China is in serious trouble. That is the conclusion of Dr. George Friedman, president of Stratfor, a geopolitical strategy consulting firm. While it has had a great 30 year run, that performance will not extrapolate 30 years into the future, as many China (FXI) bulls believe. Of the Middle Kingdom's 1.3 billion citizens, only 60 million earn a $20,000 middle class annual income, while 440 million make $3-$6/day and 600 million take in under $3/day. The People's Liberation Army, which is manned predominantly by the under classes from the hinterlands, could move the country away from its modernizing trend at anytime, especially if a recession leads to starvation in the countryside.
The problem is that the Chinese are investing their massive reserves anywhere but in China, which they fear may lead to an overheating of the economy. Are they aware of risks invisible to foreign investors? The future direction of the country may be decided by its next election, the first open one in history.
Dr. Friedman much prefers investing in Japan (EWJ), which has the benefit of a stable society, immense industrial plant, advanced technology and the largest military force in Asia. Demographic challenges can be met by offshoring labor intensive industries in China, which they have been doing aggressively for three decades. Japan is a classic case of a nation with strong fundamentals, but lousy management which can be solved with a simple change of government.
The largest threat to the nascent global economic recovery is a breakdown of back channel negotiations between the US and Iran, which could lead to a blocking of the Straits of Hormuz. This would cause oil to spike to $500 a barrel, trigger a global depression, lead to widespread sovereign debt defaults and send Western governments toppling. That's why neither the US or Israel will bomb the rogue nation's nuclear program, which in any case can only produce impractical, unusable weapons.
The greatest threat to US power would be the coalescing of a pan Middle Eastern super power. US policies that triggered a Sunni/Shiite civil war can be viewed as a success in that they prevent this from happening. The war's trillion dollar price tag is a bargain as long as we can still buy gas at home for $3/gallon.
George likes Poland (EPOL), which he describes as the South Korea of Europe. It will greatly benefit from closer relations between Russia and Germany (click here for my own recent Poland piece). Turkey (TUR) is another buy, with a rising middle class, an economy that is not dependent on exports, and a robust banking system (click here for "Turkey is on the Menu").
Russia (RSX) is moving towards a stable economic platform built around its resource riches, moving on from the kleptocracy of the nineties. It is creating integrated energy majors which are establishing a global footprint and present a potent oil weapon. Monopolies in wood, grain, and diamonds are moving in the same direction.
Dr. Friedman started out life as a refugee from Hungary, his parents rowing him across the Danube in 1949 under glaring searchlights. He obtained his BA from the City College of New York and his Ph.D. in government from Cornell. He then spent two decades teaching political science at Dickinson College in Pennsylvania. Dr. Friedman has recently published a New York Times best seller entitled The Next 100 Years: A Forecast for the 21st Century.
In the book Friedman claims the current Islamic assault on the West is failing, and will cease to be a factor on the international scene within the decade. Russia will take another run at becoming a superpower, which will fail by 2020, and leave the country even more diminished than it is today. When standards of living in China level off or reverse in the 2020's, chronic resource shortages could cause the Middle Kingdom to implode and break up. China is far more fragile than we realize.
Japan may deal with stagnant economic and population growth the same way it did during the 1930's by invading China as early as 2030. Japan may also take a bite out of indefensible Siberia when it remilitarizes. Poland, a unified Korea (click here for "The Economic Miracle that is South Korea") and Turkey will develop into regional military and economic powers in their own right.
Friedman then describes a theoretical war by a coalition of Turkey and Japan against the US in 2050, resulting in an American victory, which leads to a new US golden age in the second half of the century. Scramjet engines make possible the development of unmanned hypersonic aircraft which can launch a precision attack any place on the planet in 30 minutes. Warfare will move into space and be fought from "battle stars," which will also become major energy sources for earth. Friedman kind of lost me when he predicted that the next Pearl Harbor could come from Japan, but not from the sea going aircraft carriers of old, but from caves on the moon.
The big challenge towards the end of the 21st century will be the emergence of a Hispanic nation in the Southwest, which is culturally isolating itself by not integrating with the rest of the country. This could lead to the secession of several states, or a new war with Mexico, which by then, will develop into a major power in its own right. I think to avoid a second Civil War and offload some huge state deficits, Washington just might say "!Adios!"
You can argue that someone making many of these predictions is looney. But if you had anticipated in 1970 that China would become America's largest trading partner, the Soviet Union would collapse, Eastern Europe would join NATO, the US would enter a second Vietnam War in Afghanistan, and oil would hit $150 a barrel, you would have been considered equally nutty. I know because I was one of those people. It does seem that long term forecasters have terrible track records.
All in all, the book is a great armchair exercise in global realpolitics, and an entertaining contemplation of the impossible. More than once, I heard myself thinking "He's got to be kidding."
To listen to my interview with George Friedman on Hedge Fund Radio in full, please go to my radio archives by clicking here, and click on the "PLAY" arrow. Or you can download it to your IPod or your PC for free.
Where would Dr. Friedman focus his investments now? In the US, which with a 25% share of world GDP and the most powerful military in history is in an ideal position to dominate the global economy for another century.
From the Diary of a Mad Hedge Fund Trader.