source: www.stratfor.com
Strategic Forecasting, Inc.
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GEOPOLITICAL DIARY: CHINA'S ECONOMIC DILEMMA

We have discussed how high oil prices are affecting China. It is difficult to gather statistical data on the situation, but anecdotal evidence is accumulating, and much of it indicates the sort of problems we were concerned about. For example, we are told that there were extremely long lines at a gas station on the Nanjing-Shanghai highway on Sunday. By Sunday evening, the station was closed, with a sign saying that they were out of gas.

In another anecdote, a discussion was held with a small manufacturer of a simple consumer product in Shandong province. He reported that increased competition, labor costs and the rise of the yuan have all worked to decrease his profit margins until they were barely positive. He reported that he could not afford to raise prices because of competition, but that he was still covering costs. He also reported that seven of his competitors in Shanxi province had recently closed their doors.

These are merely anecdotes, and they can be misleading, but they are the kind of anecdotes we have been expecting and are now occurring. The Chinese are trying to cap the price of gasoline and diesel fuel in order to sustain the economy, keep prices under control in both the domestic and export markets and maintain social stability. To do this, they need to control the maximum prices charged by Chinese oil companies, which are private enterprises not under Beijing's direct control. The inevitable result is shortages. The government is asking the oil companies to operate at a loss, and they are resisting, as one could imagine.

China can address the price of oil by allowing the yuan to rise, effectively decreasing its price. But if the yuan rises, the competitiveness of Chinese exports is going to be hurt. With the slowdown in the American economy, China's main export target, price sensitivity increases. If the yuan rises even a little bit, exporters will be hurt. As prices rise -- as they must because of energy and food costs -- inflation hits manufacturers two ways. Price of labor can rise, and, even if it does not, the demand for products in the domestic market contracts.

Reports of gasoline and diesel shortages and bankruptcies among manufacturers are the last things the Chinese need -- and not because of the conventional economic issues all countries have. Oil shortages, bankruptcies and other phenomena lead to unemployment. Unemployment in China can lead to social instability, and that instability concerns the Chinese government greatly, making this far more serious than a similar process might be in another country.

We are getting additional reliable anecdotal reports of extremely aggressive policing in Beijing -- both the presence of larger numbers of security personnel and much greater assertion, particularly toward Chinese shopkeepers. Such crackdowns are common to an extent, especially in provincial cities, but the level of aggressiveness against shopkeepers is somewhat new. One good explanation, of course, is the Olympics. But there is no question that Beijing is making sure the Chinese are aware that police are present and watching.

There are fuel shortages, bankruptcies, economic pressure and increased patrolling at the street level in areas not affected by the earthquake. The situation in China is beginning to ratchet up. It is reasonable to assume that the Chinese will need to take some steps to relieve the situation. Their problem is that any step they take will have other negative effects. Revaluing the yuan will help with oil prices, but will hurt exports badly at a time when the economy is already under pressure. The Chinese certainly have dollar reserves, but subsidizing fuel, exports and banks can eat into these with remarkable speed.

Copyright 2008 Strategic Forecasting, Inc.

VENEZUELA, COLOMBIA: A FALSE STATEMENT POINTS TO A TRUE PROBLEM

Summary
A May 19 statement from the Venezuelan vice minister of food saying that Colombia would slash its meat exports to Venezuela appears to have been false. However, it points to a real need by Caracas to find a scapegoat for skyrocketing food prices.

Analysis
Stratfor reported May 19 on a statement by Venezuelan Vice Minister of Food Rafael Coronado Patino claiming that Colombia planned to reduce its meat exports to Venezuela by 98 percent. Colombian authorities immediately issued an official denial of the statement, saying that exports to all of Colombia's trade partners would remain stable. Representatives of the Venezuelan Ministry of Food are now denying that an official statement was made at all, though according to Venezuelan daily El Universal, Coronado Patino made it in a public setting.

At this point, we have little doubt that the statement was false -- it was part and parcel of the atmospherics in Venezuela's ongoing diplomatic spat with Colombia. However, the implications of the false statement may be important in themselves. With global oil and food prices at unprecedented highs, Venezuela is one of the many countries where an economic pinch is turning to a squeeze. The public will want someone to blame, and Venezuelan President Hugo Chavez does not want it to be him.

Shortages of meat and other foods have already been a problem in Venezuela for quite some time. The government is struggling to find ways to meet domestic needs in the face of skyrocketing inflation. Measures to combat shortages have ranged from nationalizations of grocery stores and slaughterhouses to the lifting of import tariffs on foodstuffs to barter deals with foreign countries.

As food prices rise globally, Venezuela's problem is likely to become more acute -- so it is possible that the statement about Colombia cutting its exports was made in order to pin the blame on Bogota for an anticipated future scarcity. Given the lack of follow-through by the Venezuelan government on pursuing the issue, it was not likely a key point for Venezuelan propaganda. In fact, given the later denials by the ministry, it may have been a one-off from an ill-advised vice minister.

The statement might have been a misstep, but it points to a fundamental truth. The Chavez government relies on popular support to maintain power, and the poor are the hardest hit by rising prices and food shortages. As the situation becomes more dire in the face of spiraling commodity prices, Chavez will have a growing need to find a scapegoat on which to focus public discontent if he is to avoid being blamed himself. With diplomatic tensions already high between Bogota and Caracas, the Chavez government is likely to look for ways to deflect Venezuelan public anger westward toward Colombia.

Strategic Forecasting, Inc.
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ARGENTINA: RALLIES, BUSINESS CLOSURES SUPPORT FARMERS' STRIKE

Businesses closed and demonstrators took to the streets June 2 in small towns in rural areas of Argentina in support of striking farmers' protest against increased export taxes and demands for new agricultural policies, media reports said. Rallies and business closures occurred in the provinces of Santa Fe, Buenos Aires, Cordoba and Entre Rios. The strikes will last "as long as necessary," Argentine Agrarian Federation president Eduardo Buzzi said.

From: Strategic Forecasting, Inc.
go to: www.stratfor.com

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U.S.: S&P DOWNGRADES SEVERAL BANKS

Standard and Poor's (S&P) issued a downgrade for several major banks June 2 and said it had lost some confidence in the banks' ability to meet financial obligations, The New York Times reported. Shares of Lehman Brothers, Morgan Stanley and Merrill Lynch dropped after S&P downgraded them. S&P also revised outlooks for Bank of America and JPMorgan Chase to negative. Another bank, Wachovia, has ousted its chief executive, and Washington Mutual said it would oust its chief executive as well.

Strategic Forecasting, Inc.
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CHINA: THE CHALLENGES OF A 'DEFENSIVE' NUCLEAR ARSENAL

Summary
China continues to struggle to sell its nuclear arsenal as defensive in nature. While there is some credence to this, the dynamics of the nuclear balance are shifting against it and will have consequences for both the credibility of its deterrent and the survivability of its space-based assets.

Analysis

U.S. Secretary of Defense Robert Gates, speaking at a regional security conference in Singapore on June 1, dismissed China's claims that its intercontinental ballistic missile (ICBM) arsenal is for defensive purposes only. While this sort of political banter is not normally of much interest to Stratfor -- Beijing and Washington have long been at odds over defense-related issues -- in this case, it is emblematic of the nuclear dynamic between the two countries.

In one sense, of course, Gates is correct: An ICBM is inherently an offensive weapon. China is indeed moving to modernize its arsenal with more capable solid-propellant missiles that can deliver more warheads more accurately to the continental United States.

But at the same time, China does not have anything close to the strategic force structure to pretend to a meaningful first-strike capability -- the ability to attempt to conduct a debilitating surprise attack against U.S. nuclear forces. As it moves to modernize its arsenal, Beijing still has much ground to cover to ensure the survivability of its own second-strike or retaliatory capability. China's work on its strategic deterrent, in other words, can hardly be termed provocative.

Ultimately, neither Beijing nor Washington is interested in any sort of escalating arms race; both have far more pressing problems, and neither has the resources right now to devote to an accelerated nuclear weapons acquisitions program (and, of course, the United States is well ahead of China in both qualitative and quantitative terms). However, each is forced to consider not just the other's near-term intent, where the two can see eye-to-eye, but also long-term capabilities and the potential for the emergence of a strategic threat to national interests. Beijing especially is left hedging its bets while attempting to mold perceptions of its military prowess as both defensive and representative of a world-class military power (positions which are not exactly compatible).

While this diplomatic justification for a nuclear arsenal is of little more concern, strategically speaking, than a spat between two defense officials in Singapore, Beijing is edging its way into a very difficult corner.

China is continuing to modernize its intercontinental-range arsenal in order to ensure its nuclear deterrent's long-term survivability and credibility (and not just with the United States, but also with China's nuclear-armed neighbors Russia, Pakistan and India). Beyond the deployment of a small ballistic missile submarine fleet, however, much of China's modernization has been one-for-one replacement of existing systems -- essentially sustaining the arsenal rather than growing it. (Of course, Washington is not required to view it that way, and part of the problem with nuclear arsenals the world over is the lack of outward transparency.)

But the United States has its own "defensive" ploy: ballistic missile defense (BMD). The Pentagon's deployment of both sea- and land-based BMD systems from California and Alaska to Japan will only continue. While all of this is ostensibly directed at North Korea's extremely limited Taepodong arsenal, it will also affect China's limited deterrent (China has as few as a couple of dozen missiles capable of targeting the U.S. eastern seaboard).

As more capable and more robust BMD systems are fielded by the United States (and thus by the Japanese Self Defense Force), they will begin to erode Chinese ICBMs' ability to penetrate this nascent missile shield. Beijing will soon find itself forced either to expand its forces more meaningfully -- both quantitatively and qualitatively -- or to accept the slow marginalization of the currency of its deterrent in Washington. The former could easily be interpreted as a prelude to an arms race -- one China knows it is all too likely to lose.

But this boxing in of the Chinese nuclear arsenal is only a side benefit of U.S. efforts in BMD, which will also begin to erode the survivability of Beijing's space-based assets.

Copyright 2008 Strategic Forecasting, Inc.