Financial crises, like epidemics, kill the unhealthy first. The present crisis
is painful for most of the world but deadly for many Muslim countries, and
especially so for the most populous ones. Policy makers have not begun to
assess the damage.
The diplomatic strategy of the industrial nations now resembles a James Clavell
potboiler, in which an earthquake interrupts a hopelessly immured plot.
Moderate Islam was the El Dorado of the diplomatic consensus. It might have
been the case that Pakistan could be tethered to Western interests, or that
Iran could be engaged peacefully, or that Turkey would incubate a moderate form
of Islam. I considered all of this delusional, but the
truth is that we shall never know. The financial crisis will sort them out
As I commented in the late autumn, the world is not flat, but flattened (see
Asia Times Online, October 28, 2008), leaving the economies of the
largest Muslim countries in ruins. It is hard to forecast the political
fallout, for when each available choice leads to a failed state, it is a matter
of indifference which one you adopt. As state finances crumble, states will
become less important, and freebooters will seize the stage. Think of the
Mumbai terrorists as a political cognate of the Somali pirates, and the
character of a Middle East made up of failed states comes into focus.
Iran's President Mahmud Ahmadinejad controls Iran through a kleptocracy of
Central African proportions, dissipating the country's oil windfall into
payoffs to an "entire class of hangers-on of the Islamic revolution", as I
wrote in June (see
Worst of times for Iran, Asia Times Online, June 24, 2008), when oil
still sold at US$135 a barrel. What will Ahmadinejad do now that the oil price
has collapsed? According to my Iranian sources, the answer is: Exactly the same
thing, but without the money. 
The point of the joke is that Iran's regime cannot reduce subsidies or raise
taxes without losing control of the constituencies that brought it to power.
They are the peasants and the urban poor who barely afford shelter and food as
matters stand. Despite the oil-price collapse, the government has not reduced
energy subsidies that the International Monetary Fund (IMF) puts at more than a
fifth of gross domestic product (GDP). A proposed value-added tax was withdrawn
last October after strikes in the bazaars, starting in Isfahan and other
provincial towns and spreading to the capital Tehran. Iran is eating through
its $60 billion of foreign exchange reserves, unable to adjust to a collapse of
its only significant revenue source.
Iran must break down, I argued last June, or break out, through a military
adventure. The sand is slipping out of the hour glass, and the regime must
decide what to do within a few months. If it does nothing, the default
position, as it were, is Pakistan.
Iran's Ahmadinejad rules through massive subsidies. Pakistan's President Asif
Ali Zardari does the same thing, but without the money. Pakistan ran out of
foreign exchange reserves in November and obtained emergency financing from the
IMF. Its current account deficit was running at an alarming 14% of GDP, or
about $20 billion a year, a small sum, but an important one for a country
two-thirds of whose 175 million people subsist on less than $2 a day.
Pakistan received just $7.6 billion from the IMF, covering a third of its
current account deficit, which means that imports must be reduced drastically
(although lower oil prices may help a bit). Inflation is running at 25% a year.
Pakistan has one of the world's youngest populations and an enormous capital
requirement. Young people borrow from old people, and countries with young
populations should import capital from countries with aging populations. That
is out of the question, for the world markets have turned Pakistan into a
pariah. The cost of credit protection on Pakistani sovereign debt is now more
than 3,000 points (or 30%) above the benchmark London Interbank Offered Rate
(LIBOR), reflecting a complete shutout from capital markets.
Cost of credit protection for Pakistan government debt (5-year term, in basis
points of spread to the London Interbank Rate).
Shown on the right-hand scale is the most populous Muslim country, Indonesia,
where investors pay 1,000 basis points (10 percentage points) above LIBOR for
five-year credit protection.
Pakistan was at least able to raise a modicum of official support. What will
Iran do if its reserves run out? The same thing as Pakistan, but without the
money, for Iran is a geopolitical pariah without access to official aid.
The Muslim risk premium has become so pervasive that investors are looking
cross-eyed at Saudi Arabia. The cost of credit protection on the Kingdom of
Saudi Arabia has jumped since August, and now is considerably higher than
Cost of 5-year credit protection on Saudi Arabia and Israel
Israel credit protection trades at 185 basis points above LIBOR, about the same
as Italy, while Saudi Arabia is at 236 basis points. Considering the kingdom's
resources, that must be interpreted as a political risk premium.
Turkey has been able to keep afloat through the crisis, but barely so. The
Turkish currency has fallen by a third, its stock market has fallen by nearly
80% in dollar terms, and the central bank must keep interest rates at a
punishing 20% to prevent money from fleeing the country. Turkey has a real
economy with a few first-rate manufacturing companies, unlike Iran and
Pakistan, so the comparison is not quite fair. Nonetheless, Turkey relied
heavily on short-term interbank borrowings to finance its balance of trade
deficit, and the crisis has pulled the carpet out from under its economy. In
August, before the crisis erupted in force, Turkey had 10% unemployment. It
will get much worse.
Turkish lira and Turkish 1-year interest rate
Turkey was the poster-child for the so-called carry trade, in which hedge funds
and other investors borrowed in low-interest currencies, for example the
Japanese yen, and lent the money in high-interest currencies, of which Turkey's
lira was the highest. The carry trade was the main source of money for Turkish
business. What will Turkey do now that the credit crisis has made the "carry
trade" a painful memory? The same thing, but without the money.
Pakistan is about to become a failed state, and Iran and Turkey will be close
behind. As I commented to Chan Akya's report of December 2 on this site (see
The hottest place in the world), Pakistan's military-age population is
far greater than those of other Muslim military powers in the region. With
about 20 million men of military age, Pakistan today has as much manpower as
Turkey and Iran combined, and by 2035 it will have half again as many.
Half the country is illiterate and three-quarters of it subsists on less than
$2 a day, according to the World Bank. That is to say that Pakistan's young men
are more abundant as well as cheaper than in any other country in the region.
Very poor and ignorant young men, especially if their only education has been
in Salafi madrassas, are very easy to enlist in military adventures.
The West at present is unable to cope with a failed state like Somalia, with
less than a tenth as many military age men as Pakistan, but which nonetheless
constitutes a threat to world shipping and a likely source of funding for
terrorism. How can the West cope with the humiliation of Pakistan's
pro-American president and the inability of its duly-constituted government to
suppress Islamist elements in its army and intelligence services? For the
moment, Washington will do its best to prop up its creature, Zardari, but to no
avail. The alternatives will require the West to add several zeros to whatever
the prevailing ceiling might be for acceptable collateral damage.
A final note: several readers have asked me to comment on the terror attack on
Mumbai in November. I will do so with great caution, given the absence of
accurate information. I have good reason to believe that the Indian authorities
lied about the attack. India claimed that 10 shooters were involved, because
nine were killed and one captured. The actual number is closer to 30, I am
reliably informed, not counting support personnel in Mumbai who arranged safe
houses with extra ammunition and explosives months in advance of the attack. It
was not a suicide attack at all, but a new kind of urban terror assault, in
which the participants had a reasonable expectation of survival, and the
majority did in fact survive. That is an important wrinkle, for a better class
of combatant can be recruited for missions in which survival is at least
No analyst I know has answered with confidence the question, cui bono?
To whose benefit was the attack? It has been suggested that al-Qaeda diverted a
Pakistani military intelligence team from Kashmir to Mumbai, in a demonstration
of power against India. But there may be another dimension. The Mumbai attack
has been a test of a different kind of warfare, the kind that emanates from
failed states: the tactics of the Somali pirates applied to random destruction
of civilian lives.
The lights are going out across the Middle East; states are failing, and it is
not in the power of the West to make them whole again. All the strategic
calculations that busied policy analysts and diplomats are changing, and the
West has a very short time to learn the rules of a new and terrible game.
1. This appears to be a variant of a joke told in many countries. One peasant
asks another, "How does a telephone work?" The second replies, "It is like a
big dog, with the tail in Isfahan and the head in Mashdad. You pull the tail in
Isfahan and it barks in Mashdad." The first replies, "But how does a cell phone
work?" The second replies, "The same way, but without the dog."