulsion” that will shape the relationship. For instance, the way China is building up its naval military projection capabilities is a perennial matter of concern for US officials, but it is very hard to imagine that China will not want to raise its military potential or that it would agree to oblige US concerns in the way it builds it.

So managing this relationship with a stakeholder-challenger will be difficult and will require that short-term issues and priorities be always set in a longer-term context. The perception of the United States as a declining power could be very dangerous to harbour in some circles in Beijing. But, equally, the notion that the existing world order is the Alpha and the Omega, is here to stay and must be preserved intact whatever changes may happen in the world could prove self-defeating – and disastrous.

Originally by Claude Smadja, Source: March 25, 2015, Business Standard

As if the intractable recession and the confrontation with Russia over Ukraine were not enough to deal with, the nightmare of the jihadist attacks in Paris and the revelations of Islamist plots being foiled in other European countries have aggravated an already very downbeat and anxious mood all over Europe. This benefits a range of populist parties that are riding the wave of popular frustration and anxiety about the economic crisis and the ever more acute issue of immigration. The convergence of crises in the economic, security, domestic policy and geopolitical domains have created a situation of unprecedented gravity on the continent, testing the mettle of European leaders and their ability to provide answers and solace to the anguish of their people.

Just as France was reeling with the trauma of three consecutive jihadist attacks, came news that unemployment had climbed to new heights in the last year and that the figures now confirm the euro zone is entering into dangerous deflation territory. The downward pressure on the euro has been increasing, with its value barely reaching 1.15 to the US dollar and the Swiss National Bank precipitously abandoning the peg to the European currency as it had become unsustainable. The acceleration of the euro’s depreciation was partly triggered by the expectation that the European Central Bank (ECB) would at long last start a Quantitative Easing (QE) program partly similar to what the US Fed had implemented successfully and had just ended.

However, the margin of manoeuvre of Mario Draghi, the president of the ECB, is very limited because of the fierce resistance of Germany, with a quarter of his Board of Governors being against any QE and a barrage of criticism from the German media. So the expectation at this writing is that the ECB will announce on 23 January a QE program limited to 500 billion euros with the crucial caveat that the responsibility for bond-buying will be divided among the central banks of the 19 euro zone members which will have to bear any loss in the value of the bonds they buy.

This is likely to limit the efficacy of the QE program in terms of easing the provision of credit to corporations and consumers in order to re-activate economic life in these countries. In addition to that, as long as Berlin keeps dictating austerity policies to the rest of the euro zone and refuses to stimulate its own domestic consumption, there cannot be any illusion that whatever QE is done will be enough to cure Europe’s crisis.
 
 In this context where more than five years of harsh austerity and spending cuts have brought tremendous social pains and have sacrificed an entire generation in Greece, Portugal, Spain, Italy, and France without significant results, it is not surprising to see the rise of populist parties all over Europe. These parties have also capitalised on the anti-immigration feelings and rising anxiety about the loss of national identity.

It is now expected that the leftist, populist party Syriza will either come first in the national elections in Greece on 25 January or will be in a position to dictate the terms of any coalition government. If Syriza sticks to its program of expanding social spending and demanding a renegotiation of Greece’s debt it is difficult to predict the ripple effects this might have on the whole euro zone.

However, one thing is for sure: A result considered as a victory for Syriza will be a tremendous boost for Podemos in Spain, a party also demanding the end of austerity. Podemos did not even exist 18 months ago and could now come first at the national elections later this year. Here again there is no predicting the ripple effects. And this is without mentioning the continuous rise of the National Front in France with its rightist, anti-EU, anti-immigration program; or of the UK Independence Party (UKIP) advocating also an exit of the UK from the EU and a tougher stance on immigration.

One key issue with all these populist parties is that while they are making the right diagnosis on some issues, they are proposing solutions that may be appealing to segments of the public but are not applicable in a world ever more complex and interdependent. Nevertheless, this creates terrible constraints and pressures on governments, aggravates the polarisation of political life and generates sometimes irresistible temptations for politicians to veer to demagoguery “to keep the electorate”.

The increase of the level of the jihadist threat in Europe is of course the kind of traumatic development that is adding to the sense of crisis in Europe and providing a tail wind to populist tendencies as we have seen also in Germany with the rise of the Pegida movement. European leaders have avoided connections between the presence of a significant Muslim population and the jihadist threat but it is true – as remarked recently by the former Head of the British Intelligence Services – that terrorism originating from the West Asia has become for Europe a threat as severe as the one posed by the Soviet Union during the Cold War. Too many of the thousands of people with European nationalities or residency who have gone fighting with extremist jihadists in Syria and/or Iraq are coming back to the continent with military training and a thirst for blood. It will be very difficult to keep the balance between the need for additional measures to preempt and fight the jihadist threat and the protection of the values of tolerance and respect for civil liberties.

In some respect, the confrontation with Presidient Putin over Ukraine is another brutal awakening from the delicious fantasy that Europe had entered the “post-conflict era”, that every conflict or problem could now be solved by clever diplomats, that positions and interests could be advanced just by using “soft power”. Obviously many people in the world – including Mr Putin or the leaders of the Islamic State or of Boko Haram in Africa – have not read the memo: they still live in the “conflict era” in which the resort to violence, to military means is part of the panoply of tools to advance national interests or ideological and religious extremist goals.

Europe – and the US in that respect – think that they can contain and “punish” Mr Putin by using economic sanctions. But as these sanctions are giving an impact on the Russian economy they are also having a boomerang effect on Europe: Germany’s already slowing economy has been hit significantly by the loss of the business it used to get from Russia; other countries have been also hit although to a lesser way. In that respect a key question is the extent of the exposure of European banks to Russian public and private debt and how this factor could play if Mr Putin feels at some stage that he has his back to the wall.

This is the year of living dangerously for Europe – in every sense of the term.

Originally by Claude Smadja, Source January 21, 2015, Business Standard

What a fateful year! In addition to bringing a new government – and restoring hope in and about India – 2014 should be remembered as the year during which six realities and trends  which, while not necessarily new, have been crystallised or magnified. The realities thus starkly exposed have forced political and business decision-makers to make adjustments.

To start with, 2014 confirmed that the US is fully back economically speaking. Its recovery has been gathering momentum; a new dynamism can be felt in almost every sector. It is not too optimistic to consider that GDP growth will get in the 3-per-cent-plus range in 2015 — with wages having started to rise and expected to continue to d so next year, and the improvement of household income being accelerated by the sharp decline of gasoline prices. Expected higher consumer demand should lead to an increase of production capacity — an element of economic stimulus that was quasi-absent in the last few years.  

By contrast, 2014 is the year that revealed the intractability of the euro zone economic woes — which derives from the fact that the real issue political in nature. There are strict limits to what monetary policy can do as long as fiscal policies remain harshly tight and it will take time before the big infrastructure plan that the new European Commission wants to launch has any impact — if it is really implemented.

The problem is that Germany is not budging from the goal of imposing the Berlin consensus on the euro zone. Chancellor Angela Merkel’s and her finance minister’s obsession with austerity for the euro zone is intact. Their zero budget deficit policy for Germany not only means the continuous degradation of the country’s infrastructure and of its education system, but the continuation of a huge current account surplus harming the prospects for other, crisis-hit, euro-zone countries.

Restoring Europe’s ability to grow will not be feasible as long as a genuine accommodation is not found between Berlin’s will to impose what is, de facto, a German Europe, and the resistance of the people in other countries – starting with France and Italy – to what a German Europe means for their daily lives.

The third element 2014 crystallised is the long-term structural impact of the shale oil and gas revolution in the US on the global energy landscape. This year has brought home the reality that – for the foreseeable future – nothing will be the same in the energy domain. In November, Saudi Arabia and the UAE led OPEC to leave levels of production unchanged, sending the barrel of Brent to hover around $60 — making a number of US and Canadian shale oil producers unprofitable, and thus forcing a production cut on shale in the hope of bringing prices back at a higher level.

The gamble will probably have an impact. It would not be unreasonable to expect the barrel to get back to $80 or $90 by the last part of 2015.  However, this will presumably be as far as high prices go as this will lead to an increase of US shale oil and gas production – especially as fracking technology is improving relatively fast, thus lowering the profitability level for US shale producers. So 2014 has sealed the era of OPEC control on the market, and of oil prices above the $100 mark. We will have to see in 2015 and beyond what this means for the development of non-fossil energies.

In China the last 12 months have crystallised three trends already at play in 2013. First is the shift from what had been so far a form of collective leadership to the one-man leadership of President Xi Jinping who has continued his drive to eliminate all potential competing centres of power — thus breaking the unwritten rules that Chinese leaders did not go after other members of the top leadership strata. The fight against corruption has proved a perfect tool for President Xi to achieve his goal, allowing him to show to a frustrated public that he is addressing the gravest source of social unrest and the most lethal threat to the hold on power of the Communist Party. Second has been the affirmation by President Xi that – from now on – Beijing as the rising economic and geopolitical player will be dealing on an equal footing with the US. This is the end of the Deng Xiaoping dogma (bid your time and lie low) which had shaped China’s international policy over the last 30 years. The third trend is China’s shift towards a new development model based more on domestic consumption, which could deliver higher quality growth, but is fraught with political uncertainties as it means a reduction of the privileges of state-owned enterprises and of the “princelings”.

Moving to Russia, 2014 has crystallised and magnified to a new level the difficulty the West has dealing with a Vladimir Putin who has never ceased to consider that the US and Europe have betrayed their pledge – real or perceived – at the end of the cold war not to push NATO’s boundaries close to Russia’s borders. For the 14 years that he has been at the helm, Putin has been fighting against what he sees as the West’s encroachments on Russia’s “legitimate” sphere of influence, and for the restoration of Russia’s status as a great power. Nobody knows if the Western sanctions to punish Moscow for the Ukraine crisis will lead Mr Putin to some accommodation; but even if this were to be the case, this will not address the basic problem of how to deal with a Russia which – as long as Mr Putin is there and maybe even after him – will feel that it does not have the place it aspires to have on the international scene.

Last but not least, 2014 has magnified the challenge and the threat that jihadist forces constitute for whoever they see as an enemy or an obstacle to the fulfillment of their extremist creed. Claims of having drastically reduced the threat represented by al-Qaeda were premature, as the Islamic State in Iraq and Syria, or ISIS, was looming on the horizon, stepping into the vacuum created by the failed regimes of Iraq and Syria to assert control over a large swath of territory. ISIS is able to attract thousands of jihadists from the West. Concerted military action might eventually succeed in annihilating the Islamic State in 2015. However, 2014 has proved that the jihadist threat would not disappear with it, and that the West – and also countries like India or Russia – will have to learn to deal with a danger taking more diffuse forms, and hence more difficult to fight.

Originally by: Claude Smadja, Source: Dec. 24, 2014, Business Standard

Negotiating a sustainable nuclear compromise with Iran is not getting any easier.

Surprise, surprise! The November 24 deadline for completing a deal to put a brake on Iran’s nuclear programme could not be met, and now the deadline to reach a broad political agreement has been extended to March 1, 2015, with all the modalities for a comprehensive deal to be set by July 2015.

It was obvious since quite some time that the gap between Iran on one side and the United States and Europe plus China and Russia on the other side could not be bridged on crucial issues, such as the level of uranium enrichment Tehran would be allowed to pursue or the number of centrifuges it would be able to keep, given the fact that the number of these centrifuges has increased 60 times over the last 10 years. Another major unresolved divergence was on the sequencing of events between the two sides: for the United States and the Europeans there had to be major – and verifiable – reductions of the scope of Iran’s nuclear programme before a significant and gradual reduction of economic sanctions would take place. And for Tehran it had to be the reverse.

From the moment the interim agreement was concluded in Geneva in November 2013, it was obvious that President Hassan Rouhani and Foreign Minister Javad Zarif were operating under a very tight leash, with no real negotiating leeway. The Western media had been prompt at the time to praise the election of Mr Rouhani as a shift in Tehran towards reformist elements keen to achieve an improvement of relations with the United States and the Western world in general. This was ignoring the fact that the reality of power had not changed one ounce, remaining in the sole hands of Ayatollah Ali Khamenei, supported by a very strong and vocal constellation of hard-line groups – comprising, for instance, the Revolutionary Guards and their powerful leader Mohammad Ali Jafari. The domain where President Rouhani has been able to have an impact has been in improving the economic situation – basically by putting an end to the nonsensical policies of his predecessor Mahmoud Ahmadinejad. Paradoxically, this might make an agreement more difficult to achieve as this has, in fact, increased the ability of Iran to sustain the hardships created by the sanctions.

So the real question now is whether the extension of the deadline for concluding the negotiations has any chance of achieving the the desired result – bringing Iran’s nuclear programme under such stringent limits and controls that it would take Tehran at least a year to have the means to build a nuclear weapon should it decide to break out from the deal. The worst outcome would be for an agreement that would end up providing comfortable cover for Iran to pursue most of its ambitions. In that respect, it is worth keeping in mind that Tehran continues to refuse to allow the International Atomic Energy Agency to conduct inspections on its Parchin nuclear site, where nuclear warheads research is suspected of being conducted. And concerns about Iran continuing to develop its nuclear programme at covert, undetected sites have been a permanent thread line in the approach of the American and European negotiators.

Beyond the extremely complex technical issues that need to be addressed to make an agreement viable, whether the extension of the deadline for concluding the negotiations will prove useful or not depends basically on three factors:

First, the regime in Tehran – and presumably a very large segment of the Iranian people – consider that Iran is “entitled” as a significant regional power to be able to build a nuclear capability that will be its insurance policy. In addition to that, the ability to pursue a nuclear programme has now become a matter of “honour” for the regime and its supporters. This factor adds to the difficulty of getting from Tehran the kind of concessions that are needed to achieve a deal acceptable by the Americans and the Europeans.

Second, whether an agreement on the nuclear issue is achieved or not, we can take it for granted that as long as the present configuration of power will exist in Tehran enmity – if not hatred – towards the United States and Israel will continue to be a key element of the regime’s DNA. So even if an acceptable nuclear deal can be reached, it would certainly be misleading to consider it as the milestone for a normalisation of United States-Iranian relations in the way Americans define the normalisation of relations between two countries. And such an agreement will definitely not be a stepping stone contributing to the resolution of the Israeli-Palestinian conflict. A salutary dose of realism is needed here to put such a deal – if it were to be concluded – in its right context.

Third, it will be crucial that the European and American negotiators resist the very common temptation in this kind of circumstances of reaching an agreement for the sake of having an agreement to bring back home. This is even more relevant considering how much the Obama administration is desperate for any diplomatic success given its dismal foreign policy record. In addition to that, it will certainly be crucial to bring Saudi Arabia and Israel “in”; their buy-in will be needed not just to ensure that any agreement is viable but also so that tensions and volatility in West Asia are not aggravated.

The Iranian regime’s strategic priority is – and will remain – to preserve as much as possible of its capacity to build a nuclear capability while loosening as much as possible the sanctions that have hurt its economy. The red line that it will not cross is acquiescing to such tight limits to its nuclear programme that it would mean a de facto renouncement of its nuclear ambitions – and this, whatever the cost might be in terms of a prolongation and extension of sanctions if a Republican-controlled Congress in Washington gets restless. On the other side, President Barack Obama knows that any deal that would not translate into a steep reduction in the number and capacity of Iranian centrifuges, and with very strict enforcement and verification requirements, will be killed by the United States Congress.

It is not sure that the additional months given for the negotiation to succeed will permit the discovery of any sustainable compromise between the strategic objectives of Iran and of the United States and Europe, which remain fundamentally at odds. And here, the key operating word is “sustainable”, since the lingering perception is that even if an agreement can be reached, it will still remain a transitory one as long as the nature of the regime in Tehran does not change. There are limits to what constructive ambiguity involved in diplomacy can achieve. And these limits will be very severely tested in the coming months.

Originally by Claude Smadja, Source: Nov 26, 2014, Business Standard India