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September 18, 2008

The Russian Resurgence and the New-Old Front
by John Mauldin

It's been a hell of a few weeks, so let's start with a little much-needed levity. Two friends, a Trader and an Investor, walk up to the roulette wheel in a casino. They watch a guy hogging the table hit on his first spin. Then his second. Third, boom. Four in a row! The guy has an enormous stack of chips which he lets ride again on a fifth spin. 00. He's wiped out and skulks off to the bar.

The two friends are excited because now it's their turn. The Trader says he's going to follow exactly the same pattern as the guy they just watched, BUT he's going to pocket his money after four spins. The Investor tells him to hold off for a minute. He wants to first buy stock in the casino....

Like most good jokes, there's a kernel of truth. When everything is in turmoil, you can't focus on the instances; you have to focus on the underlying foundations. Roulette isn't about guessing red or black; it's about understanding statistics. Today in a Special Outside the Box, we look at some potential problems from Russia that could impact the US and Latin America. It comes from George Friedman's company, Stratfor, the source I rely on for my geopolitical analysis. Peter Zeihan is one of the very sharpest thinkers in George's shop, as you'll see. The basic definition of public capital markets in the US and Europe is fundamentally different than in a country like Russia. If you don't understand the geopolitical lens through which a state views its capital markets, then you're making roulette bets instead of investments.

George is kind enough to have a special offer on a Stratfor Membership for my readers. I encourage you to click here to take advantage of this opportunity. Whether it's energy, public equities, or debt, the world's markets are inextricably intertwined. And that means you've got to understand the lay of the land. No one does a better job of providing the geopolitical drivers behind "the statistics" than Stratfor.

John Mauldin, Editor
Outside the Box

The Russian Resurgence and the New-Old Front
By Peter Zeihan

Russia is attempting to reforge its Cold War-era influence in its near abroad. This is not simply an issue of nostalgia, but a perfectly logical and predictable reaction to the Russian environment. Russia lacks easily definable, easily defendable borders. There is no redoubt to which the Russians can withdraw, and the only security they know comes from establishing buffers -- buffers which tend to be lost in times of crisis. The alternative is for Russia to simply trust other states to leave it alone. Considering Russia's history of occupations, from the Mongol horde to Napoleonic France to Hitler's Germany, it is not difficult to surmise why the Russians tend to choose a more activist set of policies.

As such, the country tends to expand and contract like a beating heart -- gobbling up nearby territories in times of strength, and then contracting and losing those territories in times of weakness. Rather than what Westerners think of as a traditional nation-state, Russia has always been a multiethnic empire, heavily stocked with non-Russian (and even non-Orthodox) minorities. Keeping those minorities from damaging central control requires a strong internal security and intelligence arm, and hence we get the Cheka, the KGB, and now the FSB.

Nature of the Budding Conflict

Combine a security policy thoroughly wedded to expansion with an internal stabilization policy that institutionalizes terror, and it is understandable why most of Russia's neighbors do not like Moscow very much. A fair portion of Western history revolves around the formation and shifting of coalitions to manage Russian insecurities.

In the American case specifically, the issue is one of continental control. The United States is the only country in the world that effectively controls an entire continent. Mexico and Canada have been sufficiently intimidated so that they can operate independently only in a very limited sense. (Technically, Australia controls a continent, but with the some 85 percent of its territory unusable, it is more accurate in geopolitical terms to think of it as a small archipelago with some very long bridges.) This grants the United States not only a potentially massive internal market, but also the ability to project power without the fear of facing rearguard security threats. U.S. forces can be focused almost entirely on offensive operations, whereas potential competitors in Eurasia must constantly be on their guard about the neighbors.

The only thing that could threaten U.S. security would be the rise of a Eurasian continental hegemon. For the past 60 years, Russia (or the Soviet Union) has been the only entity that has had a chance of achieving that, largely due to its geographic reach. U.S. strategy for coping with this is simple: containment, or the creation of a network of allies to hedge in Russian political, economic and military expansion. NATO is the most obvious manifestation of this policy imperative, while the Sino-Soviet split is the most dramatic one.

Containment requires that United States counter Russian expansionism at every turn, crafting a new coalition wherever Russia attempts to break out of the strategic ring, and if necessary committing direct U.S. forces to the effort. The Korean and Vietnam wars -- both traumatic periods in American history -- were manifestations of this effort, as were the Berlin airlift and the backing of Islamist militants in Afghanistan (who incidentally went on to form al Qaeda).

The Georgian war in August was simply the first effort by a resurging Russia to pulse out, expand its security buffer and, ideally, in the Kremlin's plans, break out of the post-Cold War noose that other powers have tied. The Americans (and others) will react as they did during the Cold War: by building coalitions to constrain Russian expansion. In Europe, the challenges will be to keep the Germans on board and to keep NATO cohesive. In the Caucasus, the United States will need to deftly manage its Turkish alliance and find a means of engaging Iran. In China and Japan, economic conflicts will undoubtedly take a backseat to security cooperation.

Russia and the United States will struggle in all of these areas, consisting as they do the Russian borderlands. Most of the locations will feel familiar, as Russia's near abroad has been Russia's near abroad for nearly 300 years. Those locations -- the Baltics, Austria, Ukraine, Serbia, Turkey, Central Asia and Mongolia -- that defined Russia's conflicts in times gone by will surface again. Such is the tapestry of history: the major powers seeking advantage in the same places over and over again.

The New Old-Front

But not all of those fronts are in Eurasia. So long as U.S. power projection puts the Russians on the defensive, it is only a matter of time before something along the cordon cracks and the Russians are either fighting a land war or facing a local insurrection. Russia must keep U.S. efforts dispersed and captured by events as far away from the Russian periphery as possible -- preferably where Russian strengths can exploit American weakness.

So where is that?

Geography dictates that U.S. strength involves coalition building based on mutual interest and long-range force projection, and internal U.S. harmony is such that America's intelligence and security agencies have no need to shine. Unlike Russia, the United States does not have large, unruly, resentful, conquered populations to keep in line. In contrast, recall that the multiethnic nature of the Russian state requires a powerful security and intelligence apparatus. No place better reflects Russia's intelligence strengths and America's intelligence weakness than Latin America.

The United States faces no traditional security threats in its backyard. South America is in essence a hollow continent, populated only on the edges and thus lacking a deep enough hinterland to ever coalesce into a single hegemonic power. Central America and southern Mexico are similarly fractured, primarily due to rugged terrain. Northern Mexico (like Canada) is too economically dependent upon the United States to seriously consider anything more vibrant than ideological hostility toward Washington. Faced with this kind of local competition, the United States simply does not worry too much about the rest of the Western Hemisphere -- except when someone comes to visit.

Stretching back to the time of the Monroe Doctrine, Washington's Latin American policy has been very simple. The United States does not feel threatened by any local power, but it feels inordinately threatened by any Eastern Hemispheric power that could ally with a local entity. Latin American entities cannot greatly harm American interests themselves, but they can be used as fulcrums by hostile states further abroad to strike at the core of the United States' power: its undisputed command of North America.

It is a fairly straightforward exercise to predict where Russian activity will reach its deepest. One only needs to revisit Cold War history. Future Russian efforts can be broken down into three broad categories: naval interdiction, drug facilitation and direct territorial challenge.

Naval Interdiction

Naval interdiction represents the longest sustained fear of American policymakers. Among the earliest U.S. foreign efforts after securing the mainland was asserting control over the various waterways used for approaching North America. Key in this American geopolitical imperative is the neutralization of Cuba. All the naval power-projection capabilities in the world mean very little if Cuba is both hostile and serving as a basing ground for an extra-hemispheric power.

The U.S. Gulf Coast is not only the heart of the country's energy industry, but the body of water that allows the United States to function as a unified polity and economy. The Ohio, Missouri, and Mississippi river basins all drain to New Orleans and the Gulf of Mexico. The economic strength of these basins depends upon access to oceanic shipping. A hostile power in Cuba could fairly easily seal both the Straits of Florida and the Yucatan Channel, reducing the Gulf of Mexico to little more than a lake.

Building on the idea of naval interdiction, there is another key asset the Soviets targeted at which the Russians are sure to attempt a reprise: the Panama Canal. For both economic and military reasons, it is enormously convenient to not have to sail around the Americas, especially because U.S. economic and military power is based on maritime power and access. In the Cold War, the Soviets established friendly relations with Nicaragua and arranged for a favorable political evolution on the Caribbean island of Grenada. Like Cuba, these two locations are of dubious importance by themselves. But take them together -- and add in a Soviet air base at each location as well as in Cuba -- and there is a triangle of Soviet airpower that can threaten access to the Panama Canal.

Drug Facilitation

The next stage -- drug facilitation -- is somewhat trickier. South America is a wide and varying land with very little to offer Russian interests. Most of the states are commodity providers, much like the Soviet Union was and Russia is today, so they are seen as economic competitors. Politically, they are useful as anti-American bastions, so the Kremlin encourages such behavior whenever possible. But even if every country in South America were run by anti-American governments, it would not overly concern Washington; these states, alone or en masse, lack the ability to threaten American interests ... in all ways but one.

The drug trade undermines American society from within, generating massive costs for social stability, law enforcement, the health system and trade. During the Cold War, the Soviets dabbled with narcotics producers and smugglers, from the Revolutionary Armed Forces of Colombia (FARC) to the highland coca farmers of Bolivia. It is not so much that the Soviets encouraged the drug trade directly, but that they encouraged any group they saw as ideologically useful.

Stratfor expects future Russian involvement in such activities to eclipse those of the past. After the Soviet fall, many FSB agents were forced to find new means to financially support themselves. (Remember it was not until 1999 that Vladimir Putin took over the Russian government and began treating Russian intelligence like a bona fide state asset again.) The Soviet fall led many FSB agents, who already possessed more than a passing familiarity with things such as smuggling and organized crime, directly into the heart of such activities. Most of those agents are -- formally or not -- back in the service of the Russian government, now with a decade of gritty experience on the less savory side of intelligence under their belts. And they now have a deeply personal financial interest in the outcome of future operations.

Drug groups do not need cash from the Russians, but they do need weaponry and a touch of training -- needs which dovetail perfectly with the Russians' strengths. Obviously, Russian state involvement in such areas will be far from overt; it just does not do to ship weapons to the FARC or to one side of the brewing Bolivian civil war with CNN watching. But this is a challenge the Russians are good at meeting. One of Russia's current deputy prime ministers, Igor Sechin, was the USSR's point man for weapons smuggling to much of Latin America and the Middle East. This really is old hat for them.

U.S. Stability

Finally, there is the issue of direct threats to U.S. stability, and this point rests solely on Mexico. With more than 100 million people, a growing economy and Atlantic and Pacific ports, Mexico is the only country in the Western Hemisphere that could theoretically (which is hardly to say inevitably) threaten U.S. dominance in North America. During the Cold War, Russian intelligence gave Mexico more than its share of jolts in efforts to cause chronic problems for the United States. In fact, the Mexico City KGB station was, and remains today, the biggest in the world. The Mexico City riots of 1968 were in part Soviet-inspired, and while ultimately unsuccessful at overthrowing the Mexican government, they remain a testament to the reach of Soviet intelligence. The security problems that would be created by the presence of a hostile state the size of Mexico on the southern U.S. border are as obvious as they would be dangerous.

As with involvement in drug activities, which incidentally are likely to overlap in Mexico, Stratfor expects Russia to be particularly active in destabilizing Mexico in the years ahead. But while an anti-American state is still a Russian goal, it is not their only option. The Mexican drug cartels have reached such strength that the Mexican government's control over large portions of the country is an open question. Failure of the Mexican state is something that must be considered even before the Russians get involved. And simply doing with the Mexican cartels what the Soviets once did with anti-American militant groups the world over could suffice to tip the balance.

In many regards, Mexico as a failed state would be a worse result for Washington than a hostile united Mexico. A hostile Mexico could be intimidated, sanctioned or even invaded, effectively browbeaten into submission. But a failed Mexico would not restrict the drug trade at all. The border would be chaos, and the implications of that go well beyond drugs. One of the United States' largest trading partners could well devolve into a seething anarchy that could not help but leak into the U.S. proper.

Whether Mexico becomes staunchly anti-American or devolves into the violent chaos of a failed state does not matter much to the Russians. Either one would threaten the United States with a staggering problem that no amount of resources could quickly or easily fix. And the Russians right now are shopping around for staggering problems with which to threaten the United States.

In terms of cost-benefit analysis, all of these options are no-brainers. Threatening naval interdiction simply requires a few jets. Encouraging the drug trade can be done with a few weapons shipments. Destabilizing a country just requires some creativity. However, countering such activities requires a massive outlay of intelligence and military assets -- often into areas that are politically and militarily hostile, if not outright inaccessible. In many ways, this is containment in reverse.

Old Opportunities, New Twists

In Nicaragua, President Daniel Ortega has proven so enthusiastic in his nostalgia for Cold War alignments that Nicaragua has already recognized Abkhazia and South Ossetia, the two territories in the former Soviet state (and U.S. ally) of Georgia that Russia went to war to protect. That makes Nicaragua the only country in the world other than Russia to recognize the breakaway regions. Moscow is quite obviously pleased -- and was undoubtedly working the system behind the scenes.

In Bolivia, President Evo Morales is attempting to rewrite the laws that govern his country's wealth distribution in favor of his poor supporters in the indigenous highlands. Now, a belt of conflict separates those highlands, which are roughly centered at the pro-Morales city of Cochabamba, from the wealthier, more Europeanized lowlands. A civil war is brewing -- a conflict that is just screaming for outside interference, as similar fights did during the Cold War. It is likely only a matter of time before the headlines become splattered with pictures of Kalashnikov-wielding Cochabambinos decrying American imperialism.

Yet while the winds of history are blowing in the same old channels, there certainly are variations on the theme. The Mexican cartels, for one, were radically weaker beasts the last time around, and their current strength and disruptive capabilities present the Russians with new options.

So does Venezuelan President Hugo Chavez, a man so anti-American he seems to be even a few steps ahead of Kremlin propagandists. In recent days, Chavez has already hosted long-range Russian strategic bombers and evicted the U.S. ambassador. A glance at a map indicates that Venezuela is a far superior basing point than Grenada for threatening the Panama Canal. Additionally, Chavez's Venezuela has already indicated both its willingness to get militarily involved in the Bolivian conflict and its willingness to act as a weapons smuggler via links to the FARC -- and that without any heretofore detected Russian involvement. The opportunities for smuggling networks -- both old and new -- using Venezuela as a base are robust.

Not all changes since the Cold War are good for Russia, however. Cuba is not as blindly pro-Russian as it once was. While Russian hurricane aid to Cuba is a bid to reopen old doors, the Cubans are noticeably hesitant. Between the ailing of Fidel Castro and the presence of the world's largest market within spitting distance, the emerging Cuban regime is not going to reflexively side with the Russians for peanuts. In Soviet times, Cuba traded massive Soviet subsidies in exchange for its allegiance. A few planeloads of hurricane aid simply won't pay the bills in Havana, and it is still unclear how much money the Russians are willing to come up with.

There is also the question of Brazil. Long gone is the dysfunctional state; Brazil is now an emerging industrial powerhouse with an energy company, Petroleo Brasileiro, of skill levels that outshine anything the Russians have yet conquered in that sphere. While Brazilian rhetoric has always claimed that Brazil was just about to come of age, it now happens to be true. A rising Brazil is feeling its strength and tentatively pushing its influence into the border states of Uruguay, Paraguay and Bolivia, as well as into regional rivals Venezuela and Argentina. Russian intervention tends to appeal to those who do not feel they have meaningful control over their own neighborhoods. Brazil no longer fits into that category, and it will not appreciate Russia's mucking around in its neighborhood.

A few weeks ago, Stratfor published a piece called "The New Era" detailing how U.S. involvement in the Iraq war was winding to a close. We received many comments from readers applauding our optimism. We are afraid that we were misinterpreted. "New" does not mean "bright" or "better," but simply different. And the dawning struggle in Latin America is an example of the sort of "different" that the United States can look forward to in the years ahead. Buckle up

Your Grinning-and-Bearing-It Analyst,

John Mauldin
Frontlinethoughts.com

Note: John Mauldin is president of Millennium Wave Advisors, LLC, (MWA) a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staff at Millennium Wave Advisors, LLC may or may not have investments in any funds cited above. Mauldin can be reached at 800-829-7273. MWA is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB). John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS) an NASD registered broker-dealer. Millennium Wave Investments is a dba of MWA LLC and MWS LLC. Funds recommended by Mauldin may pay a portion of their fees to Altegris Investments who will share 1/3 of those fees with MWS and thus to Mauldin. For more information please see "How does it work" at www.accreditedinvestor.ws. This website and any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement or inducement to invest with any CTA, fund or program mentioned. Before seeking any advisors services or making an investment in a fund, investors must read and examine thoroughly the respective disclosure document or offering memorandum. Please read the information under the tab "Hedge Funds: Risks" for further risks associated with hedge funds.

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John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staffs at Millennium Wave Advisors, LLC may or may not have investments in any funds cited above.

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