China's New, Self-Propelled Economy

A few months ago, we mentioned James Kynge's 'China Continental' thesis. In that post, we excerpted an essay Kynge had written in the Financial Times explicating his thesis for China's continuing growth in the wake of declining exports. This was the excerpt we quoted from Kynge's essay:

China is going continental. Just as the US during the 19th century underwent a transition from export-oriented growth to a greater reliance on inner dynamism, so China is looking inwards for the engine to drive its economy.

In China’s case it is still early days, but evidence suggests the conventional view of an export-dependent, river delta-driven economy no longer matches the reality. The argument here is not that trade has somehow become unimportant to China, but rather that the energy generating the world’s fastest economic growth rate this year is increasingly coming from within.

A series of indicators reveals the shift to “China Continental” – the transition of the world’s most populous country into an increasingly self-propelling economic force.

A couple of items that appeared earlier this week in the Financial Times suggest that Kynge's thesis may have been correct. This item from Monday's Lex column, "China's Stimulus" is one, and Martin Wolf's column from Monday's FT, "Wheel of fortune turns as China outdoes west", is another. Here are a couple of brief excerpts from both.

Lex:

There is no precise breakdown of stimulus spending by geography. But $366bn falls under the heading of infrastructure and post-quake recovery; another $113bn under public housing and rural development. Only a small slice – $54bn to stimulate “technological innovation” – seems to explicitly favour developed regions. Output in 12 western provinces grew an average 8 per cent in the first half – a whole percentage point better than 11 provinces in the east.

This structural shift was evident in first-half figures from ICBC, China’s largest commercial lender. Its year-on-year percentage increase in operating income in the Yangtze and Pearl river deltas fell, but rose in central and western regions. In short, China would rather finance roads in Chengdu than sweatshops in Guangdong. Many private, export-led companies in coastal areas, lacking collateral in the form of land or government relationships, are still struggling for funds. Trade data on Friday showed exports and imports falling for the 10th month, year-on-year. Weak external demand is not the only cause; this is an unabashed internalisation of growth.

Martin Wolf:

China has emerged as the most significant winner from the financial and economic crisis. At the end of 2008, many questioned whether China would achieve its growth target of 8 per cent in 2009. Who now dares to do so?

Cushioned by its more than $2,100bn (€1,440bn, £1,260bn) of foreign currency reserves, huge trade and current account surpluses and a robust fiscal position, Beijing has been able to deploy all its levers over the financial system and the economy.

[...]

Three immediate questions arise. How has China responded to the crisis? Is its resurgent growth sustainable? How far will its recovery help the world economy?

The answer to the first question is: astonishingly. According to data reported at the end of last week, industrial output expanded 12.3 per cent in the 12 months to August, up from a 10.8 per cent increase in July. This is the fastest growth for a year.

[...]

Is this growth surge sustainable? In a word, yes. Inevitably, the torrid growth of bank credit and money is spilling over into asset prices, particularly equities. But there is little danger of excessive inflation in an economy with an appreciating currency, fully embedded in a world economy still threatened more by deflation than by inflation, at least in the near term. Moreover, the government is solvent. As premier Wen Jiabao noted in Dalian, "we . . . kept budget deficit and government debt at around 3 per cent and 20 per cent of the GDP respectively". Should bad loans increase, China is well able to recapitalise its financial system.

This is good news, of course, for companies selling raw materials to China, for vendors to those companies (e.g., Alloy Steel International), and, more broadly, for countries such as Australia and Brazil that export significant amounts of raw materials to China.

Arturo "Thunder" Gatti, RIP

Commenter Stan B broke the news to me that Arturo "Thunder" Gatti had passed away. From the AP via the Los Angeles Times website ("Arturo Gatti, former boxing champion, found dead in hotel"):

Associated Press
4:10 PM PDT, July 11, 2009

SAO PAULO -- Former boxing champion Arturo Gatti, whose epic trilogy with Micky Ward branded him one of the most exciting fighters of his generation, was found dead in a hotel room in the posh seaside resort of Porto de Galihnas early Saturday.

Police investigator Edilson Alves told the Associated Press that the body of the former junior welterweight champ was discovered in his room at the tourist resort, where Gatti had arrived on Friday with his Brazilian wife Amanda and 1-year-old son.

Alves said police were investigating and it was unclear how the 37-year-old Canadian died.

"It is still too early to say anything concrete, although it is all very strange," Alves said. He declined to provide any additional details.

A spokeswoman for the state public safety department said Gatti's wife and son were unhurt. The woman declined to give a name in keeping with department policy.

"There were no bullet or stab wounds on his body, but police did find blood stains on the floor," she said.

Brazilian boxer and four-time world champion Acelino "Popo" Freitas told the G1 website of Brazil's largest TV network Globo that he was a close friend of Gatti and his wife, and that he "knew they were having some sort of problem and were about to separate."

[...]

"I never saw a crowd show so much love for someone like the way that the crowds flocked to Arturo's fights in Atlantic City," said referee Randy Neumann, who officiated Gatti's last fight against Alfonso Gomez two years ago. "I mean, they were so into him and the crowds were electric. He just fought his heart out every fight."

A quick aside: I've had the pleasure of meeting Randy Neumann on a few occasions. He was a heavyweight contender in the 1970s, and now, in addition to being a professional referee, runs his own financial planning practice in Paramus, NJ. According to a recent article in our local paper, the Record, Neumann's son, a former college football prospect, is now starting his own pro career, managed by his father. I had planned on blogging on that, but hadn't gotten around to it. The AP article quotes Neumann again,

Gatti attempted a comeback in July 2007, getting knocked out in seven rounds by Gomez. Afterward, with his legion of fans cheering for him in the arena, Gatti announced his retirement in the dressing room at Boardwalk Hall.

Neumann said it was tough for him to end that fight, simply because of Gatti's incredible ability to come back in fights.

"I couldn't stop that fight, simply because he was Arturo Gatti," Neumann said. "He was much more dignified to go out that way. He had to be counted out. When he fought, you never knew if he could come back. He looked beaten and still came back."

Neumann is a great referee. Sometimes you've got to let a fighter get counted out, and sometimes you have stop it before it gets to that, and it takes a great referee to make that call¹.

I was never a fan of Gatti -- I was pulling for the other guy in most of his fights -- but I always respected his courage. You had to -- how could you not respect the courage of a man who would keep fighting with a broken hand? May he rest in peace.

Below is a video of the 9th round of the first of three fights between Gatti and "Irish" Mickey Ward. This was probably the best round in the best fight of the trilogy, and this fight was one of the best I've ever seen. Ward, incidentally, if memory serves, was still driving a steam roller for a living in Massachusetts at the time of this fight. He got some nice paydays in the next two fights though, I think.

Mickey Ward vs Arturo Gatti I Round 9


¹I once complimented Neumann on stopping the Klitschko v. Mercer fight when he did. Mercer, the old U.S. Army champion, was "like a Sherman tank" according to Neumann. Letting him eat more of Klitschko's straight rights would have been pointless at that stage of the fight.

BRIC Versus CRIB

In an op/ed in yesterday's Financial Times, Michael Hudson, an economics professor at the University of Missouri, ventriloquized the thoughts of foreign opponents of the United States, while warning of ominous consequences from the summit in Russia this week of the BRIC countries (Brazil, Russia, India, and China) ("Washington Cannot Call all the Shots"):

Many foreigners see the US as a lawless nation. How else to characterise a country that holds out a set of laws for others – on war, debt repayment and the treatment of prisoners – but ignores them itself?

[...]

It is no mystery to other countries how the US remains above the law. Foreigners see a financial system backed by American military bases encircling the globe. The IMF, World Bank, World Trade Organisation and other Washington surrogates are seen as vestiges of a lost American empire no longer able to rule by economic strength, left only with military domination. They see this hegemony cannot continue without adequate revenues and are attempting to hasten the bankruptcy of the US financial-military world order.

[...]

US officials wanted to attend Yekaterinburg as observers. They were told no. It is a word that Americans will hear much more in the future.

Mark Chandler, Global Currency Strategist at Brown Brothers Harriman, had a slightly different take on this summit recently ("Bric or Crib?"):

Brazil, Russia, India and China, now collectively known as the BRICs, will hold a summit in Russia on June 16th. Besides the Goldman Sachs invented moniker, these countries have very little in common except for the fact that they believe, to seemingly varying degrees of intensity, that they deserve greater influence in the conduct of world affairs than they currently have. And given the enormity of US power, as hard-core realists, they know any increase in their power and influence will come at the expense of America’s.

[...]

One of the most important reasons why the BRICs do not have the economic clout that they would like is frankly they don’t deserve it. Goldman-Sachs had a story (and more) to sell with its BRICs concept, but those same letters spell a real word, CRIB. The point is that the countries, outside of China, are not among the largest.

According to Bloomberg data, at the end of last year, China was the fourth largest economy ($3.2 trillion), behind the US, Japan, and Germany. This of course takes the Chinese data at face value, and given the often large gaps between energy production and reported GDP growth, as well as the amazing consistency of the pace of growth, many often cast a suspicious eye on Chinese data.

With a GDP of $1.3 trillion in 2008, Brazil was the 10th largest economy, though it is roughly half the size of France, which is the 6th largest economy. Russia and India were neck-and-neck for 11th and 12th places with each having produced about $1.2 trillion of goods and services last year. Spain’s economy is nearly 20% bigger than Russia’s and India’s, and it is the 8th largest economy. Together the BRICs account for a little more than 12% of the world’s GDP, and China alone accounts for half of that.

Lula: "White People with Blue Eyes" Caused Financial Crisis

From today's Financial Times ("Brazil president blames white people for crisis"):

Brazil's President Luiz Inácio Lula da Silva yesterday blamed the global economic crisis on "white people with blue eyes" and said it was wrong that black and indigenous people should pay for white people's mistakes, writes Jonathan Wheatley .

Speaking in Brasília at a joint press conference with Gordon Brown, the UK prime minister, Mr Lula da Silva told reporters: "This crisis was caused by the irrational behaviour of white people with blue eyes, who before the crisis appeared to know everything and now demonstrate that they know nothing."

He added: "I do not know any black or indigenous bankers so I can only say [it is wrong] that this part of mankind which is victimised more than any other should pay for the crisis."

Lula ought to know about the victimization of black and indigenous people. After all, Brazil was the last country in the Western Hemisphere to abolish black slavery, and as recently as five years ago, Brazil acknowledged that tens of thousands of its indigenous citizens were working as slave laborers. It's interesting that Lula says he doesn't know of any black or indigenous bankers though. Perhaps all the bankers in Brazil are white, but this isn't the case in the United States. We've had African Americans at the highest levels of the financial industry -- for example, Stan O'Neal as CEO of Merrill Lynch, and Don Parsons as a director (and soon to be chairman) of Citigroup. We've also had people of all races and backgrounds involved in originating toxic mortgages -- including Brazilians. In fact, two years ago, the Wall Street Journal reported on a "mostly Brazilian ring that allegedly conspired to defraud people by persuading them to buy homes they couldn't afford" ("How the Subprime Mess Hit Poor Immigrant Groups"). Here's an excerpt from that article:

SOUTH SAN FRANCISCO, Calif. -- Naira Costa, a 27-year-old housekeeper, met her husband at Message of Peace, an evangelical church that is a spiritual and social haven for Brazilians in the Bay Area. When the couple considered buying a house a few years ago, the church's head deacon, Soario Santos, ministered to that need, too.

Mr. Santos, a fellow Brazilian, served the Pentecostal church on nights and weekends. During the day, he worked as a loan officer at a mortgage brokerage owned by a Brazilian immigrant. Mr. Santos and other church officers also working at the same real-estate business routinely approached churchgoers to encourage them to buy homes.

Weak credit and low wages weren't barriers, Ms. Costa recalls. "He told us that a house easily would appreciate $100,000 in a year," enabling the owner to refinance, says Ms. Costa. "We trusted him implicitly. Everyone at the church was buying houses from him."

Today, Ms. Costa and other former Message of Peace parishioners claim that Mr. Santos was a key part of a mostly Brazilian ring that allegedly conspired to defraud people by persuading them to buy homes they couldn't afford. Ms. Costa, the housekeeper, secured a $713,000 sub-prime mortgage. In another instance, a Brazilian baby sitter borrowed $495,000. Now, the home buyers are beset by foreclosures and additional stains on their already-tainted credit.

The graphic above, from a Knight-Ridder article on modern slavery in Brazil, comes from a website called Mongabay.com

English versus Brazilian Portuguese

The Financial Times invited a series of guest columnists to opine about the future of capitalism this week, and one of those guests was the president of Brazil, Luiz Inácio Lula da Silva. Lula's essay ("The Future of Human Beings is What Matters"), which was mocked by a letter writer later in the week¹, doesn't offer much revelation. Lula recounts his hardscrabble background, which may be of interest to those still unfamiliar with his biography, and describes some of Brazil's recent successes in growing its economy while increasing aid to its poor. In truth though, the Brazilian president deserves more credit for what he hasn't done. He has avoided the radical populist policies of some of his neighbors, and Brazil has continued some sensible macroeconomic policies on his watch. As a result, it looks to be in a better position to weather the current downturn.

That op/ed by the Brazilian president reminded me of something I read years ago, a comparison of American English to Brazilian Portuguese in Mark Helprin's 1997 novel, Memoir from an Antproof Case. The speaker below, the narrator of Helprin's novel, is an elderly American who has settled in Brazil after a long and rather picaresque life, and teaches English at the Brazilian naval academy in Rio de Janeiro:

Portuguese is a magnificent language -- Intimate, sensual, and fun. The great poets make it sound like a musical incantation of slurred elisions and rhythmic dissolves, and day-to-day, corrupted, vital, and undisciplined, it is ideal for the dissolute life of a modern city, though what it gains in humor and intimacy it loses in precision and resolution. In fact, it is, when compared to English, almost like a baby language.

Do not misinterpret me. I love baby language, for babies, but among adults it can be rather annoying, especially if you have been here thirty years with not a day of relief, having arrived fully formed and mature, and having come, as I did, from a place where language is not a perfumed cushion but a tightly strung bow that sends sharp arrows into the heart of everything.

The language of my boyhood was the language of ice and steel. It had the strong and lovely cadence of engines in a trance. The song of the world in snow, it was woefully inadequate for conveying material ecstasy, but more than enough for the expression of spiritual triumph.

Portuguese of course isn't a "baby language", but it does lend itself well to song, for reasons Helprin lyrically describes above.

The photo above is a snapshot Cheryl took a few years ago of part of Rio de Janeiro from the top of one of the local tourist sites, Pão de Açúcar (Sugar Loaf) mountain.

¹Letter writer Prof. Alex Callinicos wrote, in part:

Sir, I’m delighted to learn that Luiz Inácio Lula da Silva, president of Brazil, thinks that “the future of human beings is what matters” (March 10). Evidently your series on the Future of Capitalism is stimulating real thinking outside the box. But even worse than the familiar banalities of grandees (at least you seem to be sparing us Bono) is your own special pleading.

More Obama Supporters Concerned by the President's Recent Actions

Last week we noted the concern expressed by two supporters of President Obama, Jim Cramer and Stewart Taylor, about the President's recent statements and actions (see "Buyer's Remorse" and ""More Buyer's Remorse"). This week brings more notes of concern from Obama supporters. On Monday on CNBC, Warren Buffett made a point similar to the one Taylor and Cramer made: in an economic emergency, the president's primary focus ought to be dealing with that emergency, not trying to enact other policy priorities. To underline the point, Taylor used the metaphor of a burning house: you put the fire out first; you don't water the lawn. Buffett used the analogy of World War II, saying that we have been hit with an "economic Pearl Harbor". From the transcript of his CNBC appearance Monday:

[I]f you're in a war, and we really are on an economic war, there's a obligation to the majority to behave in ways that don't go around inflaming the minority. If on December 8th when--maybe it's December 7th, when Roosevelt convened Congress to have a vote on the war, he didn't say, `I'm throwing in about 10 of my pet projects,' and you didn't have congress people putting on 8,000 earmarks onto the declaration of war in 1941.

[...]

[J]ob one is to win the war, job--the economic war, job two is to win the economic war, and job three. And you can't expect people to unite behind you if you're trying to jam a whole bunch of things down their throat. So I would--I would absolutely say for the--for the interim, till we get this one solved, I would not be pushing a lot of things that are--you know are contentious, and I also--I also would do no finger-pointing whatsoever. I would--you know, I would not say, you know, `George'--`the previous administration got us into this.' Forget it. I mean, you know, the Navy made a mistake at Pearl Harbor and had too many ships there. But the idea that we'd spend our time after that, you know, pointing fingers at the Navy, we needed the Navy. So I would--I would--I would--no finger-pointing, no vengeance, none of that stuff. Just look forward.

Warren Buffett may not have much else in common with the "dissident" feminist intellectual Camille Paglia, but she supported Obama as well -- and like Buffett, is concerned by some of what she has seen since he was inaugurated. In the first part¹ of her Salon column Wednesday ("Obama's Clumsy, Smirky Staff is Sinking Him"), Paglia blamed the problems on Obama's staff:

Yes, free the president from his flacks, fixers and goons -- his posse of smirky smart alecks and provincial rubes, who were shrewd enough to beat the slow, pompous Clintons in the mano-a-mano primaries but who seem like dazed lost lambs in the brave new world of federal legislation and global statesmanship.

Heads should be rolling at the White House for the embarrassing series of flubs that have overshadowed President Obama's first seven weeks in office...

[...]

First it was that chaotic pig rut of a stimulus package, which let House Democrats throw a thousand crazy kitchen sinks into what should have been a focused blueprint for economic recovery. Then it was the stunt of unnerving Wall Street by sending out a shrill duo of slick geeks (Timothy Geithner and Peter Orszag) as the administration's weirdly adolescent spokesmen on economics. Who could ever have confidence in that sorry pair?

¹The second part of the column is, inexplicably, about something completely different: Paglia's recent trip to experience Carnival in Bahai, Brazil, as the guest of a popular Brazilian singer.

Samuel Huntington Passes Away

Harvard Political Scientist Samuel Huntington passed away last week at the age of 81. Prompted by his passing, RealClearPolitics links to a reprint of Huntington's famously prescient Foreign Affairs essay from 1993, The Clash of Civilizations. In 1996, Huntington published a book expanded from that article, "The Clash of Civilizations and the Remaking of the World Order". In an Atantic article on Huntington from 2001 ("Looking the World in the Eye" -- the Atlantic re-posted this on its website in response to the news of Huntington's passing), Robert Kaplan summarizes some of the themes of this book:

In the book that emerged from his article, The Clash of Civilizations and the Remaking of World Order (1996), Huntington offered a wealth of other insights. He showed that whereas the West has generated ideologies, the East has generated religions—and explained that religion is now the more menacing force on the international scene. He pointed out, counterintuitively, that because communism was a Central European ideology, the Soviet Union was philosophically closer to the West than is the Eastern Orthodox Russia that has succeeded it. He reminded us that the Cold War was a fleeting event compared with the age-old struggle between the West and Islam. In the Middle Ages, Muslim armies advanced through Iberia as far as France, and through the Balkans as far as the gates of Vienna. A similar process of advance, demographically rather than militarily, is now under way in Europe. "The dangerous clashes of the future," Huntington wrote, "are likely to arise from the interaction of Western arrogance, Islamic intolerance, and Sinic [Chinese] assertiveness."

The rest of Kaplan's article is worth reading.

Neither RealClearPolitics nor The Atlantic mentions an article Huntington wrote for Foreign Policy in 2004, "The Hispanic Challenge". In his preface to that article, Huntington wrote:

The persistent inflow of Hispanic immigrants threatens to divide the United States into two peoples, two cultures, and two languages. Unlike past immigrant groups, Mexicans and other Latinos have not assimilated into mainstream U.S. culture, forming instead their own political and linguistic enclaves—from Los Angeles to Miami—and rejecting the Anglo-Protestant¹ values that built the American dream. The United States ignores this challenge at its peril.

¹On the first page of this essay, Huntington elaborates:

Would the United States be the country that it has been and that it largely remains today if it had been settled in the 17th and 18th centuries not by British Protestants but by French, Spanish, or Portuguese Catholics? The answer is clearly no. It would not be the United States; it would be Quebec, Mexico, or Brazil.

A Brazilian once actually made a similar point to me a few years ago. During a vacation to Brazil I had scheduled a couple of business meetings, the second of which was at the Rio de Janeiro branch of a U.S.-based brokerage. In conversation with the office manager, it came up that a friend and I had visited the old colonial port city of Paraty on our way up from São Paulo. The manager explained the history of the town to me, that it had been the port from which the minerals mined from the Brazilian state of Minas Gerais ("General Mining") were shipped back to Portugal. Then he went on to contrast the difference between the original settlers of what became the U.S. with the original settlers of Brazil: "You had a higher quality of settlers," he said. "Yours -- Puritans -- came to build. Ours came to take". Of course in the 19th and 20th Centuries, Brazil attracted some of the same sort of immigrants that the U.S. did, including Italians, Poles, Germans, Jews, and Japanese (Brazil today has the largest ethnic Japanese population outside of Japan).

Stratfor's Outlook for the Third Quarter

Via John Mauldin, below is Stratfor's global forecast for the third quarter. Since it covers the whole world, there's a lot there. A few points that standout: Stratfor is bearish on India, bullish on Brazil, and sees peace breaking out in the Middle East. Brazil has appeared to be the most attractive of the BRIC countries to me with respect to investment, so Stratfor's take on it isn't too surprising. Its forecast for the Mideast is a little more surprising, but Stratfor believes that one reason violence has been dropping in Iraq is because of behind-the-scenes negotiations between the U.S. and Iran. Stratfor also predicts a peace treaty between Israel and Syria, possibly as early as this year.

-------------------------------------------------------------------------------------



Quarterly Forecast: Third Quarter 2008

By George Friedman

Introduction

For the first half of 2008, Stratfor focused its attention on three features of the international system. All three remain key factors, but all have also evolved notably.

First, we anticipated an endgame between the United States and Iran over the future of Iraq. We have been surprised at just how fast U.S.-Iranian negotiations have progressed, and consequently violence has dropped to its lowest levels since the 2003 invasion (something that would be impossible without Iranian assistance). What is truly amazing is how few items necessary for a deal are not already in place. We are unlikely to have a formal "Camp David" moment, but the U.S.-Iranian understanding seems to be building quickly on the ground.

Second, Russia's efforts to rebuild its influence throughout Eurasia have been at a critical point. With the Western-backed independence of Kosovo making a mockery of Russian foreign policy, we predicted that Moscow either had to strike back or see its credibility in key former Soviet Union territories crumble. As it turned out, Russia's internal factional struggles distracted and exhausted the Kremlin. Striking back at Europe and the United States in any place that would have caused harm proved impossible, forcing the Russians to concentrate on places such as Central Asia, the Caucasus and Ukraine. In the long run, this may well prove to be the worst of all worlds, as the Europeans are convinced they beat the Russians, while the Russians are equally convinced that they have drawn a line in the sand. For the moment, however, Russia requires time to plan and flesh out its new organizational structures. That will take up the bulk of the third quarter.

Third, we forecast that high energy prices would create a flood of petrodollars that mostly would end up flowing into U.S.-dollar assets, greatly stabilizing the financial system and helping the United States shake off its economic funk. This prediction proved true in spades, and U.S. economic growth has certainly turned a corner, but two related developments have taken root. First, having oil prices increase by 40 percent in three months cannot help but have an enervating impact on economic growth, particularly in the heavily industrialized states of East Asia. Second, all that oil income is beginning to have additional impacts.

The Arab Gulf states are grossing approximately $2 billion per day, with half of that amount flowing into the coffers of Saudi Arabia. This provides the Saudis — and other Gulf Arabs — not only with tremendous wealth, but also with tremendous political power. A key trend in the third quarter will have these states using that wealth to invest, bribe and cajole their friends and enemies into following policies more to Riyadh's liking.

This money will be most politically active in two locations: Lebanon and Iraq. In both places the Saudis want to see some flavor of a peace deal. The common thread to the two issues is the Saudi fear of Iran. An Israeli-Syrian peace deal means reducing Tehran's influence within the Sunni world — specifically, the influence it holds over Damascus and Hezbollah. A U.S.-Iranian deal over Iraq means re-establishing Iraq as a buffer against Iranian expansion. In both cases, Saudi money is useful in bringing the various players to the table — most notably Damascus and the various Iraq Sunni factions — and paying them to stick to an agreement. In the case of Israel and Syria, the constellation of forces in play suggests a deal will be struck sooner rather than later.

There is one additional topic that will feature grandly in the third quarter: the Beijing Olympics. Ruling China has always been a difficult prospect, as the country is riven with urban-rural and coastal-interior splits. But while the Olympics were supposed to have been a celebration of China's "arrival" as a modern state, they are instead serving as a showcase for all the ways in which China falls short. But dealing with these issues — entrenched corruption, financial dysfunction, (unapproved) regional autonomy, unaffordable energy subsidies — is difficult for Beijing in the weeks leading up to the Olympics because, under the glare of international spotlights, it can no longer use the tried-and-true tools of an authoritarian state. The result is a string of patchwork fixes that highlight China's weaknesses, making the Asian giant vulnerable to any foreign power with an interest in demonstrating that the emperor is less than fully clothed. Not exactly the global celebration that Beijing intended when it bid for the Olympics all those years ago.

Note to readers: Our third-quarter forecast is intended to be a supplement to our annual forecast and second-quarter forecast. Within each section of this quarterly we have extracted the critical trends identified in our previous forecasts and indicated where we have been right or wrong and what is coming in the next three months. We have also examined new trends that have evolved from regional developments, independent of the earlier forecasts.

Middle East

• Regional trend: The United States has successfully forced the countries that made al Qaeda possible into the American alliance structure. It will now use that structure to clamp down on those still resisting American power. In doing so it may inadvertently trigger tensions with Israel.

In the second quarter, U.S. efforts in the Middle East received a surprising boost in the form of petrodollars. Like the United States, Saudi Arabia wants to see Iraq stable and Iran blocked from expanding its influence. High oil prices are bringing the Saudis more than a billion dollars a day in revenues, some of which they are using to push Sunnis into Iraq's governing coalition.

Syria has found a role in the tightening Arab-American alliance, but that role has taken an unexpected form: peace talks with Israel. Soon after the negotiations came into the public eye, political instability in Israel threatened to derail them, but a deal between Israel's Kadima and Labor parties now ensures that the talks will proceed even if Israeli Prime Minister Ehud Olmert is replaced toward the end of the third quarter. While Washington certainly has its reservations about an Israeli-Syrian detente, the United States is refraining from sabotaging the talks — in part because Saudi money is supporting the initiative, in part because Turkey is hosting the talks, and in part because Hezbollah will be defanged if the talks prove successful.

The third quarter could well prove to be a decisive turning point for many actors in the region. Hezbollah has no good options. It needs to find a way to scuttle the Israeli-Syrian peace talks, and an attack on Israel might be the only way it can do so — but then it risks inviting a major retaliatory attack by Israel. Iran and the United States need to seal a deal on Iraq before the U.S. elections in November, or else risk the situation remaining unresolved for years. If a U.S.-Iranian deal proves elusive, Israel needs to ensure that Iran is knocked down a few pegs before a new U.S. administration potentially restricts the Jewish state's military options. Israel can bomb Iran only with U.S. approval.

The player that will work the hardest to ensure none of these situations spins out of control is Saudi Arabia. High commodity prices are showing signs of eating into global demand, and the last thing Riyadh wants is a war-related price spike that would push many economies over the brink. So Saudi oil income will play a growing role in buying calm throughout the region.

We expect rapid progress in the region's major peace negotiations — those between Israel and Syria and those between Iran and the United States — because most of the heavy lifting has already been done. There has been a near-halt to violence in Iraq, and Israel has been preparing its public to give up the Golan Heights. We would not be surprised at all to see deals materialize in the third quarter, with Syria and Israel more likely to be successful than Iran and the United States.

In the Israel-Syria talks — assuming that they are not derailed — we expect the traditional fanfare of a peace deal, complete with public handshakes. The U.S.-Iranian negotiations, however, are unlikely to present such a tableau. Tehran and Washington seem content to dial back tensions without dropping their public hostility, for fear that their respective populations would not approve of a public burying of the hatchet.

• Regional trend: Turkey is emerging as a major regional power and in 2008 will begin to exert influence throughout its periphery — most notably in northern Iraq.

Turkey is becoming bolder on the international stage: sending troops into northern Iraq, mediating Israeli-Syrian peace talks, pushing energy projects in the Caucasus and Central Asia and making its influence felt in the Balkans. But internally, the country is paralyzed. A domestic power struggle over the nature of the state, pitting the new socially and religiously conservative elite against the established ultrasecular elite, has stalled not only local economic growth and foreign investment but also Ankara's progress toward regional player status.

We expect Turkey's court system — operated by the ultrasecularists — to dictate terms to the elected Islamist-rooted government, likely resulting in the ruling Justice and Development Party's dissolution. A verdict is expected in mid-August on a pending case that seeks to do just that, though we cannot rule out the possibility of a compromise. Toppling the government will not reverse or deflect the underlying trend of Turkey's re-emergence as a leading regional power, but it will delay it significantly.

Eurasia

• Regional trend: Should it occur over Russian objections, Kosovar independence would deliver a massive blow to Russian credibility. Thus, Kosovo will serve as the litmus test for either the return of Russian power or a surge in the West's expansion.


• Regional trend: Russia's internal power struggles will hamper Moscow's ability to pursue its international agenda.

Russia spent the bulk of its energy in the second quarter on managing the transition from Vladimir Putin the president to Vladimir Putin the prime minister. In the shuffle, Russia's restless power clans struggled for supremacy, with the conflict reverberating through some of Russia's most crucial institutions, including the Federal Security Service, Gazprom, Rosneft and the defense sector. This struggle is now over — with the battle lines ending roughly where they began — but the fighting consumed nearly all of Moscow's attention and energy for the bulk of the second quarter.

During this reorganization, the West — particularly the Europeans — did manage to force Kosovar independence over Russian objections, making a mockery of the Russian position in Europe. But Russia did not exact any retribution — or at least, not in Europe. What Russia did do was focus some of its energy on the area where its influence is strong: its immediate periphery. Belarus, Ukraine, Armenia, Azerbaijan and Georgia all witnessed a surge in Russian attention as Moscow locked down its positions in regions it feared the West was eyeing.

The result is a continuing mismatch of perceptions: the Europeans feel that their victory in Kosovo proves the Russians are more bark than bite, while the Russians feel that they have made their true red-lines clear by focusing on their near abroad. Major Eurasian conflicts have been rooted in far smaller misperceptions, but that will be a crisis for another day.

Luckily for both sides, each has other issues to occupy it for now. The Europeans have turned inward after yet another failed attempt at a constitution, and the Russians have to get their affairs in order in the third quarter before venturing outward again.

Putin has implemented major personnel reshuffles across the length and breadth of the Kremlin, with the biggest changes in the energy industry, the military and the defense-industrial complex. Additionally, Russia is a major energy exporter and a moderate food exporter, but it still struggles with inflation — doubly so now that qualitative and quantitative labor shortages are starting to bite, courtesy of Russia's deepening demographic crisis.

While Russia might be in its best posture financially, politically and militarily since the end of the Cold War, it faces a number of nagging problems that it is organizationally ill-suited to solve. Finding a way to get through these problems is not a severe challenge, but it will take time. We expect no major moves out of the Kremlin until the very end of the third quarter at the earliest. But when Russia does return, it will do so with the most money — courtesy of petrodollars — and the best leadership team it has had in 20 years.

• Regional trend: The Concert of Powers will return as the dominant organizing structure of inter-European relations.

Europe is returning to its roots. Countries are arguing over monetary policy, France is making a grab for control of Europe's Mediterranean policy, Poland is aggravating Russia, Greece is complicating Balkan policy and the United Kingdom stands aloof as ever. Any serious thoughts of pan-European integration were thrown into disarray in June when Irish voters defeated the Lisbon Treaty, the latest attempt at a European constitution.

For the third quarter, all eyes will be on France, which will hold the rotating EU presidency for the remainder of the year. Since France is one of Europe's heavyweights, its turn at the presidency would have been notable even had Ireland ratified the EU treaty — but with political integration efforts in limbo, France now has a chance to realign European structures with its own national interests. This will not take the old Gaullist form of ambitions for French superpower status. Instead, Paris will seek to wrest the economic and political leadership of Europe away from Berlin by subtly (and perhaps not-so-subtly) undermining the EU institutions that France perceives as giving Germany an advantage.

Economically, France is better poised than Germany to weather the storm of sustained high commodity prices: It has a less-industrialized economy, is an exporter of foodstuffs and has a huge capacity to generate electricity from nuclear power rather than petroleum fuels. But Paris is well-positioned politically as well. President Nicolas Sarkozy's honeymoon might be over, but Germany finds itself distracted and divided by a failing, conflicted governing coalition that is about to enter an election campaign. Germany is still the rising star of Europe, but that rise has hit a bit of a pause, and France will seize the moment to adjust Europe's direction to its own liking as much as possible.

• Regional trend: Serbian elections will end Belgrade's position in geopolitical no-man's-land — one way or the other.

Europe has seen Serbia as the litmus test of whether the Balkan region as a whole will move decisively toward the West — with each of the Balkan states eventually joining the European Union — or whether there will be a radical wild card in the center of Southeastern Europe, which could give Russia a foothold in the region.

However, we should have known better than to think that the Serbian election could generate a clear result. While Serbia enters the third quarter with its most stable government yet, it would be a mistake to label it firm enough to execute a clear break with the country's past. Undoing 18 years of contradictory policies and international isolation is simply too large a task for any government to complete in short order, much less an untested coalition containing five parties and three ethnic groups.

Nevertheless, steps toward Serbia rejoining Europe — complete with halting steps toward EU membership — appear to be in the cards for the third quarter. Vojislav Kostunica, whose power plays have often upended Serbian policy, will not be in the new government, leaving pro-Western factions with more flexibility than they have known in years. But it will take far more than three months of progress before the probabilities for success can be assessed.

Global Economy

• Regional trend: Oil prices will soften in 2008 due to the fading of geopolitical risks in key locations. The price drop, however, is contingent upon an expected weakening of geopolitical risks.

Things are going to get worse before they get better. Global crude oil prices have risen by 40 percent since the beginning of the year — and all of that took place in the second quarter — largely because of geopolitical risks that Stratfor believes will likely ease. We envision four events occurring in the third quarter that should take some of the heat out of the markets.

First, the U.S. Congress appears to be moving toward regulations intended to lessen the impact of speculation in oil trading. This will almost certainly have some unintended consequences, but will probably result in at least a minor cooling of prices.

Second, we expect a planned Nigerian energy summit to result in additional sums of oil income being funneled to the ethnic Ijaw of southern Nigeria. The Ijaw, who typically feel cut out of the oil patronage system, are responsible for most of the large attacks on oil infrastructure. A deal that enfranchises them should result in more stable Nigerian output.

Third and fourth, we expect two deals to slide into place in the Middle East: one between Iran and the United States on the future of Iraq, and another between Israel and Syria on the future of Lebanon. The Iranian-U.S. negotiations are taking place largely behind the scenes, but will impact the oil markets indirectly if they succeed in finally stabilizing Iraq. Meanwhile, Israeli-Syrian moves toward a very public peace deal should calm those parts of the oil markets that get jumpy every time they see a headline containing the words "Israel" and "Arab."

• Regional trend: Countries the world over will pull their energy sectors back from the free market in order to stave off social instability and/or maximize profit.

The primary manifestation of this forecast in the second quarter came in the form of reinforced energy subsidies, with Russia, France, Italy, India, Venezuela, Argentina and Iran being the most obvious players. Technically, such steps are not nationalizations, but they make the liberalization of energy sectors de facto impossible (no private firm wants to supply a subsidized market).

In the third quarter, we expect more dramatic steps toward direct management of energy sectors in Malaysia and China — two states in which recent efforts to lighten the subsidy burden are likely to backfire. Europe, too, will wrestle with moves to involve the state more deeply in energy questions, as high energy prices finally begin to bite hard enough to force a government response.

• Regional trend: Despite much talk to the contrary, the United States will enjoy strong economic performance. In part, this is because of the massive inflow of money into the United States from Asian and Arabian states.

While talk of recession in the United States remains par for the course, the U.S. Federal Reserve is both becoming optimistic and leaning toward interest rate increases to contain inflation. The Fed will always err on the side of triggering faster growth (and inflation with it) rather than slower growth that could lead to deflation and induce a Japanese-style depression. Add in roughly $100 billion in stimulus checks, and the United States is well past the worst that the slowdown of the latter half of 2007 presented. This does not mean that the "strong economic performance" we anticipated has materialized — but the truth so far is much more positive than the doom-and-gloom talk that dominated American media the first half of the year.

Obviously, not all things are cheery. The American property market is far from recovery — the rising inventory of unsold homes in particular is a critical factor to watch — and strong commodity prices are making the U.S. consumer take pause. Additionally, a combination of American subprime contagion and regional structural and cyclical weaknesses could trigger a European banking crisis in the third quarter. But Stratfor's primary economic concern for U.S. growth remains tied to the election cycle. Neither presidential candidate has any interest in pointing out positive aspects of the current government's economic management. And, in past elections, "It's the Economy, Stupid" has not only garnered votes, but also has had the side effect of amplifying public perceptions of the economy's problems.

• Regional trend: Inflation is on the rise on a global scale.

But while the United States is looking toward better times, the reverse could prove true elsewhere. The sheer size of combined American purchasing power means that the United States can weather high energy and commodity prices relatively well — runaway commodity inflation plus the subprime meltdown still did not push the U.S. economy into negative growth. The same cannot be said for the rest of the global system, where inflation is now pushing 5 percent.

And of course $140 a barrel oil is still $140 a barrel oil. Most countries can no longer absorb such cost increases, and Stratfor expects to see the cracks that developed in major industrialized economies in the second quarter begin to lead to fundamental breaks in the third. Barring a truly deep price drop, a great many states are beginning to have a great many problems. Between robust prices for energy and food, there is not an economy in the world that has not had to make some sort of adjustment. Stratfor divides the effects into two categories.

First, food shortages impact political stability immediately; so food prices have been — and remain — the key issue to watch. In the second quarter, the world witnessed only sporadic, minor, localized food shortages. While grain prices continue to rise, there is some light at the end of the tunnel: plantings and weather have been favorable for most crops, and most grain forecasts for harvest in the next few months are atypically large (with corn in the U.S. Midwest being the notable exception.) It is far too early to predict a price drop, but it seems safe to say that there will not be onerous supply crunches.

Second, the broader inflationary trend remains firmly in place and will disproportionately impact the heavily industrializing — and thus energy-intensive — economies of East Asia (which is hardly to say that the rest of the developing world will escape). The country facing the biggest problems will be China, which imports massive amounts of increasingly expensive commodities. Beijing will face a growing risk of widespread social unrest as these pressures take their toll on its economy, but it will be constrained from restoring order in its accustomed fashion — that is, a security crackdown — in the third quarter because of the international spotlight brought by the Olympics. Efforts to manage the problem thus far have not proven very effective, and they are complicating parallel efforts by the government to recentralize control of the energy sector.

High commodity prices — specifically high energy prices — have also had an unforeseen impact. The political power of countries raking in large numbers of petrodollars — the Arab states of the Persian Gulf now gross a combined $2 billion daily — is at its highest point in a generation. The last time these states had this amount of financial power they underwrote projects such as the Afghan mujahideen and contributed to the fall of the Soviet Union. This time around, they are concerned with Iran's involvement in Iraq and Lebanon, and are applying their riches toward pushing the Israeli-Syrian and American-Iranian peace processes forward.

East Asia

• Regional trend: The Chinese government intends for the year 2008 to be China's day in the sun, with the Olympics showcasing how advanced and stable the country has become. This requires Beijing to act preemptively to prevent anyone with an interest in marring China's image from disrupting the Olympics.

Anti-Chinese foreign activist campaigns have been neutered with a mix of visa policy and slick organizing of counterprotests, while security has been tightened ostensibly in response to the threat of domestic terrorism. But these small victories belie much larger problems that have nothing to do with the Olympics.

The Olympic Games have created an inflection point in Chinese development, disrupting the stability of Beijing's political decision-making process. On some issues, this break point has caused the government to postpone decisions beyond when they would usually have been made, while on others, decisions have been accelerated ahead of the time frame Beijing would have preferred. Reducing energy subsidies was a policy from the former group, but the attempt to delay skidded out of the government's control. Meanwhile, allowing more media access because blackouts proved no longer feasible is an example of the latter.

In short, the Olympics have forced what is normally a gently-gently decision-making process into chaotic fire-fighting mode, and rising commodity prices are forcing the entire system into the pressure cooker. All things considered, China is juggling the issues admirably, but the scope and depth of the challenges it faces guarantee tension and a continuous trickle of small crises for the next quarter (not to mention that everyone who has an interest in seeing a weaker China will use the next several weeks to nudge the country toward as many of those crises as possible).

But the Olympics are still the Olympics, the Chinese people are still very proud to be hosting them, and regional leaders fully realize that the Politburo will certainly come for them if they spoil the show. Stratfor expects this combination of nationalism and fear to see the government through the worst of the problems. Then, once the last hungover tourist steps onto the last departing plane, cracks will likely start showing, the system will start creaking, and the gloves will come off — with the acceleration of price reforms the most likely first order of business.

• Regional trend: In order to tighten its grip on an often unstable and chaotic economy and Communist Party, the Chinese Central Committee is reshuffling the bureaucracy, with an eye to creating energy, aviation and finance superministries directly under its control.

Efforts to consolidate the energy sector are proceeding, but not quickly. The central government is meeting resistance from all of the expected groups — state oil firms, local distributors and retailers, and especially regional leaders — who stand to see their influence, wealth and sources of income all subjugated to Beijing's will. With the added complications of the Olympics and global high energy prices, the central government has been forced to shuffle and reshuffle the plans several times to keep them more or less on track.

In the quarter to come, President Hu Jintao will attempt to bring all the disparate threads of the energy sector more or less under his personal control, a task that will become even more complicated once the burning incentive of the Olympics has passed and all the players take a good hard look at their bottom lines. But in many places, the push for consolidation will not rise above the level of rhetoric, given that many of Hu's key supporters are local leaders who continue to resist change on multiple issues in order to maintain their own viability and profitability. As such, Hu will likely take his campaign to provinces and regions led by people outside of his personal network — a move that will create some tensions and contradictions in the inconsistent application of central government directives across the country.

By comparison, consolidation of the aviation sector will be a cakewalk.

• Regional trend: The U.S. alliance structure in Asia is being readjusted as states feel out both bilateral and multilateral relationships in order to maximize their influence in an evolving world.

This readjustment intensified in the second quarter, with several states becoming increasingly proactive in how they manage their bilateral relations with the United States and their neighbors. As we expected, U.S. allies sought not to sever, but simply to adjust, the ties that bind.

Australia short-circuited several plans to exclude the United States from various proposed Asian clubs by proposing to create and lead its own version of the Asia-Pacific Economic Cooperation to manage the region's economic and military affairs. South Korea, despite domestic opposition, continues to put finishing touches on a free trade deal with the Americans, still vying to become the only major Asian state to land such an agreement. Taiwan's new government sought to find a middle ground that keeps its American alliance intact while allowing it to nudge closer to Beijing. And the United States took advantage of a hurricane disaster in the Philippines to demonstrate vividly that, while it might not be flying the flag in Asia as much as in times gone by, it has hardly vacated the premises. Meanwhile, one state that is by no means a U.S. ally — North Korea — saw its relations with the United States continue shifting away from crisis management toward routine bureaucracy.

This process is only in the beginning stages and will continue to intensify and accelerate in the third quarter. Bear in mind that all four of Washington's primary allies in the region — South Korea, Australia, Thailand and Taiwan — have freshman governments that are feeling their way forward. And with China's attention absorbed by the Olympics and the Americans preoccupied by the Middle East and their own election cycle, all four realize that the time to adjust their alliance relationships is now.

South Asia

• Regional trend: The Pakistani army/state will hold together even as confusion and distractions in Islamabad greatly reduce the Pakistani government's ability (and willingness) to rein in jihadists.

This has certainly proven to be the case. Pakistan's incoming coalition is fractious, inexperienced (it has been 10 years since civilians ran the government) and certainly not in the mood to rock any domestic boats. This has led Islamabad to do everything in its power to avoid unduly angering Islamist militants operating in the country's northwestern reaches. The dawning problem is that this ungoverned land is providing opportunities for militants battling NATO forces in neighboring Afghanistan to rest, recruit and rearm — re-creating precisely the sort of environment that allowed al Qaeda to operate so efficiently until Sept. 12, 2001. In response, NATO forces are beginning to target these militants regardless of the political border, critically damaging the credibility of the Pakistani government.

The third quarter will force the new government in Islamabad to decide whether it is more afraid of NATO forces or of its own militants — who now have made leaps eastward out of the tribal areas into the North-West Frontier Province (NWFP). Ultimately, we expect the government to choose to target the militants, however half-heartedly, rather than make a stand against NATO's incursions into territory that is nominally under Islamabad's writ. The government will be driven by the fear that a conflict with NATO could, at worst, destroy Pakistan or, at best, trigger a military coup — which would end the first civilian government in a decade. In the meantime, U.S. forces will escalate their overt operations in the tribal badlands and perhaps even in the NWFP, which will complicate both the security and political situation in the country.

• Regional trend: India's schizophrenic policies regarding everything from tax regimes to special economic zones to basic infrastructure are proving that the idea of "Shining India" is a myth and will lead to a waning in foreign investment.

Hopes for a "Shining" India have all but darkened, and even that assumes that there is no fallout from the deepening militant struggle in Pakistan.

With oil prices skyrocketing, India's energy subsidized economy cannot cope and state oil refiners are buckling under the pressure. This not only spells a highly uncertain political future for the ruling Congress party, but it also raises the specter of fuel shortages in an extremely riot-prone society should the government slip in managing this fuel crisis. Add in infrastructure bottlenecks and a government that is paralyzed due to rising food prices, and it is clear even to the Indian government that New Delhi's foreign direct investment (FDI) hopes are overinflated. But with inflationary pressures in the country nearing a critical point, maintaining FDI has slid well down the government's priority list.

In the third quarter, India will continue to be squeezed by economic pressure and stymied by political paralysis, both getting worse by the day. A break point is unlikely in the next three months, however. New Delhi still has enough quick fixes at its disposal to manage the impact of the commodity crisis day-to-day, but its attention is now almost fully consumed with containing domestic dissent. The political tension will continue to intensify, but with elections still more than half a year away, the situation will continue to simmer without quite boiling over.

• Regional trend: The rest of South Asia will be consumed with domestic issues.

In the rest of South Asia, domestic squabbles between governments and their opponents took place as per our predictions with one exception: Afghanistan. The advances made by the Taliban, the diversion of U.S. attention to Afghanistan because of progress in Iraq, and the rise of Pakistan's own indigenous Taliban movement has pushed Afghanistan into a world very different from the self-contained situations in Sri Lanka, Bangladesh and Nepal. In the third quarter, the decaying security situation in Pakistan will intensify Afghan militant activity, and will push NATO in general and the United States in particular to boost the involvement of their troops in southeastern Afghanistan.

Latin America

• Regional trend: Brazil is rising as the continental hegemon of South America.

Politically, financially and militarily, Brazil is truly prospering by Latin American standards. Independent of the fact that the country discovered yet more oil fields in the second quarter, Brazil certainly surged ahead of the rest of the continent by any measure.

The economic realm is where Brazil is shining brightest. It exports or is self-sufficient in many of the commodities whose prices are causing the rest of the world no end of problems — but its governance is professional and competent enough that it is, so far, managing the stress of high prices at home.

In the meantime, its primary regional competitors — Argentina and Venezuela — are struggling, falling backward in relative power as Brazil strides forward. Brazil is leveraging this growing space competently. In the second quarter, Brazil became the largest single investor in Argentina. And in the third, it will take its first shipments of liquefied natural gas, setting the stage for it to declare full energy dependence from its unreliable neighbors. And with its investment into the energy industries of those same neighbors, Brazil is laying the groundwork for controlling their energy options, not the other way around.

• New regional trend: Crises are brewing in Latin America's leftist bloc.

In the annual and second-quarter forecasts, we dealt with Argentina, Bolivia and Venezuela separately. We now weave those three trends together: The populist policies that all have adopted are coming home to roost.

Argentina's financial, political and economic stability is taking a sharp turn for the worse. Argentine President Cristina Fernandez de Kirchner's populist efforts to placate a variety of groups have consistently laid the foundations for future, greater problems. The juggling already has radically increased Argentina's debt and reduced the country's trade surplus by a quarter — despite soaring international prices for all of Argentina's exports. This shortsightedness is triggering unrest on a national level, sparking runaway inflation of the type that has made previous Argentine governments fall. It also is gutting the country's productive capacity in industries in which it was until recently a global leader, and is raising the specter of food shortages in the not-so-distant future — quite possibly before the end of the third quarter.

Meanwhile, Bolivia is slowly sinking into chaos as the divisions deepen between the poorer, populous and indigenous highlands led by President Evo Morales and the more European and richer lowlands. Morales will hold a referendum on centralizing power in the third quarter, essentially attempting to force the lowlands into economic and political submission. So long as the lowlands physically control the economy on which the government depends, however, they cannot be talked or voted or threatened into submission. When the government realizes it cannot resolve the situation through constitutional channels — and we do not expect this realization to occur in the third quarter — Bolivia will have its defining crisis. Until then, the imbalance of political and economic forces in the country will only become more skewed, making the eventual conflict that much worse.

In Venezuela, it appeared at the beginning of the year that the opposition was beginning to coalesce into a meaningful political force that could challenge President Hugo Chavez. That trend has since faded away, but Chavez's own economic and political mismanagement has more than compensated for the lack of threats to the regime. Chavez has in many ways become his own worst enemy. Rising food and commodity prices, combined with self-destructive means of dealing with them, have soured the Venezuelan population on Chavez's leadership and fractured the ruling party. Many of Chavez's attempts to rally nationalist sentiment — threatening war against Colombia, for example — have instead backfired badly.

The country's social stability has been reduced to the point where it depends on Chavez's lavish social programs. But the cost of these programs is rising faster than the country's oil income, making Venezuela unique among oil exporters as the only one getting poorer with global crude prices at historic highs. Against this backdrop, it would be logical for foreign states hostile to Chavez to take a swipe at him, or for domestic opposition to rally against him, but no one with the capability to hurt Chavez has a deep enough interest to take any dramatic steps (the same, incidentally, goes for the Argentine and Bolivian governments). In the third quarter we expect Chavez's credibility to take hits — abroad, but even more so at home — as the system's coherence begins to crumble.

The problems of all three states feed upon each other. Bolivia's secession crisis and poor economic management are reducing natural gas flows to Argentina, complicating Argentina's existing power crisis. Venezuela's political — and by some reports, military — support for Bolivia's Morales only outrages and emboldens the secessionist lowlanders there. Venezuela's financial support for Argentina not only reduces the cash Caracas has to stabilize its own system, but several billion dollars of debt linkages now tie the economic problems of one state to the other. These connected problems, mostly rooted in the three countries' populist economics, have been building for years. In the first two quarters, cracks in the facade began to show — but in the third quarter the depth of the problems will become apparent. We do not expect any catastrophic failures in the next three months, but it is time to start thinking of just that.

• New regional trend: Mexico is facing a moment of truth in the government's war against the drug cartels.

In our annual forecast, we predicted a continuing intensification (but not a resolution) of the Calderon administration's war against the country's powerful drug cartels, particularly along the Mexican-U.S. border. But in the second quarter, the cartels began carrying out high-profile assassinations of top law enforcement personnel in Mexico City itself, and this has forced the country to a decision point that will evolve the war into something new. Sustained attacks on key personnel in the halls of power are something that no state can tolerate. If they continue, it will mean that one (or a combination) of three things must happen eventually:

1. Mexico City could strike a truce with the cartels to save the central region.


2. Mexico could hurl every asset it has into the war in an effort to at least secure the country's core.


3. The cartels could strike a truce with each other and force the government away from the border and onto the defensive. In essence, this would turn Mexico into a failed state.

None of the options is easy or pretty — and none might come to pass in the third quarter — but this much is clear: the current situation is untenable.

Africa

• Regional trend: In contrast to previous years, there will be little direct involvement of the major outside — or even inside — players. The one exception will be Angola, which will enjoy a rare day in the sun as the continent's up-and-comer.

It would have been hard to hit this one any more directly: Africa simply has not seen any meaningful direct involvement from the traditional players, whether from the continent or beyond. China has made a couple of commodities deals, but little more. India and Japan each hosted Africa summits but have not pursued other engagements. The French are participating in the European Union peacekeeping force (EUFOR) in eastern Chad, but they are keeping their heads down and have not intervened between the Chadian government and opposing rebels. The United States pulled back on plans to relocate its Africa Command (AFRICOM) headquarters from Germany to Africa. Nigeria is preoccupied with managing the Niger Delta, and South Africa has engaged in very little direct activity in Zimbabwe. Even Angola, the region's up-and-comer, is currently focused on internal development. (In the second quarter, it overtook Nigeria to become Africa's leading oil-producing state.)

But if the second quarter was quiet, it will seem like a roar compared to the third.

China has the Olympics, France has the EU presidency, and the United States is in the middle of an election campaign season and has little capacity for putting pressure on its African allies over relocating AFRICOM.

Nigeria's perennial problems with internal stability will take center stage as the country's Ijaw ethnic community makes its firmest — and, if necessary, most violent — bid for a larger slice of the country's oil revenues when Nigeria's government convenes the Niger Delta Summit, expected to commence in late July.

In South Africa, the internal issues that absorbed the country's attention for the past quarter continue to beckon. President Thabo Mbeki truly is already a lame duck and has minimal room to maneuver in either domestic or international politics. A leadership transition is only a year away, and the likely next president, African National Congress chief Jacob Zuma, continues to be hounded by corruption allegations, complete with court cases. The single issue on which Mbeki can act is Zimbabwe, where growing international condemnation has provided an opening for Pretoria's more nuanced policy of engagement.

Only Angola, awash with oil revenues, will have the luxury of picking the issues it wants to address without fear of reprisal or competition. But even Angola will have internal issues to keep it busy. Parliamentary elections — the first since 1992 — will occur in the third quarter, and the government wants to add a stamp of electoral legitimacy to its list of achievements. The rest of the world, it seems, can wait for another day.