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Some Macro-Thoughts on 2009

Trouble is Brewing?.

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Well, 2009 is nearly upon us. I’m not one for predictions, and I won’t play that game. But since I travel a great deal and have a considerable amount of experience (commercial, on-the-ground, and otherwise), it seemed like it might worthwhile to collect some of my earlier scattered thoughts into a single discourse.

I’m expecting trouble all over the place in 2009 – in a wide variety of guises.

If you’re brave and have a little time, continue reading below the fold.

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Russia

As your humble correspondent opined a couple months back, when it comes to trouble, “Russia won’t be worst, but they’ll be first.” Putin and co. are in a hurry, and they clearly saw The O as a soft target – and they were itching to get going, taking only hours (literally) after the election results came in to announce plans to deploy nuclear-capable missiles into the Kaliningrad enclave… unless we back off the missile defense plans.

My own take, expressed many times in these pages, is that almost everyone is misreading Russia.

One school of thought is still stuck back in 19th- and 20th-century thinking about these things, and views everything through what once was a conventional prism. This notion is that Russia is “resurgent” and basically the old Soviet Union is coming back.

The other school of thought is that Russia is facing crushing problems, yet its mind-numbed leaders have such dreams of imperial glory that they just don’t see Russia’s massive difficulties.

Russia does indeed face catastrophic social problems – something that the first school of thought just doesn’t seem to be able to consider. Where does one begin? Russia faces a collapsing birth rate, a collapsing population, a disastrously-short male life expectancy, frighteningly-high levels of alcohol abuse, drug abuse, and HIV infection – and now with the bursting of the oil price bubble, the real prospect of large-scale unemployment and reimpoverishment.

But here’s the rub. Putin and co. aren’t trying to re-surge in spite of these problems – they are trying to re-surge because of these problems. In the Putin worldview, all these problems exist because Russia became weak and unimportant. If Russia can become great and important again, Russian society will be reinvigorated and will cure itself. Arguing whether this view is correct or not is beside the point – this is how the Russian leadership will be making decisions in the next few years.

Despite the dispute with Georgia – and the palpable fear one feels when in the Baltic countries these days – I keep coming back to the main venue for the playing out of an attempt to re-aggrandize Russia as being Ukraine. There are cultural/emotional issues here; with Kyiv (Kiev) as the birthplace of the “Rus,” Ukraine is to some degree for Russians what Kosovo is for Serbians. And Russians have for centuries referred (condescendingly) to Ukraine as “Malo Rossiya” (“Little Russia”).

But there are practical issues in play as well. It would be too much for Russia to simple invade Ukraine and try to annex at least large parts of it; that old delight, “salami tactics” (anyone else remember that phrase?) is a more likely strategy.

Crimea is the most likely target for two reasons.

First, historically, Crimea wasn’t part of Ukraine; it was added to Russia back in the 19th century as the Tsars gradually expanded southward at the expense of the Ottoman Empire. During the first part of Soviet times, Crimea was part of the RFSFR. But sometime during the Khrushchev era, as the Ukrainian SSR was celebrating the something-th anniversary of itself, Khrushchev “gave” Crimea to the Ukrainian SSR as a birthday gift. This didn’t matter much until the Soviet Union broke up and, to the horror of Russian nationalists, Crimea thus ended up as part of Ukraine. Russian nationalists are also convinced that Khrushchev’s “gift” occurred after large quantities of vodka had been consumed – a suspicion that is certainly plausible.

The second (and more tangible) issue relating to Crimea is the Russian naval base at Sevastopol. The Black Sea littoral (I speak from the experience of seeing it myself) is for the most part straight, sandy, and shallow. There simply are virtually no good natural harbors, particularly for military use. The exception is Sevastopol in the Crimea – which has long been the base for the Russian Black Sea Fleet. When the Soviet Union broke up, the Russians retained the Black Sea Fleet and signed a 25-year lease with Ukraine for continued basing rights in Sevastopol. That lease runs out in 2017; the present Ukrainian government has made it clear that it has no intention of renewing the lease, and has already announced that it is studying how to develop the Sevastopol port facilities for civilian uses after 2017.

The problem Russia faces is that there simply are no good alternative ports on the Russian shoreline for a military fleet. The only even marginally-viable-option is Rostov-on-Don; however, Rostov is at the head of a narrow channel through which the Don empties into the Sea of Azov via extensive salt marshes. Further, the channel that separates the Sea of Azov and the Black Sea proper is extremely narrow. This is a seriously-inferior option versus Sevastopol.

How will this play out specifically? Who knows. I’m not making specific predictions here – I’m just trying to point out the possible weak spots that might be sought out.

But the bottom lines are that Putin and co. see themselves in a race against time to “save” Russia by reaggrandizing it – before it collapses. And they clearly see The O as a weak and ineffective leader whose presence provides them with a great opportunity to pursue their urgent agenda.

Longer-term (if we get there), a weakening Russia is likely to be a major problem on the world stage – largely through the depopulation of such a vast (and resource-rich) landmass. Siberia is rapidly heading for complete depopulation, creating a huge vacuum. But we can move on to the next aspect of things where the “conventional wisdom” is seriously disconnected from reality….

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China

Contrary to “conventional wisdom,” China won’t be expanding into the Siberian vacuum. China is on the verge of one of the worst demographic implosions in history; beginning in about 2015, the consequences of the “one-child” policy will kick in with a vengeance.

Let’s deal with China quickly here since we should. A demographic implosion, coupled with an implosion of demand in the low-end-goods market that Chinese manufacturing serves, coupled with the realities of vast poverty and political instability….

Back twenty or so years ago, we were hectored all the time about “rising Japan.” Japan was the rising power, it was unstoppable, it would dominate, it would crush everything in its path, etc. Only a few years later, everyone was wondering how on Earth anyone ever believed all that.

Methinks that we’ll be saying the same things with regard to “rising China” soon.

Iran

I know, this one makes the list every year. But impending storms eventually break, and this one will soon. Iran has to be close to building a working nuclear weapon. Soon they will have one. Or maybe they will just announce that they do and watch what happens. If they actually reach the ability to make them, for the first time in history a crazy society will have such weapons.

But perhaps again it’s too easy to focus on the conventional-tangible stuff, when the less-tangible stuff is more important.

The main thing Iran has had going for it for nearly 30 years now is the mystique that it has sanction to get away with anything. Iran has for all that time basically operated a one-way street with the rest of the world – Iran is to be afforded all the privileges and considerations that are granted to normal, well-behaved nation-states, while Iran itself is free to ignore all such norms at its will and whim. And for all this time, they have basically been getting away with it.

The “mystique” is able to allow a seemingly-crazy notion – that Islamic Iran enjoys direct support from Higher Power – to get more and more traction. This is the really dangerous aspect of Iran that we really haven’t grasped as of yet.

Now put yourselves in their shoes. If you were going to have Higher Power intervene on your behalf, how about dulling the Americans into electing a spineless, fourth-rate seat-warmer as President? The core of the Iranian leadership has to have watched the rise of The O with astonishment, since it’s about the best-case scenario they could have asked for from Higher Power. Just when they are getting ready to really go wild, they get the gift of a leader of the main check of their nuttiness who is contemptibly and laughably weak. They must be pinching themselves to see if they are awake.

The mullahs will clearly see all this as a whole string of green lights in front of them. There is trouble like we’ve never seen before coming from this quarter – and soon.

And that links into the next topic….

Terror

Along similar lines of thought, for a couple of years now I’ve been very afraid that 2009 would be the year when Big Terror™ would re-appear.

Our enemies are clever and cunning – and patient. And they have had to be thinking carefully about their strategy.

For some time, it’s seemed to me that their best strategy would be to go quiet and lay low – to lull us into a false sense of security. Let everyone figure that it was all just a temporary spasm of some sort, and we can now go back to the trivialities of the 1990s – and put a silly, weak leader in office for them.

This seemed to be a good plan. If they get a weak leader, they can wreak havoc and run wild for at least two years. Even if they didn’t get this outcome, they’ve saved up all this ammo, so they might as well let fly.

Well, they did indeed get the better scenario. Look out….

Economy

This will be the last topic, and perhaps the most confusing.

Strangely, of late there seems to be a great deal of optimism (particularly in the financial world) about economic prospects for 2009. When you start to de-layer all the talk and look for some exposition of suggested “root causes” for an upturn, one finds at base that there aren’t any. The basis for these notions is simply along the lines of, “Recessions last for two quarters – at most, three. Ergo, by the middle of 2009, the economy and business activity should be healthy again.”

This is pretty thin gruel, particularly in the face of both the difficulties that are piled up and some of the silly ideas that are poised to percolate out of Washington next year. And just citing the “two or three quarters” thing is merely groundless hand-waving.

You don’t have to go back too far – to the early 1980s – to find a downturn that was much longer and much worse. Despite specific numbers, this deep recession was the end-consequence of a number of years of economic and political idiocy during the 1970s. And in contrast to the early-90s and early-00s recessions, the early-80s recession was not a plain-vanilla dip in the “business cycle” – it actually represented a major structural change in the U.S. economy. It was that recession that gave us the downmarket phraseology of referring to a region of the country as “The Rust Belt.” This basically was the old big-steel-industry belt, and the situation then resembled the “Detroit” situation of today – the “miracle” of workers with no great skill but a very powerful union (and an anything-goes pricing market) receiving extraordinarily-high wages and benefits followed by relatively early retirement under very good conditions. That imploded forever in the early-80s recession – when unemployment reached 10.8% – and that was that. Today’s situation already feels similar to that – with the added fear that Washington is going to try to reprise the 1970s on top of it all.

It’s difficult to be structurally optimistic given all of these things, and the “two-or-three quarters, just the way it is” meme seems to be based more on desperate hope than on any tangible prospects.

What might get us out of the mess? When I look back at each recovery-and-growth phase of recent years, the key enabler seems to have been some breakthrough innovation. The “innovation” didn’t have to be “brand new” (it usually wasn’t), but it had to have reached the point where it could be widely deployed to improve efficiency and productivity – and to open up completely new fields of productive economic activity. We need to find that innovation and get it into the mainstream where it can have the chance to work its magic.

But, sadly, this is already an unpromising story. As I’ve described before in these pages, from my experienced perch I can see that the “innovation engine” was shut down a good 10 – 15 years ago and has never really been restarted. There is plenty of the illusion of innovation, but it’s largely become very small and incremental stuff at best – or silliness unmoored from reality that will never amount to anything at all. There’s been a great deal of using and very little real building – and this is really starting to tell as the pipeline has gone dry.

I am pressed regularly about what might be the cause of this problem and also how we might get out of it. I’ve given this a great deal of thought, and from experience I think that there’s been a fundamental shift in how these things are managed – and the possible comparisons are frightening.

This is difficult to put cleanly into words, but I’ll give it my best shot. When you look at decisions involving attempts to try to create new technology, the biggest factor is the ability to judge the risk-reward situation and how that combination plays off against itself to provide the maximum opportunity. If the risk is very low, then the reward will be very low; basically, if something is easy to do already, then anyone can quickly and easily do it, the dominant factor quickly becomes cost (which among other things favors locations that have ultra-low costs as their biggest factor), and the possible investment returns are so tiny that it’s not worth doing from scratch. At the other extreme, things that are really over the top can promise great rewards – if they can be made to succeed. But the path to making such things work is so sketchy and uncertain that the risks just outweigh the prospects for gains.

The real sweet spot is to find that middle-ground, where the risks are high enough to reflect something that is not easy to do – and that will thus be very difficult for others to quickly duplicate. The risks also have to be not-too-high, so that there is also a reasonable chance for success.

This may seem qualitatively obvious, but the reality is that there are no magic mathematical formulae for figuring this out. And that’s what has made working in this sort of sphere so interesting – trying to sort out these kinds of situations. How do you parse out the opportunities that sit in that sweet-spot, and don’t fall too far on either side? This kind of challenge requires clear and independent thinking, multiple skills, and good well-disciplined teams of people of varied skills.

What I’ve begun to realize is that the dot-com boom of the 1990s fouled this all up, and changed everything “permanently.” To make a long story short, the dot-com boom allowed the making of gobs of money in the lower end of the risk-reward space (the low-risk region). This got treated as a fundamental change in the nature of innovation – a new world of a different sort, in which the old skills described in the prior paragraph were no longer needed.

But the reality is that the period where that appeared to be the case wasn’t a fundamental change – it was a temporary fluke that was no longer operational after the bubble burst in 2000. As is too often the case in human affairs, the “system” continued to believe that this was something permanent (rather than a temporary fluke situation) and tried to keep running on the “new” rulebook. Just the results being posted this decade in the risk capital world scream out that nearly ten years of time, effort, energy – and money – have been squandered on dumb ideas and the wrong ideas. The present economic downturn is causing everyone to look at things with a more critical eye anyway, but it coincides with a crummy run that is now too long and painful to ignore.

Perhaps even worse than the squanderings enumerated above is the squandering of the goodwill of the people and entities that provide the funds that are supposed to be invested in innovation. This is basically a trust-based system – and the trust placed in those managing this process has been abused and destroyed. We will need these kinds of activities now more than ever – and the angry investment dollars are greatly incentivized to look elsewhere.

Can we get out of this mess? Well, maybe. It’s basically a management problem of realizing that the “new” rules were a brief fluke that is long gone – and that the “old” rules need to be brought back; this is basically because the “old” rules are never old – they’re the fundamental operating principles of this sphere which have been neglected and forgotten. They’ve been trying to re-assert themselves of late.

Now, here’s what worries me. I mentioned above the notion of a period that provided a temporary and beneficial fluke environment in which the risk-reward trade-off was stilted into an ahistorical cant that made it seem easy to exploit the system to produce ahistorical levels of reward. Why does this sound familiar? Well, it’s basically what happened to the auto industry during the 1950s. That was a fluke time of rapid economic growth combined with having the only undamaged plant-and-equipment in the world (it took a good 15 years for “the rest of the world” to rebuild from the Second World War). The auto industry has been sliding ever since – but everyone concerned has been frantically clinging to the notion – for more than half a century – that this period really was the new stable-state of things and that it could – should – go on indefinitely. That position is the one that is now unwinding at long last – as we can see in the travails of GM in particular.

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My fear is that in the technology/innovation space, things are going to follow the same path of a half-century of slow bleeding and waste of resources. It’s going to take a severe intervention – and soon – to clean out the stables and replace the people who should no longer be in the decision-making seats. The auto industry never did that, and look what that got us. If the seed-level technology world isn’t dragged out of that track, the consequences for the country (and its economy) will be even worse.

And now we can throw on top of this a new set of political risks of the sort we haven’t seen in nearly 30 years. We risk facing a mandate that everything must focus on worthless “green” technologies. Anything other than that will be out of fashion and declared off-limits – so that money can be thrown down the eco-rathole. There’s so much that needs to get done, and nonsense of this sort will pre-empt all of it.

Now, a wildcard in all this – one that the “new men” flooding into Washington seem unable to grasp – is that compared with earlier times, the world is a much more competitive place on a jurisdictional scale. I’ve been happy months and months back to rattle on about all the problems in which the U.S. has become uncompetitive internationally due to an inability to pay attention to the international competitive landscape. There’s tax policy (income tax, corporate tax, double taxation of foreign corporate earnings, double taxation of individual income earned outside the country, the capital gains tax, and so forth) and regulatory policy (Sarbanes-Oxley, the Williams Act, etc.). Things are bad enough now, but with their eyes and ears firmly closed the “new men” seem determined to make our position even worse. One doubts that more enlightened jurisdictions will just sit back – they’re enlightened because they pay attention and want to compete. They’ll be handed a golden opportunity to compete even more effectively – and it would be a surprise if they didn’t move to take further advantage of it.

Now, these two combine to produce a frightening scenario – one that hits close to home since I might find myself in one of the groups to be discriminated against on “prioritization” grounds. If our new masters direct that only “fashionable” things are to be worked on – basically, all that green drivel – it leaves those of us who have valuable things to offer beached. At the same time, other jurisdictions are likely to become aware of this situation and try to pluck not “business” but actual talent.

It’s mind-boggling to me that after years of working on solid, productive, needed things, there’s a scenario in which I may have to leave the country in order to keep working on what I do. That would be the ultimate sorry legacy of The O and his minions – to finally breach some 400 years of talent inflow and scatter our best talents to other places since they are no longer “in fashion.” Is it likely? Probably not. But I can’t think of any prior time where I could even see that being forced as a possible scenario.

The final upside I’ll possibly note is that the “new men” are very likely to quickly find that they have nearly no room for maneuver – far, far less than they had earlier fancied. Between the terrible economic slowdown and the realities of fierce international competition, they’ll either have to drastically modify their plans, or face disaster too obvious for even them to ignore.

Well, that ended up being far longer than I had anticipated – nearly 3800 words.

It’s worth noting that 2008 began with a great deal of optimism on most fronts. But as the year unfolded, one by one the causes for optimism faded and one by one various things fell to the ground. In contrast, 2009 begins with a great deal of realistic pessimism. So perhaps fortune will do the opposite and smile more graciously upon on this year.

To close, I’ll just wish everyone the very best of health, joy, usefulness, and prosperity in 2009.

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