An Inflection Point In China's Banking Problem

By George Friedman

The month of May witnessed an interesting
phenomenon: a spate of reports on China's nonperforming-loan problem. What
is most intriguing is that these reports did not come from organizations
like Stratfor -- minor outfits that have been talking about this for a
couple of years. It came from real, solid, serious mainstream organizations
that were, and continue to be in some cases, quite positive about China on
the whole. What is important here is not that China has a serious problem
with bad loans in its banking system. That's old news. What is important is
that mainstream analysts in the West now are taking official notice of it.
The wide divergence between the Western perception of Chinese economic
health and the realities of China's economy is beginning to close. There
will be consequences to that.

The first report came from Ernst &
Young, which released a study saying that China had a substantial problem
with nonperforming loans (NPLs). We have to confess to not having seen that
report, because the accounting firm withdrew it a few days later. The
Chinese government blasted the report, using words like "ridiculous" and
"distorted." Ernst & Young, which has a substantial practice in China,
denied having retracted
the report because of pressure from the government. Whatever their reasons
for doing so, we wish we had been faster in asking for a copy.

No
matter, because May also brought studies on the same subject from
PricewaterhouseCoopers (PWC), McKinsey Global Institute, and Fitch. Each
said the same basic thing: that Chinese banks have enormous NPL numbers on
their books. The PWC report was issued by a group within the company that
specializes in making markets in NPLs. Their news was that the water in
China was fine and everyone should come in. McKinsey focused on
inefficiencies in the Chinese banking system that should be cleared up, so
that NPLs could decline and the Chinese gross domestic product could surge.
Fitch was the harshest of the three, but that firm also argued that the
Chinese had the tools in place to handle the problem. The bottom line was
that all three acknowledged that NPLs were a big issue for China, but they
took different approaches in trying to put the problem in perspective. In
other words, they gave a warning without yelling "Fire!" Some of the reports
were criticized by the Chinese, but none were blasted. Meanwhile, Moody's
Investors Service has told us that they will be releasing a report in a
couple of weeks. It will be interesting to see what their take
is.

Let's begin this analysis by looking at a couple of quotes from
these reports. McKinsey, for example, writes:

"Underlying these
reforms, however, is capital misallocation by the system. Nonperforming
loans are the most conspicuous outcome of this misallocation, but our
research shows that the much larger volume of loans to underperforming
ventures that don't go bad but yield only negligible returns are potentially
more costly to China's economy."

Fitch's report states:


"Summing all of these figures, we come up with total official
nonperforming loans of US$206 bn and other estimated problem loans of over
US$270 bn in the banking system. We would reiterate, however, that a
large portion of this latter figure is comprised of estimated Special
Mention loans or loans that currently are not classified as
nonperforming [emphasis Fitch's]. At the same time, there is an
additional US$197 bn in NPL carveouts still remaining on the balance sheets
of China's asset management companies, which no longer represent direct
losses for banks but are a future liability for the
government."

Fitch also states:

"Beyond this, estimating a
rate of flow of new nonperforming loans is not an easy exercise given
Chinese banks' extremely weak historical data and ongoing deficiencies in
accounting and disclosure. Few banks report data on NPL flows, and those
that do show recent flow rates in the extremely low single digits. We
believe these numbers understate the likely level of ultimate credit losses,
given what we know to be the slow evolution of a strong credit culture and
risk management practices and our suspicion that China's over-reliance on
investment-led growth comes at a cost to bank credit quality."

Fitch
is estimating China's bad-loan situation (our term, lumping all these
categories together) at $673 billion, but it warns that -- given Chinese
accounting and reporting, and the fact that what reporting exists is not
credible -- $673 billion is a low number. That's important. If $673 billion
was the final number, then measures that are put in place could limit the
ultimate losses to a level below that figure. If, however, the total number
of bad loans is substantially higher than $673 billion -- which is our view
of the situation -- then the system would be lucky to have to write off only
this amount.

There are numerous ways to measure the magnitude of the
problem, but one of the simplest is this. China is said to hold nearly $819
billion in foreign reserves. Fitch's conservative estimate of the bad loan
situation comes close to matching that number, and a more liberal
calculation would swallow those reserves up and then some. Put very simply,
the Chinese banking system is in deep trouble -- and with it, so is the
Chinese economy.

It has become an article of faith that China's
economy is booming. The economy certainly is growing rapidly. But growth and
size alone don't tell you how healthy an economic entity is. During the Great
Depression, the U.S. economy was enormous, but it was crippled. Japan's
economy was growing at a phenomenal rate in the 1980s, all the while heading
for its disaster. Size and growth are but two measures of an economy -- or of
a business. They do not tell you how well it is doing.

The basic
problem of the Chinese economy, as in many Asian nations, is that the banks
have not made loans with business considerations in mind. They made loans
for political reasons and to maintain social stability. In many cases, loans
were seen as being more like grants. As a result, they were invested in
enterprises that did not make enough money to repay (or even attempt to
repay) the loans. Frequently, rather than bankrupting the business or
writing off the loan, the banks lent more money to the business -- so that
it could repay old debts, and there was an appearance that the loans were
viable. Loans went into land speculation or to investments in areas that
were already overbuilt. (And this does not attempt to take into account
ancillary problems, such as corruption
and embezzlement, which also have been significant
issues for the Chinese government.)

In the first part of 2006,
there has been a huge surge in lending in China. With the economy already
growing at rates of more than 9 percent, it would seem structurally
impossible to grow it any faster. Shortages in skilled workers, management,
buildings -- all these limit the rate of growth. The truth is that a
substantial portion of the loans that went out were issued to keep bad loans
floating, like using one credit card to pay the monthly payment on another.
You can do that for a while, but you can't do it forever.

What keeps
the Chinese system alive is not domestic consumption, which is not rising in
tandem with overall growth. What keeps China afloat is exports -- exports in
ever greater numbers, and with ever-smaller profit margins. Surging exports
are critical to China, as they were to Japan before it. They generate the
cash that allows the financial system to continue operating.

This is
also the Achilles' heel of the Chinese economy, as Fitch points
out:

"Given the weaknesses already discussed, we believe Chinese
banks remain acutely vulnerable to an economic slowdown, although the
analysis above recognizes that much work has been done to tackle these
weaknesses and at a minimum suggests that Chinese banks and the government
are more equipped today than in the past to deal with problems that may
arise."

Here is the problem. The official policy of the Chinese
government is to cool off the economy. In fact, the Chinese are attempting
to cool growth only in certain sectors, where they perceive particularly
dangerous bubbles starting to form. For the most part, however, they are
doing everything they can to keep the economy hot, in order to try to manage
the financial problem. Now, Fitch argues in its report that the Chinese banks
are better equipped than in the past to deal with their problems. We agree
with that assessment; they were completely unprepared in the past and now
are abysmally prepared. You cannot prepare to deal with a loan situation as
bad as that in China. You simply keep cycling as fast as possible and hope
that something turns up.

In our view, this spate of reports on
China's financial situation marks a turning point.

One of the things
that has kept the Chinese economy booming was cheap exports. But another was
the perception in the West that, underneath it all, China was sound. This
perception induced foreign banks to invest in Chinese banks. There have, of
course, been studies detailing the Chinese debt problem for some time:
Standard & Poor's, for example, estimated the bad debt in 2002 at $600
million. That part isn't new.

However, when "irrational exuberance"
(to quote Alan Greenspan) is at its peak, it is hard to break through the
noise. Markets continue to rise, even as bad news comes out. Last week, for
example, we saw the Bank of China make its initial public offering and
shares soar, just as these financial reports were emerging. That doesn't
mean these reports are wrong or that the Chinese have things under control.
It simply means the market is ignoring news and rising on its own giddiness.


Nevertheless, a turning point has been reached that will be difficult
to ignore. Reports from Stratfor are, of course, one thing. Reports from a
single credit agency are another. But when a series of reports from highly
respected, mainstream analysts all come out within a few days of each other
-- with each, in their own way, telling the same basic story, it becomes
hard for the system to dismiss that. Western companies moving into China
have CEOs and CFOs who must exercise due diligence. There are now too many
reports out there to be simply ignored. All of them are caveated. None of
them write China off. But a critical mass is forming that will cut through
the froth in due course.

Obviously, this does not mean that China
will implode, disappear or anything like that. It will remain an enormous
economy and an important one. But this does mean that the dynamics of the
Chinese economy are shifting. The debt issue represents a deep structural
problem that China will either deal with -- as South Korea did -- or not, as
Japan did not. (Japan reaped more than a decade of economic stagnation as a
consequence. It is significant that China lacks the degree of insulation
that Japan built up; the economy has more external exposures and would not
weather a similar crisis as well.) The point is that, ultimately, the books
have to balance everywhere. That means that the huge structural imbalance of
China, which these debts represent, must be rectified. And that process, as
in all such matters, will be painful.

It is not clear how much pain
Chinese society can withstand before it fractures. This is clearly a concern
for Beijing as it tries, simultaneously, to reform the economy and to crack
down on dissent. The Chinese, like anyone in this fix, try to put the best
possible face on the situation. Which is why they exploded at Ernst & Young.
But even the government in Beijing couldn't shout down the ensuing tidal wave
of financial reports; instead, they grumbled and pointed to the passages that
said it could all be managed.

Perhaps it can. But if it can, it won't
be easy -- and we doubt that it is possible. We have been writing about this
problem for several years now, and people keep asking when the crisis will
come. Our answer is simple: If this isn't a crisis, what would a crisis look
like? The Chinese financial system is sinking under nonperforming and
underperforming loans. Mainstream Western analysts are all writing about the
problem and calling for reforms that the Chinese cannot possibly implement in
time to make a difference. At some point, the weight of evidence will shift
the behavior of the Western financial community, and that will be that.


In the meantime, let the exports flow -- for they surely will, and
in breathtaking quantities.

U.S. Perceptions of a Chinese Threat

By George Friedman

The U.S. Department of Defense released its
annual report on China's military last week. The Pentagon reported that
China is moving forward rapidly with an offensive capability in the Pacific.
The capability would not, according to the report, rely on the construction
of a massive fleet to counter U.S. naval power, but rather on development
and deployment of anti-ship missiles and maritime strike aircraft, some
obtained from Russia. According to the Pentagon report, the Chinese are
rapidly developing the ability to strike far into the Pacific -- as far as
the Marianas and Guam, which houses a major U.S. naval base.

Whether
the Chinese actually are constructing this force is less important than that
the United States believes the Chinese are doing this. This analysis is not
confined to the Defense Department but has been the view of much of the U.S.
intelligence community. There is, therefore, a consensus in Washington that
the Chinese are moving far beyond defensive capabilities or deterrence: They
are moving toward a strike capability against the U.S. Seventh
Fleet.

If this analysis is correct, then the reason for U.S. concern
is obvious. Ever since World War II, the United States has dominated all of
the world's oceans. Following that war, the Japanese and German navies were
gone. The British and French did not have the economic ability or political
will to maintain a global naval force. The Soviets had a relatively small
navy, concerned primarily with coastal defense. The only power with a global
navy was the United States -- and the U.S. Navy's power was so overwhelming
that no combination of navies could challenge its maritime
hegemony.

In an odd way, this extraordinary geopolitical reality has
been taken for granted by many. No naval force in history has been as
powerful as the U.S. Navy. The U.S. Navy does not have the ability to be
everywhere at all times -- but it does have the ability to be in multiple
places at the same time, and to move about without concerns of being
challenged. This means, quite simply, that the United States can invade
other countries, anywhere in the world, but other countries cannot invade
the United States. Whatever the outcome of the invasion once ashore, the
United States has conducted the Iraq, Kosovo, Somali, Gulf and Vietnamese
wars without ever having to fight to protect lines of supply and
communications. It has been able to impose naval blockades at will, without
having to fight sea battles to achieve them. It is this single fact that,
more than any other, has shaped global history since 1945.


Following the Soviet Strategy?

The Soviets fully
understood the implications of U.S. naval power. They recognized that, in
the event of a war in Europe, the United States would have to convoy massive
reinforcements across the Atlantic. If the Soviets could cut that line of
supply, Europe would be isolated. The Soviets had ambitious goals for naval
construction, designed to challenge the United States in the Atlantic. But
naval construction is fiendishly expensive. The Soviets simply couldn't
afford the cost of building a fleet to challenge the U.S. Navy, while also
building a ground force to protect their vast periphery from NATO and China.


Instead of trying to challenge the United States in surface warfare,
using aircraft carriers, the Soviets settled for a strategy that relied on
attack submarines and maritime bombers, like the Backfire. The Soviet view
was that they did not have to take control of the Atlantic themselves;
rather, if they could deny the United States access to the Atlantic, they
would have achieved their goal. The plan was to attack the convoys and their
escorts, using attack submarines and missiles launched from Backfire bombers
that would come down into the Atlantic through the Greenland-Iceland-United
Kingdom (GIUK) gap. The American counter was a strong anti-submarine warfare
capability, coupled with the Aegis anti-missile system. Who would have won
the confrontation is an interesting question to argue. The war everyone
planned for never happened.

Today, it appears to be the Pentagon's
view that China is following the Soviet model. The Chinese will not be able
to float a significant surface challenge to the U.S. Seventh Fleet for at
least a generation -- if then. It is not just a question of money or even
technology; it also is a question of training an entirely new navy in
extraordinarily complex doctrines. The United States has been operating
carrier battle groups since before World War II. The Chinese have never
waged carrier warfare or even had a significant surface navy, for that
matter -- certainly not since being defeated by Japan in 1895.

The
Americans think that the Chinese counter to U.S. capabilities, like the
Soviet counter, will not be to force a naval battle. Rather, China would use
submarines and, particularly, anti-ship missiles to engage the U.S. Navy. In
other words, the Chinese are not interested in seizing control of the
Pacific from the Americans. What they want to do is force the U.S. fleet out
of the Western Pacific by threatening it with ground- and air-launched
missiles that are sufficiently fast and agile to defeat U.S. fleet defenses.


Such a strategy presents a huge problem for the United States. The
cost of threatening a fleet is lower than the cost of protecting one. The
acquisition of high-speed, maneuverable missiles would cost less than
purchasing defense systems. The cost of a carrier battle group makes its
loss devastating. Therefore, the United States cannot afford to readily
expose the fleet to danger. Thus, given the central role that control of the
seas plays in U.S. grand strategy, the United States inevitably must
interpret the rapid acquisition of anti-ship technologies as a serious
threat to American geopolitical interests.

Planning for the
Worst

The question to begin with, then, is why China is pursuing
this strategy. The usual answer has to do with Taiwan, but China has far
more important issues to deal with than Taiwan. Since 1975, China has become
a major trading country. It imports massive amounts of raw materials and
exports huge amounts of manufactured goods, particularly to the United
States. China certainly wants to continue this trade; in fact, it urgently
needs to. At the same time, China is acutely aware that its economy
depends on maritime trade -- and that its maritime trade must pass through
waters controlled entirely by the U.S. Navy.

China, like all
countries, has a nightmare scenario that it guards against. If the United
States' dread is being denied access to the Western Pacific and all that
implies, the Chinese nightmare is an American blockade. The bulk of China's
exports go out through major ports like Hong Kong and Shanghai. From the
Chinese point of view, the Americans are nothing if not predictable. The
first American response to a serious political problem is usually economic
sanctions, and these frequently are enforced by naval interdiction. Given
the imbalance
of naval power in the South China Sea (and the East China Sea as well),
the United States could impose a blockade on China at will.

Now, the
Chinese cannot believe that the United States currently is planning such a
blockade. At the same time, the consequences of such a blockade would be so
devastating that China must plan out the counter to it, under the doctrine
of hoping for the best and planning for the worst. Chinese military planners
cannot assume that the United States will always pursue accommodating
policies toward Beijing. Therefore, China must have some means of deterring
an American move in this direction. The U.S. Navy must not be allowed to
approach China's shores. Therefore, Chinese war gamers obviously have
decided that engagement at great distance will provide forces with
sufficient space and time to engage an approaching American
fleet.

Simply building this capability does not mean that Taiwan is
threatened with invasion. For an invasion to take place, the Chinese would
need more than a sea-lane denial strategy. They would need an amphibious
capability that could itself cross the Taiwan Strait, withstanding Taiwanese
anti-ship systems. The Chinese are far from having that system. They could
bombard Taiwan with missiles, nuclear and otherwise. They could attack
shipping to and from Taiwan, thereby isolating her. But China does not
appear to be building an amphibious force capable of landing and supporting
the multiple divisions that would be needed to deal with Taiwan.

In
our view, the Chinese are constructing the force that the Pentagon report
describes. But we are in a classic situation: The steps that China is taking
for what it sees as a defensive contingency must -- again, under the
worst-case doctrine -- be seen by the United States as a threat to a
fundamental national interest, control of the sea. The steps the United
States already has taken in maintaining its control must, under the same
doctrine, be viewed by China as holding Chinese maritime movements hostage.
This is not a matter of the need for closer understanding. Both sides
understand the situation perfectly: Regardless of current intent, intentions
change. It is the capability, not the intention, that must be focused on in
the long run.

Therefore, China's actions and America's
interpretation of those actions must be taken extremely seriously over the
long run. The United States is capable of threatening fundamental Chinese
interests, and China is developing the capability to threaten fundamental
American interests. Whatever the subjective intention of either side at this
moment is immaterial. The intentions ten years from now are
unpredictable.

As the Pentagon report also notes, China is turning to
the Russians for technology. The Russian military might have decayed, but its
weapons systems remain top-notch. The Chinese are acquiring Russian missile
and aircraft technology, and they want more. The Russians, looking for every
opportunity to challenge the United States, are supplying it. Now, the
Chinese do not want to take this arrangement to the point that China's trade
relations with the United States would be threatened, but at the same time,
trade is trade and national security is national security. China is walking
a fine line in challenging the United States, but it feels it will be able
to pull it off -- and so far it has been right.

U.S. Defense
Policy: Full Circle

The United States is now back to where it was
before the 9/11 attacks. Defense Secretary Donald Rumsfeld came into office
with two views. The first was that China was the major challenge to the
United States. The second was that the development of high-tech weaponry was
essential to the United States. With this report, the opening views of the
administration are turning into the closing views. China is again emerging
as the primary challenge; the only solution to the Chinese challenge is in
technology.

It should be added that the key to this competition will
be space. For the Chinese, the challenge will not be solely in hitting
targets at long range, but in seeing them. For that, space-based systems are
essential. For the United States, the ability to see Chinese launch
facilities is essential to suppressing fire, and space-based systems provide
that ability. The control of the sea will involve agile missiles and
space-based systems. China's moves into space follow logically from their
strategic position. The protection of space-based systems from attack will
be essential to both sides.

It is interesting to note that all of
this renders the U.S.-jihadist dynamic moot. If the Pentagon believes what
it has written, then the question of Afghanistan, Iraq and the rest is now
pass�. Al Qaeda has failed to topple any Muslim regimes, and there is no
threat of the caliphate being reborn. The only interesting question in the
region is whether Iran will move into an alignment with Russia, China or
both.

There is an old saw that generals prepare for the last war.
The old saw is frequently true. There is a belief that the future of war is
asymmetric warfare, terrorism and counterinsurgency. These will always be
there, but it is hard to see, from its report on China, that the Pentagon
believes this is the future of war. The Chinese challenge in the Pacific
dwarfs the remote odds that an Islamic, land-based empire could pose a
threat to U.S. interests. China cannot be dealt with through asymmetric
warfare. The Pentagon is saying that the emerging threat is from a peer -- a
nuclear power challenging U.S. command of the sea.

Each side is
defensive at the moment. Each side sees a long-term possibility of a threat.
Each side is moving to deflect that threat. This is the moment at which
conflicts are incubated.

Send questions or comments on this article to analysis@stratfor.com.

Break Point

By George Friedman

A government has been formed in Iraq. It is
a defective government, in the sense that it does not yet have a defense or
interior minister. It is an ineffective government, insofar as the ability
to govern directly is at this point limited institutionally, politically and
functionally. Ultimately, what exists now is less a government than a
political arrangement between major elements of Iraq's three main ethnic
groups. And that is what makes this agreement of potentially decisive
importance: If it holds, it represents the political foundation of a regime.


If it holds.

If it holds, the rest is almost easy. If it
doesn't hold, the rest is impossible. Therefore, the fate of this political
arrangement will define the future of Iraq and, with that, the future of the
region -- and in some ways, the future of the American position in the
region. It is not hyperbole to say that everything depends on this deal.


The deal that has been shaped is about two things: power and money.
First, it addresses the composition of power in Iraq -- defining the Shia as
the dominant group, based on demographics, the Kurds next and the Sunnis as
the smallest group. At the same time, it provides institutional and
political guarantees to the Sunnis that their interests will not simply be
ignored and that they will not be crushed by the Shia and Kurds. In terms of
money, we are talking about oil. Iraq's oil fields are in the south,
unquestionably in Shiite country, and in the north, in the borderland
between Kurd and Sunni territory. One of the points of this arrangement is
to assure that oil revenues will not be controlled on a simply regional
basis, but will be at least partially controlled by the central government.
Therefore, at least some of that money will go to the Sunnis, regardless of
what arrangements are made on the ground with the Kurds.

The Sunnis
got this deal for a simple reason: Their insurgency made them impossible to
ignore. First, the insurgency forced the Americans to recognize that their
initial inclination, de-Baathification, also meant de-Sunnification of Iraq,
and that the price for that would be painful. Second, the insurgency
threatened Iraq with partition and civil war. Any such partition would have
made Iran the dominant power in the region, something that would be
unacceptable to Saudi Arabia and the other governments in the Persian Gulf.
The Saudis were no friends of the Baathists in Iraq, but the thought of
partition -- and of only the United States to provide security against
Iranian influence -- forced them to mobilize Arab support for the Sunnis.
The insurgency was the Sunni leaders' prime bargaining chip, and they played
it well.

Now there is a twofold question that must be faced. First, in
response to the deal that has been made, can the Sunni political leadership
move decisively to end the insurgency, or at least reduce its tempo? And
second, is it willing to do so? The implications are significant: If the
insurgency continues, the entire political agreement will cease to be
meaningful to the Americans, who are sponsoring and, in effect, guaranteeing
the deal. Moreover, if Sunni insurgents continue to target Iraqi Shia, the
quietly vicious counterattacks that the Shia have carried out will surge.
The Sunnis blow things up; the Shia come quietly and kill their enemies. If
the sectarian violence continues, it will mean there is no political
foundation, no government and no change in the situation in Iraq. In that
case, the United States will have to choose between remaining and mitigating
a chaotic situation, or leaving and letting events run their course -- which
also means leaving an open field for Iranian ambitions. From the American
point of view, this agreement has to work. And everything depends on the
Sunnis.

Core Assumptions and Brass Tacks

Insurgencies
don't simply float in the air. It isn't a question of just loading a car
with explosives or setting up an improvised explosive device. Someone has to
obtain, store and distribute explosives. Someone has to train people to build
the device. Someone has to communicate with others without getting caught.
Someone has to recruit new insurgents without being detected, and without
allowing enemy agents to slip in. Someone has to provide security. And all
of this has to happen somewhere, in a geographic space.

That space
has been, for the most part, the villages and urban neighborhoods of the
Sunni Triangle. The insurgency has been rooted there, the insurgents are
known and their presence is protected in those neighborhoods. They are
provided with food and shelter, and the village and neighborhood network
warns them of enemy approaches. Mao Zedong said once that revolutionaries
must be to the people as the tongue is to the teeth: If the support of the
population is withdrawn, the revolution collapses.

At the heart of
this political settlement, then, is the expectation that -- in return for
political and financial concessions -- the Sunni leadership will order the
insurgents they do control to cease attacks, and will order the population
to withdraw support from the insurgents they don't control. In other words,
the Baathist and nationalist insurgents who are linked to the Sunni
leadership would halt operations, while the jihadists led by Abu Musab
al-Zarqawi -- who have their own set of needs and goals in the region --
would either halt operations themselves or have the shield of the Sunni
community withdrawn. The insurgency would not just end suddenly, but would
decline fairly rapidly as recalcitrant troops were squeezed out of the Sunni
region.

Given this dynamic, we would expect a surge of violence from
elements who oppose the political agreement in Baghdad and see themselves
being squeezed out. Their hope will be that the violence, particularly
against the Shia, will trigger a Shiite response and cause the settlement to
collapse. But the success or failure of that gamble will hinge on the answer
to the core question: To what extent does the Sunni leadership control the
insurgents? We assume that it is not total control, and we assume that there
are elements among the Sunni leadership who oppose the political deal.


But the central assumption is that the bulk of the leadership has
bought into the deal and, therefore, that the bulk of the insurgents will
follow their lead. There also is an assumption that the bulk of the Sunni
population will follow these leaders and withdraw support for remaining
insurgents. Now, these insurgents could enjoy some lingering support among
the public, and they could coerce others into protecting them. This would
lead to a short but intense struggle within the Sunni community that, given
the correlation of forces, ultimately would result in the defeat of the
diehards. They would hang on -- waging a campaign that would be painful but
not decisive, increasingly marginalized and ineffective.

This is the
likely path, but it assumes two things. The first is that the political wing
that has negotiated this agreement is able to assert control over the bulk of
the Sunni population. In other words, one assumes that the Americans and Shia
have been negotiating with the right people. If not, then the political
settlement will not end the insurgency, and the violence will continue. We
do not see this as the likely problem, however: The leadership ought to be
able to deliver the bulk of the Sunni community and therefore reduce the
fighting, if they want to.

The real question is whether they want to.
As we said before, the insurgency is the only bargaining chip the Sunnis
have. It was because of the insurgency that the Sunnis were not completely
bypassed by the Americans and Shia. If they stand down but retain the
ability to resume their offensive, the political deal can hold. But if, by
standing down, the Sunnis demoralize their forces or permit intelligence on
the location of weapons caches and personnel to diffuse to the Americans or
Shia over time, the Sunnis could find themselves in a position from which
they no longer can enforce the agreement.

So the key calculation for
the Sunnis is this: If they stand down, can they maintain a credible force
that is ready to serve their political purposes?

The demand that
Iraq's various militias disarm has been focused on the Shiite militias. But
at the end of the day, the Shia are the dominant force in the Iraqi
government: If their militias were integrated into the military and security
structures, they still would be available to serve Shiite political purposes.
If, on the other hand, the Sunni militias were disarmed or integrated into
the Iraqi military and security structures, they would lose their force and
their leverage.

Obviously, this is why the defense and interior
ministers have not yet been designated. It is not really about the
individuals to be named, as their power will be circumscribed by the
Cabinet. The issue is not the ministers themselves, but how the ministries
will be run. More accurately, since it is these ministries that will control
Iraq's military and internal security forces, the question that must be
answered is how these forces will be configured. The Shia do not need
guarantees. The Sunnis do. So the architecture of these ministries -- and
the constitution of military and police units -- has everything to do with
Sunni security.

There is a chicken-or-egg problem. The Sunnis do not
want to begin standing down their forces until structural guarantees are in
place. The Shia -- and in this case, the Americans -- are not going to give
those guarantees until they see that the Sunnis can and will control the
insurgents. They will not both confirm the Sunni position in the ministries
and continue to endure the insurgency. They want to see steps toward the
insurgency being controlled. The naming of the ministers is more symbolic
than real, but the ministries themselves are very real. The Sunnis cannot be
both in the army and making policy and still be waging an
insurgency.

Other Considerations

There also is a real
question as to whether the Shia want the agreement to work. Certainly the
Iranians would like another go-around in order to increase not only the
power of the Shia in general, but of those Iraqi Shia who are close to the
Iranians. A civil war would increase Shiite dependence on the Iranians,
since they would need weapons and political support. The Iraqi Shia do not
seem to have much appetite for Iranian ambitions at the moment. They will
dominate the government; they do not need to obliterate the Sunnis at the
cost of a long civil war. They have most of what they want. Still, there are
those in the Shiite community who are ambitious to displace the current power
structure, and who see civil war as the way to achieve this. They are the
ones who will continue with operations against the Sunni community, hoping
to prevent a stand-down by the insurgents. The Shiite leaders, therefore,
have a similar (though smaller) problem to the Sunnis'. They can contain the
more aggressive and ambitious Shia. But Iran's ability to destabilize their
community is the wild card.

This points up another dynamic as well.
The United States and Iran have been engaged in a seemingly incomprehensible
round of meetings, non-meetings, threats, offers of accommodation and so on
over Iraq and nuclear weapons. Each side has made strange noises, given
contemptuous shrugs and pulled fierce faces at the other. One would think
that war was imminent. In fact, the opposite is true: Each is trying to
avoid war by appearing fearsome and slightly nuts. The Americans want to
scare the Iranians away from destabilizing Iraq's Shiite community. The
Iranians want to make one last run at the Americans to maximize the power of
the Shia -- and particularly that of their allies -- in the Iraqi government.


The Americans obviously want a settlement. And the Iraqi Shia want
one. They are less dependent on Tehran than it might appear, and it seems
they are prepared to follow through. The Sunnis, all doubts and worries
aside, have every reason to want a settlement, and it is unlikely that they
will get a better one. Certainly there are Sunnis who don't want a
settlement, but it seems to us that they can be dealt with if the Sunni
leaders want to deal with them. At this point, the only alternative to this
settlement is civil war -- and it is hard to see a major player who benefits
from a civil war, even if plenty of minor ones might.

For the
Americans, the deal at hand is the exit strategy from the war. As violence
declines, the United States can draw down its forces and begin concentrating
on the question of what it plans to do in Afghanistan, the next item on the
agenda. On the other hand, if the agreement in Baghdad blows apart, there is
little point in American forces remaining in Iraq. With 130,000 troops, the
United States could not contain a civil war; the forces could only take
casualties, while achieving nothing. The ideal outcome would be a drawdown
culminating in a residual force of, say, 40,000 troops based outside of
heavily populated regions.

This goal is not unreachable at this
point. It is possible to recoup the poorly played American hand, to some
extent. But the fate of the political deal is not within U.S. control. The
outcome depends, first, on the Sunni leadership and its desire and ability
to suppress the insurgency. It depends, second, on the Iraqi Shiite leaders'
ability to dominate their community and resist destabilization by Iran. And
it depends, finally, on the Iranians accepting the current situation without
surging forces covertly into Iraq.

In other words, the United States
has become, to a great extent, a bystander. Washington can make whatever
guarantees it wants, but the calculus by all sides now is whether they can
secure their interests with their own resources. At this point, the United
States is growing less and less relevant to the outcome in Iraq, though it
remains urgently interested in what that outcome will be.

If we had
to guess, we would say that the political arrangement should work, more or
less. But we don't have to guess. It is now nearly Memorial Day. The
violence in Iraq will surge, but by July 4 there either will be clear signs
that the Sunnis are controlling the insurgency -- or there won't. If they
are controlling the insurgency, the United States will begin withdrawing
troops in earnest. If they are not controlling the insurgency, the United
States will begin withdrawing troops in earnest. Regardless of whether the
deal holds, the U.S. war in Iraq is going to end: U.S. troops either will
not be needed, or will not be useful.

Thus, we are at a break point
-- at least for the Americans.

Send questions or comments on this article to analysis@stratfor.com.

Civil Liberties and National Security

By George Friedman

USA Today published a story last week
stating that U.S. telephone companies (Qwest excepted) had been handing over
to the National Security Agency (NSA) logs of phone calls made by American
citizens. This has, as one might expect, generated a fair bit of controversy
-- with opinions ranging from "It's not only legal but a great idea" to "This
proves that Bush arranged 9/11 so he could create a police state." A fine
time is being had by all. Therefore, it would seem appropriate to pause and
consider the matter.

Let's begin with an obvious question: How in
God's name did USA Today find out about a program that had to have been
among the most closely held secrets in the intelligence community -- not
only because it would be embarrassing if discovered, but also because the
entire program could work only if no one knew it was under way? No criticism
of USA Today, but we would assume that the newspaper wasn't running covert
operations against the NSA. Therefore, someone gave them the story, and
whoever gave them the story had to be cleared to know about it. That means
that someone with a high security clearance leaked an NSA
secret.

Americans have become so numbed to leaks at this point that
no one really has discussed the implications of what we are seeing: The
intelligence community is hemorrhaging classified information. It's possible
that this leak came from one of the few congressmen or senators or staffers
on oversight committees who had been briefed on this material -- but either
way, we are seeing an extraordinary breakdown among those with access to
classified material.

The reason for this latest disclosure is
obviously the nomination of Gen. Michael Hayden to be the head of the CIA.
Before his appointment as deputy director of national intelligence, Hayden
had been the head of the NSA, where he oversaw the collection and
data-mining project involving private phone calls. Hayden's nomination to
the CIA has come under heavy criticism from Democrats and Republicans, who
argue that he is an inappropriate choice for director. The release of the
data-mining story to USA Today obviously was intended as a means of shooting
down his nomination -- which it might. But what is important here is not the
fate of Hayden, but the fact that the Bush administration clearly has lost
all control of the intelligence community -- extended to include
congressional oversight processes. That is not a trivial point.

At
the heart of the argument is not the current breakdown in Washington, but
the more significant question of why the NSA was running such a collection
program and whether the program represented a serious threat to liberty. The
standard debate is divided into two schools: those who regard the threat to
liberty as trivial when compared to the security it provides, and those who
regard the security it provides as trivial when compared to the threat to
liberty. In this, each side is being dishonest. The real answer, we believe,
is that the program does substantially improve security, and that it is a
clear threat to liberty. People talk about hard choices all the time; with
this program, Americans actually are facing one.

A Problem of
Governments

Let's begin with the liberty question. There is no
way that a government program designed to track phone calls made by
Americans is not a threat to liberty. We are not lawyers, and we are sure a
good lawyer could make the argument either way. But whatever the law says,
liberty means "my right to do what I want, within the law and due process,
without the government having any knowledge of it." This program violates
that concept.

The core problem is that it is never clear what the
government will do with the data it collects.

Consider two examples,
involving two presidential administrations.

In 1970, Congress passed
legislation called the Racketeer-Influenced and Corrupt Organizations (RICO)
Act that was designed explicitly to break organized crime groups. The special
legislation was needed because organized crime groups were skilled at making
more conventional prosecutions difficult. The Clinton administration used
the RICO Act against anti-abortion activists. From a legal point of view,
this was effective, but no one had ever envisioned the law being used this
way when it was drafted. The government was taking the law to a place where
its framers had never intended it to go.

Following 9/11, Congress
passed a range of anti-terrorism laws that included the PATRIOT Act. The
purpose of this was to stop al Qaeda, an organization that had killed
thousands of people and was thought to be capable of plotting a nuclear
attack. Under the same laws, the Bush administration has been monitoring a
range of American left-wing groups -- some of which well might have
committed acts of violence, but none of which come close to posing the same
level of threat as al Qaeda. In some technical sense, using anti-terrorism
laws against animal-rights activists might be legitimate, but the framers of
the law did not envision this extension.

What we are describing here
is neither a Democratic nor a Republican disease. It is a problem of
governments. They are not particularly trustworthy in the way they use laws
or programs. More precisely, an extraordinary act is passed to give the
government the powers to fight an extraordinary enemy -- in these examples,
the Mafia or al Qaeda. But governments will tend to extend this authority
and apply it to ordinary events. How long, then, before the justification
for tracking telephone calls is extended to finding child molesters,
deadbeat dads and stolen car rings?

It is not that these things
shouldn't be stopped. Rather, the issue is that Americans have decided that
such crimes must be stopped within a rigorous system of due process. The
United States was founded on the premise that governments can be as
dangerous as criminals. The entire premise of the American system is that
governments are necessary evils and that their powers must be circumscribed.
Americans accept that some criminals will go free, but they still limit the
authority of the state to intrude in their lives. There is a belief that if
you give government an inch, it will take a mile -- all in the name of the
public interest.

Now flip the analysis. Americans can live with child
molesters, deadbeat dads and stolen car rings more readily than they can live
with the dangers inherent in government power. But can one live with the
threat from al Qaeda more readily than that from government power? That is
the crucial question that must be answered. Does al Qaeda pose a threat that
(a) cannot be managed within the structure of normal due process and (b) is
so enormous that it requires an extension of government power? In the long
run, is increased government power more or less dangerous than al Qaeda?


Due Process and Security Risks

We don't mean to be
ironic when we say this is a tough call. If all that al Qaeda can do was
what they achieved on 9/11, we might be tempted to say that society could
live more readily with that threat than with the threat of government
oppression. But there is no reason to believe that the totality of al
Qaeda's capabilities and that of its spin-off groups was encapsulated in the
9/11 attacks. The possibility that al Qaeda might acquire and use weapons of
mass destruction, including nuclear devices, cannot be completely dismissed.
There is no question but that the organization would use such weapons if they
could. The possibility of several American cities being devastated by nuclear
attacks is conceivable -- and if there is only one chance in 100 of such an
event, that is too much. The fact is that no one knows what the
probabilities are.

Some of those who write to Stratfor argue that
the Bush administration carried out the 9/11 attacks to justify increasing
its power. But if the administration was powerful enough to carry out 9/11
without anyone finding out, then it hardly seems likely that it needed a
justification for oppression. It could just oppress. The fact is that al
Qaeda (which claims the attacks) carried out the attacks, and that attacks
by other groups are possible. They might be nuclear attacks -- and stopping
those is a social and moral imperative that might not be possible without a
curtailment of liberty.

On both sides of the issue, it seems to us,
there has developed a fundamental dishonesty. Civil libertarians demand that
due process be respected in all instances, but without admitting openly the
catastrophic risks they are willing to incur. Patrick Henry's famous
statement, "Give me liberty or give me death," is a fundamental premise of
American society. Civil libertarians demand liberty, but they deny that by
doing so they are raising the possibility of death. They move past the tough
part real fast.

The administration argues that government can be
trusted with additional power. But one of the premises of American
conservatism is that power corrupts, and absolute power corrupts absolutely.
Conservatives believe that the state -- and particularly the federal
government -- should never be trusted with power. Conservatives believe in
"original sin," meaning they believe that any ruler not only is capable of
corruption, but likely to be corrupted by power. The entire purpose of the
American regime is to protect citizens from a state that is, by definition,
untrustworthy. The Bush administration moves past this tough part real fast
as well.

Tough Discussions

It is important to consider
what the NSA's phone call monitoring program was intended to do. Al Qaeda's
great skill has been using a very small number of men, allowing them to
blend into a targeted country, and then suddenly bringing them together for
an attack. Al Qaeda's command cell has always been difficult to penetrate;
it consists of men who are related or who have known each other for years.
They do not recruit new members into the original structure. Penetrating the
organization is difficult. Moreover, the command cell may not know details of
any particular operation in the field.

Human intelligence, in order
to be effective, must be focused. As we say at Stratfor, we need a name, a
picture and an address for the person who is likely to know the answer to an
intelligence question. For al Qaeda's operations in the United States, we do
not have any of this. The purpose of the data-mining program simply would
have been to identify possible names and addresses so that a picture could
be pieced together and an intelligence operation mounted. The program was
designed to identify complex patterns of phone calls and link the
information to things already known from other sources, in order to locate
possible al Qaeda networks.

In order to avoid violating civil
liberties, a warrant for monitoring phone calls would be needed. It is
impossible to get a warrant for such a project, however, unless you want to
get a warrant for every American. The purpose of a warrant is to investigate
a known suspect. In this case, the government had no known suspect.
Identifying a suspect is exactly what this was about. The NSA was looking
for 10 or 20 needles in a haystack of almost 300 million. The data-mining
program would not be a particularly effective program by itself -- it
undoubtedly would have thrown out more false positives than anyone could
follow up on. But in a conflict in which there are no good tools, this was a
tool that had some utility. For all we know, a cell might have been located,
or the program might never have been more than a waste of time.

The
problem that critics of the program must address is simply this: If data
mining of phone calls is objectionable, how would they suggest identifying
al Qaeda operatives in the United States? We're open to suggestions. The
problem that defenders of the program have is that they expect to be trusted
to use the data wisely, and to discipline themselves not to use it in pursuit
of embezzlers, pornographers or people who disagree with the president. We'd
love to be convinced.

Contrary to what many people say, this is not
an unprecedented situation in American history. During the Civil War --
another war that was unique and that was waged on American soil -- the North
was torn by dissent. Pro-Confederate sentiment ran deep in the border states
that remained within the Union, as well as in other states. The federal
government, under Lincoln, suspended many liberties. Lincoln went far beyond
Bush -- suspending the writ of habeas corpus, imposing martial law and so on.
His legal basis for doing so was limited, but in his judgment, the survival
of the United States required it.

Obviously, George W. Bush is no
Lincoln. Of course, it must be remembered that during the Civil War, no one
realized that Abraham Lincoln was a Lincoln. A lot of people in the North
thought he was a Bush. Indeed, had the plans of some of his Cabinet members
-- particularly his secretary of war -- gone forward after his
assassination, Lincoln's suspension of civil rights would be remembered even
less than it is now.

The trade-off between liberty and security must
be debated. The question of how you judge when a national emergency has
passed must be debated. The current discussion of NSA data mining provides a
perfect arena for that discussion. We do not have a clear answer of how the
debate should come out. Indeed, our view is that the outcome of the debate
is less important than that the discussion be held and that a national
consensus emerge. Americans can live with a lot of different outcomes. They
cannot live with the current intellectual and political chaos.

Civil
libertarians must not be allowed to get away with trivializing the physical
danger that they are courting by insisting that the rules of due process be
followed. Supporters of the administration must not be allowed to get away
with trivializing the threat to liberty that prosecution of the war against
al Qaeda entails. No consensus can possibly emerge when both sides of the
debate are dishonest with each other and themselves.

This is a case
in which the outcome of the debate will determine the course of the war.
Leaks of information about secret projects to a newspaper is a symptom of
the disease: a complete collapse of any consensus as to what this war is,
what it means, what it risks, what it will cost and what price Americans are
not willing to pay for it. A covert war cannot be won without disciplined
covert operations. That is no longer possible in this environment. A serious
consensus on the rules is now a national security requirement.

Send questions or comments on this article to
analysis@stratfor.com.

The Intelligence Problem

By George Friedman

Porter Goss has been fired as director of
the CIA and is to be replaced by Gen. Michael Hayden -- who is now deputy to
Director of National Intelligence John Negroponte and formerly was director
of the National Security Agency (NSA). Viewed from beyond the Beltway -- and
we are far outside the Beltway -- it appears that the Bush administration is
reshuffling the usual intelligence insiders, and to a great extent, that is
exactly what is happening. But there is more: White House Chief of Staff
Joshua Bolten, having decided such matters as who the new press secretary
should be, has turned to what is a very real problem for President George W.
Bush: a vicious battle between the White House and the CIA.

The fight
is simply about who bears the blame for Iraq. The White House and the Defense
Department have consistently blamed the CIA for faulty intelligence on Iraqi
weapons of mass destruction and over the failure to predict and understand
the insurgency in Iraq. The CIA has responded by leaking studies showing
that its intelligence indeed was correct but was ignored by Bush and Defense
Secretary Donald Rumsfeld. The truth, as usual, lies somewhere in the middle.
There certainly were studies inside the CIA that were accurate on the subject
-- but given the thousands of people working for the agency, someone had to
be right. The question is not whether someone got it right, but what was
transmitted to the White House in then-Director George Tenet's briefings. At
this point, it really does not matter. There was a massive screw-up, with
plenty of blame to go around.

Still, it is probably not good for the
White House and the CIA to be in a vicious fight while a war is still going
on. The firing of Goss, who was a political
appointee brought in to bring the agency to heel, is clearly a concession
to the CIA, where he and his aides were hated (that is not too strong a
word.) Hayden at least is an old hand in the intelligence community, albeit
it at the NSA and not the CIA. Whether this is an attempt to placate the
agency in order to dam up its leaks to the press, or whether Bush is
bringing in the big guns to crush agency resistance, is unclear. This could
be a move by Rumsfeld to take CIA turf. But in many ways, these questions
are simply what we call "Washington gas" -- meaning something that is of
infinite fascination within Washington, D.C., but of no interest elsewhere
and of little lasting significance anywhere.

The issue is not who
heads the CIA or what its bureaucratic structure might be. The issue is, as
it has been for decades, what it is that the CIA and the rest of the
intelligence community are supposed to do and how they are supposed to do
it. On the surface, the answer to that is clear: The job of the intelligence
community, taken as a whole, is to warn the president of major threats or
changes in the international system. At least that appears to be the
mission, but the problem with that definition is that the intelligence
community (or IC) has never been good at dealing with major surprises,
threats and issues. Presidents have always accepted major failures on the
part of the IC.

Consider. The IC failed
to predict the North Korean invasion of South Korea. It failed to predict
Chinese intervention there. It failed to predict the Israeli-British-French
invasion of Suez in 1956. It failed to recognize that Castro was a communist
until well after he took power. It failed to predict the Berlin Wall. It
failed to predict or know that the Soviets had placed missiles in Cuba (a
discovery that came with U-2 overflights by the Air Force). It failed to
recognize the Sino-Soviet split until quite late. It failed to predict the
tenacity of the North Vietnamese in the face of bombing, and their
resilience in South Vietnam. The IC was very late in recognizing the fall of
the shah of Iran. It was taken by surprise by the disintegration of communism
in Eastern Europe and the Soviet Union. It failed to predict the intentions
of al Qaeda. And it failed in Iraq.

Historically, the American
intelligence community has been superb when faced with clearly defined
missions. It had the ability to penetrate foreign governments, to eavesdrop
on highly secure conversations, to know the intentions of a particular
foreign minister at a particular meeting. Given a clear mission, the IC
performed admirably. Where it consistently failed was in the amorphous
mission of telling the president what he did not know about something that
was about to change everything. When the IC was told to do something
specific, it did it well. When it was asked to tell the president what he
needed to know -- a broad and vague brief -- it consistently fell down.


This is why the argument going on between the CIA and the White
House/Defense Department misses the point. Bush well might have ignored or
twisted intelligence on Iraq's WMD. But the failure over Iraq is not the
exception, it is the rule. The CIA tends to get the big things wrong, while
nailing the lesser things time and again. This is a persistent and not
easily broken pattern, for which there are some fundamental
causes.

The first is that the IC sees its task as keeping its
customers -- the president and senior members of his administration --
happy. They have day-to-day requirements, such as being briefed for a
meeting with a foreign leader. The bread-and-butter work of the IC is the
briefing book, which tells a secretary of state what buttons to push at a
ministerial meeting. Ninety-nine percent of the taskings that come to the IC
concern these things. And the IC could get 99 percent of the task right; they
know that this minister is on the take, or that that minister is in a
terrible fight with a rival, or that some leader is dying. They do that over
and over again -- that is their focus. They are rarely rewarded for the risky
business of forecasting, and if they fail to forecast the invasion of South
Korea, they can still point to the myriad useful things at which they did
succeed.

When members of the IC say that no one sees the vital work
they do, they are right. And they are encouraged to do this work by their
customers. If they miss the fall of the Soviet Union, it is the
bread-and-butter work that keeps them going. If the nuts and bolts of
intelligence compete with the vital need of a government to be ready for the
unexpected, the nuts and bolts must win every time. The reason is simple: the
unexpected rarely happens, but meetings of the G-8 happen every year. The
system is built for the routine. It is hard to build a system for the
unexpected.

A second problem is size. The American intelligence
community is much too big. It has way too many resources. It is awash in
information that is not converted into intelligence that is delivered to its
customers. Huge organizations will lose information in the shuffle. The
bigger they are, the more they lose. Little Stratfor struggles to make sure
that intelligence flowing from the field is matched to the right analyst and
that analysts working on the same problem talk to each other, and it is
tough. Doing it with tens of thousands of sources and intelligence officers,
thousands of analysts and hundreds of briefers is a failure waiting to
happen. All of the databases dreamt of by all of the information technology
people in the IC cannot make up for total overload.

It can be argued
that there is no alternative. The United States has global interests and thus
must have global and massive resources. But the fact is that global interests
are not well-served by a system that is too large to function efficiently.
Whatever the need is, the reality is that managing the vast apparatus of the
IC is overwhelmingly difficult, to the point of failure. Moreover, the
management piece is so daunting that finding space to look for the
unexpected -- and transmit that finding efficiently to the customer -- has
been consistently impossible. The intelligence services of smaller countries
sometimes do much better at the big things than massive intelligence
services. The KGB was an example of intelligence paralysis due, among other
things, to size.

A third issue is the cult of sourcing. There is a
belief that a man on the ground is the most valuable asset there is. But
that depends on where he is on the ground and who he is. A man on the ground
can see hundreds of feet in any direction, assuming that there are no
buildings in the way. It always amuses us to hear that so-and-so spent three
years in some country -- implying expertise. We always wonder whether an
Iranian spending three years in Washington, D.C., would be regarded as an
expert around whom analysis could be built. Moreover, these three-year
wonders frequently start doing freelance analysis, overriding analysts who
have been studying a country for decades -- after all, they are "on the
ground." But a blond American on the ground in the Philippines is fairly
obvious, especially when he starts buying drinks for everyone, and the value
of his "intelligence" is therefore suspect. Sourcing is vital; so are the
questions of who, where and for how long.

The most significant
weakness of the cult of sourcing is that the most important events -- like
the Chinese intervention in Korea -- might be unreported, or -- like the
fall of the shah -- might not be known to anyone. These things happened, but
there was an intelligence collection failure in the first case; the second
failure stemmed not from a collection problem, but from a purely analytic
one. In any case, the lack of a source does not mean an event is not
happening; it just means there is no source. There is no question but that
sources are the foundation of intelligence -- but the heart of intelligence
is the ability to infer when there is no source.

Another problem is
the IC's obsession with security, compartmentalization and
counterintelligence. The Soviet Union's prime mission was to penetrate the
U.S. IC. Huge inefficiencies were, therefore, appropriately incurred in
order to prevent penetration. The compartmentalization of sensitive
information increases security, but it pyramids inefficiency. Al Qaeda is
not engaged in penetrating the IC. It is dangerous in a different way than
the Soviets were. Security and counterintelligence remain vital, but
shifting the balance to take current realities into account also is vital.
Intelligence work involves calculated risk. The current system not only
keeps smart and interesting people out of jobs, but more important, it keeps
them from access to the information they need to make the smart inferences
that are so vital. That would seem to be too high a price to pay in the
current threat environment. Information on China can be compartmentalized;
information on the Muslim world could be treated differently.

The IC
wants consistent messaging. They want to produce one product that speaks
with a single coherent voice. The problem is that the world is much messier
than that. Giving a president the benefit of the official CIA position on a
matter is useful, but not as useful as allowing him to see the disputes,
discomfort and doubts stemming from the different schools of thought. Those
disagreements are sometimes treated as embarrassing by the IC -- but honest,
public self-criticism builds confidence. Stratfor -- and we are not comparing
our tiny outfit to the IC, with its massive responsibilities -- publishes an
annual report card with our forecasts, specifying where we succeeded and
failed. We may as well; our readers and clients know anyway.

This
may not be what the president wants, of course, and Negroponte and Hayden
will want to give him what he wants. But the head of an intelligence agency
is like a doctor: He must give the patient what he needs and try to make it
look like what the patient wants. In the end, it doesn�t matter what you do,
as Porter Goss has just found out. Negroponte and Hayden will probably lose
their jobs anyway -- through resigning or being sacked, or through Bush's
second term ending. Even if they are lucky, their jobs won't last much more
than two years. There is no percentage in hedging, when you think of it that
way.

Perhaps the single greatest weakness of the IC is its can-do
attitude. It cannot do everything that it is being asked to do -- and by
trying, it cannot do the most important things that need to be done. It has
had, as its mission, covering the world and predicting major events for the
president. It has failed to do so on major issues since its founding,
finding solace in substantial success on lesser issues. But it is possible
that the bandwidth of the IC, already sucked up by massive management
burdens, is completely burned up by the lesser issues. It may be that the
briefing book to the president for his next meeting with the president of
Paraguay or Botswana will be thinner, or he might just have to wing it. The
republic will survive that. The focus must be on the things that count.


Rethinking why there is an intelligence community and how it does
its job is the prerequisite for Hayden and Negroponte to be successful. We
do not believe for a minute that they will do so. They don't have enough
time in office, they have too many meetings to attend, they have too many
divergent views to reconcile into a single coherent report. Above all, the
CIA has to be prepared to battle the real enemy, which is the rest of the
intelligence community -- from the Defense Intelligence Agency to the FBI.
And, of course, the odd staffer at the White House.

Send questions or comments on this article to analysis@stratfor.com

The Geopolitics of China

By George Friedman

Chinese President Hu Jintao visited
Washington last week for a meeting that diplomatically might be called
"nonproductive" -- or, realistically, "disastrous." Not only was nothing
settled, but a series of incidents -- ranging from a reporter shouting
insults at Hu and being permitted to continue doing so for three minutes, to
an announcement that the national anthem of "The Republic of China" (also
known as Taiwan) was being played -- marred the visit, to say the least.


It is hard for us to believe that the admission of a Falun Gong
member to the White House press pool would go unnoticed by the White House
staff, or that it would take three full minutes to silence her. We are, sad
to say, cynical people, and it is plausible that the insults were
deliberate. The American side had been leaking for weeks that Hu would try
to use the visit for his own political ends in China, and wanted to be
granted every honor conceivable during the trip. The White House appeared
irritated by this hubris, although it would, on the surface, appear quite
natural for the United States and China to exchange full diplomatic
courtesies.

Obviously, something serious is going on in Sino-U.S.
relations. The United States has openly discussed a hedge strategy on China,
under which economic relations would proceed while the United States
increased its military presence in the region as a hedge against future
trouble. China, for its part, has been more than a little troublesome in
areas where the United States does not want it to be, particularly during
the current confrontation with Iran.

China and the United States are
bound together economically. That is one of the major problems, since they
need very different things. The Chinese economy,
as we have argued in the past, is not doing nearly as well as its growth
rate would indicate. We won't rehash our views on that. However, the
economic reality creates an obvious tension.
Chinese exports are surging at very low or nonexistent profit margins in
order to sustain a financial system that has accrued a nonperforming loan
burden that is, by some measures, as high as 60 percent of gross domestic
product. The United States is addicted to Chinese imports, and China is
addicted to exporting to the United States. The United States wants China to
revalue the yuan in order to raise the price of Chinese exports. The Chinese,
eager to maintain and increase exports, have no intention of allowing a
meaningful rise in the yuan.

There are other forces binding the two
countries together as well. The most important is Chinese money -- which is
flowing out to other countries precisely because China is no longer a
particularly attractive place for Chinese investment. There is serious
capital flight under way, as money is redeployed to safer havens. The safest
haven from the Chinese point of view is the United States -- thus, Chinese
investment there is surging. And the United States needs this money. In this
sense, both countries are in a death-lock. There is no other economy that is
as large, liquid and safe as the American economy. Chinese investors need
their funds to be in the United States. And there is no larger pool of cash
than China's to finance U.S. debt.

This means that there is no
divorce looming in Sino-U.S. relations. But at the same time, it must be
noted that, despite very close connections between China and Japan,
Sino-Japanese relations have deteriorated remarkably -- and it is China that
has driven the estrangement. The reasons are political: China's government
has domestic problems, and patriotic fervor will tend to buttress Beijing's
power. Japan is still deeply hated for its behavior in World War II, and
attacking Japanese behavior is good politics. The Chinese have strained
relations with Japan nearly to the breaking point.

What is important
here is this: It must not be assumed that China is driven purely by economic
considerations. In the case of Japan, Beijing clearly has subordinated the
economic advantage of having smooth relations with Tokyo to its own domestic
considerations. Now, Japan is not the United States -- it is a significant
country for China, but not economically decisive in the way that the United
States is. The Chinese have more room for maneuver there. At the same time,
it must be understood that China is playing a complex game, and while making
money is up there on the priority list, it is not the only thing up there.
Preserving national unity in the face of centrifugal forces and foreign
power also matters a great deal to the Chinese.

It is therefore time
to stop to consider China's national strategy in the long run, and
therefore, to consider China's geopolitics.

The Geography
Factor

Beginning, as is necessary, with the outlines of China's
national boundaries, we are immediately struck by the fact that China is, in
many ways, an island. To the east are the South and East China Seas. To the
northeast is Siberia, thinly inhabited and to a great extent uninhabitable.
Some limited military expansion in that direction is possible, but a large
population could not be sustained. To the direct north is Mongolia --
occasionally part of China, occasionally the ruler of China, but currently a
fairly unimportant area, not worth projecting force into. To the southwest
are the Himalayas. There is frequent talk of India as balancing China, but
this is, in fact, meaningless.
They are as much separated as if there were a wall. There can be skirmishes
along the dividing line in the Himalayas, but no massive movement of armies.


In the southeast, there is Indochina. China could expand there, but
the last time there were land-based skirmishes, in 1979, Vietnam beat the
Chinese soundly (though both sides claimed victory). Jungles and mountains
stretching from eastern India to the South China Sea make that region
impassable, even without the need for self-defense. Finally, there are the
western approaches into Central Asia, through Kazakhstan. This has been the
traditional, and in some ways only, route for Chinese aggression. China is
certainly deeply involved in Central Asia, but its own region of Xinjiang is
both Muslim and hostile to Beijing. It does not provide a base for launching
invasions, even if one was wanted.

For these reasons, China must be
viewed as one of the most insular great powers in the world. It has occupied
most of the terrain that is accessible to it; what remains is either
inaccessible, undesirable or quite able to defend itself. China's great
interest, therefore, should be the oceans. Over the past 20 years, China has
become a major exporter and thus should have a great interest in securing its
sea lanes. But China's coastal waters are effectively controlled by the U.S.
7th Fleet. Constructing a navy that could challenge the U.S. Navy would take
a fortune, which China probably has, but also one or two generations would be
needed -- not only for construction, but for establishing a military culture
suitable for an aggressive naval force.

Most important, challenging
the U.S. Navy with a Chinese navy cannot be done regionally. The United
States has fleets other than the 7th Fleet, and if the U.S. Navy were
concentrated against China, the Chinese could not fight a defensive battle.
They would have to take the fight to the Americans, and that would mean
fielding a global naval force. China might one day have that, but they do
not have it now. In this sense, the standard concerns about a Chinese
invasion of Taiwan are not realistic. China does not have a naval force
capable of taking control of the Taiwan Strait, nor the amphibious force
needed to gain significant lodgment in Taiwan, nor therefore -- and this is
the key -- the ability to sustain a multidivisional force in
Taiwan.

The Internal Divide

China does not have many
regional options with conventional forces nor, for that matter, does it face
a conventional threat from within the region. China's primary geopolitical
problem, and thus its chief military mission, is domestic. China is a highly
diverse and fragmented country; maintaining control of the current extent of
the country is the major strategic problem. Unlike most nations, whose
external geopolitical problems define their military thinking, China's
internal geopolitical problems drive its military planning.

There
are two dimensions to these problems. The first is ethnic: China occupies
areas like Xinjiang, Tibet and Manchuria that are ethnically distinct and
sometimes restive. The other and deeper problem, however, is not ethnic but
regional. China has a large coastal plain. It also has a vast interior that
is mountainous. The tension between those two regions historically has been
a great challenge that China has faced.

The interior is heavily
driven by agriculture -- subsistence agriculture. It is extraordinarily
poor, and arable land is minimal. The coastal regions are relatively better
off, to the extent to which they conduct international trade through coastal
ports. Thus, China has had two realities. In one, the coastal regions were
cut off from the rest of the world, and there was a rough equality between
the regions. Until the British showed up in the 19th century, for example,
trading with foreigners had been illegal. After the British forced China
open, the coastal regions boomed, and the country fragmented; the coastal
regions, manipulated by foreigners who were in turn manipulated, turned
outward to the ocean, while the interior stagnated. Mao tried to create a
revolution in Shanghai and failed. Instead, he went on his Long March to
Yenan in the interior, raised a peasant army from there, and came back to
conquer the coast. He also closed off China from the world, creating poverty
but relative unity.

Deng gambled with the idea that he would be able
to have his cake and eat it too. He opened China to the world, thereby
enriching the coastal regions and recreating the tension that Mao had sought
to abolish. For 30 years, Deng's gamble worked. Now it is breaking down.
Beijing is urgently trying to shift resources from the wealthy coastal
regions to the restive interior. The coastal provinces naturally are
resisting. The great question is whether Beijing will be able to juggle the
two realities, whether China will again turn inward to maintain geopolitical
integrity or if it will fragment further into warring
regions.

Balancing the two indefinitely is the least likely outcome.
But China does have one other card to play, which is patriotism. The
Communist Party has little legitimacy at this point, but the idea of China
-- particularly among ethnic Chinese of whatever region -- is not a trivial
driver. In order to generate patriotic fervor, however, there must be a
threat and an enemy. At this point, the Chinese are using the Japanese in
order to sustain patriotism. Reclaiming Taiwan would stir the spirits and
reduce regional tensions, but this, as we have pointed out, would be
militarily difficult in any conventional way. Moreover, it would bring a
confrontation with the United States.

Priorities and
Options

If we accept the idea that maintaining the territorial
integrity of China is its greatest geopolitical imperative and that regional
prosperity comes second for Beijing, it follows that the government will
attempt to impose its will on the coast, and trade and economic concerns
will come second. Beijing's interest in having smooth trade relations wanes,
both because the wealth gap exacerbates tensions between the regions and
because the interest runs counter to its need for external confrontation. It
follows from this that China's primary interest -- and ability -- would be to
maintain security in China, and that foreign adventures would be avoided
except under circumstances in which they would have a high probability of
success and would serve internal political interests.

A secondary
goal would be to protect China's coast from foreign encroachment. Imagine
the following scenario: Business and Party interests in the coastal region
are resisting Beijing's efforts to bring them under control and impose
taxes. The situation becomes unstable, and Western interests, investments
and the expatriate community living there are jeopardized. Through some
political contrivance, these local leaders position themselves as the
regional authority and ask for American intervention. The United States
decides to intervene. Given that this is roughly what happened in the late
19th and early 20th centuries in China -- during which time there was a
major American presence in Shanghai -- it is not as far-fetched as it might
seem.

Under these circumstances, the government in Beijing would be
forced to resist or abdicate. So, if the primary interest of China is the
maintenance of internal security, a secondary interest would be deterring
foreign interventions in the event of instability. The tertiary interest
would be some form of force projection in the region, particularly against
Taiwan -- which not only could be regarded as an internal security matter
but would provide the regime with patriotic credibility.

If we accept
the premises that China's major resources will go to the army for security
purposes, and that China is at least a generation away from having a
significant naval force, then what military options do the Chinese have?
Obviously, one is its nuclear force. That is a serious deterrent; nations
have attacked nuclear powers (Egypt and Syria against Israel in 1973) but
not for the fairly marginal reasons the United States might have to get
involved in China at some hypothetical future date. But given that
deterrence runs both ways, nuclear stalemate always leaves opportunities for
subnuclear threats.

The prime military lever within China's reach is
not sea-lane control, but rather sea-lane denial. Using anti-ship missiles,
the Chinese could impose heavy attrition on the sea-lanes leading to Taiwan
and even potentially interdict Japan's sea-lanes. This would not guarantee
China control of the sea-lanes, and that is a problem if China is importing
oil by sea. However, in extremis, it would hurt Taiwan and Japan more than
China. And if the Chinese had systems that could threaten to overload U.S.
Aegis and follow-on systems designed to protect warships, then it could
force the 7th Fleet to retreat as well. The tactic would serve as a
deterrent against intervention and as a suitable secondary system to
supplement the army. It would also serve as a threat to the interests, if
not the survival, of Taiwan.

All of this is of course hypothetical
and speculative. It assumes that the current trends in Chinese relations
with Japan and the United States are merely road bumps rather than
fundamental shifts in China's pattern. But given that China does shift its
pattern every 30 years or so, and that the stresses on China make it
reasonable to expect some shift -- and finally, given that there is a trend
toward increased tensions in play -- it is not unreasonable to think of
China in a different way than has been customary. China has been seen by
Americans as a giant money factory. It is that, but it is both less than
that and more. It is a great power facing other great powers, and a
superpower. And while the scenarios here are extreme, thinking about the
extremes can be useful.

Send questions or comments on this article to analysis@stratfor.com.

The Shiite Schisms

By Kamran Bokhari

Highly anticipated public talks between the
United States and Iran over the future of Iraq have been lagging behind
schedule, while the rhetorical exchanges between Tehran and Washington over
Iran's nuclear program have been gaining volume. To our minds, the
escalation on the nuclear issue -- which can be viewed as a lever rather
than an end in itself for Tehran -- is a sign that a deal might be in the
making in other channels. But there is a sticking point that must be
resolved before public talks can take place, and that is the political
impasse that has delayed the formation of a permanent government in
Baghdad.

Despite the fact that Iraq's national election results were
finalized nearly three months ago, there has been no agreement on the
selection of a new prime minister. The interim prime minister, Ibrahim
Jaafari, has been nominated to return to that position, but his nomination
has been vehemently opposed by other political parties and even Shiite
factions within his own United Iraqi Alliance (UIA) coalition. The
situation, which appears to be worsening by the day, is born partly from
serious disagreements among the four major blocs in parliament; perhaps even
more significantly, it stems from schisms within Iraq's majority Shiite
community.

Those schisms for some time have been exploited by
others. The United States and Iran, of course, are the most critical players
at the table, and the Iraqi Shia have been integral to the
strategies of both. Thus far, Washington and Tehran have been exploiting
the internal differences of the ethnic majority in order to secure their own
interests in Iraq. However, managing the Shia has become a tremendous
challenge for both Washington and Tehran, who now need to help repair the
rifts in order to move toward their own larger goals in the region.


In short, understanding Iraq's Shiite factions -- and the interplay
between them -- is critical to understanding Iran's future course and its
implications for the region.

A Fractured Community

The
Shia are acutely aware of their own divisions and the risk to their
political power within Iraq. Ayatollah Ali al-Sistani -- the most important
religious leader for the Iraqi Shia -- has said that the unity of the Shiite
political alliance must be upheld at all costs.

Al-Sistani's
political influence has its limits, but it is not
inconsiderable.

Since the fall of Saddam Hussein's regime, Iraq's
Shiite community has been held together by three forces: the dominant
political trend of Islamism, the clerical establishment based in An Najaf,
and Iran, which has varying degrees of influence with nearly every
significant Shiite leader or group. Together, these three forces have
prevented the rise of a viable secular political group among the Shia.


Thus, when what is now the main Shiite political coalition -- the
UIA -- was formed, it was put together with the blessings of the religious
establishment, which is led by al-Sistani. The UIA is an Islamist-leaning
political bloc, but beyond that common thread, it would be difficult to
refer to the coalition as "united." There are significant tensions and
rivalries between each of its three main components -- Hizb al-Dawah (HD),
the Supreme Council for Islamic Revolution in Iraq (SCIRI) and Muqtada
al-Sadr's movement. All three groups are offshoots of the original Hizb
al-Dawah, which was founded in the 1950s by Muhammad Baqir al-Sadr -- a
leading Shiite Islamist ideologue and the uncle of Muqtada
al-Sadr.



The
al-Sadrites are a fairly new addition to the UIA. When he first emerged on
the political scene, Muqtada al-Sadr was widely regarded as an upstart.
However, given his family connections -- not only was his uncle well-known,
but his father was a grand ayatollah who was killed by agents of Saddam
Hussein -- he has been able to build a large following among the poorer
Shiite classes.

That following became important to the UIA during
the campaign season leading up to Iraq's Dec. 15 vote. The alliance already
had been weakened by disappointment with Jaafari's political leadership and
the departure of several groups, including a faction led by secular figure
Ahmed Chalabi and a part of Iraqi Hezbollah. Moreover, with Sunni parties
agreeing to participate in the election, the UIA knew it would need the
votes of al-Sadr's followers in order to maintain its parliamentary
majority. Thus, the "upstart" leader joined the ruling coalition -- and it
has been a marriage of strange bedfellows indeed.

For one thing, the
al-Sadrites have never gotten along well with SCIRI, which is led by Abdel
Aziz al-Hakim (currently the president of the UIA). SCIRI was founded in
Tehran in 1982 by Shiite exiles from Iraq who wanted to install an Islamist
regime in Baghdad. It is still viewed as the Iraqi Shiite group with the
closest political ties to Tehran. Both SCIRI and the al-Sadr movement have
militias of their own -- the Badr Organization and the Mehdi Army -- and
their clashes between April 2003 and late 2005 were what helped to clinch
the prime ministerial nomination for
the controversial Jaafari.

Jaafari's HD party is divided as well, into
two factions. The main grouping has been led by Jaafari since his
predecessor, Izz al-Deen Saleem, was killed by suicide bombers in May 2004.
This faction spent time in exile in Europe and Syria. A smaller faction,
known as Hizb al-Dawah-Tandheem al-Iraq, splintered from the main party in
the 1980s. It has been more closely aligned with Tehran and was based in
Iran during the period of exile.

Although these three groups are the
primary players within the UIA, there also are several independents who are
influential. These include Hussein Shahristani, a former nuclear physicist
who is deputy speaker in the interim parliament. Shahristani is believed to
be al-Sistani's most trusted political ally. Another key player is Muwaffaq
al-Rubaie, who serves as national security adviser under the current interim
government -- a position he also held under the previous Coalition
Provisional Authority.

The Trouble With Jaafari

Were
it not for political needs and pragmatic opportunism, it would be difficult
to understand how such a diverse grouping ever could agree on their
leadership under a united political banner. Needless to say, that process --
for the interim government that took power in spring 2005 -- was a
hard-fought battle. Ultimately, the competition was between Jaafari and
Chalabi, with the latter withdrawing his nomination under pressure from
senior alliance members.

Jaafari won out and served one term as
interim prime minister. However, by the time national elections to install a
permanent government in Baghdad were held in December 2005, public opinion of
Jaafari's administration had soured among all of Iraq's ethnic groups and in
Washington, for various reasons. That has led to serious infighting in the
UIA since the beginning of this year -- and the fissures have only widened
in recent weeks as the Bush administration, the Sunnis, the Kurds and the
secular nationalists have played their hands.

After weeks of
deliberation designed to build consensus on a prime minister nominee, the
matter went to a vote. Deputies from the alliance's member parties had to
choose between Jaafari and Adel Abdel-Mahdi, a senior leader of SCIRI.
Jaafari got the nomination by one vote, but the widespread opposition to his
leadership has led to calls, even within the UIA, for his nomination to be
scrapped in favor of another candidate, and several names have been floated.
Jaafari, of course, has refused to relinquish his position and he still has
the backing of some political allies -- even though another HD member, Ali
al-Adeeb, recently has been suggested as a replacement.

The UIA's
leadership must proceed carefully on this matter. Recognizing that too much
pressure against Jaafari could lead to the collapse of the Shiite alliance,
they have sought out al-Sistani -- who, again, is one of the few unifying
forces for the Iraqi Shiite community. The ayatollah has urged the Shiite
factions to sort out their differences but has refrained from endorsing
Jaafari or any alternative candidates.

The Shia have not yet found a
solution to the Jaafari problem, but they have bought some time through a
neat political maneuver. The UIA has made any agreement on its part to
nominate another candidate as prime minister contingent upon a deal to
revisit choices for other coveted posts: president, vice-president, speaker
of parliament, interior, defense, and oil ministries. They also have tried
to mitigate the pressure on the UIA by finding fault with a Sunni, Tariq
al-Hashmi, who was nominated as speaker of parliament. And there have been
attempts to create a National Security Council as a power-sharing mechanism.


But as yet, there is no end to the political infighting in sight.


The Influence of al-Sistani

The fact that all the
parties within the Shiite bloc have sought al-Sistani's assistance
underscores the political influence of the grand ayatollah -- perhaps more
so than the religious establishment as a whole.

There are three
other grand ayatollahs in Iraq: Muhammad Fayyad, an Afghan; Hussein Bashir
al-Najafi, from Pakistan; and Muhammad Said al-Hakim, an Iraqi. These three
men are all of equal stature. Al-Sistani outranks them all, and the Shiite
political factions are increasingly dependent upon him in the role of
kingmaker.

But it is important to note that neither al-Sistani's
interests, nor those of the Iraqi Shia as a whole, are synonymous with those
of their religious brethren in Tehran.

The clerical establishments in
Iraq and Iran certainly have common ties; Al-Sistani, for example, was born
in Iran, and Ayatollah Ruholla Khomeini -- founder of the Islamic regime in
Tehran -- studied at the seminary in An Najaf. But there is a significant
rivalry within the Shiite world as well, characterized by the Najaf and Qom
schools of thought. The Najaf school -- so called after the Iraqi city that
has been a major religious center since the Shiite sect emerged in the early
8th century -- adheres to a "quietist" approach in politics, meaning that the
ulema do not hold office directly but exercise a great deal of influence and
oversight in governance. The Qom school -- named after the Iranian religious
center, which gained prominence in the early 16th century after the rise of
the Safavid Empire -- has favored a direct role for the ulema in politics.


Thus, the Iranian regime -- heirs of Khomeini and the Qom school --
has its differences with al-Sistani, who follows the quietist approach of
the Najaf factions. Those differences also can be seen, in varying degrees,
with Iraqi groups strongly influenced by Iran.

For the time being,
al-Sistani still is able to exert influence as a spiritual leader to help
bind the various Shiite factions together. But given his age (76), previous
threats to his life and other factors, one must consider what it would mean
if he were to die or become incapacitated.

There certainly could be
opportunities for some Shiite groups in Iraq if al-Sistani were to leave a
power vacuum. The al-Sadrites, for example, harbor no great love for the
cleric for numerous reasons, including personal histories: The Hussein
regime tolerated al-Sistani and his quietist approach but tortured and
killed al-Sadr's father (rival cleric Grand Ayatollah Mohammed Sadiq
al-Sadr) and several of his brothers in the late 1990s. Moreover, the
departure of the powerful grand ayatollah could allow figures like al-Sadr,
who is not a cleric, to gain more personal clout. SCIRI, too -- as a
creation of the Iranians -- has found al-Sistani's influence as a limitation
to its own power.

That said, these factions -- and outside players
like the United States and Iran -- still need him, for the time being, to
bring what cohesion he can to the Shiite community.

The United
States is not overly concerned with the unity of the Shia per se, but the
Bush administration certainly would oppose any political moves that would
bring further disintegration to the Shiite bloc and potentially derail the
political process, which is critical to plans for a military drawdown and --
of course -- to public talks with Iran. Tehran, which has degrees of leverage
with practically all of the Iraqi Shiite factions, likely could tolerate any
candidate put forward as prime minister by the Shiite bloc. On the other
hand, it doesn't want the UIA alliance to collapse, since that would
translate into an aggregate loss of influence for Tehran in Iraq.

The
paradox by now should be clear: Most of the players -- both within Iraq and
in the region -- view a robust and united Shiite majority as a threat to
their interests, but the divisions among the Shia have reached such a
critical juncture that there are very real concerns about the overall level
of stability in the country. The one thing that everyone can agree on is
that achieving a balance somewhere in the middle would be the best outcome.
And this is nothing short of a Herculean task, given the political
landscape.

The two chief actors, as we have stated previously, are
Iran and the United States. And while they agree on the need for a certain
level of stability, they differ in their views of just how cohesive the
Iraqi Shia should be. Washington wants a sectarian faction that hangs
together well enough to act as a counterbalance to the Sunnis, Kurds and
other factions and to contain the jihadists. Tehran, of course, wants as
strong a Shiite community as possible -- and, ideally, a government in
Baghdad that will allow Iran to catapult to regional hegemony.

The
current deadlock over Jaafari and the prime ministership eventually will be
resolved, but the structural reality among the Shia is not likely to change.
The internal divisions within Iraq's majority community will continue to be
significant -- in Baghdad and far beyond -- for quite some time to come.

Send questions or comments on this article to
analysis@stratfor.com.

Idealism, Realism and U.S. Foreign Policy

By George Friedman

Iran says it has enriched uranium. Hosni
Mubarak is claiming that Shia in Sunni states are traitors to their
countries. The French are in political and economic gridlock. With all these
urgent things going on, it seems to us that it is time to talk of something
important, something that has driven and divided American politics for
centuries and will continue to do so: the argument between those who have
been called idealists and those who have been labeled realists in U.S.
foreign policy.

When the United States was in its infancy, France
experienced a revolution that was in many ways similar to the American
Revolution. Some Americans wanted to support the French revolutionaries,
arguing that the United States had to pursue its moral ideals and stand by
its moral partner. Others pointed out that the American economy was heavily
dependent on Britain,