[china crowd nervous panic ]Jason Lee/Reuters The Chinese stock market fell dramatically a few weeks ago. That sounds significant, but it actually isn’t. First, the Chinese stock market doesn’t serve the same function as Western markets. The equities sold there don’t allow shareholders to control companies. Nor do the underlying values of these companies correlate with the price of the stocks in any way. Second, the percentage of China’s wealth that flows through the markets is relatively small compared to the size of China’s economy. Market capitalization has little to do with the value of Chinese companies. The really significant news that week was related to China’s foreign exchange reserves. The People’s Bank of China revealed that the country ended 2015 with lower reserves than it started the year with. It’s been the first time FX reserves shrank over the course of a year since 1992. In effect, China has seen its first decline in reserves since the Chinese boom really got under way. The surprising part of this development is not the contraction that has been going for at least a year, but the fact that it was announced. A NEW, UNSTABLE ERA FOR CHINA This announcement told us that China entered a new era in 2015 and is now in uncharted waters. There are more important implications of the decline in reserves than the Chinese stock market’s panic. Aggressive assertions of confidence, demands for greater discipline, and increased arrests of Chinese officials, businessmen, and others have revealed the government’s anxiety. Indeed, the government has been worried for several years, and President Xi Jinping has been trying to maintain social stability in the face of a sea of change in China’s economy. Now, as he attempts to reform and control the People’s Liberation Army—which is the key to China’s regime—China is in the witching hour. The question is whether the regime can maintain stability in the country while it undergoes managed change. EURASIA IN CRISIS I wrote not so long ago about China’s reality and strategy in anticipation of this sort of crisis. The task this week is to step back and take a look at the global reality. China is not the only nation in Eurasia facing social and political instability as a result of economic shifts. Almost all of Asia, with the major exception of India, is undergoing growing instability of different sorts. The Europeans struggle to deal with massive economic and political divergences within the European Union. The Russians simultaneously attempt to deal with an economic crisis stemming from declining oil prices, but rooted in their inability to use oil revenues to build a more robust economy. The Middle East is in political and military chaos due to reasons ranging from US attempts at disengaging from the region to deep animosity between Shiite and Sunni Muslims. While Central Asian countries, caught between Russian and Chinese dysfunction and the lapping waters of Muslim discontent, struggle to contain the resulting unrest. [middle east riyadh oil]Jason Lee/Reuters What we see is a region—from the Atlantic to the Pacific, and from the Arctic to the Indian Oceans—destabilizing. Of the seven billion souls alive today, five billion live in this region. In most of Eurasia, the realities that have been taken for granted for the past generation are no longer certain. There has been a belief in much of the region that, at some point, everything will go back to normal. It was assumed that China’s economy would flourish; that Europe would sort out its problems; that conflicts in the Middle East would subside without the US presence; and that Russia would accommodate itself to its new liberal democratic principles. However, none of those things are going to happen. Instability, uncertainty, and increasingly impotent regimes trying to find their way out of the crises they stumbled into are the new normal. The different parts of Eurasia will not experience the same type of crisis. China’s problems are not the Middle East’s, and the Middle East’s are not Europe’s. These regional crises, however, have a common cause and interact with each other, making things worse… THE ROOTS OF THE EURASIAN CRISIS I wrote a recent article for Mauldin Economics about an emerging crisis for major exporting countries. I want to expand on this so we can understand the underlying cause of the Eurasian crisis—interdependence. Interdependence has been seen as a panacea for humanity’s problems. However, it solves problems, but also creates them. Its most important weakness is that a systemic failure in one region rapidly spreads to other regions. Attempts to solve problems in some nations also affect other countries. Therefore, a byproduct of an interdependent system actually turns into the most dangerous reality of all. This byproduct is conflict among nations as they struggle to stabilize their own crises and are constrained by the behavior of other countries. The conflicts brought on by interdependence are the most dangerous because they breed the greatest desperation. The current Eurasian crisis began in 2008, a crisis that resulted in recessions that had a global impact. The United States and Europe reduced the amount they imported from around the world. China was in a particularly vulnerable position because its economy was heavily dependent on exports. It had been expanding dramatically for over a generation and such an expansion wasn’t always sustainable. By 2008, China was reaching the limits of its economic model. But China still sought to extend the model, not so much out of greed as out of fear of what slow growth might mean socially The Chinese sought to sustain the economy through various forms of subsidies that continued to support growth in GDP—although not at the same level as before—but also increased irrationalities of the economy. [Construction China]Jason Lee/Reuters Financial reserves cushioned it, but that couldn’t last long. China’s economy has continued to slow. The last update from China’s official statistics agency reported a 6.8 percent annualized growth rate in the fourth quarter of 2015. I suspect, although can’t prove, that the real growth rate is substantially less than what Beijing claims. And assuming the growth was real, it was likely not very profitable. China has many competitors who sell the same products at a lower price. Because of the slowing growth, the amount of industrial commodities China could buy (from iron ore to oil) declined. There was a common failure of the markets to grasp that the Chinese economy was not going to return to the old normal and, therefore, commodities prices were irrationally high. The inability of markets to see that a new normal had been in place for several years was critical over those years. But this is a normal feature of financial markets, which struggle to identify discontinuities. It is the true irrationality of markets, but a dangerous one to try to exploit. The market’s ability to delude itself collectively for extended periods of time is part of one of the fundamental realities of geopolitics: the interaction between economics, politics, and war. It’s the place we all live our lives and certainly where Eurasia is now. THE CONSEQUENCES OF FALLING OIL PRICES The illusion of China, which I once called the China Bubble, burst in 2014. I should emphasize that this was not the result of China’s economic shift. That had been going on for years. Rather, 2014 was when the markets realized that China’s downturn was now a permanent feature of the international system. Interestingly, the positive effects of lower oil prices on consumers were important, but not nearly as significant as they would have been 30 years ago. Efficiencies and alternatives had decreased the importance of oil to consumers. But they did not decrease oil’s importance to producers. The economic consequences of declining profits have been significant for mineral producers (it’s important to go beyond oil). But their political consequences have been critical. A few weeks ago, the son of the Saudi king said that Saudi Arabia was interested in selling part of the state-owned oil firm Saudi Aramco. The only reason to put this on the table is that the Saudis need money badly. The potential political consequences of the sale of Aramco are enormous. [Saudi Aramco Chief Executive Officer Khalid al-Falih speaks to the media at the company's booth during Petrotech 2014 (a petrochemicals conference) at the Bahrain International Exhibition Centre in Manama May 19, 2014. REUTERS/Hamad I Mohammed ]Jason Lee/Reuters For decades before the 1970s, European and American interests had owned most of the region’s oil. This had been a sore point in the region; however, the Saudis and others changed this dynamic following the 1973 oil embargo. Nevertheless, the hostility toward the West in the Arab world has increased. More importantly, the two groups are fighting a war in the region. For the Saudis, to raise the possibility of selling part of Saudi Arabia’s oil resources (however small the amount) back to Western interests, reveals the deep crisis that falling oil prices have created. A similar problem exists for Russia. The Russians fumbled the Ukrainian crisis. They went from having a light but real control of all of Ukraine, to seeing the country governed by a pro-Western government while Russia clings to Crimea and a small strip of support in the east. They were in the middle of confronting the West on this issue when the oil crisis hit. Oil revenues were a major component of Russia’s national budget and the driver of the economy. Their dramatic contraction led to a significant financial and economic crisis for which the Russians have no solution. There are many reasons for why they became more assertive in their foreign policy, but maintaining domestic confidence in the government is the key. The decline of oil prices and its impact on the economy will remind most Russians of the events prior to the fall of the Soviet Union. By appearing to be a major player in Syria (Russia actually has deployed relatively few aircraft and fewer troops), the government has maintained its popularity in spite of the emerging hardships. THE NEW EURASIA The point here is that not only is Eurasia as a whole in crisis, but the crises in individual countries and regions are increasingly interacting. The Middle East crisis is interacting with Russia. It is also interacting with Europe, both in terms of the refugee crisis and European deployments in the Middle East. The refugee crisis—with an extra million people on a continent of about 700 million people—has revealed deep fault lines within Europe over the question of borders. Borders are the single central issue of the European Union, and it was thought to be settled. [A Turkish Coast Guard fast rigid-hulled inflatable boats tow refugees and migrants in a dinghy on the Turkish territorial waters of the North Eagean Sea, following a failed attempt of crossing to the Greek island of Lesbos, off the shores of Canakkale, Turkey, November 9, 2015. REUTERS/Umit Bektas ]Jason Lee/Reuters In addition, Europe’s ongoing inability to solve its economic malaise—and I don’t expect a solution for a long time—has intensified China’s problems. After all, Europe was China’s largest customer. Also, the crisis in Ukraine has focused Poland and Romania on the perceived threat from the east, much to the indifference of the rest of Europe, but drawing in the United States as the guarantor of the eastern frontiers. And as mentioned, our forecasting model at Geopolitical Futures points to serious instability in Central Asia as a result of Russian, Chinese, and Middle Eastern problems. Trade is another potential source of disruption brought on by interdependence. Exports constitute about 23 percent of China’s GDP. They make up almost 50 percent of Germany’s GDP and 30 percent of Russia’s. In Saudi Arabia, it’s 52 percent. However, in Japan it’s 16 percent. And, in the United States, exports are only 13.5 percent of GDP and only about 8 percent is attributed to countries outside of NAFTA. When we look at the export levels, we are measuring a nation’s vulnerability to the international system. I would draw the boundary of excessive dependence on exports at about 20 percent of GDP. It is important to add that I evaluate the consequences of dependence not so much in economic terms, but in their impact on social and political stability. High exporters are not necessarily unstable, but their risk is higher. Based on this, and looking only at a handful of major powers, we can see one of the drivers of the crisis in Eurasia. We can also see why economically hard-pressed Japan has not destabilized. In looking at the American numbers and at the geography of its exports, it is also evident why the United States—which may have triggered 2008—has generally not suffered much of the social chaos. It is least exposed to what happens in Eurasia because it depends least on those markets. There are other reasons, of course, but it is important to bear these export numbers in mind. George Soros said recently that we are heading for a crisis similar to 2008. I disagree with him to this extent. First, the 2008 crisis never ended. It just merged with political, social, and military processes and became part of them. Second, the economic crisis, while there may be one, is trivial compared to the conflicts within Europe and along the European-Russian borders. It is trivial compared to the chaos in the Middle East and the economic dysfunction in China. Ultimately, the 2008 crisis never ended. Indeed, it defines the new Eurasia, a place where most human beings live and where stability is increasingly hard to find. 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