The European debt crisis dominates headlines, with the Anglo-Saxon media crowing about the lazy, shiftless Meds (as opposed to the diligent and careful Germans) and blaming socialism for their problems. This of course has a number of flaws within it. Greeks work the most hours in the EU – 2000 per year, relative to 1300 in Germany. And the only major EU nations without huge debt and fiscal problems are the Scandinavians, who are about as “socialist” as one gets nowadays.

But this is all sidestepping the fact that debt and fiscal crisis afflict the entire Western world, and it is just that – due to the special political weaknesses of the Eurozone – have manifested first and foremost in Greece, Italy, and Spain. However, a look at the actual statistics reveals that even the “serious” countries are in a great deal of trouble. For instance, in 2010 both the US and Britain had bigger primary deficits (cyclically adjusted) than “basketcase” Greece, whereas Italy’s was actually positive! The Meds’ total net government debt is larger, but on the other hand, if even France is beginning to experience perturbations – a country whose fiscal balances are better in every way than Britain’s or America’s – then it surely cannot be long before the crows come home to roost in the Anglo-Saxon world.

The fiscal crisis

Below are two tables that would be very informative for discussions about the crisis, as they overturn many of the lazy myths and tropes populating the discourse.

Though the US position looks salvageable because of the positive GDP growth less cost of finance indicator (suggesting that its ability to pay back its debts are growing faster than the debts themselves), I am not convinced of the reliability of that indicator. First, it assumes fast growth – growth that has yet to materialize despite massive fiscal and monetary stimulus since 2008. Second, it assumes that interest rates on Treasuries will remain low – but that assumes a US that is becoming rapidly indebted and making signals it is going to inflate it away remains an investor safe heaven. It shows zero ability to make a credible commitment to eliminating the budget deficit, which is only going to be compounded as the baby boomers start retiring.

This chart from Michael Pollaro shows that in some respects the US position is actually worse than those of the PIGS in aggregate. For every $60 it received in revenue, it spends $100, and it would take almost 6 years for the US to repay its debt if the entire budget was devoted to it. In contrast, the average PIGS figure is $78 in revenue for every $100 in spending, and it would take them only 2 years of their combined budgets to repay their debts.

The position of Britain is very weak. It’s economy, and especially its budget, is highly reliant on the City of London. The tanking of the financial system has resulted in zero growth (GDP is still about 5% below peak 2007 levels) and chronically high budget deficits at around 10% of GDP, and the prospect of a second recession with pull the figures even further into the red. Nor has a weaker pound stimulated an export based recovery. Britain’s big trump card is that its bonds have very high average numbers of years to maturity, so refinancing will be easier even if its rates were to suddenly lurch upwards. Now its still over-extended and will probably go bankrupt within this decade, but probably later than the Meds or even the US.

Germany has a strong position, with only a modest budget deficit and reasonable levels of debt. Overall, it is net global creditor, with a net international investment position of 37% of GDP. But this presents another problem. Quite a lot of that is in the forms of loans to and assets held by its banks in the stricken Med region. A meltdown there would send the value of these assets plummeting, necessitating massive bailouts that could in turn threaten even Germany’s solvency. Hence, a possible reason for the recent poor sales of German government bonds.

Despite chronic budget deficits and an astronomic public debt of 220% of GDP, I actually think that Japan may be the country in the least danger in the medium-term future. 95% of its government debt is domestic, largely to Japanese corporations, which lend to the government for social spending in exchange for the understanding that tax rates will be held low. But those same banks and corporations are flush with cash: Japan’s net international investment position is an impressive 56% of GDP. In a way, it’s just a different method of financing a welfare state. It’s still probably unsustainable – domestic investors too may dry up, especially as the Japanese population continues to age and begins to spend rather than save - but I’d wager less so than the US or most of Europe.

Fiscally secure nations include China, Latin America, Scandinavia, and Russia. China has problems with various non-performing loans and municipal over-indebtedness, granted, but these weaknesses are largely mitigated by its phenomenal growth rate and a net international investment position of 36% of GDP. Latin America and Scandinavia tend to have responsible fiscal management and adequate growth rates.

Russia has globally low levels of government debt, its citizens likewise have low debt levels (a feature more of its underdeveloped credit system, granted), and an international net investment position of 17% of GDP. Though the budget deficit is currently balanced thanks to high oil prices, a significant drop can take them into the red very quickly and deeply; however, this is NOT a problem because it is a near certainty that on average oil prices in the next decade will remain high and rise further. What IS a problem is that Russia is a “high-beta” economy, highly affected by developments elsewhere – in 2008, its recession was deeper than in any major Western economy (though compared to them it also had the strongest recovery). The primary reason was the sharp cut-off in Western credit to Russian banks and corporations, resulting in multiple refinancing crises. Today, this problem is less acute, with the Russian banks and corporations having learnt that such dependence may be a problem – nonetheless, a huge sovereign debt crisis in the West can still give Russia a very sharp knock in the short-term.

The exergy crisis

This brings us to another side of the issue: peak oil. Oil reserves are depleting, and global production – after being on a plateau from 2005 to today – will probably begin to consistently fall from 2012 as oil megaprojects sharply fall off. Furthermore, a war with Iran, and its possible capability to blockade the Strait of Hormuz for some time, may cause an extremely disruptive spike in world oil prices, as 25% of world oil supplies transit through the Persian Gulf. On the other hand, China is right now entering the mass automobile age, with the numbers of cars sold per year overtaking the US in 2010. So we will see a rise in demand from China and other emerging markets.

But this is not all. As discussed on other posts in the blog, e.g. here, here, economic growth in general is crucially dependent on net energy availability and the efficiency with which it is converted into useful work. Both indicators have slowed to a crawl, and quite soon the former may well go into reverse. Furthermore, the reality of open global markets with limited global energy supplies means that countries will be more and more competitively bidding for the high-EROEI energy sources that remain (primarily, oil). The US in particular is highly dependent on oil to power its service-based economy, but it simply cannot afford oil to the same degree as can China (see this excellent Oil Drum post A Brief Economic Explanation of Peak Oil for an explanation). This means that the economic pie is now limited, and growth in one place (above all, China) is now to the detriment of growth in other already high-income places (the US, and the less efficient parts of Europe). For a limited time, this issue can be bypassed by the accumulation of debt in the high-income countries – much of which, it should be noted, is loaned out from China and the oil exporters. But poor countries lending to maintain rich country living standards is bizarre at face value, and it is unsustainable in the long-run.

How to survive the coming storm?

From the investment perspective: Keep assets in US dollars, but only those that can be sold off at relatively short notice.

Though dangerous in the short-term, China, Russia, and some countries in Eastern Europe are very good long-term plays. In particular, buying in at the depths of crisis can pay huge dividends in the future. A good bet right now: property in Bulgaria and Minsk.

Natural resources are another excellent long-term play (including gold – a good bet in a time of instability). However, it is probably not a good time to buy in right now, as there is the risk of a sharp (but short) fall once the economic deterioration gathers critical pace.

If you have the means to be an independent financial speculator, try out US CDS. The US will probably never formally default – controlling its own currency, at the most, it will do so via inflation – however, the perceived risk of default WILL be reflected in those instruments. Don’t bet the farm on it, as they’re high risk, but do consider setting aside 10% of your investment poll into this or similar instruments, as the returns have the potential to be mindbogglingly high.

The other two BRIC’s, India and Brazil, I am not so certain of because their low human capital precludes very fast growth.

In terms of specific sectors in the long-term, probably the best bets are IT and medicine because the entire world is aging, and when people are unemployed, they will spend their time on Facebook and playing video games.

Perhaps I’ll have another post on the other aspects of how to keep afloat in the coming era of turbulence. Keep an eye out for it.

Reread S/O posts about the return of geopolitics to Europe and my decade forecast and piece on future superpowers, and continue reading this blog as it is ahead of so many issues well before they started becoming conventional wisdom.

1. On August 2nd, give or take a few days, the US Treasury will run out of money. Some commitments will have to be broken. As this article explains, first in line will be Treasury bond holders; frankly, the US sovereign reputation is so valuable that it will not want to risk it at almost any cost. Nor does either party want to see SS recipients, veterans, and soldiers not getting their salary. Once these are accounted for, little else will remain (the US borrows $1.40 for every dollar it now spends). If a deal isn’t reached, there will be massive furloughs and a shutdown of most non-”essential” government functions.

2. Though the current deficit of 10%+ of GDP is patently unsustainable, the immediate drop in spending the failure to raise the debt limit will represent will instantly plunge the US into deep recession (if not depression, if sustained; i.e. a cumulative GDP drop of more than 10%). The economy is very weak, with recent revisions showing the post-2007 drop in output to have been deeper than thought, and the subsequent recovery much weaker. With consumer spending hurt by deleveraging and high commodity prices; it is only being propped up by government stimulus.

3. The political ramifications. This is a risky bet on the Republicans’ part; whereas the Obama administration would have otherwise got the blame for a sluggish recovery, their perceived role in triggering a deep recession will erase that (nor can we take for granted that Republicans are able to logically perceive this; their Tea Party wing in particular has heavy ideological blinkers). In any case, it was the Republicans who got the blame for the previous government shutdown in 1995.

I went counter-consensus in the immediate aftermath of the Osama bin Laden killing by betting on a Republican win in 2012. This was on favorable odds, with all the commentators crowing that Obama has a victory locked up. Now I’m not sure this was such a good move. As of now, this is ALSO increasingly counter-consensus; in the last few days, many people have began to say Obama’s chances of winning are slipping. I disagree. The Republicans are volunteering themselves as free targets for the blame games that make up Presidential campaigns. If they go through and shut down government, then Obama will seize the opportunity to blame them.

4. So, in the end, what will happen? I think there is a high chance that the US will not go into formal default (that is practically impossible, for now) and that there will be a compromise, if not by August 2nd then within two or three weeks. But if the Republicans remain obstinate, then its back to deep recession.

5. The WSJ on what Russia thinks: Oil-Rich Russia Calm Ahead of U.S. Debt Deadline. I basically agree with it.

6. As in 2008, China will remain largely unaffected – even if the US slips into a deep recession. As I argued in my post on Top 10 Sinophobe Myths, the idea that China depends in any real way on manufacturing exports doesn’t hold water.

7. The PMI indicators show that large parts of Europe are slipping into zero growth or outright recession. But Germany remains solid, and Russia seems to be picking up its pace.

As soon as the US debt limit crisis is papered over, the focus will shift back to Europe. Italy’s budget deficit is small (relatively, anyway), but its debt to GDP ratio is huge and the average maturity of its bonds is only about five years. And needless to say, Italy is no Greece. That said, Europe’s overall fiscal position is better than that of the US, Japan, Britain (which is, despite a 13% of GDP budget deficit, becoming a mini safe haven) so the recent moves towards a German-controlled “eurobond” has diminished the risks of contagion.

STRATFOR provides food for thought with Germany’s Choice: Part 2.

8. Where can investors go? In the past few days, we’ve had the bizarre sight of investors, frightened by the rising turbulence and concerns about low growth, scurrying into the “safe haven” of US Treasuries; issued by the same institution that will not have money to pay the bills in a few days! Well, what can I say… Investors aren’t rational creatures. And it does illustrate the massive reputational advantage still held by the US… a reputational advantage that brings it massive benefits (very low interest rates, most of the international trade in commodities being denominated in its currency, etc) that its more rational politicians will be very unwilling to squander.

Nonetheless, this doesn’t change the fact that no matter how this debt limit issue is going to be resolved in the coming days and weeks, in the longer term US hegemony is unsustainable. That is because its fiscal position is unsustainable, and it is unsustainable because its political system is fundamentally dysfunctional. The Republicans want cuts in spending, but not enough to wipe out the deficit (since some influential lobbies like the MIC, Big Oil, agriculture, etc. are to be protected); the Democrats want to keep entitlements spending and military spending largely as is but increase revenues, but the Republicans are unwilling to raise taxes an iota, not even on natural resource companies and high income earners. It is an idiot’s limbo whose only foreseeable resolution is through a debt trap / default or massive inflation.

The only thing the current antics are doing is, by giving cause to doubt the creditworthiness of the US (previously unthinkable), the politicians are merely bringing forward the day of reckoning.

9. Whither commodities? It will basically be a race between these two forces:

• Recession – and hence falling demand – in the fiscally bankrupt Western nations.
• Stagnant oil supplies (or the onset on rapid decline); rising demand from China to fill any gap left by falling consumption in the West; and investors fleeing from stock-markets and indebted government-issued papers for commodities, where the long-term trend is now certainly for prices to go up.

Which one will win out in the next few months? I don’t have a fucking clue. If I did, I’d be out there gambling on the commodity markets.

One thing I would (still) recommend doing is investing in US credit default swaps; even if the debt limit crisis is amicably resolved, it is still a great long-term play.

10. One final article: Emerging markets could be the new safe haven for investors.

It is bizarre that Russia, a country with almost zero debt and a tiny budget deficit, or China, or dozens of other fiscally sustainable countries are rated much worse (and have higher CDS spreads on their bonds) than a country like the US or the UK. Arguably even Argentina is a less risky investment at this point.

Question for consideration: How will Russia be affected by a possible Greece-style scenario unfolding in Italy, Spain, or even the US? (More generally, how do you think the next global financial and economic crisis is going to play out? What effects will it have on the Eurozone, US dollar’s status as reserve currency, etc?).

I don’t know the answers to any of these questions (if I did I’d be out there getting rich not writing this post). However, I can offer a provisional framework that may help you think about this issue.

Russia Positives

• Very low sovereign debt; fiscal books are more or less balanced.
• High oil prices… for now.
• A moderately paced recovery has almost returned output levels to peak-2008.
• Households far less reliant on borrowing to finance consumption than in typical developed nations.

Russia Negatives

• Dependence of the budget on oil prices. 
• In 2008, one of the main causes of the sudden collapse in industrial output was the draining of liquidity. Russian industrial groups had relied on Western financial inter-mediation for accessing capital. From August, this suddenly dried up as the crisis exploded and global investors scurried to the “safe haven” of US Treasury bonds. So several related questions for today:

1. To what extent has the Russian private and quasi-state sector reduced this dependence on foreign credit since 2008? (My impression: by a bit, but not fundamentally so).
2. In the case of a global credit crunch, will Russia be spared? On the one hand, its macroeconomic fundamentals are very good (RELATIVELY speaking); on the other hand, this was the same case in 2008 and widespread sentiments that Russia was a “haven of stability” patently didn’t work out.
3. To what extent will the fact that the next crisis will likely be one of sovereign collapses benefit Russia relative to other countries? After all in 2008 investors parked their savings in the bonds of countries perceived to be stable; above all, US bonds. This was because this was a primarily financial / banking crisis and sovereigns remained solvent. This calculus may be fundamentally different in the next crisis. Where can the safe haven investor invest? Euro bonds are out of the question. No bond vigilantes have yet appeared for US Treasuries, but surely with the chronic inability to cut the deficit this will eventually change? The yuan isn’t convertible… for now.
4. So only commodities are left as a major investment vehicle (which benefits Russia), HOWEVER… big sovereign defaults will force the world economy back into recession, lower oil demand, and relieve pressure on commodities leading to a collapse of their prices – which is bad for Russia. Alternatively, prices may remain high if investors remain big on commodities and Asian demand quickly makes up for any shortfall in developed country demand for commodities – which is good for Russia. Which of these two forces will win out?

• Dependence on credit for consumption. Credit based purchases were beginning to play a huge role in Russian consumption in 2007-2008; this was cut off and constitutes another main cause of the depth of its 2009 recession. This dependence on credit for consumption is already creeping back in 2011, though it has yet to reach the levels of early 2008.
• Stampede effect. Despite aforementioned good fundamentals, many institutional investors have rules to abandon EM’s if a global financial crisis strikes (regardless of the specifics of the country in question). To avoid losses, other investors are forced to flee too.

Go, discuss.

* At the beginning of this year I speculated which of the “dominoes” among the PIGS, the US, and Japan would fall first when the global economic crisis resumed. Perhaps the PIGS will prove to be the weakest link after all.

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One thing that strikes you, as you wander the shops of any Russian city, is the sheer cheapness of booze and cigs. As little as 3 years ago, one could buy a pint-sized bottle of beer or a pack of cigarettes for just $1, while a 0.5l bottle of vodka cost as little as $3. Prices have since risen, but they remain very low in comparison to incomes.

This happy era was due to come to an end. The Finance Ministry planned to raise excise duties on ethanol products by a factor of 4.3 and by a factor of 15 on tobacco products, in a graduated way through to 2015. The result would have quadrupled the minimum price of lower-range vodkas (105 rules, to 410 rubles) and of the average cigarette pack (24 rubles, to 100 rubles). The practice of selling beer in large, plastic containers is to be forbidden from January 2013. Given that alcohol was found to cause 32% of aggregate mortality amongst middle-aged Russians in 2005, and the high prevalence of smoking among Russian men, these measures are surely long overdue. The plans will help Russia to consolidate the reductions in alcohol-related mortality of recent years.

The original, Ministry of Finance plan.

The main driving force behind this seemed to be Finance Minister Kudrin, if for reasons that have little to do with public health (the taxes are estimated to bring in a further $11 billion in revenues, in addition to the $3 billion garnered through existing ones). Though these sums are very small relative to Russia’s total budget, they will nonetheless help to appreciably narrow the budget deficit.

However, these ambitious plans may have received a setback following Putin’s criticism of the plans in late March; namely, that such rapid price rises would encourage more Russians to take to moonshine alternatives. The alcohol and tobacco lobbies also raised objections.

According to a Finance Ministry source who contacted Russian Reuters, the revised plans call for a smaller increase in excise tax on vodka, by a factor of 2.2 instead of the previous 4.3 by 2015. The result will be a mere doubling of lower-end vodka prices (105 rules, to 180 rubles); and, given rising incomes and substantial inflation, only a modest decrease in its relative affordability. Likewise, smokers are in for good news: the former quadrupling is now little more than a doubling by 2014. It is still unclear which plan will ultimately be favored. For instance, the pro-Communist Trud speculates that the revised plan will be adhered to until after the 2012 elections – after which there is a chance that the rate of excise tax increases will be stepped up.

The fear amongst Putin, lobbyists, most Russian regions, and about 50% of Russians as per a VCIOM poll, the main effect of rapid price rises is going to be negative, as many people will supposedly only switch to “dangerous and unregulated homebrews, as well as poisonous surrogates like eau de cologne, shoe polish and even jet fuel”, according to Mark Schrad of the NYT. The Gorbachev experience, in which alcohol laws were made stricter from 1985, is continuously cited as evidence.

I remain to be convinced. First, according to that same VCIOM poll, 30% of Russians say they will continue drinking the same alcohol and another 20% say they will drink less; only 15% say they will start drinking homebrews and 4% will look for bootlegged vodka.

Gorbachev's anti-alcohol campaign: now maligned, but more or less successful while it lasted.

Second, for all that maligned Soviet experience of restricting vodka, life expectancy increased from 67.7 years in 1984 to more than 69 years for the rest of its existence (peaking at 70.0 years in 1986-87); and only fell below the late Soviet-era low in 1993, when the state’s vodka monopoly was dissolved and the country was in the midst of a rapid socio-economic collapse. Now given the differences between the Soviet Union and modern Russia, namely that there are far more alternatives to hard spirits, e.g. beer and wine, increasing prices will probably be even more effective now.

So while I don’t usually agree with Boris Nemtsov, I can only support him in his condemnation of the regime for reducing the scope of vodka and tobacco excise tax increases.

EDIT 5/18/2011: Synopsis of final FinMin plans from Kommersant. The growth in excise taxes will be minimal until after the 2012 elections. From July 1st, 2012, they will start increasing at a faster rate, reaching 500 rubles per 0.5l of spirits (prev. 901 rubles) and 1040 rubles per 1000 cigarettes (prev. 874 rubles) – with the possibility of going higher if the action is coordinated with neighboring Belarus and Kazakhstan. The result is that the typical price of a lower-range 0.5l vodka bottle will rise from 125 rubles now, to 175 rubles in H2 2012, 220 rubles in 2013, and 260 rubles in 2014. The minimal price of a pack of cigarettes will rise from 16 rubles now, to 22 rubles in 2012, 29 rubles in 2013, and up to 38 rubles rubles in 2014.

As expected, this is a substantially watered down version, under which the price of vodka and tobacco will remain well under Western norms through to 2015. Cynical electoral populism, and the influence of the alcohol and tobacco lobbies, are working to limit the potential public health gains that could have resulted from a more aggressive plan for raising excise taxes on spirits and tobacco.

First, there is a major delusion that affects a disturbing amount of the commentary surrounding the size of the American and Chinese economies. Newsflash: nominal GDP and real GDP are different things! China overtook Japan in nominal GDP this quarter, but its real level of output has been the world’s second largest for almost a decade*. The reason China’s nominal, or market exchange rate, GDP is twice lower than its real GDP is because its currency is undervalued relative to the US dollar – simply put, living in China is a lot cheaper than in America. But it’s not an accurate proxy for the actual output of the Chinese economy, which is now at around 2/3 of the US level (IMF)**. The “purchasing power parity” GDP is better suited for gauging a country’s real living standards and economic strength.

Furthermore, many analysts are making the stunningly incompetent, sub-Econ 101 mistake of projecting Chinese’s 10% real growth rates to its nominal GDP. (Needless to say, this is totally absurd; China’s nominal GDP is growing much faster than its real GDP, because as it gets richer its price levels begin to approach those of the developed world). The convenient result of such calculations is to delay China’s sorpasso of the US economy decades into the far future.

Applying linear projections of 10% growth for Chinese GDP and 3% growth for US GDP sees the Middle Kingdom overtaking its superpower rival by 2017. By 2025, China’s economy is 75% bigger than the US.

Now one may make the entirely valid observation that linear extrapolation of current trends is bad futurism. I agree. China’s GDP growth will like moderate in the years ahead, as China develops and gets less bang for each investment yuan. On the other hand, there is still plenty of scope for rapid catch-up. China today is where South Korea was in late 1980′s and its trend rate of growth is slightly higher at 10% relative to Korea’s 8% from the 1960′s to the 1980′s. As China gets richer, this growth rate can be expected to ease to 7-8% (Korea in the 1990′s) and 4-5% (Korea in the 2000′s).

The US cannot expect to see anything approaching 3% growth in the next decade. The realistic scenario is 1) a private sector deleveraging as households begin to rein back the debt-income ratios to some semblance of normality and 2) massive yearly budget deficits supporting a permanently weak economy at a 0-1% growth level. Think an American version of Japan’s Lost Decade.

In the graph below, China grows at 10% until 2015, 7% until 2020, and 5% thereafter – roughly replicating South Korea’s trajectory from 1985/1990. The US slugs along at 1% until 2020, then improves to 2%. In this scenario, China sails past the US in 2015 and is 60% larger by 2025.

In reality, the world is far more complex than macroeconomics alone can describe. As I argued in Shifting Winds, American hegemony is metastable: though outwardly imposing, an interlinked failure in critical nodes such as energy (e.g. oil shock), finance (e.g. currency flight) and geopolitics (e.g. Iran) can lead to a cascading collapse of the entire  system.  Few will risk sticking their neck out with such predictions beforehand, but once the collapse becomes visible in our rear-view mirror, it will acquire the tinge of historical inevitability.

The American service-based economy is reliant on cheap and reliable petroleum supplies to keep the office plankton fed and mobile, but is put at critical risk by the imminent peaking of global oil supplies. The financial / credit system relies on trust and belief (“credo”) in future growth to keep functioning as an economic fertilizer, but it is threatened by awning US economic disbalances and the possibility of disruptions in energy supplies. Finally, both the energy and the financial crisis can be triggered by a single geopolitical event, such as a successful Iranian blockade of the Straits of Hormuz (e.g. in retaliation for an Israeli strike against its nuclear facilities).

The risk of cascaded collapse would not exist if Pax Americana faced fewer challenges, or if its foundations were still strong and wholesome. They are most definitely not in our era of permanent deficits, tight oil supplies and imperial overstretch. In the worst case scenario, this collapse could manifest itself in a fall in GDP of up to 30% to a new “steady state” output level.

But at least the US will recover quickly, right? Not likely. Though a US dollar collapse will restore competitivity to some of its older industries, global resource constraints will prevent it from ever fully recovering. Why should increasingly scarce energy sources continue feeding the office plankton of American suburbia, as opposed to Chinese factory cities whose products the entire world wants?

Contrary to popular commentary, China is unlikely to be hurt much by an economic collapse in its prime market. Net exports only account for 7% of China’s GDP, so though exports will decline, so will the imports used to assemble exports, and the overall effect will be modest. Though ebbing US demand for Chinese goods will hurt coastal regions, create unemployment and incite low-level protests, it is unlikely to reach a critical level since China can refocus development efforts on the interior and raising domestic consumption (there are numerous signs that this is already happening).

China’s biggest challenge will be the peaking of its coal production and AGW-induced declines in crop yields within ten to twenty years. Mitigating these developments will require a great deal of capital and ingenuity, things China is fortunate to have in abundance. Ultimately, with 20% of the world’s population but just 7% of its arable land, the Limits to Growth may cap China’s peak GDP at not much more than America’s current level.

On to our third scenario. From 2011, some combination of critical system shocks initiates a cascading collapse of Pax Americana, resulting in a cumulative US GDP decline of 30% from peak (this is similar to Latvia’s collapse in 2007-2009). After that, there is a permanent zastoi – unlike in previous emerging market crises, a significant recovery will be impossible in the new world of neo-mercantilism and energy constraints. China will be able to leap past the US sometime around 2013-15 and grow to more than double its size by 2025 – despite the slowing of China’s own growth due to peak exergy and the natural effects of economic catch-up.

What is the probability of each of these scenarios happening? In my opinion, Scenario 1 is pure fantasy. Scenario 2 is what I’d vouch for in “respectable” conversation. Scenario 3 is what I really believe will happen (and what I tend to write about on this blog).

In any case, the general outline is clear: no matter which “prism” you see the world through – be it techno-cornucopian, “realist”, or peakist – it appears that China, by sheer virtue of combining 1.3bn souls with modern technics, is destined to soar past the US to become the leading pole, if not of the world system, then certainly of the Pacific region.

This breakout will be all the more dramatic under the American collapse scenario: wracked by internal decline and preoccupied with internecine politicking, it’s not impossible to imagine the US simply not noticing the ebbing of its influence in East Asia.  Of course, there’s a perfect precedent for this: see how post-Maoist China managed to break past the seemingly impregnable Soviet empire that collapsed into anarchic stasis in the early 1990′s.

[Angus Maddison's data adjusted to equalize with IMF 2008 data; note that "former USSR" is a very rough estimate].

* There’s a big debate on the reliability of official Chinese economic statistics. Are Chinese statistics manipulated? by Gao Xu is a recommended rebuttal h/t “in the loop”.

** That is also assuming that the 30% downwards revision to Chinese GDP by the World Bank and IMF a few years ago was well-founded and not undertaken out of political considerations to preserve America’s #1 status. If not, China’s real GDP may already be surging past America’s.

1. After the sharp -7.9% contraction in 2008, Russia has began to recover at a slower than expected rate, with GDP rising by 2.9% in Q1 relative to the same period last year (in comparison with China’s 11.9%, Turkey’s 11.7%, Brazil’s 9.0%, India’s 8.9% and Mexico’s 4.3%). However, there are indications it accelerated in Q2. The slowness and bumpiness of the recovery is presumed to be due to the waning of crisis stimulus spending and continuing low demand.

The current recession was also significantly deeper and longer-lasting than the 1998 one, though its humanitarian impacts were almost insignificant (see later).

Also, the recovery has been uneven across sectors. Tradables and manufacturing sprang back very quickly in Q1 (as well as transport and comms), but retail stagnated and construction fell by 9%. However, the latest April (and May) figures show an improving performance in retail and construction.

Demand grew slowly on the back of recovering wages, but remains low due to sluggish credit activity and higher unemployment. Investment remains depressed, falling -4.7% relative to the same period last year in Q1 – “most enterprises appeared to be increasing their utilization rate of existing capacity while restocking inventories”.

2. The World Bank’s own summary:

Summary. Amid heightened global uncertainties, Russia is experiencing a bumpy recovery. Domestic demand is rising, but with high unemployment and limited credit and investment activity. Budget execution is better than anticipated due to higher oil prices. Implementing fiscal consolidation is a key medium-term policy objective. Dilapidated infrastructure, especially in transport, could pose serious risks to competitiveness and longer-term growth prospects.

3. Read the Report for the low down on unemployment, current and capital accounts and rollover of external debt obligations by Russian banks and companies. Nothing particularly new or interesting happening there.

4. What is really interesting is the graph of stock of credits to companies and households shown below.

Note how the flow of net credits stopped dead in the water after September 2008, after two years of furious expansion. This suggests that Russian companies had become highly dependent on debt-based growth in the years preceding the crisis. As soon as the spigots turned off in late 2008 and global funds flew to safety, there occurred a sharp drop in demand and investment in Russia.

Not only did this not happen to the Western developed economies, but they also pursued a drastic monetary loosening (while Russia tightened), which may explain why the GDP declines in countries like the US or UK were much more modest than in Russia (despite their much larger stocks of debt relative to GDP).

On the positive side, Russia’s inflation rate has sunk to a record low level of just 6% in its post-Soviet history.

5. Russia’s fiscal position remains strong, as according to Ministry of Finance estimates “the consolidated budget had a surplus of 2.5 percent of GDP” in Q1 2010 (this should be compared to deficits of 10%+ in the US and UK). On the downside, the World Bank notes that the tremors emanating from Club Med may torpedo oil prices yet again, thus widening Russia’s deficit in a few months.

6. Big Russian stimulus spending on social measures such as wages and pensions greatly alleviated the humanitarian impact of the crisis. They are now being phased out.

“The focus on people’s incomes has helped mitigate the social impact of the crisis, but at the expense of greater rigidity in the expenditure structure and infrastructure expenditures”. The World Bank points out that it might have been wiser to direct some of that spending towards addressing “acute infrastructure bottlenecks, [which] could have much larger fiscal multipliers”.

Despite the withdrawal of most stimulus measures, it is predicted that a planned 46% pensions hike by end 2010 will cause the federal budget to remain well in the red at -5.4% of GDP, but slightly lower than the -5.8% of 2009. The downside is that infrastructure spending, especially on roads, is to get deferred again.

The Report has a one page spread on the state of Russia’s infrastructure, which isn’t anything to write home about. Nonetheless, as I argued here, it almost certainly isn’t infrastructure constraints that are going to constrain Russia’s future growth… and in any case it is not clear why spending a lot of money on improving roads at this point in history (of peak oil, climate change, etc) is a great idea.

7. So what will happen if Europe goes haywire? Encouragingly, unlike in the last crisis, the costs of ensuring Russian debt hasn’t been spiking. This may not be a high bar to overcome, but it would be apt to point out that Russia is no longer assumed to be a weak link in the chain like Greece or Spain by global investors. (Indeed as Ben Aris argues in Rerating Russia its credit-worthiness is now higher than most of the developed world’s).

8. What the World Bank thinks will happen in the next two years:

Summary: The debt crisis in Western Europe has sharpened downside risks to global recovery and oil prices. But the impact on Russia is likely to be limited because of Russia’s better fiscal and debt positions and limited trade and financial linkages with the affected countries. Taking into account global developments and assuming no default/restructuring and no broader contagion in Europe, Russia is likely to grow by 4.5 percent in 2010, followed by 4.8 percent in 2011 as domestic demand expands in line with gradual improvements in the labor and credit markets. Employment situation is expected to improve only gradually with attendant reductions in poverty.

Below is a table showing projected growth for different regions.

9. Despite the World Bank’s concerns that Russia may be becoming too free with its wallet – which may put it into a dangerous situation if oil prices collapse and remain depressed for a long time (but which they are unlikely to do because of peak oil) – as things stand Russia is in an enviable fiscal position relative to practically all developed countries.

[Note that Japan, with a debt to GDP ratio of about 220%, is literally off the graph].

Funny, isn’t it, how it is almost all Western countries that are in a fiscal pickle. In contrast, the Russia (of kleptocrats), the China (of bad loans) and Venezuela (of spendthrift populism) are facing a sovereign debt apocalypse really well off comparatively speaking!

10. The World Bank’s Russia forecasts for this year:

Consumption, particularly household consumption, will be the main driver of economic growth in 2010, especially toward the year’s end. A modest contribution to growth is likely to come from inventory restocking in Q2 2010. At the same time, we do not expect large increases in fixed capital investment in 2010 given the excess production capacity and limited credit. So an increase in investment in Q2 will be due mainly to inventory restocking… But the positive contribution of net exports to aggregate growth from 2009 is likely to turn negative in by the end of 2010, as import volume picks up in line with economic recovery…

Below is a graph showing the composition of Russia’s GDP growth drivers.

The World Bank projects a deterioration in the current account as imports pick up and a rise in the capital account “if the European debt crisis has no significant contagion effect”. Furthermore, “an increase in fiscal revenues due to higher oil prices is likely to be partly offset by new expenditure pressures from additional social spending and increases in pensions”. As a result, “we project the fiscal deficit at 4.6 percent of GDP in 2010 and at 3.8 percent in 2011, taking into account additional pensions expenditures.” Inflation will be at 7-8% and “large banks and corporations should be able to finance or roll over their debt obligations in 2010″.

11. I already pointed out that the humanitarian impact of the 1998 crisis was much larger than of the current one: “While the percentage of the population barely making ends meet went up from 29% in July 1998 to 40% in December 1998, this figure remained stable at around 10% throughout the recent crisis”. This is reflected in Russia’s official poverty stats, whose non-rise was “a reflection of the unemployment increasing less than initially feared and likely also due to increased transfers to the population”.

12. The Report concludes with a discussion of how to solve or mitigate Russia’s monotown problem:

Summary: Monotowns present complex challenges for diversification and social and enterprise restructuring in the postcrisis period. Money alone will not solve them. Multipronged market-driven approaches, including active partnerships between the monotown and the private sector, based on good international practice, stand a better chance of success.

The case of the East German Bund–Länder-Program, Pittsburgh USA and Glasgow UK are offered as examples of how to revive ailing post-industrial towns.

13. A compendium of Russia economic stats since 2006.

14. Further thoughts. I do think that the European debt crisis will spill over and that there are already numerous signs of a second dip in the Great Recession – this time centered around sovereigns (1, 2, 3). According to quite a few leading indicators, this will probably occur within a few months, i.e. by this September or November.

Meanwhile, more dynamic and decoupled economies in the World of the Rest – especially China – are rapidly taking over industrial share from the indebted and aging developed world. They still have plenty of room left to grow so I think they will keep oil prices relatively buoyant (especially considering that global oil production is now falling or stagnating).

Russia seems to be in a stronger position than it was in 2008. Though still dependent on foreign debt intermediation, it is now to a lesser degree than two years back, and besides its comparatively excellent fiscal balances will probably mean that global credit flows will not desert it as fully or suddenly as before. The state will remain strong and solvent. Nonetheless, growth will probably slow to stagnation in late 2010-2011 should the events of 2008 be repeated.

One possible consequence is that Russia’s leadership will become disillusioned by the multi-year, post-2008 failure to lift Russia’s GDP any higher than that which prevailed at the peak of Soviet output, and the end result – within a few years – could be an all-out shift to the “mobilization model” proposed by Gregory Khanin, with the state taking a far more prominent role in forcing modernization from above than is the case even today.

Update July 8: It’s worth pointing out that newly released figures indicate that Russian consumer confidence has largely returned to near pre-crisis levels in Q2 2010. This may reinforce the evidence that the recovery accelerated during the period.

Putin. Not (quite) my God.

I’ve been accused of being a “Russophile cockroach”, an “amoral Putin lackey”, and overall bad guy. Guilty as charged! Yes, I do like Russia and don’t have much good to say about the Western media’s coverage of it. Yes, I don’t give much of damn for the moralistic posturing that any vapid idiot Kremlinologist can easily excel in. And yes, I do have a positive opinion of Vladimir Putin (as do 75%+ of Russians). Now granted, part of this probably has something to do with the huge amounts of money his FSB minions kindly slip under my door for glorifying their Tsarist godfather on the Internet in my spare time. But this doesn’t necessarily mean that I set my alarm clock to VVP’s speeches, drink prodigal amounts of Putinka for breakfast, and bow before his icon at the Altar of Neo-Stalinism in my basement before logging onto my workstation to fulfill my job description as ein strammer Putin-soldat. In reality, my positive view of Putin is moderate and hedged.

Don’t believe my word as “the dishonest, progangadizing (very, very) little maggot” that I really am? Below I present five major shortcomings of the Putin Presidency.

What Putin did wrong

1. Waiting until 2006, or too little too late.

Since 2006, Russia embarked on a range of policies designed to check its demographic decline, reduce poverty, and recover its status as a Great Power. The main examples would be the National Priority Projects; a revamped industrial policy; health promotion; pro-natality, AIDS containment and anti-alcohol measures; military modernization; and incubation of hi-tech industries such as nanotechnology. Many of these are already bearing fruit – quite literally on the demographic front, where the total fertility rate rose to 1.56 children per woman by 2009, from 1.1-1.3 before 2006. In conjunction with falling mortality rates, this resulted in Russia experiencing its first year of population growth in 2009 since 1994. But why did Putin take so long to start addressing all these issues?

Though there are several possible explanations, I think the most accurate is that at the time Putin was simply too preoccupied with stabilizing the Russian shell of the collapsed Soviet empire. Each functioning state rests on its monopolization of legitimate violence, of tax collection, and of the issuing of money. All three monopolies were under grave threat by the late 1990′s. Homicide rates were sky-high, organized crime infiltrated state structures, and Chechen bandits raided Russia proper. The state was too weak to collect taxes from the oligarchs, producing chronic budget deficits that culminated in the 1998 default. Inflation raged unchecked, most transactions were in dollars or in kind, and many analysts were starting to describe Russia as a failed state. Therefore it cannot be surprising that Putin in his first term devoted most of his attention towards containing and mitigating these mortal threats to the Russian state. The invasion of Chechnya, the political subjugation of the oligarchs, the strengthening of the “power vertical” – all these were intended to restore some modicum of state control over the Russian Federation.

Yet as the political struggle went on at the top, the “real Russia” remained largely stagnant. With the inflow of ethnic Russians from the Near Abroad largely exhausted, demographic decline accelerated in the 2000-2005 period. In contrast to the broad-based growth after 2005/2006, in the early Putin years manufacturing remained depressed, while more than a third of economic growth accrued to the recovery in oil extraction. Little new infrastructure was built. The rate of military procurement dropped even below the miserly levels of the Yeltsin era. Thanks to the Putin government’s myopic negligence or administrative inability, Russia’s manifold, deepgrained socio-economic problems only began to be seriously addressed within the past few years.

Strike 1 – Contrary to most fans and critics alike, Putin didn’t do too much. He did too little, and too late. Under the first few years of his watch, Russia lost historical time just as it did under Yeltsin. On many socio-economic indicators, the RF in 2010 has only caught up to what the RSFSR achieved back in 1990.

2. Red tape and corruption, or the bureaucracy is expanding to meet the needs of an expanding bureaucracy.

Corruption remains “public enemy number one”, according to President Medvedev. This can be confirmed by any number of horrific anecdotes: the absurdly inflated Moscow housing market,  bureaucrats owning property worth hundreds of their yearly salaries, entrepreneurs losing their businesses to well-connected thugs. Apart from a few cosmetic house-cleaning campaigns under the Putin President, the state’s efforts to control this scourge have been decidedly lack-luster, and Russia continues to be perceived as one of the most corrupt nations on Earth.

[Sources: Transparency International's "Corruption Perceptions Index"; Transparency International's "Global Corruption Barometer", answers to the question, "In the past 12 months, have you or anyone in your household paid a bribe in any form?" (% saying "yes"); World Bank's "Worldwide Governance Indicators" (Control of Corruption), country percentile].

This corruption is directly related to the arbitrary power of Russia’s bureaucracy, and the labyrinth of regulations that “justify” its existence. Love them or hate them – and yes, most Russians hate them – bureaucrats are indispensable for running a modern state. However, in Russia bureacrats are neither accountable unlike in most developed nations nor held under close scrutiny unlike in the USSR or today’s China. Furthermore, their numbers are well in excess of necessity. In contrast to a few post-Soviet nations like Estonia and Georgia which fired many of their bureaucrats, the Russian bureaucracy grew rapidly under Putin.

[Source: Rosstat].

The extractions of rent-seeking bureaucrats stunt the development of small and medium businesses. Furthermore, corruption indirectly kills people (e.g. grocery pharmaceuticals are expensive and unreliable) and fosters a destructive social mentality in which anything and everything is considered exchangeable for money and the privileged and connected can act with impunity.

As the man at the top of the pyramid, Putin was responsible for perpetuating this system during his Presidency. Sensational rumors of foreign villas and multi-billion dollar offshore accounts to the contrary, there is no evidence that Putin is personally corrupt*. However, controlling corruption within one’s circle and further down is extremely hard; no Russian ruler, except the most steely and despotic, has ever managed to rein in his bureaucrats. Now you could go down the neo-Stalinist route, but executing corrupt bureaucrats is now politically incorrect in most places outside China. Perhaps Putin should have simply axed this Gordian knot, like Saakashvili in Georgia**? That might have worked, – no regulation, no bureaucrat, no problem. But something stayed his hand. Maybe he feared chaos, since the bureaucracy is one the forces gluing a nation together. Maybe they were considered necessary to reconsolidate the state and rebuild the power vertical. I don’t know.

Maybe Putin shouldn’t have suppressed Russia’s civil society and media outlets if he was serious about checking corruption? But this is a false narrative. It is not the federal government or Putin, but unreformed institutions such as the Ministry of Internal Affairs (MVD), the FSB, the Prosecutor-General, etc, that pose the greatest hazards to Russia’s nascent civil society. It is not VVP who runs around killing and harassing journalists, but the “stationary bandits” in government and/or business taking advantage of Russia’s culture of impunity. The ultimate proof of the pudding is Ukraine – despite its pluralistic politics and journalistic freedoms after the Orange Revolution, corruption there remains at least as bad as in semi-authoritarian Russia***. No matter the personal integrity or ability of Russia’s (or Ukraine’s leaders), the entire post-Soviet state system remains unacceptably opaque and unaccountable.

Strike 2 – Putin could have mitigated Russia’s corruption and culture of impunity by: 1) stripping away the reams of red tape that create opportunities for rent-seeking, 2) decimating the ranks of the bloated bureaucracy, traffic police, etc, or 3) increasing the penalties for, or the “costs” of, corruption. In reality, there was some improvement in 1) and 3), and massive backtracking on 2). It is only under Medvedev that government and citizenry are beginning to show signs of taking corruption more seriously.

3. Inequality, or oiligarchs & their little adults.

Russians are not Americans. Though most accept the capitalist system, a majority of Russians believe the state has a duty to narrow down inequality between rich and poor and assure everyone a decent standard of living. Opinion polls indicate that around 63% of Russians are essentially “statists”, while only 25% are economic “liberals” and an insignificant 4% are small-government libertarians. Thouh there has been impressive progress on lifting all boats in the past decade – poverty rates were slashed, consumer goods became much more affordable – the Putin regime also presided over an era of slowly rising inequality****. This does not sit well with many Russians, especially the elderly who put great stock in egalitarian values.

[Source: Rosstat].

It is no great exaggeration to say that Russia’s government is by the rich and for the rich. Though perhaps at first necessary as the most reliable way for a broken state to combat tax evasion, the 13% flat tax on incomes now perpetuates inequalities. A much bigger burden falls on productive companies in the form of (highly regressive) social security contributions, which are set to rise from 26% to 34% of the first 400,000 rubles of income this year to help correct the budget deficit. However, Putin had no problems with reducing taxes for oil companies, so that they could either extract and sell off Russia’s oil the faster, or pocket the extra change.

Worst of all are the effects on social cohesion. All Russian oligarchs earned their wealth through their connections with the state – there is not a single Sergei Brin or Bill Gates amongst them. The inheritance tax was abolished in 2006, and now more than a hundred Russian children, or “little adults“, are set to acquire billions without earning a single ruble. Sure, these “new Russians” get to experience the shallow thrills of conspicuous consumption, and take power in their sleazy connections with state structures to run over ordinary Russians with impunity (sometimes literally). The price Russia pays for tolerating these historyless elites is a perpetual bankruptcy of social capital, the cooperative spirit that welds a nation together. Amongst other things, this dearth of social capital manifests itself in society’s tolerance for petty corruption. After all, why should a simple traffic policeman, doctor, or other low-paid state worker refrain from taking bribes, when oligarchs make off with billions in cahoots with the state?

There has been no effort to check or reverse the growth of inequality under either Putin or Medvedev. Even as the Fair Russia opposition party calls for progressive taxation and a luxury tax, Roman Abramovich is indulging himself to his biggest yacht so far, armed with a missile defense system and laser shield.

Strike 3 – Putin presided over an increase in inequality, made all the more unholy by money’s marriage with socio-political privilege. Though neither the trend towards nor the magnitude of inequality is exceptional by global standards, it clashes with Russian popular sentiments and undermines social capital.

4. Economic mismanagement, or stationary bandits who don’t know or care about limits to growth.

First, the “Muscovite” rent-granting political economy over which Putin presided is both economically inefficient and socially unjust. Take the Russian oil industry, in which politically subservient oiligarchs are given free rein to manage their own companies. This combines the worst of both private and state ownership. Lacking security over their assets, the oiligarchs are loath to plow too much of their own money into maximizing long-term oil extraction and revenue. Far better to maximize short-term extraction by overexploiting their oil fields, pleasing the Tsar with generous rent payments, and to make off once these fields go into premature decline. In the meantime, astronomical profits are diverted into a few oiligarch hands instead of going to the Russian state. Now granted, Putin’s “purgatory”, run by clans of “stationary bandits”, might be an improvement over Yeltsin’s “hell” of asset-stripping “roving bandits”… but they are all still bandits nonetheless.

Yet when all is said and done, it is not entirely clear that Putin could have realistically done better on any of these issues. He inherited the “Muscovite system” from Yeltsin and can be credited with actually making it workable, in the sense that the oligarchs were forced into paying their taxes and Russia’s chronic budget deficits were finally eradicated. Reversing privatization and trying to create a Russian version of Statoil, the efficient state-owned Norwegian energy company, was entirely unrealistic given the institutional rot of the Russian state. The other extreme, a full-scale liberalization of the oil sector, would have probably been counter-productive because of that same weakness of the Russian state. For proof, look no further than how Khodorkovsky used YUKOS’ resource wealth to mount a direct political challenge to the Kremlin… would the Russian people really have been well served if their state had been hijacked by the Menatep bandits?

Second, even accounting for its being a cold, landlocked country with a lot of heavy industry, Russia remains very energy inefficient. There are serious uncertainties over its ability to meet future domestic and European gas demand, and its oil production will soon peak and go into decline. However, by world standards, Russia is supremely well-endowed with energy resources. Thus, it makes manifest sense to use the earnings from foreign hydrocarbons sales to aggressively implement energy efficiency measures and build a green energy infrastructure. The World Bank estimates that investing 320bn $ into energy efficiency could save Russian consumers 80bn $ and generate more than 100bn $ in extra export revenues annually. Putin prefers to go the much more expensive route of greatly expanding generating capacity, e.g. by building many nuclear power plants, while less glamorous but cheaper options like insulating housing, upgrading utilities, or reducing natural gas flaring are neglected. So yes, Russia’s policies on energy are short-termist and “cornucopian”, – but the very same could be said for almost any country one cares to name. Only a bare handful of nations, like Sweden or Germany, have made serious commitments to sustainable development (and none acknowledge the concept of Limits to Growth).

Third, the main reason Russia experienced such a deep recession during the 2009 global financial crisis was because its banks and corporations had become dependent on infusions of Western credit. Once this system throttled up in late 2008, emerging markets were the first to be cut off. Unfortunately, Russia under Putin’s watch had failed to develop the deep indigenous credit systems that enabled countries like Brazil or China to weather the storm in good shape, and it saw a massive GDP decline of 7.9% in 2009. But it’s not exactly clear how Russia could have prepared better. The main reason Russia’s financial system was starved of capital was because instead of reinvesting the proceeds from hydrocarbon sales into the economy, the government bought up foreign currency reserves in order to prevent an excessive ruble strengthening from short-circuiting the revival of Russia’s manufacturing base. Ironically, by trying to reduce its resource dependency, Russia actually increased its exposure to the Western financial system, whose weaknesses only became obvious with the benefit of hindsight. Nonetheless, despite the severity of the GDP drop in 2009, the Russian economy is now showing signs of mounting a vigorous recovery.

Finally, Putin should be given big props for protecting Kudrin – the main architect of Russia’s macroeconomic stability – from the attacks of the spendthrifts and siloviki in his circle. This did nothing to benefit him politically, but as a result Russia today is “one of the world’s most fiscally secure nations”, according to Liam Halligan, chief economist with Prosperity Capital Management.

Strike 4 – under Putin, Russia remained economically unproductive, socially unjust, energy inefficient, and acquired a dependence on Western credit. These problems are deep and are unlikely to go away without intelligent intervention by the state.

5. White elephants, or Siberian bridges to nowhere.

The Russian state has always liked “white elephant” solutions to complicated problems. Putin continued in this proud tradition. Perhaps the best example of this were Russia’s wild-eyed plans to construct six aircraft carriers during the giddy heights of its pre-crisis boom. Let’s look at the problems with this scheme:

1. The global hegemony of the United States rests on the power projection capabilities of its 11 aircraft carrier battle groups. Russia is a regional land power whose strategic interests do not extend far beyond its Near Abroad.
2. Russia’s economic base is seven times smaller than America’s.
3. Even the “structurally militarized” USSR never had much success with aircraft carriers. Russia’s military-industrial complex is now almost an order of magnitude smaller and no longer has access to the big drydocks in Ukraine.
4. Russia can’t even build a decent helicopter carrier, and eventually took the rational decision to order Mistrals from France.
5. The days of the aircraft carrier may well be numbered due to the development of cheap carrier-killing weapons systems.

This particular white elephant never was to be. But far too many are real enough, such as the bridge to nowhere near Vladivostok that will connect the Russian mainland to a small island populated by a few thousand residents, projected to cost more than 1bn $ and intended as a showpiece for the 2012 APEX summit. Meanwhile, the roads from the Urals to Vladivostok remain little more than dirt tracks.

Now admittedly, white elephants are minor nuisances relative to the first four problems. Their attractions are hardly unique to Russia, and it could even be argued that some, like the Sochi Olympics, are a net positive thanks to their impact on national morale. Nonetheless, I still think improving Russia’s energy efficiency or networking its clunky armed forces is somewhat more important than erecting suspension bridges in Siberia or dreaming about multiple carrier battle groups patrolling the Russian Arctic.

Strike 5 – Putin is sometimes too influenced by the traditions of Soviet gigantism to consider humbler, more cost-effective ways of solving problems.

What Putin did right

But what about that KGB spy’s ruthless suppression of freedom and democracy? False narrative. The majority of Russians approve of Putin and his system – as of 2008, some 75% of Russians felt that they either had “enough” or even “too much” freedom. Today’s Russians feel much happier and freer than in either the late Soviet Union or Yeltsin’s Russia.

But hasn’t Putin suppressed the free media and brainwashed Russians into worshipping him? Yet if that were the case, one would presumably expect most Putinistas to be old, sour-mouthed Stalinists, whereas in fact support for Putin (and disillusionment with the West) is highest amongst young, university-educated Muscovite men – the very segment of the Russian population that is most exposed to the West through the Internet and foreign travel! (Of course, to the Western chauvinist, this must mean that the Russian people are ignorant, nationalist sheeple… since nothing can be allowed to challenge their faith, there is little point in talking to them).

What about Putin’s hatred of the West? Again, false narrative. Putin the KGB operative is inseparable from the Putin who served under Sobchak, the liberal mayor of St.-Petersburg in the 1990′s, or the Putin who favored the “civiliki” clan (Surkov, Medvedev, “patriotic liberals”) over the FSB-connected “siloviki” in his choice of successor. But why then does Putin antagonize America by maintaining relations with freedom-haters like Ahmadinejad and Chavez? Newsflash! This is Realpolitik, practiced by all sane and sovereign nations. Bending over backwards to advance Washington’s national security interests is not part of Putin’s job description. Not can it reasonably be expected, due to US support for states hostile to Russia (e.g. Georgia) in its Near Abroad.

One of Putin’s greatest strengths is that he recognizes the immense harm Russia suffered from single-minded past pursuits of abstract ideals, and rejects mindless idolization of the West as surely as he rejects the old Marxist-Leninist dogmas. He is a national figure of post-ideological reconciliation, a leader who sees no paradox in defending the Soviet Union against politicized attempts to equate it with Nazi Germany while honoring Russians like the dissident Aleksandr Solzhenitsyn or the White general Anton Denikin.

Zhou Enlai may have been exaggerating when he said the impact of the French Revolution was “too early to tell”, but nonetheless, I think it is fair to say that we must wait at least a few decades before we have any hope of objectively determining Putin’s legacy. Based on the criticisms I’ve made in this post, some analysts would rush to dismiss Putin as an incompetent idiot or malicious enemy of the Russian people. After all, it doesn’t take much to pronounce judgment from the comforts of one’s armchair… Yet none of us have been in Putin’s boots. We didn’t experience his early struggles with the oligarchs, the contraints and frustrations he faced trying to rule Russia through an unwieldy and corrupt bureaucracy, the pyramid of cards he has to build and maintain to balance the warring Kremlin clans. I can do no better than quote a great speech by Theodore Roosevelt to illustrate this point:

It is not the critic who counts: not the man who points out how the strong man stumbles or where the doer of deeds could have done better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood, who strives valiantly, who errs and comes up short again and again, because there is no effort without error or shortcoming, but who knows the great enthusiasms, the great devotions, who spends himself for a worthy cause; who, at the best, knows, in the end, the triumph of high achievement, and who, at the worst, if he fails, at least he fails while daring greatly, so that his place shall never be with those cold and timid souls who knew neither victory nor defeat.

Putin’s critics, knowing neither victory nor defeat, are nothing more than the dust at the feet of that great man who continues struggling, striving, and spending himself as Russia’s humble servant.

* To the best of my knowledge, all these allegations of Putin’s 40bn $ of personal wealth originate from Stanislav Belkovsky, a professional purveyor of kompromat and creature of Sechin’s silovik clan.

** Georgia’s success at controlling corruption shouldn’t be exaggerated. In recent years, the Saakashvili regime acquired the habit of pressuring independent businesses to provide “voluntary contributions” in return for not bankrupting them under corruption prosecutions.

*** Russia’s corruption should be viewed in perspective. Is it a serious problem that reinforces privelege and blights the lives of many people? Certainly. Apocalyptic? Not at all. First, Russia is not excessively corrupt by the standards of most middle-income countries, and there is evidence that “everyday” corruption (as opposed to business corruption) fell under Putin’s watch. See here, here, and here. Second, corruption does not seriously affect Russia’s growth potential. Italy was systematically corrupt in the 1970′s-80′s (and still is), as exposed in the short-lived mani pulite investigatations of the early 1990′s. But that did not stop Italy from overtaking Britain’s GDP back in 1987 in the so-called “Il Sorpasso”. Likewise, Russia’s myriad strengths – the strong education system, energy wealth, and macroeconomic stability – means that its systematic corruption is unlikely to constitute an insurmountable barrier against its convergence to Western levels of development.

**** Russia’s levels of inequality shouldn’t be exaggerated, however. The Gini index of income inequality has been stable at around 40 since the early 1990′s, and is only high by European standards. (The US and China are at 45, most Latin American countries exceed 50).

After briefly stalling in early 2009, China’s economy roared back to life on the back of massive credit loosening to build (or overbuild) infrastructure and industrial capacity. Though not the most efficient use of resources, it did have the advantage of 1) maintaining growth, 2) forestalling the social unrest that would rise up if it wasn’t, and 3) at least Chinese investments went into building up their real economy (amongst other things, it became the world’s largest producer of wind turbines and photovoltaic panels in 2009), instead of the pork and oligarch welfare programs more characteristic of the US “stimulus”. And though Russia’s GDP contracted by 7.9% in 2009 – far higher than expected by most commentators, largely thanks to the dependence its big corporations acquired on continuous flows of intermediated Western credit – it began to slowly recover from mid-2009, industrial output is now rising at a fast clip, and investment banks are predicting growth of 4-6% for 2010. The other two BRIC’s, Brazil and India, didn’t have too many problems at all since they had neither a big credit nor trade dependence on the submerging Western markets.

In the long-term, I argued that the brunt of the crisis would fall on the “submerging” Anglo-Saxon markets, thanks to their “charades over “quantitative easing” (translation: printing money), transfer of toxic “assets” onto the public account”, and unsustainable fiscal stimuli. Today, the American political system is for all practical purposes broken. Republicans won’t agree to tax increases, Democrats won’t agree to cutting entitlement programs. The legislative process is reverting to that of the 17th century Polish-Lithuanian Commonwealth, when a single veto could (and did) prevent anything being agreed on in their Sejm, or parliament. (Hint: the ultimate consequences weren’t good for Poland).

The inflated hopes and expectations accompanying Obama’s accession to power were indeed, just as I suggested on his election, “greatly constrained by financial and institutional realities”. He is a weakling President, alternating between meaningless populist rhetoric and pandering to the Wall Street oligarchs; scorned by the left as Bush II with gloss, and condemned by the right as a foreign Marxist Islamofascist: his policies and outreaches failing at home and abroad, rejected in his own heartlands, these outcomes are engendered by and in large part made inevitable by his hopelessly pollyannish belief in his own messianic powers of compromise and persuasion.

If you think things look bad now, with the budget deficit at 10% of GDP for 2009 and a similar figure projected for 2010, don’t look at what awaits us in a few more years. The fiscal pressure is only going to increase as the baby boomers start retiring, and as long as the US remains a populist democracy the public will not allow it to cut entitlements (at least until China and the world’s oil exporters force it on them). For instance, the Congressional Budget Office believes that the US will never again run a balanced budget, and you can guess its consequences for American global power. Furthermore, this doesn’t take into account that 1) the vast majority of prior budget forecasts have been optimistic and 2) this assumes that none of the potential breaking-points that could doom Pax Americana (which I’ve identified as imperial overstretch, geopolitical shocks, and oil-credit perturbations caused by peak oil) come to pass.

[Source: New York Times. Click to enlarge.]

As shown above, the US has had an almost continous budget deficit since the start of its “age of diminished expectations” in the 1970′s, funded by investors willing to buy up its Treasuries, accepting low returns in exchange for America’s perceived status as a “safe haven” (so-called “American alpha”). Yet with the American empire crumbling at the margins and their own most optimistic forecasts predicting a structural deficit into the foreseeable future, will investors continue buying up Treasuries – or will they turn to more promising emerging markets? Could it even be possible that the US is already in its imperial endgame, as argued by John Greer?

A different reality pertains within the Washington DC beltway. Where states that fail to balance their budgets get their bond ratings cut and, in some cases, are having trouble finding buyers for their debt at less than usurious interest rates, the federal government seems to be able to defy the normal behavior of bond markets with impunity. Despite soaring deficits, not to mention a growing disinclination on the part of foreign governments to keep on financing the same, every new issuance of US treasury bills somehow finds buyers in such abundance that interest rates stay remarkably low. A few weeks ago, Tom Whipple of ASPO became the latest in a tolerably large number of perceptive observers who have pointed out that this makes sense only if the US government is surreptitiously buying its own debt.

The process works something like this. The Federal Reserve, which is not actually a government agency but a consortium of large banks working under a Federal charter, has the statutory right to mint money in the US. These days, that can be done by a few keystrokes on a computer, and another few keystrokes can transfer that money to any bank in the nation. Some of those banks use the money to buy up US treasury bills, probably by way of subsidiaries chartered in the Cayman Islands and the like, and these same off-book subsidiaries then stash the T-bills and keep them off the books. The money thus laundered finally arrives at the US treasury, where it gets spent.

It may be a bit more complex than that. Those huge sums of money voted by Congress to bail out the financial system may well have been diverted into this process – that would certainly explain why the Department of the Treasury and the Federal Reserve Bank of New York have stonewalled every attempt to trace exactly where all that money went. Friendly foreign governments may also have a hand in the process. One way or another, though, those of my readers who remember the financial engineering that got Enron its fifteen minutes of fame may find all this uncomfortably familiar – and it is. The world’s largest economy has become, in effect, the United States of Enron.

And it’s not only tree-hugging Druids that are raising the alarm. Niall Ferguson, court historian for Pax Americana, is also tolling the bell for its imminent demise on the pages of the Financial Times (A Greek crisis is coming to America).

What we in the western world are about to learn is that there is no such thing as a Keynesian free lunch. Deficits did not “save” us half so much as monetary policy – zero interest rates plus quantitative easing – did. First, the impact of government spending (the hallowed “multiplier”) has been much less than the proponents of stimulus hoped. Second, there is a good deal of “leakage” from open economies in a globalised world. Last, crucially, explosions of public debt incur bills that fall due much sooner than we expect. …

For the world’s biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the “safe haven” of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.

Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase “safe haven”. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941. …

The International Monetary Fund recently published estimates of the fiscal adjustments developed economies would need to make to restore fiscal stability over the decade ahead. Worst were Japan and the UK (a fiscal tightening of 13 per cent of GDP). [AK: Yes, Britain is screwed. So is Japan]. Then came Ireland, Spain and Greece (9 per cent). [AK: The PIIGS (Portugal, Italy, Ireland, Greece, Spain are screwed too, especially Greece and Spain at this point]. And in sixth place? Step forward America, which would need to tighten fiscal policy by 8.8 per cent of GDP to satisfy the IMF.

Explosions of public debt hurt economies in the following way, as numerous empirical studies have shown. By raising fears of default and/or currency depreciation ahead of actual inflation, they push up real interest rates. Higher real rates, in turn, act as drag on growth, especially when the private sector is also heavily indebted – as is the case in most western economies, not least the US.

Although the US household savings rate has risen since the Great Recession began, it has not risen enough to absorb a trillion dollars of net Treasury issuance a year. Only two things have thus far stood between the US and higher bond yields: purchases of Treasuries (and mortgage-backed securities, which many sellers essentially swapped for Treasuries) by the Federal Reserve and reserve accumulation by the Chinese monetary authorities.

But now the Fed is phasing out such purchases and is expected to wind up quantitative easing. Meanwhile, the Chinese have sharply reduced their purchases of Treasuries from around 47 per cent of new issuance in 2006 to 20 per cent in 2008 to an estimated 5 per cent last year. Small wonder Morgan Stanley assumes that 10-year yields will rise from around 3.5 per cent to 5.5 per cent this year. On a gross federal debt fast approaching $15,000bn, that implies up to $300bn of extra interest payments – and you get up there pretty quickly with the average maturity of the debt now below 50 months. [AK: This refers to the dreaded "debt compound trap", in which the real costs of servicing debt spiral out of control and the only way out is restructuring (partial / negotiated default) or "monetization" of the debt (inflation). PS. The "debt trap" is essentially what brought down the regime of Louis XVI in 1789].

The Obama administration’s new budget blithely assumes real GDP growth of 3.6 per cent over the next five years, with inflation averaging 1.4 per cent. [AK: Ha!] But with rising real rates, growth might well be lower. Under those circumstances, interest payments could soar as a share of federal revenue – from a tenth to a fifth to a quarter.

Last week Moody’s Investors Service warned that the triple A credit rating of the US should not be taken for granted. That warning recalls Larry Summers’ killer question (posed before he returned to government): “How long can the world’s biggest borrower remain the world’s biggest power?”

The US is a weakened skier and is now hurtling towards a rock-strewn double black for which it is not prepared in any way, shape, or form. But at least for now, its position looks stable – after all, it grew at an annualized 5.7% in Q4, 2009 (half due to inventories buildup). The same cannot be said of Greece and the Eurozone, which seem to be approaching a major crisis in mid-2010.

Afflicted with a dysfunctional political system and chronically unable to balance its budget (sound familiar?), yet without the manifold benefits of “American alpha”, Greece is facing a looming default propelled by a 13%-of-GDP budget deficit (even granting full benefit of the doubt to Greece’s dodgy statistics service), public debt at 113% of GDP (well above the 60% limit imposed by Maastricht), and draconian austerity plans that are politically unrealizable.

If Greece were to impose the draconian pay cuts under way in Ireland (5pc for lower state workers, rising to 20pc for bosses), it would deepen depression and cause tax revenues to collapse further. It is already too late for such crude policies. Greece is past the tipping point of a compound debt spiral. …

Remember, Athens holds the whip hand over Brussels, not the other way round. Greek exit from EMU would be dangerous. Quite apart from the instant contagion effects across Club Med and Eastern Europe, it would puncture the aura of manifest destiny that has driven EU integration for half a century. …

No doubt, EU institutions will rustle up a rescue. RBS says action by the European Central Bank may be “days away”. While the ECB may not bail out states, it may buy Greek bonds in the open market. EU states may club together to keep Greece afloat with loans for a while. That solves nothing. It increases Greece’s debt, drawing out the agony. What Greece needs – unless it leaves EMU – is a permanent subsidy from the North. Spain and Portugal will need help too.

The danger point for Greece will come when the Pfennig drops in Berlin that EMU divergence between North and South has widened to such a point that the system will break up unless: either Germany tolerates inflation of 4pc or 5pc to prevent Club Med tipping into debt deflation; or it pays welfare transfers to the South (not loans) equal to East German subsidies after reunification.

Before we blame Greece for making a hash of the euro, let us not forget how we got here. EMU lured Club Med into a trap. Interest rates were too low for Greece, Portugal, Spain, and Ireland, causing them all to be engulfed in a destructive property and wage boom. The ECB was complicit. It breached its inflation and M3 money target repeatedly in order to nurse Germany through slump. ECB rates were 2pc until December 2005. This was poison for overheating Southern states.

And according to Stratfor:

The crisis is rooted in Europe’s greatest success: the Maastricht Treaty and the monetary union the treaty spawned epitomized by the euro. Everyone participating in the euro won by merging their currencies. Germany received full, direct and currency-risk-free access to the markets of all its euro partners. In the years since, Germany’s brutal efficiency has permitted its exports to increase steadily both as a share of total European consumption and as a share of European exports to the wider world. Conversely, the eurozone’s smaller and/or poorer members gained access to Germany’s low interest rates and high credit rating. And the last bit is what spawned the current problem.

Greece now has the following choices:

1) Balance the budget. To do this Greece would have to cut its government spending by as much as half, resulting in sky-rocketing unemployment (20%+) and severe social unrest. Greeks are volatile, not like disciplined Germans or apathetic Latvians.

2) Leave the EMU. And print a New Drachma to inflate away its debt into oblivion, as was once typical for the Med nations. But then it would lose its geopolitical anchor in Europe and lose access to any further foreign investor money. According to Willem Buiter, this isn’t too likely.

Would a eurozone national government faced either with the looming threat of default or with the reality of a default be incentivised to leave the eurozone? Consider the example of a hypothetical country called Hellas. It could not redenominate its existing stock of euro-denominated obligations in its new currency, let’s call it the New Drachma. That itself would constitute a further act of default. If the New Drachma depreciated sharply against the euro, in both nominal and real terms, following the exit of Hellas from the eurozone, the real value of the government debt-to-GDP ratio would rise. In addition, any new funding through the issuance of New Drachma-denominated sovereign bonds would be subject to an exchange rate risk premium, and these bonds would have to be sold in markets that are less deep and liquid that the market for euro-denominated Hellas debt used to be. So the sovereign eurozone quitter and all who sail in her would be clobbered as regards borrowing costs both on the outstanding stock and on the new flows.

A sharp depreciation of the nominal exchange rate of the New Drachma vis-a-vis the euro would for a short period improve the competitive position of the nation because, with domestic costs and prices sticky in nominal New Drachma terms, a nominal depreciation is also a real depreciation. Nominal rigidities are, however, less important for eurozone economies than for the UK, and much less important than in the US. Real rigidities are what characterises mythical Hellas, as it does real-world Greece, Italy, Spain, Portugal and Ireland. The real benefits from a nominal exchange rate depreciation would be eroded after a year – within two years at most – before you could say cyclical recovery. The New Drachma would be a little currency in a big global financial market system – not an instrument to be used to gain competitive advantage or to respond efficiently to asymmetric shocks, but a source of extraneous noise, excess volatility and persistent misalignments, rather like sterling.

A eurozone member state faced with the prospect of sovereign default, or just having suffered the indignity of sovereign default, would be immensely relieved to be a member of the eurozone. The last thing it would want to do is give up the financial shelter provided by membership in the eurozone to try and emulate Iceland, New Zealand or the UK.

3) Old-school default. And be shunned by the rest of Europe. Though threatening to blow up the bomb is to Greece’s advantage, since this will shift the burden to…

Europe – or precisely, Germany – having to make their choice.

1) Let them burn. Germany is getting impatient of being used as Europe’s cash cow for the past 60 years, and may simply tell Greece to deal with it herself. This will likely lead to spiraling debt service costs, fiscal-social-political breakdown, and heightened borrowing costs for the other PIIGS, maybe even a “cascading collapse” of Europe’s entire southern periphery (in the most extreme case, even Belgium and France would be threatened). This would finish off the EU as a meaningful institution, and with it will go the main vehice through which Germany and France wield power at a global level.

2) Berlin bails out Greece. Involves a different set of problems. A straight-out bailout will invite moral hazard and political dissatisfaction amongst the German electorate, who have had their wages constrained for years while the PIIGS wallowed in their bubbles. But all in all, preferable to the above scenario, or the prospect of a spreading crisis of confidence also forcing Germany to bail out Italy, Spain, or even France, all of whom have far bigger borrowing needs (and for which even Germany doesn’t have the resources). Therefore, Germany will probably lead an EU bailout of Greece (even though there is no formal mechanism for doing so) – but in exchange, it will want major political concessions.

But the days of no-strings-attached financial assistance from Germany are over. If Germany is going to do this, there will no longer be anything “implied” or “assumed” about German control of the European Central Bank and the eurozone. The control will become reality, and that control will have consequences. For all intents and purposes, Germany will run the fiscal policies of peripheral member states that have proved they are not up to the task of doing so on their own. To accept anything less intrusive would end with Germany becoming responsible for bailing out everyone.

Granted, at the moment the EU is stalling, not making any commitments; not surprising, given the cluttered and unwieldy talking shop that it is. But as Greece’s bond auctions (almost certainly) fail over the next few months to meet its soaring debt financing commitments, and as it falls into its debt compound trap, the fiscally secure nations – that is, primarily Germany – will realize the dangers of allowing the contagion to spread. And Germany in particular will see a chance to regain the sphere of influence over Mitteleuropa denied it since the Second World War.

Either way, in 2010 the EU institutions are going to be sidelined in favor of more workable, bilateral relations – especially between the Franco-German core and the weakening peripheries. The way will be opened for the return of Great Power politics to the European continent.

Looking further ahead, within a year the US will again enter a state of crisis. Based on Obama’s low popularity at the end of his first year (is he going to set a time record for failed Presidency?) and his loss of Massachusetts (!) to the Republicans, the political gridlock will only harden. As I forecast last September, “the feds will face challenges from the far-left (new Huey Long’s, anarchism, etc) and the far-right (demands for more state rights, anti-tax movements, “American reactionary patriots”, etc)”  - though right now, the far-right movements appear to be the more powerful emerging faction (see the grassroots appeal of the reactionary, back-to-the-18th-century Tea Partiers, who in an electoral contest would now garner 17% of the vote – is the US finally going to see a powerful 3rd party?). PS. American corporations can now legally buy themselves political parties.

Second, in addition to the political problem, there will be a renewed economic and credit problem as the Second Wave of the Housing Crisis engulfs the nation because of rising defaults from adjustable-rate mortgages, many of which will be coming due by 2011.

And this brings us to a third problem, a renewed banking crisis. But this time, instead of withdrawing from emerging markets to the “safe haven” of the US, the banks will instead invest more into promising emerging markets (e.g. the BRIC’s) and commodity speculation (see peak oil), while divulging their US holdings and triggering capital flight. This will compount the political and economic problems, as America’s “rootless cosmopolitans” / financial and their political flunkies come under fire from both the far-left and right-wing producerist reactionaries.

Then there’s the fourth problem – peak oil. World oil production capacity may have peaked in 2010, and projections indicate that 2012 will see an accelerating downslide. This time there will be a both severe credit contraction, far exceeding the one in 2008-2009 (because this time capital will be fleeing the US) and soaring oil prices. The American consumer will live through a far more severe retrenchment than in 2007-2009, starting in 2011. The entailing fall in consumption will further reinforce the banking crisis, the wider economic crisis, and the political crisis. By this point, the “Tea Party”-Republican candidate may be well ahead of Obama, who by this point is utterly discredited.

Now what should Obama do? Note that by this time the Iran crisis will be coming to a head. Sanctions will have failed (China and Russia will see no reason to cooperate seriously). Israel will be getting extremely restless, since it treats the Iranian nuclear bomb as an existential threat. And Obama may well come to view a decisive resolution of the Iran issue as the only road still left open to him to claw back domestic and international legitimacy. However, Iran likely has the capability to block the Strait of Hormuz to oil tankers for several weeks using mines and anti-ship missiles. 20% of the world’s oil shipments pass through those narrow Straits. Needless to say, in a world entering the downslope of Hubbert’s peak, any disruption to global oil supplies will have tremendous, chaotic repercussions – economic, financial, political, and geopolitical – that we have no way of predicting in advance.

In conclusion, Pax Americana is going to face a series of severe crises in the next three to five years (and not only its lynchpin, the US). The European crisis, linked to the Med credit bubbles, is leading to the slow unraveling of the EU’s legitimacy in favor of its core states, France and especially Germany. It will come to a head in the next few months. Japan is facing an irredeemable fiscal and debt crisis, which will explode in the next few years: eventually, it will likely bandwagon with China (leveraging its technological base to gain favorable access to China’s markets and labor force) and ditch its post-1990 turn towards neoliberalism, which was never suited for the Japanese mentality anyway, in favor of Asian socialism.

Finally, the US itself will face a panoply of challenges – fiscal profligacy (stemming from its belief that it can have both guns & butter on a shrinking industrial base), imperial overstretch (Afghanistan, Iraq), political dysfunction, a new housing, credit, and economic crisis, soaring energy prices (disastrous for suburbia), and geopolitical challenges (Iran, China, Russia). It can deal with any one of them, but I can see no way how it would be able to deal with all of them coming within a few years of each other. The consequences?

Namely, there will be a partial collapse of legitimacy in the government; the feds will face challenges from the far-left (new Huey Long’s, anarchism, etc) and the far-right (demands for more state rights, anti-tax movements, “American reactionary patriots”, etc); fertility will collapse from the current replacement-level rates to around 1.3-1.7, as welfare shrinks and the utility of having children for the very poor, currently the most fecund social group, drops; crime will increase, etc. Yet within a decade a new social order will gradually emerge, probably fiscally and socially conservative and more authoritarian than the current one, and with it a new equilibrium will slowly, painfully come into being.

However, the US will almost certainly remain a Great Power. I certainly do not see it collapsing into separate states or regions, as dreamt of by the likes of Igor Panarin or Gerald Celente. In some ways, by casting aside its global imperial shell, it will actually become stronger – it will no longer be weighed down by the burden of global empire, and can focus on other activities the more effectively, such as reconstructing its industrial base and reinforcing its neo-colonial sphere around North America, the Carribbean, and perhaps Central America / Venezuela. Whatever form America’s new political economy takes (something resembling Putinism?, or maybe Chavismo?), it will likely be far better suited for the coming age of scarcity industrialism (characterized by economic statism, Realpolitik, and mercantile trade relations), than the crumbling colossus that is today’s Pax Americana.

The most powerful and influential member of this new world is China, which has become the “workshop of the world” since its graduated opening up from the late 1970′s. Accounting for half of global steel and cement production, China has built up an enormous infrastructure of roads, railways, and ports to support its mercantile expansion. In 2009 it became the world’s largest automobile market. Furthermore, China is now advancing higher up the ladder of added-value industries by expanding into hi-tech areas such as commercial aircraft, renewable energy, and supercomputers.

One of the most important factor making China’s rise all the more significant is that it is concurrent with the accelerating decline of Pax Americana that is spurred on by the end of cheap oil, US economic weakness, and regional threats to American hegemony from the “challenger Powers” (e.g. Russia, Iran, and China itself). Should the current international order suffer a “cascading collapse” – which is not unlikely, given the brittleness of the world financial and energy system – then it is possible that China will emerge as an equal, or even superior, pole to the US superpower as soon as 2020.

The Inevitability of China’s Return to Hegemony

Critics aver that ordinary Chinese remain much poorer than Americans, but they miss the obvious fact that with its 1.3bn+ population, China needs only a Romanian level of per capita economic output to equal the US; should they reach Portugal’s level, China’s economy would be double America’s size. (Economic power underpins military power). Nor is there any reason for supposing that China’s growth will soon falter due to social and regional inequality, environmental degradation, bad loans, population aging, or social unrest (though it may well experience a Malthusian collapse along with the rest of the world by 2050). For a refutation of the major concerns, see my old post A Long Wait at the Gate of Delusions, or in summary:

1. Regional disparities. The sharp divide between the affluent coastal and poorer internal regions is not new in Chinese history. In the absence of firm central control, this has in the past led to fragmentation – coastal administrations orientating themselves to foreign commercial interests, the interior sinking beneath a morass of poverty and corruption. However, modern China is not the ailing China of the 19th century in the throes of Malthusian stagnation. It is now a proud and rising Great Power, its regional separatist movements are quelled, and it is under the firm control of the CCP. As such, the chances of a jaded Japan or declining USA successfully exploiting this divide are very slim.
2. Income inequality. There is also a great deal of inequality between China’s urban and rural, between its new oligarchs and itinerant indigents, and between the privileged and non-privileged. However, this is entirely typical of capitalist societies at the height of the industrialization drive, and levels of inequality tend to fall once a more affluent state decides on expanding social welfare schemes to contain labor unrest. As will be covered in a later, related post on China’s internal debates, the ideological underpinnings for such a shift are already coming into place with the concept of the “Harmonious Society“.
3. Environmental degradation. A major problem. An innovative attempt to start measuring economic performance with “Green GDP” (accounting for pollution costs) was quietly squashed when it indicated that China had almost no real growth. That said, localized pollution per se, like city smog or collapsed ecosystems, won’t bring about China’s fall just as they haven’t led to the fall of any other post-agrarian society. The same certainly cannot be said for anthropogenic climate change, whose effects will become devastating to China by the 2030′s (floods, droughts, desertification, dust storms, etc). The most ominous prospect is the melting of the Himalayan glaciers, though some point out that this may be a centuries-long process. Nonetheless, these potential disasters won’t come in time to prevent China’s assumption of its superpower mantle, which I predict for 2020.
4. Bad loans. A valid point, but they only tend to result in – or more accurately, contribute to – long-term stagnation by the time high growth rates falters, such as when a developing society nears convergency with the rich world (e.g. Japan in the early 1990′s). South Korea got a severe economic shock in 1997 stemming from its structural weaknesses, but respectable rates of growth continued up until the 2008 economic crisis. Speaking of which, Western critics should be doubly cautious now when criticizing China for its bad loans. As recent history might have proven, investing in industrial overcapacity may be rather less useless than building suburbs with no future, printing money under euphemisms like quantitative easing, or whatever the latest bondoogles are.
5. Will China get old before it gets rich? The concerns over aging are ridiculous because 1) China’s TFR is at a respectable 1.8 (OK, more like 1.6-1.7 if one accounts for their skewed sex ratios, but still…), 2) its labor force will continue growing until 2030, and 3) it still has massive labor armies locked up in the countryside which can be drawn into higher-added value economic sectors. The real problem cases in the aging department are Central Europe, the Mediterranean, and Japan. See Will China Grow Old Before Getting Rich? (Goldman Sachs) for a more comprehensive analysis which reaches the same basic conclusion.
6. Excessive export dependency. Frankly, I’ve always thought the image of the heroic American consumer saving the world by kindly consuming much of what the the world produces to be somewhat ridiculous – and this image is already being revealed for the hallucination it really is, thanks largely to US fiscal profligacy, imperial overstretch and peak oil. But I digress. First, China’s export dependency is nowhere near as high as suggested by the official figures because much of its exports are merely assembled in China from parts made in and imported from Korea, Japan, etc. Whereas gross exports are near 40% of GDP, net exports are at just 7% of GDP. In 2008, China clocked up a respectable 8% GDP growth rate (albeit, one only enabled by prodigious credit infusions), even though its exports fell by 20%. Second, the main reason for Chimerica – Chinese saving / production – American dissaving / consumption – in the first place was it allowed China to acquire the foreign currency to pay for resource imports, build up its industrial base, and acquire advanced technologies, while the US got back cheaper goods to cushion its rising inequality and industrial stagnation. But China interest in this deal is flagging. It already has by far the world’s largest industrial base by volume and it has bought up, or stolen, most of the key technologies needed for advanced industrialism. From now on, growth will be slower as it is curbed by stagnant world demand, accumulating bad loans, diminishing returns, etc, – it will likely be around 5-7% a year in the 2010′s, rather than the 10% typical of the 1980′s to 2000′s. Nonetheless, growth should continue at a fast enough rate to soak up the new landless labor, ease social tensions and enable China to launch a geopolitical breakout. The inevitable transition from a centrally-weak, disbalanced and commercialized nation-state, to a more centralized, balanced, hegemonic empire will not be smooth, but China’s forward momentum is simply too large to derail its rise to superpower status.
7. Social unrest. Unlikely to happen in a big way as long as fast economic growth continues, which it likely will for the next decade. China still has plenty of room for economic convergence, and its investments in human capital are going to be paying off handsomely in this period – “during the past decade, China has produced college and university graduates at a significantly faster pace than Korea and Japan did during their fastest-growing periods” (Goldman Sachs). Nor are resource or ecological limits to growth likely to intrude in the next ten years. Of course, this situation won’t last forever and by 2030 at the latest, China will be forced to radically reform its model to hold together, e.g. to nationalist expansionism or ecotechnic dictatorship.
8. China’s monolithic and non-democratic nature. Though the CCP projects an image of internal unity on the world, under its placid exterior there is a flux of dynamic debates about how China should reconcile growth with environmentalism, capitalism with socialism, democracy with stability, and cultural influence with military strength. The necessity of liberal democracy for success is a figment of the Western end-of-history mentality, and will be recognized as such by the time the West realizes history doesn’t end.

In conclusion, China has the tools at its disposal to become the world’s last industrial superpower (the US and Japan are in relative decline, Russia has too few people, India is coming to the party too late). The creeping dissipation of the global financial system will remove the US from its position as the system’s intermediator, and with it will go a key pillar of neoliberal internationalism. This will clear the foundations for the emergence of a new symbiosis between the oil-exporting nations of the Middle East and a China which can provide them with cheap consumer goods and security guarantees in place of a deindustrialized, unpopular, and increasingly insular America. These trends will become the conventional wisdom by 2020.

China and the World: Coal, CO2, and Geopolitics

By that date, the age of scarcity industrialism will be in full bloom. Three issues will come to the forefront of all discussions about China’s global significance.

First, the impact of 1.3bn people enjoying rising levels of personal affluence on the global environment. Its electricity generation fueled almost entirely by coal, China has recently overtaken the US to become the world’s biggest CO2 emitter. Today, given the absence of any egalitarian, spiritual, or ultra-nationalist ideology keeping the country together, China requires rapid growth to prevent spiraling unemployment and social unrest. The CCP wants to remain in power, and for that it needs stability, and that needs growth, and that needs more and more coal plants every year. Hence the reason for China’s unwillingness to agree to any but the weakest CO2 emissions targets – i.e., a non-binding resolution to a 45% reduction in Co2 intensity per unit of GDP by 2020 from the levels of 2005. However, since China’s GDP is expected to treble or even quadruple from 2005 to 2020, its emissions will grow by 50-100% even if it achieves this non-binding target. Needless to say, this will be catastrophic for our efforts to contain climate change to a global temperature rise of below 2C, at which point runaway dynamics are expected to become predominant. As the last superpower, I expect China to take the lead in any global or national “final gambit” at geoengineering our way out of runaway climate change.

Second, China’s ability to generate industrial growth from its own resources is shrinking. It is already a major oil importer and its grain production is on a slowly dipping plateau, thanks to increasing urbanization and environmental damage (desertification, salination, depletion of fossil aquifers, etc). It is already restricting exports of the strategic Rare Earth Metals that constitute key components of hi-tech devices such as hard drives, wind turbines, and electric cars. This is a major problem for the world outside China, since China accounts for a stunning 95% of global REM production. It will take a decade to reopen the old mines, and in the interval the West could experience a severe “tech crunch”.

Since the bulk of Chinese electricity consumption comes from coal and its geo-economy is not structurally dependent on cheap oil on the same massive scale as the US, China will not be as hard hit by peak oil as the Anglo-Saxon world; besides, its manufacturing prowess and foreign currency reserves will allow it to outbid most competitors for the black gold. However, the downside to using coal is that it too will peak – in China’s case, perhaps within 10 to 15 years, after which it will go into a rapid decline. As such, China can be expected to “lock in” foreign energy supplies with long-term contracts, increase exploitation of unconventional fossil fuel sources such as coal seam gas, and accelerate its current attempts to force through a renewable transition. In 2009, China became the world’s largest producer of both wind turbines and PV panels; however, they have made nary a dent in its CO2 emissions, and are unlikely to do so any time soon. Coal is much cheaper and more importantly, provides the vital base load power that intermittent wind and solar flows cannot.

Third, China’s military power and neo-colonial influence is set to increase in the coming decades. After suppressing military spending from the late 1970′s to the early 2000′s in order to free up its energies for rapid economic growth, the People’s Liberation Army is now being paid back handsomely for its patience. A prescient quotation from the Economist in 1986, from the days when the magazine was still worth reading:

For China’s military men with the patience to see the economic reforms through, there is a payoff. If Mr. Deng’s plans for the economy as a whole are allowed to run their course, and the value of China’s output quadruples, as planned, between 1980 and 2000 (admittedly big ifs), then 10 to 15 years down the line the civilian economy should have picked up enough steam to haul the military sector along more rapidly. That is when China’s army, its neighbors and the big powers will really have something to think about.

That time is now. Defense spending is now rising faster than GDP, as China intensifies military modernization and acquires new capabilities in electronic, information, and anti-satellite warfare. The overall strategic balance has also changed. The dissolution of the Soviet Union meant that the old Chinese fear of a tank invasion from the north has dissipated; coupled with the growing importance of maritime trade and foreign energy supplies, this has produced a reorientation to coastal defense and broader power projection to the south and east. China’s most ambitious military project is its decision to embark on the construction of a real blue-water navy, a vital tool in the renewed “gunboat diplomacy” we are likely to see in the years ahead.

In the short term, this has extended to China acquiring Russian weapons such as four Sovremenny-class guided missile destroyers, twelve Kilo-class diesel-electric submarines, and advanced anti-ship missiles and supercavitating torpedoes such as the Sunburn, Sizzler, and Shkval. Domestic production of naval vessels is expanding rapidly: whereas US shipbuilding is withering away, China now accounts for a third of global shipbuilding and “is in the midst of a shipbuilding and acquisition craze that will result in the People’s Liberation Army Navy having more ships than the U.S. Navy sometime in the next decade”, including four aircraft carriers by 2020. China’s military modernization has already tipped the regional balance of power. A recent RAND study indicates that China is already be able to establish air superiority over Taiwan in the event of a hot war over the straits, and on current trends it will probably be able to conquer it outright within the decade.

In tandem with its military modernization, which is mostly geared to fighting and winning possible local wars in south-east Asia (Taiwan, Spratly Islands, Vietnam), China is pursuing a far-sighted “string of pearls” strategy of naval base construction on its outlying coastal islands and friendly nations such as Myanmar, Sri Lanka, Bangladesh, and Pakistan. They will host radar stations and anti-ship batteries, and will form logistics hubs for naval operations. The underlying strategy is to reinforce China’s coast against foreign encroachment and to protect its sea lines of communication (SLOC) – especially the vital energy routes supplying it with Middle East oil.

Finally, the broadest form of China’s projection of influence is its rush to buy out mines, arable land, oil field concessions, and foreign national elites, from Australia to Brazil to Ukraine to Angola; indeed, Africa is a focal point of interest, with up to half a million Chinese already working on building up the continent’s industrial infrastructure and tapping its energy and mineral wealth. Closer to home in South-East Asia, most nations are both appreciative and fearful of China’s rise, bandwagoning with the US on security while engaging with China economically. The fact of America’s accelerating decline means that this state of affairs is not permanent. Any future “downsized” US empire will have minimal interests in East Asia, and will concentrate its energies on the Americas, Africa, and perhaps the Middle East (though it will be largely displaced by Turkey and China there).

The second greatest East Asian Power, Japan, will have neither the will to mount a serious challenge to China’s emerging hegemony, nor the strategic foundations. Japan is almost entirely reliant on foreign supplies of energy, and as soon as the PLA Navy surpasses the Imperial Japanese Navy, it will be utterly eclipsed by China. Why struggle, when Japan can instead exist as in a comfortable symbiosis with a China whose post-1978 growth it actively nourished – spats over their wartime history to the contrary? Japan is capital-rich, China is labor-rich; both share Asian values based on paternalism, state capitalism, and national sovereignty… Japan has two choices. It can try to construct an encircling alliance encompassing Russia, Korea, India, and the US to contain China, but this is a truly ambitious undertaking because 1) Russia has – and by that point the US will have – no overriding reason to confront China, 2) the “pan-Asian” appeal of China, 3) Japan has territorial disputes with Russia, whereas Russia in turn has close if suspicious relations with China through the SCO, and 4) as argued by the late Samuel Huntington, Asian societies have a tendency to bandwagon with the leading regional power – now it’s the US, in the future it will be China. The other alternative, and I would argue the likelier and more natural one, is for Japan to acknowledge Chinese regional hegemony. Once Japan takes this plunge, every other nation in in the region will follow.

Conclusion

It is no exaggeration to say that whither goes China goes the world. It is already the world’s greatest industrial power, at least as measured by physical throughput, energy consumption, and pollution emissions. Though still technologically backward, it is much less so than 10 years ago. China’s purchases of foreign technology, copying, and industrial espionage are rapidly closing the gap, and China’s rapidly expanding R&D workforce will be able to successfully hit the ground running once there arises the need for indigenous innovation.

The extent to which China will be able to solve its energy, minerals, food, and water problems will have major impacts domestic and international, and its success or lack of at reducing – or mitigating – its greenhouse gas emissions, is probably going to determine whether the world as a whole will be able to wriggle out of its Limits to Growth predicament. Finally, China’s cultural, economic, and neo-colonial influence is going to metastasize – in the process transforming it into an East Asian regional hegemon and primary pole in world geopolitics.

China’s greatest challenges lie in geopolitics (how to manage its own rise?), coal (how to power growth?), and CO2 (how to grow, or just stay still, sustainably?). The answers to these questions will determine its future political, social, and economic trajectory. It is therefore vital to to find out how its elites are planning to stand up to this panoply of perils and opportunities, which will be the subject of my next post on China.

By repressing the economic potential of eastern Europe and China throughout much of the 20th century, one of Marxism-Leninism’s greatest legacies is to have indirectly postponed humanity’s reckoning with the Earth’s limits to industrial growth in the form of resource depletion and AGW. Had Eastern Europe and Russia become industrialized, consumer nations by the 1950′s-1960′s instead of the 2010′s-2020′s; had China followed the development trajectory of Taiwan; had nations from India to Brazil not excessively indulged in growth-retarding import substitution, it is very likely that today we would already be well on the downward slope of Hubbert’s curve of oil depletion, and burning coal to compensate – in turn reinforcing an already runaway global warming process.

Though one might refrain that socialist regimes tended to focus on heavy industries and had a poor environmental record, this pollution tended to be localized (e.g. acid rain over Czechoslovakia, or soot over industrial cities); however, CO2 per capita emissions – which contribute to global warming – from the socialist bloc were substantially lower than in the advanced capitalist nations. Furthermore, it should be noted that the overriding spur to heavy industrialization in the first place was the encirclement by capitalist powers, which created a perceived need for militarization (most prominent in the USSR from the 1930′s, and now North Korea). This process also distorted other aspects of those regimes, e.g. the inevitable throwing aside of universal pretensions (in practice, though not in rhetoric) in favor of nationalism, and what could be called a reversion to the “Asian mode of production” with industrial overtones, which could be used to describe Stalinism, or the militarized neo-feudalism of the Juche system of North Korea. So one cannot point to those countries as “proof” of the superiority of capitalism; to the contrary, we should take away the lesson that any anti-capitalist transition should be universal if it is to survive.

The Real Contradictions of Capitalism

Capitalism was a viable and successful system when there was still plentiful land, labor and cheap resources to be exploited (even Engels acknowledged the primacy of nature in powering history’s march forward, for it “supplies [labor] with the material that it converts into wealth”). The cheap resources are now ending, so a system predicated on debt-financed perpetual growth is no longer tenable; this became visible in Japan from the early 1990′s, and is now becoming clear in Europe and the US too, where economic collapse in 2008-09 was only checked thanks to a massive transfer of private losses and bad debts onto the public account (socialism for the elites, capitalism for the rest). The neoliberal era underwritten by cheap oil, global finance, and the US Navy is coming to an end.

Given that oil production peaked in 2008, and the decreasing EROEI of other energy sources, willingly or not we are going to return to the zero-growth of pre-industrial times: then we can either 1) successfully get out of our overshoot predicament and restart conventional development (unlikely), or 2) we can effect a “sustainable retreat” to lower levels of physical throughput and increased efficiency, or 3) we can with ever more coercive state efforts, with the help of modern cybernetics and electronic technology, use the tools of the industrial era to try to maintain the industrial infrastructure and its associated institutional-cultural superstructure.

Most likely we will choose the latter, but it will almost certainly fail; all the Limits to Growth models all suggest that both markets and technology – Mammon and the Machine – are powerless to solve the fundamental predicament that a limited world can support unlimited growth, and they don’t even take further negative feedback loops such as the debilitating effects of political populism and geopolitical competition; nor do those models incorporate the observation that the technological base is dependent on the economic-industrial base for its support, so once the latter fails, technologies from plant bioengineering to energy efficiency also go into retreat.

Thus we see the emergence of capitalism’s real contradictions – not so much the impoverishment of the workers (that, too, will come eventually as industrial civilization approaches collapse), but ecology. Throughout the pre- Industrial Revolution era, peasants all over the world have traditionally viewed merchants with suspicion, since capitalism’s profit motive undermined the egalitarian village social relations and support mechanisms necessary to guarantee community survival in a Malthusian world predating modern economic growth (K. Polanyi, 1957). These attitudes will resurge with a vengeance in the coming neo-Malthusian future. Capitalism will have dug its own grave by eating away the basis of its own existence.

Socialist Sustainability

To avoid collapse, by far the safest route is to kickstart a transition to sustainability – not sustainable development, because it’s far too late for that (we should have started on that during the 1970′s), but sustainable retreat – cutting down on real “living standards” (or at least as measured by the deeply flawed measure of GDP, which counts prisons and environmental cleanup as wealth), to transition to a way of life that is compatible with Gaia.

In practice, this will probably imply a transition to a roughly Cuban way of life. The tropical island is, by one measure (developed level of HDI, low ecological footprint per capita), the world’s only sustainable society.

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Predictably enough, there will be several heated objections to living like Cubans, but they can all be effectively countered.

1) Poverty. Don’t they try to swim to Florida? Yes, some do. But Cuban poverty is in part the result of US sanctions, and their punishment of foreign companies doing business in Cuba. Furthermore, it is still far more comfortable than any Malthusian-age, pre-industrial society (or any conventional Third World society). The perception of poverty is created by the “international demonstration effect”, in which images of Western consumerism (based on unsustainable exploitation of Gaia) create false needs and frustrations in poorer societies, a false consciousness hoisted upon all humans connected to the System.

If the rest of the world embraced the concept of sustainable retreat and accepted Cuba as a valid example, then it will become to look much more attractive as 1) it regains access to leading global technologies technologies and know-how, and 2) because its people will no longer be encouraged to judge success by the standards of how new and how big their SUV’s are, but by their ecological wealth, social harmony, and cultural output.

2) Political repression. Yes, Cuba locks up dissidents and is, in Western terms, an unfree society. However, note that the US has been fighting a decades-long information war against Cuba, that the Western media has an incentive to exaggerate its human rights abuses, and that Cuba’s rulers themselves have to fight against this information war and international demonstration effect to maintain Cuban sovereignty. Given that they are much poorer and less influential, the tools at their disposal are much cruder.

Furthermore, as argued by Zizek, the main impact of the communist idea (a secular successor to Christianity’s chiliastic fantasies of salvation) so far was not so much the perfection of the societies acknowledging the idea, as the elucidation of the historical laws (dreams?) by which the perfect society is to appear.

As Alain Badiou pointed out, in spite of its horrors and failures, the “really existing Socialism” was the only political force that – for some decades, at least – seemed to pose an effective threat to the global rule of capitalism, really scaring its representatives, driving them into paranoiac reaction. Since, today, capitalism defines and structures the totality of the human civilization, every “Communist” territory was and is – again, in spite of its horrors and failures – a kind of “liberated territory,” as Fred Jameson put it apropos of Cuba. What we are dealing with here is the old structural notion of the gap between the Space and the positive content that fills it in: although, as to their positive content, the Communist regimes were mostly a dismal failure, generating terror and misery, they at the same time opened up a certain space, the space of utopian expectations which, among other things, enabled us to measure the failure of the really existing Socialism itself. What the anti-Communist dissidents as a rule tend to overlook is that the very space from which they themselves criticized and denounced the everyday terror and misery was opened and sustained by the Communist breakthrough, by its attempt to escape the logic of the Capital. In short, when dissidents like Havel denounced the existing Communist regime on behalf of authentic human solidarity, they (unknowingly, for the most part of it) spoke from the place opened up by Communism itself – which is why they tend to be so disappointed when the “really existing capitalism” does not meet the high expectations of their anti-Communist struggle. Perhaps, Vaclav Klaus, Havel’s pragmatic double, was right when he dismissed Havel as a “socialist”…

The difficult task is thus to confront the radical ambiguity of the Stalinist ideology which, even at its most “totalitarian,” still exudes an emancipatory potential. From my youth, I remember the memorable scene from a Soviet film about the civil war in 1919, in which Bolsheviks organize the public trial of a mother with a young diseased son, who is discovered to be the spy for the counter-revolutionary White forces. At the very beginning of the trial, an old Bolshevik strokes his long white mustache and says: “The sentence must be severe, but just!” The revolutionary court (the collective of the Bolshevik fighters) establishes that the cause of her enemy activity was her difficult social circumstances; the sentence is therefore that she be fully integrated into the socialist collective, taught to write and read and to acquire a proper education, while her son is to be given proper medical care. While the surprised mother bursts out crying, unable to understand the court’s benevolence, the old Bolshevik again strokes his mustaches and nods in consent: “Yes, this is a severe, but just sentence!”

It is easy to claim, in a quick pseudo-Marxist way, that such scenes were simply the ideological legitimization of the most brutal terror. However, no matter how manipulative this scene is, no matter how contradicted it was by the arbitrary harshness of the actual “revolutionary justice,” it nonetheless provided the spectators with new ethical standards by which reality is to be measured – the shocking outcome of this exercise of the revolutionary justice, the unexpected resignification of “severity” into severity towards social circumstances and generosity towards people, cannot but produce a sublime effect. In short, what we have here is an exemplary case of what Lacan called the “quilting point [point de capiton],” of an intervention that changes the coordinates of the very field of meaning: instead of pleading for generous tolerance against severe justice, the old Bolshevik redefines the meaning of “severe justice” itself in terms of excessive forgiveness and generosity. Even if this is a deceiving appearance, there is in a sense more truth in this appearance than in the harsh social reality that generated it.

We must still undergo a trial, a Great March, of sustainable retreat, at the end of which (due to the elimination of materialist thinking) we will transition into what could be called Green Communism – a sustainable, steady-state human existence founded on the (ever-elusive) reconciliation between freedom and equality. How?

Roads to Green Communism

1) The hippies, Green Parties (including Green Party USA), authors of LTG, etc, stress the importance of the grassroots, of Gramscian infiltration, of gradualism – all couched in fluffy, cuddly polar bear-language like “ecological wisdom” or “community-based economics” or “respect for diversity”. The end state is to be a kind of “gift economy”, perhaps in practice encouraged into being through social engineering and widespread psychosomatic therapy. All well and good, but none of this is going to motivate many people to make real change, even in progressive enclaves like the Bay Area (people here mark “Earth Hour” and marginally tone down their CO2 emissions for one hour every 24*365 hours – news flash! it ain’t gonna do much!). Lacking any real drive or force, the elites will ignore these movements at will, and the new Caesars of the coming collapse era will suppress them.

2) The revolutionary extremist road: Alinsky-style activism, propaganda of the deed, catechism of the revolutionist, etc. Problem is that it will not win over the people, and as long as the state remains strong it will take coercive actions against these movements. Unlikely to succeed, but may be the only real chance for change. For capitalism-usury is founded on perpetual growth, by forsaking this tenet the System annihilates itself, so it will not willingly do that.

Second, most analysts are either part of, or suborned by, the System – the sum total of the texts and power relations that make up a society’s set of beliefs. The former category, which includes government policy-makers and corporate strategists, suffers from an “institutional myopia” which gives answers in advance and precludes all questions questioning the legitimacy of their own institutions.

For instance, what can a rational, capitalist state – interested in self-preservation, predicated on unlimited economic growth, and confronted with irrefutable evidence of the dire consequences of business-as-usual greenhouse emissions on the world’s climate – do to resolve these contradictions? The answers are buzzwords like “green growth”, “skeptical environmentalism”, or geoengineering; the forbidden question relates to the efficacy of industrial capitalism as a system to confront the imminent challenges of man-made climate change.

The Gramscian approach of 1) may be doomed by this Bolshevik-Zizek argument that “a political intervention proper does not occur within the coordinates of some underlying global matrix, since what it achieves is precisely the “reshuffling” of this very global matrix”. Yet even if the Revolution is successful, power corrupts; any state formed on the foundations of any such “intervention” may well degenerate into its own nemesis.

3) The laws of history tend to be follow the laws of dialectical materialism – opposites, negation, and transformation – on a route that may lead to a technological singularity, assuming that the ecological base remains intact long enough to sustain the transformation of the industrial System onto a higher plane of existence.

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The following extract I found in one of my texts:

The history of the universe is accelerating evolution. A cursory examination of the past reveals growth to be exponential over any sufficiently long period, as can be measured by the frequency of paradigm shifts. Hence, biological life has evolved over a period of billions of years; advanced organisms over several hundred million years. The appearance of intelligent life took place ushered in a technological epoch, which also shows overwhelming evidence of exponential growth – it took ten thousand years from the beginnings of agriculture to catalyse modern economic growth, which has yielded the information revolution in just two hundred years. There are credible prognosesthat posit the appearance of molecular nanotechnology and intelligent machines within the first half of the twenty-first century.

There exist patterns to the evolutionary process itself. According to futurist-inventor Ray Kurzweil, ‘each stage or epoch uses the information-processing methods of the previous epoch to create the next’. Life emerged due to the chaotic interplay of increasingly complex carbon-based compounds. Its DNA-driven evolution eventually gave rise to agents with information-processing capabilities, which culminated in the human ability to create abstract models of reality within their brains. This capacity to conduct mind experiments created the concepts of technology and machines – the bedrock upon which modern material civilization is built. Futurist pundits, extrapolating current trends in computing, predict the coming of a ‘singularity’ that will result from a merger of human and (exponentially expanding) machine intelligence, leading to a universe saturated with intelligent life.

All epochs are based on integrated networks that can be described and mathematically modelled. The first network was based on atomic constituents, governed by physical forces. The universe’s
fine-tuned physical constants made life possible, which was born as the biosphere on planet Earth, which lies in a narrow ‘zone of habitability’. The biosphere (or Gaia) took over the geosphere as the primary architect of its own evolutionary path by evolving a feedback system which seeks to optimize the environment for life. Later, technological growth was able to increase the carrying capacity of the land, leading to demographic growth, greater scope for innovation and therefore faster technological growth in a positive feedback cycle. Agriculture permitted the uneven but inexorable coalescence of complex, stratified societies that in the long-run vanquished the biosphere, be it embodied in forests or hunter-gatherers; the world entered the Holocene, in which the environment – land, and increasing air and water – is shaped by the collective will of the noosphere. Basically, networks in evolution build upon each other. A consequence is that later, more complex superstructures, like intelligence, depends for stability on its biological foundations that regulate the geosphere – something we’re putting in jeopardy via environmental damage.

If we manage to unleash a technological singularity – and avoid its various perils and pitfalls – then the super-abundance produced by self-assembling nanotechnology will eliminate scarcity, the “dematerialization of production” will make classes obsolete, the borders between reality and virtual reality will fade into oblivion as the Earth metamorphoses into Tlön, modern society’s atoms in the iron cage will become avatars of e-Gods in an electronic cage (like on online forums), based on horizontal networks, instead of the power verticals of today. This form of Green Communism is not of the material, but of the cyber-ethereal.

However, the projections suggest that a singularity-driven transition to sustainability may elude us, for both “singularitarians” and “doomers” / “kollapsniks” mostly place their respective events (Singularity or civilizational collapse) in the 2030-50 timeframe.

So which trend will win out? Will we “transcend” just as industrial civilization begins to finally collapse? Or will the world’s last research lab be burned down by starving rioters just as the world’s first, and last, strong AI pops into super-consciousness inside?

What is to be Done?

One idea would be to look at the manifesto of the Collapse Party!, whose goals, essentially, are to ascertain and pursue the optimal road to Green Communism out of those presented above. It is quoted below in full:

The Collapse Party Manifesto

The world is finite, and so the resource stocks and pollution sinks that sustain industrial civilization (“the System”) are limited. We have been in a state of “overshoot”, beyond the “carrying capacity” of the Earth, since the 1980′s (The Limits to Growth, 2004). Limited resources have been drawn down much faster than they could be replenished, and the Earth’s pollution sinks have been overfilled much faster than they could be regenerated.

Elements of this overshoot can already be seen in phenomena as diverse as plateauing crop yields, topsoil loss, accelerating climate change, peak oil, collapsing fisheries, the depletion of higher-EROEI energy sources, dying rivers, global dimming, the proliferation of “failed states”, neo-colonial exploitation, and rising antibiotic resistance. But things are yet going to get much worse…

Based on paleoclimate reconstructions of CO2 levels, an eventual global warming of above 2C is already inevitable. This will set off a cascade of climatic disasters that will speed up the rate of warming, leading to the desertification of much of the world’s land and oceans, the drying of the great Asian rivers, and massive inundations of the low-lying coasts and deltas that harbor humanity’s heartlands. States will collapse into anarchy, spawning Biblical-scale famines and floods of climate refugees.

Meanwhile, the energetic resources that power the System will be coming under severe strain. Oil production has already peaked, and natural gas and coal will follow in a few more decades. The remaining resources are much harder to extract, since the easiest pickings have already been exploited. We will have to divert ever more energy, labor, and capital towards mitigating the effects of both energy depletion (renewables, remote hydrocarbons) and runaway climate change (adaptation, geoengineering).

This will starve agriculture and the consumer sector, ushering in disillusionment, social discontent, and a longing for a strong hand at the helm of power. This will undermine liberal democracy’s political legitimacy, leading either to anarchy (“failed states”) or increasing coercion (authoritarianism). Geopolitical rivalries over the remaining energy resources will intensify, extinguishing the already dim prospects for international cooperation. Long-term thinking will recede into irrelevance, for political leaders will have their hands full with much more pressing issues – building sea walls, feeding the military, and placating (or dispersing) angry mobs.

Our only way to escape this trap is to rapidly effect a global transition towards “sustainable development”. The imperative of such a transition was recognized as early as the 1970′s, but we have yet to see any truly meaningful action. Nor are we likely to, since the defining feature of industrial-capitalist civilization is indefinite growth, based around the taking of loans against (higher) future returns. There’s a reason why Malthusian societies suppressed usury – and should we continue business-as-usual, we will soon rediscover why.

Though the System is very effective in some ways, it cannot foresee its own demise; nor can its servants even ask questions that hint at the unpalatable answer. However, the casual, detached, and informed observer can. Yes, in a purely technical sense, disaster can still be averted if one could convince people to make, or more likely force through, drastic reductions in First World overconsumption, a full-scale retooling of the industrial system towards renewables and recycling, and a global system of “contraction and convergence” on CO2 emissions.

Achieving this, however, is unlikely in the extreme; any transition to sustainability is going to be stymied by social myopia and geopolitical anarchy, as well as innate human psychological features such as the conservative bias, the denial complex, hedonism, and susceptibility to “creeping normalcy” and “landscape amnesia”. Unless we overcome these failings, or discover a technological silver bullet, we will collide with planetary limits to growth sometime around 2030 to 2050.

In that scenario, the System as a whole will become increasingly fragile, such that a large enough perturbation – say, a major war or global climatic disaster – will send it into a self-reinforcing spiral down into chaos. The electrical-industrial infrastructure supporting modern technology, especially the massive repositories of information entombed within cyberspace, will crumble away into oblivion.

After a short period of unprecedented violence, famine, pestilence, and death known as “the Collapse”, the world will get larger once more, and society will retreat back into the comforting blackness of a new Dark Age.

Faced with these grim prospects, we see it fitting to launch a multi-pronged initiative to if not avert a Collapse (as is the purpose of the global Green movement), then at least to attempt to mitigate, as best we can, its catastrophic humanitarian consequences. We do not wish on the demise of technological civilization, for we recognize that for all its ecological obliviousness and social injustices, it has enabled tremendous progress in science and many aspects of culture and human welfare. That said, we recognize that sometimes, the Second Law of Thermodynamics – the tendency for all closed, complex systems to decay – cannot be sidestepped.

…

We propose a program of “sustainable retreat”, to be characterized by the following policy planks:

• use the remaining high-EROEI fossil fuel stocks in a crash program to build as large a nuclear and renewable energy infrastructure as possible.
• clean up radioactive and toxic installations while we still have the technologies and resources to do so.
• work on fostering global unity and a common human identity to encourage cooperation and discourage competition and resource wars.
• preserve as much as possible of the world’s stock of technologies, bioresources, and knowledge in dispersed repositories (“lifeboats”) in durable, physical format.
• retool the education system to disseminate practical skills and democratize it using the power of the Internet (as long as it continues to exist).
• liberalize copyright laws.
• promote communal-agrarian values, while ditching the individualist and accumulative mentality that is spelling our doom.
• unite all social groups under different wings of the Party – conventional Greens, as well as socialists, feminists, right-wing survivalists, etc – that are amenable to the kollapsnik message.
• eschew militarism, dismantle overseas military bases, and repatriate the troops; but maintain a minimal nuclear deterrent.
• nationalization and / or regulation of the commanding heights of the economy to optimize resource conservation and pollution control.
• establish a network of self-contained “resiliencies” across the nation and the world, modeled on the Kibbutzim, that will provide physical, mental, and spiritual nourishment to those who need it.
• allow mostly-unimpeded free enterprise for small, non-strategic, and low-material throughput businesses, for it will still be necessary to keep the consumerist urgings satiated.
• the Party is to be aim to operate on a horizontal and democratic basis, in which promotion and honors are to be based on the judgments of peers on one’s competence and commitment to the cause.
• the winding-down of the prison-industrial complex in a controlled manner; the nature of law and order to be determined in further internal debate.
• general debt amnesty to wipe the slate clean and start from Year Zero in our quest for sustainability.
• expand resources into research on areas such as sustainable energy, geoengineering, and artificial intelligence to increase the chances of achieving a technological “silver bullet”.