Reshuffling the deck in the Mideast

The U.S. presence in the Middle East, which for years provided some control over one of the world's most volatile regions, appears to have dissolved into chaos. By removing Saddam Hussein from power, the U.S. removed his tyrannical but stabilizing hand from the powder keg that always existed in the poorly designed nation state of Iraq. Rather than attempting to repair the damage, President Obama appears intent on leaving what he terms "a quagmire." Predictably, chaos has emerged, not just in Iraq, but in Syria as well. The rapidly changing political landscape is pushing major regional players like Turkey, Egypt and Saudi Arabia to drastically reshuffle their assumptions and allegiances.

It is said that nature abhors a vacuum and that history is broadly the history of leaders. The vacuum that is the Middle East is now drawing in Vladimir Putin, one of the boldest characters on the world stage. By drastically raising its military presence in the region, Russia is taking advantage of political confusion and paralysis in the West to create a Middle East that may be more supportive of her interests. While the focus now is on Syria, highlighted by the surprise visit of Bashir al Assad to Moscow, the real target of Russia's gambit may be Saudi Arabia, which is now incurring massive military expenditures as a result of fighting in Yemen and by proxy in Syria. Like Russia, Saudi Arabia is being hurt by low oil prices. Given both country's dependency on the price of crude oil, they may have more in common than many may expect.

Russia's finances have recently been devastated by the drop in crude prices and by the U.S.-led NATO sanctions imposed for the Ukraine incursion.. To maintain its viability, Russia must seek to push up the price of oil by any means at her disposal. Coordinated production agreements between Russia and Saudi Arabia could offer Russia that possibility. However, this would not be in America's interest. Rising oil prices would add to inflation pressures and put more pressure on the Fed to raise rates. This is an outcome which should be raising eyebrows around the world, but sadly no one seems to be considering the possibility.

As a high cost producer, Russia can't survive in a long term low price environment. Traditionally, Saudi Arabia has agreed to align its own oil production policies to the broad strategic interests of the United States in exchange for U.S. protection against its regional rivals, in particular the Shiite state of Iran. But the Obama administration's recent courtship of Iran (through its nuclear treaty), its failure to support allies in Egypt, and its hesitancy to follow through with threats against Syria, might be encouraging the Kingdom to seek newer, more reliable allies.

Still a military superpower, Russia appears set, under President Putin, to challenge the U.S. as part of a strategy to restore its position as a major global player. Given America's vastly superior financial muscle, the contest is only possible given Putin's greater mastery of power politics and the realities of global statecraft. Obama's foreign policies reveal a strong leftist leaning, a stunning lack of military understanding, and a naïve belief in the benign power of organized democracy.

Putin could scarcely be more different. Rather than organizing community activists in Chicago, Putin cut his teeth as head of the KGB in former East Germany. Subsequently, his political rise was fast, illustrating a clear ability to work within power politics. As opposed to Obama's discomfort with America's military history, Putin is a patriotic Russian who was mortified to witness the fall of the Soviet Union. He has proven to be a very calculating opportunist bent on restoring Russia's sphere of influence in the Crimea, the Ukraine and now the Middle East. Putin has shown that he is not afraid to stand up to the United States and its allies. This has increased his domestic support and international standing.

To support its ally in Syria, Russia is now deploying ground troops, including tanks and heavy artillery. Clearly, Putin is thinking in regional terms. With an airbase in Syria, his fighter-bombers can project power into and throughout the region, an opportunity that it has not enjoyed for decades. Thus far Russian forces have not been used to destroy ISIS, as the U.S. would have hoped, but to directly support the Assad regime. Sometimes this means the Russians are going after factions directly supported by the U.S., setting up a dangerous proxy war between the superpowers.

As part of his efforts to move closer to Iran, Obama appears to have put aside old, well-established relationships with Israel and Saudi Arabia. This has caused resentment and a feeling that the U.S. can no longer be trusted as a reliable ally.

According to an article in Brookings, Saudi Crown Prince and Defense Minister, Prince Mohammed bin Salman visited President Putin in St. Petersburg in June 2015. The most trusted son of the Saudi King, Prince Mohammed was accompanied by the Saudi Foreign Minister, Adel Al Jubeir. Perhaps most interestingly, the delegation included the Saudi Minister of Petroleum, Ali Al Naimi, together with some senior military and intelligence officials. Apparently the meetings went well, with reciprocal State Visit invitations offered by both parties. Reuters reported that, on October 3, 2015, Russian Energy Minister Alexander Novak said in referring to the possibility of Russia's preparedness to meet with OPEC and non-OPEC oil producers that, "If such consultations are to happen we are ready to take part."

Low oil prices have kept inflation down, allowing the Fed to continue stalling on a normalization of U.S. interest rates. A rise in oil prices likely would result in increased inflation. This would remove a crucial public excuse, enabling the Fed to justify zero interest rates.

In this column we have argued for many months, even years, that the Fed will not normalize interest rates, other than a possible token 0.25 or even 0.125 percent, until forced to do so by market forces. A higher oil price leading to inflation may provide such pressure if not to the Fed directly, then to international bond markets. A market-triggered interest rate increase likely would do damage to the credibility of the Fed, the international monetary system and to the current prices of financial assets standing at inflated prices, including bonds, equities and, over the short-term, real estate.

As a result, the chess match now unfolding in the Middle East, may not be as insulated from the American economy as Wall Street would like the investing public to believe. If Saudi Arabia drifts out of America's orbit, our ability to avoid financial collapse will be that much more difficult.

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John Browne is a Senior Economic Consultant to Euro Pacific Capital. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

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