November 2004 Volume 5 Edition 7



In this issue:


(full-text Advisor below, or click on title for single article window)

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Editor: Dr. Scott B. MacDonald, Sr. Consultant

Deputy Editors: Dr. Jonathan Lemco, Director and Sr. Consultant and Robert Windorf, Senior Consultant

Associate Editor: Darin Feldman

Publisher: Keith W. Rabin, President

Web Design: Michael Feldman, Sr. Consultant

Contributing Writers to this Edition: Scott B. MacDonald, Keith W. Rabin, Sergei Blagov, Jonathan Lemco and Jim Letourneau

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The Bush Victory and What It Means

By Scott B. MacDonald

NEW YORK (KWR) One of the most hard-fought elections in several decades is over. President George W. Bush won re-election and Democratic challenger Senator John Kerry lost. Bush gained 274 electoral votes, four more than needed for a win. He also won the popular vote, 51% to 48% for Kerry. In addition, the Republicans expanded their majorities in Congress and hold more than half of the governor mansions. The response in the U.S. corporate bond market was a rally almost across the board.

Those sectors with the most to gain from a Republican victory are the pharmaceutical and health care sectors, defense, energy, basic materials, and any company with asbestos litigation (Halliburton). The last-mentioned is largely because of the loss of Democratic Minority Leader Senator Tom Daschle of South Dakota, who was active in obstructing legislation that sought to undo the litigation mess surrounding asbestos settlements. The expectation is that the Bush victory should provide a positive note for the U.S. corporate bond market in November. Simply stated, the lack of disputed votes and the graciousness of John Kerry in conceding in a timely manner removes a major uncertainty for the market.

Why Did Kerry Lose? Although a lot is said about the division of the United States into two countries (one conservative and deeply religious and the other liberal and secular), that is not a satisfactory answer to why Senator Kerry lost the 2004 presidential elections. A more practical answer is that Kerry failed to persuade enough people that he was more capable of executing the war than Bush.

Iraq dominated all three debates, figured prominently in most of the candidates’ major speeches and certainly was a point of concern among the electorate. Along these lines, Kerry had the problem of appealing to the center by showing that he would win the war, and appealing to the Democratic left by showing that he would end the war. Trapped between the two political groups, he found himself forced to campaign by attacking Bush. In the course of that, he failed (just barely) to persuade the majority that he had a coherent policy. In the end, he could not persuade enough voters that he was better than Bush, even though he might have persuaded them that Bush was bad.

Kerry’s failure to get elected reflects another issue - the decline of the Democratic Party. Despite more people registered as Democrats, the Democratic Party is becoming the minority party in holding political office. It is struggling to regain momentum across the country. Once the dominant player throughout the American south, the party failed to carry any states in that region for Kerry, even with Senator Edwards from North Carolina running as his vice presidential candidate. Yet, even in a heavily Democratic state like New York (which overwhelmingly voted for Kerry), the governor and mayor of its most populous city, are both Republicans. California, another heavily Democratic state, also has a Republican governor.

For any future Democratic candidate to win the White House, considerable thought is required as to what the party represents and where it wants to take the United States. Bill Clinton’s success came from his ability to take to the political center and in some areas clearly borrowed from the Republicans. Kerry and Edwards in many regards harkened back to the old more leftwing Democratic Party. While this guaranteed that they won the nomination process, it hurt them with the political center. As mirrored by the elections results, the old message is not selling. For the Democrats it is time to come up with a new message that sells.

George W. Bush has four more years. He faces challenging environments in both domestic and foreign policy arenas. Approaching the policy arenas he has a strong mandate. Not only has Bush gained in the popular vote since 2000, the Republican Party has greater control over both houses of Congress. This means that Republicans will continue to control important committees in the Congress, including Ways and Means and Banking.

Bush’s economic policy in the second term will focus around three major initiatives - Social Security reform, tort reform and making the earlier round of tax cuts permanent (and making headway on estate taxes). This dovetails with ongoing Bush programs for maintaining a high level of defense spending and reforming the GSEs (Government-Sponsored Enterprises). Trade policy has a protectionist bent, something that is likely to resurface.

Another important issue on the economic policy side is the Federal Reserve. In the short term we do not see any change in Fed policies - at the next FOMC meeting on November 10, we expect rates to go from 1.75% to 2.0%, with one more possible hike by year-end. Although this interest rate cycle is likely to end earlier than most, the Fed is likely to push rates above core inflation.

More importantly, Alan Greenspan is likely to step down at some point during the next Bush administration. This means that the next Fed head is to be selected by a Republican president and Congress. This should have a major impact on regulatory policy and GSEs. As Greenspan has been supportive of reforming the GSEs, we would expect his successor to be like-minded, especially considering that this is a major issue for the chairman of the Senate Banking Committee Richard Shelby, a close Bush ally. Look for more headlines on reforming Fannie Mae and Freddie Mac (actions which are likely to be more bondholder friendly and less equity friendly).

Moving into the next term, the Bush administration expects that economic growth will strengthen as more Americans have more money to spend (because of a smaller tax burden), hence maintaining strong consumer demand. As economic growth picks up, companies will add personnel, bringing down unemployment. At the same time, economic growth will help generate higher tax revenues from corporate America. The combination of these factors will allow the administration to pursue its reforms.

Perhaps the economic scenario of the Bush administration is a little too rosy. The budget deficit is likely to be an obstacle to any new economic policy initiatives. And as spending is not likely to fall, the pressure is on raising revenues. This potentially represents a problem, considering that the administration is still looking for over 4% growth in 2005. We expect real GDP growth in 2005 to be in the 2.5%-3.0% range, largely due to higher oil prices. Consequently, the government will have less money than it thought, which should reduce its ability to launch new initiatives. In addition, there is likely to be growing pressure within the Republican Party to reduce the deficit. Rounding out the picture, the current account balance of payments in massive – close to 6% of GDP. This also represents a challenge to the ability of Bush II to push ahead with more spending.

The other critical area of business facing President Bush in his second term is what to do with Iraq and the war against terrorism. This dominated his first term. Indeed, he responded with a sense of vision that embraced a highly controversial and ambitious policy to make the Middle East a region of democratic governments. U.S. policy, therefore, is based on the holding of elections in Iraq (set for January) and supporting whatever government emerges. Along these lines, Iraq represents much more bloodshed and a testing of U.S. political will. It also means leaning on other governments in the region, such as Iran (with its nuclear ambitions), Syria and Saudi Arabia (home of al-Qaeda’s founder and a majority of the 9/11 terrorists).

U.S. policy also includes the option to strike first, something that has led to considerable friction with a number of Washington’s allies. Yet, Libya was leaned on (starting with the Reagan administration) and eventually surrendered its weapons of mass destruction. Although there is much that can be debated about Bush’s Middle Eastern gambit, if it is successful, he will looked inspired. If he fails, Iraq will be compared to Vietnam, an unpleasant memory in American history.

Presidents going into a second term are searching for their place in history. This is the period when long-term policies already put in place can be sharpened and reinforced. New initiatives can be launched. Bush needs to focus more on the domestic side of policy. Indeed, it can be argued that domestic economic issues - unemployment, the high cost of prescription drugs and the loss of health care insurance - almost cost him the election. The country is divided and needs gracious leadership. It requires a presidential heavy hitter like Ronald Reagan and Franklin Delano Roosevelt, who can restore a sense of domestic purpose and unity. That means dealing with the deficit, reforming Social Security, appointing new Supreme Court justices and restoring a dialogue within the country. Failure to do so will not put Bush with the likes of Reagan and Roosevelt, but in the camp of Rutherford Hayes and Benjamin Harrison, forgotten Republican presidents of the Gilded Age, who presided over growing inequalities in their country. Much is at stake in the next four years.

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A Two-part Guide to Understanding Investing in Asia

(This article originally appeared in the October Global Edition of Business Facilities Magazine)

Part One: The Essential Importance of an Asian Business Development Strategy

By Keith W. Rabin

If for no reason other than demographics, it is clear future growth in the world economy will be primarily driven by activity outside the U.S. and Western Europe. Japan also faces extremely serious demographic problems; however, it appears to belong in a special category when one considers the immense potential now beginning to be realized as restructuring and reform takes hold and the $3 trillion plus in savings presently invested in its Postal Savings system begins to finance retirements, pushing consumption higher.

At this point, indicators such as the recent forecast by Goldman Sachs that China will overtake the U.S. to become the world's largest economy in less than 40 years—not to mention the inherent growth in other Asian economies—is almost common knowledge. However, another important point was recently raised by Martin Spring in On Target, who noted even then China's per capita income will be only one-sixth that of the U.S. That will leave China many more decades of growth until income parity with the U.S. is achieved. Spring goes on to quote Financial Times bureau chief James Kynge as saying that "within 10 years [China's] appetite for base metals, food, and probably also luxury goods, will strain the world's ability to produce them."

These developments will have a profound impact not only on commodity prices but also on the market for all kinds of goods and services. At a minimum this will mean Asia will account for a far greater share of global consumption and financial market capitalization.

As highlighted in "The 2003 Aging Vulnerability Index" by Neil Howe and Richard Jackson, the bottom line is that the role of Asia, especially China and India, will be far more significant in the future world of our children. For forward-looking investors and corporations, that means there will be real business growth opportunities in the emerging markets and those countries that can sell to them.

This trend is further exacerbated by the growth of outsourcing. A recent Fortune article quoted Gartner data indicating that U.S. companies will spend some $17 billion on human resources outsourcing in 2004. Of that, $6.4 billion—more than one third—will be in payroll processing. This indicates major outflows of U.S. service jobs to other countries, with countries such as India as well as the Philippines and other places with strong English capabilities being the beneficiaries.

It seems fair to say in coming decades, any company seeking to maintain its growth, momentum, and market share will have to define and implement a global expansion strategy. This will be a real problem as U.S. companies, particularly those that lack the scale and resources of the Fortune 500 and other major multinationals, have enough problems initiating nationally-scaled strategies. As a result they have traditionally been reluctant to focus their attention overseas.

A recent survey undertaken by KWR International in cooperation with Business Facilities underscored the difficulties and the ambivalence of many companies seeking to initiate overseas expansion strategies. While many recognized that "international expansion is important," a notably smaller amount were ready to declare it a near-term priority. Additionally, of the respondents who noted they were already internationally active, a significant number expressed dissatisfaction with their efforts—leaving substantial room for improvement.

The reasons for this are many. A more complete analysis of the obstacles and constraints and the steps that firms of all sizes might take to overcome them must be addressed in another article. That said, they essentially revolve around the fact that most small to mid-sized and even many major firms lack the familiarity, experience, and ability needed to understand and operate in foreign markets. They are also hard pressed to apply the resources, attention, and focus needed to define and develop effective and sustainable implementation strategies, to nurture their long-term success, and to access the outside support and facilitation that could help in these efforts.

This inherent difficulty, however, is no excuse for inaction. Developing an effective international expansion strategy, particularly in Asia—where trust and relationships are absolutely essential ingredients to success—takes a lot of time and effort. It cannot be rushed. Therefore, companies that seek to sustain and expand their competitiveness in the face of the economic forces now unfolding before us are well advised to start giving these issues careful consideration so that they might begin to address them in an effective and coherent manner.

Part Two: Predicting the Economic Success of Asia

By Dr. Scott B. MacDonald

Asia is enjoying a period of solid economic growth: current account balances are generally in surplus, and foreign exchange reserves are at record high levels. In China, the region's new economic locomotive, efforts to achieve a soft landing appear to be succeeding, albeit in a gradual fashion. Elsewhere, India has achieved a change in government and many of the key elements of the country's economic reforms are intact.

Generally speaking, good news also dominates in Southeast Asia. Even in Japan, economic reforms have helped set the stage for what appears to be a sustainable recovery. The task ahead for many Asian governments and businesses is to manage success and not fall back into the pitfalls that led to the Asian financial crisis of 1997-98.

Clearly a very strong desire on the part of most Asian governments not to relive the socio-economic disequilibrium of the late 1990s has resulted in a substantial stockpiling of foreign exchange reserves (China has $483 billion), measures to improve corporate governance, and the restructuring of financial sectors. In some cases, there has been an improvement on labor market flexibility and less red tape for foreign investment.

Asia is also benefiting from relatively benign international economic conditions. In particular, the region's major trade partner, the United States, is enjoying moderate economic growth. In addition, European economic growth is set to accelerate moderately in 2005, which should help maintain export expansion in Asia.

Although there is a strong likelihood that Asia will continue to enjoy strong economic growth through 2004 and 2005, there are some clouds on the horizon. Asia's strong pattern of economic expansion can not happen without access to vast amounts of natural resources. In particular, China's spurt of industrial expansion over the past three years has fueled heavy demand for natural resources. The recent round of oil price hikes were, in part, caused by strong growth in China, which combined with renewed demand in the U.S. and geopolitical uncertainties in key oil producer nations, led to a sustained rise in international hydrocarbon prices. Some 30% of China's energy needs are imported. And behind China is India, with a population of around one billion and an increasing consumer appetite that will raise energy needs.

Asia's need to maintain strong levels of growth is renewing the old debate over securing access to key resources. While it is doubtful that any Asian countries will come to blows over coal or copper, oil is another matter altogether. For energy deficient countries such as China, South Korea, and Japan the economic lifeline extends from their home ports in the Pacific to the Middle Eastern and Central Asian oil fields. This raises issues of the security of supply lines as well as potential areas for exploration. Closer to home, it means greater attention to overlapping national claims in such areas as the Kurile Islands and the South China Sea around the Spratly Islands. In the latter, tensions have run high in the past, as reflected by a 1988 naval battle between Vietnamese and Chinese forces.

For much of Asia, economic growth was and remains export-driven. While there is a degree of complementary exports, China's long growth spurt (beginning in 1978) has elevated it into a competitor for many of the same goods produced by other Asian countries. Thailand, Malaysia, South Korea, and Japan have all felt the impact of competitive Chinese exports, based on lower labor costs. Japan and China have already locked horns on a number of trade issues and more are likely. As China climbs the industrial ladder, its competitive nature will only increase and trade frictions are likely to rise.

Other obstacles include the weakness of the Asian financial sector, where reforms have been made but more must occur, and poor corporate transparency and disclosure that hurts investors. Last, but hardly least is the threat of terrorism. There are elements throughout the region that feel marginalized by the formal political system and have opted for terrorism as a means to achieving their goals.

Yet, for all the potential points of economic derailment, Asia is more likely to stay on track. For all the tensions emerging in the region, there are critical reasons for governments to find peaceful solutions. Common economic gains are likely to outweigh the potential for conflict. Consequently, the major task confronting Asia is how to manage the challenges and avoid the pitfalls, something that it can do considering the political will and vision its leadership has demonstrated in the past. Prior to the Asian financial crisis there was considerable discussion about the Asian Century; that talk was premature, but the years ahead could be just that.

Commodities – More Bullish Than Not

by Scott B. MacDonald

NEW YORK (KWR) On October 28, China announced it was raising interest rates for the first time in nine years. The message from some analysts was that China’s dynamic 9%+ real GDP growth is over and, with that, so is the demand for industrial inputs such as oil, coal, steel and copper. They believe commodity prices will now decline, including oil, which could fall sharply back into the $30s. We are not so certain: we could see oil heading lower by year-end, but chances are that commodity prices are going to stay high for the foreseeable future.

The reasons we are likely to see sustained high prices in many commodities are both structural and geo-political. Oil and natural gas prices climbed because of the short-term fear that access to supply would be reduced by geopolitical events emanating from Nigeria, Norway, Iraq, and Venezuela. Shoot-outs with al-Qaeda-linked radicals in Saudi Arabia did not help matters. On a structural basis, there is greater demand from China and India, not to mention higher demand from more traditional markets in Europe, Japan and North America, owing to economic recovery. We would add that a number of speculators helped to push oil prices up, taking advantage of the fear factor. And, gradually seeping into oil market concerns is that this form of energy is ultimately finite and that the global economy is dependent on fields that are beginning to peak.

As for many other commodities, limited supply is a factor. Prior to 2003, most mining companies were careful not to build up supply, having been hurt by large inventories in coal, copper, nickel and zinc during the late 1990s and early 2000s. Because many companies were careful in moving too fast to bring on capacity, both in terms of the actual resources as well as the processing and other facilities needed to bring them to market, supply for a number of commodities, from coal to uranium is tight. Indeed, copper stockpiles monitored by the London Metals Exchange are at a 14-year low.

In addition, rails and ports in countries like the United States, Canada and South Africa are already running at capacity, making it more difficult for greater supply to make it to end users, hence contributing to the tightness in supply for key commodities. As Con Fauconnier, the head of South Africa’s Chamber of Mines stated (November 2): “Transport infrastructural shortcomings in our country make it impossible, most certainly right now and in the immediate future, to meet not only the demand from China but also a number of other potentially profitable commodity export destinations.”

In the past, energy spikes have been followed by economic slowdowns, usually recessions. This time, however, we have different structural factors at work that are likely to moderate the downturn – namely China’s slowdown is not going to radically reduce its need for commodities. China is suffering from power shortages and will still require high levels of oil, gas and coal imports. There is also a political element: for China to control the current trends of rising public discontent with the widening gap between new rich and poor and official corruption, the government needs to maintain a relatively strong pace of growth. For China to have some level of economic growth, it must have inputs. It is as simple as that.

Although China has signaled that it is taking further measures to reduce the pace of its economic growth, the action of that country’s central bank is not a magic wand that will suddenly bring oil prices and other commodities to more sane numbers. We think that China’s growth will cool, though it will be a soft landing, probably in the 7-8% growth range. At the same time, higher oil prices will moderate global growth in 2005. We see U.S. real GDP growth in the 2.5-3.0% range.

One last factor to consider is the weather. A number of powerful hurricanes recently interrupted oil and gas production in the Gulf of Mexico, which accounts for around 20% of U.S. supply. According to weather data, the hurricane seasons for the next several years are likely to be more severe as part of a long-term cycle. Considering the recent battering from these hurricanes, it is likely that the pattern will be repeated in some capacity through 2005 and 2006.

Short of a global depression in which China, India and all other rapidly industrializing countries collapse and revert to a pre-industrializing state, it is hard to see global commodity prices collapsing in the future. Prices for oil, gas, coal and copper are likely to moderate, but we see no major decline as occurred in the late 1990s and early part of this decade, even with slower global growth forecast in 2005.

Malaysia: A Stable Polity Amidst a Growing Economy

by Jonathan Lemco

NEW YORK (KWR) For the past six months, Malaysia has been an investor darling. The economy is growing at a nice clip, the state-owned petroleum company, Petronas, is profitable, and the political transition from Prime Minister Mahatir to Prime Minister Badawi has been smooth. Inflation is low and the nation’s external debt is capably managed. We think that Malaysia enjoys the advantage of high oil prices. But when they fall, the nation is still poised to prosper as it has diversified its industrial base.

Malaysia has one of the most open economies in Southeast Asia, and as a consequence it benefits from a greater boost from global growth (consensus estimates are that Malaysia will grow 7.0% in 2004) than many of its neighbors. The current account has been in surplus since 1998. As of Mid-October 2004, exports had risen 24% year-on-year. The strong balance of payments has allowed the central bank to accumulate more than a quarter of its international reserves in 2004 (US $54.5 billion as of August 2004), to the point that they now exceed the external debt.

Oil prices are high and this supports the Malaysian economy. Further, there has been some progress in passing structural reforms. Also, the Malaysian government has taken steps to reduce its external debt. The credit rating agencies have taken notice and we expect Moody’s to upgrade its “Baa1” rating of Malaysia by one notch to “A-”. Standard and Poor’s already rates the Malaysia credit “A-“.

A credit rating upgrade will be an important boost for Malaysian credit quality, but also an affirmation of the government’s fiscally prudent policies. The 2005 Budget, which proposes a moderate pace of fiscal consolidation, is realistic. In fact, it might be considered investor-friendly in that it eases foreign investor rules in brokerage, fund management, futures brokerages and venture capital firms. It also removes the tax on interest income for non-resident investors, which should drive more investor interest into Malaysia’s domestic bond markets.

Also, private investment growth seems to be picking up. The government estimates that investment will grow by 14.8% in 2004. In the meantime, the Central Bank (Bank Negara Malaysia) emphasizes caution in hiking interest rates such that no increase is expected for 6-12 months. While the government plans for fiscal consolidation, balancing the budget is not sacrosanct. The government intends to narrow the fiscal deficit from 4.5% of GDP in 2004 to 3.8% of GDP in 2005. The Malaysian Central Bank has also reinforced its commitment to a pegged exchange rate, which it regards as underpinned by low inflation and strong external accounts.

After years of stable, if partly authoritarian and confrontational government, under Prime Minister Mahatir, Prime Minister Badawi enjoys strong and unrivalled political support. Although some analysts suggest that Anwar Ibrahim could pose a political threat, we think that the mechanics of the Malaysian political system make this unlikely for the foreseeable future. Badawi has made progress in improving the public delivery system to lower the cost of doing business and increasing transparency (especially in the public bidding of projects).

The Malaysian economy is not without risks. It must continue to attract foreign direct investment when oil prices eventually decline. The Malaysian corporate sector must be made more competitive. Corruption remains a problem in both the private and public sectors. A tax system overhaul is needed to attract more multinational companies. In fact, in 2007 the Malaysian government plans to introduce a goods-and-services tax so that it can cut taxes for individuals and corporations. In the meantime, Malaysia’s corporate tax rate of 28%, is uncompetitive relative to Singapore’s 20 percent.

Malaysia is on the right track for balanced and steady growth going forward. It has been a strong economic performer since the 1997-98 financial crisis. There is every reason to believe that Malaysia will continue to provide an attractive environment for international investment. Fund Research tracks equity and bond fund flows, cross border capital flows, country and sector allocations, and company holdings data from its universe of 5,000 international, emerging markets and US funds with more than $2.5 trillion in assets, including both offshore and US-registered funds. The data is used by top emerging markets and international analysts, strategists and portfolio managers. The firm also provides investment management clients with qualitative analysis on international markets.
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Russia Sees Gains in Bush Reelection

by Sergei Blagov

MOSCOW (KWR)--The Kremlin suggested that Bush's electoral triumph was a victory over international terrorism. In the meantime, despite remaining differences, Russia appears to eye economic and political benefits in the U.S. election outcome, which could also affect Moscow’s Asian policies.

Meanwhile, the Kremlin eyes economic and political benefits in Bush’s reelection. Russia’s Renaissance Capital brokerage said that Bush's re-election would be "better for Russia." A second Bush administration would probably give President Putin a freer hand in domestic and post-Soviet affairs, and preserve high oil prices, which would fuel economic growth, Renaissance said in the report.

Annual bilateral trade only accounts for about $11 billion and Russia accounts for a little more than half percent in U.S. foreign trade. However, Moscow seemingly hopes to boost bilateral trade by energy supplies.

In its drive towards the American energy market, Russia has been focusing on natural gas, particularly in its liquefied form. Last August, Russia’s gas giant Gazprom pledged to move commercial gas sales to the U.S. Supplies should start before 2010. Russia, which holds the largest gas reserves in the world, has been viewing the United States as a long-term major market of liquefied natural gas (LNG) by sea.

Russian companies have been also attempting, with government backing, to take over from Saudi Arabia as the main oil provider to the U.S. The companies are also seeking American capital for investment in Russian oil, which could help deliver Russian oil to America's West Coast.

Meanwhile, direct oil and gas shipment to the U.S. remains a challenging task given the distance and the lack of infrastructure in Russia. In 2002, Russia's state-owned Rosneft oil company and the US firm Marathon Oil Corporation announced a decision to participate jointly in Urals North American Marketing (UNAM), a project to supply oil from the Urals region in Russia to North America. Oil supply under this project was due to begin in 2003, but the ambitious plan is yet to materialize.

Most Russian media outlets pronounced Russia better off with a re-elected U.S. President George W. Bush. "Bush's victory is beneficial for Russia," Alexander Livshits, Putin's former economic adviser, wrote in a commentary. "We know him, we know members of his team. We are used to them, and they are used to us. Bush's administration does not tell us how to live. It does not interfere much with our country's domestic affairs. And the personal relationship that our two presidents have established is also important," he wrote.

The fall of 2001 was a high point in U.S.-Russian relations and Russia seemed to become one of the United States' close allies for the war on terrorism. Yet subsequently the two countries were struggling to overcome their differences over the U.S.-led war on Iraq as well as Iran’s nuclear ambitions.

For instance, last month Russia responded coolly tothe deployment of the U.S. missile shield following the announcement that the missile defense system could become operational in Alaska later this year. The U.S. defense system is designed to deploy a field of interceptors in Alaska and California that would fly into space to meet and destroy a missile. U.S. officials have acknowledged that the system would not defend against Russian or Chinese technology, but against the countries like Iran or North Korea that are developing long-range missiles and weapons of mass destruction that could be carried by the missiles.

After President Bush pulled out of the 1972 Antiballistic Missile Treaty in order to pursue the new antimissile defense program, to be launched in Alaska, Russia announced it no longer felt bound by previous agreements that prohibited missiles with multiple warheads. In February 2004, Russia said it successfully tested a new strategic supersonic system, that would allow avoid U.S. defenses. Russian officials claimed that the prototype weapon proved it could maneuver so quickly as to make "any missile defense useless."

Moves towards strengthening its own strategic deterrent have caused little controversy, but Russia has long come under fire from Washington for its help in building the Bushehr 1,000 megawatt light-water nuclear plant on Iran's Gulf coast. The U.S. insisted that the Russian technology could be used to develop nuclear weapons, but Moscow and Tehran argued that the plant could be used only for civilian purposes. Russia has vowed to complete construction of Iran's first nuclear reactor at Bushehr, despite U.S. concerns that Tehran was using $800 million project as a cover for a nuclear weapons program.

Apart from Iran’s nuclear ambitions, there have been other bilateral disagreements as well. Washington has warned against Russia’s richest man Mikhail Khodorkovsky’s case implication for the rule of law in Russia and the country's commitment to free markets. Russia accused the U.S. of double standards approach. Moscow has described the U.S. comments on a variety of events in Russia, including recent moves to limit elections and boost centralized controls, as “interference in Russia’s internal affair.”

Moscow’s move towards Kyoto ratification happened to come as a blow to the Bush Administration, which had been pressuring Russia not to ratify. Russia recently moved to approve the Kyoto Protocol, bringing the international treaty to limit greenhouse emissions closer to coming into force worldwide. George W. Bush rejected the pact in 2001, saying the tough regulations would adversely affect the country's economy.

On the other hand, Moscow has been keep to continue security cooperation with the U.S. Russia has offered some help in tackling security threats, including standoff with North Korea. In the wake of Bush's reelection, Moscow could become more pro-active in search for a solution of a crisis over Pyongyang’s nuclear ambitions.

Putin has openly supported Bush's reelection bid and has demonstrated intention to overcome acrimony over Iraq. The Russian leader made several statements over the last months, voicing his strong support for Bush’s reelection bid. Last summer, Putin said that the Iraq invasion was indeed justified, because Saddam was planning terror attacks against U.S. targets, according to Russian intelligence. Two weeks before the US vote, Putin said international terror groups aimed to sink Bush's reelection efforts.

As democrats have voiced stronger criticism of Russia, concerns were voiced in Moscow that relations with the U.S. could decline under the Democrats. Subsequently, Russia has been aiming at stronger ties with China, seemingly to balance those with Washington.

Hence it remains to be seen whether shared interests of the U.S. and Russia could outweigh potential problems. Official pledges to overcome differences in bilateral relations are to be followed up by more concrete results.

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Chavez’s Kingdom – Venezuela’s Caudillo Flexes His Muscles

by Scott B. MacDonald

NEW YORK (KWR) Having survived a coup attempt, a major strike by the country’s most powerful union (oil workers at PDSVA), and a referendum to constitutionally oust him from office, President Hugo Chavez remains firmly in control of Venezuela, the world’s fifth largest oil exporter. In many regards, the President has extended his control over the nation’s body politick to such an extent that it is dubious that any opposition movement can oust him – legally or through a coup. Through suasion and coercion, Chavez has created a government, which in some ways a state akin to Mexico’s old PRI regimes, where an opposition was tolerated (to a point), the politically ambitious were channeled into the system (or life became very complicated), and the spoils of the economic system were guided to the key bases of support. The economy is increasingly bearing the mark of mixing command economics with what is left of the country’s private sector. And for now, Chavez’s government is enjoying the benefits of higher oil prices, which helps cover up considerable economic mismanagement.

The latest consolidation of power for President Chavez and his Bolivarian revolution came with the October 31, 2004 gubernatorial and mayoral elections. The outcome was a massive sweep for the Chavistas. According to the official count, pro-Chavez candidates won 270 out of 334 mayor’s offices and 20 out of 22 governor’s mansions. The latter included seven states that were previously held by opponents. Among the defeated were two of the most prominent anti-Chavezista leaders, Miranda Governor Enrique Mendoza and Carabobo Governor Henrique Salas Feo. The only two states that did not fall before the Chavezista electoral juggernaut were in Zulia in the west and Nueva Esparta in the north.

Chavez clearly recognized the significance of the election results, stating: “This is a giant victory. Venezuela has changed forever. The revolution has arrived, and there is no going back.”

Maybe. The elections were not without controversy. The National Electoral Council (CNE) was quick to call results, leaving some of the outcome for a number of tight elections questionable. In addition, there was no independent oversight of the vote and opposition parties were clearly not welcome as observers. Moreover, CNE officials claimed that voter abstention was 55 percent; independent sources dispute that number, indicating it was closer to 70 percent. The fundamental reason for the high level of voter apathy was that many Venezuelans regard the electoral process as fraudulent.

The opposition also managed to survive. Despite the failure to provide a more unified front, the opposition managed to hold on to Zulia, one of the major oil-producing states and Maracaibo, its capital. This turn of events came even after a very concerted push by pro-Chavez forces to unseat Manuel Rosales, Zulia’s governor. Rosales could emerge as a challenger in the 2006 presidential elections.

What is next for Chavez? With the military largely under his control, a majority of the electorate in his favor (or just plain apathetic), the judiciary packed with his followers, Cuban advisors, and oil prices still high, he is now gearing up for the congressional elections in 2005 and the presidential contest in 2006. Clearly having either members of his Fifth Republic Movement (Movimiento Quinto Republica) and its ally, the Fatherland for All Party, along with smaller parties (including the Communists), sitting in mayor’s halls and gubernatorial mansions, gives Chavez dominance over the country’s political system, both nationally and locally.

Chavez is also benefiting from the oil bonanza. After the economy contracted by 7.5 percent in 2003, real GDP growth is expected to be over 12 percent in 2004. According to the IMF, real GDP growth for next year will be a more moderate 3.5 percent, reflecting the assumption that oil prices will moderate. The government is more bullish, looking to 5 percent growth. If oil prices plunge (which we do not expect), the government will have to scramble to make ends meet – or opt to use the printing press and inflation be damned. It should also be noted that Chavez is using the oil wealth to pay for social programs, reinforcing his support among the population’s working class sectors.

Hugo Chavez is clearly leaving his mark on Venezuela’s history. He assumed control of a country long troubled by economic mismanagement, substantial socioeconomic inequalities, and massive corruption. The old republic’s political elite was popularly regarded as inept, corrupt and self-serving. Under Chavez, the former political elite has been defeated and left grappling with how to re-invent itself. In its place, Chavez has advanced his political agenda of reshaping Venezuela’s political life – along the lines of a liberal Cuban model, where political control is well-defined and there is a little more openness in terms of the private sector and foreign involvement in the economy. All the same, Chavez is the dominant political figure and without a credible and more cohesive opposition, he is likely to remain the left-leaning strongman well into the next decade.



Featured Guest Opinion
(note: Featured Guest Opinions do not necessarily reflect the opinions of KWR Intl.)

China Minmetals Meets Mild Canadian Resistance

Jim Letourneau, Big Picture Speculator

CALGARY (KWR) Global demand for commodities has been a boon to resource rich countries like Canada and Australia. Increasing demand for raw materials has led the Chinese government to take a proactive role in the procurement of commodities and the facilitation of their production. The proposed $7 billion purchase of Toronto-based Noranda by China’s Minmetals is part of this initiative.

Resistance to the transaction is not unexpected. Noranda has a made-in-Canada corporate history dating back to 1922. The transformation of a prospector’s dream into an international mining conglomerate is a source of national pride. The sale of Canada’s largest mining also includes 60% of Canada’s third largest miner, Falconbridge.

Although much is being made of Canada’s resistance to this transaction it appears to be restricted to the minority. The loudest complaints have been from the 3rd ranking opposition NDP party who are raising the specter of China’s human rights record. Some are even trying to wrap themselves in the red maple leaf flag and raise sovereignty issues about Canada’s resources. While there may be a time when countries want to hoard their raw materials for domestic consumption in the face of shortages, the fact remains that Canada is great exporter of raw materials. After all, there are 32 million Canadians and 1.3 billion Chinese.

Images of Tiananmen Square in 1989 are still fresh in people’s minds but the advances in the average living standards and freedoms for the Chinese people have been ignored. China’s transition from Soviet style central control to a more market driven economy has been extraordinarily rapid.

Human rights issues are important to Canadians, we believe in diversity, freedom of expression and compromise. We don’t want evil empires using our resources for nefarious purposes. Countries that execute criminals, torture political prisoners and discourage freedom expression might not be ideal trading partners but as long as Canadian’s are willing to turn a blind eye to the human right’s record of other countries there are no moral grounds to not trade with China as well. So far trade restrictions on softwood lumber, grain, and beef that benefit American special interest groups have been refreshingly absent for Canada-China trade relations.

It appears unlikely that Canadians will be undertaking a global inventory companies involved with countries with human rights issues. There are numerous small-scale resource development projects being spearheaded by Canadian companies in countries with sketchy human rights records. If a country is open for resource-related business, chances are there’s a TSX Venture exchange company using Canadian capital to explore for it.

I know from personal experience that almost everything we buy comes from China. During a recent move, I collected approximately 20 different sized boxes from the local Wal-Mart. While the in-store recorded announcement distracted unconcerned soothed crowed that the vast majority of the goods they sold were “sourced from Canadian suppliers”, the boxes all had the words “Made in China” on them. As my daughter Veronica succinctly stated “Where else are we going to get our stuff from?”. Trade is a two-way street.

China as also indicated that they are in the market for Canadian energy assets. Canada’s oilpatch has a longstanding tradition of selling its assets to the highest (usually American) bidder when prices are high and then buying them back for a song when prices are low. Foreign investment in Canadian natural resources is nothing new.

On a more practical level Bombardier is in the running for $4.5 billion worth of Chinese transportation contracts. Canadian Prime Minister Paul Martin is clearly aware of the consequences of restricting the free flow of goods and services between the world’s most rapidly growing economy and Canada. Mild opposition followed by practical compromise is the preferred modus operandi of Canadians. While the purchase of Canadian companies by Chinese interests may not be greated with open arms, there are no reasons to prevent it outright. A multi-billion dollar transaction without a European or American purchaser is a new phenomenon to Canadians. Ultimately, everyone will get what they want. China will get access to Canadian resources, technology and capital markets, Canadians will strengthen trade relations with China and the Canadian opposition parties will get attention by opposing it all. Noranda will be sold and China will be making additional investments in Canadian resources in the near future.

Geo-Political Notes:

Arafat’s Departure

by Scott B. MacDonald

For a region already filled with political upheaval, the news that the 75-year old Yasser Arafat is dead does not bode well. This is not to say that the long-time Palestinian leader was a man of peace. Rather, the risk is that his legacy is one of chaos and civil war among the Palestinians, which has implications well beyond the confines of the Gaza Strip and West Bank. Arafat is the last of the Nasserites, who came to age in the aftermath of European dominance. Like Egypt’s Nasser, Syria’s Assad and Algeria’s FLN leadership, Arafat’s orientation was Arab nationalism, socialist economics and alignment with the Soviet Union during the Cold War. It is important to emphasize that this placed him in the secular camp, not the radical Islamic camp. Although he mouthed the Islamic rhetoric, his closest allies are secular and, perhaps most telling, his wife is Christian (though officially she converted to Islam but has lived in Paris with the couple’s daughter for the past three years).

The Arafat legacy cuts two ways. His stubborn nature helped create a Palestinian nation such as it is. At the same time, his stubbornness also guaranteed that the experiment in government was dysfunctional and dependent on his personality. With no clear-cut successor and a weak core of followers within his Fatah party, his departure from the West Bank for Paris leaves behind a very fluid political situation. Waiting on the sidelines is Hamas, a well-defined political movement centered around radical Islam and with a proclivity for terrorist actions. As the Arafat era appears to be drawing near, the next step is probably going to be an intense and bloody contest for leadership within the Palestinian community. This is not a positive for the Palestinians, Israelis or anyone hoping for stability in the Middle East.


Algeria – An End to the Violence?: Algeria has been locked in a civil war between the secular-oriented government, which is dominated by the military and radical Islam since 1992. That conflict has claimed an estimated 100,000 lives since it started. Now a general amnesty is being considered for Algerians implicated in violence and murder over the past 12 years. Accordingly, President Abdelaziz Bouteflika believes the time is right to try to move to the next stage to bring peace to Algeria. Hence, the idea of an amnesty was recently brought up during events to mark the 50th anniversary of the start of the war of independence against France.

Bouteflika, however, was very specific in stating that despite his party's strong victory in April's election such a decision could not be taken by his government alone. Instead, he suggested a referendum would be needed, because, according to the constitution, the people are sovereign and not parliament or the president. Along these lines, a general amnesty would be expected to pertain to of all those who have been implicated in the sectarian violence of the past decade, including the armed Islamists as well as members of the security forces accused of torture, and summary executions. There are also those involved in the disappearance of more than 7,000 Islamist prisoners, arrested during this period.

The families of the victims of both the Islamists and members of the security forces do not generally agree with each other. However, in this case they appear to have found common ground over a possible amnesty. Consequently, President Bouteflika envisions a general amnesty as being part of the country's path to dialogue that will eventually end the conflict with reconciliation. This has considerable importance to global energy supply as Algeria is a leading exporter of oil and gas to Europe and is one of the few OPEC members thought to have still unexplored regions capable of holding substantial hydrocarbon reserves.

Mauritania and Oil: Long an economic backwater, the African country of Mauritania is quietly becoming an oil-based economy. Mind you, this former French colony that shares borders with Mali, Senegal, Algeria and Morocco is not destined to become the next Saudi Arabia. Oil is still a relatively young industry, commencing with experimental wells in 2001. The economy has traditionally been dominated by agriculture, fish processing and the mining of iron ore. Periodic drought has complicated the dependence on agriculture, while foreign fishing companies are threatening to deplete the rich offshore waters. Consequently, the increasing level of exploration for oil and natural gas, both onshore and offshore, is regarded with considerable hope.

In early November it was announced that the Mauritanian government is expected to commit to taking 12 percent of the $600 million Chinguetti oil project off the country’s coast (which would effectively reduce stakes in the field owned by Woodside Petroleum). This puts the government into the development of a 120 million-barrel field, which is due to start up in March 2006. The government is exercising an earlier agreed upon option, making it the third-largest shareholder in the project after Woodside (whose stake falls from 53.8 percent to 47.4 percent) and Perth-based Hardman (19 percent).

The development of the hydrocarbon industry is critical for Mauritania’s economic development. The country has long been one of the poorest nations in the world, with 50 percent of the population estimated to live below the poverty line and with unemployment over 20 percent. In addition, the population is young – 45.9 percent of the population is below the age of 15 years. If properly managed wealth generated from oil and natural gas exports could make a contribution to the country’s economic development. If poorly managed, oil wealth will prove to be an additional source of corruption and greater socio-economic inequality. As further exploration efforts hit their targets and the weight of hydrocarbons grows on the economy, Mauritania’s leadership will have some tough decisions to make, all of them with long-term consequences for the well-being of their people.

Mexico’s Pemex - Change at the Top:
On November 1, 2004, the CEO of Pemex, Raul Munoz Leos, the first private company executive to run Pemex, Mexico's state-owned oil company resigned. Leos was brought in to run Pemex four years ago by President Vincente Fox, with the idea that a CEO with private sector experience could improve the operating efficiences of Pemex, long the domain of high-ranking and usually moderately competent bureacrats. Leos was also regarded as the right man to open up more of the Mexican oil sector to foreign companies, badly needed to help in exploration and development on new fields. Mexico faces the problem that it is pumping faster than it can explore, raising questions as to the long-term life of national hydrocarbon reserves. Any change in Mexico's oil laws, many of which date back to the early 1920s and represent a strongly nationalistic tradition, have been the source of considerable political tension. Leos was repeatedly blocked by powerful influences within the Mexican government, including some cabinet ministers who are opposed to any openings to foreign companies. Leos will be replaced by Luis Ramirez, Pemex's head of exploration and production. This is not a positive development for the credit as it underscores political influence over Pemex. Although we do not expect to see any ratings action because of this development, it reflects that Pemex's longer-term problems pertaining to exploration and reserve life are still not being properly addressed.

Book Review: Kim Jong-Il: North Korea's Dear Leader

Michael Breen, Kim Jong-Il: North Korea's Dear Leader (New York: John Wiley, 2004). $24.95


Reviewed by Scott B. MacDonald



Click here to purchase John Wiley's book, "Kim Jong-Il: North Korea's Dear Leader," directly from

Michael Breen, an old Korean hand and journalist, has written an entertaining, must-read book on North Korea's dictator, Kim Jong-il, also known as the "Dear Leader".

Having traveled to North Korea a number of times and now living in the South, he clearly has an understanding of the local political culture and how it often collides when the West looks at North Korea, which he ultimately describes as thus: "It's Hitler's Germany and Stalin's Russia in the middle of Mao's Cultural Revolutionary madness." Considering the fractured nature of data available about North Korea and its dubious place as part of President George W. Bush's Axis of Evil, Breen provides an educated glimpse into a country made critical by the combination of its harsh political regime and possession of nuclear weapons.

Breen traces Kim Jong-il's childhood, his relations with his family and describes the world around him. He notes that the Dear Leader's rise to national leader in the boots of his father, Kim Sung-il (the Great Leader) was not a given, considering the existance of a half-brother, the son of the elder Kim's second marriage. As Breen notes: "The stage was better set for his half-brother Pyong-il to be seen as the new 'first son', and Jong-il to be the more obscure Billy Carter/Roger Clinton figure identified in the pictures as 'second left, back row, with the hair'." What saved Jong-il from this fate was that his mother had been a partisan and that he was active in promoting the personality cult for his father. Indeed, the younger Kim demonstrated a strong interest in film and opera, all of which aimed at reinforcing the personality cult of North Korea's Great Leader and the mission of self-reliance (Juche). Along these lines, we are treated to such exciting revolutionary operas as The Sea of Blood, True Daughter of the Revolution, and (how can we forget!) Fate of a Member of the Self-Defense Corps. Nonetheless, Jong-il's patriotism and loyality to Kim Sung-il made an impression on the veterans around the Great Leader. As the Great Leader aged, these veterans increasingly looked to Jong-il as the successor. By 1980, Jong-il emerged as the official successor, though he was exceedingly careful not to upstage his father. When the elder Kim died in July 1994, Jong-il was probably actively involved in running the government. Even so, he did not officially emerge as North Korea's undisputed leader until 1997, having observed a lengthy period of respect. He was also busy consolidating his power.

Although Breen admits that it is tempting to regard Kim Jong-il as a "nutter", someone that suffers from malignant narcissism (according to one political psychological profile), he emphasizes that the Dear Leader is a product of local political culture. Korean political culture is clearly heirarchical, founded upon Confucianism. While this is changing in the South due to democratization and globalization, it has been allowed to go unchecked in the North, with the dyfunctional twist of fate being the emergence of a Communist dynasty. Within this context, Kim Jong-il is aware that the North Korean state is a facade of forced loyalty, held in place by a system of gulags and military power. Breen also asserts that Jong-il is aware that his father generated real emotion from his people having fought against the Japanese in the liberation of his country and then against the Americans. In contrast, the son does not generate that level of support. In fact, according to Breen, he is the one fat man in a country hard hit by famine during the 1990s (that might have left 3 million dead) and focused on remaining in power and living the high life. In a sense, Kim must relaize that he is trapped. If he makes the changes necessary to moving North Korea out of its developmental cul-de-sac, he is also opening the door for his own demise. Any crack of freedom (even just economic), threatens to disrupt a system of ruthless and total control. Consequently, the system is run to have total loyalty to the Dear Leader and focus with a deep hatred on the enemies that threaten the North Korean workers paradise.

Why do we care? According to Breen we care because Kim Jong-il presides over a country that is unable to feed itself, but has the capacity to threaten the surrounding region with weapons of mass destruction. The new series of missiles, which probably can carry nuclear weapons, can currently reach Japan, China, Russia and Alaska. The next generation of missiles might be able to hit the U.S. west coast. This certainly makes
Washington take notice of the strange, chubby man with the funny hair sitting in Pyongyang. While we have our own security concerns, there is also the fate of the North Korean people, caught in the world's most isolated state.

What to do? North Korea represents a very difficult foreign policy problem. The Kim regime is a brutal authoritarian regime, armed with weapons of mass destruction. At the same time, no one really wants to see the North Korean state implode. The economic and political costs of a failed state in North Korea would be massive for South Korea and poise tough questions for both China and the United States. Breen believes that North Korea needs to be nudged along, gradually making the necessary changes. U.S. policy should broaden its focus from the nuclear issue to a more fullsome approach, including the discreet interdiction of the regime's illicit trafficking in drugs and weapons (cutting off the flow of cash which allows Kim Jong-il to buy his imported cognac), a non-agression pact, a Korean War peace treaty, U.S. embassy in Pyongyang, loans, and access to U.S. markets. In addition, North Korea should be made to sign a human rights agreement with the U.S., China, South Korea, Japan and Russia. Although it would be difficult to enforce, it would give the outside world a little more legal leverage on promoting change within the North. Although none of this is perfect, it could create a workable peace. As Breen concludes:

"But then, although unstated, a comprehensive engagement approach would also lay the groundwork for the eventual regime change and the exit of Kim Jong-il - which, after all - is what we're all waiting for. The sad fact is that, until that happy day, the poor people of North Korea will continue to suffer."

Breen's Kim Jong-il is a very worth while read.

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