The New New Great Game: Geography, Energy, The Dollar And Gold

Submitted by Paul Mylchreest of Monument Securities

The New New Great Game: Geography, Energy, The Dollar and Gold (pdf link)

Sir Halford Mackinder’s 1904 speach in which he outlined his “Heartland Theory” was a founding moment for geo-politics. He argued that control of the Eurasian landmass (Europe, Asia and the Middle East), which contained the bulk of the world’s population and natural resources, was the major geo-political prize.

As time passed, energy (first crude oil then natural gas), became increasingly integral to this concept and its strategic significance cannot be overstated.

Remarkably, Mackinder’s theory has remained equally valid, if not more so, in the modern era - although key “pivot areas” for exercising control have evolved. In addition to Central Asia and Trans-Caucasus in Mackinder’s day, the oil producing nations of the Middle East took on increasing importance in the “New Great Game”.

The geo-political confrontation between the US on one hand and China (in increasingly close cooperation with Russia) on the other, is evolving rapidly. We see a “New New Great Game” (NNGG) emerging and have “tweaked” the Heartland Theory to include.

An additional geographic “pivot”, the South and East China Seas, due to their importance in terms of world trade, oil and gas reserves and numerous territorial claims.

A monetary “pivot”, the dollar-based system of world trade and its reserve status. China is taking the lead role in pushing ahead with its strategy of dismantling the dollar’s supremacy.

Geo-political tension in each of the pivot areas is escalating. For example Central Asia and Trans-Caucasus (Ukraine), Middle East (Iran) and South and East China Seas (Senkaku Islands). The rising powers, China and Russia, are adopting more aggressive geo-political tactics towards US/EU/NATO/Japanese interests. The more “dovish” US policy towards Iran, following the recent nuclear deal, is threatening to destabilise the decades-long status quo in diplomatic relations with Israel and Saudi Arabia.

Just about every aspect of the escalating geo-political tension has an energy element, either directly or indirectly. Viewed from a “Mackinderian” perspective, the strategic value of the energy sector is immense. It begs the question whether, after five years of underperformance, the equity market is under-pricing energy assets, including those deeply out-of-favour integrated oil and gas stocks? Probably, in our view.

We believe that the significance of the monetary pivot in the NNGG is under-estimated as China accelerates preparations to undermine the dollar’s role in world trade. The other aspect of China’s strategy is its diversification into “hard assets” and, as far as we can tell, China is attempting to “corner” the market for physical gold. Its strategic significance is lost on most Western investors. We present some insights into today’s gold market which might shock Western investors - similarities with the run-up to the major lows in the gold price more than a decade ago - and China’s understanding of modern gold market mechanics.

The threats to the existing US-centric order are substantial and the geo-political sands are shifting. The US will respond and has the largest economy and military (with vast ocean-going naval advantage), most powerful investment banks and deepest financial markets and significant (albeit declining) political/diplomatic influence. In terms of boxing metaphors, we wonder whether the Ali versus Foreman fight in Kinshasa in 1974 (knockout in the eighth) or the Leonard versus Hagler fight at Caesar’s Palace in 1987 (points victory where the argument as to who actually won continues) will be the parallel.

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From an anonymous source prior to the major lows in the gold price more than a decade ago.

“Someone once said, ‘no one wants gold, that’s why the US$ price keeps falling.’ Many thinking ones laugh at such foolish chatter. They know that the price of gold is dropping precisely because ‘too many people are buying it’! Think now, if you are a person of ‘great worth’ is it not better for you to acquire gold over years, at better prices? If you are one of ‘small worth’, can you not follow in the footsteps of giants? The real money is selling ALL FORMS of paper gold and buying physical! Why? Because any form of paper gold is losing value much, much faster than metal. Some paper will disappear all together in a fire of epic proportions! The massive trading continues at LBMA, but something is now missing...We have reached production costs...The great mistake by the BIS was in underestimating the Asians. Some big traders said they would buy it all below $365+/- and they did. That’s what forced LBMA to go on a spree of paper selling! Now, it’s a mess.”

Interesting?

The gold price is approaching production cost again.

We have the physical versus paper demarcation again (most commentators are clueless on this - the paper market is still determining the screen price, but it will probably die once and for all this time around – the question is at what level?).

The Asians are being underestimated again when the price is declining (although not by the BIS - China is buying physical gold in unprecedented volumes – at least 70-75% of world mining production this year).

But accelerating developments in the monetary sphere is only one element of...

The “New New Great Game”

Mackinder’s “Heartland Theory”

The traditional “Great Game” obviously dates back to the geo-political rivalry between Great Britain and Russia for supremacy in the central Asian region during the nineteenth and early part of the last century. In his famous speech, “The Geographical Pivot of History”, to the Royal Geographical Society in 1904, Sir Halford Mackinder outlined his “Heartland Theory. ” According to Wikipedia.

“This is often considered a, if not the, founding moment of geo-politics...”

Briefly, this posited that the major geo-political prize is Eurasia (the “World Island”), i.e. the European, Asian and Middle Eastern land mass, which contained the bulk of the world’s population and its natural resources. Mackinder argued that control of the “pivot area“ of central Asia was the key to controlling Eurasia.

This is taken from his paper published in the April 1904 edition of the “The Geographical Journal.”

He also emphasised the important difference between sea power and land power. From Zurich-based ISN’s 2009 “Geopolitics and US Middle Eastern Policy: Mackinder and Brzezinski.”

“Mackinder’s theory was a counter-argument to notions that maritime supremacy was sufficient for a power such as Great Britain to safeguard its hegemony. He claimed that, with the emergence of new transportation routes [e.g. Trans-Siberian railway] and technology, a power that could control the centre (and the abundant resources) of the Eurasian landmass...would ultimately be able to attack the colonies of a sea power everywhere on the continent. “

The Trans-Siberian Railway.

In the wake of World War One, Mackinder argued the case for preventing a convergence of interests between Russia and new “pivot” states of Eastern Europe (Austria, Hungary, Czechoslovakia and Poland). This led to his famous dictum.

“Who rules East Europe commands the Heartland;
Who rules the Heartland commands the World Island;
Who rules the World Island commands the World.”

It’s important to emphasise that the pivot area does evolve/fluctuate with changes in geo-political reality. Indeed, Mackinder included the Baltic states in one of his revisions.

As the world industrialised and became increasingly dependent on crude oil (and later, natural gas), energy resources became ever more integral to the Great Game. With such a large proportion of the world’s oil and gas reserves found on the Eurasian land mass, this was easily accommodated within Mackinder’s theory.

The period just before World War One, with the British Navy’s switch from coal to oil and the adoption of the automobile, set the stage for this. Indeed, in 1913, the British government acquired a 51% controlling interest in the Anglo-Persian Oil Company, the forerunner of BP.

Remarkably, the validity of Mackinder’s theory has stood the test of time, even though most people are unfamiliar with it. The following quote is from the Reagan Administration’s “National Security Strategy of the United States” published in January 1988.

“The first historical dimension of our strategy is relatively simple, clear-cut, and immensely sensible. It is the conviction that the United States’ most basic national security interests would be endangered if a hostile state or group of states were to dominate the Eurasian land mass – that area of the globe often referred to as the world’s heartland.”

Right now, it’s obvious that US national security interests are threatened by a combination of China and Russia.

This was the influential globalist (and former National Security Advisor), Zbigniew Brzezinski, writing in his famous 1997 book, “The Grand Chessboard.”

“Ever since the continents started interacting politically some 500 years ago, Eurasia has been the centre of world power… For America, the chief geopolitical prize is Eurasia – and America’s global primacy is directly dependent on how long and how effectively its preponderance on the Eurasian continent is sustained.”

In the “New Great Game”, (NGG) of the modern era, the major rivalry is between US/NATO on one side and China, Russia, other members of the Shanghai Cooperation Organisation and the likes of Iran, on the other.

The “pivot states” in the NGG are.

• The key nations in Central Asia and the Trans-Caucasus: especially those with substantial energy resources and/or pipelines (e.g. Azerbaijan, Ukraine, Turkmenistan, Uzbekistan etc). Here is a chart showing the major gas pipelines

And the major oil pipelines:

• The major OPEC nations of the Middle East: here we borrow part of US geo-strategist, Nicholas Spykman’s, “Rimland” theory. Spykman, the “godfather of containment” was both a disciple and critic of Mackinder. He believed that the “Rimland”, European coast, Arabian-Middle Eastern desert and Asiatic Monsoon region was more important for controlling the Heartland.

This was Brzezinksi on the Central Asian Republics, or “Eurasian Balkans” as he terms them in his book. This was in 1997, when China’s economic and military might was still a distant prospect.

“They are of importance from the standpoint of security and historical ambitions to at least three of their most important and more powerful neighbours, namely Russia, Turkey and Iran, with China also signalling an increasing political interest in the region. But the Eurasian Balkans are infinitely more important as a potential economic prize; an enormous concentration of natural gas and oil reserves is located in the region, in addition to important minerals including gold.”

It’s a reminder of the strategic importance of energy and gold and puts the US-supported “Color revolutions” into sharper focus - Ukraine (Orange, 2004), Georgia (Rose, 2003) and Kyrgyzstan (Tulip, 2005).

Tweaking the Heartland Theory

We agree with the modern interpretation of the NGG, but we see TWO additional elements which make the current situation a “New New Great G