Monday, March 11, 2013

Report from WorldAffairs 2013 in San Francisco

I was honored when the World Affairs Council of Northern California invited me to attend their WorldAffairs 2013 conference as a member of their first-ever Veteran Fellowship Program.  The WAC wants its members to benefit from the experiences of military veterans from our recent conflicts.  I attended every session of this conference last week and gathered wisdom straight from the mouths of thought leaders.  My summaries of the key speakers' comments are in regular text, so attribution is implied, and my own observations are in italics.

CEO Jane Wales introduced some of the transitions, disruptions, and innovations we could expect to encounter at the conference.  She emphasized that governance is the management of shared problems and stewardship of shared resources.  Of all things, that reminded me of a line from President Bill Clinton's second inaugural address that government is not the problem nor the solution (neither of which he defined at that time).  Social contracts are contested worldwide; Egypt held elections before it had ratified a constitution, so there was no social contract for the elections to validate.  Climate change is the ultimate disruption, requiring us to set aside biases and work together.  Readers of my Alfidi Capital blog know that I have expressed skepticism of anthropocentric climate change theories.  Skepticism is the minority view among the world's policymaking elite, so the rest of us must live with carbon trading and more stringent environmental regulation.

John Steinbruner keynoted on climate change, an appropriate enough transition from the introduction.  He broke down the scientific understanding of carbon dioxide into the thesis that CO2-driven thermal impulses drive energy imbalances throughout Earth's history, and the thermal imbalance projected for our time is running late.  We cannot presume an effort to mitigate this thermal impulse will take effect in time to moderate global geophysical changes.  I disagree; there's a ton of literature on mitigating climate change and plenty of lobbying money available from the sectors who can profit from implementing countermeasures.  The UN has made climate change mitigation an international norm.  The World Bank is promoting investment in mitigation technologies.  Businesses who want to make some easy money can jump on this bandwagon.  Pakistan is at the forefront of the coming thermal impulse because Himalayan runoff sets its dependence on the Indus River watershed.  Reduced Indus River water flows will complicate Pakistan's water delivery tradeoff between agriculture and hydropower.  What happens if Pakistan can't solve its water crisis?  Regimes faced with insoluble (no pun intended) domestic problems often resort to nationalism and aggression.  This may be sufficient incentive for India to share water resources more generously with Pakistan, but India has its own tremendous need for water.  Climate change will induce failed states, prompting instability and intervention.  Instability may not always be followed by intervention.  India could easily intervene in Pakistan, either benevolently by sharing water or in response to Pakistani provocation.  Israel and the Palestinians will face water conflicts but no armed Arab coalition has ever been able to force Israel to do anything.  Mr. Steinbruner warns us not to count on global political leaders to initiate a globally integrated response.  Volcano eruptions have shown us how sulfate aerosol injections into the stratosphere counteract CO2's warming effect.  The 1991 Mount Pinatubo eruption is a good example.  These injections are no substitute for mitigation because they risk acidification of the oceans that will alter the global food chain.  Aw come on, ashen fish will be the new delicacy, just like blackened redfish once took the culinary world by storm.  I'm allowed to be sarcastic.  Mr. Steinbruner's preferred solution for converting our hydrocarbon economy to a non-calamitous mode is the massive expansion of nuclear power using small reactors, because biomass energy won't be sufficient by itself.  I wonder if he's referring to molten salt reactors using liquid salt thorium.  Mr. Steinbruner dropped a bombshell when he said the member of the intelligence community who sponsored his NAS briefing was publicly outed in a possible attempt to derail his report.  It's a shame that the intelligence community does this to itself.  Sponsors should be more discreet.

Mr. Steinbruner's talk gave me, a climate change skeptic, plenty of food for thought.  Addressing climate change is similar to making Pascal's Wager on the existence of an omnipotent supreme being.    Betting on accommodating climate change and being wrong has far more favorable consequences than betting against its existence and being wrong.  The trouble with mitigation lies in game theory; the first advanced economy to opt out of a climate control regime will attract a burst of short-term investment from hydrocarbon energy producers.  That's why the UN and World Bank are creating norms and incentives to minimize the chance that major carbon-generating nations will opt out of things like carbon credit trading even if emerging economies refuse to opt in.  There's plenty of money to be made from the move to a mitigation regime.  Lawrence Livermore National Laboratory has plenty of carbon-related projects begging for investors and entrepreneurs to turn them into businesses.  The use of carbon injection in oil and gas fracking sounds like a win-win for both carbon sequestration and energy production, provided it doesn't cause small earthquakes.  Carbon control will work best when it's subject to free market incentives.  Let traders make markets on carbon products.  

I elected to attend a panel with Daniel Sneider and Jonathan Penby on "China's Economy:  A Genuine U.S. Rival?"  Alfidi Capital blog readers know I sold off my remaining Chinese equity holdings last year out of alarm over that economy's malinvestment and questionable data.  Mr. Fenby noted that the partial market reforms of Deng Xiaoping have pulled more people out of poverty than ever before in history.  Views of China's future as either "collapse" or "world ruler" are flawed because it will remain poorer than the U.S. on a per capita basis even if its GDP becomes the world's largest.  China's leadership knows double-digit growth isn't sustainable; IMHO the massaged growth figures from China's statisticians are clumsy efforts at managing expectations.  The "pig cycle" in food is the foundation of China's economy.  That means every year should be the Year of the Pig in the Chinese zodiac, oink oink.  Bad loans and the shadow banking system raise the first-ever possibility of defaults on China's sovereign-backed debt.  Actually, previous Chinese governments have defaulted on debt in the 1920s and '30s, so this will be the first Communist default.  China's growth is a political story that legitimizes the monopolistic role of the Communist Party but needs a new model besides building infrastructure.  Agriculture is their Achilles' heel because one bad harvest will wreck the economy.  China prices its water and energy so cheaply that waste creates shortages.  This means re-pricing it to reflect scarcity will curtail growth and increase price inflation.  There's no way out of it!  Any reforms would affect vested interests of Party insiders and cause short term stagflation.  Party leaders are terrified that any reform will start a Gorbachev-style implosion.

The discussion moved from development to its effects on strategy and social structure.  China is "people rich and resource poor."  Resource scarcity at home drives China's resource acquisition strategy in Africa.  China often imports its own workers for its projects in Africa, which is no help to local employment.  I had no idea.  A recent hacking intrusion in the U.S. was traced to a Chinese university campus near the PLA's cyberwar HQ.  Most protests are local, single issue, and often environmentally focused.  The Party has successfully co-opted the middle class, so revolution to upset the existing regime or a repeat of the 1989 uprising is unlikely.  The last thing a secure middle class wants is seven hundred million peasants threatening their social status with demands for democracy.  The most powerful ideologies in China today are materialism and nationalism.  Failure to deliver materialism means the regime will be tempted to overcorrect by pushing nationalism.  A slow growth model in China can't meet rising expectations unless population falls rather dramatically.  This makes military aggression inevitable.  

Addressing China's military is always fun.  Mr. Fenby thinks the PLA is inefficient, technologically backward, and heavily politicized.  IMHO Westerners need to realize that China's concept of joint warfare is immature because ground-based operations predominate over everything.  The navy and air force are considered subordinate arms of the PLA.  The army's origins as the muscle behind Mao's Long March to unification count for everything in the strategic emphasis of Chinese warfighting doctrine.  Mr. Fenby thinks the PLA is not an independent political actor.  I disagree.  China's PLA owes much to the Long March but has also never quite shed the warlord impulse among its generals.  The maiden flight of the Chengdu J-20 stealth fighter went right over President Hu Jintao's head to his apparent surprise.  Mr. Fenby doesn't subscribe to the theory that China uses North Korea to provoke the U.S.  It's more likely that they fear a unified Korea allied with the U.S., which would mean they fought the Korean War in vain to keep the U.S. away from the Yalu River.  China does not control the DPRK in the way the Soviet Union controlled the Warsaw Pact, but it does exert enough influence to moderate Pyongyang's behavior.  The good news is that Beijing is fed up with Pyongyang's more extreme antics.

The risk of debt default in China is largely with the shadow banking system because state-owned banks can be ordered to bail out bad banks.  We went through our own version of this in the U.S., where the SIFIs aren't state-owned but our regulators and politicians are bank-owned.  It's a distinction without much of a difference.  Anti-corruption campaigns go nowhere be cause they threaten the wealth that Part leaders have amassed.  Police don't stop cars marked with military plates, which is why those plates are for sale on the black market.  Privileges that can be commoditized will always be abused.

I wasn't able to attend the concurrent focus sessions on left-leaning Latin America and inevitable climate change, so someone else will have to publish whatever lessons they learned.  The next keynote was from Chris Anderson on the Maker Revolution.  Folks, being a maker is the next big thing and is sustainable in a way that dot-com models and home equity will never be.  He had an older model, producing a plastic toy.  Life expectancy and population size were constants for much of human history until the Industrial Revolution.  Makers are leading the third phase of this revolution by combining desktop manufacturing, digital design, and cloud computing.  Anyone can download apps that will allow you to capture an image with your smartphone, modify the image as a 3D mesh scan, and port that scan to a manufacturer.  Crowdfunding participation accelerates market research for a new prototype.  I get the creative commons licenses covering common generic designs, but there is huge potential for IP owners to use lawfare against designers who infringe on copyrights with careless scanning.  That is how big traditional manufacturers will try to shut down maker sites.  Mr. Anderson's best insight was that globalization is driven by labor arbitrage.  Labor costs have declined as part of a finished product's value chain.  Arbitrage via global labor differentials becomes less of a factor in sourcing production.  Time arbitrage becomes the new deciding factor in production.  This puts a whole new spin on speeding products to market.  Faster entrants who modify simple images into designs will win in the additive manufacturing space.  

Additive printing adds material layer by layer, which means they can fall apart by layer.  This is why the recent controversy over printing firearms parts in 3D is overblown.  The firearm will blow up on first use.  Delamination is the limiting characteristic of what 3D printing can make.  This rules out 3D printing for parts subject to stress from torque or temperature.

Mr. Anderson switched gears quickly to the coming proliferation of drones.  Additive manufacturing will make lots of cheap drones available for everyone.  He thinks agriculture is a big potential drone market because drones can be programmed to conduct daily automated crop surveys, allowing instant decisions on farm management techniques like pesticide application and irrigation.  The cost savings to farmers from pesticide reduction and water conservation will be huge, more than the cost of printing a drone and crowdsourcing its navigation app.  He closed by pointing out the future of education at Khan Academy and Udacity, although schools that adopt his suggestion of plugging a 3D printer into their computer lab will of course accelerate their own obsolescence.  If that's the stalking horse, it's a good one.

That was just the first day, March 7.  Friday's action was even more fun.  I fulfilled my obligation as a Veteran Fellow by hosting a Friday morning breakfast table discussion on the sustainability of China's rise as a world power.  I thank the very thoughtful people who shared my table for many ideas:  the potential for conflict between China and its neighbors, especially India; China's access to water; the capabilities of its slightly used aircraft carrier; the state of its rare earth metal mining sector; and plenty of other food for thought.  Speaking of food, the St. Regis Hotel's catering kitchen is pretty good.

The Friday morning keynote on the U.S. fiscal crisis brought Laura Tyson over from U.C. Berkeley and Gillian Tett from the Financial Times.  Ms. Tyson had good facts on the macro economy but I disagree with her dismissal of inflation.  She may be unaware that the BLS has underreported the CPI for decades with hedonic adjustments and other tricks.  She even thinks the U.S. doesn't have a real fiscal crisis.  I wish I could show her the Reinhart/Rogoff point we crossed when our nation passed 90% debt/GDP over a year ago.  I hope she returns to this conference after we have our Minsky Moment.  I guess someone had to represent the Paul Krugman camp of spending our way to prosperity.

Ms. Tett was up next, putting economies into their socio-political context.  BTW, she was really attractive.  I can't help but notice, plus her British accent made me think of some of Doctor Who's cute assistants.  Okay, enough of that, let's summarize what she said.  Troubled economies grapple with dysfunctional political systems.  Moderation broke into turbulence in 2007, and now we face brinksmanship and gridlock. Europe's postwar politics forced incremental change by consensus.  The Eurozone is fractured between its elite and masses.  The ECB has forestalled crisis but reform doesn't happen without discomfort.  I admit I'm unsure of what she meant; the ECB doesn't have powers comparable to the Fed that would enable it to force reform, regardless of anyone's comfort level.  IMHO Europe's problem is not just lack of federal integration; they simply have too much debt.

Ms. Tyson and Ms. Tett went back and forth on the 2008 financial crisis.  I disagree with their use of the word "unprecedented."  History gives us plenty of precedent for regimes where excessive debt and political capture lead to financial repression and currency debasement.  Ms. Tett combined two related observations.  First, war is an effective crisis-solving strategy by creating a national rallying cry against a clear threat.  Second sacrifice requires social cohesion.  In other words, war forces cohesion and enables solutions to previously impossible problems.  Whether those solutions are efficient, legal, or even moral is left to be addressed by historians.  Ms. Tyson noted just how impossible it is to solve our problems given our political structure.  She mentioned Nate Silver's analysis that Congressional incumbents are vulnerable to extremist challenges, inhibiting compromise.  She also said that support for compromise outside the political process doesn't penetrate the Beltway.  In other words, we're in an "ancien regime" scenario and the breaking point will bring us something we probably haven't seen before as a crisis-resolution mechanism.  Germany flirted with letting Greece leave the euro in 2012, and now they hide the cost of the bailout from their own taxpayers.  It doesn't hurt yet because this cost ensures a benefit to German exporters from keeping Greece in the euro; when the hurt becomes to large to ignore, Germans will revolt and Greece will see the brightly lit exit sign.  My impression of this panel is that the participants were circumscribed by the known boundaries of elite consensus thinking at this time.  They can't break out with the kind of discontinuous solutions that would solve our perpetual financial crises - shrink the Eurozone, bankrupt some TBTF SIFIs, end the Fed's QE - because elites at Davos, Bilderberg, and other locales feel the muddled status quo is working out just fine.  People inside an unsustainable status quo usually can't see the stress fractures until it's too late.  Just ask anyone who thought the Palace of Versailles was a safe refuge in 1789.  

Next up was a panel on assessing the U.S.'s top security challenges.  Pakistan is a failed state and problem for the U.S. but more development aid sure would be nice.  I disagree.  Pakistanis by and large despise the U.S.  They are very willing to accept our relief aid in natural disasters but this has never changed their attitudes.  The hatred is cultural and endemic thanks to the radicalization of much of Pakistan.  Aid won't fix it IMHO.  It reminds me of the "who lost China" debate in the late 1940s, as if some mythical level of American intervention anywhere (except a totally defeated and psychologically exhausted belligerent like Germany, Italy, or Japan after WWII) can determine every nation's destiny.  BTW, any endorsement of developmental aid for Pakistan must account for the enormous Saudi funding of Pakistani madrasas that create radical mullahs.  

The panel noted that anti-drone reports are often colored by Pakistanis who want to portray them as negatively as possible.  The U.S. military has assessed that drone trikes cause very little collateral damage.  The U.S. may have the moral high ground after all but we can only help our own case by publicizing drone missions.  The "evil drone user" meme plays into the hands of radical Islamic operatives' information operations campaign directed against U.S. allies who might otherwise permit drone use.  

Syria is a problem, with the civil war now destabilizing its neighbors.  See what happens when we start arming and training "freedom fighters" with no clue as to their true intentions?  Israel is far more secure with the Assads in power.  Radical Islamists taking over Damascus will make everyone nervous.  The West has learned nothing about the Middle East.  Even Laura Tyson admitted during her panel that the West can succumb to confirmation bias when it sees pro-democracy aspirations where there are none.  

Iran is a different problem.  They have no nuclear weapon now but the West has few military options to play.  Tehran can play an oil supply shock, which will IMHO hurt themselves more than anyone else.  A U.S.-Israel bombing campaign will rally Iranians to their regime, consistent with the conclusion of every strategic bombing study the U.S. has ever undertaken.  IAEA's continuing inspections give the world insight into whether Iran will make a final weaponization decision and close off diplomatic options.  Iran does not have free elections; the Supreme Leader makes the important decisions.  The Arab Spring embarrasses Iran.  The Green Revolution opposition wants the U.S. to stay out of direct involvement in Iran's internal affairs and criticizes the sanctions for hurting the Green presence among the middle class.  The Gulf Arab states quietly urge the U.S. to attack Iran, sort of like elementary school kids who have fun goading bigger kids into a fight.  Israel is not likely to strike Iran as long as their military intelligence establishment is not fully on board.  It's been a while since I checked DEBKAfile; they were prescient in the run-up to the U.S. invasion of Iraq.

I should mention that some local high school students gave a great presentation on their simulation of a peaceful resolution of a crisis in Africa.  I remember my own participation in Model U.N. meetings in high school.  This kind of thing is a fun and safe way to introduce future thought leaders to the policy community. They even produced a newsletter just for this conference, with a photo of our Veteran Fellows prominently featured.  The kids are alright.

The after-lunch keynote from Fouzia Saeed on the women's movement in Pakistan was inspirational.  Pakistani women face daily harassment and honor killings still occur.  One of her key innovations was to convince bank regulators to include sexual harassment policies in their bank audits.  This movement for equality is IMHO one of the few forces stabilization preventing Pakistan from collapsing into all-out radical Islam.  Moderates and professionals who remain engaged in civic life are a bulwark against nutcase mullahs.  She noted that the activist paradigm does not see problems the same way as the development paradigm.  Discrimination crosses the rich/poor, urban/rural divides (unlike development, which focuses on the poor).

I hit up another focus panel on China's new leadership.  The new government is four months old and hit an early populist success with a ban on alcohol consumption in the military.  Economic policy is typically rolled out at the Third Plenum in October, so the world will see then whether reformist claims are true.  The Deng template gave incentives to city and province leaders in the Party who built support for his reform agenda.  Rhetoric supporting the rule of law has not yet been translated into policy action.

China since 2009 has increasingly used coercive diplomacy and maritime patrols to try to change accepted facts of sovereign claims to territory.  Chinese civilian policymakers have become more belligerent while military leaders have remained restrained and concerned with controlling escalations.  China's Foreign Ministry is not the source of foreign policy, which is driven by domestic politics.  China used to rein in its military ambitions so it's economic growth wasn't jeopardized.  Now it shows a greater willingness to risk escalation.  The lack of an NSC-type body makes final authority less clear and risks miscalculation.  The U.S. and China are aware they are in a strategic rivalry, so Washington must confine this rivalry to a manageable level.

Here comes the most important revelation of this particular panel.  A major soil pollution survey is a Chinese state secret!  The public release of the amount of arable land taken out of production by heavy metal contamination would be alarming.  I believe American national strategists should closely follow the statistics on food exports from the U.S. to China.  This will establish the susceptibility of China to U.S. pressure, much like the Soviet Union's dependence on U.S. wheat during the Cold War.  The risk for the U.S. is that applying resource pressure can backfire if the target's dependency is extreme.  The U.S, slapped an oil embargo on Japan that precipitated its decision to strike Pearl Harbor.  Using food as a strategic lever against China can risk open conflict!  The good news is that China is not yet engaged in a massive pre-war military buildup despite 15 years of an increasing military budget.  China doesn't even produce aircraft engines domestically and Russia doesn't sell China its most advanced weapons.  .
China is notably allowing U.N. Security Council discussions of sanctions against North Korea.  China lost face when North Korea defied its request not to test ballistic missiles.  China's contribution to the Korean War isn't even acknowledged in North Korea's museums.  Ouch!

One audience member in the China panel made a brilliant observation that China's pursuit of a comprehensive area denial strategy, its presence in Pakistan's Quetta port, and its support for a Myanmar pipeline that will enable it to bypass sanctions will all reach a culmination point in 2025.  I will have a lot more to say about these and other strategic thrusts in future blog posts.  China is an emerging threat to India, Japan, South Korea, and the U.S.  Analysts cannot ignore these developments.

Someone asked about the fate of Tibet.  Maybe they attended too many of those Tibetan freedom concerts that never freed Tibet.  The panel noted that China is 92% Han ethnicity and there is no doubt that Tibet will remain part of China.  Tibet is strategically critical to China's national survival.  So is Xinjiang.  There is no chance that these theoretically non-integrated regions will separate politically from the People's Republic of China.  This is true in the absence of an existential threat, but things can change when a threat fulfills its potential.  It is difficult but not impossible to imagine events that would result in the breakup of China into several parts.  Plenty of Western analysts missed the breakup of the Soviet Union.  

The closing keynote address of the conference belonged to Fareed Zakaria.  He ran through the ups and downs of the last three decades of the U.S.'s political and economic history in parallel with his own career progress as a policy analyst.  Civilization is resilient.  The end of the Cold War has brought a political and economic convergence in which the "rise of the rest" brings competition for the West.  Authoritarian regimes in the Middle East are imperiled by the Information Revolution.

The most worrying U.S. statistic for Mr. Zakaria is that it now takes much longer for employment to return to pre-recession levels than ever.  Technology is now much more productive with less skilled labor.  He thinks the U.S.'s demographic growth will eventually drive a new housing boom.  I think there's more to housing than demographics.  Stagnant incomes and huge student loan debts are serious counterweights to any demographic impulse to leave the nest.  The nations' existing housing stock is at an all-time high with banks still holding shadow inventory and interest rates bound to rise in the future.  Sorry, folks, but twentysomethings are staying in the nest.  He recognizes that the U.S. government is terrible at VC-type investing but can do large-scale basic research on energy technology.  Indeed, I agree.  He correctly traces the Arab Spring to economic anxiety over food price inflation.  I'd like to see more mainstream analysts make the ultimate connection to the Fed's QE driving hedge fund money into hard assets and private equity into farmland.  I also suspect analysts will have to walk back claims that Arab Spring bribery was more effective than repression once they consider the Peninsula Shield Force's action in Bahrain.

Mr. Zakaria's analysis of Syria was a breath of fresh air.  Imposing a no-fly zone will not restrain the regime because almost all of the fighting is in urban areas.  Many weapons handed to the insurgents have already ended up in the hands of Kurdish rebels fighting in Turkey.  The Alawites are 12% of Syria's population and are fighting because they fear a massacre if the regime is defeated.  The insurgents are very factionalized and there are few desertions from the Syrian army.  I am very impressed with his analysis.

He noted that Iran (and Persia) have practiced sophisticated statecraft for 5000 years.  They won't just give up under pressure from the U.S.  Our President's negotiating room is limited by likely criticism from political opponents.  This guy was on a roll.  Development aid goes farther when targeted to women.  Women enrich intellectual conversations but but men still tend to dominate mixed conversations.  I'm not sure which group of developing countries he meant with these remarks.  The U.S. experience in Afghanistan shows that development aid in a xenophobic, patriarchal society will be misappropiated by men and never get to women.  If it does get to women, they may even reject it if it disrupts their accepted roles in rural life.  Some countries are just really tough nuts to crack.  Mr. Zakaria had one good academic anecdote from the informal mantra of Harvard University academic committee meetings:  "Everything has been said, but not everyone has said it."  Harvard sounds like a civilization ruled by windbag egotists.  Mr. Zakaria escaped, to his credit and our benefit.

This was a totally awesome conference.  I'm grateful for the chance to host a discussion table and I will definitely be involved in the World Affairs Council for many years to come.  See you all next year.