When Giants Fall

A Different Kind of Weapon

In Chapter 4 of When Giants Fall, "Money Talks," I argue that some U.S. rivals will look to gain advantage through the "financial firepower" at their disposal:

The United States’ waning influence, unraveling global imbalances, ongoing economic woes, and various resource-related concerns suggest that more aggressive tactics—short of all-out war—will also be used. In fact, an increased emphasis on asymmetric strategies, like those intended to counter the United States’ advantages in conventional military firepower, suggests geopolitical up-and-comers won’t be loath to tap their arsenals of economic weaponry. Aside from controls on trade, currency, and investment flows; taxes and regulations that place foreign-owned firms at a distinct disadvantage; and “beggar thy neighbor” currency devaluations, countries will threaten cutoffs in cross-border financing, shifts in asset allocations at state-run funds, and reductions in holdings of certain securities.

Based on the following Reuters report, "China PLA Officers Urge Economic Punch Against U.S.," we may be nearing the point where one of the more aggressive tactics is put to the test (italics mine):

Senior Chinese military officers have proposed that their country boost defense spending, adjust PLA deployments, and possibly sell some U.S. bonds to punish Washington for its latest round of arms sales to Taiwan.

The calls for broad retaliation over the planned U.S. weapons sales to the disputed island came from officers at China's National Defence University and Academy of Military Sciences, interviewed by Outlook Weekly, a Chinese-language magazine published by the official Xinhua news agency.

The interviews with Major Generals Zhu Chenghu and Luo Yuan and Senior Colonel Ke Chunqiao appeared in the issue published on Monday.

The People's Liberation Army (PLA) plays no role in setting policy for China's foreign exchange holdings. Officials in charge of that area have given no sign of any moves to sell U.S. Treasury bonds over the weapons sales, a move that could alarm markets and damage the value of China's own holdings.

While far from representing fixed government policy, the open demands for retaliation by the PLA officers underscored the domestic pressures on Beijing to deliver on its threats to punish the Obama administration over the arms sales.

"Our retaliation should not be restricted to merely military matters, and we should adopt a strategic package of counter-punches covering politics, military affairs, diplomacy and economics to treat both the symptoms and root cause of this disease," said Luo Yuan, a researcher at the Academy of Military Sciences.

"Just like two people rowing a boat, if the United States first throws the strokes into chaos, then so must we."

Luo said Beijing could "attack by oblique means and stealthy feints" to make its point in Washington.

"For example, we could sanction them using economic means, such as dumping some U.S. government bonds," Luo said.

The warnings from the PLA come after weeks of strains between Washington and Beijing, who have also been at odds over Internet controls and hacking, trade and currency quarrels, and President Barack Obama's planned meeting with the Dalai Lama, the exiled Tibetan leader reviled by China as a "separatist."

MILITARY SPENDING BOOST

Chinese has blasted the United States over the planned $6.4 billion arms package for Taiwan unveiled in late January, saying it will sanction U.S. firms that sell weapons to the self-ruled island that Beijing considers a breakaway province of China.

China is likely to unveil its official military budget for 2010 next month, when the Communist Party-controlled national parliament meets for its annual session.

The PLA officers suggested that budget should mirror China's ire toward Washington.

"Clearly propose that due to the threat in the Taiwan Sea, we are increasing military spending," said Luo.

Last year, the government set the official military budget at 480.7 billion yuan ($70.4 billion), a 14.9 percent rise on the one in 2008, continuing a nearly unbroken succession of double-digit increases over more than two decades.

The fresh U.S. arms sales threatened Chinese military installations on the mainland coast facing Taiwan, and "this gives us no choice but to increase defense spending and adjust (military) deployments," said Zhu Chenghu, a major general at China's National Defence University in Beijing.

In 2005, Zhu stirred controversy by suggesting China could use nuclear weapons if the United States intervened militarily in a conflict over Taiwan.

The United States switched official recognition from Taiwan to China in 1979. But the Taiwan Relations Act, passed the same year, guarantees Taiwan a continued supply of defensive weapons.

China has the world's biggest pile of foreign currency reserves, much of it held in U.S. treasury debt. China held $798.9 billion in U.S. Treasuries at end-October.

But any attempt to use that stake against Washington would probably maul the value of China's own dollar-denominated assets.

China has condemned previous arms sales, but has taken little action in response to them. But Luo said the country's growing strength meant that time has passed.

"China's attitude and actions over U.S. weapons sales to Taiwan will be increasingly tough," the magazine cited him as saying. "That is inevitable with rising national strength."

Heading South in Mexico

After reading the following Arizona Republic report, "Drug Cartels Tighten Grip; Mexico Becoming 'Narco-State,'" my question is: Why is Mexico only in 98th place on Foreign Policy's Failed States Index, 57 places behind 41st-ranked Colombia? The way things are going, the long-time Latin American hot spot is beginning to look a bit like a safe haven in comparison to our neighbor immediately to the south.

Rising lawlessness echoes state of '90s-era Colombia

MEXICO CITY - For months, the leaders of Tancitaro had held firm against the drug lords battling for control of this central Mexican town.

Then one morning, after months of threats and violence from the traffickers, they finally surrendered.

Before dawn, gunmen kidnapped the elderly fathers of the town administrator and the secretary of the City Council. Within hours, both officials resigned along with the mayor, the entire seven-member City Council, two department heads, the police chief and all 60 police officers. Tancitaro had fallen to the enemy.

Across Mexico, the continuing ability of traffickers to topple governments like Tancitaro's, intimidate police and keep drug shipments flowing is raising doubts about the Mexican government's 3-year-old, U.S.-backed war on the drug cartels.

Far from eliminating the gangs, the battle has exposed criminal networks more ingrained than most Americans could imagine: Hidden economies that employ up to one-fifth of the people in some Mexican states. Business empires that include holdings as everyday as gyms and a day-care center.

And the death toll continues to mount: Mexico saw 6,587 drug-related murders in 2009, up from 5,207 in 2008 and 2,275 in 2007, according to an unofficial tally by the respected newspaper Reforma.

Cartels have multiplied, improved their armament and are perfecting simultaneous, terrorist-style attacks.

Some analysts are warning that Mexico is on the verge of becoming a "narco-state" like 1990s-era Colombia.

"We are approaching that red zone," said Edgardo Buscaglia, an expert on organized crime at the Autonomous Technological University of Mexico. "There are pockets of ungovernability in the country, and they will expand."

For the past decade, he said, parts of Mexico have been sliding toward the lawlessness that Colombia experienced, in which traffickers in league with left-wing rebels controlled small towns and large parts of the interior through drug-funded bribery and gun-barrel intimidation.

In the latest sign of the cartels' grip, on Wednesday the National Action Party of President Felipe Calderón announced it was calling off primary elections in the northern state of Tamaulipas because drug traffickers had infiltrated politics.

And in Chihuahua, the government is redeploying troops from the embattled city of Juarez to the countryside because of fears that the cartels are cementing their control in smaller border towns.

Even Calderón, who a year ago angrily rebutted suggestions that Mexico was becoming a "failed state," is now describing his crackdown as a fight for territory and "the very authority of the state."

"The crime has stopped being a low-profile activity and has become defiant . . . . plainly visible and based on co-opting or intimidating the authorities," he told a group of Mexican ambassadors last month. "It's the law of the 'bribe or the bullet.' "

Towns on the ropes

In places like Tancitaro, population 26,000, the battle already may be lost.

In the past year, gunmen killed seven police officers, murdered a top town administrator and kidnapped others, said Martin Urbina, a city official. The reasons were unclear - most of the town leaders are in hiding and could not be reached for comment - but the drug traffickers were apparently demanding the removal of certain police officers, Urbina said.

When the traffickers kidnapped the two officials' fathers on Nov. 30, it was the last straw.

"If someone comes and puts a pistol to your head, what are you going to do?" said Gustavo Sánchez, who was appointed by the Michoacan state governor as interim mayor after the mass resignation. "It's happening in all of the states, not just here."

In Vicente Guerrero, in Durango state, 34 of 38 police resigned after the police chief and four officers were kidnapped. The victims have not been found.

In the border town of Puerto Palomas, the police chief fled to the United States and asked for asylum in March, saying Mexican officials could not protect him. In October, traffickers killed the town administrator in Puerto Palomas.

In the northern town of Namiquipa, traffickers killed the mayor and two top town officials last year. Police there are woefully outgunned, police Chief Jesus Hinojosa said. There are only 15 weapons for 39 police officers.

Often the cartels target city officials they believe are cooperating with federal authorities, said Juan Manuel Bautista, the City Council secretary in the western town of Novolato, where traffickers have killed 25 police, two city councilmen and a town administrator in the past two years.

Other times, they are simply lashing back at the most convenient targets, he said.

"In these small-town governments, everyone knows your business and who you are," Bautista said. "If they want to take revenge on you, it's easy."

Even when governments replace police chiefs, mayors and town councils, it's often only a matter of time before the replacements are bribed, intimidated at the barrel of a gun or killed, and the scenario repeats itself, said Bernardo Gonzalez Arechiga, an expert on crime at the Monterrey Institute of Technology and Advanced Studies.

In May, federal officials arrested 10 mayors in Michoacan state on charges of protecting smugglers.

In June, Mauricio Fernández, a mayoral candidate in the wealthy Monterrey suburb of San Pedro Garza Garcia, was recorded telling a meeting of supporters that he had negotiated a truce with the Beltrán Leyva gang as a way of guaranteeing security in the town. Fernández later denied any contact with the gang. He easily won the July 2 election.

Financial octopus

The attempt to dismantle the cartels has created a new appreciation for how deep their financial networks go, said Joel Kurtzman, a senior fellow at the Milken Institute, an economic think tank in Santa Monica, Calif.

In many towns, smugglers pay for playgrounds and other things the government cannot afford. Bank loans are expensive and hard to get in Mexico, a lingering effect of the country's bank crises during the 1990s, so traffickers have stepped in to provide small-business loans.

"What people did not recognize in Mexico was how deeply ingrained in both the economy and society the drug trade was," Kurtzman said. "So it's not as if the drug traders are unpopular - they're looked at in many cities like Robin Hoods."

Since 2006, the number of Mexican citizens and companies on the U.S. Treasury's blacklist of suspected drug smugglers has nearly doubled, from 188 to 362.

They are as varied as a day-care center in Culiacan, a gym in Hermosillo and an electronics company in Tijuana. There are meat packing plants, horse stables, dairies, hotels, a mining company and gasoline stations.

Dozens of those companies are still operating because Mexican prosecutors lack few legal tools to shut them down, Buscaglia said.

In March, the financial magazine Forbes included Joaquín "Chapo" Guzmán in its list of the world's billionaires for the first time. Guzmán, the head of the Sinaloa Cartel, was listed at No. 701 with a net worth of about $1 billion.

In fact, Guzmán's cartel and other gangs probably bring in $3.8 billion just to Sinaloa state alone, said Guillermo Ibarra, an economist who used bank and government statistics to compile an estimate this year.

That is 20 percent of the state's economy, twice as much as all of its factories put together. The drug trade employs about a fifth of the state's 2.6 million population, either directly or indirectly, he said.

"It trickles down to construction, to car sales, you name it," Ibarra said. "Drug money ends up everywhere."

The cartels' criminal activities also are becoming more diverse, Buscaglia said.

La Familia Michoacana, which produces methamphetamine at clandestine laboratories in Michoacan state, has broadened into prostitution, protection rackets and software piracy.

Street vendors in Mexico now sell music CDs and DVDs stamped with "FM," the gang's logo.

Likewise, the Zetas, once the elite hit men of the Gulf Cartel, now run kidnapping-for-ransom rings in Mexico City and steal gasoline from government pipelines. Pemex, the state-run oil company, says it lost $747 million in stolen fuel in 2008.

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Year of the Tiger

(Image Source)

Even though there's still a week to go before the Year of the Tiger celebrations begin, there seems to be lots of growling coming from the East. If the following reports are anything to go by, it looks like the 12-month period dedicated to one of the animal kingdom's most ferocious creatures might just live up to its name.

What Guides the Chinese Tiger As It Grows Stronger?" (The National)

The Chinese will celebrate their New Year on February 14. The year of the ox will close and the year of the tiger will begin. China’s leaders don’t appear to have waited for the stars to tell them to pursue a more aggressive course.

First they derailed the climate change talks at Copenhagen in December. Then they took the stage at Davos in January to denounce any accusations that they were manipulating the value of their currency. Throw in disputes with Google and their rebukes of the US president Barack Obama for meeting the Dalai Lama and approving weapons sales to Taiwan, and the world has seen another side of China.

China is emboldened; its coffers are swollen with $2.4 trillion in currency reserves and it is no longer prepared to kowtow to anybody, particularly the United States. For the first time in centuries China is ready to strut on the world stage.

"China’s Hawks Demand Cold War on the US" (The Times)

MORE than half of Chinese people questioned in a poll believe China and America are heading for a new “cold war”.

The finding came after battles over Taiwan, Tibet, trade, climate change, internet freedom and human rights which have poisoned relations in the three months since President Barack Obama made a fruitless visit to Beijing.

According to diplomatic sources, a rancorous postmortem examination is under way inside the US government, led by officials who think the president was badly advised and was made to appear weak.

In China’s eyes, the American response — which includes a pledge by Obama to get tougher on trade — is a reaction against its rising power.

Now almost 55% of those questioned for Global Times, a state-run newspaper, agree that “a cold war will break out between the US and China”.

An independent survey of Chinese-language media for The Sunday Times has found army and navy officers predicting a military showdown and political leaders calling for China to sell more arms to America’s foes. The trigger for their fury was Obama’s decision to sell $6.4 billion (£4 billion) worth of weapons to Taiwan, the thriving democratic island that has ruled itself since 1949.

“We should retaliate with an eye for an eye and sell arms to Iran, North Korea, Syria, Cuba and Venezuela,” declared Liu Menxiong, a member of the Chinese people’s political consultative conference.

He added: “We have nothing to be afraid of. The North Koreans have stood up to America and has anything happened to them? No. Iran stands up to America and does disaster befall it? No.”

Officially, China has reacted by threatening sanctions against American companies selling arms to Taiwan and cancelling military visits.

But Chinese analysts think the leadership, riding a wave of patriotism as the year of the tiger dawns, may go further.

“This time China must punish the US,” said Major-General Yang Yi, a naval officer. “We must make them hurt.” A major-general in the People’s Liberation Army (PLA), Luo Yuan, told a television audience that more missiles would be deployed against Taiwan. And a PLA strategist, Colonel Meng Xianging, said China would “qualitatively upgrade” its military over the next 10 years to force a showdown “when we’re strong enough for a hand-to-hand fight with the US”.

Chinese indignation was compounded when the White House said Obama would meet the Dalai Lama, the exiled spiritual leader of Tibet, in the next few weeks.

“When someone spits on you, you have to get back,” said Huang Xiangyang, a commentator in the China Daily newspaper, usually seen as a showcase for moderate opinion.

An internal publication at the elite Qinghua University last week predicted the strains would get worse because “core interests” were at risk. It said battles over exports, technology transfer, copyright piracy and the value of China’s currency, the yuan, would be fierce.

As a crescendo of strident nationalistic rhetoric swirls through the Chinese media and blogosphere, American officials seem baffled by what has gone wrong and how fast it has happened.

During Obama’s visit, the US ambassador to China, Jon Huntsman, claimed relations were “really at an all-time high in terms of the bilateral atmosphere ... a cruising altitude that is higher than any other time in recent memory”, according to an official transcript.

The ambassador must have been the only person at his embassy to think so, said a diplomat close to the talks.

“The truth was that the atmosphere was cold and intransigent when the president went to Beijing yet his China team went on pretending that everything was fine,” the diplomat said.

In reality, Chinese officials argued over every item of protocol, rigged a town hall meeting with a pre-selected audience, censored the only interview Obama gave to a Chinese newspaper and forbade the Americans to use their own helicopters to fly him to the Great Wall.

"China Says US Protectionism Endangers Trade Ties: Xinhua" (Agence France-Presse)

BEIJING — China accused the United States of protectionism that has "seriously affected" their trade ties, state media reported late Monday, amid a worsening spat between the two countries.

Ministry of Commerce spokesman Yao Jian made the comments on the ministry's web site in response to US moves to impose anti-dumping duties on electric blankets and wire trays from China, news agency Xinhua said.

"Since the outbreak of the financial crisis, the US trade protectionism has been apparently on the rise, and China has become the biggest victim of US abuse of trade relief measures," Yao said, according to Xinhua.

Tensions between Beijing and Washington are already high over the US approval last week of a 6.4-billion-dollar arms deal for Taiwan, which follows on from a range of disputes including Google's revelations last month about alleged cyberattacks by China.

"With Defense Test, China Shows Displeasure of U.S." (New York Times)

BEIJING — China said late Monday that it had successfully tested the nation’s first land-based missile defense system, announcing the news in a brief dispatch by Xinhua, the official news agency. “The test is defensive in nature and is not targeted at any country,” the item said.

Even if news accounts on Tuesday did not provide details about the test — and whether it destroyed its intended target — Chinese and Western analysts say there is no mistaking that the timing of the test, coming amid Beijing’s fury over American arms sales to Taiwan, was largely aimed at the White House.

In recent days, state media have been producing a torrent of articles condemning the sale of Patriot air defense equipment to Taiwan. China views the self-ruled island as a breakaway province, separated since the civil war of the 1940s, and sees arms sales as interference in an internal matter.

The Defense and Foreign Ministries have released a half-dozen warnings over the weapons deal, saying it would have grave consequences for United States-China relations. A columnist in Global Times, a populist tabloid, urged readers come up with ways to retaliate against the United States.

Writing in the newspaper Study Times, Maj. Gen. Jun Yinan said China had the power to strike back. “We must take countermeasures to make the other side pay a corresponding price and suffering corresponding punishment,” wrote General Jun, a professor at China’s National Defense University.

The Coming 'Moment of Truth'

In a recent Bloomberg Television interview, economic historian and Financial Times contributing editor Niall Ferguson argues that mushrooming sovereign debt concerns in Europe are a sign of things to come -- for the U.S. Here are a few excerpts:

I looked at the IMF numbers for gross debt-to-GDP today for developed economies -- the United States is number six. It is not that far behind Greece in terms of the size of its debt and the problem it's going to have getting back into any kind of balance in the foreseeable future.

...

The problem with massive deficits as a response to the recession is that, at some point, you are going to see upward movements in yields. Upward movements in long-term nominal interest rates at a time of relatively low inflation -- that spells trouble for anybody with a large burden of debt, and, of course, practically everybody in the U.S. has a large burden of debt, including...the federal government. So, although it is going to take a while to reach these shores -- I think this will play out in Europe for a while, spreading from one country to another -- at some point, people are going to look at the finances of the United States and say, you know, we really need more than 3.5 percent on a 10-year bond with numbers like these because they really aren't much better than the finances of Greece.

...

At some point -- and I think it is over the next six-to-12 months -- there is going to be a re-rating, a reappraisal of U.S. fiscal prospects, and that, it seems to me, will be the moment of truth.

Here is the video (via YouTube):

(Hat tip to The Business Insider)