Editor's Note: Our third quarter forecast is intended to be a supplement to our annual forecast and second quarter forecast. Here we have extracted the critical global trends identified in our previous forecasts and indicated what is coming in the next three months.
The most important geopolitical issue continues to be the global economy and how the recession is reshaping the global economic system. From the beginning of the subprime crisis, STRATFOR has held the view that while the financial havoc will be substantial, the recession that results from it will be fairly routine in terms of post-war recessions. It might last a bit longer, go down a bit more, but it would not shift the cycles that have been in place since World War II. We are comfortable with our prediction for the United States. Since World War II, a variety of models have succeeded each other within the dominant general paradigm of growth and rapid technological innovation. There have been sub-cycles of expansion and recession ending in 1948, 1970, 1982 and 2000. Each of these had very different patterns, but all of them had far more in common than any had with pre-war models. Our view is that the newest sequence of this post-war pattern is emerging, but that the post-war paradigm itself has not changed. In this sense, we are comfortable that the United States is beginning to emerge from its recession, but that deleveraging — what economists have taken to calling paying off debts — will continue to retard economic growth. There is a huge distinction between this and the catastrophic busts prior to World War II. As we once put it at the beginning of this crisis, this isn't the big one. This quarter will begin showing that. However, what is true for the United States is not necessarily so for the rest of the world. Europe is trying to come to grips with the fact that its multi-national institutions seized up, and that each nation-state had to sort things out for itself. They will grope for a way to deal with these challenges this quarter. The Chinese are facing the uncomfortable fact that being the ultimate exporter of goods makes them the ultimate candidate for unemployment when other economies decline. And in the Russian participation in the Opel bailout, we see the Russians pulling together assets from their own battered economy to tie the Germans even closer to them. This is part of a broader Russian effort to roll back U.S. influence by increasing its power all along its periphery — from Central Asia and the Caucasus to Germany and the Baltic states. Most of Russia's tools in this effort have not been weakened in the slightest by the economic downturn, even though by most measures the recession has been far more crushing in Russia than in the United States or even Europe. While Moscow still has some damage control to take care of on the economic front, it also has a busy foreign policy agenda. Left with a bad taste in its mouth from its recent negotiations with U.S. President Barack Obama, Russia will focus its attention in the next quarter on complicating U.S. relations with key countries — namely Poland, Germany, Turkey and Iran. Russia's relationship with Iran, in particular, bears close watching in the coming weeks and months. Washington is already hitting a dead end in its negotiations with Iran and a surge of Russian influence in Iran will only exacerbate Washington's ongoing struggle in the Islamic world. These dynamics aside, the name of the global game remains the economy. We expect this to be the quarter in which the United States at least begins its long climb out of the hole it has been in — the time when things stop getting worse — while for other countries, good times will be long in coming.
The trajectory of the global economy depends largely on how well — and how soon — the United States recovers from recession. East Asian manufacturing- and export-oriented economies are paying particularly eager attention to American developments, while the more diversified economies of Europe are actually likely to be left behind somewhat. Meanwhile, oil-exporting Middle Eastern states like Saudi Arabia and Kuwait are putting their large cash reserves to use while looking for solid evidence of a U.S. recovery that can sustain the price of oil. There might not be irrefutable evidence of a recovery yet, but the U.S. economy is displaying some positive signs. When evaluating the condition of the U.S. economy, STRATFOR considers four factors: the presence of any systemic shocks, the stock markets (a leading indicator), new unemployment benefits claims (a lagging indicator) and the balance between retail sales and inventories (a mixed lagging/leading indicator). In the second quarter, these measures were positive. The biggest shock to the U.S. economy we saw was the failure of two of the three major U.S. automakers. The glory days of the American automotive sector are firmly in the past, and liquidation is probably an economic necessity in the long run. But an immediate liquidation would trigger so many job losses that talk of any economic recovery in 2009 would end. The government-brokered bankruptcy/bailout packages, while starting the industry down the road to liquidation, will defer most of the pain to another day. In essence, what is left of the sector is being put on a sort of government-funded life support. This will cost the United States in economic efficiency overall, but should delay the pain sufficiently so that the automakers' eventual liquidation will not unduly hamper what STRATFOR sees as a building recovery in the latter half of 2009. The S&P 500 Index is now up more than 30 percent since its low in March, in sharp contrast to the volatile and distressing performance of the previous six months. As stock market performance tends to be a leading indicator, this is very positive news. New unemployment claims in the United States — after a year of tracking higher — have stabilized, and have now fallen considerably from their March highs. While still uncomfortably high at 565,000 — anything over 400,000 indicates a weak labor market — unemployment claims are moving in the right direction and are a lagging indicator, one of the last things that improves as the economy mends. Against all odds, retail sales have held relatively steady — almost all of the drops of the past year were limited to gasoline and automobile sales — indicating that while American consumers have been rattled, they have not been fundamentally damaged. With inventories continuing to drop and retail sales holding steady, we are coming closer to the point where retailers will have to initiate orders to fill their shelves — a development which would stimulate production and with it employment. Moreover, we are already seeing positive movement in various manufacturing indices. In fact, in both May and June, even automobile sales were positive for the first time since the recession began. Considering these factors together, STRATFOR is cautiously optimistic for American economic growth in the third quarter. But this does not mean we expect strong growth. Data from the U.S. Federal Reserve indicates that growth in bank lending has yet to return to pre-recession levels. Until private credit is flowing again, the economy will find healing difficult. (click image to enlarge) In the broader international picture, there are signs that the credit environment is loosening, and while it is an overstatement to say that this is fixing everything, the increasing availability of credit is certainly mitigating the recession's effects. At the height of the panic in September 2008, money from all over the world flooded into short-term U.S. government bonds, widely considered the safest and most liquid asset in the world (next to simply holding cash). In the second quarter of 2009, that flow began reversing. Confidence is rising somewhat and it is leading investors to begin — tentatively — to seek out opportunities. Such action is how global recessions usually begin easing. And there is more than private investment at work. The International Monetary Fund (IMF) has used two programs to stabilize a broad array of emerging economies. The IMF has allotted $48 billion to help reform mismanaged economies in need of major surgery, and has earmarked another $52 billion for credit lines for states whose management has been sound but simply got caught up in the global recession. Taken together, these factors tell us that not only has the U.S. economy experienced a substantial improvement since the first quarter, but that there is now reason to begin feeling some cautious optimism about the rest of the global economy. But not everything is cause for cautious optimism. In fact, Europe — after four consecutive quarters of negative growth more than twice as harsh as what the United States has suffered — is just now beginning its recession. The European banking system faces far more numerous and far more severe problems than its U.S. counterpart, and is only beginning to notice that its problems existed long before the American-triggered credit crunch. If the third quarter proves to be less distressing for the Europeans than the first half of the year, it will only be because rising demand in the United States is assisting their export markets. STRATFOR expects European demand to remain weak, largely due to the faltering local banking system.
In STRATFOR's 2009 annual forecast, we outlined how one of the year's dominant issues would be Russia's effort to force the United States to make a strategic bargain: Russia would grant U.S. forces a northern supply route into Afghanistan in exchange for an expunging of Western influence from former Soviet territory. At the start of the second quarter, Russia made a tentative offer on the supply route issue but was quickly rebuffed during a meeting with Obama, and both countries slid back into their confrontational stances. When this occurred, STRATFOR forecasted that Russia would redouble its efforts and consolidate its position in Ukraine, Georgia, Armenia and Azerbaijan — which Moscow accomplished masterfully. Like clockwork, another chance for Russia to bargain with the United States came at the start of the third quarter, during Obama's visit to Moscow. As before, Russia tentatively gave in on supply routes to Afghanistan and was rebuffed by the United States on the issues Moscow considered vital: a public repudiation of NATO expansion, abandonment of ballistic missile defense (BMD) in Poland and Washington's general refusal to admit to Russia a sphere of influence in the former Soviet space. Since this is the second time this year Moscow has been in this situation, it knows it cannot allow Washington to continue dismissing it. Russia has been in such a position before — in the aftermath of Kosovar independence. Moscow's response to Washington's moves then was to invade Georgia in August 2008 and prove that the United States would not be able to rescue its ally in the Caucasus. This time around, Russia has laid the groundwork for some more interesting moves against U.S. interests. Russia's moves in the former Soviet states of Ukraine, Georgia, Armenia and Azerbaijan will continue, with Russia already holding the upper hand in each state. Moscow is prepared for new elections in Ukraine — whenever Kiev finally holds them — and has ties to, or outright controls, every major candidate running but one. Russia has destabilized Georgia on many fronts by increasing its military presence on Georgia's northern and southern borders and funding the opposition to sustain chaos in the capital. Russia has also maneuvered its way into the middle of talks between Armenia and Azerbaijan over the secessionist region of Nagorno-Karabakh as well as talks between Armenia and Turkey over the restoration of diplomatic ties between the two. Currently, Moscow holds the reins in both situations — demonstrating its total control over Armenia and its rising influence over Azerbaijan. Russia has also laid the groundwork to counter U.S. influence in the former Soviet areas of the Baltics and Central Asia. The Baltics are particularly significant since they are both NATO and EU members, and vehemently anti-Russian. But they are also in a tailspin due to the global financial crisis and resulting political turmoil. Russia is more actively funding — and manipulating — Russia-friendly political parties in the Baltics and leveraging the resulting social tension this generates. In Central Asia, each state except Uzbekistan has increased its ties to Russia in the last quarter, in essence giving Moscow control of the routes that the United States wants to use to supply its forces in Afghanistan. It is relatively easy for Russia to meddle in former Soviet states, but there are four other countries — Turkey, Germany, Poland and Iran — that are vital to the United States' global strategy and are places where Russia aims to exert influence. Russia wants to ensure that Turkey's newfound confidence (see the Middle Eastern section in this report) does not lead it to join the Americans in challenging Moscow, and so it is dangling the prospect of better relations with Armenia and preferential access to Russian energy in front of Ankara. It is not so much of a zero-sum game — a rare thing in Russian strategy — as it is Moscow offering itself to Ankara as a lever in other relations. The two are experimenting with using each other against third parties — Turkey using Russia to push forward its EU membership bid, Russia using Turkey to increase its energy leverage over Europe — to achieve unrelated goals. Further developments in this relationship will be seen when Russian Prime Minister Vladimir Putin travels to Ankara in August. The other influential NATO ally, Germany, has also been growing very close to Russia as a rift has developed between Berlin and Washington. Germany feels that the United States has abandoned it during the economic crisis, and so Russia has stepped in by offering investments into key industries. Add in Germany's existing dependence on Russian energy, and Germany's willingness to challenge Russia seems to be shrinking. And with Germany the central EU power and a major player in NATO, the unity of both organizations is coming into question — something Russia has been after for decades. The biggest saving grace for the Western institutions in the third quarter is that Germany is too distracted to do anything overly bold — it is election season. Poland is an odd state for Putin to visit — he will be doing so Sept. 1 — considering how Poland fears Russia, and until now Russia only dealt with the Poles through the Americans. But now Putin is addressing Poland directly to see if he can make any progress in loosening the American-Polish alliance. Sticks will be in abundance. What one must watch for is the carrots. Iran is one of the easiest — and most effective — cards for Russia to play. Moscow has already blocked discussion of U.N. sanctions against Iran, and it is almost certain to continue doing so. But if Russia wants to up the ante, it could cause trouble for Washington directly and quite easily by furthering its support for Tehran's nuclear program or delivering more military hardware, such as the S-300 strategic air defense system, to Iran. This would do more than disturb bilateral U.S.-Iranian relations; it would ripple through domestic U.S. politics and security efforts in Iraq. Iran is an a vulnerable issue for the United States. Russia has been wary of using this card, but Moscow might feel that it is at the point where it must be played. Russia has a multitude of big and small tools available for use against the United States. Some moves have already begun, while the groundwork has been laid for others. But the window of opportunity granted by American deployments to the Middle East will not be open forever. Russia must act in the next two quarters to limit American power. Soon, American troops currently stationed in Iraq will become available for other deployments — deployments that could potentially limit Russian options. If not, then the United States will have the opportunity to prove that it is Russia — not the United States — that is overstretched and past its prime.
The United States is steadily shifting focus away from the dwindling war in Iraq to the next phase of the war in Afghanistan. The extent to which the United States is able to shift gears from the Middle East to South Asia will depend in large part on how the Iraqis manage their own security over the next several months. Sectarian tensions in Iraq are already rising as political and energy battles are heating up ahead of the January 2010 parliamentary elections. At the same time, U.S. forces are withdrawing from Iraqi cities and are thus removing a crucial buffer between Iraq's feuding sects. Though the United States still has sufficient forces in Iraq to put out sectarian fires that Iraqi security forces may prove incapable of handling on their own, any flare-ups will directly affect the U.S. timetable to pare the 130,000 troops that remain in the country and free up forces for Afghanistan. Iraq will hold itself together in the coming months, but the withdrawal process will be difficult and slow. In Afghanistan, signs of a revised strategy will come to light in the coming quarter as U.S. forces move away from offensive combat operations to traditional counterinsurgency doctrine, where success is not measured strictly by territory reclaimed or the number of Taliban militants killed, but rather by the ability of U.S. and NATO forces to protect the local population, build institutions from scratch and provide enough local governance to deprive the enemy of a viable support base. In essence, this is the long-haul "hearts and minds" campaign that (thus far) has prevailed in the Washington debate over how to best manage the war in Afghanistan. The strategy has gone into effect, but definitive results will not be seen in the third quarter. As STRATFOR said in our previous quarterly forecast, there are vast tactical differences between Iraq and Afghanistan, and a divide-and-conquer approach holds low prospects for success while the Taliban feel little inclination to negotiate with an occupying force that has a limited attention span for such resource- and time-intensive wars. One of the most critical flaws in the counterinsurgency plan is that it assumes the enemy will provide the space and time for the strategy to yield results. The Taliban may live in caves, but they understand the U.S. political sensitivities to war casualties. As a surge of 17,000 troops and some 4,000 police trainers into Afghanistan wraps up this quarter to boost security for the August national elections, the media's attention will focus on U.S.-led military offensives in southwestern Taliban strongholds. The flight of Taliban militants from these areas is not a clear measure of success, however. The Taliban will not launch their counteroffensive where U.S. troops are concentrated. In the face of overwhelming firepower, insurgents will withdraw, disperse and target vulnerable supply lines, patrols and security outposts that are expected to increase with the new U.S. strategy. The increasing tempo and spread of attacks by Taliban and their al Qaeda affiliates in Afghanistan suggest that this is an insurgent force that still has room to mature on the battlefield — which would mean that the full extent of the Afghan challenge has yet to be seen. Elections in Afghanistan could give the Taliban a symbolic opportunity to carry out attacks and for U.S. and NATO forces to demonstrate some level of public intolerance of Taliban rule, but the overall effect of the elections will be minor. Despite his unpopularity, a lack of credible competition is likely to allow Afghan President Hamid Karzai to retain his position, and the government that emerges from the election will be no less plagued by internecine rivalry among feuding tribes and warlords than the current one. On the other side of the Durand Line, Pakistani forces are going on the offensive against local Taliban militants in the country's northwest. The irony of the situation is that this renewed vigor in Pakistan's fight against its former militant proxies is more likely to hamper than help the U.S. counterinsurgency efforts in Afghanistan. STRATFOR failed to anticipate the Swat offensive that was launched in the early part of the second quarter, and forecasted instead that Pakistan would stick to ineffectual deal-making and shy away from military combat to cope with its jihadist problem. But the collapse of a peace deal (just a few days after our last quarterly forecast was published), the rapid Taliban spread in Swat and surrounding areas in the North-West Frontier Province and a wave of deadly suicide attacks struck a nerve in Islamabad. Taliban activity in the northwest periphery is one thing, but any sign of Taliban encroachment in the Punjabi heartland is far too close for comfort in Islamabad's view. Pakistani forces' ability to hold the territory they have reclaimed in Swat remains in doubt, especially as the Taliban have proven their ability to disperse, regroup and then return to areas where local governance and security remain dangerously weak and vulnerable. While struggling to hold ground in Swat, Pakistani forces will begin focusing on an ongoing offensive in South Waziristan. This offensive, however, is vastly different from the operation in Swat and poses far greater challenges. The Pakistani objective in this offensive is thus extremely narrow in scope: to neutralize the network of leading Pakistani Taliban commander Baitullah Mehsud, who has demonstrated a capability to carry out large-scale attacks well beyond Pakistan's northwest tribal regions. By focusing on Mehsud, the military is drawing a line in the sand and illustrating the consequences of turning against the state. But the challenges in Waziristan are already mounting, as Mehsud is doing an effective job of bribing and intimidating local tribes into cooperating against the military. The Waziristan offensive will consume Pakistan's attention in the coming quarter but will do very little to aid the American war effort in Afghanistan. In conducting this offensive, Pakistani military commanders are sticking to their tradition of distinguishing between "good" and "bad" Taliban. Mehsud is on the hit list, but there are still scores of other jihadist groups operating on Pakistani soil that Islamabad continues to view as long-term assets to use against India and to retain influence among Pashtuns in Afghanistan. In Pakistan's mind, the only way to avoid turning every Pashtun against the state is to turn a blind eye to, and occasionally facilitate, jihadist movement into neighboring Afghanistan, thereby further complicating U.S.-NATO operations in the region. For the United States, some action by the Pakistani military is better than no action at all. While Pakistan is engaged in this military offensive, it is more capable of fending off U.S. pressure. This dynamic makes India especially nervous and will lead to friction between Washington and New Delhi, even if only behind closed doors. Pakistan's preservation of militant assets for use against India is naturally New Delhi's main concern. Although the Indians have preferred to remain on the sidelines of this conflict and leave it to the Americans to deal with the Pakistanis, any slackening of U.S. pressure on Islamabad will mean that Washington will have to spend more time trying to assuage Indian concerns. While India remains on alert for jihadist spillover from Pakistan, it is also dealing with other distractions at home. A growing Naxalite insurgency along the eastern belt of the country is gaining traction and exposing just how unequipped the state is to deal with internal security threats. And while the ruling Congress party is in a stronger political position after its recent election victory, the party's enhanced political clout will do little to improve India's national security infrastructure or speed up the country's recovery from the global economic crisis. Part Two: Third Quarter Forecast 2009: Regional Breakouts