Monday, July 11, 2005

Where the Pentagon Meets Goldman Sachs

We've got two interesting New York Times stories that reflect Thomas Barnett's influence upon my worldview. The first is from last week:

WASHINGTON, July 4 - The Pentagon's most senior planners are challenging the longstanding strategy that requires the armed forces to be prepared to fight two major wars at a time. Instead, they are weighing whether to shape the military to mount one conventional campaign while devoting more resources to defending American territory and antiterrorism efforts.

The consideration of these profound changes are at the center of the current top-to-bottom review of Pentagon strategy, as ordered by Congress every four years, and will determine the future size of the military as well as the fate of hundreds of billions of dollars in new weapons.

The intense debate reflects a growing recognition that the current burden of maintaining forces in Iraq and Afghanistan, along with the other demands of the global campaign against terrorism, may force a change in the assumptions that have been the foundation of all military planning.

The concern that the concentration of troops and weapons in Iraq and Afghanistan was limiting the Pentagon's ability to deal with other potential armed conflicts was underscored by Gen. Richard B. Myers, chairman of the Joint Chiefs of Staff, in a classified risk assessment to Congress this spring. But the current review is the first by the Pentagon in decades to seriously question the wisdom of the two-war strategy.

The other story is from today:

SHANGHAI, July 10 - Goldman Sachs and Allianz of Germany are in talks to acquire a $1 billion stake in China's largest state-owned bank, the Industrial and Commercial Bank of China, according to a person briefed on the discussions.

The talks come at a time when some of the world's biggest financial institutions are rushing into China to acquire stakes in some of the country's large but troubled state-owned banks ahead of planned initial public offerings in the next few years. The Bank of America said last month that it would pay $3 billion for a 9 percent stake in the nation's third-largest lender, the China Construction Bank, which is expected to offer shares to the public late this year.

And UBS said last month that it was considering investing as much as $500 million in the Bank of China, another huge state-owned bank.

"All the big financial institutions want a piece of the action," said Jack J. T. Huang, who oversees China coverage for the law firm Jones Day in Taipei, Taiwan. "This is not necessarily a rational decision when you look at the numbers. But these institutions believe the government won't allow these banks to fail. They will step in to help them succeed."

How are these stories related? You've got a major shift in Pentagon strategic thinking going on here. Planners in the Pentagon are presumably considering that its future conflicts will not be a conventional, big war, U.S.-Soviet-style match up:

Senior leaders are trying to develop strategies that will do a better job of addressing the requirements of antiterrorism and domestic defense, while acknowledging that future American wars will most likely be irregular - against urban guerrillas and insurgents - rather than conventional.

This isn't to say the Pentagon is totally discounting the possibility of a Taiwan Straits Naval battle with the Chinese. Indeed, "Several officials involved in the review characterized the debate as 'an effort to create a construct that will bring a better balance' among domestic defense, the antiterrorism campaign and conventional military requirements." Yet, in today's story out of Shanghai, you read about the big guns of American investment banking rushing to set up shop in China, which inevitably forces China to clean up its banking system because they know the potential benefits for serious investment flows:

But analysts say the government has pressed the big financial institutions to help clean up the banking system by taking sizable stakes in the four largest state-owned banks, which also include the Agricultural Bank of China.

Goldman Sachs and Morgan Stanley - considered the two most powerful foreign investment banks in China - have each purchased a substantial number of bad loans from China's financial institutions.

Goldman, J.P. Morgan Chase and I.C.B.C. have also teamed up to agree to loan about $9 billion to the China National Offshore Oil Corporation, one of China's largest state-owned oil companies, if it succeeds in acquiring the Unocal Corporation, an American company. The Chinese oil company, known as Cnooc, is in a bidding war with Chevron over Unocal, and Goldman and J. P. Morgan are Cnooc's financial advisers in that effort.

Indeed, Goldman has moved aggressively in recent years to strengthen its operations in China and solidify its ties to the government in the expectation that the country could some day be a source of billions of dollars in profits.

Henry M. Paulson Jr., Goldman's chairman, has made dozens of trips to China in recent years. And last year, Goldman agreed to donate $67 million to the government to bail out a Chinese brokerage firm.

Goldman then got approval to form a joint venture that could operate in China's domestic securities market. Altogether Goldman's investment in the joint venture is expected to top $200 million in the first few years.

The level of economic integration between the U.S. and China is deep and it is consequential. Certainly you've got a mob-style government running China, which loves profit, but also doesn't mind selling nasty weapons to nasty governments. But as China develops a middle class, and as it connects more and more to the West, its democratic governance where everyone is equal under the law, and its rule-based institutions like the WTO, China is going to have make a decision. Does it want sustained prosperity? Or will it choose to be a belligerent, continued to deny its people their basic human rights and risk all that they've gained? That's the balancing act those in the Pentagon are still assessing. But it looks like Wall Street already knows the answer.


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