The Fallacy of Grievance-based Terrorism

by Melvin E. Lee
Middle East Quarterly
Winter 2008
http://www.meforum.org/article/1830

The fundamental premise of much scholarly examination and public discourse is that grievances with U.S. policies in the Middle East motivate Islamist terrorism. Such assumptions, though, misunderstand the enemy and its nature. In reality, the conflict is sparked not by grievance but rather by incompatibility between Islamist ideology and the natural rights articulated during the European Enlightenment and incorporated into U.S. political culture. Acquiescing to political grievances will not alter the fundamental incompatibility between Lockean precepts of tolerance and current interpretations of Islam: Only Islam's fundamental reform will resolve the conflict.

Many scholars mark the post-World War I partition of the Ottoman Empire as the origin of Islamist opposition to the West.[1] The idea that the Middle East would be a tolerant, prosperous contributor to the global environment today if World War I victors had left intact the Ottoman Empire is a premise in the literature accompanying the rise of twentieth-century jihadism. Historian David Fromkin argued in his influential A Peace to End All Peace that present day Muslim unrest is the direct result of Winston Churchill's early twentieth-century decisions.[2] British journalist Robert Fisk also holds British officials responsible although he prefers to blame Arthur Balfour, foreign secretary between 1916 and 1919.[3] Both authors are wrong, though, to base their theories of grievance on such arbitrary demarcation of eras. The roots of jihadism and its opposition to the United States as part of the non-Muslim West were cast long before World War I erupted. The interaction between the United States and Muslim states and societies dates back to American independence.[4] Contemporary jihadism is not the result of accumulated grievance; rather it has for cultural reasons been an integral factor in Islamic societies' interaction with the United States.

The Die is Cast

Almost immediately after independence, the U.S. government found itself in conflict with the Barbary sheikhdoms of Morocco, Tunis, Algiers, and Tripoli. For centuries, these states filled their coffers by piracy, stealing cargoes, enslaving crew, and collecting ransom. European sea-going nations often entered into treaty and tribute arrangements with the Barbary leaders in order to buy immunity and curtail competition.[5] In 1784, Moroccan pirates hijacked the U.S. merchant ship Betsy in the Mediterranean and enslaved her crew. A year later, Algerine pirates seized two more vessels, the Maria from Boston and the Dauphin from Philadelphia. The U.S. ministers to England and France, John Adams and Benjamin Franklin, and Thomas Jefferson oversaw a peace treaty with Morocco, but the Algerine leadership refused any accommodation. In 1796, President George Washington ordered construction of six warships to form a U.S. navy and to protect U.S. shipping from Barbary pirates. In 1801, in the wake of an upsurge in piracy, President Thomas Jefferson entered into war with Tripoli, bombarding the city three years later and winning the release of American hostages.[6] Peace did not last. With the U.S. military embroiled in the War of 1812, Algerine pirates again began terrorizing American crewmen and disrupting U.S. trade. They miscalculated. In 1815, President James Madison dispatched a squadron of U.S. Navy frigates, which defeated the pirate fleet and won reparations from Algiers, Tunis, and Tripoli.[7]

Many historians consider the Barbary wars a sideshow relative to contemporaneous events such as the French Revolution, Napoleon's conquests, and the War of 1812, but the Barbary wars are significant to today's conflict. Franklin, Washington, Adams, Jefferson, and Madison each believed the Barbary wars to be a continuation of the American Revolution. The ground war in North America may have freed the United States from British tyranny, but the Barbary campaign was necessary to win the same freedom of action and commerce within the international community.[8] The episode also crystallized perceptions of Islam and the Ottoman Empire in the American mind. While Americans did not perceive the Barbary wars as a conflict between Christianity and Islam per se, religion was an issue. The two sides fought, not over theological differences, but rather as a result of the divergent ideologies enabled by the two faiths.[9] Washington and Adams referred to the Muslim leaders as "nests of banditti" while Jefferson's and Madison's campaign literature called them "petty tyrants."[10] The "despotic Turk" became the antithesis of early American republican identity.

What Americans and Europeans saw as piracy, Barbary leaders justified as legitimate jihad. Jefferson related a conversation he had in Paris with Ambassador Abdrahaman of Tripoli who told him that all Christians are sinners in the context of the Qur'an and that it was a Muslim's "right and duty to make war upon them wherever they could be found, and to enslave as many as they could take as prisoners."[11] Islam gave great incentive to fighting infidels, Abdrahaman explained, because the Qur'an promised that making war against infidels ensured a Muslim paradise after death.[12] Richard O'Brien, the imprisoned captain of the Philadelphia merchantman Dauphin and later the U.S. consul to Algiers, related similar conversations with ‘Ali Hasan, the ruler of Algiers.[13] Ottoman leaders used the same rationale to justify the enslavement and trading of captives from the Balkans, Caucasus, and Ukraine.[14]

The role that jihadi ideology played in the Barbary wars is documented with explicit references to jihad and holy war in the treaties that U.S. officials entered into with Muslim rulers. Tunis and Algiers, as the western outposts of the Ottoman Empire, even described themselves to American envoys as the "frontier posts of jihad against European Christianity."[15]

U.S. officials took a conciliatory attitude. Realizing that the North Africans were hypersensitive to the historic conflict between Islam and European Christianity, especially in the context of the expulsion of the Moors from Spain, U.S. officials bent over backwards to deny the religious and ideological nature of the conflict, especially to the Muslims themselves. They realized that religious conflict might jeopardize the commerce that the United States still hoped to find in the Mediterranean. In 1821, President John Quincy Adams was barely able to resist assisting the Greeks in their war of independence when both the American and European publics urged war with the Ottoman Empire.[16] The founders possessed a deep conviction for religious tolerance and proudly explained in the short-lived 1797 treaty with Tripoli that the U.S. was not a Christian state at all but rather one which had no official religion and maintained laws forbidding the prohibition of religion.[17] Perhaps their denial of the religious and ideological nature of the conflict foreshadowed the attitude many Washington policymakers adopt today. Then as now, it has become the basis of a fundamental misunderstanding of the root of the conflict.

The Barbary conflict was the beginning of continuous U.S. interaction with the Muslim Near and Middle East. While Jefferson and Madison believed that a continuous U.S. military presence in the Mediterranean was necessary to protect U.S. national interests, in 1831, President Andrew Jackson secured a treaty of amity and free trade with the Ottoman Empire leading the secretary of the navy to report seven years later that it was no longer necessary to keep a U.S. fleet in the Mediterranean.[18] Three years after Washington withdrew the squadron, Ottoman privateers began raiding U.S. shipping, forcing the reconstitution of the fleet after the U.S. Civil War.

No longer, though, did the U.S. government feel content to view relations with Muslim governments only through a commercial lens. The Civil War interjected discussion of natural law and freedom into U.S. policy formulation. American missionaries increased their presence in the Muslim Middle East throughout the nineteenth century although Muslim prohibitions on conversion to Christianity led them to focus their efforts more on aid and education than on proselytization. Simultaneously, the Ottoman sultan and other Muslim rulers began to pursue more pronounced repression against both Christians and Jews.[19] Intolerant, fundamentalist strains of Islam gained ground on the Arabian Peninsula and in North Africa.[20]

By 1840, the final year of his administration, and again during his unsuccessful campaign for a second term in 1848, Martin Van Buren expressed concern for the plight of Jews in the Ottoman Empire, which he called "the most anti-Semitic of countries."[21] In the last quarter of the nineteenth century, strife between Muslims and Christians in the Balkans and in Istanbul led President Ulysses Grant to dispatch six warships to the waterways around the city to ensure the safety of Americans.[22] In 1882, President Chester Arthur dispatched the Mediterranean Squadron to Alexandria to help evacuate Americans and Europeans following anti-Christian violence in the city. President Grover Cleveland even proposed an Anglo-American intervention in the Ottoman Empire to assist Armenian Christians against Muslim violence.[23] In 1903, an assassination attempt on the U.S. consul in Beirut amid anti-Christian rioting led President Theodore Roosevelt to dispatch marines to the city. A few months later, marines landed in Tangiers after the kidnapping of a Greek businessman from the U.S. consulate there.[24] Behind each incident was Muslim violence toward minority Christian and Jewish communities.

The nineteenth century foreshadowed increasing conflict between the United States and Muslim Middle Eastern countries. The failure of effective Ottoman political reform coupled with the evolution of Islamic reform toward greater Islamism and less tolerance set up a conflict between the American notion that governments rule at the consent of the governed and the dominant attitude among Muslim potentates who subscribed to an intolerant, coercive, anti-Semitic, and anti-Christian ideology.

Twentieth-century Continuity

Into the early twentieth century, successive U.S. administrations sought to remain aloof from Arab and Ottoman politics. President Woodrow Wilson did not include the Ottoman Empire in the U.S. declaration of war against Germany and the Austro-Hungarian Empire, an omission he said was to mitigate the risk of Ottoman retaliation against its Christian or Jewish populations, thereby implying his sense that the Porte saw the United States through a religious rather than just diplomatic lens.[25]

The U.S. government sought to remain detached in all but the commercial sphere. The U.S. trade relationship with the Middle East expanded exponentially in the mid-twentieth century. In the decade following the end of World War II, U.S. commerce increased 167 percent. The next decade saw a 226 percent rise, and the following decade a 321 percent increase in absolute terms.[26] Such involvement, though, had diplomatic and strategic overtones.

During the Cold War, "armed neutrality" could no longer protect U.S. strategic interests. Successive administrations and the State Department pursued a "pro-Arab" policy in the region to stymie the expansion of Soviet influence into those countries. In a January 1945 correspondence, Dean Acheson, secretary of state and chief architect of the U.S. Cold War Soviet containment policy, argued for a pro-Arab tilt to U.S. policy in order to deny the Soviet Union any possible inroads into the region.[27] Successive administrations embraced the policy. Dwight D. Eisenhower sided with Gamal Abdul Nasser against Israel, France, and Great Britain during the 1956 Suez crisis. While the U.S. government often stayed on the sidelines, in eleven of the twelve major Cold War and immediate post-Cold War conflicts between Muslims and non-Muslims, Muslims and secular forces, or Arabs and non-Arabs, the U.S. government supported the former group.[28] Washington, for example, backed the Afghan mujahideen against the Soviet Red Army in the 1980s and supported Bosnian Muslims against Serbs and Croats. U.S. administrations have even leaned hard on Israel, preventing the Jewish state's destruction of the Egyptian, Jordanian, and Syrian armies in 1967; ignoring the Israeli government's pleas not to sell state-of-the-art weaponry to Saudi Arabia; and pressuring for concessions to the Palestinian Authority despite its embrace of terrorism. The only exception to Washington's pro-Arab tilt has been U.S. diplomatic intervention in support of Israel at the United Nations and White House commitment to maintain Israel's qualitative military edge.

During the six decades since Washington abandoned its "armed neutrality" policy in favor of deeper relations with Arab states, friction has increased between U.S. officials and Islamist ideologues. The pro-Arab tilt Washington pursued during the Cold War to stymie Soviet intrigues and maintain energy security, meant partnership with non-democratic regimes and often corrupt rulers in Saudi Arabia, Jordan, Egypt, Tunisia, Morocco, and the Persian Gulf emirates. Islamists and other opposition groups argued that Washington should support the people and not autocrats. But such rhetoric is laid bare by the antagonism that U.S. support for Israel engendered among many of these self-professed democrats. Israel is the only democracy in the region. Its citizens, 17 percent of whom are Muslim, enjoy basic civil liberties regardless of their faith and, even in the West Bank, enjoy a standard of living far superior to that of Egyptians and Jordanians.[29]

Jihadi Antipathy

Both the United States and Jews have become the focus of Islamists' irrational enmity as Islamist thinkers and Arab demagogues deflect any internal responsibility for Muslim countries' woes. This was a common theme both of Sayyid Qutb, the leading Muslim Brotherhood ideologue and, later, Al-Qaeda founder Osama bin Laden.[30] In Knowing the Enemy, Mary Habeck, a professor of military history at Johns Hopkins University's School of Advanced International Studies, documents how Qutb and bin Laden spread a message that the decline of majority Muslim polities is not the result of flaws within Islam itself but is instead the deliberate effort of the United States and the Jews.[31] Today Pakistani madrasas (Islamic schools) alone spin out more than one million graduates per year steeped in jihadi ideology.[32]

Underlying much jihadi thought is antipathy toward democracy. Both Qutb and bin Laden argued that democracy is not a solution to inequity and corruption in Islamic societies.[33] In a video that marked the sixth anniversary of the 9-11 attacks, bin Laden said, "It has now become clear to you and the entire world the impotence of the democratic system and how it plays with the interest of the peoples and their bloody sacrificing of soldiers and populations to achieve the interests of major corporations."[34] While some Islamists—such as the Muslim Brotherhood in Egypt or Muhammad Khatami in Iran[35]—speak of their embrace of democracy, seldom do they include Enlightenment concepts such as tolerance, rule-of-law, and property rights. They do not accept, as did the U.S. founding fathers, that people are endowed with both the natural right to freedom from coercion and the liberty to improve their lives. In practice, then, regardless of their rhetoric, they eschew democracy.

The failure of Islamic states to incorporate the Enlightenment's advances in thought has caused their stagnation, if not decline, over the last several centuries. In contrast, the incorporation of Enlightenment and democratic principles into Western governance has resulted in history's most rapid improvement in the human condition. Only those Muslim countries that have embraced, in some fashion, Western principles of democracy, free markets, property rights, tolerance, and the rule of law have prospered. Most Arab states refuse. Bernard Lewis, perhaps the doyen of Middle East studies in the Western world, explained, "By all indicators from the United Nations, the World Bank, and other authorities, Muslim countries—in matters such as job creation, education, technology, and productivity—lag ever further behind the West. Even worse, the Arab nations also lag behind the more recent recruits to Western style modernity, such as Korea, Taiwan, and Singapore."[36] All majority Muslim countries except Qatar, Bahrain, Kuwait, Oman, and Turkey, which have recently adopted significant free market and democratic reforms, rank in the bottom half of world productivity; of the rest, only Morocco, Indonesia, Saudi Arabia, and Bangladesh reach the third quartile.[37] According to the World Bank, the average per capita income of all majority Muslim countries collectively is less than half of the average for the globe. Only Kuwait approaches the global average life expectancy;[38] all other Muslim majority states lag in the bottom half of the world in this important measure of health.

Jihadis thrive in such stagnated conditions. This leads to negative annuity: Jihadism both grows amid stagnation and fuels stagnation. It accelerated coincident with the European Enlightenment and the relative decline of the Muslim Middle East. At its core, jihadism is a violent rejection of many of the fundamental principles of the European Enlightenment. Democracy, free markets, tolerance and freedom of religion, secular government, and separation between the religious, the political, and the individual spark religious fury. It is no coincidence, then, that jihadis, under the banner of cleansing their religion of evil Western influence, have focused their attentions on the United States, the clearest manifestation of the European Enlightenment today. They will continue to threaten Western civilization until they are checked.

Fumbled Strategy

One of the greatest challenges facing strategic leaders today is objectively examining the centuries-old roots of Islamic jihadism and developing a strategy that will lead to a lasting solution to the Western conflict with it. Many Western policymakers fail to assess realistically why Arab and Islamic governments have been unable to improve the condition of their populations, especially in contrast to the West. This inability to grasp the root of Islamic jihadism is the result of a moral relativism prominent in modern Western liberal thought. For example, over the last few decades, it has become common to value diversity and multiculturalism above societal well-being and improvements in the human condition.

It is not, as Thomas Friedman argues in The World Is Flat, that the fruits of the American experiment—free markets, property rights, tolerance, democracy, and the rule of law—have left Islam behind.[39] On the contrary, it is Islam that has opted out of progress by allowing, promoting, and embracing centuries of reactionary and retrospective reforms that rejected the idea that humans can indeed improve their condition through reason and rationality. Muslim clerics and leaders within the impoverished nations of the Islamic world need to understand that they are responsible for the condition and grief of their people. It is Islamism's rejection of religious tolerance, democracy, and the rule of law, in conjunction with its embrace of anti-Semitism, theocracy, and sectarian strongmen exempt from law and privileged by the authority they have usurped, that is the real enemy in the Islamic world's centuries-long interaction with the United States. While Islamists skillfully manipulate the Western mass media to enunciate an à la carte menu of grievances, eighteenth- and nineteenth-century interactions show these are not the root cause of jihadi terror. Indeed, a U.S. intelligence assessment, published two years before Israel's independence and any subsequent jihadi grievance, already highlighted Islamist terrorism as a long-term threat.[40] So long as Western officials adopt a nearsighted, grievance-based view of the roots of Islamist terror, they will embolden jihadis through appeasement.

It is essential that the grand strategy of the United States addresses this basic conflict of interest. The present conflict is not new. And it is religious. Believing that only a few "rogues" have misappropriated religion is both naïve and counterfactual. U.S. and Western leaders must confront the reality that jihadism is a religious phenomenon that has grown popular and powerful enough to threaten the continued progress of the American experiment and the European Enlightenment. In the new grand strategy to defeat Islamic jihadism, America must campaign, through its scholars and theologians if appropriate, to encourage and facilitate imams and other Islamic religious authority figures to reform Islam in a forward direction, one that breaks from the past and encourages tolerance, the rule of law, free inquiry, and free markets. Imams who support, either passively or actively, jihadism should be undermined and exposed.

How should the United States revitalize its strategy? At home, the U.S. government must better educate and explain the conflict to the general audience. Education at all levels should inculcate U.S. citizens in the history, philosophy, mechanics, virtues, responsibilities, and achievements of the Western approach to freedom, liberty, and the free market. Tolerance and diversity need not mean acceptance of oppression and tyranny. Such an effort would entail reinstalling this subject matter into the curricula of public schools. The strategic leadership of the nation should drive the public education effort, much as the founders did in the eighteenth century. The Federalist Papers, generally attributed to James Madison, Alexander Hamilton, and John Jay, are prototypical examples of effective strategic communications that aimed, among other things, to create a government strong enough to defend itself against the Barbary pirates.

Internationally, U.S. foreign policy should reflect U.S. national values and long-term objectives rather than near-term expediencies devoid of the principles enumerated by the founding fathers. U.S. foreign aid programs need reform.[41] Washington should set a visible standard by supporting non-corrupt democracies, rather than funding kleptocracies. Rather than fund short-term stability in regimes where power is centrally concentrated, Washington should promote trade and development in Islamic nations supporting the rule of law, tolerance, and democracy. Trade and development in these nations empowers people and entrepreneurs, catalyzes economic progress, and decentralizes power in a culture that has deep tendencies toward autocracy.[42]

The half-century-long policy of supporting Arab state stability regardless of its governance is a relic of the Cold War. In order to defeat jihadism, U.S. foreign policy should marginalize Muslim nations that are not supportive of the development of the rule of law, tolerance, and democracy. Washington should not apologize for supporting regional countries that seek peace, prosperity, and the improved well-being of their citizens. To do otherwise fuels jihadi rhetoric that the U.S. government seeks to oppress Muslims throughout the world.

Another requirement is for the West to embark on a radical program to redefine how its economies obtain and distribute energy. Former director of Central Intelligence R. James Woolsey argues that denying jihadis the use of oil as a weapon against the United States and the West should be Washington's highest priority.[43]

Finally, the history of U.S. interaction with Muslim polities shows that "diplomacy backed by force" is the only effective approach to relations with them.[44] Diplomacy is essential to ensure intentions are understood. Consistent diplomacy is essential to build the trust that majority Muslim countries need to support U.S. aims to advance Enlightenment ideals. Military weakness and the inability to project U.S. power have consistently led jihadis and Muslim kleptocrats to launch attacks against U.S. interests.

Melvin E. Lee is a sea captain and a nuclear engineer in the United States Navy. He serves as special operations officer for the commander, U.S. Naval Forces Europe, and commander, U.S. 6th Fleet. The views expressed in this article are those of the author and do not necessarily reflect the policy or position of the Department of the Navy or U.S. government.

[1] Ussama Makdisi, "‘Anti-Americanism' in the Arab World: An Interpretation of a Brief History," Journal of American History, Sept. 2002, p. 546.
[2] David Fromkin, A Peace to End All Peace: The Fall of the Ottoman Empire and the Creation of the Modern Middle East (New York: Henry Holt, 1989), pp. 23-62.
[3] Robert Fisk, The Great War for Civilization: The Conquest of the Middle East (New York: Alfred A. Knopf, 2005), pp. 305-15.
[4] Michael Oren, Power, Faith, and Fantasy: America in the Middle East, 1776 to the Present (New York: Oxford University Press, 2006).
[5] Frank Lambert, The Barbary Wars: American Independence in the Atlantic World (New York: Hill and Wang, 2005), pp. 106-9.
[6] Richard B. Parker, Uncle Sam in Barbary: A Diplomatic History (Gainesville: University Press of Florida, 2004), pp. 103-30; Lambert, The Barbary Wars, pp. 49-78.
[7] Kevin Baker, "The Shores of Tripoli," American Heritage, Feb./Mar. 2002, p. 21.
[8] James A. Field, "Novus Ordo Seclorum," America and the Mediterranean World, 1776-1882 (Princeton: Princeton University Press, 1969), pp. 3-26; Lambert, The Barbary Wars, pp. 15-28.
[9] Lambert, The Barbary Wars, pp. 106, 112-4.
[10] Ibid., pp. 110, 123.
[11] Thomas Jefferson, "‘The American Commissioners' Report to John Jay," in Paul L. Ford, ed., The Works of Thomas Jefferson, vol. 9 (New York and London: G.P. Putnam's Sons, 1904-5), p. 358; quoted in Lambert, The Barbary Wars, p. 116.
[12] Thomas Jefferson, "The American Commissioners' Report to John Jay," p. 358; quoted in Lambert, The Barbary Wars, p. 117.
[13] Lambert, The Barbary Wars, p. 110-1.
[14] Bernard Lewis, The Middle East: A Brief History of the Last 2,000 Years (New York: Simon and Schuster, 1995), p. 175.
[15] "The Truce with Tunis," Naval Documents Related to the United States Wars with the Barbary Powers, vol. 1 (Washington, D.C.: Government Printing Office, 1939), pp. 158-9; quoted in Lambert, The Barbary Wars, p. 117.
[16] Field, America and the Mediterranean World, pp. 133-40.
[17] Parker, Uncle Sam in Barbary, pp. 134-5.
[18] Field, America and the Mediterranean World, p. 209.
[19] Ibid., pp. 345-73.
[20] Ahmad Dallal, "The Origins and Objectives of Islamic Revivalist Thought, 1750-1850," Journal of the American Oriental Society, July-Sept. 1993, p. 352.
[21] Field, America and the Mediterranean World, pp. 345-73.
[22] Ibid., pp. 368-70.
[23] Ibid., pp. 445-7.
[24] Anne Cipriano Venzon, "Gunboat Diplomacy in the Med," Proceedings of the U.S. Naval Institute, Apr. 1985, pp. 26-31.
[25] Fromkin, A Peace to End All Peace, pp. 259-60.
[26] Bernard Lewis, The Crisis of Islam, Holy War and Unholy Terror (New York: Random House, 2003), pp. 126-8.
[27] Dean Acheson, "Internal Correspondence of the U. S. Department of State, January 1945," quoted in Robert Baer, Sleeping with the Devil (New York: Crown, 2003), p. 79.
[28] Barry Rubin, "The Real Roots of Arab Anti-Americanism," Foreign Affairs, Nov.-Dec. 2002, p. 75.
[29] R. James Woolsey, "Grand Strategy in the Middle East: The Long War of the 21st Century," in K. M. Campbell, ed., An American Grand Strategy for the Middle East (Washington, D.C.: Aspen Institute, 2004), p. 37.
[30] Richard W. Bulliet, "The Crisis within Islam," The Wilson Quarterly, Winter 2002, p. 15.
[31] Mary R. Habeck, Knowing the Enemy: Jihadi Ideology and the War on Terror (New Haven: Yale University Press, 2006), p. 12.
[32] Michael G. Knapp, "The Concept and Practice of Jihad in Islam," Parameters, Spring 2003, p. 92.
[33] Reza Aslan, No God but God: The Origins, Evolution, and Future of Islam (New York: Random House, 2005), p. 138; Habeck, Knowing the Enemy, p. 162; Lewis, The Crisis of Islam, p. 159.
[34] Anderson Cooper 360 Degrees, CNN, Sept. 7, 2007; United Press International, Sept. 7, 2007.
[35] Muhammad Khatami, "Islamic Civil Society," speech to the eighth session of the Islamic Summit Conference, Tehran, Radio Islam, Dec. 9, 1997.
[36] Lewis, The Crisis of Islam, p. 114.
[37] James Gwartney, Robert Lawson, and William Easterly, Economic Freedom of the World, 2006 Annual Report (Vancouver: Fraser Institute, 2006), p. 39.
[38] Lewis, The Crisis of Islam, p. 113-9.
[39] Thomas L. Friedman, The World Is Flat: A Brief History of the Twenty-first Century (New York: Farrar, Straus, and Giroux, 2005), pp. 470-9.
[40] "Assessing the Islamist Threat, Circa 1946," Middle East Quarterly, Summer 2006, pp. 76-82.
[41] Alberto Alesina and Beatrice Weder, "Do Corrupt Governments Receive Less Foreign Aid?," American Economic Review, Sept. 2002, pp. 1126-38.
[42] Iqbal Z. Quadir, "The Bottleneck Is at the Top of the Bottle," The Fletcher Forum of World Affairs, Summer/Fall 2002, pp. 86-8.
[43] Woolsey, "Grand Strategy in the Middle East," pp. 33-4.
[44] Parker, Uncle Sam in Barbary, p. 160.

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January 21, 2008
Israel Is Set to Promote the Use of Electric Cars

By STEVEN ERLANGER
JERUSALEM — Israel, tiny and bereft of oil, has decided to embrace the electric car.

On Monday, the Israeli government will announce its support for a broad effort to promote the use of electric cars, embracing a joint venture between an American-Israeli entrepreneur and Renault and its partner, Nissan Motor Company.

Prime Minister Ehud Olmert, with the active support of President Shimon Peres, intends to make Israel a laboratory to test the practicality of an environmentally clean electric car. The state will offer tax incentives to purchasers, and the new company, with a $200 million investment to start, will begin construction of facilities to recharge the cars and replace empty batteries quickly.

The idea, said Shai Agassi, 39, the software entrepreneur behind the new company, is to sell electric car transportation on the model of the cellphone. Purchasers get subsidized hardware — the car — and pay a monthly fee for expected mileage, like minutes on a cellphone plan, eliminating concerns about the fluctuating price of gasoline.

Mr. Agassi and his investors are convinced that the cost of running such a car will be significantly cheaper than a model using gasoline (currently $6.28 a gallon here.)

“With $100 a barrel oil, we’ve crossed a historic threshold where electricity and batteries provide a cheaper alternative for consumers,” Mr. Agassi said. “You buy a car to go an infinite distance, and we need to create the same feeling for an electric car — that you can fill it up when you stop or sleep and go an infinite distance.”

Mr. Agassi’s company, Project Better Place of Palo Alto, Calif., will provide the lithium-ion batteries, which will be able to go 124 miles per charge, and the infrastructure necessary to keep the cars going — whether parking meter-like plugs on city streets or service stations along highways, where, in a structure like a car wash, exhausted batteries will be removed and fresh ones inserted.

Renault and Nissan will provide the cars. The chairman of both companies, Carlos Ghosn, is scheduled to attend the announcements on Monday. Other companies are developing electric cars, like the Tesla and Chevrolet Volt, but the project here is a major step for Renault, which clearly believes that there is a commercial future in electric cars.

Israel, where the round-trip commute between Tel Aviv and Jerusalem is only 75 miles, is considered a good place to test the idea, which Mr. Agassi, Renault and Nissan hope to copy in small countries like Denmark and crowded cities like London, Paris, Singapore and New York. London, which has a congestion area tax for cars, lets electric cars enter downtown and park free.

Project Better Place’s major investor, Idan Ofer, 52, has put up $100 million for the project and is its board chairman. He will remain chairman of Israel Corporation Ltd., a major owner and operator of shipping companies and refineries. “What’s driving me is a much wider outlook than Israel,” Mr. Ofer said. “If it were just Israel, I’d be cannibalizing my refinery business. I’m not so concerned about the refineries, but building a world-class company. If Israel will ever produce a Nokia, it will be this.”

Mr. Ofer has his eye on China, with its increasing car penetration, oil consumption and environmental pollution, where he has interest from a Chinese car company, Chery, for a similar joint venture.

Renault will offer a small number of electric models of existing vehicles, like the Megane sedan, at prices roughly comparable to gasoline models. The batteries will come from Mr. Agassi. The tax breaks for “clean” electric vehicles, which Israel promises to keep until at least 2015, will make the cars cheaper to consumers than gasoline-engine cars. “You’ll be able to get a nice, high-end car at a price roughly half that of the gasoline model today,” Mr. Agassi said.

He contends that operating expenses will be half of those for gasoline-driven vehicles, especially in Europe and Israel, where gasoline taxes are high. The company, and the consumers who use it, will normally recharge their batteries at night, when the electricity is cheapest, and they expect the batteries to have a life of 7,000 charges, though Mr. Agassi says he is counting on only 1,500 charges, which is roughly 150,000 miles, the life of the average car.

“Because the price of gasoline fluctuates so much during the life of a car, it’s hard to predict the cost basis for driving,” Mr. Agassi said. “But electricity fluctuates less, and you can buy it in advance, so I can give you a guaranteed price per mile, cheaper than the price of gas today.”

Mr. Agassi predicts that a few thousand electric cars will be on Israeli roads in 2009 and 100,000 by the end of 2010; Israel has two million cars on the road, and about 10 percent are replaced each year.

Mr. Agassi suggested this model for the electric car — concentrating on infrastructure rather than on car production — at a 2006 meeting of the Saban Forum of the Brookings Institution, which Mr. Peres attended. He was enthralled by the idea.

Mr. Peres, who is sometimes dismissed as a dreamer by more cynical Israelis, has in the past embraced and helped to develop some successful notions — like Israel’s nuclear weapons program. He is a strong believer in Israel’s mission to better the world, he says, and not simply sell arms to it. Israel is the 11th-largest arms exporter, as measured by dollar sales, according to the Stockholm International Peace Research Institute.

Mr. Peres, who knew Mr. Agassi’s father, said in an interview that after hearing Shai Agassi speak: “I called him in and said, ‘Shai, now what?’ I said that now is the time for him to implement his idea, and I spoke to our prime minister and other officials and convinced them that this is a great opportunity.”

“Oil is becoming the greatest problem of our time,” Mr. Peres said in an interview in his office. Not only does it pollute, but “it also supports terror and violence from Venezuela to Iran.”

“Israel can’t become a major industrial country, but it can become a daring world laboratory and a pilot plant for new ideas, like the electric car,” he said.

Mr. Peres sees this project as part of his “green vision” for Israel, arguing that what the nation may lose in tax revenue it will save in oil. He also supports a larger investment in solar power, saying that “the Saudis don’t control the sun.”

Mr. Ofer wants profits, but also thinks the project will help the environment, especially in developing countries. “China is on a very dangerous march from bicycles to cars without any notion of what they’re doing to this planet in terms of air,” he said.

And in Mumbai, he said, “you can’t even see the sky.”

James D. Wolfensohn, the former World Bank president, is a modest investor in the project.

“Israel is a perfect test tube” for the electric car, he said. “The beauty of this is that you have a real place where you can get real human reactions. In Israel they can control the externalities and give it a chance to flourish or fail. It needs to be tested, and Agassi is to be commended for testing it and the Israeli government for trying it.”

ANUARY/FEBRUARY 2008 ATLANTIC MONTHLY
The Chinese are subsidizing the American way of life. Are we playing them for suckers—or are they playing us?

BY JAMES FALLOWS
The $1.4 Trillion Question
Stephen Schwarzman may think he has image problems in America. He is the co-founder and CEO of the Blackstone Group, and he threw himself a $3 million party for his 60th birthday last spring, shortly before making many hundreds of millions of dollars in his company’s IPO and finding clever ways to avoid paying taxes. That’s nothing compared with the way he looks in China. Here, he and his company are surprisingly well known, thanks to blogs, newspapers, and talk-show references. In America, Schwarzman’s perceived offense is greed—a sin we readily forgive and forget. In China, the suspicion is that he has somehow hoodwinked ordinary Chinese people out of their hard-earned cash.

FROM THE ARCHIVES:

"CASHING OUT"
(September 2007)
Is private equity just another bubble, or a sign of sickness in America's public stock markets? By Clive Crook

INTERVIEWS: "PRIVATE EQUITY DECONSTRUCTED"
(August 14, 2007)
Atlantic senior editor Clive Crook weighs in on the private-equity business—why it's booming, where it's headed, and what it means for American capitalism.

Last June, China’s Blackstone investment was hailed in the American press as a sign of canny sophistication. It seemed just the kind of thing the U.S. government had in mind when it hammered China to use its new wealth as a “responsible stakeholder” among nations. By putting $3 billion of China’s national savings into the initial public offering of America’s best-known private-equity firm, the Chinese government allied itself with a big-time Western firm without raising political fears by trying to buy operating control (it bought only 8 percent of Blackstone’s shares, and nonvoting shares at that). The contrast with the Japanese and Saudis, who in their nouveau-riche phase roused irritation and envy with their showy purchases of Western brand names and landmark properties, was plain.

Six months later, it didn’t look so canny, at least not financially. China’s Blackstone holdings lost, on paper, about $1 billion, during a time when the composite index of the Shanghai Stock Exchange was soaring. At two different universities where I’ve spoken recently, students have pointed out that Schwarzman was a major Republican donor. A student at Fudan University knew a detail I didn’t: that in 2007 President Bush attended a Republican National Committee fund-raiser at Schwarzman’s apartment in Manhattan (think what he would have made of the fact that Schwarzman, who was one year behind Bush at Yale, had been a fellow member of Skull and Bones). Wasn’t the whole scheme a way to take money from the Chinese people and give it to the president’s crony?

The Blackstone case is titillating in its personal detail, but it is also an unusually clear and personalized symptom of a deeper, less publicized, and potentially much more destructive tension in U.S.–China relations. It’s not just Stephen Schwarzman’s company that the laobaixing, the ordinary Chinese masses, have been subsidizing. It’s everyone in the United States.

Through the quarter-century in which China has been opening to world trade, Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States. This is the real meaning of the vast trade surplus—$1.4 trillion and counting, going up by about $1 billion per day—that the Chinese government has mostly parked in U.S. Treasury notes. In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China. Like so many imbalances in economics, this one can’t go on indefinitely, and therefore won’t. But the way it ends—suddenly versus gradually, for predictable reasons versus during a panic—will make an enormous difference to the U.S. and Chinese economies over the next few years, to say nothing of bystanders in Europe and elsewhere.

Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.

Neither government likes to draw attention to this arrangement, because it has been so convenient on both sides. For China, it has helped the regime guide development in the way it would like—and keep the domestic economy’s growth rate from crossing the thin line that separates “unbelievably fast” from “uncontrollably inflationary.” For America, it has meant cheaper iPods, lower interest rates, reduced mortgage payments, a lighter tax burden. But because of political tensions in both countries, and because of the huge and growing size of the imbalance, the arrangement now shows signs of cracking apart.

In an article two and a half years ago (“Countdown to a Meltdown,” July/August 2005), I described an imagined future in which a real-estate crash and shakiness in the U.S. credit markets led to panic by Chinese and other foreign investors, with unpleasant effects for years to come. The real world has recently had inklings of similar concerns. In the past six months, relative nobodies in China’s establishment were able to cause brief panics in the foreign-exchange markets merely by hinting that China might stop supplying so much money to the United States. In August, an economic researcher named He Fan, who works at the Chinese Academy of Social Sciences and did part of his doctoral research at Harvard, suggested in an op-ed piece in China Daily that if the U.S. dollar kept collapsing in value, China might move some of its holdings into stronger currencies. This was presented not as a threat but as a statement of the obvious, like saying that during a market panic, lots of people sell. The column quickly provoked alarmist stories in Europe and America suggesting that China was considering the “nuclear option”—unloading its dollars.

A few months later, a veteran Communist Party politician named Cheng Siwei suggested essentially the same thing He Fan had. Cheng, in his mid-70s, was trained as a chemical engineer and has no official role in setting Chinese economic policy. But within hours of his speech, a flurry of trading forced the dollar to what was then its lowest level against the euro and other currencies. The headline in the South China Morning Post the next day was: “Officials’ Words Shrivel U.S. Dollar.” Expressing amazement at the markets’ response, Carl Weinberg, chief economist at the High Frequency Economics advisory group, said, “This would be kind of like Congressman Charlie Rangel giving a speech telling the Fed to hike or cut interest rates.” (Cheng, like Rangel, is known for colorful comments—but he is less powerful, since Rangel after all chairs the House Ways and Means Committee.) In the following weeks, phrases like “run on the dollar” and “collapse of confidence” showed up more and more frequently in financial newsletters. The nervousness only increased when someone who does have influence, Chinese Premier Wen Jiabao, said last November, “We are worried about how to preserve the value” of China’s dollar holdings.

When the dollar is strong, the following (good) things happen: the price of food, fuel, imports, manufactured goods, and just about everything else (vacations in Europe!) goes down. The value of the stock market, real estate, and just about all other American assets goes up. Interest rates go down—for mortgage loans, credit-card debt, and commercial borrowing. Tax rates can be lower, since foreign lenders hold down the cost of financing the national debt. The only problem is that American-made goods become more expensive for foreigners, so the country’s exports are hurt.

When the dollar is weak, the following (bad) things happen: the price of food, fuel, imports, and so on (no more vacations in Europe) goes up. The value of the stock market, real estate, and just about all other American assets goes down. Interest rates are higher. Tax rates can be higher, to cover the increased cost of financing the national debt. The only benefit is that American-made goods become cheaper for foreigners, which helps create new jobs and can raise the value of export-oriented American firms (winemakers in California, producers of medical devices in New England).

The dollar’s value has been high for many years—unnaturally high, in large part because of the implicit bargain with the Chinese. Living standards in China, while rising rapidly, have by the same logic been unnaturally low. To understand why this situation probably can’t go on, and what might replace it—via a dollar crash or some other event—let’s consider how this curious balance of power arose and how it works.

Why a poor country has so much money
By 1996, China amassed its first $100 billion in foreign assets, mainly held in U.S. dollars. (China considers these holdings a state secret, so all numbers come from analyses by outside experts.) By 2001, that sum doubled to about $200 billion, according to Edwin Truman of the Peterson Institute for International Economics in Washington. Since then, it has increased more than sixfold, by well over a trillion dollars, and China’s foreign reserves are now the largest in the world. (In second place is Japan, whose economy is, at official exchange rates, nearly twice as large as China’s but which has only two-thirds the foreign assets; the next-largest after that are the United Arab Emirates and Russia.) China’s U.S. dollar assets probably account for about 70 percent of its foreign holdings, according to the latest analyses by Brad Setser, a former Treasury Department economist now with the Council on Foreign Relations; the rest are mainly in euros, plus some yen. Most of China’s U.S. investments are in conservative, low-yield instruments like Treasury notes and federal-agency bonds, rather than showier Blackstone-style bets. Because notes and bonds backed by the U.S. government are considered the safest investments in the world, they pay lower interest than corporate bonds, and for the past two years their annual interest payments of 4 to 5 percent have barely matched the 5-to-6-percent decline in the U.S. dollar’s value versus the RMB.

Americans sometimes debate (though not often) whether in principle it is good to rely so heavily on money controlled by a foreign government. The debate has never been more relevant, because America has never before been so deeply in debt to one country. Meanwhile, the Chinese are having a debate of their own—about whether the deal makes sense for them. Certainly China’s officials are aware that their stock purchases prop up 401(k) values, their money-market holdings keep down American interest rates, and their bond purchases do the same thing—plus allow our government to spend money without raising taxes.

“From a distance, this, to say the least, is strange,” Lawrence Summers, the former treasury secretary and president of Harvard, told me last year in Shanghai. He was referring to the oddity that a country with so many of its own needs still unmet would let “this $1 trillion go to a mature, old, rich place from a young, dynamic place.”

It’s more than strange. Some Chinese people are rich, but China as a whole is unbelievably short on many of the things that qualify countries as fully developed. Shanghai has about the same climate as Washington, D.C.—and its public schools have no heating. (Go to a classroom when it’s cold, and you’ll see 40 children, all in their winter jackets, their breath forming clouds in the air.) Beijing is more like Boston. On winter nights, thousands of people mass along the curbsides of major thoroughfares, enduring long waits and fighting their way onto hopelessly overcrowded public buses that then spend hours stuck on jammed roads. And these are the showcase cities! In rural Gansu province, I have seen schools where 18 junior-high-school girls share a single dormitory room, sleeping shoulder to shoulder, sardine-style.

Better schools, more-abundant parks, better health care, cleaner air and water, better sewers in the cities—you name it, and if it isn’t in some way connected to the factory-export economy, China hasn’t got it, or not enough. This is true at the personal level, too. The average cash income for workers in a big factory is about $160 per month. On the farm, it’s a small fraction of that. Most people in China feel they are moving up, but from a very low starting point.

So why is China shipping its money to America? An economist would describe the oddity by saying that China has by far the highest national savings in the world. This sounds admirable, but when taken to an extreme—as in China—it indicates an economy out of sync with the rest of the world, and one that is deliberately keeping its own people’s living standards lower than they could be. For comparison, India’s savings rate is about 25 percent, which in effect means that India’s people consume 75 percent of what they collectively produce. (Reminder from Ec 101: The savings rate is the net share of national output either exported or saved and invested for consumption in the future. Effectively, it’s what your own people produce but don’t use.) For Korea and Japan, the savings rate is typically from the high 20s to the mid-30s. Recently, America’s has at times been below zero, which means that it consumes, via imports, more than it makes.

China’s savings rate is a staggering 50 percent, which is probably unprecedented in any country in peacetime. This doesn’t mean that the average family is saving half of its earnings—though the personal savings rate in China is also very high. Much of China’s national income is “saved” almost invisibly and kept in the form of foreign assets. Until now, most Chinese have willingly put up with this, because the economy has been growing so fast that even a suppressed level of consumption makes most people richer year by year.

But saying that China has a high savings rate describes the situation without explaining it. Why should the Communist Party of China countenance a policy that takes so much wealth from the world’s poor, in their own country, and gives it to the United States? To add to the mystery, why should China be content to put so many of its holdings into dollars, knowing that the dollar is virtually guaranteed to keep losing value against the RMB? And how long can its people tolerate being denied so much of their earnings, when they and their country need so much? The Chinese government did not explicitly set out to tighten the belt on its population while offering cheap money to American homeowners. But the fact that it does results directly from explicit choices it has made—two in particular. Both arise from crucial controls the government maintains over an economy that in many other ways has become wide open. The situation may be easiest to explain by following a U.S. dollar on its journey from a customer’s hand in America to a factory in China and back again to the T-note auction in the United States.

The voyage of a dollar
Let’s say you buy an Oral-B electric toothbrush for $30 at a CVS in the United States. I choose this example because I’ve seen a factory in China that probably made the toothbrush. Most of that $30 stays in America, with CVS, the distributors, and Oral-B itself. Eventually $3 or so—an average percentage for small consumer goods—makes its way back to southern China.

When the factory originally placed its bid for Oral-B’s business, it stated the price in dollars: X million toothbrushes for Y dollars each. But the Chinese manufacturer can’t use the dollars directly. It needs RMB—to pay the workers their 1,200-RMB ($160) monthly salary, to buy supplies from other factories in China, to pay its taxes. So it takes the dollars to the local commercial bank—let’s say the Shenzhen Development Bank. After showing receipts or waybills to prove that it earned the dollars in genuine trade, not as speculative inflow, the factory trades them for RMB.

This is where the first controls kick in. In other major countries, the counterparts to the Shenzhen Development Bank can decide for themselves what to do with the dollars they take in. Trade them for euros or yen on the foreign-exchange market? Invest them directly in America? Issue dollar loans? Whatever they think will bring the highest return. But under China’s “surrender requirements,” Chinese banks can’t do those things. They must treat the dollars, in effect, as contraband, and turn most or all of them (instructions vary from time to time) over to China’s equivalent of the Federal Reserve Bank, the People’s Bank of China, for RMB at whatever is the official rate of exchange.

With thousands of transactions per day, the dollars pile up like crazy at the PBOC. More precisely, by more than a billion dollars per day. They pile up even faster than the trade surplus with America would indicate, because customers in many other countries settle their accounts in dollars, too.

The PBOC must do something with that money, and current Chinese doctrine allows it only one option: to give the dollars to another arm of the central government, the State Administration for Foreign Exchange. It is then SAFE’s job to figure out where to park the dollars for the best return: so much in U.S. stocks, so much shifted to euros, and the great majority left in the boring safety of U.S. Treasury notes.

And thus our dollar comes back home. Spent at CVS, passed to Oral-B, paid to the factory in southern China, traded for RMB at the Shenzhen bank, “surrendered” to the PBOC, passed to SAFE for investment, and then bid at auction for Treasury notes, it is ready to be reinjected into the U.S. money supply and spent again—ideally on Chinese-made goods.

At no point did an ordinary Chinese person decide to send so much money to America. In fact, at no point was most of this money at his or her disposal at all. These are in effect enforced savings, which are the result of the two huge and fundamental choices made by the central government.

One is to dictate the RMB’s value relative to other currencies, rather than allow it to be set by forces of supply and demand, as are the values of the dollar, euro, pound, etc. The obvious reason for doing this is to keep Chinese-made products cheap, so Chinese factories will stay busy. This is what Americans have in mind when they complain that the Chinese government is rigging the world currency markets. And there are numerous less obvious reasons. The very act of managing a currency’s value may be a more important distorting factor than the exact rate at which it is set. As for the rate—the subject of much U.S. lecturing—given the huge difference in living standards between China and the United States, even a big rise in the RMB’s value would leave China with a price advantage over manufacturers elsewhere. (If the RMB doubled against the dollar, a factory worker might go from earning $160 per month to $320—not enough to send many jobs back to America, though enough to hurt China’s export economy.) Once a government decides to thwart the market-driven exchange rate of its currency, it must control countless other aspects of its financial system, through instruments like surrender requirements and the equally ominous-sounding “sterilization bonds” (a way of keeping foreign-currency swaps from creating inflation, as they otherwise could).

These and similar tools are the way China’s government imposes an unbelievably high savings rate on its people. The result, while very complicated, is to keep the buying power earned through China’s exports out of the hands of Chinese consumers as a whole. Individual Chinese people have certainly gotten their hands on a lot of buying power, notably the billionaire entrepreneurs who have attracted the world’s attention (see “Mr. Zhang Builds His Dream Town,” March 2007). But when it comes to amassing international reserves, what matters is that China as a whole spends so little of what it earns, even as some Chinese people spend a lot.

The other major decision is not to use more money to address China’s needs directly—by building schools and agricultural research labs, cleaning up toxic waste, what have you. Both decisions stem from the central government’s vision of what is necessary to keep China on its unprecedented path of growth. The government doesn’t want to let the market set the value of the RMB, because it thinks that would disrupt the constant growth and the course it has carefully and expensively set for the factory-export economy. In the short run, it worries that the RMB’s value against the dollar and the euro would soar, pricing some factories in “expensive” places such as Shanghai out of business. In the long run, it views an unstable currency as a nuisance in itself, since currency fluctuation makes everything about business with the outside world more complicated. Companies have a harder time predicting overseas revenues, negotiating contracts, luring foreign investors, or predicting the costs of fuel, component parts, and other imported goods.

And the government doesn’t want to increase domestic spending dramatically, because it fears that improving average living conditions could paradoxically intensify the rich-poor tensions that are China’s major social problem. The country is already covered with bulldozers, wrecking balls, and construction cranes, all to keep the manufacturing machine steaming ahead. Trying to build anything more at the moment—sewage-treatment plants, for a start, which would mean a better life for its own people, or smokestack scrubbers and related “clean” technology, which would start to address the world pollution for which China is increasingly held responsible—would likely just drive prices up, intensifying inflation and thus reducing the already minimal purchasing power of most workers. Food prices have been rising so fast that they have led to riots. In November, a large Carre four grocery in Chong qing offered a limited-time sale of vegetable oil, at 20 percent (11 RMB, or $1.48) off the normal price per bottle. Three people were killed and 31 injured in a stampede toward the shelves.

This is the bargain China has made—rather, the one its leaders have imposed on its people. They’ll keep creating new factory jobs, and thus reduce China’s own social tensions and create opportunities for its rural poor. The Chinese will live better year by year, though not as well as they could. And they’ll be protected from the risk of potentially catastrophic hyperinflation, which might undo what the nation’s decades of growth have built. In exchange, the government will hold much of the nation’s wealth in paper assets in the United States, thereby preventing a run on the dollar, shoring up relations between China and America, and sluicing enough cash back into Americans’ hands to let the spending go on.

What the Chinese hope will happen
The Chinese public is beginning to be aware that its government is sitting on a lot of money—money not being spent to help China directly, money not doing so well in Blackstone-style foreign investments, money invested in the ever-falling U.S. dollar. Chinese bloggers and press commentators have begun making a connection between the billions of dollars the country is sending away and the domestic needs the country has not addressed. There is more and more pressure to show that the return on foreign investments is worth China’s sacrifice—and more and more potential backlash against bets that don’t pay off. (While the Chinese government need not stand for popular election, it generally tries to reduce sources of popular discontent when it can.) The public is beginning to behave like the demanding client of an investment adviser: it wants better returns, with fewer risks.

This is the challenge facing Lou Jiwei and Gao Xiqing, who will play a larger role in the U.S. economy than Americans are accustomed to from foreigners. Lou, a longtime Communist Party official in his late 50s, is the chairman of the new China Investment Corporation, which is supposed to find creative ways to increase returns on at least $200 billion of China’s foreign assets. He is influential within the party but has little international experience. Thus the financial world’s attention has turned to Gao Xiqing, who is the CIC’s general manager.

Twenty years ago, after graduating from Duke Law School, Gao was the first Chinese citizen to pass the New York State Bar Exam. He returned to China in 1988, after several years as an associate at the New York law firm Mudge, Rose (Richard Nixon’s old firm) to teach securities law and help develop China’s newly established stock markets. By local standards, he is hip. At an economics conference in Beijing in December, other Chinese speakers wore boxy dark suits. Gao, looking fit in his mid-50s, wore a tweed jacket and black turtleneck, an Ironman-style multifunction sports watch on his wrist.

Under Lou and Gao, the CIC started with a bang with Blackstone—the wrong kind of bang. Now, many people suggest, it may be chastened enough to take a more careful approach. Indeed, that was the message it sent late last year, with news that its next round of investments would be in China’s own banks, to shore up some with credit problems. And it looks to be studying aggressive but careful ways to manage huge sums. About the time the CIC was making the Blackstone deal, its leadership and staff undertook a crash course in modern financial markets. They hired the international consulting firm McKinsey to prepare confidential reports about the way they should organize themselves and the investment principles they should apply. They hired Booz Allen Hamilton to prepare similar reports, so they could compare the two. Yet another consulting firm, Towers Perrin, provided advice, especially about staffing and pay. The CIC leaders commissioned studies of other large state-run investment funds—in Norway, Singapore, the Gulf States, Alaska—to see which approaches worked and which didn’t. They were fascinated by the way America’s richest universities managed their endowments, and ordered multiple copies of Pioneering Portfolio Management, by David Swensen, who as Yale’s chief investment officer has guided its endowment to sustained and rapid growth. Last summer, teams from the CIC made long study visits to Yale and Duke universities, among others.

Gao Xiqing and other CIC officials have avoided discussing their plans publicly. “If you tell people ahead of time what you’re going to do—well, you just can’t operate that way in a market system,” he said at his Beijing appearance. “What I can say is, we’ll play by the international rules, and we’ll be responsible investors.” Gao emphasized several times how much the CIC had to learn: “We’re the new kids on the block. Because of media attention, there is huge pressure on us—we’re already under water now.” The words “under water” were in natural-sounding English, and clearly referred to Blackstone.

Others familiar with the CIC say that its officials are coming to appreciate the unusual problems they will face. For instance: any investment group needs to be responsible to outside supervisors, and the trick for the CIC will be to make itself accountable to Communist Party leadership without becoming a mere conduit for favored investment choices by party bosses. How can it attract the best talent? Does it want to staff up quickly, to match its quickly mounting assets, by bidding for financial managers on the world market—where many of the candidates are high-priced, not fluent in Chinese, and reluctant to move to Beijing? Or can it afford to take the time to home-grow its own staff?

While the CIC is figuring out its own future, outsiders are trying to figure out the CIC—and also SAFE, which will continue handling many of China’s assets. As far as anyone can tell, the starting point for both is risk avoidance. No more Blackstones. No more CNOOC-Unocals. (In 2005, the Chinese state oil firm CNOOC attempted to buy U.S.–based Unocal. It withdrew the offer in the face of intense political opposition to the deal in America.) One person involved with the CIC said that its officials had seen recent Lou Dobbs broadcasts criticizing “Communist China” and were “shellshocked” about the political resentment their investments might encounter in the United States. For all these reasons the Chinese leadership, as another person put it, “has a strong preference to follow someone else’s lead, not in an imitative way” but as an unobtrusive minority partner wherever possible. It will follow the lead of others for now, that is, while the CIC takes its first steps as a gigantic international financial investor.

The latest analyses by Brad Setser suggest that despite all the talk about abandoning the dollar, China is still putting about as large a share of its money into dollars as ever, somewhere between 65 and 70 percent of its foreign earnings. “Politically, the last thing they want is to signal a loss of faith in the dollar,” Andy Rothman, of the financial firm CLSA, told me; that would lead to a surge in the RMB, which would hurt Chinese exporters, not to mention the damage it would cause to China’s vast existing dollar assets.

The problem is that these and other foreign observers must guess at China’s aims, rather than knowing for sure. As Rothman put it, “The opaqueness about intentions and goals is always the issue.” The mini-panics last year took hold precisely because no one could be sure that SAFE was not about to change course.

The uncertainty arises in part from the limited track record of China’s new financial leadership. As one American financier pointed out to me: “The man in charge of the whole thing”—Lou Jiwei—“has never bought a share of stock, never bought a car, never bought a house.” Another foreign financier said, after meeting some CIC staffers, “By Chinese terms, these are very sophisticated people.” But, he went on to say, in a professional sense none of them had lived through the financial crises of the last generation: the U.S. market crash of 1987, the “Asian flu” of the late 1990s, the collapse of the Internet bubble soon afterward. The Chinese economy was affected by all these upheavals, but the likes of Gao Xiqing were not fully exposed to their lessons, sheltered as they were within Chinese institutions.

Foreign observers also suggest that, even after exposure to the Lou Dobbs clips, the Chinese financial leadership may not yet fully grasp how suspicious other countries are likely to be of China’s financial intentions, for reasons both fair and unfair. The unfair reason is all-purpose nervousness about any new rising power. “They need to understand, and they don’t, that everything they do will be seen as political,” a financier with extensive experience in both China and America told me. “Whatever they buy, whatever they say, whatever they do will be seen as China Inc.”

The fair reason for concern is, again, the transparency problem. Twice in the past year, China has in nonfinancial ways demonstrated the ripples that a nontransparent policy creates. Last January, its military intentionally shot down one of its own satellites, filling orbital paths with debris. The exercise greatly alarmed the U.S. military, because of what seemed to be an implied threat to America’s crucial space sensors. For several days, the Chinese government said nothing at all about the test, and nearly a year later, foreign analysts still debate whether it was a deliberate provocation, the result of a misunderstanding, or a freelance effort by the military. In November, China denied a U.S. Navy aircraft carrier, the Kitty Hawk, routine permission to dock in Hong Kong for Thanksgiving, even though many Navy families had gone there for a reunion. In each case, the most ominous aspect is that outsiders could not really be sure what the Chinese leadership had in mind. Were these deliberate taunts or shows of strength? The results of factional feuding within the leadership? Simple miscalculations? In the absence of clear official explanations no one really knew, and many assumed the worst.

So it could be with finance, unless China becomes as transparent as it is rich. Chinese officials say they will move in that direction, but they’re in no hurry. Last fall, Edwin Truman prepared a good-governance scorecard for dozens of “sovereign wealth” funds—government-run investment funds like SAFE and the CIC. He compared funds from Singapore, Korea, Norway, and elsewhere, ranking them on governing structure, openness, and similar qualities. China’s funds ended up in the lower third of his list—better-run than Iran’s, Sudan’s, or Algeria’s, but worse than Mexico’s, Russia’s, or Kuwait’s. China received no points in the “governance” category and half a point out of a possible 12 for “transparency and accountability.”

Foreigners (ordinary Chinese too, for that matter) can’t be sure about the mixture of political and strictly economic motives behind future investment decisions the Chinese might make. When China’s president, Hu Jintao, visited Seattle two years ago, he announced a large purchase of Boeing aircraft. When France’s new president, Nicolas Sarkozy, visited China late last year, Hu announced an even larger purchase of Airbuses. Every Chinese order for an airplane is a political as well as commercial decision. Brad Setser says that the Chinese government probably believed that it would get “credit” for the Blackstone purchase in whatever negotiations came up next with the United States, in the same way it would get credit for choosing Boeing. This is another twist to the Kremlinology of trying to discern China’s investment strategy.

Where the money goes, other kinds of power follow. Just ask Mikhail Gorbachev, as he reflects on the role bankruptcy played in bringing down the Soviet empire. While Japan’s great wealth has not yet made it a major diplomatic actor, and China has so far shied from, rather than seized, opportunities to influence events outside its immediate realm, time and money could change that. China’s military is too weak to challenge the U.S. directly even in the Taiwan Straits, let alone anyplace else. That, too, could change.

A Balance of Terror
Let’s take these fears about a rich, strong China to their logical extreme. The U.S. and Chinese governments are always disagreeing—about trade, foreign policy, the environment. Someday the disagreement could be severe. Taiwan, Tibet, North Korea, Iran—the possibilities are many, though Taiwan always heads the list. Perhaps a crackdown within China. Perhaps another accident, like the U.S. bombing of China’s embassy in Belgrade nine years ago, which everyone in China still believes was intentional and which no prudent American ever mentions here.

Whatever the provocation, China would consider its levers and weapons and find one stronger than all the rest—one no other country in the world can wield. Without China’s billion dollars a day, the United States could not keep its economy stable or spare the dollar from collapse.

Would the Chinese use that weapon? The reasonable answer is no, because they would wound themselves grievously, too. Their years of national savings are held in the same dollars that would be ruined; in a panic, they’d get only a small share out before the value fell. Besides, their factories depend on customers with dollars to spend.

But that “reassuring” answer is actually frightening. Lawrence Summers calls today’s arrangement “the balance of financial terror,” and says that it is flawed in the same way that the “mutually assured destruction” of the Cold War era was. That doctrine held that neither the United States nor the Soviet Union would dare use its nuclear weapons against the other, since it would be destroyed in return. With allowances for hyperbole, something similar applies to the dollar standoff. China can’t afford to stop feeding dollars to Americans, because China’s own dollar holdings would be devastated if it did. As long as that logic holds, the system works. As soon as it doesn’t, we have a big problem.

What might poke a giant hole in that logic? Not necessarily a titanic struggle over the future of Taiwan. A simple mistake, for one thing. Another speech by Cheng Siwei—perhaps in response to a provocation by Lou Dobbs. A rumor that the oil economies are moving out of dollars for good, setting their prices in euros. Leaked suggestions that the Chinese government is hoping to buy Intel, leading to angry denunciations on the Capitol floor, leading to news that the Chinese will sit out the next Treasury auction. As many world tragedies have been caused by miscalculation as by malice.

Or pent-up political tensions, on all sides. China’s lopsided growth—ahead in exports, behind in schooling, the environment, and everything else—makes the country socially less stable as it grows richer. Meanwhile, its expansion disrupts industries and provokes tensions in the rest of the world. The billions of dollars China pumps into the United States each week strangely seem to make it harder rather than easier for Americans to face their own structural problems. One day, something snaps. Suppose the CIC makes another bad bet—not another Blackstone but another WorldCom, with billions of dollars of Chinese people’s assets irretrievably wiped out. They will need someone to blame, and Americans, for their part, are already primed to blame China back.

So, the shock comes. Does it inevitably cause a cataclysm? No one can know until it’s too late. The important question to ask about the U.S.–China relationship, the economist Eswar Prasad, of Cornell, recently wrote in a paper about financial imbalances, is whether it has “enough flexibility to withstand and recover from large shocks, either internal or external.” He suggested that the contained tensions were so great that the answer could be no.

Today’s American system values upheaval; it’s been a while since we’ve seen too much of it. But Americans who lived through the Depression knew the pain real disruption can bring. Today’s Chinese, looking back on their country’s last century, know, too. With a lack of tragic imagination, Americans have drifted into an arrangement that is comfortable while it lasts, and could last for a while more. But not much longer.

Years ago, the Chinese might have averted today’s pressures by choosing a slower and more balanced approach to growth. If they had it to do over again, I suspect they would in fact choose just the same path—they have gained so much, including the assets they can use to do what they have left undone, whenever the government chooses to spend them. The same is not true, I suspect, for the United States, which might have chosen a very different path: less reliance on China’s subsidies, more reliance on paying as we go. But it’s a little late for those thoughts now. What’s left is to prepare for what we find at the end of the path we have taken.

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http://www.nytimes.com/2008/01/21/washington/21military.html?hp

Pentagon Weighs Top Iraq General as Chief of NATO


By MICHAEL R. GORDON and ERIC SCHMITT
Published: January 21, 2008
WASHINGTON — The Pentagon is considering Gen. David H. Petraeus for the top NATO command later this year, a move that would give the general, the top American commander in Iraq, a high-level post during the next administration but that has raised concerns about the practice of rotating war commanders.

Related
Times Topics: General David H. Petraeus
A senior Pentagon official said that it was weighing “a next assignment for Petraeus” and that the NATO post was a possibility. “He deserves one and that has also always been a highly prestigious position,” the official said. “So he is a candidate for that job, but there have been no final decisions and nothing on the timing.”

The question of General Petraeus’s future comes as the Pentagon is looking at changing several top-level assignments this year. President Bush has been an enthusiastic supporter of General Petraeus, whom he has credited with overseeing a troop increase and counterinsurgency plan credited with reducing the sectarian violence in Iraq, and some officials say the president would want to keep General Petraeus in Iraq as long as possible.

In one approach under discussion, General Petraeus would be nominated and confirmed for the NATO post before the end of September, when Congress is expected to break for the presidential election. He might stay in Iraq for some time after that before moving to the alliance’s headquarters in Brussels, but would take his post before a new president takes office.

If General Petraeus is shifted from the post as top Iraq commander, two leading candidates to replace him are Lt. Gen. Stanley A. McChrystal, who is running the classified Special Operations activities in Iraq, and Lt. Gen. Peter W. Chiarelli, a former second-ranking commander in Iraq and Defense Secretary Robert M. Gates’s senior military assistant.

By this fall, General Petraeus would have served 19 months in command in Iraq and would have accumulated more than 47 months of service in Iraq in three tours there since 2003. In the NATO job, General Petraeus would play a major role in shaping the cold-war-era alliance’s identity, in coping with an increasingly assertive Russia and in overseeing the allied-led mission in Afghanistan.

General Petraeus, 55, has been criticized by Democratic lawmakers opposed to Mr. Bush’s decision to send additional combat forces to Iraq. A NATO post would give him additional command experience in an important but less politically contentious region, potentially positioning him as a strong candidate in a few years to serve as chairman of the Joint Chiefs of Staff, several military officials said. They and some others who discussed the potential appointment declined to be identified because they were speaking about an internal personnel matter.

Some experts, however, say General Petraeus’s departure would jeopardize American efforts in Iraq, especially since the No. 2 officer in Iraq, Lt. Gen. Raymond T. Odierno, is scheduled to complete his tour and leave Iraq in mid-February.

General Petraeus “should stay at least through this year,” said Anthony Cordesman, a military specialist at the Center for Strategic and International Studies. “We really need military continuity in command during this period in which we can find out whether we can transition from tactical victory to some form of political accommodation.

“We have in Petraeus and Crocker the first effective civil-military partners we have had in this war,” Mr. Cordesman added, referring to Ryan C. Crocker, the United States ambassador in Baghdad. Gen. George W. Casey Jr., General Petraeus’s predecessor, served nearly three years in the top Iraq job before becoming Army chief of staff.

There has been speculation that General Petraeus’s next post might be as head of the Central Command, which has responsibility for the Middle East region. That would enable him to continue to influence events in Iraq while overseeing the military operation in Afghanistan and developing a strategy to deal with Iran. The Central Command post is currently held by Adm. William J. Fallon. Admiral Fallon, through a spokesman, denied that he intended to retire from the military in the next several months.

General Petraeus, through a spokesman, declined to comment on a possible NATO assignment. Geoff Morrell, the senior Defense Department spokesman, said no decision had been made.

“Trying to guess General Petraeus’s next assignment is the most popular parlor game in the Pentagon these days,” Mr. Morrell said. “Where and when the general goes next is up to Secretary Gates and President Bush, and they have not yet decided those matters. However, they very much appreciate his outstanding leadership in Iraq and believe he has much more to contribute to our nation’s defense whenever his current assignment comes to an end.”

Of the potential successors for General Petraeus, Generals McChrystal and Chiarelli would bring contrasting styles and backgrounds to the fight. General McChrystal has spent much of his career in the Special Operations forces. He commands those forces in Iraq, which have conducted raids against Al Qaeda in Mesopotamia, the mainly Iraqi group that American intelligence says has foreign leadership, and against Shiite extremists, including cells believed to be backed by Iran.

In June 2006, Mr. Bush publicly congratulated General McChrystal on the airstrike that killed Abu Musab al-Zarqawi, the Jordanian terrorist who was the head of Al Qaeda in Mesopotamia. The Pentagon does not officially acknowledge the existence of some of the classified units that General McChrystal leads, and Mr. Bush’s comments were a rare acknowledgment of the role those troops played in a high-level mission.

General McChrystal, a 53-year-old West Point graduate, also commanded the 75th Ranger Regiment and served tours in Saudi Arabia during the Persian Gulf war in 1991 and in Afghanistan as chief of staff of the military operation there in 2001 and 2002.

He was criticized last year when a Pentagon investigation into the accidental shooting death of Cpl. Pat Tillman by fellow Army Rangers in Afghanistan held the general accountable for inaccurate information provided by Corporal Tillman’s unit in recommending him for a Silver Star. The information wrongly suggested that Corporal Tillman, a professional football player whose decision to enlist in the Army after the Sept. 11 attacks drew national attention, had been killed by enemy fire.

General Chiarelli’s strengths rest heavily on his reputation as one of the most outspoken proponents of a counterinsurgency strategy that gives equal or greater weight to social and economic actions aimed at undermining the enemy as it does to force of arms. General Chiarelli, 57, has served two tours in Iraq, first as head of the First Calvary Division, where he commanded 38,000 troops in securing and rebuilding Baghdad, and later as the second-ranking American officer in Iraq before becoming the senior military aide to Mr. Gates.

In a 2007 essay in Military Review, he wrote: “Unless and until there is a significant reorganization of the U.S. government interagency capabilities, the military is going to be the nation’s instrument of choice in nation-building. We need to accept that reality instead of resisting it, as we have for much of my career.”

General Petraeus’s last post in Europe was as a senior officer for the NATO force in Bosnia, where he served a tour in 2001 and 2002. “He did a great job for me as a one-star in Bosnia,” said Gen. Joseph W. Ralston, who served as NATO commander at the time and has since retired. “He would have the credibility to keep Afghanistan focused for NATO.”

Posted: Fri., Jan. 18, 2008, 4:05pm PT
Al-Jazeera fined for insulting Kuwatis
Net sued after blaming citizens for 1990 invasion
By BRYAN PEARSON
BAGHDAD -- Qatar-based news channel Al-Jazeera has been ordered by a Kuwaiti court to cough up 20,000 dinars ($73,000) for insulting the citizens of Kuwait in a program aired in 2002.
The satcaster was sued by four Kuwaiti lawyers after it beamed a program in which it said Kuwait and its people were responsible for the 1990 Iraqi invasion of their country.

"We filed the case as Kuwaiti citizens who thought that the channel's management allowed insults and lies to be aired against our country," said one of the lawyers, Mohammad Taleb.

The Kuwaiti court made its first instance ruling on Tuesday.

The lawyers had sought compensation of $219,000 after the court in an earlier verdict had ordered Al-Jazeera to pay less as "temporary" compensation.

That payment was made in 2005 when the Kuwaiti government allowed Al-Jazeera to reopen its office after a two and a half year closure.

Al-Jazeera has said it will appeal the new ruling, while Taleb and his colleagues also plan to appeal, saying the amount awarded is too small.

The court's ruling will only be effective if confirmed by the courts of appeal and cassation.

Kuwait closed the satcaster's offices in November 2002 in the run-up to the U.S.-led invasion of Iraq, because it said the channel was hostile toward Kuwait.

The offices were reopened in May 2005 following an official visit to Kuwait by Qatar's Emir Sheikh Hamad bin Khalifa al-Thani.

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