Markets and the Power Shift to the Emerging Economies

The weight of economic activity is shifting from the US & Europe to Asia & Iberoamérica

Energy squeeze – higher prices

The longer-term energy story is complex. The developed world is now barely increasing its use of energy and energy demand is projected to remain stable for the forseeable future, at least for the next couple of decades. Energy use in the emerging world, by contrast, continues to grow relentlessly every year.

The emerging world now uses more energy than the old developed world. This is what you would expect to happen, for as the weight of economic activity shifts from the US and Europe to Asia and Iberoamérica, so too will demand for energy. But it means the price paid by the developed world will be increasingly determined by the emerging world. The so called “West” (the US and Europe) has never been in this position since industrialisation. There is a weak parallel with the rise of Opec in the 1970s when the oil producers cut supply and quadrupled the price. At that time, the US and Europe found other sources of oil and reduced their dependence on Opec. But this time the squeeze comes from the demand side, not the supply, and there is not much the US and Europe can do about it.

And what next for the commodities markets 

The Chart below provides an overview contrasting developed countries with emerging economies' share of GDP and their world share of some of the most important commodity markets and other indicators:

Source: The Economist Daily Charts

Many analysts believe that the long-running boom in commodity prices (for some of the world's most important raw materials) has been driven up by financial speculation as much as physical need. Hence the commodities market may be heading for a massive crash on the scale of sub-prime. The commodity boom has not reached the excess so evident in the subprime era but it is pretty big nevertheless. Recently, some analysts have speculated that the gigantic merger between the mining company Xstrata and the commodity trading house Glencore is a signal of the prospect of a looming crash in the commodities markets. Just before the subprime crash, many massive subprime acquisitions came at the end of a massive boom in the securities markets and those doing the deals appeared to have sensed that the party was coming to an end and that they had to do something spectacular to be able to reap the super profits to be had in the final stages of the blowout. The Geo-Trade Blog believes it is possible that this deal may be the signal that the commodity markets are today where debt markets were on the eve of the credit crunch.

Printing Money and Bubbles in Markets

In the immediate aftermath of the subprime crash, printing money or quantitative easing (QE) as it is also known helped a wide variety of financial institutions to avoid facing up to their losses, covertly recapitalising US and European banks that were, to all intents and purposes, insolvent. Over the last few years protests from countries including Thailand, Australia, South Africa and China have been heard complaining that the US' unprecedented monetary expansion was responsible for causing dangerous bubbles in commodity markets going way beyond US equities. The US government also knows, although it denies it, that the more money it prints, the more speculative pressures push up global food prices. 

While the causes behind the Arab Spring unrest in 2011 are complex, it must be noted that it was surging food price that provided the spark. Hence the large emerging economies view "quantitative easing" as a developed country policy aberration, dressed up as a "legitimate technical solution" that they do not agree with at all. Brazil's finance minister has described it as "throwing dollars out of a helicopter and the Russian PM has described it as "economic hooliganism". The emerging economies clearly perceive the current trials and tribulations of the developed countries very differently to the conventional wisdom that underpins the policy decisions and assumptions that justify QE in the developed world. Emerging Economies are aghast that the US is now shouldering declared federal liabilities of $9,100bn - making it by a long way the world's largest debtor. Furthermore US Government debt is set to reach 42pc of GDP by 2015 according to official estimates. And more and more interest is being shown in the fact that the US' total sovereign liabilities including off-balance sheet items such as Medicare and Mediaid amount to $75,000bn - no less than five times annual GDP.

 

Mongolia – a new concept for "buffer states" in the 21st Century

Map of Mongolia, geographically located between China and Russia, 
the 21st century regional powers in the former "buffer states" of Central Asia



Qing (Manchu) Dynasty

The 清朝Qing (Manchu) Dynasty (1644-1911) was China's last dynasty. The Manchus were Mongol-like horsemen turned merchants from Manchuria. They were of mixed Mongolian, Korean, Chinese and Jurchen stock. The Manchus sucessfully expanded the Chinese Qing empire far into Central and Southeast Asia and managed to bring Tibet and Mongolia under Chinese control through a system of buffer states. The Manchu success was attributed to their ability to marry Mongol military technique with Chinese administrative government.

Buffer states and Chinese territorial control up until 19^th century

For around 18 centuries, China's geographical position was protected in all directions by a system of buffer states. The aim was to carefully administer and rule a “China territorial core” (which roughly hadn't changed territorially since China's first unification under the Qin emperor in 221 BC) and then surround this with a group of buffer states or territories, ruled through different forms of agreements. This system granted security, trade and served to expand Chinese imperial virtue to the outside world.

In the 17th century the 清朝Qing dynasty conquered China, taking over the Ming Dynasty. At the same time Russian encroachment started into the once deserted and loosely controlled Siberia. The Russians started thinking of Siberia in terms of the European state, that is they wanted clear, limited frontier positions, not loosely ruled, buffer zones. This led to a series of treaties and wars marking the borders between Qing China and Russia for over two centuries, by which Russia took large parts of Siberia's frozen desert.

In the 19th and 20th centuries, the buffer states were increasingly encroached upon from all sides. While the Russians were coming from the north, the British were coming from the sea and from the south. The first opium war came in 1839-42, which led China to accept different rules of trade and administration of foreign merchants working in China, and in 1939-42 the first British-Afghan war saw British forces reaching the south west frontier of one territory which was loosely under China control - Tibet. In the same period the French conquered Indochina, a buffer state of the Qing dynasty, and the Japanese rejected Chinese patronage and conquered Korea, also a part of the Qing empire. The Qing dynasty eventually collapsed in 1911. But encroachment by foreign powers on all the sides of the Chinese border changed China's perception of its own territory and of the use of buffer states.

Mongolia today in 21^st century

Today the concept of buffer states for security and trade with Central Asia and other surrounding countries is no longer relevant. Instead Mongolia and other former buffer states in Central Asia are now the subject of intense commercial interest due to their immense mineral resouces and proximity to China. Mongolia has some of the largest coal mineral resources in the world as well as immense reserves of copper, gold and uranium.

China's national energy strategy is currently focused on securing increasingly scarce resources while diversifying away from the western world. Hence China is investing heavily in mineral resources from Mongolia. Since 2003, it has invested around $500m in FDI in Mongolia. This is because much of Mongolia's coal is the high-quality “coking” variety vital to steel production and it is located only 145km from the Chinese border. Interestingly, China now produces 50pc of the world's steel. Hence Mongolian coal is set to become a cornerstone of Chinese energy policy that will fuel Chinese economic growth in the 21^st century. 

Mongolia and other Central Asian States have long been intertwined with Chinese history and its system of "buffer state" territorial control. But today, China's investment in this former buffer zone, where a third of Mongolians are still nomadic or semi-nomadic in the 21st century, is beginning to open it up to the outside world. A further development is the beginning of a new wave of commercial relations between China and Russia that the US is unable to compete with.

So far, it appears, in the 21^st century, that neither China nor Russia sees Central Asia as its exclusive domain. In Mongolia, both Russia and China are treading carefully. Russia's influence in Central Asia combined with Chinese investment cash, together, is working to transform what were fragile buffer states into a transit corridor based on trade in energy and minerals. The Geo-Trade Blog believes that it is highly possible that this could give rise to trade in a whole range of goods and services in a flourishing new trading corridor through the former Central Asian buffer states which the European bloc countries could also tap into due to their geographical proximity. It is here where economic power is being exerted and the shape of the world in the 21st century is beginning to emerge.

The Arctic in the 21st Century - a New Polar Frontier

Arctic Ocean Ice Breaker

In April 2010 Russian President Medvedev paid a state visit to Norway. The highlight of this visit was a surprise announcement – after 40 years of negotiations – an agreement on the division of a disputed zone in the Arctic Ocean into roughly equal parts for Russia and Norway. A newly agreed Arctic maritime delimitation line was announced accompanied by treaty provisions for new rules and procedures to ensure responsible management of natural resources. The disputed territory measured 175,000 sq km which is equivalent to about half of the land territory of Norway.

Map of Arctic Region Boundaries

Experts believe that the oil potential of the formerly disputed parts of the Arctic Ocean could be more than 5 bn metric tonnes of oil – 10-times Saudi Arabia's production potential and still larger gas reserves 10,000 bn cubic metres of natural gas – five times Norway's proven reserves. But experts argue the high cost and inaccessibility of these resources mean large-scale development of these resources could be years away.

Russian interests in the Arctic

Russia has long held an interest in the Arctic. Indeed, Russia underlined the importance of the Arctic by declaring its plans to make the Arctic Region its primary resource base by 2020 in its 2009 Arctic Strategy. PM Putin visited Russia's Arctic territory shortly after President Medvedec's visit to Norway last year, where he proclaimed the Arctic's importance was in “Russia's deepest geopolitical interests”. Russia sees itself along with Norway as the two “principle Arctic countries” although it reluctantly acknowledges the need for cooperation with the other Arctic countries: US, Canada and Denmark.

However Russia's political ambitions are not reflected by its technical and financial reality. Russia badly needs international technical expertise to implement cutting-edge projects in such difficult acreage, and money to begin exploration in the offshore Russian Arctic. Hence the recently announced deal in January this year between the British company BP and the Russian company Rosneft to work together to extract oil from above Russia's Arctic Circle. The deal recognises the importance of BP's geological know-how with BP swapping a 5pc stake in itself for a 9.5pc share of Rosenef.

Chinese interests in the Arctic

China is not an Arctic state. Nor does it have an official Arctic Strategy yet. Nevertheless it is increasingly active and vocal on the international stage on issues concerning the region.

In recent years China has been trying to bolster its position in the Arctic by seeking observer status on the Arctic Council (which was denied). China has also emphasized the rule of law in the Arctic. In an article in the Asia Times, in February 2011, Rear Admiral Yin Zhin was quoted saying:

“The United Nations Convention on the Law of the Sea, the North Pole and surrounding areas are the commonwealth of the world’s people and do not belong to any one country… China must play an indispensable role in Arctic exploration as we have one-fifth of the world’s population.”

Chinese oil companies are not yet in a position where they can offer technical expertise. But in the near future, it is highly possible that China could become a major player in the Arctic by financing Russian activities in the region.

Environmentally Sensitive Arctic

It is estimated that the Arctic region holds 25pc of the world’s oil and 9pc of the world’s coal and it is one of the last remaining regions that has not been mined for resources.

Many believe the sensitive Arctic environment is the last place that should be drilled for oil because the risks just aren't worth it. In July 2010, Environmental NGOs called for moratorium on new offshore drilling in the environmentally sensitive Arctic. The calls for a moratorium echo growing concerns across the Arctic that industry needs to prove Arctic oil development will not cause catastrophic damage to the Arctic environment. A US environmental NGO, the Pew Foundation, recently published this video about the risks of Arctic exploration:

What is the future for the Arctic?

In the 21^st century, the Arctic is fast becoming a new Geo-strategic region in natural energy resources, as competition for its massive untapped reserves of oil, gas and coal heats up.

The presence of natural resources has increased the incentives for Arctic countries to settle old maritime territorial claims, largely because no private company will invest without them. But the process of deciding who owns what is aided by international law but often not fully resolved. As a consequence, we should expect much competition and jostling in the foreseeable future among the 5 Arctic countries and their investors as they stake their claims to the Arctic's wealth of natural resources.

But it is also worthwhile remembering that resources are not always mined because they are there but rather because the price is right or because the politics are right (preferably both). The key issue in large parts of the Arctic will be to understand the political risks and whether the necessary long-term investments in infrastructure are made in this previously unexploited polar region.