June 2010 Economic Update: The Joint Operating Environment

One of the reports we most look forward to reading every two years is known as "the JOE." This is the outlook for the future "Joint Operating Environment", which is published by the United States Joint Forces Command. It is intended to "provide a perspective on future trends, shocks contexts and implications for joint force commanders and other leaders and professionals in the national security field." Inevitably, it is a well-written and thought provoking document.

This year's JOE begins with an appropriate caution: "The purpose of the [report] is not to predict, but to suggest ways leaders might think about the future...It is impossible to predict precisely how challenges will emerge and what form they might take. Nevertheless, it is absolutely vital to try to frame the strategic and operational contexts of the future, in order to glimpse the possible environments where political and military leaders will work...Only by wrestling with the possibilities, determining the leading indicators, and then reading the signposts of the times will the Joint Forces have some answers to the challenges of the future. The alternative, to focus exclusively on the here and now or to pass this mission on to the bureaucracy, will certainly result in getting caught flat-footed, reacting to near-term crises as they arise, at great cost in blood and treasure."

"Thinking about the future requires an understanding of both what it timeless and what will likely change...[That said], the nature of the human condition will guarantee that uncertainty, ambiguity, and surprise will dominate the course of events. However carefully we think about the future; however thorough our preparations; however coherent and thoughtful our concepts, training and doctrine; we will be surprised. Even the wisest statesmen have found their assumptions about the future confounded by reality...Our goal is not to eliminate surprise -- that is impossible. Our goal is, by a careful consideration of the future, to suggest the attributes of a joint force capable of adjusting with minimum difficulty when the surprise inevitably comes. The true test of military effectiveness in the past has been the ability of a force to diagnose the conditions it actually confronts, and then quickly adapt. In the end, it will be our imagination and agility to envision and prepare for the future, and then adapt to surprises that will determine how [we] will perform over the next twenty-five years..."

The JOE then offers some critical reminders that apply far beyond the national security realm: "There are other aspects of human conflict that will not change no matter what advances in technology or computing power may occur: fog and friction will distort, cloak, and twist the course of events. Fog will result from information overload, our own misperceptions and faulty assumptions, and the fact that the enemy will act in an unexpected fashion. Combined with the fog of war will be its frictions -- that almost infinite number of seemingly insignificant incidents and actions that can go wrong. It will arise from fundamental aspects of the human condition and unavoidable unpredictabilities that lie at the very core of combat processes. The constant fog and friction of war turns the simple into the complex. In combat, people make mistakes. They forget the basics. They become disoriented, ignoring the vital to focus on the irrelevant. Occasionally, incompetence prevails. Mistaken assumptions distort situational awareness. Chance disrupts, distorts, and confuses the most careful of plans. Uncertainty and unpredictability dominate. Thoughtful military leaders have always recognized that reality and no amount of computing power will eradicate this basic messiness. Where friction prevails, tight tolerances, whether applied to plans, actions, or materiel are an invitation to failure -- the more devastating for being unexpected. Operational or logistical concepts or plans that make no allowance for the inescapable uncertainties of war are suspect on their face -- an open invitation to failure and at times defeat."

Looking to the future, the JOE observes that while change often occurs at an exponential rate, people often view it as linear. As a result, "we often overestimate the impact of change in the short-term, and underestimate it in the long-term." Moreover, because success tends to reinforce one's view of the world, "leaders are often late to recognize changes, and even when they do, inertia tends to limit their ability to adapt quickly. Driven by an inherent desire to bring order to a disorderly, chaotic universe, human beings tend to frame their thoughts about the future in terms of continuities and extrapolations from the present and occasionally the past. But a brief look at the past quarter century, to say nothing of the past four thousand years, suggests the extent of changes that coming decades will bring." For example, "the revolution in information and communications technologies, taken for granted today, was largely unimaginable in 1983." So true. "In thinking about the world's trajectory, we have reason to believe that the next twenty-five years will bring changes just as dramatic, drastic, and disruptive as those that have occurred in the past quarter century. Indeed, the pace of technological and scientific change is increasing."

The JOE goes on to note the central challenge posed by what it calls "disruptions." Trends may suggest possibilities and potential directions, but they are unreliable for understanding the future because they interact with and are influenced by other factors. The downturn of Wall Street after the crash of 1929 might well have remained a recession, but passage of the Smoot-Hawley tariffs destroyed American trade with other nations and turned the recession into a catastrophic global depression. In considering the future, one should not underestimate the ability of a few individuals, even a single person, to determine the course of events. One may well predict that human beings will act in similar patterns of behavior in the future, but when, where and how remains entirely unpredictable. The rise of a future Stalin, Hitler, or Lenin is entirely possible, but completely unpredictable, and the context in which they might reach the top is unforeseeable. The interplay of economic trends, vastly different cultures and historical experiences, and the idiosyncrasies of leaders, among a host of other factors, provides such complexity in their interactions as to make prediction impossible. Winston Churchill caught those complexities best in his masterful history of World War I: 'One rises from the study of the causes of the Great War with a prevailing sense of the defective control of individuals upon world fortunes. It has been well said, 'there is always more error than design in human affairs.' The limited minds of the ablest men, their disputed authority, the climate of opinion in which they dwell, their transient and partial contributions to the mighty problem, that problem itself so far beyond their compass, so vast in scale and detail, so changing in its aspects -- all this must surely be considered'...Clearly, not all disruptions occur through the actions of individual leaders. Great events, involving the overthrow of regimes, the collapse of economic systems, natural disasters, and great conflicts within or among states have taken the flow of history and channeled it into new and unforeseen directions. Such disruptions are truly unpredictable, except for the fact that we can be sure that they will happen again. They will twist the future into new and unforeseen directions. Here, the only strategy that can mitigate the impact of surprise is knowledge of the past, an understanding of the present, and a balanced force that is willing and able to adapt in the future."

Having placed the report in its proper context, the authors of the JOE then turn to what they see as critical trends that will drive the future context in which the Joint Force will operate. In the following pages, we will highlight the key points from the JOE; however, we note that there is much more to read in the report itself (which can be downloaded at www.jfcom.mil/newslink/storyarchive/2010/JOE_2010_o.pdf).

Demographics

"In total, the world will add approximately 60 million people each year and reach a total of billion by the 2030s. Ninety-five percent of that increase will occur in developing countries. The more important point is that the world's troubles will occur not only in the areas of abject poverty but also, to an even greater extent, in developing countries where the combination of demographics and economy permits populations to grow, but makes meeting rising expectations difficult. Here, the performance of the global economy will be key in either dampening down or inflaming ethnically or religiously based violent movements... The developed world faces the opposite problem. During the next 25 years population growth in the developed world will likely slow or in some cases decline. Russia in particular exemplifies this trend. Russia's population is currently declining by 0.5% annually, and given Russian health and welfare profiles, there is every prospect that decline will continue, barring a drastic shift in social attitudes or public policy. As a recent Center for Strategic and International Studies (CSIS) report suggested, "Russia needs to cope with a rate of population decline that literally has no historical precedent in the absence of pandemic." To Russia's west, a similar, albeit less disastrous, situation exists. Over all, European nations stopped replacing their losses to deaths in 2007, and despite considerable efforts to reverse those trends, there is little likelihood their populations will significantly increase by the 2030s. This raises serious concerns about the sustainability of economic growth in that region. It also has serious implications for the willingness of European societies to bear the costs involved in lives and treasure that the use of military force inevitably carries with it."

"Likewise, Japan's population will fall from 128 million to approximately 117 million in the 2030s, but unlike the case of Russia this will result not from any inadequacy of Japanese medical services, which are among the world's best, but from the collapse of Japan's birth rate. The Japanese are taking serious steps to address their demographic decline, a fact which explains their major research and development efforts in the field of robotics as well as their shift to a capital intensive economy."

"Over the next quarter century, China's population will grow by 170 million, but its population will age significantly because of strict enforcement of the government's edict of one child per family. An additional demographic factor, which may influence Chinese behavior, is the choice of many families to satisfy that limitation with a male child. How the resulting imbalance between young males and females will play out in China's external and internal politics is impossible to predict because there are few historical analogues. Already we have seen exuberant displays of nationalistic feeling among the youth in response to criticisms of China's behavior in Tibet. By the 2030s, the U.S. population will climb by more than 50 million to a total of approximately 355 million, in contrast to many of its peers. This growing population may be a significant advantage in international economic competition. This growth will result not only from births in current American families, but also from continued immigration, especially from Mexico and the Caribbean, which will lead to major increases in America's Hispanic population. By 2030 at least 15% of the population of every state will be Hispanic in origin, in some states reaching upwards of 50%. How effective Americans prove in assimilating these new immigrants into the nation's politics and culture will play a major role in America's prospects. In this regard, the historical ability of the United States to assimilate immigrants into its society and culture gives it a distinct advantage over most other nations, which display little willingness to incorporate immigrant populations into the mainstreams of their societies."

"India will grow by 320 million during the next quarter of a century. The tensions that arise from a growing divide between rich and poor could seriously impact its potential for further economic growth. Exacerbating tensions will be the divide between the sub-continent's huge middle class and those in the villages mired in poverty, as well as the divide between Muslims and Hindus. Nevertheless, India's democratic system gives the country wide latitude for political changes to accommodate the society's poor. The continued population growth across the Middle East and in Sub-Saharan Africa has only recently begun abating, but not fast enough to forestall a demographic crisis in which economic growth fails to keep pace with population growth."

Globalization

"For the most part, the developed world recognizes that it has a major stake in the continuing progress of globalization. The same can be said for those [countries] moving into the developed world. Nevertheless, one should not ignore the histories and passions of popular opinion in these states as they make their appearance. One should not confuse developed world trappings for underlying stability and maturity of civil societies. A more peaceful, cooperative world is possible only if the pace of globalization continues. In particular, this means engaging China and other nations politically and culturally as they enter into the developed world... Serious violence resulting from economic trends has almost invariably arisen where economic and political systems have failed to meet rising expectations. A failure of globalization would equate to a failure to meet those rising expectations. Thus, the real danger in a globalized world, where even the poorest have access to pictures and media portrayals of the developed world, lies in a reversal or halt to global prosperity. Such a possibility would lead individuals and nations to scramble for a greater share of shrinking wealth and resources, as they did in the 1930s with the rise of Nazi Germany in Europe and Japan's "co-prosperity sphere" in Asia..."

"Remittances sent home by emigrant workers are often overlooked as a facet of globalization, but represent the biggest income source for developing nations. The total amount sent home by foreign workers exceeds the amount that the whole world spends on foreign aid and capital investments combined... However, as a prolonged economic downturn reduces work opportunities for emigrants, the reduction of this key source of income may also stunt the growth of the middle classes in developing countries, which are the driving force for the development and support of democratization and the rule of law, all of which are central to the evolution of stable and orderly states around the world."

Economics

"The JOE 2008 reported that the emerging economic downturn and financial crises were likely to be significant events. From our vantage point in 2010 the scope and implications of the downturn are clarifying, though the perturbations both in mid and longer terms are yet unclear. Projected revenues from taxation in most plausible economic scenarios are far below that which is necessary to meet current and assumed commitments by the federal government. Furthermore, chronic trade and currency exchange imbalances in the global economic system have exacerbated both U.S. current account deficits and overall government indebtedness such that the amount of U.S. government debt held by foreigners has grown from 1.3 trillion to 3.5 trillion dollars representing some 40% of total U.S. debt. Large exporting nations accept U.S. dollars for their goods and use them both to build foreign exchange reserves and to purchase U.S. treasuries (which then finance ongoing U.S. federal operations). The dollar's "extraordinary privilege" as the primary unit of international trade allows the U.S. to borrow at relatively low rates of interest. However, the emerging scale of U.S. Government borrowing creates uncertainty about both our ability to repay the ever growing debt and the future value of the dollar. Moreover, "any sudden stop in lending...would drive the dollar down, push inflation and interest rates up, and perhaps bring on a hard landing for the United States."

"The precise nature of a "hard landing" of this sort is difficult to predict should creditor nations such as China demand higher interest rates, increasing the perception that the U.S. no longer controls its own financial fate. This dynamic could encourage the establishment of new reserve currencies as global economic actors search for alternatives to the dollar. Changing conditions in the global economy could likewise have important implications for global security also, including a decreased ability of the United States to allocate resources for defense purposes, less purchasing power for available dollars, and shifting power relationships around the world in ways unfavorable to global stability. Domestically, the future of the U.S. financial picture in both the short and long term is one of chronic budget deficits and compounding debt. The federal deficit for the 2009 fiscal year was about $1.42 trillion or one tenth of U.S. economic production in that year. For the first two months of the 2010 fiscal year, the cumulative deficit was already higher than any previous total yearly deficit run by the federal government and even the most optimistic economic projections suggest that the U.S. will add $9 trillion to the debt over the next decade, outstripping even the most optimistic predictions for economic growth upon which the federal government relies for increased tax revenue...Although these fiscal imbalances have been severely aggravated by the recent financial crisis and attendant global economic downturn, the financial picture has long term components which indicate that even a return to relatively high levels of economic growth will not be enough to right the financial picture. The near collapse of financial markets and slow or negative economic activity has seen U.S. Government outlays grow in order to support troubled banks and financial institutions, and to cushion the wider population from the worst effects of the slowdown. These unfunded liabilities are a reflection of an aging U.S. Baby-Boom population increasing the number of those receiving social program benefits, primarily Social Security, Medicare, and Medicaid, versus the underlying working population that pays to support these programs."

"Rising debt and deficit financing of government operations will require ever-larger portions of government outlays for interest payments to service the debt. Indeed, if current trends continue, the U.S. will be transferring approximately seven percent of its total economic output abroad simply to service its foreign debt. Interest payments are projected to grow dramatically, further exacerbated by recent efforts to stabilize and stimulate the economy, far outstripping the current tax base. Interest payments, when combined with the growth of Social Security and health care, will crowd out spending for everything else the government does, including National Defense. The foregoing issues of trade imbalance and government debt have historic precedents that bode ill for future force planners. Habsburg Spain defaulted on its debt some 14 times in 150 years and was staggered by high inflation until its overseas empire collapsed. Bourbon France became so beset by debt due to its many wars and extravagances that by 1788 the contributing social stresses resulted in its overthrow by revolution. Interest ate up 44% of the British Government budget during the interwar years 1919-1939, inhibiting its ability to rearm against a resurgent Germany. Unless current trends are reversed, the U.S. will face similar challenges, anticipating an ever-growing percentage of the U.S. government budget going to pay interest on the money borrowed to finance our deficit spending."

Energy

"To meet even the conservative growth rates posited in the economics section, global energy production would need to rise by 1.3% per year. By the 2030s, demand is estimated to be nearly 50% greater than today. To meet that demand, even assuming more effective conservation measures, the world would need to add roughly the equivalent of Saudi Arabia's current energy production every seven years. Absent a major increase in the relative reliance on alternative energy sources (which would require vast insertions of capital, dramatic changes in technology, and altered political attitudes toward nuclear energy), oil and coal will continue to drive the energy train. By the 2030s, oil requirements could go from 86 to 118 million barrels a day (MBD)...Assuming the most optimistic scenario for improved petroleum production through enhanced recovery means, the development of non-conventional oils (such as oil shales or tar sands) and new discoveries, petroleum production will be hard pressed to meet the expected future demand of 118 million barrels per day..."

"That production bottleneck apart, the potential sources of future energy supplies nearly all present their own difficulties and vulnerabilities. None of these provide much reason for optimism. At present, the United States possesses approximately 250 million cars, while China with its immensely larger population possesses only 40 million. The Chinese are laying down approximately 1,000 kilometers of four-lane highway every year, a figure suggestive of how many more vehicles they expect to possess, with the concomitant rise in their demand for oil. The presence of Chinese "civilians" in the Sudan to guard oil pipelines underlines China's concern for protecting its oil supplies and could portend a future in which other states intervene in Africa to protect scarce resources. The implications for future conflict are ominous, if energy supplies cannot keep up with demand and should states see the need to militarily secure dwindling energy resources... "

"A severe energy crunch is inevitable without a massive expansion of production and refining capacity. While it is difficult to predict precisely what economic, political, and strategic effects such a shortfall might produce, it surely would reduce the prospects for growth in both the developing and developed worlds. Such an economic slowdown would exacerbate other unresolved tensions, push fragile and failing states further down the path toward collapse, and perhaps have serious economic impact on both China and India. At best, it would lead to periods of harsh economic adjustment. To what extent conservation measures, investments in alternative energy production, and efforts to expand petroleum production from tar sands and shale would mitigate such a period of adjustment is difficult to predict. One should not forget that the Great Depression spawned a number of totalitarian regimes that sought economic prosperity for their nations by ruthless conquest."

Radical Ideologies

"In the 1940’s the Democratic West faced down and ultimately defeated an extreme ideology that espoused destruction of democratic freedoms: Nazism. Afterward, these same powers resisted and overcame another opposing ideology that demanded the diminution of individual liberties to the power of the state: Communism. We now face a similar, but even more radical ideology that directly threatens the foundation of western secular society. Al Qaeda terrorists, violent militants in the Levant, radical Salafist groups in the Horn of Africa, and the Taliban in the mountains of Afghanistan are all examples of local groups pursuing local interests, but tied together by a common, transnational, and violent ideology. These groups are driven by an uncompromising, nihilistic rage at the modern world, and accept no middle ground or compromise in pursuing their version of the truth. Their goal is to force this truth on the rest of the world's population. These radical ideological groups have discovered how to form cellular, yet global networks that operate beyond state control and have the capacity -- and, most importantly, the will -- to challenge the authority of states. Because these organizations do not operate within the international diplomatic systems, they will locate bases of operations in the noise and complexity of cities and use international law and the safe havens along borders of weak states to shield their operations and dissuade the U.S. from engaging them militarily."

"Combining extreme ideologies with modern technology, they use the Internet and other means of communications to share experiences, tactics, funding, and best practices...These radical groups are constructing globe-spanning "narratives" that effectively dehumanize their opponents, legitimizing in their eyes any tactic no matter how abhorrent to civilized norms of conduct. They believe that their target audience is the 1.1 billion Muslims who are 16 percent of the world's total population. The use of terror tactics to shock and silence moderate voices in their operational areas includes suicide bombing and improvised explosive devices to kill and maim as many as possible. Most troubling is the possibility, indeed likelihood, that some of these groups will achieve a weapons of mass destruction (WMD) capability through shared knowledge, through smuggling, or through the deliberate design of an unscrupulous state. The threat of attacks both abroad and in the homeland using nuclear devices, custom bio-weapons, and advanced chemical agents intended to demonstrate dramatically our security weaknesses are real possibilities we must take account of in our planning and deterrent strategies. No one should harbor the illusion that the developed world can win this conflict in the near future. As is true with most insurgencies, victory will not appear decisive or complete. It will certainly not rest on military successes. The treatment of political, social, and economic ills can help, but in the end will not be decisive. What will matter most will be the winning of a 'war of ideas,' much of which must come from within the Islamic world itself."

Pandemics

"One of the fears haunting policy makers is the appearance of a pathogen, either man-made or natural, able to devastate mankind, as the "Black Death" did in the Middle East and Europe in the middle of the Fourteenth Century. Within barely a year, approximately a third of Europe's population died. The second and third-order effects of the pandemic on society, religion, and economics were devastating. In effect, the Black Death destroyed the sureties undergirding Medieval European civilization. It is not likely that a pandemic on this scale will devastate mankind over the next two decades. Even though populations today are much larger and more concentrated, increasing the opportunities for a new pathogen to spread, the fact that mankind lives in a richer world with greater knowledge of the world of microbes, the ability to enact quarantines, a rapid response capability, and medical treatment suggest that authorities could control even the most dangerous of pathogens. The crucial element in any response to a pandemic may be the political will to impose quarantine. The rapid identification and response to the 2009 H1N1 flu strain and the rapid termination of the 2003 Severe Acute Respiratory Syndrome (SARS) pandemic illustrate the seriousness with which medical authorities view these. In the case of SARS, after initial reports surfaced from East Asia in February of an atypical respiratory disease, medical authorities reported more than 8,000 cases in 30 different countries. The disease itself was highly contagious and life-threatening: almost 10% of reported cases died. However, once doctors identified the disease, the combined efforts of local, national, and international authorities contained it within five months. Newly reported cases increased rapidly in March and April 2003, peaked in early May, and rapidly declined thereafter."

"The H1N1 and SARS examples do not mean, however, that the threat of social disorder or disruption originating from a viral source is nonexistent. A repetition of the 1918 influenza pandemic, which led to the deaths of millions world-wide, would have the most serious consequences for the United States and the world politically as well as socially. The dangers posed by the natural emergence of a disease capable of launching a global pandemic are serious enough, but the possibility exists also that a terrorist organization might acquire a dangerous pathogen. The deliberate release of a deadly pathogen, especially one genetically engineered to increase its lethality or virulence, would present greater challenges than a naturally occurring disease like SARS. While the latter is likely to have a single point of origin, terrorists could seek to release the pathogen at several different locations in order to increase the rate of transmission across a population. This would seriously complicate both the medical challenge of bringing the disease under control and the security task of fixing responsibility for its appearance."

China

"The Sino-American relationship represents one of the great strategic question marks of the next twenty five years...The course that China takes will determine much about the character and nature of the 21st Century -- whether it will be another bloody century, or one of peaceful cooperation. The Chinese themselves are uncertain as to where their strategic path to the future will lead. Deng Xiaoping's advice for China to 'disguise its ambition and hide its claws' may represent as forthright a statement as the Chinese can provide. What does appear relatively clear is that the Chinese are thinking in the long term regarding their strategic course. Rather than emphasize the future strictly in military terms, they seem willing to see how their economic and political relations with the United States develop, while calculating that eventually their growing strength will allow them to dominate Asia and the Western Pacific."

"History provides some hints about the challenges the Chinese confront in adapting to a world where they are on a trajectory to become a great power. The continuities of Chinese civilization reach back to a time when the earliest civilizations in the Nile and the Mesopotamian valleys were emerging. But those continuities and the cultural power of China's civilization have also provided a negative side: to a considerable extent they have isolated China from currents and developments in the external world. Much of its Twentieth Century experience had further exacerbated that isolation. The civil wars between the warlords and the central government and between the Nationalists and Communists, the devastating invasion and occupation of the 1930s and 1940s by the Japanese, and the prolonged period of China's isolation during Mao's rule further isolated China. Yet, one of the fascinating aspects of China's emergence over the past three decades has been its efforts to learn from the external world. This has been neither a blatant copying of the West nor an effort to cherry pick ideas from history or Western theoretical writings on strategy and war, but rather a contentious debate to examine and draw lessons from the West's experience. Two historical case studies have resonated with the Chinese: the Soviet Union's collapse and the rise of Germany in the late Nineteenth and early Twentieth Centuries. These case studies, written in a series of books, were also made into documentary films that constitute one of the most popular shows on Chinese television. From the case of the Soviets the Chinese have drawn the lesson that they must not pursue military development at the expense of economic development. That is the path Deng laid out in the late 1970s and one which they have assiduously followed. Indeed, if one examines their emerging military capabilities in intelligence, submarines, cyber, and space, one sees an asymmetrical operational approach that is different from Western approaches, one consistent with the classical Chinese strategic thinkers... The emphasis on nuclear submarines and an increasingly global Navy in particular, underlines worries that the U.S. Navy possesses the ability to shut down China's energy imports of oil, 80% of which goes through the straits of Malacca. As one Chinese naval strategist expressed it: 'the straits of Malacca are akin to breathing -- to life itself.'"

"Chinese writers on military and strategic subjects seem to be in agreement that there is a window of opportunity that will last to the 2020s, during which China can focus on domestic economic growth and expanded trade with the world to make it a truly great power...What then are the potential courses that China might follow? The challenges that Chinese leadership confronts at present are enormous, and an unsuccessful China is perhaps more worrisome than a prosperous one. China is confronting major internal problems that could have an impact on its strategic course. The country will face increasing demographic pressures as its population ages. Due to its one child policy, China may grow old before it grows rich. Furthermore, a cultural preference for male heirs will create a surplus male population nearing 30 million by 2020. With a birth rate below replacement levels of 2.1 children per mother, China faces a "4-2-1 problem" with four grandparents having two children and one grandchild, a demographic profile that makes inter-generational pension programs impossible to finance. Urbanization, pollution on a monumental scale, water shortages, and the possible responsibility to protect a growing ethnic diaspora in places such as Siberia or Indonesia represent realities the Chinese leadership cannot easily dismiss."

"Over the course of its history, internal stability and the threat of foreign invasions have represented the twin political and strategic challenges that Chinese governments have confronted. Moreover, as recent events in Tibet and with the Uighurs suggest, tensions between the minorities and the central government in Beijing have been building. Yet with China's approach to strategy, there is considerable sophistication in the leadership's understanding of its internal problems. Taiwan is a wild card. Here the picture is unclear. A reunification might bring with it the spread of democratic ideals to the mainland and a weakening of the Party's grip on an increasingly educated and sophisticated population."

Russia

"Russia's future remains as uncertain as its past has been tragic. The world has watched its decline from one of the world's most heavily populated nations in 1914. Blessed with overwhelming stocks of natural resources and rapid growth through industrialization, Russia instead tread a path to dissipation and collapse in the catastrophes of World War I (3-4 million military and civilian dead), civil war (5-8 million), man-made famines (6-7 million), purges (2-3 million), and World War II (27 million), accompanied by sixty years of 'planned' economic and agricultural disasters. The 1990 implosion of the Soviet Union marked a new low point, one that then-President Vladimir Putin decried as 'the greatest geopolitical catastrophe of the century.' With the collapse of the Soviet Union, Russia lost the lands and territories it had controlled for the better part of three centuries. Not only did the collapse destroy the economic structure that the Soviets created, but the weak democratic successor regime proved incapable of controlling the criminal gangs or creating a functioning economy. Moreover, the first attempt by the Russian military to crush the rebellion in Chechnya foundered in a sea of incompetence and faulty assumptions."

"Since 2000, Russia has displayed a considerable recovery based on Vladimir Putin's reconstitution of rule by the security services -- a move most Russians have welcomed -- and on the influx of foreign exchange from Russia's production of petroleum and natural gas. How the Russian government spends this revenue over the long term will play a significant role in the kind of state that emerges. The nature of the current Russian regime itself is also of concern. To a considerable extent, its leaders have emerged from the old KGB, suggesting a strategic perspective that bears watching. At present, Russian leaders appear to have chosen to maximize petroleum revenues without making the investments in oil fields that would increase oil and gas production over the long term. With its riches in oil and gas, Russia is in a position to modernize and repair its ancient and dilapidated infrastructure and to improve the welfare of its long suffering people. Nevertheless, the current leadership has displayed little interest in such a course. Instead, it has placed its emphasis on Russia's great power status."

"For all its current riches, the brilliance of Moscow's resurgence, and the trappings of military power, Russia cannot hide the conditions of the remainder of the country. The life expectancy of Russia's male population, 59 years, is 148th in the world and places the country somewhere between East Timor and Haiti... Perhaps more than any other nation Russia has reason to fear the international environment, especially considering the invasions that have washed over its lands. There are serious problems: in the Caucasus with terrorists; in Central Asia where the stability of the new oil-rich nations is seriously in question; and in the east where the Chinese remain silent, but increasingly powerful, on the borders of eastern Siberia. In 2001, Russia and China agreed to demarcate the 4,300 mile border between them. However, demographic pressures across this border are increasingly tense as ethnic Russians leave (perhaps as many as a half million in the 2000-2010 time frame, or 6% of the total population) and ethnic Chinese immigrate to the region. Estimates of the number of ethnic Chinese in Siberia range from a low of about 480,000 (or less than 6% of the population) to more than 1 million (or nearly 12%). Russia must carefully manage this demographic transition to avoid ethnic tensions that could erupt into a cross border conflict with China..."

"Russia's failure to diversify its economy beyond oil and natural gas, together with its accelerating demographic collapse, will create a Russia of greatly decreased political, economic, and military power by the 2020s."

India

"India has a special place in the future international environment. Few countries in the world may figure as prominently in future U.S. strategic calculations. As demographic trends indicate, India is on course to be the most populous nation on Earth in the next decade and a half. Furthermore, it shares with the U.S. a domestic political system based on the consent of the governed, and is highly diverse culturally and ethnically. India sits on the rim of an ocean pivotal to U.S. interests, and possesses a navy larger than any other in the region. It borders a troubled Pakistan, a growing China, is in a neighborhood at high risk of nuclear proliferation, is a common target for radical ideological groups using terrorist tactics, and sits astride key sea lanes linking East Asia to the oil fields of the Middle East..."

"India could more than quadruple its wealth over the course of the next two decades, but large swaths of its population will likely remain in poverty through the 2030s. Like China, this will create tensions between the rich and the poor. Such tension, added to the divides among its religions and nationalities, could continue to have implications for economic growth and national security. Nevertheless, its military will receive substantial upgrades in the coming years. That fact, combined with its proud martial traditions and strategic location in the Indian Ocean, will make India the dominant player in South Asia and the Middle East... In the 21st Century, the emergence of India as a strong, stable, democratic, and outwardly looking player with global interests has the potential to enhance the effectiveness of the international system and well-being of all, in a positive sum game."

The Middle East and Central Asia

"Based on current evidence, a principal nexus of conflict will continue to be the region from Morocco to Pakistan through to Central Asia. Across this part of the globe a number of historical, dormant conflicts between states and nations over borders, territories, and water rights exist, especially in Central Asia and the Caucasus. Radical extremists will present the first and most obvious challenge. The issue here is not terrorism per se, because terrorism is merely a tactic by which those who lack the technology, weapons systems, and scruples of the modern world can attack their enemies throughout the world. Radical extremists who advocate violence constitute a transnational, theologically-based insurgency that seeks to overthrow regimes in the Islamic world. They bitterly attack the trappings of modernity as well as the philosophical underpinnings of the West despite the fact their operations could not be conducted without the internet, air travel and globalized financial systems. At a minimum radical Islam seeks to eliminate U.S. and other foreign presence in the Middle East, a region vital to U.S. and global security, but only as a first step to the creation of a Caliphate stretching from Central Asia in the East to Spain in the West and extending deeper into Africa..."

"The problems in the Arab-Islamic world stem from the past five centuries, during which the rise of the West and the dissemination of Western political and social values paralleled a concomitant decline in the power and appeal of their societies. Today's Islamic world confronts the choice of either adapting to or escaping from a globe of interdependence created by the West. Often led by despotic rulers, addicted to the exports of commodities which offered little incentive for more extensive industrialization or modernization, and burdened by cultural and ideological obstacles to education and therefore modernization, many Islamic states have fallen far behind the West, South Asia, and East Asia. The rage of radical Islamists feeds off the lies of their often corrupt leaders, the rhetoric of radical imams, the falsifications of their own media, and resentment of the far more prosperous developed world. If tensions between the Islamic world's past and the present were not enough, the Middle East, the Arab heartland of Islam, remains divided by tribal, religious, and political divisions, making continued instability inevitable."

Iran

"Iran has an increasingly important role in this center of instability [in the Middle East and Central Asia]...Although the U.S. has removed Iran's most powerful adversary (Saddam) and reduced the Taliban, the regime continues to foment instability in areas far from its own borders. Despite a population that remains relatively favorable to the United States, the cleric-dominated regime appears ready to continue dedicating its diplomatic and military capabilities to confrontation with the United States and Israel, and to cultivate an array of very capable proxy forces around the world. Hezbollah in Lebanon, Hamas in Gaza, various groups in Afghanistan, Yemen, Iraq, and the Caucasus, and other client states will serve to extend and solidify Iranian influence abroad. Internal dynamics will continue to play a large role in the Iranian leadership’s decision-making calculus. The intervention by the Iranian Government in the outcome of the June 2009 Presidential elections has reinvigorated the Iranian public's widespread disillusionment with their ruling class, and the Iranian leadership will tread an increasingly fine line in maintaining political and social control while satisfying their public's growing desire for democratization and transparency. As one means of maintaining political support and suppressing dissension, Iran will continue to frame the nuclear power issue as a matter of nationalist pride and as the "right" of any sovereign country as a means to its own security. However, the Government of Iran will also have to match its nationalist rhetoric with tangible progress on the economic front. Extreme volatility in oil prices is eroding national revenues due to the failure of the regime to diversify the national economy, which stifles the future prosperity of the Iranian people. Iran must create conditions for its economic viability beyond the near term or face insolvency, internal dissension and ferment, and possible upheaval."

Conclusions

The JOE 2010 provides a sobering look at what lies ahead, as seen through the eyes of the people whose lives will be at stake in future conflicts. As the authors note, "the United States has dominated the world economically since 1915 and militarily since 1943. Its dominance in both respects now faces challenges brought about by the rise of powerful states. Moreover, the rise of these great powers creates a strategic landscape and international system, which, despite continuing economic integration, will possess considerable instabilities. Lacking either a dominant power or an informal organizing framework, such a system will tend toward conflict. Where and how those instabilities will manifest themselves remains obscure and uncertain."

So what are the implications of the JOE 2010 for strategic asset allocation and risk management? Perhaps the most important is that, due to recurring bouts of uncertainty and perhaps active conflict, the next decade is not likely to be one in which equities deliver strong returns. Conversely, these same factors may cause government bonds (both real and nominal return), volatility and gold to perform well. Commercial property may also benefit from higher instability, particularly in those countries where investors have traditionally turned to it in troubled times (e.g., Switzerland, the Eurozone, and the UK). Commodities seem to present more of a quandary. The JOE 2010 highlights the likely upward pressures we are likely to see in oil prices over the next decade. Yet those high prices, along with the heightened (and perhaps actually realized) potential for conflict along many fault lines, and particularly in China, suggests a heightened risk of lower global GDP growth which bodes ill for many commodity prices and returns. On the other hand, prolonged instability may benefit timber, to the extent more investors view it as an attractive means of preserving the real value of their capital in troubled times.

Last but not least, the JOE 2010 offers wise counsel for the way we as investors, and stewards of other people's savings, must approach the uncertain times that lie ahead: "The defining element in military effectiveness in war lies in the ability to recognize when prewar visions and understanding of war are wrong and must change. Unfortunately, in terms of what history suggests, most military and political leaders have attempted to impose their vision of future war on the realities of the conflict in which they find themselves engaged, rather than adapting to the actual conditions they confront. The fog and friction that characterize the battle space invariably make the task of seeing, much less understanding what has actually happened, extraordinarily difficult. Moreover, the lessons of today, no matter how accurately recorded and then learned, may no longer prove relevant tomorrow...The challenges of the future demand leaders who possess rigorous intellectual understanding. Providing such grounding for the [leaders] of the 2030s will ensure that the United States is as prepared as possible to meet the threats and seize the opportunities of the future."

| This Month's Letters to the Editor: How can a UK Investor Access Volatility as an Asset Class? and II Uses Crystal Ball for some of its Monte Carlo Simulation and Calculations. Do you have a preference for CB over @Risk? | Table: Fundamental Asset Class Valuation and Recent Return Momentum | June 2010 Issue: Key Points | Product and Strategy Notes: Developing an Agile Mindset; Good News in the U.S. Financial Regulation Bill; Impact of High Frequency Trading; Common Sense and Value Investing; Two Excellent Papers on Risk Management | Investor Herding Risk Analysis | June 2010 Economic Update: The Joint Operating Environment | Global Asset Class Valuation Updates Detail through May 31, 2010 | Overview of Our Valuation Methodology | Uncorrelated Alpha Strategies Detail | Global Asset Class Returns | Table: Market Implied Regime Expectations and Three Year Return Forecast | Feature Article: Understanding and Predicting Uncertainty Shocks, Part 1 |